J. Bradford DeLong

Fiscal Policy in a Depressed Economy

In a depressed economy, with short-term nominal interest rates at their zero lower bound, ample cyclical unemployment, and excess capacity, increased government purchases would be neither offset by the monetary authority raising interest rates nor neutralized by supply-side bottlenecks. Then even a small amount of hysteresis—even a small shadow cast on future potential output by the cyclical downturn—means, by simple arithmetic, that expansionary fiscal policy is likely to be self-financing. Even if it is not, it is highly likely to pass the sensible benefit-cost test of raising the present value of future potential output. Thus, at the zero bound, where the central bank cannot or will not but in any event does not perform its full role in stabilization policy, fiscal policy has the stabilization policy mission that others have convincingly argued it lacks in normal times. Whereas many economists have assumed that the path of potential output is invariant to even a deep and prolonged downturn, the available evidence raises a strong fear that hysteresis is indeed a factor. Although nothing in our analysis calls into question the importance of sustainable fiscal policies, it strongly suggests the need for caution regarding the pace of fiscal consolidation.

Asset Returns and Economic Growth

America is probably facing a slowdown in the rate of natural population increase and possibly a slowdown in productivity growth. We argue that, if these two factors depress the rate of future economic growth, one cannot assume that the past performance of asset returns is indicative of future results. Simple standard closed-economy growth models predict that a growth slowdown will likely lower the marginal product of capital and thus the long-run rate of return. Moreover, if current asset valuations represent rational expectations, simple arithmetic shows that it is almost impossible for past rates of return to continue through a growth slowdown. In standard models at least, only a large shift in the income distribution toward capital, or future current account surpluses that are larger and more persistent than those that nineteenth-century Britain sustained for generations, give promise for reconciling a future slowdown with a continuation of historical asset returns.

Should We Fear Deflation

compared with only 36 in the first half of 1997 and 10 in the first half of 1990. For sixty years, ever since the middle years of the Great Depression, deflation was a nonissue. Next to no one worried about it. Next to no one viewed a general decline in the price level as even a remote possibility. Now people do. And now people worry about it. One reason to worry about deflation is that today the rate of inflation in the United States is quite low, less than 2 percent per year. But that is not the whole story. The post–Korean War 1950s and the early 1960s saw measured rates of inflation as low as those of today (figure 1). 2 Yet back then people worried not about deflation, but about inflation. 3 Why is it that, in the late 1990s, inflation of 2 percent per year or less calls forth the fear of deflation, where it did not in the 1950s and 1960s? The principal reason why the low inflation of the 1950s and 1960s did not create fears of deflation was that economists in those days believed that economic institutions had a bias toward inflation, a legacy of the Keynesian revolution. Today that belief in an inflationary bias is gone, or at least greatly attenuated. What has happened to that belief, and to that built-in

Financial Crises in the 1890s and the 1990s: Must History Repeat

THE 1990S HAVE seen three large international financial crises shake the world economy: the collapse of western Europes Exchange Rate Mechanism (ERM) in the fall of 1992, the collapse of the Mexican peso in the winter of 1994-95, and the East Asian financial crisis of 1997-98. Other crises late in the decade, in Brazil and Russia, did not develop the scope or reach of these three, even though observers and central bankers at the time feared that their consequences could become even worse.(1) The European crisis resulted from a standoff in economic policy between the chancellor and the central bank of Germany, Europes largest economy, over how to finance the enormous reconstruction expenditures required by the absorption of the former East Germany.(2) The standoff produced a monetary policy that was too tight for the rest of western Europe (and, indeed, too tight for Germany). Speculators bet that such tight monetary policies in other western European countries would prove unsustainable, and that political pressures in those countries to devalue their currencies against the deutsche mark would in the end prove irresistible. Speculating on the prospective collapse of the ERM thus became a classic one-way bet. Only even tighter monetary policies for the rest of western Europe could have provided an incentive not to speculate on the prospective rise of the mark, yet such policies had an even smaller chance of being politically sustainable in the long run.(3) In northern Europe, at least, the crisis looked self-fulfilling and self-generated: it was only the belief that macroeconomic policies would prove unsustainable in the end that made them inappropriate; in the absence of that belief, policies in those countries would in all likelihood have been sustainable and appropriate.(4) The second crisis, the collapse of the Mexican peso in the winter of 1994-95, did follow an episode in which monetary policy had been wildly, unsustainably expansionary throughout 1994. But this episode had been transitory, linked to the septennial redistribution of wealth and political favors by the corrupt Institutional Revolutionary Party as the outgoing president gave way to his chosen successor. Such a transitory burst of monetary expansion would not normally have been thought to have a significant impact on expectations. And whether the peso was overvalued in real terms as a result of this expansion depended on the long-run rate of flow of capital from the United States to Mexico. A high rate of inflow would require a relatively appreciated peso. Indeed, the two years leading up to the crisis had seen foreign exchange markets place at least as much upward as downward pressure on the pesos dollar value.(5) The third crisis, the Asian crisis of 1997-98, has so far proved impossible to fit neatly into the category of financial crises generated by macroeconomic instability. That crisis hit countries where the economic fundamentals were sounder and macroeconomic policies far less subject to criticism than was the case in either of the other two major crises. Their economies bore next to no resemblance to the picture painted by Paul Krugman of an economy vulnerable to currency crisis because it is pursuing unsustainable macroeconomic policies.(6) The economies of the Asian Pacific Rim hit by the crisis--Indonesia, Malaysia, Singapore, South Korea, Taiwan, and Thailand--had, as a group, achieved the fastest sustained rate of economic growth ever seen in any group of countries in any era.(7) Yet once investors in New York and elsewhere had decided that they had invested too large a share of their portfolios in Asia, the rapid shift in opinion and in capital flows had the same consequences as in Mexico and western Europe previously.(8) Practically every observer who commented on these successive waves of crises saw them as symptomatic of deep troubles in the structure of global finance. All agreed that if the financial system were properly structured and properly managed, we would not see so many severe crises following wave upon wave. …

Review of Skidelsky's John Maynard Keynes: Fighting for Britain

Skidelskys three-volume biography of Keynes, of which this is the third, gives us Keynes, entire. The meat of the biography lies in the well-constructed narrative and in the magnificent portraits of Keynes and his age. Robert Skidelsky has given us a superb intellectual biography.

Macroeconomic Vulnerabilities in the Twenty-first Century Economy: A Preliminary Taxonomy

Our current information technological revolution is, by crude metrics, two to three times the relative size of previous industrial revolutions which transformed the economy and the world. However, at the moment, it is anyones guess what changes in macroeconomic vulnerabilities and opportunities our current industrial revolution will bring. It seems highly likely that it will bring a better-performing labour market. It also seems highly likely that it will bring larger swings in asset prices and investment demand, which will call for more aggressive counter-cyclical monetary policy. It is possible that it will bring a reduction in the size of the inventory-driven component of the business cycle, and that it will add to the difficulties of financial regulation as complexity increases the governments task while euphoria diminishes its competence. Copyright 2002 by Blackwell Publishers Ltd.

Bending the Health Cost Curve: The Promise and Peril of the Independent Payment Advisory Board

Underlying todays and the futures health-care reform debate is a consensus that Americas health-care financing system is in a slow-moving but deep crisis: care appears substandard in comparison with other advanced industrial countries, and relative costs are exploding beyond all reasonable measures. The Obama Administrations Patient Protection and Affordable Care Act (ACA) attempts to grapple with both of these problems. One of ACAs key instrumentalities is the Independent Payment Advisory Board-the IPAB, designed to discover and authorize ways to reduce the rate of growth of Medicare and other categories of health spending. The IPAB is a peril. Expert boards to perform regulatory tasks in the interest of efficiency and social goals always run a high risk of being captured by the industry they are supposed to regulate. Even should it succeed at its task of reducing the rate of growth of Medicare spending, who is to say that the reductions will not come at a heavy cost in reduced quantity and effectiveness of medical care? But the IPAB also has promise. The need for a better process than our current specialist-driven one to assign value to the medical services provided by Medicare is great. The bellwether status of Medicare payment systems means that commercial insurance consumers and payors would also benefit mightily from bringing more coherent, technocratic, and cost-effectiveness oriented logic to this process. And the current system of relative Medicare reimbursement rates is, in the judgment of many, currently well out of whack. We quail when we consider the magnitude of the tasks the IPAB faces--even its initial task. Nevertheless, we remain optimistic that this administrative agency will manage to bend the long-run healthcare cost curve and moderate future price increases.

Divergent Views on the Coming Dollar Crisis

Is the U.S. vulnerable to a full-blown dollar crisis? Why are international finance economists scared and jittery, but domestically-oriented macroeconomists much less concerned?

Contrary to Robert Shiller's Predictions, Stock Market Investors Made Much Money in the Past Decade: What Does This Tell Us?

Bradford Delong and Konstantin Magin remind us that a decade ago, many thought the stock market overvalued, and yet on balance the last decade has been good for investors who bought and held. What does this tell us?