The Tail is Wagging the Dog

Two weeks ago I proclaimed that macro was sleeping and wouldn’t you know it, all the news lately has been about macro policy. Much of the discussion among economists and journalists shows that macro must have one eye open. These policy discussions are as confused as I have ever seen them.

Here are some of the themes. First, the Fed is pretty sure that inflation is going to rise above the cherished 2% target, and they will have to attend to a potential inflation monster with a more aggressive monetary tightening. But then they admit that inflation is not roaring back yet and there is always the worry that a rough policy would lead us into a recession. Second, recent economic growth news from the UK and Germany have us worried that global growth may be in a new tailspin. Just days ago, we were worried that the world might grow too fast. Wham bam – now we are not so sure. Third, we might be headed into a global trade war pitting the US against China, Europe, and several far-off planets. Or maybe not.

Isn’t macro policy fun? It is true that all of us except for John Travolta cannot see the future, and economists always disagree about best policies for any given 7-minute time frame. But today we find ourselves more confused than ever. Why does macro seem so lame these days? What happened to our rocket science?

My explanation begins with the vivid notion that the tail is now wagging the dog. Nolan knows that a dog is supposed to wag its tail and not vice versa. The dog is short-term macroeconomic oscillation. The tail is everything else. It used to be that everything was about the dog. Central banks and treasuries are laser focused on short-term macro stuff. Is the consumer going to be happy this year and buy another car? 

Will tax cuts cause consumers and businesses to spend more? Are firms going to build inventories? Will rising oil prices rob consumers of money they could spend on JD and potato pancakes? In that world, the dog is our focus and we use monetary and fiscal policies to buff up spending when conditions are weak and the opposite when people are spending too much.

But the dog is a mere pussycat today. And the tail is roaring. The tail is the aftermath of the worst world recession that the Tuna can remember. The world economy never entirely exited that recession. We lumber along. Some wonder if capitalism is doomed. Others worry about the lack of enthusiasm firms have for buying new and exciting equipment. Then there is that debt overhang from beer-guzzling college students to pot-smoking boomers with hip pain.

This dragging tail of an economy is also weighed down by a disenchantment of both the young and old for the labor force and the nonchalant attitudes about investment and the resulting lagging productivity gains.

The sad fact is that our dog-oriented policy makers are in the dark when it comes to the tail. They know how to fix the dog and that’s where they focus their attention. If you are a hammer, then every problem is a nail! But dudes, it ain’t the dog. Focusing on the dog means you miss the point. Focusing on the dog means that you are confused by the macroeconomic data. John Maynard Keynes said that we are all dead in the long-run so we should focus on the short-run. But today the tables have turned. We seem to be very alive in the long-run, and the short-run will be a very dull and confusing place if we don’t take care of the future.

Like a 24-hour news cycle, the Fed is always in our thoughts. But the Fed has little to do with the long-run except to provide ample money for long-term growth. All this noise about whether they are going to raise rates 3 or 9 times this year sells soap but is mainly a distraction. Whack-A-Mole economic performance in the US and abroad is similarly uninteresting. The world economy is stuck in neutral, and it has everything to do with longer-term challenges.

We need to put Keynesian economics to bed. It’s hurting our sleep. Let’s require all decision makers at the Fed and in Congress to take a course in long-run macro. But that’s silly. I doubt most of them are smart enough to understand it. And none of our 24 hour news station would find it interesting enough.