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Thomas Sargent Recounts History of U.S. Debt Limits

The interview below is from the IMF Survey. Also, see my interviews with Thomas Sargent in 2002, 2012, and a recap in 2015 after Sargent winning the Nobel-Prize.
In a recent visit to the IMF, Nobel Laureate Thomas Sargent brought to life the economic and financial history of the United States, with stories of how debt limits have evolved over the years before and since the creation of the Bretton Woods Institutions.


On December 2, Thomas Sargent, 2011 Nobel Laureate in Economics, delivered the inaugural Richard Goode Lecture at the IMF. Convened by the IMF’s Fiscal Affairs Department (FAD), the Richard Goode Lecture, named after FAD’s first director, who served from 1965–1981, is designed to bring together annually academia and policymakers to discuss important topics of fiscal policy.


As noted by David Lipton, First Deputy Managing Director of the IMF, the forum “will offer an opportunity to reflect on the evolution of fiscal policy and think about fiscal challenges that lie ahead.”


In his address, Sargent, the William R. Berkley Professor of Economics and Business at New York University, the Donald L. Lucas Professor in Economics, Emeritus, at Stanford University, and Senior Fellow at the Hoover Institution, discussed the role debt limits have played throughout the economic and financial history of the United States. IMF Survey sat with Sargent to discuss his work on the debt limits.

IMF Survey: Professor Sargent, could you please explain the role debt limits have played in the economic history of the U.S.?

Sargent: Based on the evidence that my friend George Hall and I have assembled, the answer is different before 1917 and after 1939.

Before 1917, there was not an aggregate debt limit. Instead, interestingly, there was a debt limit bond by bond. Congress designed every bond and put a limit on the amount that could be issued. And those limits were taken seriously. They seem to have provided information about what upper bound on what future debt would be, except during wars.

After 1939, an aggregate debt limit was created for the first time. It restricts the par value of the total amount of debt. If you adjust for inflation, in real value, the government debt limit was constant until a little after 1980. It actually went down after 1945. In real terms, the value of debt relative to GDP went down even more. After 1983, nominal debt limits rose and more than inflation except in the Clinton administration. So, as I said, the answer seems to differ substantially after 1939 and before 1917.

IMF Survey: And what was the reason for moving from this bond-by-bond approach to the aggregate limit?

Sargent: Good question. The U.S. Secretary of the Treasury, Andrew Mellon, gave his reasons. After World War I, the federal government had big debts. These debts were in discrete issues of bond of particular maturities. They were issued in big lumps with “echo effects”: lumpy debt service events; potential liquidity and roll-over risks. In the 1920s, the U.S. ran a primary surplus, but not big enough to service all the debt that would come due. So when those big bonds matured, Mellon knew that he was going to have to ask Congress for authority to issue new bonds. He foresaw those “echo effects”. So he asked Congress for authority and flexibility to smooth those things over time. Congress assented. Mellon wanted to manage the debt in ways that would increase the liquidity and allow him freedom basically to be a good portfolio manager.

It is interesting why Congress assented to Mellon’s request while it had denied such requests from earlier Secretaries of the Treasury. You have to know more about the politics of the times than I do to answer that question. The Republicans had big majorities in Congress in the 1920s and they mostly trusted Mellon. Congress evidently thought Mellon’s was a reasonable request and at that time he was respected a lot.

IMF Survey: When would debt limits work effectively in restricting spending?

Sargent: I don’t know. I began this talk [Richard Goode lecture] with a quote from a smart Assistant Treasury Secretary who said debt limits are totally a sideshow, meaning that they are totally irrelevant. Just entertainment. But if you go back to 19th century, they seem to have been taken seriously. In various episodes, they constrained what the President and the Secretary of the Treasury could do, or thought that they could do. Something must have changed between then and now. We are trying to learn more about those changes or at least to frame the question.

IMF Survey: What lessons can policymakers in other countries learn from the U.S.?

Sargent: This is speculative, but the way I look at it is that any decision maker, whether he or she admits it, has two things: (1) a model about the way the world is put together, and (2) some interests they want to advance or protect, that is their constituents’ interests. To me, they try to do the best they can in terms of their constituents’ interests, given their understanding of the way the world is put together. They have theories of economics, including theories about government fiscal policy, whether it matters or not, how it matters.

I think if you go back in the 19th century and try to read and listen, people talk about their theories. Congressmen and journalists discussed and debated them. Presidential elections were fought about intricate technical matters of monetary policy: the silver standard, the greenback, the gold standard, bimetallism. It looks to me as though people on both sides had a common theory.

I believe that the economic doctrines that are in policymakers’ heads are very important. It is very corny to say it, but it is still true.

IMF Survey: How about the IMF? What can we learn from this history?

Sargent: The IMF was set up for good reasons. Keynes and Harry Dexter White and many other good people wanted to solve problems that had devastated the world economy after World War I: adjusting international monetary policies and international debts. The founders of the IMF had theories about how the international monetary system could be set up to handle adverse events in ways that would attenuate adverse consequences.

I see a pretty straight line: the IMF has embodied that theory in a set of practices. I view it as an important institution that seeks to keep alive the thoughts and concerns of its founders. For better or worse, in some countries, they say we don’t want to do it the IMF way. Well, the IMF way is that you have to respect the government budget constraint, mostly from your own domestic taxpayers’ resources, not from abroad. If you want some good outcome, this is what you have to do. A lot of this is just arithmetic and sensible economics. (Some of the arithmetic is unpleasant—that is one reason they call ours “the dismal science”.) The package of IMF policies is coherent and makes sense.

IMF Survey: What is the most interesting thing you have learned from your work?

Sargent: To me, one of the most fascinating things is how the U.S. Congress and Treasury recognized and managed rollover risks and interest rate risks; and how they thought about the sources of the fundamentals that drove interest rate risk, some under the government’s control, some not. Many of their discussions and decision seem very wise and modern. The government did various things about rescheduling and issuing callable debt and exercising call options. It was quite a sophisticated operation, done 150 years ago. We are trying to understand: (1) were those good things to do; and (2) what motivated those decisions.

IMF Survey: What’s next for your research?

Sargent: Debt limits are just a part of what we are doing. We are digging deeper and trying to find interesting stories behind individual episodes. Then, we hope to tell some convincing stories—and supplement them with sensible analysis.

The interview below is from the IMF Survey. Also, see my interviews with Thomas Sargent in 2002, 2012, and a recap in 2015 after Sargent winning the Nobel-Prize.

In a recent visit to the IMF, Nobel Laureate Thomas Sargent brought to life the economic and financial history of the United States, with stories of how debt limits have evolved over the years before and since the creation of the Bretton Woods Institutions. Read the full article…

Posted by at 10:21 PM

Labels: Profiles of Economists

Dialogue with Angus Deaton

Congratulations to Angus Deaton for winning the Nobel Prize in Economics. Below is my IMF Survey interview with Deaton (July 2002) on When numbers don’t tell the full story about poverty in India and the world

Before the world can answer questions about how poverty is reduced, it needs to know how progress can be measured. But estimates of the number of the world’s poor and questions about whether it has been decreasing or increasing have given rise to one of the hottest controversies in the development community. Angus Deaton, Professor of Economics and International Affairs at Princeton University’s Woodrow Wilson School, who has looked in detail at India’s poverty numbers, has been at the center of this debate. He speaks here with Prakash Loungani of the IMF’s External Relations Department about the dimensions of the problem and what can be done to provide more transparent and more reliable data on the world’s poor.

LOUNGANI: The World Bank’s estimate that 1.2 billion people live on less than $1 a day is cited everywhere. How reliable is this estimate?

DEATON: There’s surely a very large margin of error in that estimate. Even small changes in the design of the survey used to measure poverty can often have dramatic impacts on the poverty estimates. For instance, you could lower the estimate of the number of poor in India by 175 million just by shortening the recall period from one month to one week.

LOUNGANI: It’s a dramatic example, but you’ll have to explain what a recall period is.

DEATON: To measure poverty, you have to survey people and ask them to recall their expenditures— how much they spent on food, clothing, and so forth. You have to choose whether to ask them to recall how much they spent over the past week or how much they spent over the past month. That’s the recall period. Choosing a one-week recall period generally yields higher expenditures, and therefore lower rates of poverty, than choosing a one-month recall period. (The latter is measured on a weekly basis, of course, so that you’re comparing like and like.) India has long used a 30-day recall period. In recent years, the statistical authorities in India did an experiment to see what difference the recall period makes to the estimate of the number of poor. They found, as I mentioned, that shifting to a one-week recall period would essentially halve the number of poor in India. That must be the most successful poverty-reduction program in the world!

LOUNGANI: But haven’t you been working to resolve such data problems and come up with a good estimate of the number of poor in India?

DEATON: Yes, I have been trying to use the parts of the survey that are consistent over time to adjust the poverty numbers and put them on a consistent track. What that has shown in the end is that there has been fairly steady poverty reduction in India. The number of people living in poverty has declined at a steady rate over the past 20–30 years; there is no evidence of a pickup in the rate of decline since the reforms of the 1990s. I end up with an estimate of a poverty rate for India of 28 percent in 2000. Scholars at the Delhi School of Economics, working independently and using methods quite different from mine, have reached similar conclusions

LOUNGANI: Your findings won’t give much comfort to either side of the debate in India.

DEATON: I think that is broadly right. But the reformers have more to cheer about than their opponents. The findings don’t give the reformers everything they would have liked—notably, a pickup in the rate of poverty reduction in the postreform era. But it certainly shows that the claims of their opponents that poverty reduction stalled as a result of the reforms or that poverty actually increased are quite incorrect.

LOUNGANI: Is the problem just with India’s poverty statistics or is it broader?

DEATON: It is a broader problem, but I should remark that, even with all the problems of measurement, we do know that India accounts for about one-third of the world’s poor. So coming up with a more reliable estimate of India’s poor goes a long way toward getting a better estimate of the world’s poverty rate. But the problems that we face with the poverty data in India are quite likely to be present elsewhere.

LOUNGANI: What are some of the problems with the poverty estimates, setting aside the issues of survey design that we’ve already to some extent discussed?

DEATON: Let me try to get the first problem across in a simple way. Suppose that I had tried to see if income growth in China had any impact on the poverty rate in India. Right away you’d say: “That’s crazy. You need the income and poverty numbers to be from the same country.” Well, in most countries the data on income and the data on poverty come from two different sources. And, exaggerating a bit now to make the point, sometimes these two sources are so far apart in the stories they tell that they may as well be from different countries.

LOUNGANI: For example?

DEATON: The problem is endemic, but again the most dramatic case is India’s. According to its national income accounts, India has had robust economic growth over the last decade, and this certainly accords with what most people think has happened. But, at least until the latest figures came out, the national survey statistics, which are the source of the poverty estimates, showed that average consumption has essentially been flat over the last decade. These two stories about what’s happened in India cannot both be right. How can you have strong growth in consumption in the national income accounts and no growth in average consumption in the household survey? Either consumption hasn’t grown as much as the national accounts say it has or consumption has grown more—and perhaps poverty has been reduced more—than the national surveys say it has. So this, in simple terms, is the first problem—the lack of reconciliation between the household survey and the national income accounts.

LOUNGANI: The lack of price indices is also a big problem, I guess?

DEATON: Absolutely. There are two separate issues here. One is that to compare poverty rates across countries, to make the kind of $1 a day numbers that you mentioned are cited everywhere, you have to use purchasing power parity (PPP) exchange rates. Well, revisions to these exchange rates can play havoc with the poverty estimates. The World Bank itself was caught in this trap: in the 1997 World Development Report, before the crisis, Thailand is shown as having a poverty rate of only 1 /10 of 1 percent of the population. This figure was attributed by then chief economist Joe Stiglitz to the Asian economic miracle. But this was less a demonstration of the miracle than of the dangers of inappropriate PPP conversion. It’s a bit disconcerting when the World Bank’s dream of a world free of poverty can be realized simply by misusing exchange rate data.

LOUNGANI: You said there was a second issue with respect to price indices?

DEATON: Yes, you also need good price indices to compare poverty rates within the country, particularly between urban and rural areas. Countries often have good data for urban centers but not for the countryside, which is often where most of the poor live. This can be a big problem. For instance, I think the unavailability of good price indices for rural areas is in part responsible for the very conflicting views of what impact the Asian crisis had on the poor in Indonesia.

LOUNGANI: If the poverty data are so error-ridden, why don’t we rely on other socioeconomic indicators?

DEATON: That is done. Statistics on life expectancy, infant mortality, and literacy are all things that people look at to supplement the poverty numbers. Amartya Sen has been the intellectual force behind this broader look at deprivation. The United Nations Development Program has come up with a Human Development Index that aggregates all this information in a certain way. I don’t think the way they aggregate it is quite right, but at least it’s wrong in a very transparent fashion. But it is important to realize that income or consumption poverty is an important dimension of poverty in its own right and we should not be using other indicators as a proxy for it, any more than we should be using income poverty as a proxy for health or illiteracy. They are different things.

LOUNGANI: Should we just ignore the poverty numbers altogether?

DEATON: No, that’s clearly going too far. I don’t have objections to the concept of poverty. We do have a notion of poverty, like we have a notion of being cold or being hot; people can generally identify who in their community is poor. But it’s one thing to have a rough notion of poverty in your community, quite another to come up with an estimate of the number of poor in the whole developing world. That, as we’ve discussed, requires a lot of decisions. So what I’m objecting to is the pretense that at the end of this series of decisions we can draw a very sharp cutoff, a poverty line. It encourages a rather Micawberish view of things where the result is taken to be happiness on one side of the line and misery on the other. (“Annual income twenty pounds, annual expenditure nineteen nineteen six, result happiness. Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.”) We should admit that the poverty numbers have large margins of error but keep working to improve them.

LOUNGANI: That’s a nice segue to my final set of questions. What institutional changes are needed to get some quality control on the poverty numbers?

DEATON: The often rather informal arrangements under which numbers are produced need to be looked at. I think the poverty numbers were first thought up for the Bank’s 1990 World Development Report. There was a lot of heroic work by Bank economists to put these numbers together. But they weren’t regarded then as frontline numbers. When folks first started doing GDP numbers, a few academics put some numbers together, and they were thought of as interesting and neat rather than solid numbers you could hang your hat on. Now the poverty numbers have become big important numbers on which many things, including the evaluation of the Bank’s own performance, hinge. At the moment, pretty much no one other than Bank economists can tell you how these numbers were put together and how they can be reproduced. So when someone comes along and accuses the Bank of biasing the numbers one way or the other, it’s difficult for an outside agency or independent scholars to leap to its defense and help resolve the controversy. So we need greater transparency at the Bank on how the poverty numbers are going to be put together in the future. You could imagine setting up other institutions to do this, but greater transparency would get us going in the right direction. And helping countries resolve statistical issues is something that the Bank and the IMF should do a lot more of.

LOUNGANI: It’s difficult for the IMF to take a deep interest in poverty measurement when some still call for us to leave the “poverty business” altogether.

DEATON: I’m in favor of the IMF’s staying in the poverty business, within limits. I was persuaded by [former IMF First Deputy Managing Director] Stan Fischer’s remarks at the conference last year [on macroeconomic policies and poverty reduction] as to why poverty is central to the IMF’s mission. He said that the IMF cannot use the “Von Braun defense”— “I just put the rockets up, and it’s someone else’s business where they fall”—to keep out of poverty. I don’t see how the IMF can cleanly mark out its core mission and say that poverty reduction is someone else’s business. The question is, how far do you go? Certainly, you don’t want to turn yourself into the Bank and hire all the specialists it has and replicate all the detailed poverty analysis it does. But showing greater awareness of poverty measurement issues is essential.

LOUNGANI: What are some areas we could focus on?

DEATON: Several of the problem areas that we discussed are areas where IMF economists are very highly skilled. In countries where there are discrepancies between the national income accounts and the national surveys, IMF staff may have some clues about the extent to which fudges in the national income accounts are responsible. The IMF also has had a long-standing interest in accurate price indices because of the need to get accurate measures of real monetary aggregates, real exchange rates, and the like. And I believe the IMF these days actually issues guidelines on how to provide macroeconomic data and assess their quality. That should be extended to poverty data. This is not the IMF changing its line of business, but simply recognizing that to do your business well you have to be well informed about the measurement of poverty.

Congratulations to Angus Deaton for winning the Nobel Prize in Economics. Below is my IMF Survey interview with Deaton (July 2002) on When numbers don’t tell the full story about poverty in India and the world

Before the world can answer questions about how poverty is reduced, it needs to know how progress can be measured. But estimates of the number of the world’s poor and questions about whether it has been decreasing or increasing have given rise to one of the hottest controversies in the development community.

Read the full article…

Posted by at 2:16 PM

Labels: Profiles of Economists

The Frenchman Who Reshaped the IMF

From the Globalist:

Reflections on the work of Olivier, the IMF’s now retired chief economist. 

The IMF is often caricatured as an institution that wants to nail every problem with the hammer of austerity and structural reforms.

An article in TIME claimed that the IMF tends to “dish out roughly similar advice to all countries, no matter what their circumstances,” noting that a cursory look at the IMF’s website would show that “prudent fiscal policy and reforms” had been recommended to Lesotho, France and Russia.

Whatever the merits of the caricature, Olivier Blanchard, the French-born, former MIT economist who served as the IMF’s chief economist from September 2008 to September 2015, achieved a rare feat.

He not only changed perceptions of the institution both on the inside and the outside but also, even more crucially, managed to reshape IMF policies.

Under Blanchard’s watch, the IMF:

  • lent its support to a global fiscal stimulus during the Great Recession
  • urged a very cautious removal of this stimulus during the Not-So-Great Recovery, and
  • staunchly advocated easy monetary policies—including quantitative easing.

Even a famous critic of the institution agreed: “A recovery in aggregate demand is the single best cure … what a relief to hear the Fund say that,” Paul Krugman cooed about the thrust of IMF policy prescriptions during the Great Recession.

Olivier Blanchard also threw out some controversial ideas for discussion, such as: Should inflation targets be raised?

That idea ran into some predictable criticism (“if you flirt with inflation, you end up marrying it,” said a former German Bundesbank president).

But it also drew fire from friendly sources—Blanchard’s mentor and long-time collaborator Stan Fischer, currently the U.S. Fed Vice Chairman, thinks that a higher target would be a “mistake.”

Blanchard also nudged the IMF towards less doctrinaire positions on several other issues, notably on the use of capital controls during crises.

He thereby gave an impetus to a rethinking that had started after the Asian crisis of 1997-98—see my article for The Globalist entitled “The Vindication of Joe Stiglitz.”



The fiscal triptych

The biggest change that Blanchard brought about was in the IMF’s advice on fiscal policies. This came in three steps:

  1. In early 2008, Larry Summers advocated a U.S. fiscal stimulus that was “timely, targeted and temporary.” Avoiding alliteration’s allure, Blanchard and co-authors advocated a global fiscal stimulus that was “timely, large, lasting, diversified, contingent, collective, and sustainable.”
  2. Next came a chapter in the October 2010 edition of the IMF’s flagship publication (World Economic Outlook), which Blanchard played an active role in shaping. To the question “Will austerity hurt?” the chapter gave a clear answer: “Yes.
  3. And then came three pages that Gavyn Davies in a FT blog said could have “a greater effect on global economic policy than all of the interminable” sessions held in Tokyo that year at the Bank-Fund annual meetings.

This was in the October 2012 World Economic Outlook—and subsequent paper — where Blanchard and his colleague Daniel Leigh showed that “in advanced economies, stronger planned fiscal consolidation has been associated with lower growth than expected.”

Translation: the adverse impact of austerity on output was perhaps larger than had been expected.

The upshot of this work was not that fiscal consolidation should never be undertaken. Rather, it was that one should expect austerity to lower output.

Moreover, this effect could be greater in some circumstances (e.g., when monetary policy was constrained because policy interest rates could not be pushed below zero).



It wasn’t just fiscal

Here are three other areas where Blanchard left his imprint through his own writing, by guiding the work of others or by creating an open atmosphere where his staff could explore new pastures:



Who’s afraid of capital controls?

Blanchard presided over a series of papers by IMF staff that nudged the Fund towards a more flexible position on capital controls.

A December 2012 blog by Blanchard and Ostry “explains the logic and research that underpins the shift” in the Fund’s position.



The “4% solution”

In a paper with Giovanni Dell’Ariccia and Paolo Mauro, Olivier posed the question: “Should policymakers therefore aim for a higher target inflation rate in normal times, in order to increase the room for monetary policy to react to such shocks?”

Though the paper never explicitly advocated a new 4% target (that was done later by Larry Ball in an IMF working paper), and certainly not one to be adopted right away, this quickly became known as the “4 percent solution.”



Inequality

The IMF has received a lot of credit for its work on inequality. The finding that captured attention — by Jonathan Ostry and Andy Berg — was that inequality was detrimental to sustained growth.

Blanchard initially regarded this finding as an interesting cross-section correlation and then as a correlation that had cleverly tapped into the zeitgeist.

It is only more recently, in his foreword to the April 2014 WEO, that Blanchard has come to the view that the implications of inequality for macroeconomic developments are a “central issue.”

From the Globalist:

Reflections on the work of Olivier, the IMF’s now retired chief economist. 

The IMF is often caricatured as an institution that wants to nail every problem with the hammer of austerity and structural reforms.

An article in TIME claimed that the IMF tends to “dish out roughly similar advice to all countries, no matter what their circumstances,” noting that a cursory look at the IMF’s website would show that “prudent fiscal policy and reforms” had been recommended to Lesotho,

Read the full article…

Posted by at 12:14 PM

Labels: Profiles of Economists

Johan Norberg: India Awakes

Since 1991, 250 million people have been lifted out of poverty in India. Johan Norberg’s documentary India Awakes discusses how this happened.
It used to be said that Indians succeeded everywhere except in India. Now Indians are starting to succeed in India.

At an event at Cato, Norberg said that “India is waking up because the government is starting to take a nap every now and then (imposing fewer regulations)”.

“What you can do and at what price matters more than who you are or what caste,” said Norberg.

“It’s morning in India but that is when the work day begins.”

India has set the goal of being in the top 50 countries in the World Bank’s Doing Business Index. Today it is at number 142 out of 189 countries.

A lesser known fact about Norberg is that he helped me inaugurate the IMF’s Book Forum: the topic was “Capitalism and its Critics”. The transcript makes for very interesting and prescient reading today – all the speakers (Jerry Muller, Ann Florini and Norberg) brought their ‘A’ game. For a short summary of the event click here.

Since 1991, 250 million people have been lifted out of poverty in India. Johan Norberg’s documentary India Awakes discusses how this happened.

It used to be said that Indians succeeded everywhere except in India. Now Indians are starting to succeed in India.

At an event at Cato, Norberg said that “India is waking up because the government is starting to take a nap every now and then (imposing fewer regulations)”.

“What you can do and at what price matters more than who you are or what caste,”

Read the full article…

Posted by at 5:50 PM

Labels: Profiles of Economists

Tom Sargent on U.S. and Europe: A Blast from the Past

Nobel-Prize winner Tom Sargent has an op-ed in the WSJ. Some of it was in an interview he did with me a couple of years ago.

Loungani: Europe’s fiscal challenges are foremost on minds here. This is something you have worked on in the past—the interplay of monetary and fiscal policy. 

Sargent: Yes. I think Europe can learn from the U.S history. In the 1780s, the U.S. consisted of 13 sovereign states and a weak center. The states could levy taxes, the federal government could not. Government debt, federal plus state, was 40 percent of GDP, very high for a poor country. It was a crisis. Creditors worried that they could not be repaid. 

Loungani: How was it resolved? There wasn’t an IMF … 

Sargent: Well, in the end the outcome was that the U.S. founding fathers rewrote the constitution so that it gave better protection to creditors. The constitution reflected a grand bargain: the central government bailed out the states, and the states gave up the power to levy tariffs. Knowing that the federal government had the power to raise tax revenues gave creditors reassurance that their debts would be repaid. 

A fiscal union 

Loungani: You’re saying the present U.S. constitution was adopted to give better protection to creditors? 

Sargent: Yeah, makes me sound like a Marxist, doesn’t it? But it’s all there in our history. Alexander Hamilton was basically creating a fiscal union—bailing out the states in return for a transfer of tax-levying authority to the center. And the point of a fiscal union was to change the expectations of creditors about the chances of being repaid now and in the future. Note, by the way, that the U.S. had a fiscal union before it had a monetary union. 

Loungani: So what are the lessons for Europe today? 

Sargent: Don’t some aspects of the EU today remind you of the historical experience I’ve described? The member states have the power to tax, not the center. Many EU-wide fiscal actions require unanimous consent by member states. But reforms that could lead to a fiscal union are being proposed, as they were in the U.S. in the 1780s. I think at the very least the historical episode—not just the one I described but several others that I could—shows that many configurations of fiscal and monetary arrangements are possible, and some of these work to provide assurance to creditors that there will be enough tax revenues to service the debt. I offer this as hope, but I must say that I am not an expert on day-to-day European economics or on their politics. 

Curing U.S. unemployment 

Loungani: You are an expert on the U.S., and particularly on unemployment, which you’ve also worked on over the years. What would you do about the high U.S. unemployment rate? 

Sargent: I would deal with the fundamental causes of financial crisis—the housing market particularly, where there are debts that haven’t been settled and people can’t yet see how they will be settled. And then to the extent that uncertainty about the course of government regulations is holding things back, I’d tackle that. 

Loungani: That could take time. How would you ease the pain of the unemployed in the meantime? 

Sargent: Some of the European countries, Germany and the U.K., have the right idea. They seem to do better on what’s called welfare-to-work programs—ways of helping the unemployed get into new jobs. We could have done more of that here in the U.S. 

Loungani: We extended unemployment benefits many times. Were you in favor of that? 

Sargent: I worry that can be a trap—we could end up with persistently high unemployment. 

Loungani: Why? 

Sargent: You have to go back to the basic ideas in the work that I’ve done with colleagues over the years. Our work builds on the finding that after about 1980 something changed. The [adverse] hits that people suffered to their incomes became more permanent in nature. In the jargon of our profession, the volatility in the permanent component of earnings increased; workers were more likely to suffer permanent shocks to their human capital. Tom Friedman’s The World is Flat has many examples of all this and the reasons why it happened. So we talk about the Great Moderation at the macro level but for individual workers it was just the opposite. 

An unemployment trap 

Loungani: How does this lead to the trap? 

Sargent: Well, think about what can happen when workers suffer a permanent hit to their incomes, and you offer then the alternative of generous and long-lasting unemployment benefits. For older workers, particularly, the benefits become an attractive option relative to looking hard for another job, which is not going to pay as much because your human capital just took a hit. And getting retrained is hard. I mean I was just 30 when my human capital was hit. You know I went to Harvard, right? I actually got pretty good at playing around with the IS/LM model, which is what I learnt there. And then a new thing—rational expectations—came along and I had to learn all this math and it was hard. Well, if you’re in your 50s you’re not going to be eager to try out the hard things. You’ll try to get by with the unemployment benefits. You end up with lots of workers who are detached from the labor force. I think that’s what happened in Europe in the 1980s. They’d always had more a generous welfare system but the impact of that wasn’t felt until the nature of the shocks to incomes changed in the manner that I described. 

Loungani: Yes, the interaction of shocks and institutions. Olivier Blanchard once said when the shocks changed Europe became like someone wearing a winter jacket in the summertime—the labor market institutions curbed flexibility when it was needed. 

Sargent: Exactly. So I think the people who want to keep extending U.S. unemployment benefits have the right motives but we can end up in the wrong place—a world of persistent high unemployment. So, while in the case of fiscal institutions Europe could look to early U.S. history, in the case of labor market institutions, the U.S. should keep in mind the European experience of not so long ago. 

Nobel-Prize winner Tom Sargent has an op-ed in the WSJ. Some of it was in an interview he did with me a couple of years ago.

Loungani: Europe’s fiscal challenges are foremost on minds here. This is something you have worked on in the past—the interplay of monetary and fiscal policy. 

Sargent: Yes. I think Europe can learn from the U.S history. In the 1780s, the U.S. consisted of 13 sovereign states and a weak center. Read the full article…

Posted by at 11:49 AM

Labels: Profiles of Economists

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