Latin America and Caribbean’s Winding Road to Recovery

By Alejandro Werner, Anna Ivanova, and Takuji Komatsuzaki Latin America and Caribbean economies managed to bounce back from COVID-19’s initial economic devastation earlier in 2020. But the pandemic’s resurgence towards the end of the year threatens to thwart an uneven recovery and add to the steep social and human costs. After the sharp contraction in […]

Read More

Supply and aggregate supply are unrelated concepts

The AS/AD model that we teach our students is misnamed, as it has nothing to do with the supply and demand model used in microeconomics. To take one simple example, the vast majority of industry supply curves are almost perfectly elastic (horizontal) in the long run. The long run aggregate supply curve is almost perfectly inelastic (i.e. vertical.) These are just completely unrelated concepts.

This can help us to evaluate some issues raised by Tyler Cowen:

If you think “stimulus” is effective right now, presumably you think supply curves are pretty elastic and thus fairly horizontal. That is, some increase in price/offer will induce a lot more output.

If you think we should hike the minimum wage right now, presumably you think supply curves are pretty inelastic and thus fairly vertical.  That is, some increase in price for the inputs will lead not to much of a drop in output and employment, maybe none at all.  The supply curve is fairly vertical.

What matters for stimulus is the short run aggregate supply curve.  What matters for the minimum wage is the long run industry supply curve.  These two curves are especially unrelated.

[There also the question of whether industry supply curves even exist. Minimum wage proponents usually deny it–claiming that industries are monopolistically competitive.  The evidence suggests that industry supply curves do exist.]

I oppose both fiscal stimulus and minimum wage laws, but for reasons mostly unrelated to supply elasticities.

If you favor a minimum wage hike because you think the demand for labor is inelastic, does that mean you don’t see “downward sticky wages” as a big problem?  After all, the demand for labor is inelastic, right?

Minimum wage laws should be evaluated on the basis of their long run effects.  Proponents probably believe that a good chunk of the higher minimum wage will come out of the pockets of other workers (via higher prices.)  I’ll have to pay more for fast food.  And the empirical evidence supports that claim.  So minimum wage proponents would claim no inconsistency in their views on minimum wages and sticky wages.  But this is one problem with the argument for higher minimum wages.  If they raise prices then they probably also cost jobs.  (My own view is that the bigger problem with minimum wage laws is that they reduce non-wage compensation.)

This is a good point:

If you favor a minimum wage hike, do you criticize wage subsidies because inelastic demand for labor means most of the value of the wage subsidy will be captured by the employer? Or do you somehow want both policies at the same time, because they both involve “government helping people”?

I support wage subsidies to low wage workers because I believe that minimum wage industries tend to be highly competitive, with zero long run economic profits.  And for exactly the same reason I oppose minimum wage laws.




Read More

Top 10 Charts of the Week for 2020

2020 will soon be over, and with it an incredibly trying year. The editors at IMFBlog wish you good health and peace over the holidays ahead, and into the new year. In case you missed some of the compelling facts and figures in our Charts of the Week series this year, we have pulled together […]

Read More

Relief, not stimulus

In a rare bit of good news out of DC, it seems as though the “stimulus” part of the new fiscal package may be dropped:

Direct cash payments to most American households were one of the most popular and efficient measures Congress enacted as part of its response to the coronavirus pandemic earlier this year, but lawmakers seem to have lost interest in another round of checks.

Legislators this week resuscitated talks over a new coronavirus relief package, which includes new unemployment assistance, money for vaccine distribution and more aid for businesses and state governments. But none of the potential compromise proposals includes another round of stimulus checks.

“We’re sending money out as a relief for people in distress, as opposed to a stimulus. This is not a stimulus bill,” Sen. Mitt Romney (R-Utah) told HuffPost about bipartisan $900 billion legislation he is crafting with other moderate senators.

The main factor holding back the economy is not a lack of disposable income; indeed areas where people are free to spend (retail sales, housing, etc.) are booming.  Rather the recession is heavily concentrated in services where social distancing is a problem.  Once the vaccines are widely available in the early spring, those sectors will bounce back strongly.  Many people who skipped summer vacation this year will be anxious to take a vacation next summer.  As an analogy, consumption rebounded strongly after the WWII-era rationing came to an end.  The postwar depression predicted by Keynesian economists never happened.

I have not examined the proposed legislation in detail and thus don’t have a position on the overall bill.  But right now the economy does not need fiscal stimulus.  If any fiscal package is going to be enacted, it makes sense to focus on those who are negatively affected by the crisis, especially the unemployed and small businesses adversely affected by Covid-19.  There is no obvious reason to send $1200 checks to Americans with good jobs.

I wouldn’t be opposed to a bit more monetary stimulus, although I suspect the Fed will hit its 2% average inflation target sooner than most economists expect.  The Fed did not actually do very much monetary stimulus in 2020.  They have plenty of ammo.


Read More

Lesson of Abenomics

With the recent resignation of Shinzo Abe, there have been a number of articles analyzing the record of Abenomics. There seems to be pretty general agreement on two points:

1. Japan’s economy improved after Abe took office at the beginning of 2013. Deflation came to an end, nominal GDP began rising, the public debt was brought under control, and unemployment fell to just over 2%.

2. The policy was not completely successful. Most notably, inflation continued to run well below the 2% target set by the Bank of Japan.

I believe that summary is correct. Where I part company with other pundits is in the lessons that Abenomics offers for monetary and fiscal policy. The Economist is fairly typical:

The first lesson is that central banks are not as powerful as hoped. Before Abenomics, many economists felt Japan’s persistent deflationary tendencies stemmed from a reversible mistake by the Bank of Japan (boj). It had combined fatalism with timidity, blaming deflation on forces outside its control, and easing monetary policy half-heartedly. In 1999 Ben Bernanke, later a Fed chairman, called on the boj to show the kind of “Rooseveltian resolve” that America’s 32nd president showed in fighting the Depression. . . .

The central bank is doing everything it can to revive private spending. Until it succeeds, though, the government has to fill whatever gap in demand remains. The shortfall in private spending is what makes government deficits necessary.

This seems to be the consensus as to the “lessons” of Abenomics.  Monetary stimulus is not enough; you also need fiscal stimulus.  And yet if you look at the actual record of Abenomics, there’s not a shred of evidence to support this claim, indeed the opposite seems to be the case.

For nearly two decades before Abe took office, Japan ran perhaps the largest combined monetary/fiscal stimulus in human history, at least during peacetime.  Remember, combined fiscal/monetary stimulus is the new consensus, the policy that most pundits in academia and the media now favor.  And what was the result of this massive stimulus?  Basically zero growth in nominal aggregate demand for almost two decades, a record even worse than seen in slow growing Italy.  If you’d told economists in the early 1990s that over the following 20 years Japan would mostly hold interest rates close to zero and increase the national debt from less than 70% of GDP to roughly 230% of GDP, and still have virtually no growth in nominal GDP, they would have responded that we need to abandon the standard textbook model of economics, as what we are teaching our students is clearly wrong.  Instead, we responded to this amazing analytical failure by doubling down on the very same flawed theory.

The massive fiscal stimulus came to an end with Prime Minister Abe.  Taxes were raised several times and the national debt leveled off at just over 230% of GDP.  Instead of a combined monetary fiscal stimulus, Abe relied on monetary stimulus and fiscal austerity.  And the Japanese economy actually improved!

I must admit that I am perplexed as to how my fellow economists draw their “lessons” from this record.  When people question monetary stimulus by pointing to the fact that Japan fell short of its 2% inflation target under Abe, I respond, “so do more”.  This doesn’t seem to convince anyone.  People seem to think I’m cheating, coming up with a theory that’s unfalsifiable.  “Yeah, you can always say they didn’t do enough.”

But when it comes to fiscal policy, this skepticism goes right out the window.  If I point out that the huge Japanese fiscal stimulus of 1992-2012 failed boost aggregate demand, they say the Japanese should have done even more fiscal stimulus, as if boosting the national debt from less than 70% to 230% of GDP is not enough.  When I point out that the Bush tax cuts of 2008 failed, they say the tax cuts should have been even bigger.  When I point out that the Obama stimulus of 2009 led to an unemployment rate that was far higher than proponents predicted even in the absence of stimulus, they say the stimulus should have been even bigger.  When I point out that the economy actually sped up in 2013, despite widespread Keynesian predictions that it would slow due to austerity, they say that without austerity it would have improved even more.  When I point out that the economy did not fall off the cliff at the end of July when Congress failed to renew the fiscal stimulus, they say it would have improved even more with additional stimulus (even though the fall in unemployment in August was the second largest in history.)

Now it’s certainly possible that I’m wrong and the Keynesians are right about fiscal stimulus.  Counterfactuals are tricky.  Maybe in all of these cases if they had only done more the results would have been better.  But in that case I’m honestly confused as to why I’m not allowed to argue the BOJ should have done more monetary stimulus.  Especially since while fiscal stimulus might become costly in the future if interest rates rise above zero, monetary stimulus is actually profitable, as central banks earn income on the assets they purchase with zero interest base money.  It’s monetary policy that seems to have truly unlimited “ammunition”, not fiscal policy.

Nonetheless, I’ve been beating my head against the wall for so long on this issue that I feel I need to change the argument.  Thus I’ve recently focused not so much on the claim that Japan needed to do more, rather that Japan needed to do different.  The ultra-low rates and massive QE are actually a symptom of previous tight money mistakes.

For example, the yen was about 124 to the dollar in mid-2015.  Today it’s roughly 105 to the dollar.  If Japan had simply pegged the yen to the dollar at 124 back in 2015, Japanese interest rates actually would have been higher over the following 5 years, mirroring the rise in interest rates in the US during this period (due to interest parity).  Monetary policy would have looked tighter to the Keynesian skeptic who (wrongly) feels that the actual Japanese monetary policy was highly expansionary, and ineffective.  And yet because the yen would have been far weaker, Japan would have actually experienced higher inflation than otherwise.  Indeed Lars Svensson made essentially this argument back in 2003, when he described a “foolproof” way for Japan to escape a liquidity trap.  He also noted that the higher nominal interest rates would be nothing to worry about, as this policy would have reduced the real interest rate in Japan, due to higher inflation expectations.

There are political difficulties with pegging the yen to the dollar, but Japan could have achieved a similar result by setting an aggressive price level target combined with a “whatever it takes” approach to QE.

So today I say to Japan, “don’t do more, do different.”

And I say to my fellow economists, “use the same criterion for drawing lessons from monetary policy as you use for drawing lessons from fiscal policy.”

PS.  Some economists do econometric tests of fiscal policy efficacy.  Elsewhere, I’ve criticized those tests for ignoring monetary offset.




Read More

What if the economy does not tank in August?

In late July, there were increasingly frantic claims in the media that failure to enact another massive fiscal package would hurt the economy. I’ve pointed out that disposable income growth in 2020 has been astounding, and argued that a lack of fiscal stimulus is not the problem. So what will people say if the economy does not tank in August?

One prediction I can make with near 100% certainty is that a continued recovery in August would not be viewed as evidence against the (old) Keynesian view of fiscal stimulus and in favor on the New Keynesian/monetarist view. The efficacy of fiscal stimulus is now accepted almost as a matter of faith, despite the 2013 debacle. Instead, other explanations will be sought.

Here’s the headline and subhead to a new Bloomberg piece by Conor Sen:

The Stealth Sunbelt Virus Turnaround Will Boost the Economy

Even without a new stimulus package, there are reasons for optimism.

It’s worth noting that those reasons for optimism were typically not cited in late July, before the recent data on falling unemployment claims and rising stock prices.  So we need to figure out whether the “reasons for optimism” reflect new economic data, or actual external shocks that would justify an increased level of optimism.  I suspect it’s the recent economic data.

Sen cites the recent Covid-19 data from Arizona, which has indeed improved sharply in recent weeks, after a very bad July.  But Arizona is only a tiny fraction of the overall economy.  Here is daily Covid-19 fatality data for the US:

Deaths peaked at just over 2000/day in April, fell to just over 500/day in late June, and then doubled again by late July.  Ignoring day of the week fluctuations in Covid reporting, the first half of August is still near the July peaks.  So one does not see the Arizona improvement in the national fatality data.

On the other hand, reported new cases are trending downward nationwide, although they are still several times higher than in June. (The recent decline is a bit smaller than it might appear to the naked eye, as the most recent two days are weekend data (reported Sunday and Monday), and today will probably see a jump upward).

This decline may partly reflect reduced testing, but a portion of the decline is almost certainly real.  The question is whether that’s enough to explain a modest improvement in the economy in August, despite the end of fiscal stimulus.  I doubt whether consumers are that sensitive to a drop in reported cases that is not showing up (yet) in the fatality data, but I can’t rule it out.

Even so, you have to wonder how important fiscal policy actually is if a fairly modest improvement in Covid-19 can explain why dire economic predictions don’t seem to be coming true.  If anything, I believe this supports my claim that it’s the virus, not a lack of disposable income, which is driving the economy right now.

PS.  I always need to point out that a major increase in the budget deficit was appropriate this year.  I am merely questioning stimulus for stimulus sake, such as giving $1200 to middle class people with jobs and giving unemployed people more than they earned on their previous jobs.  I favored the provisions that expanded unemployment compensation to a wider range of people during recent months.  So I’m not suggesting that doing nothing right now is appropriate; rather this post is aimed at the macroeconomic effects of using fiscal stimulus as a tool to boost disposable income.


Read More

Chart of the WeekAging Economies May Benefit Less from Fiscal Stimulus

By Jiro Honda and Hiroaki Miyamoto In the midst of the current COVID-19 pandemic, policymakers around the world are undertaking fiscal stimulus—a combination of spending increases and tax reductions—to support their economies. Even before the present crisis, the importance of fiscal policy has been increasing, with monetary policy constrained by near-zero interest rates. Our new […]

Read More

Wasted ammunition?

The second quarter of this year saw what is probably the biggest fiscal stimulus in American history, in terms of increase in the budget deficit. And today we see the results: nominal GDP fell by 34.3% at an annual rate. That means the fiscal stimulus prevented a much bigger fall in GDP—right?

Well, that might be true, but how would we know? We have models, but these models certainly don’t predict that NGDP would fall at a 34.3% rate in a quarter where disposable income is actually rising. And not just rising, but (according to the BEA) rising at an almost insane annual rate of 42.1%.  In real terms it was even higher, due to deflation:

Real disposable personal income (DPI)—personal income adjusted for taxes and inflation—increased 44.9 percent in the second quarter after increasing 2.6 percent in the first quarter.

Why do I mention disposable income? Because the models that predict fiscal stimulus will boost the economy are based on a transmission mechanism that runs from more fiscal stimulus to more disposable income to more spending. Thus our (Keynesian) models don’t really explain why NGDP fell so sharply in Q2.  Indeed, if anything these models predict an extraordinary boom.

You might respond that our common sense does provide an answer—people were afraid to go out shopping due to the virus. I accept that theory. But as far as I know there are no models that predict fiscal stimulus will be effective when people are afraid to go out shopping. And with the new Q2 GDP data there is also no empirical evidence that fiscal stimulus boosted GDP.

Before discussing the policy implications of all this, a few caveats:

1. Yes, I understand “ceteris paribus”. It’s plausible that the fiscal stimulus had some positive effect.  After all, even during periods where the virus is the dominant factor, disposable income does matter at the margin.

2. A very large budget deficit in Q2 was appropriate, as standard public finance theory says you should take in less tax revenue during a severe slump, and spend more on unemployment compensation. Then there’s spending on the virus itself.  I accept all of that. A big deficit was inevitable and appropriate.

What I question is the part of the deficit that was motivated solely by the desire to boost disposable income. For instance, why give $1200 to middle class people with stable jobs who were actually benefiting from a decline in the cost of living? That seems like wasted ammunition.  What were they expected to do with the money?  Why not just do enough stimulus to keep disposable income stable, if the problem is that people are afraid of spending?  Why a 44% (annualized) real increase?

In fairness to the other side, the fiscal stimulus this time around was larger and timelier than I expected. I would have expected gridlock in DC to slow the process. Nonetheless, it seems plausible to me that the massive fiscal stimulus was mostly wasted, due to the reluctance of people to spend. Ironically, this might be the one recession where it would have been better to delay the fiscal stimulus until 2021.  If we get a vaccine this winter (which experts seem to think increasingly likely) then perhaps people will become more willing to shop in 2021. That’s when the fiscal stimulus might have been effective, at least if you buy the underlying Keynesian model.

For myself, I believe monetary stimulus would be more effective in boosting the economy in 2021, at a much lower cost. Monetary and fiscal policy are very different. Monetary stimulus does not exhaust ammunition; rather it actually creates ammunition by raising the natural rate of interest. Fiscal stimulus really does exhaust ammunition.

Despite the preceding comments, I actually believe the economy received too little stimulus even in Q2 of this year.  I would have preferred to see monetary policy be expansionary enough to prevent disinflation.  It wasn’t.  So I’m not one of those conservatives who argue that “stimulus” doesn’t help in a slump.  Rather, I favor monetary stimulus (which is basically costless) over fiscal stimulus that imposes a heavy burden on future taxpayers.  If there’s a vaccine this winter, then I believe that monetary stimulus alone (done properly) could give us a V-shaped recovery.

In the past, I argued that fiscal stimulus did boost GDP in Q2 of 2008, but did not boost GDP for 2008 as a whole. That’s because the Fed responded to Bush’s spring of 2008 tax rebate by tightening money to slow inflation (CPI inflation peaked at 5.5% in mid-2008.) The rest is history.

In my view the recent fiscal stimulus did slightly boost NGDP in Q2, but the gains are likely to be taken away in 2021.  We’ll do a bit less monetary stimulus in 2021 because of all of the fiscal stimulus done in 2020, money that was basically wasted.

PS. Yes, the unannualized drop in NGDP was much smaller than 34.3%, but still pretty horrific by historical standards.


Read More

The Global Economic Reset—Promoting a More Inclusive Recovery

By Kristalina Georgieva  The COVID-19 crisis is inflicting the most pain on those who are already most vulnerable. This calamity could lead to a significant rise in income inequality. And it could jeopardize development gains, from educational attainment to poverty reduction. New estimates suggest that up to 100 million people worldwide could be pushed into […]

Read More