Mark Thoma on Fiscal Policy, Econometrics, and Political Business Cycles

The fiscal response to the 2008 financial crisis could have been much stronger, and it may have ensured a more robust economic recovery.

Mark Thoma is a professor of economics at the University of Oregon and author of the popular blog, “Economist’s View.” Mark joins Macro Musings to talk about his journey into econometrics and the application of econometric techniques to macroeconomic and monetary issues. He and David also discuss the role of monetary policy and financial regulation during this time. Finally, Thoma also explains some of his work on political business cycles: instances where politicians affect policy to increase the likelihood of being reelected.

Read the full episode transcript:

Note: While transcripts are lightly edited, they are not rigorously proofed for accuracy. If you notice an error, please reach out to [email protected].

David Beckworth: Welcome to the show, Mark.

Mark Thoma: Thank you. Thanks for having me on.

Beckworth: Yes, we're glad you're here. Let's begin, as I do with most of my guests, by asking, "How did you get into macroeconomics?"

Thoma: In grad school I was torn between doing micro and doing macro, probably leaning a little bit towards micro, particularly IO. I really like that topic. I was at not the best grad school in the country, and my dissertation advisor, who was a micro person, actually explained that, "If you come out of here saying IO or labor, you're going to be in competition with all these people from Michigan and all these places.

Thoma: You probably won't do well in the market, but there's this other thing, time series econometrics, that really seems to be in shortage out there." I was interested in money issues, anyway, very interested, and so I decided to do that, instead. I think it was a good decision. He was actually right. There was quite a bit of demand for time series sorts of issues at that time. Monetary neutrality was also a big issue, and that's something I was interested in. I applied time series econometrics techniques, VAR models, causality, Granger causality, that sorts of thing, to the issues of monetary neutrality.

Beckworth: Yes. You'd call yourself an econometrician, right?

Thoma: Mostly, yes. That's mostly what I've done.

Beckworth: Go ahead.

Thoma: Mostly applied that to various questions I've been interested in. Mostly it's been about issues around the Fed.

Beckworth: That speaks to the influence of professors, right? That's quite a change in career paths.

Thoma: Yes. Yes, it was. I was torn between the two. I just liked economics. I don't think I had a strong preference for one over the other. I was looking for something ‑‑ a lost grad student, my third year.

Beckworth: Little did your professor know the path it would take you on to one day being here on the show.

Thoma: Yeah...

Beckworth: We're all grateful for your professor's career advice. Let me talk about your blog since it is so prominent and has really done a lot for the conversations that we've had about economics over the past few years. Let's begin by asking, how did you get into blogging?

Discussing the Economic Blogosphere

Thoma: It was right after Bush was re‑elected. There were a couple of things going on in my mind. One, I was really unhappy with the way economic issues have been covered in the press and particularly issues involving Social Security and tax cuts, whether they paid for themselves and all those things that were big back then. I thought maybe something...First I wrote it, three letters to the editor. Then I wrote a couple of op‑eds for the local paper. Then one day I decided I was going to start a blog.

Thoma: The other thing that was going on in my head was I had felt that during the election ‑‑ this is a little bit political ‑‑ that the Democrats have been pigeonholed as anti‑market and people who really didn't like capitalism. I wanted a voice out there saying, "No, look, these issues involving regulation, market intervention to, say, pure market power or overcome market power, issues involving social insurance have a strong grounding in economics. There's actual economics that can support these points‑of‑view." I didn't feel like there were enough voices out there that were making that case. We had lost the middle. I didn't have any idea when I started the blog. I just did it one day.

Beckworth: What year did you start?

Thoma: Gosh, it was in 2005, I believe. That's around 11 years ago now. One day, I started it. I had no idea it would turn into anything. My idea was if I could convince one person, I was doing my job. If everybody got out there and became an advocate for these things and convinced one person that Democrats weren't crazy, anti‑market types of people, and maybe you could have some influence on the press and get the coverage better.

Thoma: I really think that the influence of blogs on the press has been underrated. It's very, very different from what it was back then. They listen to us. They've really changed how they cover things. There's a strong interaction between academics and press that I didn't see at that time and many, many more voices are listened to.

Thoma: At that time, it was just a few people that always showed up in the press. I seem to recall one or two people in the country. Now there's a lot more people that have a voice and that's important. Anyway, how mainly through Brad DeLong and Paul Krugman, it really got to be known, and here we are today.

Beckworth: Now, when you started blogging in 2005, there were a few other blogs that comes to mind. I think Freakonomics blog was around back then, Marching Revolution. I don't recall any macro‑economic blogs at the time, am I correct? Were you the only one?

Thoma: No, there were a few, I think. Brad DeLong was out there. He'd been out there for a long time. He was doing macro issues. There was a blog called Angry Bear. It's still around, but it was very different back then. It had a completely different set of contributors. They did a lot of macro issues. There's a couple of blogs that have died that were also contributing on macro, I think Andrew Samwick was this smaller...He looked at macro issues as well as health insurance issues. There were a few others that were out there, but it was pretty thin at that time.

Beckworth: Now, you did this as an associate professor. So you had to balance your research responsibilities, your teaching responsibilities along with your blogging. Your blogging took off. I mean, it became prolific. You're well known for it. How did you handle that tension, those trade‑offs there, trying to do all three?

Thoma: At the beginning, it was almost a negative. In fact, it was a negative. I remember one of the faculty members in our department sitting down in my office and saying, "You should stop doing this because it's going to hurt you." I said, "That's what tenure's for."

Thoma: It was difficult at first. Fortunately, my kids were all gone. I had a lot of time, and so I could keep up research at that time and also do the blogging without having one significantly affect the other. Over time my research has been crowded out more and more. In my particular case, I'm not sure that's such a bad thing. I mean, to be honest, I don't think I would have contributed more than marginal changes in the profession on the research side.

Thoma: I have way more recognition from the best people in their profession than I ever would have had and way more influence in terms of the types of ideas and the types of questions that people are addressing.

Thoma: In that sense, I think it's been a good thing in terms of the impact on the profession more than I would have had from research. But it was difficult at first. I spent a lot of time each day doing the blog, probably all day every day. I haven't missed a day since I started 11 years ago posting something.

Beckworth: Wow!

Thoma: It's taken a lot of time, and slowly over time it has crowded out research. I don't know how to think about that. Part of me feels guilty, and sometimes I think you need to just get back to it more than you have. Other times, given the feedback I get, people telling me the impact it has on the profession and how much they appreciate it. I think, well, this is what I ought to be doing. It's a bit of an internal debate that I have with myself.

Beckworth: I found following blogs and participating myself to be very useful in terms of coming up with ideas for new research, for learning what are the hot topics out there. I do think it's useful for young professors who are finding their way, even going to tenure. But there is this issue of making sure that you're getting the proper publications.

Beckworth: I wonder, as time goes on, if some of those expectations will change. If you really do have an influential blog like MarkThoma, will that count for something as opposed to just peer reviewed academic article? Any thoughts?

Thoma: Well, I can speak about my case. At first, it didn't, as I said. I think the department probably was just, "Oh gosh." But over time as it caught on more and more, one thing that really made a difference is people would go out and get papers, and they'd hear about the blog. They'd say, "Wow!" So, impact.

Thoma: When I was promoted to full professor, it actually was part of my tenure case, and I did get recognition from the dean and others. I said, "Does this mean the university is endorsing me, using part of my time to do blogging?" They said, "Yes, this is what it means." In that sense, I don't feel as guilty about letting it substitute for research. They found some value in it.

Thoma: On the other hand, when Noah Smith was still a graduate student and he started blogging and wanted me to start promoting some of his stuff, I made him get permission from his dissertation advisor that it was OK. I didn't want him to get crowded out.

Thoma: In my own department they have difficulty. They want to give me credit, but they don't want to create incentives for young people to think that this is a path where they can get enough credit to get tenure. The ethic is, it's your research purely and simply that's going to get you tenure. Maybe at the margin this makes a bit of a difference. It's also difficult for them to come up with metrics.

Thoma: Do you get outside letters? Exactly how do you evaluate the impact of a blog? They don't know how to measure it. They want to give me credit, but they don't want to create bad incentives for younger people in the department to think that this is a way in which you might be able to...a path to tenure, or helping your tenure case if it's on the margin. If you have that choice between starting a blog or doing one more paper, you better do one more paper. That's the message they want to send.

Beckworth: I think that's the norm everywhere.

Thoma: I think so, too.

Beckworth: I did review Miles Kimball on the show earlier, and he believes, though, the future is different. He believes that at some point ‑‑ and, maybe, even we're gradually getting there ‑‑ that departments will look at blogging. In fact, he makes the case some of the successful departments today are ones that have professors that do blog ‑‑ someone like you, Peller Calvin, Miles Kimball himself, University of Michigan. He believes that it attracts grad students to their programs in addition to having solid research agenda, having some notoriety for being a blogger. It'll be interesting to see how this all unfolds going forward.

Thoma: We have gotten grad students because of the blog. They were sort of out of that. We've also got donations to the department. Not big ones, but things like, so there are, certainly, impacts.

Thoma: What I'd like to see departments do in the future is start...When I first started my blog, I actually didn't make it just for myself. The apostrophe in "economist's view" was outside the S. I wanted it to be collective, so I went around to the departments and said, "Look, we're all experts of various things. When there's important public issues, let's use this blog as a way of letting the public, letting the press and others know, 'Here's what economics has to say about these issues.'

Thoma: You don't have to do it every day, but every once in a while, when a topic comes up in environmental things, or labor things, or international, whatever your specialty is, why don't we go out there and start giving our department a voice?" No one else was really interested in doing it, so I moved the apostrophe over and did it alone.

Beckworth: That's interesting.

Thoma: I'd like to see departments have department blogs where everyone who does a research paper is also required to explain it to the public or explain it at least to other people in the profession. Here's what this paper's addressing. Here's why it's important. Here's what it has to say about policy, or whatever it is the paper's addressing.

Thoma: That doesn't work for all papers, purely theory papers that make minor changes in the assumptions needed to show this or that. I think in a lot of cases, particularly our department, where most of our issues are applied theory and a lot of data work, what is it that you're saying? Why is this important? I think that would be a really valuable thing for departments to do.

Beckworth: Yeah, I talked to John Cochrane also, on the show, in a previous episode. He'd mentioned some highlights from blogging because he does it quire regularly, as you know. He mentioned he was tinkering around in one of his early neo‑fisherian posts and that Michael Woodford saw it and picked it up and did a paper based on one of John Cochrane's posts.

Beckworth: John Cochrane found great joy in that, he told me. He felt this was an outlet where he could put something out there that wasn't really fully developed, that was partly there, and some other academic picked up on it. He gave an example there where it was useful, and he found it productive for his own research efforts, even if it wasn't a formal paper. I do think we see some of that, and like you just said, the impact on policy discussions is immediate.

Thoma: Yes.

Beckworth: It's real time and there's lots of example we've talked about on the show before. The discussion over TARP, remember that being influenced by bloggers. Discussions about QE Programs, real‑time feedback from folks. I'm sure you can come up with many other examples given your...

Thoma: I was told directly that the people doing TARP were, at Treasury, were very much monitoring blogs and it had a huge impact on the way they thought about issues. I think that was an important thing.

Thoma: I think one place blogs have a lot of value that papers can't provide is in what I call real time economics. When these issues hit that are important and policy makers have to make an immediate choice, I think blogs are a great way to provide that immediate feedback and to say, "Here's what the profession knows. Here's what we don't know. Here's some ideas.

Thoma: Maybe they're not fully developed and cooked. We'll start working on the papers now, but here's what we're thinking about." I think that's a really important thing that economists can do through blogs. Let me also add that I had a similar experience in terms of a graduate student coming up to me and saying, "One of the posts that you put up on your blog," ‑‑ it was something that I had taken from somewhere else and just inserted ‑‑ "it gave me an dissertation idea," so he was really thankful for that. He was struggling to find an idea and there it was suddenly for him.

Beckworth: That's fascinating. Let's ask, how do you actually do it? Let's talk about the mechanics of it. When you get up in the morning, or do you even sleep? Let me ask that question.

Thoma: Yes.

Beckworth: OK, you do sleep, great. How does a typical day start for Mark Thoma?

Thoma: The first thing I do when I get up is look at my email. If there's anything I have to answer, I do that, but I mostly set it aside. Then I go to my RSS feed. I use a very old RSS reader, but I think it's really efficient and better than the ones other people are using called FeedDemon. I monitor 300 to 400 feeds.

Thoma: I just start going through them, and it's just the first cut. I click on anything that I like, and it goes up as a tab on a browser, and I leave it there. The first hour or so is spent simply going through all the RSS feeds, scanning as fast as I can ‑‑ this looks interesting, this looks interesting, this doesn't ‑‑ and putting it up.

Thoma: Then I go through those more carefully, either scan them or read them. I don't actually fully read everything, [laughs] I'll have to admit, but I at least scan everything for the main ideas and whether I think it's going to be of interest to...I think there's several groups that I think about ‑‑ the academics, the press, and the general public. I try to serve all three.

Thoma: Does this have an audience? Does it have something that people would be interested in? If so, it makes the cut. If not, I delete it. Then I pretty much do that all day long to try to keep up and not let that RSS feed get out of control. There's a lot of things that come up in the feeds all day long. Most of the day is spent as a struggle trying to keep up with the RSS feed.

Thoma: Once I get that first group up, I try to do a set up post. I try to do three a day. Today I've only had one, and I'm feeling guilty. I got to get two more, but I just haven't found anything yet that I want to put up. Then I start putting things up. I have a lot of deadlines that I have to meet for columns and the articles at CBS.

Thoma: The biggest struggle for me is finding [laughs] ideas. If I can come up with an idea, I try to work on that stuff and get any deadlines met that I have to meet. Then I turn to the school stuff. I teach a lot. My course work, try to get that done and then any research or other sorts of things I'm doing. Then, at night, I come back to the blog and every night at 10 o'clock I post the links for the next day. Sometimes it's a little later than that, but that's pretty much how it works, these...

Beckworth: You've got blog on the mind all day, then, huh?

Thoma: Yeah, it's all day, every day. Pretty much from the time I wake up to the time I go to bed, that's what I'm doing, for the most part.

Beckworth: Sounds exhausting. How do you filter out new additions to the blogosphere, new sites, because there's constantly new people joining? Of course, there's probably some who are leaving as well, but how do you find new quality talent when it does emerge?

Thoma: Some of it comes by email ‑‑ "Hey, I've got this blog. You haven't ever actually linked to it. How about you link to it?" Quite of bit of it comes to me that way. People are pretty willing. I remember being embarrassed about that when I started writing people and saying, "I did a post on that. You should link to..." [laughs] It was kind of hard.

Thoma: Twitter, I see things on there. I follow those links. If it's a blog I haven't seen before, I'll add it to my RSS feed and put it onto the side bar, the list of blogs that are there. Or, if somebody does a post and talks about a blog I haven't seen, I'll look for them there. I just got a couple more I hadn't seen on one of those top 100 lists. Somehow I overlooked this.

Thoma: There was one on econometrics ‑‑ I can't think of its name right now ‑‑ that I added to the list that way. Mostly it's just monitoring the feeds that are out there, then the Twitter feeds, and the RSS feeds, and the general discourse. When something new comes up, add it to the list.

Thoma: I have to tell everyone out there. If you don't have an RSS feed, you're probably not going to get any links from me because I don't have time to go to individual blogs each day. It would just be too, too hard to do it that way. Some people have truncated their RSS feeds, so also probably don't get as much recognition. It's the full feeds that are of most value to me.

Beckworth: This is the Mark Thoma search algorithm. If you want to get seen by him, take note.

Thoma: I'm sorry. That's it.

Beckworth: No, that's honest. It's a grueling job you do, and we're going to make it as efficient as possible for you. I have to also note, before we move on from our blog discussion, that my first blog post was mentioned by you. I was one of those brave souls who [laughs] emailed you. This was back in 2007. I think it was August 2007.

Beckworth: I had attempted to write an op‑ed like you did. Of course, it got rejected. I was actually ripping Jim Cramer ‑‑ "Mad Money." In retrospect, I think he was actually right. Back in 2007 he was going off on the Fed and I called him, in my post, I think, a liquidity addict.

Beckworth: In retrospect I think he was actually on to something. The panic was far worse than anyone had expected and Cramer was making that point. I wrote this piece kind of going off on him, and no one picked it up in the newspaper, so I made my own blog. I'd been reading yours and others for a few years, and I said, "What the heck. Why don't I just publish it myself on a blog?" You were gracious enough to link to it, and the rest is history. In some small part today because you took time to recognize my post, so I'm grateful for that.

Thoma: I try to do that. People helped me when I started. I wouldn't be here if other people hadn't been willing to say, "Oh, here's another blog you ought to look at." It really takes a long time for traffic to build up over time. When you have a post, what I've seen happens is you'll get several thousand people will come and you think, "Oh, gosh. I'm there now," but very little of that sticks. Maybe 50 of those people will stick and come back the next day. It takes a concerted effort of other people linking to you over time to build up an audience.

Beckworth: That's great. Blogging has been fun. It's fascinating, and we continue use it as macroeconomists. Let's move on to some topics now in macro. Part of your blogging job is traveling to conferences, and you read almost everything, it seems. At least you get the highlights of the important discussions going on out there.

Beckworth: You've been covering these topics for a while, so I'm going to run through them with you and get your thoughts on them. Let's begin with the topic that was discussed back during the crisis, and that was what actually caused the housing boom. There's a number of stories there ‑‑ Fed policy was too easy, there's a saving glut for regulatory oversight, lending standards were lowered. What is your take based on your reading of the literature and all these debates? What happened that led to the housing boom?

The Causes of the Housing Boom and the Ensuing Crisis

Thoma: I would characterize it a little bit different. All those things played a role. I think at that time there was this big debate about the savings glut, and there was a lot of liquidity running around. Something you just mentioned. It was looking for a place to park itself. There was this promise from financial engineering, what they had taking the mortgage markets.

Thoma: They'd sliced and diced mortgages up. Things like taking all the first payments of mortgages, let's say 10,000 mortgages. Wrapping those up as one financial security and doing all these different ways. Taking the second payments from 10,000 mortgages and wrapping those up as a different financial security and selling them.

Thoma: The first one would have less risk than the second one. Of course, when you get out there to 30‑year mortgages and that 360th payment, and you wrap that up as a financial asset, that's going to be highly risky because there's much more chance that people will have something bad happen and not be able to pay their mortgage over a 30 years than there will be in that first month.

Thoma: The financial engineers that had this promise, that they had actually reduce the overall risk and not just cause the risk to be shared by a lot more people, and dispersed that risk. I think there was this idea from financial engineering that these mortgages were somehow a safe way to park your money because of all the financial engineering.

Thoma: On the one hand we could call it excess liquidity running around looking for a place to park itself. When we had these financial securities from the housing markets, they were paying a little bit more than other securities that were equally rated in terms of their risk.

Thoma: All of that money tended to fall into the housing market and just flowed downward in a way that allowed the mortgages to be supported and found, so more and more mortgages were being made based upon this money that was coming into the system under this false promise from financial engineering.

Thoma: I think the regulators were very much unaware of the way in which the risk hadn't really been dispersed. There were all clauses. The banks thought they'd offloaded a lot of the risk, and it was distributed across the whole world.

Thoma: If the housing market crashed, it wasn't going to cause a big deal, but there are all these clauses in these financial engineering instruments that caused that risk to come right back onto the bank balance sheets. If the price fell below a certain amount, then the bank was obligated to make good on the financial security and other sorts of things.

Thoma: The risk was much more complicated, I think, than regulators, or anyone, realized. When the crisis hit, suddenly the risk was concentrated. Banks began going down. I think the other place that we really failed from a regulatory point of view was people look back now and say, "We didn't see the crisis coming."

Thoma: Well, that's sort of true and it sort of isn't. People didn't really predict it, but there was a lot of people saying there was a change. Even Greenspan was, "Well, we're seeing tiny bubbles, but there's no big bubbles. Even if we had a great big crash," Bernanke said the same thing. "It's going to be limited to the housing market. It won't be a big deal for the rest of the economy."

Thoma: I think that where they didn't really recognize what would happen was the risk that was posed by a run on the repo market. I think where regulators really failed, was to put the right safeguards in place to get a run on that repo market wouldn't just destroy financial markets and cause a whole system to come crashing down.

Beckworth: Moving on to the great recession, then. Do you see that it was primarily the cause of a financial panic or the housing market itself going down?

Thoma: I think it was a combination of both. I think there was a lot of loss of wealth that causes households to retrench and wonder how the heck they're going to pay for their retirement and their kid's education and all those sorts of things. Unemployment and other things were wiping out whatever assets they had, a lot of households.

Thoma: I think some of it was what we'd call a balance sheet effect on the household side. I think the financial market also dried up a lot of the...the financial panic, and the fear it caused, caused investment to crash for a long time, particularly in housing markets. I also think it isn't recognized, probably, enough is it was also right at a time when demographic issues were beginning to become important. China, a few years later, was beginning to slowly slow down. There was a lot of problems in the world market. I think we were also ripe for a correction.

Thoma: Part of this slow recovery we're seeing is exactly that, but the world is undergoing some sort of correction in terms of we're seeing, maybe, the possibility of a secular stagnation, the demographic effects hitting, the effects of China slowing down and all sorts of those things going on. I think the financial crisis certainly caused a great recession, but I think over time a lot of other things have played into sort of making the recession last as long as it has, in our difficulty recovering, and the slow economy we're seeing now.

Beckworth: Looking back at the great recession, particularly how sharp it was, the sharpest recession since the great depression. I guess you could consider 1982 as a pretty steep one as well, but...

Thoma: Yeah.

Beckworth: Do you think it was inevitable? Could the recession of 2007, 2009 have been a milder one, a garden variety recession, or was it inevitable we're going to have this sharp contraction because of financial panic tied in with the housing collapse?

Thoma: I don't think it needed to be as sharp as it was. I think the financial collapse, in particular, could have been much less. Had we had the right regulations in the market, just sort of had a lot more insulation and make sure that risk was more dispersed than it was. I think that, if you look back and say, "Had we known the things we know now..."

Thoma: Whether we could have known them then, I don't know. That's a different question, but if we knew what we know now, and put the proper safeguards into effect, I think it could have didn't have to be as bad as it was. As I said, the run on the repo market didn't need to happen the way it happened. We could have had a lot more buffers in terms of banks having the kinds of buffers they needed to withstand these sorts of things, and we could have done a lot better job in regulating risks.

Thoma: The notion that the market that Greenspan had that we didn't need to regulate markets because, of course, they'll regulate themselves because they have the most interest in making sure something like this doesn't happen. That just didn't happen, and even he admits that in retrospect. I don't think it needed to be as sharp as it was if we'd had the knowledge we have now.

Beckworth: You would have imposed higher capital requirements on banks?

Thoma: Yeah. Yes, definitely, as one particular aspect of it. [laughs]

Beckworth: Yeah, that's definitely one that seemed to be missing, in retrospect. You mentioned a slow recovery. I think you alluded to it being a financial crisis. There's this kind of view ‑‑ the Rogoff‑Reinhart argument ‑‑ that financial crisis are inevitably followed by slow recoveries.

Beckworth: There's been some other literature that's come out. A number of people, including Michael Border, have looked, historically, and they've said, "Well, not so fast. They can be long, protected recoveries, but they aren't necessarily. It depends on the policy response." Looking back, number one, do you find that a plausible argument, that our recovery could have been faster had fiscal policy and monetary policy been done differently?

Thoma: I come down on the side that the type of recession matters, so '82 was a Fed‑induced recession, for the most part. The Fed can easily lower it. They raise interest rates quickly, they can easily bring them back down and make that thing go away.

Thoma: I think that financial panics are very difficult to recover from, probably because business balance sheets, household balance sheets are all affected and it takes a long time to crawl out from the losses that happen when you have a financial panic. I don't think that anything we could have done could have cured it immediately.

Thoma: Could it have been faster? Yes, I very much think it could have been. Particularly, I think fiscal policy is where I would point the finger the strongest that the move to austerity didn't need to happen. We could have done a lot more. Seven years ago, eight years ago, however long it's been, people were saying, "All right, we don't have time to do infrastructure spending because it takes a long time." "Well, it's going to be a long recession," everyone kept saying. We had time to do it, but people kept using that as an excuse not to do fiscal policy.

Thoma: Partly, it was the shape fiscal policy was in when we came into the darn thing. We already had a lot of debt coming in, so people were unwilling to do the types of fiscal policy we needed. I think that was wrong thing, but I understand the political implications of that that people were facing. Had fiscal policy reacted more strongly, had we done much more than we did, I think that the recession could have been much shorter. When it comes to the fed, I'm far less critical. I think the fed's been behind the curve the whole time. They keep wanting to see green sheets just around the corner. We just saw it again.

Thoma: They keep saying this expectation and interest rates will drop soon, and I think that's been harmful, but, overall, they've were very, very creative. When the financial crisis hit and markets needed liquidity, they found lots and lots of ways to get around institutional roadblocks and roadblocks just from the recession itself, and found ways to get the liquidity that was needed to stop the recession. It could have been even worse. They say it could have been better, but I also think it could have been even worse than it was.

Thoma: I give the Fed a lot of credit for the way they creatively created all these different types of policies, these different institutions within the Fed, to get the liquidity where it needed ways in which they got banks they could loan to, to loan to other people who they couldn't loan to, these various deals and that sort of thing.

Beckworth: You mentioned that Fed policy could have been far worse, we could have had a repeat of the great depression, as an example. We didn't have that, so we should be grateful for that, but, as you know, I've been critical the Fed didn't do enough. Maybe I've been too harsh.

Beckworth: I will acknowledge that I'm definitely doing Monday morning quarterbacking here, just looking back and saying, "Hey guys, you should have done this. You should have done that." One thing that has bothered me, and I find hard to understand sometimes, is the low inflation that's been with us since the crisis.

Beckworth: Since mid‑2009 we've had core PCE inflation averaging about one‑and‑one‑half percent. The Fed announced the target in 2012 of two percent, and implicitly before then it was still aiming for something near two percent. It seems to have persistently undershot its target.

Beckworth: I know there's good excuses at any point in time. The Fed could point to low oil prices, different transitory factors, but after almost seven years of what seems to me to be a persistent pattern of low inflation, I have to think there's some kind of revealed preference theme shown here, or maybe some unconscious desire by the Fed to keep inflation low.

Beckworth: I wonder if it's tied to something even bigger than the Fed, and that is the body politic wants low inflation. Inflation targeting's been so successful that it's difficult for the Fed, even if Bernanke or Yellen wanted to temporarily have, say, three, four percent inflation to help spark a robust recovery, they simply couldn't do it. They'd go to congress; they'd get in trouble there. Voters would be upset. Am I providing a fair critique or am I being too harsh?

The Fed and Persistently Low Inflation

Thoma: I think it's fair. I think the Fed, for one, has created the two percent as a ceiling rather than an average, and that overshooting would have been a good idea for some time period, and they've been very unwilling to do that. When I say unwilling, though, I mean one of the things I've been surprised about prior to the great recession, I used to teach my class, basically saying, "Inflation's easy to create. You just print money." I didn't realize the extent to which that money could simply pile up in banks and not go out there and create the kind of demand that it needs to create.

Thoma: On the other hand, I think the Fed could have been more creative and found ways to get that money out of the banks and get it out there creating the kind of demand you need to cause prices to go up. I'm with you. I think the Fed was behind the curve quite a bit of the time, and that's been a problem.

Thoma: I think they could have done more to create inflation, been more creative with the way in which they conducted policy that would have done it. Where we probably disagree is that I'm not sure the impact would have been very great in terms of investment and in terms of creating actual changes in the real GDP.

Thoma: If I was going to spend political capital trying to get something to be done, I think fiscal policy has a far greater impact on aggregate demand and unemployment and all those sorts of things than the Fed. I've spent much more of my time being critical of congress than I have being critical of the people at the Fed. For the whole, I have a lot of criticism in terms of the particular and the way they've done things and their timing, but on the whole I think the Fed's done a pretty darn good job.

Beckworth: Yeah, you can give them credit for operating in a very difficult environment. Bernanke, every time he went up to the Hill, he had a hard time there. People really were harsh. I remember one time one senator accused him of currency debasement and Bernanke retorted, "Hey, we've had the lowest inflation on record since the great depression."

Thoma: One thing I didn't say is that I think the Feds are in a very difficult position. We had people talking about taking their independence away. They have to worry not just about their ability to react to this recession, but their ability to react to all future recessions as well. If they do things that we all think they should be doing, creating more inflation and the like, and congress reacts in a way that takes away powers, that limits their ability from now into who knows how far into the future. I think those political consequences are something the Fed really has to think about in a way that all of us, as critics, don't always understand.

Thoma: I think the Fed has been very worried about its political independence as well as what it can do for the economy, and that that's another important consideration in how they've reacted. I wish congress hadn't done what they've done. I've been critical on fiscal policy. I've been just as critical in the way they've reacted to the fed and the kinds of things you're talking about ‑‑ currency debasement and fear of inflation that they've put out there on a lot of people and all those sorts of things. I think they've tried to have tied the Feds hands in the way a lot of people don't understand.

Beckworth: Yeah, the Fed is supposed to be a flexible inflation targeter which allows for some overshooting effort. You have a sharp drop in inflation, so that on average you have your two percent inflation rate.

Beckworth: What you mentioned earlier, the way you hit an average is if you drop below it then you go above it so they offset each other. I want to be clear to our listeners. Mark and I are not advocating here a case of this wild, reckless inflation. We're talking about something that's more systematic tied to a flexible inflation target.

Beckworth: Let me push back just a little bit on your fiscal policy idea. Let's say the federal government had done more fiscal stimulus spending. Maybe they sent out checks. Maybe it was investment spending. Let's say it did generate some aggregate demand growth and it started to push up inflation.

Beckworth: Inflation got to two percent, and all of a sudden the Fed begins to panic. "Oh, no, we're going to be going above two percent," and so they hit the brakes. They offset what fiscal policy's attempting to do. Do you not worry that that might have happened?

Thoma: It could have, but if they're panicking because the economy's doing much better, they're simply trying to now prevent it from overshooting and creating inflation because we're reaching potential output. I'm not too upset by that, but if, then, interest rates are higher right now than they otherwise would have been, then we're in much, much better shape if another recession hits because now they've got some more on the downside. I think interest rate policy has a huge impact on the...not a huge impact, but a large impact on the economy, enough to manage recessions.

Thoma: I think QE has a much less impact on the economy. It's much harder to manage the economy. If fiscal policy had pushed the economy up to the point we're creating inflation, which, to me, wouldn't happen unless we're approaching potential output. Then that causes them to raise interest rates. Well, great. Now we're in a much, much better position going forward to curing problems that might hit the economy.

Beckworth: Let's talk about secular stagnation, another factor playing into the effectiveness of policy. Larry Summers has argued forcefully that we are in the midst of secular stagnation, a perineal shortfall of demand that has led to some atrophy and economy. As a consequence, the neutral interest rate has dropped, and that makes monetary policy more challenging. Do you see this as a good characterization of what's going on?

Secular Stagnation and he Effectiveness of Monetary Policy

Thoma: I'm, at this point, keeping an open mind. I think it's certainly a possibility. I'm not fully convinced that we're not just seeing demographic issues affecting the long‑term growth rate, and I think that's a big part of it.

Thoma: On the other hand, given our infrastructure needs, given that that's probably a good solution to secular stagnation, and given this slow recovery, I think it's worth saying, "OK, let's just do it as insurance." If we don't really have secular stagnation, then at least we're going to end up with something that's going to help our long‑term growth rate in a way that I think the economy needs. I think it's certainly a possibility. I'm just not fully convinced yet that we're not going to slowly climb out of this. That's sort of where I was stand.

Beckworth: You had a post a few years ago and I followed up with something similar. Your post was based on the idea of this endogenous side to potential GDP. That potential GDP, it's been declining. The CBOs estimates continually seem to march downward. Your argument was, "Well, maybe potential GDP would go back up to where it was before the crisis, the path it was on, if we had more robust aggregate demand growth.

Thoma: Yes, yes, and you started drawing back all these resources that have left. Think about labor, people who have left the labor market. Looks like it's permanent, but is it really permanent. I don't think we know. How many of those resources could be drawn back into productive use as aggregate demand goes back up. I think there's a chance that some of that will happen, but we need to see the demand first.

Beckworth: I think that's difficult. Going back to the earlier critique I had about Fed policy and fiscal policy, is that this commitment to really low inflation, which is normally a good thing, is constraining us from ever finding out the answer to that question. Can we actually generate robust aggregate demand growth when there's this institutional commitment to low, low inflation? I'm not sure that we can.

Thoma: I think we probably both share the view that if the Fed wants to...I think inflation's kind of hard to create. It's kind of hard for the Fed to create aggregate demand. I think there's an asymmetry. I had a paper about this long, long ago, but I think the Fed is very, very good at slowing down an overheated economy.

Thoma: This idea that inflation's going to suddenly go out of control, I just think is wrong. Why not push as hard as we can with all types of policy, monetary and fiscal, with all the buttons that we need. If then we're wrong, then we're much closer to potential output than we think where we start seeing inflation and full employment, and those things, the Fed can take care of it. I just don't see that there's a huge risk in pursuing that kind of a policy.

Beckworth: I would add to that that we could also do this within a framework of level targeting, whether it's price level targeting or nominal GDP level targeting, which would provide a constraint, a rule that would allow us to try this robust aggregate demand growth without unanchoring a long‑run price level path. That, too, would be radical departure from what we're doing now. I'm not hopeful that we're going to get back or undo the economic atrophy that we arguably have seen in the economy.

Thoma: The '70s did a lot of damage. The inflation of the '70s did a lot of damage to people. There's people that are still really worried that that's going to happen again. A lot of that was oil prices and other sorts of things that have nothing to do with monetary policy. I just think the fears, and a lot of people in control of the Fed, and politicians and like, we all lived through that time period. It's in our minds and we just can't let that happen again. The idea that that was solely due to poor monetary policy, I think, is partly...I just think that's wrong.

Thoma: Monetary policy could have done better during that time period, but I think the fear that we're going to suddenly have the 1970s over again, and interest rates that are up at 17, 18 percent, and that kind of thing, I just don't think that's going to happen. The fed has learned a lot since then. They don't conduct policy the way they conducted policy in those days. They understand things they didn't understand. Those risks, I don't think are there.

Beckworth: Again, I think we could try this, but then an approach that would prevent that from ever happening again, with level targeting.

Thoma: Yes.

Beckworth: Along those same lines of secular stagnation with Larry Summers, Robert Gordon has come out with a similar but slightly different argument. His view is that we've come to the end of the big innovations, that all the great inventions, the practical life‑changing inventions, they're with us, and all the technology we see, they're on the margin. They aren't having the same kind of impact on productivity growth. We're going to see a permanent productivity growth slowdown. How do you take that argument?

The Productivity Growth Slowdown

Thoma: I don't want to believe it. I'm a technology optimist, so I think the digital revolution and all of the things we're learning are going to make great differences, not only just for the economy, but for people's lives.

Thoma: Maybe not the same kind of thing as the invention of electricity, or plumbing, or those sorts of things, but I think some of the things we're seeing ‑‑ in health care and other sorts of things, robots and other sorts of things ‑‑ are going to make a huge difference in terms of how we produce goods and services and what we're able to do.

Thoma: I'm much more optimistic. We're simply in a bit of a lull as we learn how to use all of these things rather than we're in a long‑run permanent slowdown. I have a lot of hope for the future rather than a lot of pessimism. As I look back through history, this idea that the economy's eventually going to stagnate.

Thoma: It goes back to Ricardo and everyone else that we're out of good ideas and someday we're going to hit this stationary state where we just...there's no more growth in the economy. That's just never happened for hundreds and hundreds of years. I just don't think it's going to happen again, but I do think we're in a little bit of a lull. I do think, as I've said earlier, there's demographic things that are going to affect our long‑term growth rate, but I am just not the pessimist that others are on this score.

Beckworth: I'm with you on that. I definitely think innovation's going on right now, but it will make a big difference over the next decade. I also...

Thoma: I'm just saying, I think there's distributional issues in terms of who owns the robots, who owns the self‑driving cars, and that sort of thing that society's going to have to grapple with. In terms of the underlying ability to produce goods and services, I'm not so worried about that.

Beckworth: What about the issue of mismeasurement of GDP? A lot of the new technology is not being counted. If you look at your smartphone, for example, there's a number of apps on there that formerly would have been part of GDP. You go get your encyclopedia off your phone, you get maps off your phone, you get music. Many of those things are free or very low cost. Previously, they would have been counted as a part of GDP. Do you think any part of the slowdown is tied to this mismeasurement issue?

The Mismeasurement of GDP

Thoma: I think it is, and I have to, though, tell everyone that the recent research that's come out that's tried to measure that effect through various ways simply hasn't been very supporting of that idea. Nevertheless, there's just a part of me that says that's true.

Thoma: When I think about my own life, just simple things like not having to take out a map or always knowing where I am, having the whole encyclopedia of the world with me, wherever I go. I can take all of my classes and put them on my cell phone. Video lectures and that sort of thing.

Thoma: There's just all these things that I can do that I couldn't do long ago that I think make a huge difference in the way I conduct my life. I think there is something to that. Again, when we've tried to measure that, it hasn't found a lot of support in the research.

Beckworth: Yeah, I've come across that recent research, too, and I've been surprised by it. They looked at cross‑country, not just the US, and they find that the mismeasurement issue may not be that big, but there's a part of me that wants to push back against that because I think maybe at some point we'll find out differently.

Thoma: Intuitively, I just feel differently, but the research is the research.

Beckworth: Right. Well, I guess we'll have to dig into the research ourselves and find out the holes in it. What about the safe asset shortage problem? This is an issue near and dear to my heart. I'd like to hear your thoughts on it. Is this a real issue? Do you think it explains the decline in long‑term bond yields?

Beckworth: Just today, on Twitter, I got into an exchange with someone about whether there is financial repression going on. I made the case that several banks are intervening, there are negative rates now. All those are symptomatic of a deeper underlying process of there being a safe asset shortage, that the demand for those are growing for some of the reasons you've mentioned already ‑‑ demographics, I might also add uncertainty and selective rapid recovery. Do you see the safe asset shortage problem as a legitimate problem and one that needs to be resolved?

The Legitimacy of the Safe Asset Shortage Problem

Thoma: Yeah, I do. I would add what you just added ‑‑ that it partly it's a result of people trying to park their money in a safe place. That's partly due to the fear that's out there and the inability to find investments that people are confident in, willing to take a risk in. It's partly due to this non‑appetite for risk, because people aren't able to find the types of investments they'd historically like to make and take any risks with their money.

Thoma: Maybe that's a result of inequality and too many people having so much they don't need to do that. I don't know. But if you look out there with people just trying to use safe assets as a way to back international transactions, Barry Eichengreen had a Project Syndicate piece about that just this week.

Thoma: They're finding it very difficult to conduct certain kinds of international transactions, because the kind of collateral you need, which is usually in things like T‑bills just isn't out there. There's a lot of reasons to think that yes, there is a safe asset shortage out there and that's partly what's driving down the long‑term yields and driving up the prices, as you've said, so yeah, I agree.

Beckworth: As the monetarist in me likes to point out, the safe asset shortage is really a money shortage. As you just said, these safe assets are used in transaction purposes often for institutional investors. It's really, end of the day, a shortage of institutional money assets and that's just lowering transaction and ultimately lowering demand. Interestingly enough, this would be one way that fiscal policy could really help.

Thoma: I just didn't have that panic.

Beckworth: You've been talking about the spending side of fiscal policy. I like to look more at the supply safe assets side of fiscal policy, and again within a rules‑based constrained framework. I do think that this is an's also one that it's tough sometimes to wrap our minds around, because if you look at all these yields that have been falling across the world for safe assets ‑‑ Germany, UK, the US, Switzerland, Canada, Australia ‑‑ these are all countries with safe assets and their yields have been falling persistently since the crisis.

Beckworth: It says to me that the world is saying, to these countries that, we need more of your debt. There used to be a joke, back in the early to mid‑2000s ‑‑ and I was also reading your blog and following. If you recall back then, we were concerned about the dollar having crash. It was overvalued, huge current deficit and I was all on‑board like, "Yeah! We're going to have this problem, me to fix it." But in retrospect, we're wrong. The world was clamoring for dollar and dollar denominated asset.

Beckworth: The joke back then, was well, "Our comparative advantage is exporting debt. We're good at creating debt." We get a good laugh out of that. But, I think, there is some truth to that. We have the deep capital markets, we have relatively good institutions, and we just have the capacity to create safe assets like no one else. Germany can do it, UK can do it, but they're smaller, there's some limit to what they can do. And surely, there's a limit of what we can do too. But, we are the last option on the planet. You mentioned earlier that the liquidity looking for a home during the housing boom, that's another symptom of this.

Thoma: It was also in the crash shit. Everyone expected the dollar to go down, instead what happened is all these international money came to the US in search of treasury bills as a safe place to park their money until they figured out what the heck was going on. That's still going on.

Beckworth: Yeah. Definitely an interesting story. It tough to wrap our mind around because it implies, among other things that, some of the run up in debt that we had over the past seven‑eight years, was that's much or at least partially traced to this demand from the world. We like to put the blame at the Congress or the President but to some extent what they're doing is indulging us to this global appetite for our safe assets.

Thoma: The fear in Congress is always been interest rates spikes. That's the big fear of debt. You can have these big interest rates spikes but this is true, that's just not going to happen.

Beckworth: It's definitely something we want to think about when doing fiscal policy. What is our true debt capacity? I do think, long term we have some issues with unfunneled liabilities like, but I think in near term we need to look closely at the safe asset shortage problem and see what does it mean for our debt capacity.

Thoma: And do a much better job, when times are good, in getting ourselves in to the fiscal position...

Beckworth: Right.

Thoma: We can do the things we need to do when times are bad. We were the situation of cutting taxes and creating debt during that, when were you thought it was a good time. Housing pyramid was bit of a false promise. Instead of building up the reserves, we needed to have the space to do these things, instead we were cutting taxes and doing exactly what we didn't need to be doing. As economists, we need to put more pressure on Congress to say, "Look, there's a way to do this, to manage cycles that you need to be responsible and be aware of."

Beckworth: We have a few minutes left. I want to go to some of your research, I've been holding off, but some really fascinating work that you've done on the political business cycle. Can you tell us, what is a political business cycle? What have you learned about it?

The Political Business Cycle

Thoma: This was quite a while ago now, but it's the notion that, as you approach elections, either monetary or fiscal policy will be used to stoke the economy in a way that will make it more likely that you get re‑elected. If you're an incumbent, you may use fiscal policy measures to make the economy look better.

Thoma: Or, if you had control of the money supply, you may lower interest rates or, in the old days, increase the money supply trying to make the economy look better. If you look at the lags that are out there, for instance, with monetary policy, the way it might work is that the effect on real output seems to happen faster than the effect on inflation.

Thoma: What you could do to increase the money supply, cut interest, have unemployment put in before the election, if you can time it right, and not see the negative parts that voters are going to hate the inflation until after you're already elected. Then promise yourself that, "Gee, once we get past the election, what we'll do is we'll then bring the money supply back down so that we don't see the inflation," which that's like promising you'll go running tomorrow after you've eaten cake today. That promise doesn't seem to be...

Thoma: It may not be a conscious thing. With an independent Fed, it may just be that the Fed is so worried as you approach an election about doing something negative that might negatively affect the economy that they tend to have a bias towards ease as you approach elections. Maybe we'll see that as we approach this election with the Feds.

Thoma: They claim and claim they don't do this, that they're going to do what they think is right, but maybe that's not quite true. Maybe what they're really worried about is if they raise interest rates too fast as the election approaches, they could get blamed for any consequences that will affect the election, not what they want to do with political liabilities is where it is these days.

Beckworth: It's more of an unconscious political business cycle. There have been a few cases, at least one I'm well aware of, Arthur Burns, I'm not sure, didn't he allegedly help ease monetary policy to get Richard Nixon elected?

Thoma: Yes.

Beckworth: But, in general, when we think of political business cycles, is this more of a phenomenon overseas? Or, do we find it in advanced economies as well?

Thoma: When we looked at our work, and again this has been 10 years ago, we went into, what's called, a frequent zone domain and looked for four‑year cycles in monetary and fiscal policy. In money supply, you could actually find what looked like a fairly strong four‑year cycle the way policy was conducted.

Thoma: Whether it was direct or indirect or for whatever reason, it looked like, and I haven't really updated this work since then, but at least in the past there was some evidence of these four‑year cycles being stronger than other cycles you could find in the data.

Beckworth: Our guest today has been Mark Thoma. Mark, thank you for being on the show.

Thoma: Thanks for having me.

About Macro Musings

Hosted by Senior Research Fellow David Beckworth, the Macro Musings podcast pulls back the curtain on the important macroeconomic issues of the past, present, and future.