Tag: federal-reserve

What I got wrong in 2020

Just as there are some things I got right in my early impressions of the pandemic, there are things I got wrong. There’s a saying that economists have predicted 8 of the last 2 recessions, and it resonates with me more than a little; I’ve also internalized Pavement’s question, “Is it a crisis or a boring change,” when thinking about the likely magnitude or direction of a change, between the onset of the pandemic and now. Given my on-the-record praise for other economists that have admitted their mistakes, I’m doing this for accountability. My mistakes definitely aren’t isolated to these, but these are three big ones, at least domestically, that have affected my thinking overall.

Financial Deregulation and the Risk of Crisis:

Early in the pandemic, there was a proliferation of articles about the likelihood of bank and business failures, zombie firms, and more as the Federal Reserve and US government rushed to implement emergency lending measures, grants, and loans that were apparently always intended to be grants (ahem, Paycheck Protection Act). It’s hard for me to think back to March of 2020 without my heart rate rising, given all the articles about miles-long lines of cars at food banks while farmers buried rotting produce that they couldn’t sell to restaurants and my pessimistic assumption that congress would fail to respond decisively, as it had after 2008. Early reports that the Fed and Congress were rushing programs to bail out airlines whose passengers were locked down and couldn’t fly, lifting reserve requirements for banks whose borrowers couldn’t pay interest on loans, and other support for firms seemed like a typical Washington approach that would prioritize corporate interests at the expense of households. Like more than a few progressive observers of banks, I worried that removing reserve requirements and otherwise softening capital requirements would risk another Global Financial Crisis on top of all the other Pandemic related economic fallout.

As it turned out, I was… wrong? As I’ve mentioned in other posts, I was wrong about Congress’s willingness to pass policies that made a material difference for households (poverty rates actually fell while expanded unemployment insurance was in effect). But I was also wrong that banks were bound to fail if they weren’t required to hold reserves. Indeed, banks wouldn’t really start to fail until much later, after the Fed had been hiking rates for almost a year, more on which later…

The scope of inflation we would ultimately observe

I’ve been teaching macroeconomics classes (principles and intermediate level) since 2010, and it wasn’t until about three years ago that I finally had to hand it to students that inflation was worth being a major source of concern. (I’ve written about this on this blog.) Early in Covid, as governments around the world announced lock downs to attempt to contain the spread of the virus, I panicked about the likelihood of supply shortages and prices rises. (To be fair, I was panicking about a lot of things, local, global, social, economic, you name it.) And then … I mostly stopped? I was intrigued by the slowdown in shipping time of furniture and other more substantial goods like appliances by the summer of 2020 and beyond, but I figured that if prices weren’t rising, then maybe it wasn’t going to be such a big issue?

Ha. Ha ha ha.

As we all know, inflation rates rose in the US considerably. While I still believe that most of that change was transitory (at least by an economist’s understanding of inflation as the rate of increase of price levels, rather than a reversion of prices to lower levels), and that most of that inflation was supply related (which I’ve written about with Jason Oakes elsewhere), it’s undeniable that changes in demand have had some role rising prices over this period. I wish it weren’t so! But in 2024, I don’t think we can deny that upper and upper middle income households propensity to purchase new homes or renovate existing housing highlighted the gaps in productive capacity that had to some large degree been a legacy of the anemic response to the Great Recession. If demand increases, especially if supply capacity has been shrunk, prices are likely to rise. Leaving any moral judgements about the intent or the outcome aside, if firms observe that many households’ demand has increased, and they figure that the time is right to raise prices, even if it’s greed induced, that movement sprung, in part, from the demand shock first.

Real incomes have risen over this period, particularly for the lowest income households, which helps, of course, though the expiration of lots of subsidies from the government for a wide range of services including child care centers have exacerbated the cost problem since 2020. The  largest sources of inflation are housing (subject to supply constraints and sensitive to interest rates, about which more soon), and auto insurance (something I do want to dig into more), which is a source of some optimism and some pessimism, but there we are. And climate change certainly doesn’t help, when resources for building new housing (like timber) are vulnerable to heightened risks of wildfire, and other volatile agricultural commodities (grain, peas, and more) are vulnerable to increased propensity of catastrophic weather events. While I think that these have the potential to stabilize in the face of major industrial policy and subsidies to households, I know that’s not a universal position, but it’s a topic for another day. At the very least, I’d like the Fed and Congress to weigh in more on how to target their policies to better elevate lower-income household spending and home construction.

The likelihood that Jerome Powell and the Fed would go back to inflation targeting policies when that inflation shoe dropped

Well, it was good while it lasted. I loved the expanded credit facilities under Covid. I applauded Powell’s recognition of racial inequity in unemployment rates. I appreciated the shift to an average annual inflation target. I somehow – and I know just how naïve this is – forgot that if inflation breached a certain level, that the Fed and other major central banks would probably certainly shift back to raising rates.

I am ambivalent about aspects of this strategy – there’s a political value to some degree in targeting rate hikes when vast numbers of Americans argue that inflation is out of control and something must be done, though I’d guess that a lot of people are less immersed in the ways that those changes are meant to play out and the material consequences of rate hikes. I’ve had lots of friends outside of academia and, ah, social media, lecture me about interest rates and how bad their attempts to sell/buy homes have been. Fundamentally, I think it’s bad, not good, for rates to rise when we want more business development and housing construction. I also think the international spillovers of the Fed and others’ rate hikes have been awful, and I’ve been somewhat buoyed by some very mainstream economists’ arguments in favor of debt forgiveness as a strategy.

Another source of my ambivalence has to do with the practical impact of monetary policy. In recent history, long stretches of low interest rates have helped the tech industry flourish during a period of sluggish demand in the decade after 2008; rate hikes since March 2022 have played some significant role in the failures of the tech sector since. Those rate hikes and defaults have also played a role in generating financial instability in banks, if we think back to the Silicon Valley Bank fiasco and others. I’d bet that the development of the cryptocurrency industry likewise has something to do with low demand, low interest rates, and idle venture capital, but I want to read more about it first. The Fed’s willingness to use very targeted support for banks without lowering interest rates was interesting to watch, and may be a harbinger of what’s to come policy wise in the future.

When I teach macro, I’ve increasingly been asking students to think about both demand and supply dynamics when modelling a shock to an economic system. Traditionally we leave some forms of spending as demand, despite their links to supply (chief among them, investment expenditure), and we also assume that some policies like a tax cut or a rate hike will only operate on the demand side, though taxes and interest rates are clearly costs for firms. All of this adds ambiguity to the potential effects of interventions on the economy at large, and it’s something I’m expecting to dig into more in my own work going forward.  

About that NYT Piece

I had the pleasure of providing some background information for a provocative piece that Talmon Joseph Smith recently wrote for the New York Times about some analysts’ and economists’ tentative arguments about the possible end of the business cycle, given the apparent soft landing of the US economy after more than a year of steady rate hikes. I even have a quotation in it, about how I’m sometimes freaked out by how optimistic I feel about things, at least economically.

I’d be lying if I said that reading that line in the paper of record didn’t make my stomach do a flip or two. I’m superstitious on the best day, and I feel baseline uneasy about any positive outlook I might have for the US or world economy at large. My mind may have even flashed to Gob Bluth saying over and over again, “I’ve made a huge mistake” as I saw bemused reactions to the piece on social media: “so … uh… what makes this time different?” “just wait for that Minsky moment!” “these economists really think crises are over?”

So, some clarification. First of all, read the piece! No one thinks the economy is immune from external shocks; I certainly don’t. When economists and analysts discuss the possibility of a softening business cycle, what we’re talking about is what happens after the shock. There’s also nothing saying that business interests won’t somehow bring about a recession of their own volition; I have many ambivalent feelings about crypto and other asset bubbles, and I was on tenterhooks for the duration of the Silicon Valley Bank fiasco (about which more later). Here’s what I feel optimistic about: in contrast with 2008, the US’s federal government and the Federal Reserve together mobilized lots of spending, massive liquidity provision, and novel methods of stabilizing volatile asset markets to prevent fears about the domestic and global economy from bringing about those feared changes. Solidly mainstream economists have discussed how their fears that expanded unemployment insurance might tank labor markets after the pandemic have publicly announced their errors, and recommended that policy makers consider similar measures next time around. Even the fickle Fed, which spent more than a year raising rates and likely helping cause instability for a bunch of mid-size banks continued to provide ample support for banks and international central banks (a selection of them, anyway) worried about their solvency in the days and weeks after SVB’s failure.

If we compare these responses with government and Fed responses to the 2008 Global Financial Crisis, there’s a wide gulf. The scope and the range of the Fed’s responses to crises since 2008 dwarfs that earlier response, which was, itself, remarkable at the time. The federal government’s interventions have supported households, small businesses and banks, and large businesses and banks. As mentioned, mainstream economists that I ‘did not have on my bingo card’ came out, on the record, in support of expanded unemployment insurance, and have levied more than fair criticism of the support that went to firms who did not, um, use the funds for what they said they would. And to anyone smirking about Minsky moments, it would be worthwhile to remember Mike Beggs’s always germane writing about those moments, and the fact that the Minsky Moment is the rescue, rather than the crisis itself.

There’s also the point Talmon Smith makes about the makeup of the US economy, and the sheer mechanics of spending and GDP and what translates as a recession. We all observed the massive decrease in spending in March and April of 2020, and then almost immediately, there was a big rebound in all kinds of spending. Many firms in the service industries – coffee shops, restaurants – and other retailers figured out how to make the remote commerce thing work. Purchase of goods from online retailers boomed past anyone’s imagination. Large swathes of unemployment payments allowed furloughed waitstaff and other workers to keep spending. All of this contributed to the recession being two months. Two months! It took a while for consumption to reach its pre-March trajectory, but it’s incredible that we’ve actually rejoined our pre-2008 trajectory as other sectors of the economy have rebounded. I’m always struck by this when I walk through US GDP data with my macro students, and I do it a bunch of times each semester.

Something that didn’t make it into the piece that I think is really important is that while I think it is excellent that policy makers are quick to use these tools during crises, I wish that policy makers in the government and at the Fed were more sanguine about deploying these tools for the social benefits that would follow outside of crises. Jamie Galbraith is right that we shouldn’t dismiss perceptions that the economy is not perfect for everyone, even if many metrics, like wages for the lowest income brackets, have shown huge improvement since 2020. I’d like the Fed to make dollar swap lines available to way more economies’ central banks. The end of the Child Taxcare Credit was a huge policy failure. I want more targeted credit facilities, and I’d really like the Federal Reserve to do something about liquidity risks likely to flow from climate change. I think that subsidies for housing, education, and more should be constant phenomena. I also think that a uniform and federally administered unemployment insurance system would be a gargantuan improvement over the US’s state-level hodgepodge of systems that range from the overtaxed and slow to the frankly awful, before we can move on to expanding unemployment payments more generously as a baseline. I also think that we should raise corporate taxes and minimum wages, pass more union friendly legislation, increase all manner of social benefits and on and on.

Ultimately, none of this is mutually exclusive with my being more optimistic about the potential for the US government to respond to economic crises in ways that lessen the long-term hardship created by the initial recession. We should have more debt relief for students, and lower tuition levels for public education in any event. We should have more unemployment for people, whether we’re in a once-in-a-century pandemic or not. We should have more policies that have been proven to shrink the poverty rate (which should, itself, be recalculated to better serve households across the country). At the same time, it’s a very good thing to be able to count on a government to do more to support its population. What really freaks me out is the prospect of losing a government that thinks that this is a good thing, on net. But that’s another story!