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Jérémie Cohen-Setton

Jérémie Cohen-Setton

Jérémie Cohen-Setton is a PhD candidate in Economics at U.C. Berkeley and a summer associate intern at Goldman Sachs Global Economic Research. He was previously an economist at HM Treasury where his work focused on the preparation of the London Summit. Jérémie also worked at Bruegel, a European think-tank on international economic issues in 2007 after graduating from the Paris School of Economics.

Articles by Jérémie Cohen-Setton

The Fed’s rethinking of normality

August 22, 2016

What’s at stake: As we approach Jackson Hole, monetary policymakers are considering how to redesign monetary policy strategies to better cope with a low r-star environment.

The new murky economics
Paul Krugman writes that we’re no longer in the simple, depressed-economy world anymore. Early in the crisis, liquidity-trap macroeconomics had become the story of the day. And the basic message of the models — that everything changes when you hit the zero lower bound — was being overwhelmingly confirmed by experience. It was all beautifully hard-edged: a crisp boundary at zero, a sharp change in the impact of monetary and fiscal policy when you hit that boundary.
Paul Krugman writes that things have now gotten a bit murky. We’re no longer in a liquidity-trap macroeconomic situation, but we’re not either in what we used to call a normal macroeconomic situation. We are, if you like, half-out of the liquidity trap, with one foot on dry land — but the other foot is still hanging over the edge, and it wouldn’t take much to topple us right back in.
The new environment
Gavyn Davies writes that when the FOMC increased rates last December they seemed fairly sure that they knew what “normal” meant. Now, they seem to have lost that certainty, and have simultaneously shifted their central assessment of the “normal” level for short rates sharply downwards. Ylan Q.

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The state of macro redux

August 16, 2016

What’s at stake: In 2008, Olivier Blanchard argued in a paper called “the state of macro” that a largely shared vision of fluctuations and of methodology had emerged. With the financial crisis and our inability to prevent the greatest recession since the 1930s, the discipline entered into a period of soul searching. The discussions on the state of macro received new echoes this week after Blanchard published a short essay on the future of DSGE models.

The ingredients of DSGE models
Olivier Blanchard writes that DSGE models have come to play a dominant role in macroeconomic research. Some see them as the sign that macroeconomics has become a mature science, organized around a microfounded common core. Others see them as a dangerous dead end. Olivier Blanchard thinks that DSGEs should be the architecture in which the relevant findings from the various fields of economics are eventually integrated and discussed, but this is not the case today.
Timothy Taylor writes that DSGE models are a method that is both well established and the stuff of continuing controversy. Olivier Blanchard writes that DSGE models make three strategic modeling choices: First, the behavior of consumers, firms, and financial intermediaries, when present, is formally derived from microfoundations.

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Racial prejudice in police use of force

July 18, 2016

What’s at stake: This week was dominated by a new study by Roland Fryer exploring racial differences in police use of force. His counterintuitive result that blacks and Hispanics experience discrimination for all types of interaction involving force except for officer involved shootings provoked debate after the study was published on Monday.

Roland Fryer writes that from Bloody Sunday on the Edmund Pettus Bridge to the public beatings of Rodney King, Bryant Allen, and Freddie Helms, the relationship between African-Americans and police has an unlovely history. The raw memories of these injustices have been resurrected by several high profile incidents of questionable uses of force. These incidents, some captured on video and viewed widely, have generated protests in Ferguson, New York City, Washington, Chicago, Oakland, and several other cities and a national movement (Black Lives Matter).
Methodology and results
Rajiv Sethi writes that Fryer provides evidence of significant racial disparities in the experience of non-lethal force at the hands of police, even in data that relies on self-reports by officers. Using official statistics from New York City’s Stop, Question and Frisk program, he finds that blacks and Latinos are more likely to be held, pushed, cuffed, sprayed or struck than whites who are stopped.

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The great risk shift and populism

July 11, 2016

What’s at stake: For many commentators, Brexit was the signal of a broad populist backlash and illustrated the need to articulate policies that address the grievances of those citizens who have been left behind by recent economic changes.

Brexit and the new fault lines
Martin Sandbu writes that since Brexit has shaken elites out of their complacency and got them to think belatedly about what policies are needed to help those left behind by the economic changes of recent decades. Philippe Legrain writes that the “Brexit” vote could presage a broader nationalist, anti-establishment, anti-immigration backlash in many of the world’s democracies.
Nouriel Roubini writes that the United Kingdom’s narrow vote to leave the European Union had specific British causes. And yet it is also signaling a broad populist/nationalist backlash – at least in advanced economies – against globalization, free trade, offshoring, labor migration, market-oriented policies, supranational authorities, and even technological change. In the “Brexit” vote, the fault lines were clear: rich versus poor, gainers versus losers from trade/globalization, skilled versus unskilled, educated versus less educated, young versus old, urban versus rural, and diverse versus more homogenous communities. The same fault lines are appearing in other advanced economies, including the United States and continental Europe.

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The breakdown of productivity diffusion

June 27, 2016

The OECD has been pushing the idea that the productivity slowdown is not so much due to a lack of innovation but rather due to a lack of innovation diffusion between firms.

The OECD view
Jane Bourke writes that a recent OECD report – “The Future of Productivity” – presents a new perspective on what drives national productivity growth. The OECD explains that in every world economy there are some ‘frontier firms’, which are internationally competitive and match global high standards in productivity. However, the majority of firms – up to 80 per cent – are not in this category. These firms may have a more domestic market orientation, and much lower average productivity and the OECD calls them ‘non-frontier firms’.
Timothy Taylor writes the report argues that slower productivity in high-income countries is not because cutting-edge firms are slowing down in their productivity growth, but rather because other firms aren’t keeping up. To put it another way, productivity growth isn’t diffusing across economies.
Chiara Criscuolo writes that the slow productivity growth of the “average” firm masks the fact that a small cadre of firms are experiencing robust gains.

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The cyclicality of structural reforms

June 13, 2016

What’s at stake: In line with the crisis-induced reform hypothesis, European countries have since 2010 enacted unpopular reforms in labor market regulation and social welfare systems.

The crisis-induced reform hypothesis
Romain Ranciere and Aaaron Tornell write that structural reforms, whereby organized groups lose their power to extract rents, tend to occur in bad times rather than during prosperous times. Alessandra Bonfiglioli and Gino Gancia write that although most observers tend to agree that promoting product market competition, providing free access to markets and reducing public debt are often essential to preserve economic growth, the extent to which such measures are adopted varies enormously across countries.
Gilles Saint-Paul writes that even though many reforms are best implemented in booms, political logic makes them more likely to happen in slumps. In a boom the politician in power is all too happy to capitalize on existing good macroeconomic conditions, and will not jeopardize his popularity by engaging in a structural reform whose consequences are uncertain, especially if the associated losses are frontloaded and the gains come later. Furthermore, to the extent that society is constantly learning about the costs and benefits of reforms, it should rationally infer in a boom that rigidities are not that costly, and infer the opposite in bad times.

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The new Washington Consensus

June 3, 2016

What’s at stake: Since 2008 the IMF has been at the forefront of a revaluation of the orthodox policy toolbox. While the majority of policies that constituted the old Washington Consensus remain in place, the consensus has moved on financial openness and fiscal consolidations.
The Washington Consensus and neoliberalism
John Williamson coined the term Washington Consensus in 1989 as he examined the extent to which the old ideas of development economics that had governed Latin American economic policy since the 1950s were being swept aside by the set of ideas that had long been accepted as appropriate within the OECD.
John Williamson provided a list of ten policies that more or less everyone in Washington agreed were needed more or less everywhere in Latin America:
Fiscal Discipline.
Reordering Public Expenditure Priorities.
Tax Reform.
Liberalizing Interest Rates.
A Competitive Exchange Rate.
Trade Liberalization.
Liberalization of Inward Foreign Direct Investment.
Privatization
Deregulation
Property Rights.
Jonathan D. Ostry, Prakash Loungani, and Davide Furceri write that the neoliberal agenda rests on two main planks. The first is increased competition – achieved through deregulation and the opening up of domestic markets, including financial markets, to foreign competition.

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The abandonment of counter-cyclical fiscal policy

May 30, 2016

What’s at stake: The reluctance to use fiscal policy as a stabilizing tool in the current deflationary environment has been puzzling to many and a number of authors are now putting forward possible explanations.
The move from counter-cyclicality to procyclicality
In its 2015 Fiscal Monitor, the IMF writes that to be stabilizing, the fiscal balance needs to increase when output rises and to decrease when it falls. That way, fiscal policy generates additional demand when output is weak and subtracts from demand when the economy is booming.
Jeffrey Frankel writes that the heyday of activist fiscal policy was 50 years ago. The position “we are all Keynesians now” was attributed to Milton Friedman in 1965 and to Richard Nixon in 1971. In the late 20th century, most advanced countries managed to pursue countercyclical fiscal policy on average: generally reining in spending or raising taxes during periods of economic expansion and enacting fiscal stimulus during recessions. The result was generally to smooth out the business cycle (as Keynes had intended). It was the developing countries who tended to follow procyclical or destabilizing policies.

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Regulation and growth

May 16, 2016

What’s at stake: A heated debate took place this week on the blogosphere on the link between regulation and growth following an op-ed by John Cochrane claiming the US economy could be five times richer if regulations were scrapped.
The question of how much
Noah Smith writes that it’s easy to look around and find examples of regulations that protect incumbent businesses at the expense of the consumer — for example, the laws that forbid car companies from selling directly to consumers, creating a vast industry of middlemen. You can also find clear examples of careless bureaucratic overreach and inertia, like the total ban on sonic booms over the U.S. and its territorial water (as opposed to noise limits). These inefficient constraints on perfectly healthy economic activity must reduce the size of our economy by some amount, acting like sand in the gears of productive activity. The question is how much.
John Cochrane writes that much more growth is really possible from better policies. To get an idea, see the nearby chart plotting 2014 income per capita for 189 countries against the World Bank’s “Distance to Frontier” ease-of-doing-business measure for the same year. The U.S. scores well, but there is plenty of room for improvement. A score of 100 unites the best already-observed performance in each category. So a score of 100—labeled Frontier—is certainly possible.

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The economics of crime and punishment

May 2, 2016

What’s at stake: The Senate announced this week revisions to a sentencing reform bill – the Sentencing Reform and Corrections Act – that would lower mandatory minimums for some low-level drug crimes.
Jason Furman and Douglas Holtz-Eakin writes that Congress is considering bipartisan legislation to loosen tough sentencing laws. Inimai M. Chettiar writes that it would also give judges the discretion to depart from minimum sentences for low-level offenders if they believe specific circumstances of the crime warrant it. Most importantly, these changes would put resources where it matters: arresting, prosecuting and punishing those who commit the most serious and violent crimes. The Brennan Center writes that the legislation was revised in recent weeks to address concerns from some Republicans who said the previous version would endanger public safety.

The economics of deterrence
Aaron Chalfin and Justin McCrary write that deterrence is important not only because it results in lower crime but also because, relative to incapacitation, it is cheap. Offenders who are deterred from committing crime in the first place do not have to be identified, captured, prosecuted, setenced, or incarcerated.

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Understanding HM Treasury’s Brexit analysis

April 25, 2016

What’s at stake: The UK will hold a referendum on its membership of the EU on June 23rd 2016. Her Majesty’s Treasury released an assessment of the impact of Brexit finding that the economy would be between 3 and 7% smaller in 2030 if the UK left the EU than it would be if it stayed in.
The general approach
The LSE Center for Economic Performance writes that the Treasury studies the long-run effects of Brexit using a three-step process:
Step 1: how Brexit would affect trade and foreign direct investment (FDI);
Step 2: how the reduction in trade and FDI following Brexit would affect productivity;
Step 3: the results of Steps 1 and 2 are combined with a global macroeconomic model to predict how Brexit would affect overall UK national income.

Gravity models and the causal impact of trade on GDP
The HM Treasury analysis uses a widely adopted gravity modelling approach, which distinguishes the specific effect of EU membership and the alternatives from all the other influences that determine trade and foreign direct investment.
The most straightforward and widely used method to quantify the impact of EU membership is to incorporate a set of dummy variables (Martin Sandbu discusses two alternative approaches: structural models and synthetic controls).

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Blogs review: Trade deficits and jobs at the ZLB

April 4, 2016

What’s at stake: In the populist narrative against globalization, trade deficits are seen as costing jobs. While this mercantilist view of the world is hard to square in normal times, a number of authors have suggested that the intellectual basis for that view is stronger in a liquidity trap.
Imbalanced trade in normal times
Neil Irwin writes that Donald Trump believes that a half-trillion-dollar trade deficit with the rest of the world makes the United States a loser and countries with trade surpluses like China and Mexico winners. Jared Bernstein writes that as long as there’s been trade, there’s been imbalanced trade, as countries invariably produce more than they consume, i.e., they’re run a trade surplus, while others, like us, will do the opposite. To somehow insist on balanced trade for all would be a huge policy mistake, one that would preclude billions of people from the reaping the benefits of trade, both as consumers and producers.
Neil Irwin writes that it’s true that the United States has a $58 billion trade deficit with Mexico, for example. But it’s not as if Americans were just flinging money across the Rio Grande out of charity. Americans get a lot of good stuff for that: avocados, for example, and Cancún vacations.

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Blogs review: The procyclicality of TFP growth

March 29, 2016

What’s at stake: The argument that total factor productivity (TFP) is procyclical has been getting a lot of airtime over the past few weeks as it was central to understanding the recent controversy over the economic impact of Sanders. But it also speaks to the question of the current TFP slowdown and to the issue of a clean separation between cycles and trends.
Alexander Field writes that between 1890 and 2004, TFP growth in the US was strongly procyclical. For over a century TFP growth varied systematically with the business cycle, and the elasticity of TFP growth with respect to a change in the unemployment rate was remarkably stable in the years before and after the Second World War and in a variety of subperiods during which trend growth rates of TFP were quite different. A fall in the unemployment rate by one percentage point led to an increase in the growth rate of TFP of about 0.9 percent per year. The three most serious twentieth-century output gaps developed in 1929-1933, 1974-1975, and 1979-1982. In each of these episodes, TFP declined sharply.

Source: Renaissance Macro via @M_C_Klein
Anti-hysterisis and the Sanders controversy
J.W.

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The trade-backlash explanation of Trump & Sanders

March 21, 2016

What’s at stake: The success of presidential candidates Donald Trump and Bernie Sanders has had bloggers wondered whether the backlash against globalization is eventually getting political traction.
A working-class revolt against globalization
Jordan Weissmann writes that the near-simultaneous rise of Donald Trump and Bernie Sanders has often been described as a working-class revolt against globalization and free trade—a bipartisan protest by blue-collar voters who are angry after watching factory after factory close thanks to foreign competition. Eduardo Porter writes that voters’ anger and frustration may not propel either candidate to the presidency. But it is already having a big impact on America’s future, shaking a once-solid consensus that freer trade is, necessarily, a good thing.
Paul Krugman writes that it’s true that much of the elite defense of globalization is basically dishonest: false claims of inevitability, scare tactics vastly exaggerated claims for the benefits of trade liberalization and the costs of protection, hand-waving away the large distributional effects that are what standard models actually predict.  The elite case for ever-freer trade is largely a scam, which voters probably sense even if they don’t know exactly what form it’s taking.

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The elimination of High Denomination Notes

March 7, 2016

What’s at stake: As high-denomination notes (HDNs) make it easier to transact crime, finance terrorism, and evade taxes, a number of commentators have called for their elimination.
The case for killing HDNs
Peter Sands and Lawrence H. Summers writes that their advocacy for the elimination of high denomination notes is based on a judgment that any losses in commercial convenience are dwarfed by the gains in combatting criminal activity, not any desire to alter monetary policy or to create a cashless society. Peter Sands writes that getting rid of high denomination notes would not eliminate tax evasion, crime, terrorism, and corruption. But it would make life harder for those pursuing such activities, raising their costs and increasing the risks of detection. They would find substitutes – lower denomination notes, Bitcoin, disguising transactions through the banking system, even gold and diamonds. Yet each of these is, in one way or another, more costly, less convenient, and more prone to detection.
Peter Sands writes that the $100 bill and the €500 note are the payment instruments of choice for criminals across the world. Of course, the $100 bill is worth significantly less than the €500 note, but with over $1 trillion outstanding, the $100 bill is ubiquitous in criminal and corruption seizures all over the world.

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The Sanders controversy

February 29, 2016

What’s at stake: A recent study claiming that Sanders policies would produce 5.3 percent growth a year over the next decade has been at the center of this week’s discussions in the blogosphere.
Voodoo economics and arithmetic mistakes
Ezra Klein writes that Bernie Sanders has been under assault from the technocratic wing of the Democratic Party. The charge? His campaign has circulated economic projections that show stunning — and rather implausible — benefits from Sanders’s agenda. JW Mason writes that Jerry Friedman wrote a piece several weeks ago, arguing that a combination of increased public spending and income redistribution (higher minimum wages and other employment regulation favorable to labor) proposed by the Sanders campaign could substantially boost growth and employment during his presidency.
Paul Krugman writes that the Republican candidates have been widely and rightly mocked for their escalating claims that they can achieve incredible economic growth, starting with Jeb Bush’s promise to double growth to 4 percent and heading up from there. But Mr. Friedman outdoes the G.O.P. by claiming that the Sanders plan would produce 5.3 percent growth a year over the next decade. Christina Romer and David Romer writes that careful examination of Friedman’s work confirms the old adage, “if something seems too good to be true, it probably is.

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The impotency of central banks

February 22, 2016

What’s at stake: The negative market reaction to the latest efforts to provide further monetary stimulus has generated an important discussion on whether central banks have lost credibility in their abilities to fight downside risks and shore up economies.
From potency to impotency
Leo Grohowski writes that central bank policies and the uncertainty around their effectiveness is the big macro concern right now. William Watts writes that with central banks continually undershooting inflation targets despite extraordinarily loose policy, there are growing fears that the ability of monetary policy to affect the real economy has been impaired. Amid a growing realization that central banks’ powers are on the wane, investors are rushing for havens.
Bill Gross writes that “how’s it workin’ for ya?” – would be a curt, logical summary of the impotency of low interest rates to generate acceptable economic growth worldwide. John Plender writes that arguably now the most important question in global finance concerns the limits to the power of central banks. Since 2009 investors have staked their all on the notion of central bank potency. Last week the doubts set in seriously, contributing not a little to the market turmoil.
Zero Hedge writes that first, it was the Bank of Japan (BOJ)’s utter collapse from omnipotence to impotence.

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Blaming the Fed for the Great Recession

February 1, 2016

What’s at stake: Following an article in the New York Times by David Beckworth and Ramesh Ponnuru, the conversation on the blogosphere was dominated this week by the question of whether the Fed actually caused the Great Recession. While not mainstream, this narrative recently received a boost as Ted Cruz, a Republican candidate for the White House, championed it.
An alternative story
David Beckworth and Ramesh Ponnuru write that it has become part of the accepted history of our time: The bursting of the housing bubble was the primary cause of a financial crisis, a sharp recession and prolonged slow growth. The story makes intuitive sense, since the economic crisis included a collapse in the prices of housing and related securities. But there is an alternative story.
David Beckworth writes that the Fed began to passively tighten during the second half of 2008. A passive tightening of monetary policy occurs whenever the Fed allows total current dollar spending to fall, either through a fall in the money supply or through an unchecked decrease in money velocity. Such declines are the result of firms and households expecting a worsening economic outlook and, as a result, cutting back on spending. In such settings, the Fed could respond to and offset such expectation-driven declines in spending by adjusting the expected path of monetary policy.

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Oil and stock prices

January 25, 2016

What’s at stake: The recent positive link between oil and stock prices has been puzzling for most observers. While a decrease in the price of oil was traditionally seen as a net positive for oil importing countries such as the United States, the concurrent declines in the price of oil and the US stock market suggest that the relationship may be different in the current environment.
Greg Sharenow writes that oil prices have fallen by about 20% this year for a myriad of reasons: Concerns over Chinese growth, a deceleration of manufacturing in the U.S., extremely mild winter temperatures in key Northern Hemisphere oil-consuming regions and the impending return of Iranian oil production.
Olivier Blanchard writes that the headlines are now about low oil prices leading to low stock prices. Traditionally, it was taken for granted that a decrease in the price of oil was good news for oil importing countries such as the United States. Consumers, with more money to spend, would increase consumption, and increase output. We learned in the last year that, in the short run, the adverse effect on investment on energy producing firms could come quickly and temporarily slow down the effect, but this surely does not undo the general conclusion.

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The use of models by policymakers

January 11, 2016

What’s at stake: The latest discussions on the blogosphere have been dominated by a back and forth trialogue between Larry Summers, Paul Krugman and Brad DeLong on the appropriate use of models as policy guides. While they all agree that the Fed’s decision to raise rates was a mistake, they disagree on the intellectual reasons behind it.
Martin Sandbu writes that disagreement throws light on some deep questions about how economic theorizing is and should be used to inform policymaking. DeLong expressed doubts that the Fed’s analysis was indeed compatible with existing models; Krugman asserted that conventional models straightforwardly showed the Fed to be in the wrong. Summers, on the other hand, considers that the Fed’s mistake comes down to its attachment to the standard Phillips curve mode of thought. In making his argument, Summers also showed a certain willingness to listen to those who may have an untheoretical “feel” for the market.
Paul Krugman writes that the Fed seems to hold beliefs that are very much at odds with Macroeconomics 101, whose basic Hicksian models do not at all support the Fed’s eagerness to hike rates. I think I understand how being an official, surrounded by men (and some but not many women) who seem knowledgeable in the ways of the world, can create a conviction that you and your colleagues know more than is in the textbooks.

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Finland and asymmetric shocks

December 21, 2015

What’s at stake: Finland exemplifies the difficulty of dealing with asymmetric shocks within a Monetary Union as the Finnish economy has struggled to recover from a series of idiosyncratic shocks – the decline of Nokia, the obsolescence of the timber industry, and the fallout of the Russian crisis.
Adjustment in the euro: Not a one-time problem
Paul Krugman writes that this is a reminder that the euro system creates huge problems for adjustment everywhere, that this isn’t a one-time problem. Adjustment can take place even with a single currency; but it’s a very slow and painful process. The single currency isn’t totally unworkable. It’s just extremely costly.
Paul Krugman writes that we’re increasingly seeing that the problems of the euro extend well beyond the troubles of southern European debtors. Economic performance has also been very bad in several northern nations with good credit ratings and low borrowing costs — Finland, Denmark (which isn’t on the euro but shadows it), the Netherlands. We’re seeing the classic problems of asymmetric shocks in a currency area that isn’t optimal. The problems of the euro, in other words, weren’t caused by an outbreak of fiscal irresponsibility that won’t recur if the Greeks can be brought to heel; they weren’t even, in a deep sense, the result of big capital flows that won’t come back again.

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The predictability of political extremism

December 14, 2015

What’s at stake: The rise of the extreme right in the latest French election has mostly been treated as surprising or reflecting special circumstances like the November 13 Paris attacks. But a large literature linking extreme right votes to persisting depressed economic conditions suggests that longer run factors are at play.
The usual pattern
Alan de Bromhead, Barry Eichengreen, and Kevin O’Rourke write that the danger of extremism is greatest where depressed economic conditions are allowed to persist. Using data covering 171 elections in 28 countries between 1919 and 1939, the authors show that what mattered was not the current growth of the economy but cumulative growth or, more to the point, the depth of the cumulative recession. One year of contraction was not enough to significantly boost extremism but a depression that persisted for years was.
Kevin O’Rourke writes that in August of this year, the inevitable happened: our current recovery was overtaken by that of the interwar period.
Figure 1: World industrial output in the Great Depression and in the Great Recession

Manuel Funke, Moritz Schularick, and Christoph Trebesch write that far-right votes increase by about a third in the five years following systemic banking distress.

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The puzzle of technical dis-employment and productivity slowdown

December 7, 2015

What’s at stake: Larry Summers made an important speech a few weeks ago at a Peterson Institute conference on the productivity slowdown arguing it is hard to see how recent technical change could both be a major source of dis-employment and not be associated with productivity improvement.
A paradox
Larry Summers writes that it’s really hard to square the view that the “new economy is producing substantial dis-employment” with the view that “productivity growth is slowing”. The fact that you move through an airport with much less contact with ticket takers, the fact that you can carry on all kinds of transactions with your cellphone, the fact that you can check out of an increasing number of stores without human contact, the fact that robots are increasingly present in manufacturing, make a fairly compelling case that the increasing dis-employment we see is related to technical change. And yet, if technical change is a major source of dis-employment, it is hard to see how it could be a major source of dis-employment without also being a major source of productivity improvement.
Adam Posen writes that it is a real puzzle to observe simultaneously multi-year trends of rising non-employment of low-skilled workers and declining measured productivity growth. Either we need a new understanding, or one of these observed patterns is ill founded or misleading.

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Unlearning economic paradigms

November 30, 2015

What’s at stake: Both the crisis, its aftermath, and the empirical econ revolution have changed our understanding of economics. Conventional wisdoms about the supply side of the economy, the length of the short run, or the international adjustment process are all being challenged. Even conventional microeconomic wisdoms about the role of minimum wages and welfare programs are being challenged by new data raising questions about how economics should be taught and used to guide policymaking.
Unlearning macroeconomics
Adam Posen writes that a lot of economists have spoken about the need to fundamentally rethink major parts of macroeconomics following the global financial crisis.
Paul Krugman writes that what hasn’t worked nearly as well is our understanding of aggregate supply. One big problem has been the absence of deflation. The “accelerationist” Phillips curve that used to be standard — inflation depends on unemployment and lagged inflation — seemed consistent with the experience from previous big slumps, which were associated with large declines in the rate of inflation. Specifically, we used to cite the “clockwise spirals” one saw in unemployment-inflation space as evidence for something like the Friedman-Phelps theory of the natural rate.

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The persistence of slow growth

November 16, 2015

What’s at stake: The persistence of slow economic growth in the Great Recession has been puzzling. Two recent papers have tried to present a coherent framework for understanding this phenomenon. The first paper argues that we may have underestimated the importance of hysterisis effects. The second paper argues the global safe asset shortage cannot be resolved by lower world interest rates once we reach the zero lower bound. It is instead dissipated by a world recession that rebalances global asset markets.
Story one: Hysterisis and Superhysterisis
Olivier Blanchard, Eugenio Cerutti and Lawrence Summers write that a surprisingly high proportion of recessions, about two-thirds, are followed by lower output relative to the prerecession trend even after the economy has recovered. Perhaps even more surprisingly, in about one-half of those cases, the recession is followed not just by lower output, but by lower output growth relative to the prerecession output trend. That is, as time passes following recessions, the gap between output and projected output on the basis of the prerecession trend increases. If these correlations are causal, they suggest important hysteresis effects and even “superhysteresis” effects (the term used by Laurence Ball (2014) for the impact of a recession on the growth rate rather than just the level of output).

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The uncertain decline of the natural rate of interest

November 9, 2015

What’s at stake: Controversies over whether and by how much the natural rate of interest – the rate compatible with full employment and stable prices – has declined in the past few years has shaped views about the pace and extent to which central banks should normalize policy rates.
Wicksell, Woodford and Greenspan
Martin Sandbu writes that there is a simple idea that frames some of the biggest economic questions of our time and helps to clarify the positions and the stakes in the deepest disagreements over policy.
Thomas A. Lubik and Christian Matthes write that the usage of the natural interest rate concept dates back to the Swedish economist Knut Wicksell, who in 1898 defined it as the interest rate that is compatible with a stable price level. An increase in the interest rate above its natural rate contracts economic activity and leads to lower prices, while a decline relative to the natural rate has the opposite effect. A century later, Columbia University economist Michael Woodford brought renewed attention to the concept of the natural rate and connected it with modern macroeconomic thought. He demonstrated how a modern New Keynesian framework, with intertemporally optimizing and forward-looking consumers and firms that constantly react to economic shocks, gives rise to a natural rate of interest akin to Wicksell’s original concept.

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QE and investment

November 2, 2015

What’s at stake: Quantitative Easing has been criticized for generating inflation risks, financial stability risks, and distributional risks. The newest criticism from Kevin Warsh, a former Fed Governor, and the 2001 Nobel Prize laureate Michael Spence is that QE actually reduced investment!
QE is bad because…
Paul Krugman writes that in the eyes of critics, QE is the anti-Veg-O-Matic: it does everything bad, slicing and dicing and pureeing all good things. It’s inflationary; well, maybe not, but it undermines credibility; well, maybe not but it causes excessive risk-taking; well, maybe not but it discourages business investment, which I think is a new one.
Lawrence Summers writes that they blame the weakness of business investment during the current recovery on the Fed. Every major macroeconomics textbook teaches students that investment increases as real interest rates decline. This is motivated in a variety of quite compelling ways. It is noted that lower rates raise the present value of the returns from investment and so make them more attractive. It is observed that lower rates mean lower borrowing costs or lower costs of drawing-down liquid asset holdings, making the purchase of capital goods more attractive. For these reasons, millions of students have been taught that Hicks famous IS curve slopes downward.

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