I never considered myself a macroeconomist. When my job required me to discuss macroeconomics, I did it, but I wasn’t as good at it as I was with other projects. Trying to predict next quarter’s GDP growth or discuss the implications of the Fed’s rate cuts was not something I did well. At my most dismissive, I would call it ‘macro-voodoo’. I liked basic price theory much more.
However, it is really important. Despite my aloofness, there is a lot—a whole lot--to say about macroeconomics. Here are some quick takes:
A simple model
One simple model I have is that the economy is like a car going down the road. We don’t want bumps in the road (recessions), but once we smooth the road, we will naturally drive too fast (too much leverage, over extended consumers and businesses) and the crashes become much worse. Recessions are bad, but we want them to be bumps, not crashes.
Macroeconomics and regulation
Regulatory policy is underrated. Traditionally, macroeconomics has talked about two broad tools that the government has: monetary policy and fiscal policy. I think there is a third policy tool: regulatory policy.
Regulatory policy covers a lot: taxes, labor, trade and tariffs, capital reserves for banks, health care, energy, agriculture, etc.
Here is where macro blends into microeconomics. Want more housing? First, get rid of rent controls. Want lower energy prices? Don’t ban certain forms of energy production.
The Ideal Stimulus Program
Have we stumbled upon the ultimate fiscal stimulus tool in the last twenty years? When I studied macroeconomics, fiscal policy through government spending was stuff like infrastructure, jobs programs, and increased unemployment benefits. The economics all worked out that under the right assumptions there could be a nice multiplier effect from government spending. The concern was that this spending had inefficiencies, drags and unintended consequences, so it might be far less effective than anticipated or simply too late.
I can think of at least two instances of the U.S. government just sending out checks to people, which when you think about it, has to be the quickest, most efficient way to stimulate an economy: just give people money to spend. This is the helicopter effect that textbooks talk about. I think it is a significant ‘policy innovation’ or tool that future administrations will use.
Instance #1: In early 2008, there was a big concern that we were heading into a recession. If I remember correctly, $600 dollar checks were widely sent to low and middle-income wage earners. It stimulated the economy enough that the second quarter had positive GDP growth, but this was a huge deception and in the third quarter the economy plummeted into the Great Recession.
Instance #2: In Covid, the government sent out checks to an even wider group of people and gave away money to businesses ostensibly for payrolls. This succeeded so well that it helped ignite the highest inflation rate in 40 years.
The Fed Target Rate
I have an iconoclastic view on how the Fed should set interest rates. I believe the proper long run target policy rate is about 0.25% higher than the target inflation rate. Economists call this r* (“r-star”) and it has been a huge area of research and debate. Historically, my r* has been much, much lower than the economic consensus, which has been set around 2.0% and I’ve seen some analysts go as high as 2.75%. The historic consensus view would put the long run Fed target rate at 4.0% (2.0% inflation + 2.0% r*), while I would have it at 2.25%.
My short rationale: Economists have been confusing a short-term riskless rate (3mo T-Bills) with the aggregate cost-of-capital, which in equilibrium has to equal the nominal growth rate of the economy.
Think of it this way: why should the most risk-adverse investors—people in money market and short-term CDs--deserve to earn the growth rate of the economy? They are taking the least amount of risk possible; they should earn only a very small slice of the real growth rate. I wouldn’t be surprised if r* is as low as 0.10% or 0.05%.
In my model, equities earn above the nominal growth rate of the economy and government bonds earn below the nominal growth rate of the economy (but above inflation—they do have a modest real return). In equilibrium, the market weighted average of the asset classes is equal to the nominal economic growth rate.
Also, if cash earns the growth rate of the economy, then where do the returns for bonds and equities come from? Labor?
The old consensus of r* around 2.0% has slowly been revised closer to my view. In the latest Fed projections, I interpret their long run r* to be about 0.75%, a more plausible number.
I will write more about this at another time.
That’s it for now.