How Were So Many Economists So Wrong About the Recession?

By Tyler Cowen.

"That is the topic of my latest Bloomberg column, I thought it was time to call out all the Orwellian rewriting of intellectual history going on, so here goes:

As Treasury Secretary Janet Yellen said last week: “So many economists were saying there’s no way for inflation to get back to normal without it entailing a period of high unemployment, [or] a recession. And a year ago, I think many economists were saying a recession was inevitable. I’ve never felt there was a solid intellectual basis for making such a prediction.”

Many of those economists may have been relying on the work of … Janet Yellen. Her own (highly regarded) macro research focuses on nominal price and wage stickiness and output-inflation trade-offs, predicting that if there is a significant fall in aggregate demand, employment should also fall, giving rise to a recession. She is also co-author (with many distinguished colleagues) of a well-known paper arguing that there is an output/inflation trade-off even at high rates of inflation.

Economist Christina Romer (often with co-authors) has provided some of the most persuasive evidence that negative monetary policy shocks induce recessions in output and employment. Her work has been especially influential — worthy of a Nobel Prize, in my opinion — because it does not rely on a complicated mathematical model of the economy, and it had been accepted on a bipartisan basis. Paul Krugman has been predicting for most of this year that the recent disinflation would not cause a recession, and he deserves credit for getting this right. Yet he is less keen to tell us that for many years he trumpeted the predictive virtues of old-style Keynesian macroeconomics, using models that predict disinflation will lead to a loss in output and employment.

Krugman has lately further explained his position — complete with unironic headline — suggesting that the untangling of broken supply chains had helped lower the rate of inflation. That point, too, is correct. He didn’t mention that there also has been a massive negative shock to aggregate demand: High rates of M2 growth became slightly negative rates of M2 growth. Fiscal policy peaked and then retreated. The Fed raised interest rates from near-zero levels to the range of 5%, and fairly rapidly. It also sent every possible signal that it was going to be tight with monetary conditions.

…There is a reason that so many economists had been predicting a recession — and it is not because they are out of touch, or repeating talking points from Donald Trump’s presidential campaign. They predicted a recession because that is what experts such as Yellen, Krugman, Romer and many others had been teaching for decades. I do not myself presume to have any immunity from the general confusion here, as all along I thought there was a reasonable chance of a recession.

Larry Summers was wrong about the recession, but at least he has been consistent in his application of model-based reasoning, and now somehow he is the whipping boy for having done this.  Let’s hope that some historical memory holds and this one does not get swept under the rug…"

On Exceptions to the Case for a Policy of Unilateral Free Trade

By Don Boudreaux.

"In my latest column for AIER I discuss some rules for considering exceptions to the rule in favor of a policy of unilateral free trade. Two slices:

Someone emailed me not long ago to say that “it’s impossible to import another nation’s goods without importing some of its values. When the UK used to import Southern cotton, it necessarily imported the South’s tolerance of slavery. Or when we import Chinese goods, we necessarily import Chinese statism.”

This observation about trade deserves respectful attention.

Might this observation point to legitimate exceptions to the case for a policy of unilateral free trade? Of course. But as is true for all rules, the asserted exceptions must be carefully considered on a case-by-case basis and constrained by imposing the burden of persuasion on those persons who support setting the rule aside in any particular instance. This burden’s weight should never be modest, and be heavier for more-important rules.

The fact that following a rule in a particular case might not yield, in that case, an optimal outcome is itself never a good reason to violate a rule. We do not follow rules because we expect that in each instance the results will be optimal. Indeed, following a good rule might never produce an optimal outcome. Instead, by following rules we expect that the ongoing stream of outcomes will be superior to the stream of outcomes that would emerge if in each instance people made a case-by-case determination of how to act. You do not run through red lights even in those instances when you’re highly confident that doing so would cause no accident. By following the rule “remain stopped whenever the light is red” you know that you will in many cases remain stationary when moving forward in that case would be better – when running through that particular red light would save you valuable time without causing harm to anyone else. But by following this rule, over time the risk of you injuring yourself and others with your automobile is kept far lower than it would be without the rule.

In short, good rules, while almost never producing optimality in any one instance, produce streams of outcomes that approach optimality when judged as streams.

Therefore, correctly identifying as “suboptimal” the results of a policy of unilateral free trade in one or more cases in no way justifies restricting trade in those cases. A policy – a rule – of unilateral free trade is justified because the stream of results over time will be better than these would be absent this rule. Justification of a policy of free trade does not rest on the claim that free trade in each and every case yields ‘optimal’ results, or a stream of results as excellent as those that would be achieved if protectionist policies were run only by people with God-like knowledge and goodness.

…..

What help do these ruminations offer to address my correspondent’s concerns about trading freely with the Chinese? The answer is that they prompt questions that must be answered satisfactorily before conceding that the rule of free trade should in those particular instances be violated. Such questions include:

• When we trade freely with China, do we really “necessarily import Chinese statism”? Do Americans’ purchases of iPhones assembled in China really necessarily bring to America’s shores Chinese statism? Might the possibility of these purchases exist despite, rather than because of, Beijing’s statism? Because the years of investments in China that today make these, and other, purchases possible were driven more by market forces and not by statism, perhaps what we’re mostly importing today from China is not statism but, instead, the fruits of whatever market liberalism remains in that country.
• Even if we come to the highly unlikely conclusion that Americans’ imports from China now are largely the fruits of Chinese statism (rather than of market forces in China), does the amount of Chinese statism that we import exceed or fall short of the additional dollop of American statism necessary to restrict Americans’ freedom to trade with the Chinese? The alleged “imported” statism must be weighed against the domestically produced statism proposed for use as an antidote.
• Furthermore, what holds true for America holds true also for China. And so when statism is increased in America in the form of additional protectionism, one result will be that, through her trade with America, China will import more statism. How should we Americans weigh this negative consequence?"

Tyler Cowen on Recent Fed Policy

By Scott Sumner. 

"David Beckworth did a podcast with Tyler Cowen, and there was an extensive discussion of recent Fed policy.  Here’s one interesting comment:

Cowen: We did as well as we did coming out of 2008-2009 because of that work. Probably, we should have done more, as you and others have argued, but I give them a lot of credit for that. And I think next time around, if we have a crash like that crash, we will do more and tolerate a 4% inflation rate in a way that we didn’t in 2009, and things will be much better. That’s when the real payoff of what Scott has done and you have done, Bennett McCallum earlier, and others, next time around we’re going to say that we can live with 4% inflation, we can get it back down later on in a painless enough way, and in the situation like the next 2009, we’re going to do better. I strongly believe that. And all of the Fed talk in the meantime, it’s Straussian. The real question [is], would Congress put up with the Fed doing 4% inflation next time around? I think it’s yes.

After mid-2008, the recession of 2008-09 was an aggregate demand shock—a severe decline in nominal spending.  If the Fed were to do NGDP level targeting during that sort of crisis, then you would not even need 4% inflation.  Most of the excess NGDP growth during the recovery period would show up as real growth, not inflation.

[Technically, the recession began in December 2007, and there was high inflation during the first 6 months of 2008 due to rising commodity prices.  But the deep slump began in mid-2008, and was caused by a negative demand shock with falling prices.]

In addition, I’d argue that a repeat of 2008-09 would only happen in if Fed policy had no credibility.  But in that case the make-up policy would likely be ineffective, just as in 2009.  The point of level targeting is not to get a quick recovery when there’s a deep slump, the point is to prevent a deep slump.

(Covid was one of those once in a century exceptions, when a deep slump was inevitable.  But Covid is not a good example to think about when designing a system.)

When I make this argument people ask me “OK, but what if there is a deep slump, what then?”  It’s clear to me that they don’t really believe level targeting will work.  My answer is that you try to get back to the trend line if you’ve announced that as your policy, but I honestly don’t think it would work in that case.  If markets don’t expect success, why should I?  If an NGDP futures market showed a big drop in future expected NGDP, then you’d try to reverse that.  But the market forecast already incorporates the likely policy response.  So if markets are pessimistic then I’m also very pessimistic, even if the Fed claims to be following my preferred policy.

I thought the Fed had adopted average inflation targeting back in 2020.  The markets saw through those claims before I did, and of course the markets were correct.

Cowen: Scott himself has said that it’s the worst time to have nominal GDP rules. In a pandemic, I think all rules get tossed out the window, whether or not they should be, they probably should be, but they will be. Then your price data… So, if I wanted to see a movie in May 2020, is the price infinite? Is the price still $14? That’s quite arbitrary. So, how you define the price indices for services, to me, becomes arbitrary. Nominal GDP targeting just becomes seat of the pants, which to be clear I’m fine with, but it’s not really nominal GDP targeting, because the quality of the price data is gone.

I’m confused by this.  If movie theaters are shut down and price data is ambiguous, that’s a stronger argument for NGDP targeting.  During Covid, the price of movies was ambiguous, but the contribution of movie theaters to NGDP was precisely zero.  One reason that NGDP is superior to inflation is that NGDP is a relatively clear concept, whereas the price level is a very vague concept that’s never been adequately defined.

It’s true that I didn’t think it made sense to maintain steady NGDP growth during the shutdown, but there’d be no problem in continuing to target one or two-year forward NGDP along a 4% trend line during a pandemic.  And as a practical matter, it’s impossible to stabilize “spot NGDP”, so NGDP targeting has always been about stabilizing future expected NGDP.  The only thing that changes during a pandemic is that you might briefly wish to target NGDP a bit further out (say two years instead of one.)  If the Fed had done so, we would have avoided the inflation fiasco of 2021-22.  With 4% NGDP level targeting, inflation would have averaged 2% during 2019-23, even if headline inflation briefly reached 4% or 5% for a few months in 2022.

So perhaps once every 100 years there’s a shock that leads the central bank to target two year forward NGDP instead of one year forward NGDP.  That’s doesn’t seem like a large concession.

Cowen: I don’t think that we can have a Fed bound by rules, as much as I would like to do that. The old Carl Schmitt idea, “he who is sovereign decides the exception.” I just don’t think you’re going to get around that. I don’t think the Fed would ever accept rules or recommend them to Congress. What you want is a Fed imbued with NGDP ideology, that at critical key moments in history, is willing to take some chances in the right direction. We got that. We’ve won, maybe temporarily, but for now-

I’m not sure what Tyler means by a “NGDP ideology”, but it can’t be anything like NGDP level targeting.  The Fed followed up a disastrous NGDP shortfall in 2008-09 with a wildly excessive level of NGDP growth in 2021-23, with no attempt to revert to the previous trend line.  So I’m not sure who has “won”, but it clearly is not market monetarists.

In case this post sounds too grouchy, I do recognize that the Fed now has a better understanding of the need for make-up policy.  But being half way to enlightenment is very dangerous when an institution has a lot of discretionary authority and is subject to political pressure.

I added an update to my recent post entitled Nemo judex in causa sua, where I linked to a book by Peter Boettke, Alexander Salter and Daniel Smith.  They do an excellent job showing the dangers of discretionary policy.  Tyler might be correct that discretionary policies are inevitable.  But in that case, there’s no reason to be optimistic about future Fed policy."

How Covid-19 regulations has made the air-traffic-control controller shortage worse

See Fatigue and Mandatory Overtime: America’s Air-Traffic Controllers Are Stretched Thin by Andrew Tangel, Micah Maidenberg and Alison Sider of The WSJ. Excerpt:

"The FAA has fallen behind its training and hiring goals, a situation exacerbated by the Covid-19 pandemic, earlier government shutdowns and what former agency officials complain has been years of inadequate funding. As the coronavircovus began spreading more than three years ago, the agency suspended training at its academy for new hires for four months and paused training elsewhere for stretches ranging from seven months to almost two years, according to a Transportation Department inspector general’s report."

DeSantis Is Right About Medicaid

North Carolina becomes the 40th state to join the expansion, which harms taxpayers and existing beneficiaries alike.

By Brian Blase. Excerpts:

"Expansion leads to a surge in spending but reduces healthcare access for traditional Medicaid enrollees such as low-income children and people with disabilities. And it doesn’t improve health."

"If Florida expands Medicaid, some 2.5 million people would newly enroll in the program. Three in 10 Floridians would be on Medicaid, and there would be only 1.5 workers for every Medicaid enrollee. Among people who join Medicaid, 65% would replace private coverage."

"The cost of expansion to Florida’s state taxpayers would reach $2 billion by the end of the decade."

"Expanding Medicaid also leads to much higher federal deficits. Florida’s decision to reject ObamaCare’s Medicaid expansion has already saved American taxpayers nearly $50 billion.

After ObamaCare’s Medicaid spending surge, federal officials found that more than 20% of payments nationwide were improper—mainly payments to health insurers for ineligible recipients."

"In the first four years of Medicaid expansion, mortality trends were worse in expansion states."

"After expansion, Medicaid enrollees were one-third less likely to secure doctor appointments, driving more people into emergency rooms. A Mercatus Center study found that Medicaid spending stagnated for children and people with disabilities and significantly increased for able-bodied working-age adults in expansion states."

"If Florida decides to expand and the enhanced match rate ends, the state’s extra costs will exceed $40 billion over the next decade, according to my estimates. North Carolina’s decision to expand creates fiscal risk for the state exceeding $10 billion over the next decade."

Biden’s Drug-Price Boomerang

Prices are rising faster since the IRA passed. Here’s why. 

WSJ editorial.

"President Biden keeps trying to persuade Americans his policies are helping them, but voters aren’t buying it. The latest example is the Inflation Reduction Act’s (IRA) Medicare drug rebates, which are raising the cost of medicines.

The White House on Thursday proclaimed that the IRA’s drug rebates are already saving seniors money: “President Biden’s prescription drug law cracks down on price gouging from Big Pharma.”

Under the IRA, drug makers must pay Medicare rebates if they raise list prices more than the rate of inflation. If a company increases the price of an immunotherapy by, say, 8% while inflation is increasing at 3%, it must pay Medicare the 5% difference. Co-insurance payments made by patients are then based on the inflation-adjusted price.

Rebates are deposited in the Medicare Supplementary Medical Insurance Fund, which is mainly financed by general tax revenue. In other words, politicians, not seniors, are the real beneficiary of the rebates.

According to the Administration, IRA drug rebates save seniors “as much as $618 per average dose on 47 prescription drugs” (our emphasis). This is deceptive marketing. It’s possible that Medicare co-insurance as a result of the IRA could be hundreds of dollars less on a cancer drug that costs tens of thousands of dollars per dose and whose list price increases by double digits. But most Medicare patients will see little benefit.

On the other hand, privately insured patients will likely pay much more for drugs owing to the rebates. Democrats tacitly conceded this when they drafted the law. They initially planned to apply the IRA inflation rebates to the private insurance market too. That’s because employers worried that drug makers would offset the cost of the Medicare rebates by raising prices for their workers.

This is what has happened in Medicare with hospital and physician fees. Because Medicare typically pays less than the cost of care, providers charge privately insured patients more to compensate. Private health plans paid hospitals 224% of Medicare rates in 2020, according to a Rand Corp. study. Between 2013 and 2018, prices paid to providers increased at double the rate for commercial insurers as for Medicare fee for service.

Medicaid’s mandatory rebates—23.1% for brand drugs and 13% for generics off the average manufacturer price—save Medicaid tens of billions of dollars a year. But drug makers have raised prices that privately insured and Medicare patients pay to offset those Medicaid rebates, especially for drugs used mostly by low-income patients. Medicaid rebates have also reduced the already slim margins for making generic drugs, contributing to the current shortages.

Senate budget rules blocked Democrats from extending inflation rebates to private markets. So drug makers will invariably raise prices for privately insured patients and launch new drugs at higher prices. This may already be happening. Prescription drug prices have increased at a faster rate since the IRA passed, even as overall inflation has moderated.

Prescription drug prices increased by 2% during the Trump Presidency owing to greater generic competition, yet they’ve increased 5.5% so far under Mr. Biden. In November they rose at an annual rate of nearly 6%. Has the White House considered that the reason Americans don’t believe that the President’s policies have helped them is because they haven’t?"

Social Security Was Doomed From the Start

The fatal flaw was FDR’s decision to make it a pay-as-you-go benefit. We should have fixed it by now

By Phil Gramm and Mike Solon. Excerpts:

"FDR’s Justice Department successfully argued before the Supreme Court that Social Security payroll taxes weren’t reserved for future retirees. “These are true taxes, the purpose being simply to raise revenues,” assistant attorney general Robert Jackson asserted in his brief to the justices. “The proceeds are paid unrestricted into the Treasury as internal revenue collections, available for general support of the Government.”

By 1939, Social Security taxes were collecting about 8% of federal revenue and funding part of the explosion of New Deal social spending. None of this revenue was used to purchase marketable equities or private bonds to fund future benefits. Only a notional accounting of the Social Security surpluses was recorded by the issue of nonnegotiable government bonds—which provided nothing to fund future benefits, since it was debt the federal government owed itself.

With Social Security running large cash “surpluses,” Congress started adding new benefits. These included payments for dependents and survivors, cost-of-living adjustments, disability benefits, Supplemental Security Income, a minimum benefit, a death benefit and a student benefit. When the War on Poverty and the Vietnam War triggered—and social spending and monetary expansion sustained—9.2% average annual inflation from 1973-81, the Social Security surplus quickly evaporated. By 1980, the Social Security trustees projected the fund would be depleted in 1981.

But inflation and profligacy alone didn’t bankrupt Social Security. One retiree in 1940 could be supported by a 2% payroll tax paid by 159 workers. By 1981, with growing life expectancy and an aging population, that same retiree needed a 10.7% payroll tax paid by 3.2 workers."

"Social Security required immediate action when President Reagan took office. His 1981 budget reconciliation bill, Gramm-Latta, ended Social Security’s adult student benefit and the minimum benefit. It also limited the death benefit."

"The [1983] agreement required most federal employees to pay Social Security taxes, accelerated the implementation of the payroll tax hikes enacted in 1977, gradually raised the retirement age to 67, and delayed for six months the annual cost-of-living adjustment."

"a new supplemental federal retirement program for future federal employees that would make real investments and pay benefits based on returns."

"the Social Security reformers of 1983 . . . never considered investing the cash surpluses created by the reforms. We simply spent them on general government.

The actual annual Social Security cash surpluses grew from $2.7 billion in 1984 to a peak of $90 billion in 2001 and then fell to $3 billion in 2009 before turning negative. Had each annual cash surplus been invested—70% in the S&P 500 and 30% in investment-grade corporate bonds—the invested trust fund would have held $3.9 trillion of marketable assets by 2010."