Relevant and even prescient commentary on news, politics and the economy.

Low Interest Rates have become a Self-fulfilling Prophecy

So the Fed has kept interest rates at their rock bottom. Will they ever be able to raise them? Let me take a closer look…

Tim Taylor writes about the impact of low long-term interest rates. He ends his post with this quote…

“The BIS report raises the uncomfortable question of whether we are riding a merry-go-round in which sustained ultra-low interest rates bring financial weakness in various forms, and then the financial weakness is the justification for continuing ultra-low interest rates.”

The idea is that ultra-low interest rates have become a self-fulfilling prophecy in that they have led to conditions that further justify them.

I wrote about this issue last December here on Angry Bear. (link) All I had to do was search for “self-fulfilling prophecy” to find the post. The IS-LM model was used to show how low interest rates beget low interest rates when one sees full-employment much greater than it really is. Full-employment is when output reaches its potential.

Tim Taylor includes this point in his post referring to a BIS article…

“After all, pre-crisis, inflation was stable and traditional estimates of potential output proved, in retrospect, far too optimistic. If one acknowledges that low interest rates contributed to the financial boom whose collapse caused the crisis, and that, as the evidence indicates, both the boom and the subsequent crisis caused long-lasting damage to output, employment and productivity growth, it is hard to argue that rates were at their equilibrium level. This also means that interest rates are low today, at least in part, because they were too low in the past. Low rates beget still lower rates. In this sense, low rates are self-validating.”

From the point of view of Effective Demand, the economy is already at potential output as seen in the following graph. Blue line is how effective demand sees the output gap. Orange line is how the Fed and CBO see the output gap. (Keep in mind that the CBO keeps adjusting potential output to be less optimistic. They still have a lot of adjustment left, but they cannot make huge adjustments at once. So we are stuck with a CBO potential output that must slowly come back to reality.)

update output gap 1

This point was also reflected in a post by Paul Krugman today where he sees the Fed’s projection of the NAIRU receding over time. (link) The confusion of the potential is rooted in why inflation keeps being so weak. There are reasons for continued weak inflation even in spite of the US economy being at full-employment and potential output.

From the point of view of effective demand, once again the view of potential output is far too optimistic. I do not see a negative output gap. The business cycle has already closed the gap. The post I wrote last December uses the IS-LM model to show how the interest rate will stay low when the view of potential output is too optimistic. (I will not repeat that post here. You can read through this link.)

I will finish this post with a comment that I made to Julian Silk under that post from last December. It is somewhat prophetic.

“Inflation has a good chance to fall below 1%. What should the Fed do? They will not be able to raise the Fed rate. They are too far behind the curve now.

There was a window that they had to go through a couple years ago in order to start raising rates. They had to bite the bullet and challenge the markets at that time. There has to be more destruction in the economy in order to have more productive firms. The markets needed discipline but the Fed kept babying markets. The economy is now basing its production and investment decisions upon low rates. They know that the Fed is incapable of disciplining. The Fed cannot risk a downturn from disciplining the markets. The markets had resilience a couple of years ago but not now.
So I agree with you that rates will not rise. Money demand is not going to be strong on its own. The Fed has been forcing artificial money demand for too long. In general the economy still wants to save. There should have been much more fiscal stimulus.
So now I say that the liquidity trap has become a self-fulfilling prophecy. The Fed was unable to discipline the markets. Now they are weak and accustomed to being spoiled even though profits are high. The system is not working. Standards of excellence have fallen. The economy is decaying.”

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A Carleton S. Fiorina Finger Exercise

Brad DeLong catches Tim Berners Lee Timothy B. Lee [h/t Bob in comments] being, to be nice, disingenuous:

…The idea was that [HP and Compaq] would be able to do the things they already did more effectively if they joined forces. Management consultants who examined the merger for HP found that (as Fiorina loved to put it) HP and Compaq ‘fit together like a zipper’…

Stop right there: when you are reduced to quoting management consultants hired to make the case for the deal the CEO wants to do, you are demonstrating that you have no good arguments.

Brad is being too nice. Here’s the Daniel Davies-style Finger Exercise:

  1. A CEO runs a company with an annual ROE of X. They are considering buying a company of similar size that (best case) products that might be complementary to—but also modular to—the company’s highest-margin good.
  2. The company to be aquired has a current annual ROE of Y. Y is significantly less than X, and the company’s primary market continues to become increasingly commoditized.
  3. The CEO tells you they are doing this in an attempt to increase the company’s margins (which should in turn increase company ROE).


1) Attempt to specify an algorithm that can justify your claimed expectations. Caution: use of negative coefficients is not permitted.

Use your results to answer the following questions:

2) Is there anyone with math skills greater than the average third-grader who couldn’t see at the time that this was sheer idiocy?*

3) Would you be surprised if that CEO were fired and never again offered the opportunity to run a company of any size?

Bonus Question:

4) Even granting West Coast bias, why would anyone looking at Fiorina’s performance at Lucent have been silly enough to offer her the job at HP in the first place?

*Exclude Carleton S. Fiorina and Michael Eisner from possible answers

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Low Unemployment with falling Capacity Utilization… Not a good sign for Fed Liftoff

Should the Fed raise the base interest rate? They really shouldn’t at this point. Will they? They probably will because they still see years of growth. I do not see years of growth ahead… Let me explain.

Almost one year ago I wrote that capacity utilization would start falling. (link) It has fallen since that time, even until today’s report that capacity utilization in August was 77.6%. This number was below expectations but perfectly in line with a limit line in a model that I use.

The model plots the movement of capacity utilization and unemployment. The model has two limit lines that act upon the increasing utilization of labor and capital. One for Effective Demand (basically labor share) and one for Profit Maximization (equation in graphs). The utilization of labor and capital moves toward the limits during a business cycle to increase profits. Once the movement hits the limits, profits are further increased by only moving downward along the limits, which means that capacity utilization will decrease as unemployment falls. This pattern has existed for decades before a recession. When the plot starts to pull away from the limits, a recession is beginning.

Here is the model from a year ago.

3d sept 2014

When I saw the plot reaching the limit lines last year, I wrote…

“My sense is that firms are in a race to maintain profit shares at the end of a business cycle. They felt the chill of declining profits in September. From here on out, firms will have to contract in order to maintain profit shares, as seen by the plot hitting the orange line. Now firms will have to contract capital utilization while trying to maintain the same output in order to maintain profit rates.”

So here is the model with data since September of 2014. The coefficients seen at the top are the same in both graphs for easier comparison. The coefficients though can change if labor share was to significantly change.

update 3d monthly

Yes, everyone loves the fact that unemployment is falling, but at the same time capacity utilization is falling perfectly to keep profits maximizing. Is that a good thing? Well, the business cycle stays alive and more people get hired. However, this process has its limits. Capacity utilization is now being maxed out on profits. Generally throughout the economy, it is currently only profitable to lower unemployment at some cost of capacity utilization. When capacity gets restricted too much without labor share rising, a recession becomes easier to trigger. Then we would see the plot moving up and to the left with capacity utilization falling and unemployment rising.

So the Fed decides this week whether they should raise the Fed rate or not. They are encouraged by the low unemployment number. Yet, from my perspective, the economy is very close to the end of the business cycle and too sensitive to tightening of monetary policy. The Fed could push the economy into a recession with a Fed rate rise. Basically, the Fed can no longer raise the Fed rate during this business cycle. It is too late.

According to the graphs, the natural rate of unemployment would be where the plot touches the limit lines. In this business cycle, it appears to be around 5.6%. So we have already passed the natural rate of unemployment. It is doubtful that we will see much if any inflation as conditions just do not support inflation with low interest rates promoting supply vis-a-vis weak labor share of income.

So the Fed is seeing that unemployment will drop further, and they expect some rise in inflation. However, if they are expecting a few more years of growth in this business cycle… I beg to differ.

In order to extend the life of this business cycle, the Fed should really not liftoff the interest rate.


J.Goodwin in the comments below requested a look at this model for the 1980’s. Here it is. You will see that the effective demand limit was higher at 80.2%. The “b” coefficient is the same as now. The movement of capacity utilization and unemployment headed straight for the crossing point of the two limits as they did in this business cycle. You will also see that in mid 1989, capacity utilization started to fall abruptly leading up to the recession a bit later.

You will also notice in the middle of the plot that in 1986, capacity utilization fell abruptly while unemployment stayed fairly steady. 1986 and 1987 were a global crisis of foreign debt which stressed business. But in the end the economy pushed through the problems because there was still effective demand to expand the utilization of capital and labor together.

1980s 3d

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Capital Flows, Credit Booms and Bank Crises

by Joseph Joyce

Capital Flows, Credit Booms and Bank Crises

Studies of the impact of capital inflows have established that debt inflows can lead to bank crises (see here and here). Unlike equity, payments on debt are contractual and can not be cancelled if there is an economic downturn, which intensifies any shocks to the financial system. In the case of short-term debt, a foreign lender may decide not to roll over credit at the time when it is most needed. But recent papers have shown that foreign debt can also be a determinant of the credit booms that lead to the bank crises.

Philip Lane of Trinity College and Peter McQuade of the European Central Bank (working paper version here) looked at the relationship of domestic credit growth and capital flows in Europe during the period of 1993-2008. They suggest that financial flows can encourage more rapid credit growth by increasing the ability of domestic banks to extend loans, while also contributing to a rise in asset prices that encouraged financial activity. They found that debt flows contributed to domestic credit growth but equity flows did not. Moreover, the linkage of debt and domestic credit was strongest during the 2003-08 pre-crisis period.

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70% Defaulted in 2013

To add to this attention getter, 70% of all the students who defaulted in 2013 went to non-traditional schools or “for-profit” schools. Of students who graduated from traditional schools and were required to start paying back student loans in 2011, two percent of graduate students and eight percent of undergraduate students defaulted as compared to ~21% of students from non-traditional schools within two years. Mind you, this does not exonerate traditional schools from the financial burden placed upon graduating students. The only cost increasing at a faster rate than healthcare is the cost of pursuing a college education.

invisible hand

In 2000, one nontraditional school of the top ten schools was the second highest with associated student loan debt to attend it. University of Phoenix was second to a traditional school at $2.1 billion. In 2014, the University of Phoenix moved to #1 at $35 billion of associated student loan debt to attend it. Of the next 10 schools, 8 were non-traditional and 2 were traditional schools in 2014. New York University went from 1st on the list in 2000 to 8th on the list in 2014 with triple the amount of student debt associated with getting a degree there. The number two school in 2000, University of Phoenix amassed student loan debt of $35 billion to attend. This was more than 17 times what the University of Phoenix had in 2000.

The numbers of student loan borrowers doubled from 2000 to 2014 to 42 million and the debt quadrupled to $1.1 trillion. With this explosion in borrowers and increase in debt, defaults reached its highest level in 20 years. “Half of the borrowers exiting college in 2011 had attended a for-profit school or a 2 year college and represented 70% of the student loan defaults. As reported in “A Crisis in Student Loans?,” the default crisis centered around borrowers who attended non-traditional schools such as Phoenix and to a lesser extent two year colleges. In the past those who attended non-traditional schools represented a small portion of borrowers and those attending two year schools did not require borrowed funds to attend. So what changed?

Student loans are the roach motels of the banking/lending industry. Once you sign on the dotted line at 18 years old, you are little more than an indentured servant to the ultimate bill collector, the government, until the loan is paid off or you become disabled or die. This type of loan can not be discharged in bankruptcy. However, this is not just a story about young men and women going to college at 18. From 2000 onward with the decrease in higher paying and lower skill jobs, many older and low income people went back to school to improve their skills and knowledge in the hope of becoming technicians, nurses, etc. Especially in 2008 and afterwards when companies laid-off thousands of people, Labor went back to school as a panacea to lack of work. It did not work quite as they had hoped.

Schools and especially nontraditional schools engaged in deceptive advertisements for job placement and graduation rates advertising their offering of additional education in specific fields as the elixir to a lack of jobs in the less skilled fields. I am sure you have seen the TV commercials and billboards advertising making more money. Furthermore, most nontraditional schools did not offer grants or scholarships; however, the lower income students were eligible for the ~$5,000/year Pell Grants. 73% of the lower income students enrolled in nontraditional schools applied for these grants as opposed to 37 to 45% of students at traditional colleges and universities. Unfortunately, the Pell Grant paid only a portion of the average yearly tuition of ~$15,000 at a nontraditional school.

Nontraditional school students ran up against a limitation on Federal backed loans. The Federal Government restricts what an 18-year-old undergraduate can take out in loans to ~$31,000 and ~$57,000 for older, independent students. As a result, students at nontraditional schools needing more money turned to the shark-pool of commercial loans which also can not be discharged in bankruptcy and with the government acting as the “ultimate” bill collector again. Some nontraditional colleges also offered in-house student loans. Now in bankruptcy, Corinthian Colleges was one of the nontraditional schools offering their “Genesis Loan” with an interest rate sometimes as high as 15%. Finally waking up after the bankruptcy, the Consumer Financial Protection Bureau is suing the college for setting tuition as high as $75,000 for a bachelor’s degree forcing students to take loans, guiding students to in-house loans to pay the tuition, and partaking of some of the lender loan fees. This was also a practice engaged in by traditional schools, which ended in the late nineties as the government cracked down on the practice

As Adam Looney and Constantine Yannelis reported in A Crisis in Student Loans? the numbers of those defaulting on educational loans has dropped for nontraditional for-profit schools which means the twenty year high will also decrease over time. I would point out the schools such as the bankrupt Corinthian Colleges as well as DeVry, Kaplan, ITT Tech, and others are under government investigation for deceptive recruitment tactics, falsifying job placement, and graduation rates. There has been no solution for the thousands who took out loans in the hope of bettering their future. In the mean time, the government will continue ham-fisted-bill-collecting role for private businesses making the loans.

These are the Schools Driving America’s Student Loan CrisisJim Tankersley and Danielle Douglas-Gabriel, The Washington Post, September 10, 2015

A crisis in student loans? Adam Looney and Constantine Yannelis, BPEA Conference Draft, September 10 – 11, 2015

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Conceding too much to Supply Siders

This is my usual post lamenting the fact that reasonable people allow supply side dynamic scorers to set the terms of debate. They confidently assert that tax cuts for the rich cause more rapid GDP growth and want to argue whether that means they pay for themselves . Jeb!’s economists admit that they don’t without 2 magic asterisks. But if one concedes that the effect on growth is positive and argues about the magnitude then one should concede that taxes on the rich should be cut — we don’t dislike deficits because they cause us pain by themselves but rather because they harm the economy.

There is no reason to believe that cutting the top marginal tax rate will cause higher GDP growth. The evidence points the other way.

The very excellent Kevin Drum makes my knee jerk with one sentence (with which I don’t even disagree) in this excellent post on the conservative Tax Policy Center’s analysis of Jeb!’s proposed tax cuts.

My comment.

Nice catch and post. However I think you (impicitly) conceded too much when you wrote “The Tax Foundation has a very rosy view of dynamic effects, which are almost certainly far less than they estimate.” The reason is that “less” can mean smaller (closer to zero) or lower (closer to negative infinity). In principle, it is also possible to argue that Jeb’s tax cuts will cause 20% lower GDP. is this less than the effect the tax policy center asserts ? It’s larger in absolute value.

I haven’t run the numbers (I can’t) but I am confident that Jeb’s plan would cause lower growth. Partly this is because of post WWII data on top marginal tax rates (I admit on labor income) and growth in OECD countries. Atheoretic estimates, if taken literally, suggest that the growth is maximized at a top rate of over 50% (some estimates are 70%). In contrast, I know of essentially no evidence published in the peer reviewed literature that lower rates cause more rapid growth (the essentially is in regressions which consider convergence that is incude initial per capita GDP as a regressor — it’s negative coefficient is overwhelmingly statistically significant for the sample.

The Jeb team analysis (not tax policy center but Feldstein Hubbard et al) assumes additional growth from unspecified regulatory reform and also assumes unspecified spending cuts. They consider no effects of spending but costs — that is assume the spending is pure waste. In standard models, eliminating wasteful government spending causes increased growth, but the assertion that government spending is waste is completely unproven in the Jeb team analysis — it is just assumed.

This is important because if the tax cuts without the magic spending cuts cause higher deficits, the higher deficits will cause higher interest rates (The Fed is lifting off the zero lower bound soon or in a few months) which cause lower investment which causes lower growth.

Back to atheoretic data analysis — deficits are strongly negatively correlated with growth. Of course the case against supply side voodoo is very familiar to Americans who follow the news with the Clinton tax increase followed by a boom and the W Bush tax cuts followed by disaster and the 2013 tax increases followed by a (slight) increase in GDP growth.

My point is that international evidence and reasonable theory support the impression that the Tax Policy center didn’t just get the magnitude of the dynamic effect wrong but also are wrong about its sign.

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Rapid Progress Towards Real Reporting at the New York Times

At 12:07 Eastern standard time 9/10/2015 Alan Rappaport wrote an article on Jeb Bush’s tax proposal whose headline seemed to me to be the title of a Bush campaign press release — it stressed the proposal to close the carried interest loophole and not the huge cuts to top tax rates. About 4 hours later Rappaport and Matt Flegenheimer wrote a Ballanced article whith a headline which noted both.


Then after 2 more hours Josh Barro wrote a serious analysis of the proposal noting that it, like all Republican tax proposals, would amount a to huge gigantic tax cut for the rich (and small piddling tax cuts for the non rich).


I think this shows the huge gap between beat reporters who aim to please sources and blogging related journalistic activities which are based on looking up the facts and analysing them. The problem is that the Barro article in the upshot will get much less attention than the Rappaport and Flegenheimer article on the web front page.

To me the key question is whether the new blogger influenced fact based journalism of the Upshot, Vox, Wonkblog, TPM etc will prevent Republicans from tricking voters about their plans to serve the rich as George Bush did in 2000.

Do opinions on shape of planet still differ ?

This has become very strange. The front page includes a link to Barro’s article but the headline on the Rappaport and Flegenheimer article has regressed describing huge tax cuts for the rich as “populism”. The NYTimes headline writer is debating with himself or herself. I guess the insane new main headline was needed to Ballance Barro.


I wonder if part of the issue is innumeracy. Vastly more dollars are involved in the rate cuts than the carried interest loophole but rate cuts consist of replacing a number with another number while “the carried interest loophole” is a phrase. I don’t see how anyone with any sense for numbers can present both in parallel in the same abstract as if they were remotely similar in scale.

update:Well the blogosphere sure is on it. The NY Times and especially the un-named Times person who wrote “populism” in the headline is being denounced vigorously
ed Kilgore links to

Jonathan Chait who covers the coverage much better than I do. Chait has an anti-blogger past (really he wasn’t always a blogger) so he contrasts narrative based journalism and data driven journalism. He admits he doesn’t know how it will turn out (data journalism is still relatively obscure — will the front page journalists be willing to learn from the nerds on the back pages ?). But the point is just read Chait — he’s done more research than I have (a low bar to clear) and writes better (a lower bar).

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