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Last Build Date: Tue, 17 Oct 2017 15:13:04 -0500

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Thoughts on the UMich Immigration Debate, by Bryan Caplan

Tue, 17 Oct 2017 15:13:04 -0500

Thoughts on my latest debate:1. Hans von Spakovsky was the most lawyerly opponent I've ever debated.  His first (and second) approach to almost any issue was simply to describe the law.  In most cases, he didn't even defend its wisdom or justice.  Instead, he simply exhorted people to obey the law or convince Congress to change it.2. Still, after a great deal of legal description, von Spakovsky finally shared his actual view: low-skilled immigration should be sharply reduced in favor of high-skilled immigration.  When asked about refugees, he refrained from calling for outright cuts in the quota; instead, he maintained that existing numbers are roughly the most we are capable of handling. 3. The debate was explicitly about Trump's views on immigration, and von Spakovsky has pretty close ties to the administration.  But von Spakovsky said almost nothing about Trump or his policies - and studiously failed to defend the president I repeatedly called "intellectually lazy and irrational."  Perhaps he respects Trump so deeply that he considered my claims unworthy of a response.  Or perhaps - like many elite Republicans - he avoided the topic because he is well-aware of Trump's glaring epistemic shortcomings.4. The most engaging part of the debate, at least for me, began when my opponent spontaneously described his traffic tickets.  This seems to show that - contrary to his grandiose claims about its sanctity - he's often not ashamed to break the law.  In other words, he's an normal American driver.  You could argue that traffic laws are uniquely bad, but that's silly.  They plausibly protect other human beings from dangerous driving - and compliance is usually only a minor inconvenience.  Why, then, would it be wrong to break immigration laws - which immensely harm would-be immigrants at great economic cost to natives?  If anything, we should enforce traffic laws far more strictly than immigration laws.5. During Q&A, Reason's Shikha Dalmia amplified my point by referencing the slogan that Americans commit three felonies a day.  Von Spakovsky did not dispute her claim, but drew a strong distinction between natives' accidental law-breaking and illegal immigrants' deliberate law-breaking - an odd retreat for such a lawyerly thinker.  When I pointed out that natives often knowingly break the law, my opponent declined to call for a strict crack-down on said scofflaws.6. I repeatedly pointed out that governments selectively enforce laws all the time.  Indeed, they have no choice; there aren't enough resources in the world to enforce all the laws we have.  Furthermore, governments often officially announce their enforcement policies, so people know what to expect.  Given this, I don't even see what the legal objection to DACA or DAPA is supposed to be.7. I argued that Trump's travel ban bears little connection to the problems he claims to be worried about.  Saudi Arabia isn't on the list, even though 15 of the 19 9/11 attackers were Saudi.  Von Spakovsky dismissed my claim by by providing details about how the administration formulated its new policy.  He even urged listeners to go to the White House webpage.  This morning, I took his advice.  A typical passage:The Secretary of Homeland Security assesses that the following countries continue to have "inadequate" identity-management protocols, information-sharing practices, and risk factors, with respect to the baseline described in subsection (c) of this section, such that entry restrictions and limitations are recommended:  Chad, Iran, Libya, North Korea, Syria, Venezuela, and Yemen.  The Secretary of Homeland Security also assesses that Iraq did not meet the baseline, but that entry restrictions and limitations under a Presidential proclamation are not warranted.I am perfectly happy to admit that there is a bureaucratic process at work.  There always is.  But if an intellectually lazy, irrational president wants X, are his functionaries [...]

Again on the Catalonian secession and the EU, by Alberto Mingardi

Tue, 17 Oct 2017 09:02:45 -0500

Many people have pointed out that the Catalonian secession can trigger an economic shock. The Catalonians say they want to stay in the European Union and keep the euro, but they can't do so. If they secede, they'll need to enter again the EU (and the euro) as an independent state. And Spain would likely veto them out of the EU.

FT columnist Wolfgang Münchau wrote that "Catalan breakaway would make Brexit look like a cake walk", arguing that the main argument against Catalan independence is thus economic.

It may be a matter of words, but I thought that the problem was not "economic." Small states, if they're open economies, can survive and prosper in an era of globalisation. A more extended division of labour doesn't imply political unification, all the more so in an age when transferring information and traveling have never been faster and cheaper.

Rather the problem is political: that is, the European Union doesn't allow for an ordered exercise of the right of self determination. You can consider this inevitable, if you think the EU is nothing but a cartel of states. But it is certainly in striking contrast with that principle of subsidiarity often hailed by the European founding fathers. Or at least so I've argued in a letter to the Financial Times:

Secession from Spain would trigger exit from both the EU and the euro, which may account for a global economic shock. In fact, the Catalans do not want to leave the euro or the single market: only Spain. And yet they'll be forced out of European institutions because the latter are tailored around member nation states.

When you're forced to do something you do not want to, it's not economics, it's politics. And, indeed, the main argument Mr Münchau refers to is not economic, but political. In a globalised world, smaller political units do not need to fear isolation as long as they are open economies. Smaller states are less likely to be tempted by protectionism as its cost will be higher for them.

The problem the Catalans are facing lies with the legal infrastructure of the EU. Though the EU's founding fathers preached the principle of subsidiarity, they didn't allow room for the principle of self-determination of peoples in the treaties. Perhaps it is the political problem that should be tackled, establishing ordered ways of exercising the principle of self-determination at least within the EU.


Two Texas Talks, by David Henderson

Mon, 16 Oct 2017 20:59:46 -0500

I'll be giving in two talks in Texas this week.

Southern Methodist University, Dallas
Sponsor: O'Neil Center for Global Markets & Freedom
Topic: How Economists Helped End the Draft
Time: Wednesday, 6:00 to 7:00 p.m. (Reception to follow)
Place: Ernst & Young Gallery (Room 220 of the Fincher Building)

Baylor University, Waco
Sponsor: Baugh Center for Entrepreneurship & Free Enterprise
Hankamer School of Business
Topic: Economic Inequality: Popular Misconceptions and Important Facts
Time: Thursday, 4:00 to 5:15 p.m. (refreshments provided)
Place: Hankamer School of Business, Foster 240

If you come, please come up afterwards and introduce yourself.


Rethinking Macroeconomics, by Scott Sumner

Mon, 16 Oct 2017 15:54:16 -0500

I recently attended a conference at the Peterson Institute on "Rethinking Macroeconomics", which mostly meant returning macro to its Keynesian roots. Readers may know that I have a contrarian take on the crisis---I believe it occurred because macroeconomists did not take macro theory seriously enough. We do not need to rethink macro by adding in fiscal policy or paying more attention to the financial sector, rather we need to impress upon the world's central banks the importance of doing whatever it takes to keep aggregate demand growing at an adequate level. The major central banks (except in Australia) did not do that in 2008 (for many different reasons) and hence we had the Great Recession. I don't get invited to many left-of-center conferences, for some reason I'm more likely to get invitations from groups like Cato, AEI, Heritage, etc. Thus I thought it might be interesting to provide a few impressions: 1. At an intellectual level the conference was very impressive---there were many brilliant economists presenting and also in the audience. The overall impression was of a center-left perspective, but hardly monolithic. After Alan Auerbach presented a paper on fiscal policy, several panel members (including Robert Rubin) expressed skepticism---viewing the problems we face as mostly supply-side. 2. I sometimes had a sort of "Paul Krugman reaction", as the general discussion seemed more grounded in reality than at a right-of-center macro conference. Most speakers seemed very aware of the importance of shortfalls in AD during the Great Recession, a basic understanding that I often feel is missing on the right. 3. On the negative side, I was extremely disappointed by some of the comments on monetary policy. In response to calls for a higher inflation target to avoid the zero bound problem, Jeremy Stein of Harvard University asked something to the effect "What makes you think the Fed can achieve higher inflation?" (Recall that Stein was recently a member of the Federal Reserve Board.) I was pleased to see Olivier Blanchard respond that there is no doubt that we can achieve 4% inflation, or indeed any trend inflation rate we want. But then Larry Summers also suggested that he shared Stein's doubts (albeit to a lesser extent.) I kept thinking to myself: Why do you guys think the Fed is currently engaged in steadily raising the fed funds target? What do you think the Fed is trying to achieve? How can a top Fed official not think the Fed could raise its inflation target during a period when we aren't even at the zero bound? Why has the US averaged 2% inflation since 1990---is it just a miracle? When Summers came out for NGDP targeting I briefly wondered whether I'd made a mistake in favoring Yellen for Fed chair, but this comment reconfirmed my initial preference. 4. While the left is ahead of the right in their understanding of the importance of demand shocks, they lag far behind in understanding the importance of more subtle forces shaping the economy. Thus they are even less likely than the right to blame the Fed for destabilizing aggregate demand, and they almost entirely ignored the problem of moral hazard in a panel on the financial system. On the left there's a reflex to always seek solutions in more government (financial regulation, fiscal policy, etc.), not in removing government policies that cause problems (moral hazard, unstable monetary policy.) Unfortunately the solutions offered by the left do not address the root causes of economic crises, and hence are likely to be ineffective. Banks will eventually find their way around any regulations enacted to limit their risk taking. Fiscal policy has been repeatedly shown to be largely ineffective. (Remember the 2013 recession trigger by "austerity"? Me neither.) 5. Larry Summers dominated the conference due to a combination of his force of personality and his intellectual brilliance. (That's right, I don't judge intellects based on whether they agree with[...]

Does Trump's Immigration Agenda Harm Democracy? My Opening Statement, by Bryan Caplan

Mon, 16 Oct 2017 15:08:36 -0500

Last Friday, I debated Heritage's Hans von Spakovsky on "Does Trump's Immigration Agenda Harm Democracy?"  The resolution was unusual for me in three ways:1. I usually try to stick to timeless issues.  For this debate, I had to discuss and analyze current events in detail.2. We were originally going to discuss Trump's immigration policies, but it's not clear that he'll manage to dramatically change immigration policy.  That's why we switched to his immigration agenda - i.e., the policies Trump would like to impose.3. Since I put no intrinsic value on democracy, I'd rather argue that immigration policies are harmful, rather than "harmful for democracy."  But I think I learned a good deal from sticking to the agreed topic.  Hopefully you'll agree!Does Trump's Immigration Agenda Harm Democracy? Let's start with the big question: What does it mean to "harm democracy"?  It's tempting to cynically say:  "harms democracy" equals "clashes with my favorite policies" or even "fails to give power to my party."  But if you get some distance, there are plenty of plausible standards against which to judge democratic performance.  Above all: 1. In a healthy democracy, leaders calmly assess the evidence before forming a plan to solve social problems.  They consider costs as well as benefits.  2. In a healthy democracy, leaders seek objective estimates of policies' actual effects, even if they don't like the answers.  For example, if they're setting the minimum wage, they'll want sober estimates of the effect of a $1/hour increase on the number of workers hired.  3. In a healthy democracy, leaders defuse popular prejudices instead of pandering to them.  If the majority wrongly believes leeches cure cancer, leaders don't advocate a $100B National Leech Fund.  Instead, they politely but firmly refuse to waste of taxpayer money. These standards aren't Democratic or Republican, liberal or conservative.  They're common sense and common decency.    Now, you might say, "Common sense and common decency aren't so common."  Or even: "I don't know any leaders of either party who live up to these standards.  Successful politicians are experts at winning and retaining power, not carefully crafting wise policy.  And the way to win and retain power is to tell voters what they want to hear, whether it's true or not."    If that's your reaction, I completely agree.  I have a whole book - called The Myth of the Rational Voter: Why Democracies Choose Bad Policies - on the shortcomings of democracy.  But the fact that politicians routinely harm democracy hardly implies they're all equally harmful.  And of course, politicians could be better on some issues than others.  So how does Donald Trump's approach to immigration policy measure up?  1. In the real world, politicians rarely calmly assess evidence before offering solutions.  If you know a politicians' ideology, you can generally predict what he's going to say about even the most complex issues.  And immigration is an especially emotional issue.  Even so, Trump's statements about immigration are unusually intellectually lazy and irrational.  Consider some of his main public reflections on the topic.  a. He's claimed there are 30-34 million illegal immigrants in the U.S. - roughly triple the number virtually any quant accepts.  When asked for a source, he said, "I am hearing it from other people, and I have seen it written in various newspapers. The truth is the government has no idea how many illegals are here."  b. "The Mexican Government is forcing their most unwanted people into the United States."  Evidence for this strange conspiracy theory?  None.  And: "Likewise, tremendous infectious disease is pouring across the border."    c. "I will build a great wall -- and nobody buil[...]

Fred McChesney RIP, by David Henderson

Mon, 16 Oct 2017 14:00:58 -0500


Law and economics scholar Fred McChesney died last Thursday at age 68. He was a first-rate scholar, a wonderful friend, and an engaging conversationalist. I'm so glad that he called me up when he was in Monterey a couple of years ago. I went to his hotel and had a great visit with him and his lady friend. I remember feeding the parking meter for an hour, thinking that would be enough, and then finding the conversation so interesting and fun that I went out after an hour and a quarter and fed it for another hour.

Here's a great write up of some of his accomplishments.

Fred wrote the antitrust article for The Concise Encyclopedia of Economics. Out of the over 160 entries, it is one of my 20 favorite pieces. It covers a lot of territory succinctly while still giving the essential economic analysis on each issue.

He also wrote 10 articles for the Econlib Feature Article series. My favorite two are "Armen Alchian: An Economist-Lion in Winter" and "Smoke and Errors."

Here's a great paragraph from "Armen Alchian: An Economist-Lion in Winter":

Perhaps no other economist of our time has given as much attention to costs as has Armen Alchian. He discovered, while working at the RAND Corporation after the war, that military engineers and economists disagreed over the efficient ways to produce armaments because their concepts of cost were quite different.6 Engineers registered cost as a function of total output, and so saw costs as generally declining. But to economists, the costs associated with different levels of output depend on the rate at which they are produced: Producing the same volume but in a shorter period of time would be more expensive, ceteris paribus. Moreover, once one recognized the importance of time for reckoning cost, one had also to take into account the present value of the outlays required to produce, outlays that would vary depending on the timing of production. All of this Alchian explained in one of his most important articles.

Here are two great paragraphs from "Smoke and Errors":

In short, good old-fashioned rent seeking accounts for the rise of public fire-fighting. It explains as well the survival of an entity that, more and more, is losing its raison d'être. Modern building materials are relatively fire-proof, while clothing and other fabrics are flame-retardant. Municipal codes increasingly require sprinkler systems, smoke detectors and other devices to reduce the incidence and costs of fire. So today's fireman has much less to do. The number of home and building fires has plunged 40 percent in the past two decades.

With fewer fires to fight, one would expect to find fewer fire-fighters--in a private firm, anyway. But not in a public agency. Despite the 40-percent decline in fires, in the past twenty years the number of paid city fire-fighters has increased by 20 percent. Only in government firms does employment go up as demand and output decline.

HT2 Tyler Cowen.


Mises was a neocon, and other oddities , by Alberto Mingardi

Mon, 16 Oct 2017 09:34:49 -0500

It is of great comfort to us who share an antiquarian passion for the history of political thought that fundamental questions such as, "What is the state?" invariably come to the surface. But sometimes you get the impression that new interpretations focus more on the 'political' than on the 'thought'. 

I'm referring to a long opinion piece published by Yoram Hazony in The Wall Street Journal. From his byline we know that Mr Hazony, President of the Jerusalem-based Herzl Institute, is publishing a book entitled The Virtue of Nationalism. His article's political goal is clear: he wants to argue that Donald Trump's blend of conservatism is in line with an old tradition that goes back to Edmund Burke. Trump is thus implicitly considered the torch-bearer of a system of ideas that value the nation-state as providing the soil which allowed Western liberty to flourish. From this comes skepticism towards exporting such values in different cultures and a similar anxiety for opening the door to immigrants that come from illiberal cultures.

 But leaving aside what President Trump stands for, or rather represents, Mr Hazony's story is quite problematic.

 He thinks that "Classical liberalism ... offers ground for imposing a single doctrine on all nations for their own good. It provides an ideological basis for an American universal dominion." So, for Mr Hazony it was "liberal abstractions", based upon John Locke's ideas that matured into contemporary neo-conservatism. Note that for Mr Hazony classical liberalism is "rationalist". I'm not so sure that Locke can be considered a "constructivist", but it is hard to assume that David Hume and Adam Smith were not central to the original arc of liberalism--that is, classical liberalism. Moreover, it could be argued that Burke himself had strong (classical) liberal leanings. On issue after issue, his tendency was usually liberal.

 Mr Hazony seems to ignore the extent to which the modern libertarian movement, in the United States, tends to favour anti-interventionism and how skeptical prominent libertarians were of exporting democracy, let alone neo-conservatism itself. 

He quotes from Mises's 1927 pamphlet "Liberalism" to argue that classical liberals are actually internationalist advocates of world government. So writes Hazony: Ludwig von Mises thus advocates a 'world super-state really deserving of the name,' which will arise if we 'succeed in creating throughout the world . . . nothing less than unqualified, unconditional acceptance of liberalism. Liberal thinking must permeate all nations, liberal principles must pervade all political institutions. Let's read the quotation in its entirety:

 To be sure, the League does hold out, even though very cautiously and with many reservations, the prospect of some future boundary adjustments to do justice to the demands of some nations and parts of nations. It also promises--again very cautiously and qualifiedly--protection to national minorities. This permits us to hope that from these extremely inadequate beginnings a world superstate really deserving of the name may some day be able to develop that would be capable of assuring the nations the peace that they require. But this question will not be decided at Geneva in the sessions of the present League, and certainly not in the parliaments of the individual countries that comprise it. For the problem involved is not at all a matter of organization or of the technique of international government, but the greatest ideological question that mankind has ever faced. It is a question of whether we shall succeed in creating throughout the world a frame of mind without which all agreements for the preservation of peace and all the proceedings of courts of arbitration will remain, at the crucial moment, only worthless scraps of paper. This frame of mind can be nothing less than the unqualified, unconditio[...]

Hassett on Tax Cuts and Growth, by David Henderson

Sun, 15 Oct 2017 22:29:56 -0500

On October 5, Kevin Hassett, the new chairman of President Trump's Council of Economic Advisers, gave an excellent talk at the Tax Policy Center. The topic was taxes and economic growth. The transcript of the talk is here. The video is here. In the talk, Kevin gave some estimates of the effects of cuts in marginal personal and corporate income tax rates on growth. Drawing on the literature, he came up with substantial estimates of both. A few excerpts follow. First, his own background on this issue: Perhaps the reason I hold these beliefs is that I started graduate school back in 1984, and was taking Alan Auerbach's public finance class when the 1986 Tax Act was enacted. At the time, I began working on how the 1986 reforms would affect business capital spending. The literature surprisingly found little effects of tax policy on the economy, often suggesting that tax and interest rate variables did not drive capital spending. But Alan and I noticed something funny in the data. Politicians tended to pass Investment Tax Credits in recessions, then let them expire when the recession was over. Thus it appeared that the economy partly drove tax policy, even if to [sic] tax policy also affects the economy. However, because recessions induced tax-cuts, any analysis of how tax cuts affected the economy would need to separate this out to not wrongly conclude that tax cuts caused recessions. When Alan and I discovered a way to overcome this problem, we found very large effects of tax policy on investment behavior. Since then, there has been a veritable scientific revolution of papers that use different methods to identify tax effects, and like our first study, they have found again, and again and again, that tax policy is a major driver of economic growth, if one does the science correctly. His summary of the literature: I don't have time to go into the scientific methodology in great detail, but have done so in more detail in a number of recent review articles. But for thinking about the broad-brush growth impact of the President's proposals, a number of recent papers published in top journals provide a guide to the possible scale of the growth effects. Romer and Romer (2010), utilize narrative history to separate out tax changes with motivations unlikely to be driven by the business cycle; they estimate that a 1 percentage point reduction in the total tax share of GDP increases GDP by 1 percent on impact, and by between 2.5 and 3 percent over three years. Cloyne (2013) and Hayo and Uhl (2014) apply the same approach using data from the United Kingdom and Germany, and obtain almost identical estimates. Other authors, such as Mertens and Ravn (2013), have extended this work with more sophisticated methods and find that a 1 percentage point reduction in the average personal income tax rate raises real GDP per capita by 1.4 percent in the first quarter, and by up to 1.8 percent after one year. They further find that a 1 percentage point cut in the average corporate income tax rate raises real GDP per capita by 0.4 percent in the first quarter, and by 0.6 percent after a full year. Using a similar approach, Mertens and Olea (2017) find that in the first two years following a tax decrease of 1 percent, GDP is expected to be higher by about 1 percentage point. Applying the estimates from the literature to Trump's proposed cuts: Applying these estimates to the proposed reduction in the statutory corporate income tax rate from 35 to 20 percent and the simultaneous introduction of full expensing requires calculating the effect these changes would have on federal tax liabilities, which will depend on the bill's final details. But just to illustrate the scale of these effects, a rough preliminary estimate of the combined revenue effect of the corporate tax proposal, combined with these macro elasticity estimates, implies that tax cuts of this scale wo[...]

1967 and 2008: Two botched policies, by Scott Sumner

Sat, 14 Oct 2017 11:22:17 -0500

I've occasionally done blog posts explaining how it's possible to prevent recessions from occurring, even after they have begun. That's because a recession is dated from the point where output starts falling, but it's not considered a recession unless the decline persists for a considerable period of time. This is one reason why economists are so poor at predicting recessions. During the past three recessions, a consensus of economists failed to predict the recession until it was well underway. It occurred to me that I failed to provide an example of a recession that was prevented after it had already began. Today I will do so. In 1966 the Fed tightened monetary policy to slow inflation, which had recently been increasing. As a result, industrial production fell by 1.9% between October 1966 and July 1967. But that's much less than the nearly 8% decline observed during the 1970 recession, which was itself fairly mild. We had no recession in 1967 because the Fed sensed a slowdown, and eased policy in the spring of 1967. Because of this action, unemployment merely nudged up from 3.6% in November 1966 to 4% in October 1967, before renewing its long decline. Now let's look at industrial production during late 2007 and early 2008: After peaking in November 2007, industrial production fell by only 2.2% over the next 7 months. Then after June 2008, output fell sharply, and by June 2009 was more than 17.3% below pre-recession levels. June 2008 is considered a recession period whereas July 1967 is not, primarily on the basis of what happened later. Unlike in 1967, the Fed decided not to ease monetary policy in the middle of 2008, despite growing signs of recession. Indeed policy was actually tightened sharply, as the fed funds target was held at 2% from April to October, despite a rapidly falling natural rate of interest. If the Fed had eased aggressively in June 2008, then they might have entirely prevented a recession that technically began in December 2007. It wasn't too late! The decline in output from late 2007 to June 2008 was too small to constitute a recession. Yes, the NBER eventually declared that the recession began in December 2007, but there would have been no recession to date in the first place if industrial production had risen in the second half of 2008, as it did in the second half of 1967. (I would add that the post-Lehman crisis might also have been milder, indeed Lehman might not have even failed.) Ironically, the Fed made the wrong call in both 1967 and 2008. In 1967 the Fed should have allowed a (very mild) recession to occur, in order to prevent the "Great Inflation" of 1966-81 from occurring. That inflation did far more damage than a rise in unemployment to, say, 5% in late 1967. Indeed, a mild recession in 1967 might have made the 1970 recession unnecessary. In contrast, the Fed should have prevented the 2008 recession. In 1967, the Fed was too worried about unemployment and not worried enough about inflation, whereas the reverse was true in 2008. The solution is to ignore both inflation and unemployment, and focus on keeping NGDP growing at a stable rate. Even at the low point of the second quarter of 1967, 12-month NGDP growth was running at over 5.4%. There was no reason at all for the Fed to ease monetary policy. By the 3rd quarter of 1968, 12-month NGDP growth had soared to 9.9%---the Great Inflation of 1966-81 was underway. Now look at NGDP growth in early 2008: In the second quarter of 2008, the 12-month NGDP growth rate was only 2.7%. Admittedly this data was not yet available to Fed officials in June 2008, but even the first quarter data showed only a 3.05% NGDP growth rate---far below trend. So why did the Fed (passively) tighten policy in mid-2008, by keeping rates at 2% as the natural rate of interest plunged sharply lower? In a wor[...]

Bernanke proposes an inflation/price level hybrid target, by Scott Sumner

Thu, 12 Oct 2017 12:54:44 -0500

I am currently in DC attending a star-studded macroeconomic policy conference at the Peterson Institute. Today's participants included Bernanke, Summers, Blanchard, Draghi, Fischer, and many other eminent economists. Bernanke's paper was by far the most interesting, especially his proposal for addressing the zero bound problem: So, to be concrete, at some moment when the economy is away from the ZLB, suppose the Fed were to make an announcement like the following: (1) The FOMC has determined that it will retain its inflation-targeting framework, with a symmetric inflation target of 2 percent. The FOMC will continue to pursue its balanced approach to price stability and maximum employment, meaning in particular, that the speed at which the FOMC aims to return inflation to target will depend on the state of the labor market and the outlook for the economy. (2) However, the FOMC recognizes that, at times, the zero lower bound on the federal funds rate may prevent it from reaching its inflation and employment goals, even with the use of unconventional monetary tools. The Committee agrees that, in future situations in which the funds rate is at or near zero, a necessary condition for raising the funds rate will be that average inflation since the date at which the funds rate first hit zero be at least 2 percent. Beyond this necessary condition, in deciding whether to raise the funds rate from zero, the Committee will consider the outlook for the labor market and whether the return of inflation to target appears sustainable. Of course I'd prefer NGDP level targeting, partly for reasons outlined in this post. But Bernanke's proposal would still be a dramatic improvement over current policy. More importantly, this is something that is much more politically feasible than any other proposal that I've seen. It actually makes the long run future price level more predictable than under current policy, which conservatives should love. It makes policy more expansionary at the zero bound, which liberals should love. It also eliminates the need to offset under and overshoots of inflation when not at the zero bound, which should assuage the fears of those who oppose traditional forms of level targeting. Indeed I think Bernanke's proposal is now the odds on favorite to be official Fed policy the next time the US hits the zero bound. Most people at the Fed understand that something like this is needed at the zero bound, and Bernanke's proposal could be sold to Congress as being fully consistent with the Fed's 2% inflation target. You might assume that under Bernanke's proposal we'd still be at the zero bound, because we are still far below the 2% trend line from 2008. Not necessarily: Note though, that if this policy rule had been in place prior to 2008, and if it had been understood and anticipated by markets, then longer-term yields would likely have been lower and the effective degree of policy accommodation during the past decade might have been significantly greater. In that counterfactual world, inflation might have been higher and the average-inflation criterion might have already been met. This is because the Fed would have already communicated their intention to be more accommodative going into the ZLB episode. (9 COMMENTS)[...]