Studies in this week’s Hutchins Roundup find that the amount of monetary and fiscal space influences how well countries recover from financial crises; immigrants mitigate some negative impacts of technology on native workers; and more.
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Countries that lack monetary and fiscal maneuvering room fare worse after financial crises than others
Christina and David Romer from Berkeley examine how monetary space (interest rates far above zero) and fiscal space (relatively low debt as a share of GDP ) before a financial crisis affect an economy’s subsequent recovery. Using a new measure of financial distress for 24 advanced economies, they find that the aftermath of financial distress is much worse when a country lacks monetary and fiscal policy space than when it has room to use at least one policy aggressively. Specifically, the decline in output following a crisis is less than 1 percent when a country possesses both types of policy space, but almost 10 percent when it has neither. Further, they show that financial distress persists when there is less policy space. Countries with ample policy space use monetary and fiscal policy more aggressively, which largely explains this difference, they say.
Technological change over the last three decades has increased polarization in the job market, reducing demand for routine (middle-wage) labor, and increasing demand for cognitive- (high-wage) and manual (low-wage) labor. With data on local U.S. labor markets, Gaetano Basso of the Bank of Italy, Giovanni Peri of the University of California, Davis, and Ahmed Rahman of the U.S. Naval Academy find that immigrants mitigate this labor-market polarization for natives. Immigrants meet the demand for low-wage workers, which shields natives from downgrading from routine to manual jobs. Immigration also generates demand for mid-skill workers, they explain. The authors show that areas with a higher concentration of immigrants have smaller declines in routine jobs and wages, as well as smaller increases in manual employment and wages for natives. Without immigrants, mid-skilled natives would be more prone to employment losses and wage decreases, they find.
Olivier Blanchard of the Peterson Institute for International Economics and Lawrence Summers of Harvard draw several lessons for macroeconomics from the tumult of the past decade. Among them: (1) Monetary policy is not well equipped to head-off bouts of financial instability; instability is best prevented not by raising interest rates, but through macro-prudential and regulatory policy, including stiff capital requirements. (2) The notion underlying much of macroeconomics—that economic shocks are random, and that advanced economies rebound after such shocks and return to potential growth afterwards—is incorrect. “The relevant image is much more of plate tectonics and earthquakes,” they say. Stresses build slowly before a crisis, and often end with a long period of depressed output. (3) Reversing the conventional wisdom of the recent decades, fiscal policy is an important stabilization tool even in a time of high debt levels and is particularly important in an era of persistently low interest rates.
Chart of the week: Disability insurance enrollment is falling
Quotes of the week:
“When I proposed a simple rule as a guideline for monetary policy… I made no suggestion that the rule should be written into law, or even that it be used to monitor policy, or hold central banks accountable. As I described in this talk, the objective was to help central bankers make their interest rate decisions in a less discretionary and more rule-like manner, and thereby achieve the goal of price stability and economic stability. Why does legislation fit into the debate now? Because, as the debate we are having makes clear, there is evidence that, starting around 2003-05, monetary policy became more discretionary and less rule-like than it was in the 1980s and 1990s. A legislated rule can help normalize policy, restore rule-like monetary principles consistent with long-term price stability and strong economic growth, help prevent harmful deviations in the future, and provide a catalyst for sorely needed international monetary reform.” says Stanford economist John Taylor.
In response, Boston Fed President Eric Rosengren says, “Simple policy rules are useful for many reasons, not least of which is in capturing how monetary policy has reacted historically. This makes these rules very useful benchmarks, providing useful guidance on how current policymakers are acting relative to how earlier FOMC participants reacted to misses on inflation and full employment. However, a legislated policy rule that is rigid could lead to large policy mistakes, as key inputs to policy rules that can change over time are estimated with substantial error. From my perspective, policy effectiveness will be better served, instead, by a more robust formulation of monetary policy that draws on a diverse set of guidelines and benchmarks – which is the exercise Fed policymakers conduct every six weeks for actual FOMC meetings.”