Basil Halperin on eclectically optimal policy
Plus thoughts on monetary policy and the current economy
David Beckworth recently interviewed Basil Halperin on his podcast MacroMusings. The interview focused on two primary issues: the effect of AI on the macroeconomy and how to think about optimal monetary policy. I see Halperin as a pragmatist in the tradition of Bennett McCallum, which is one reason why he’s my favorite young macroeconomist. Later, I’ll offer some comments on recent trends in the economy.
Halperin’s model suggests that if extremely rapid AI growth were to occur, it would lead to much higher interest rates. The fact that we do not see extremely high rates is taken as evidence that the financial markets do not expect explosive growth over the next decade or two:
Halperin: . . . I think it’s totally plausible that we just get something like the late ’90s, the dot-com boom, where we have a large surge in growth. AI companies make a lot of money and continue to have really fast revenue growth, like the 10 times a year that Anthropic has had last year. Not reaching the 30% GDP growth, certainly in the next five years, again, that some people take very seriously.
Maybe 20 years down the line, things change. I do think that rapid acceleration really is possible in the long run if we have something closer to full automation of human labor. Those sci-fi scenarios, I actually do think our models say that’s quite possible. Economic history says rapid economic speed-ups are quite possible. In the next five years, the next 10 years even, maybe even the next 20 years, that’s where the markets are not seeing this. Markets are pretty good at predicting the future, its own form of artificial intelligence.
Beckworth: You’re hopeful that, within my lifetime, I will see transformative AI?
Halperin: “Hopeful” is a strong word because big changes are both good and scary.
Others have argued that an AI boom might actually lower interest rates, but I don’t find the assumptions about income distribution in those models to be plausible.
The interview is full of great observations. Here he pushes back on the view (which I once held) that AI might solve our public debt problems:
Faster growth means higher tax revenue, but faster growth in general equilibrium means higher interest rates, that is, higher rates on new debt. The average maturity of Treasuries is like six years or something so the US has to roll over its debt stock every six years or something like that. After six years, we’re going to be stuck with all those higher new interest rates. Hence then, the question is this R versus G, or really R minus G, is the effect of AI on interest rates or on growth larger? What determines that? . . .
And this is what the empirical estimates in my paper with Zach and Trevor would find where . . . we have some nice data showing that R and G are indeed lined up. Higher growth leads to higher interest rates or correlationally leads to higher interest rates. We estimate something around one for the slope of that relationship, this elasticity of intertemporal substitution. I would say that higher growth leads to one-for-one higher interest rates so that new debt is not any easier or any harder to pay off as a response to AI. That would say that AI is not a magic solution to our debt problem.
Halperin is a fan of NGDP targeting, citing the influence of George Selgin’s book Less Than Zero:
[Selgin’s] book has influenced me a lot. I think, to my very idiosyncratic taste, it’s one of the most conceptually important works on monetary economics in the last 30 or 40 years because it really drills in on what should central banks actually be doing from a number of directions that the formal literature eventually developed on, even if George’s work wasn’t mathematically formalized so much and wasn’t so much directly cited. He previewed works in top journals that were published 20 or 30 years later, including inspiring my paper that you mentioned with Daniele Caratelli.
Milton Friedman is another influence:
Halperin: . . . If the real interest rate is going to rise, if r-star is going to rise, that means monetary policy needs to pay attention to that, to either not keep interest rates too low so that you have some inflationary outcome, or not have interest rates too high to have excess unemployment, like the Citrini scenario. That’s the second point.
A third point is that I think monetary policy can be helpful to not screw up how the economy goes during an AI-driven transition, but cannot solve the problem. This really is a question for fiscal policymakers. It is a question of redistribution. What monetary policy should be sure to do is just not screw things up. I keep saying Friedman in this episode, maybe appropriately because he’s the GOAT, as your boss, Tyler, would say.
What monetary policy can do versus what it can’t do: What it can do is ensure that it doesn’t screw up the economy in response to shocks. That’s the fundamental lesson of his 1968 presidential address, famous paper. Implementing the less-than-zero policy that Selgin recommends or this countercyclical inflation that comes out of my work would be one plausible way of doing that.
Halperin agrees with Bennett McCallum that because we don’t know exactly which form of wage and price stickiness is the most important, we need a robust approach to monetary policy that is relatively optimal under a wide range of assumptions.
Halperin: Even zooming out, is sticky prices obviously the most important nominal friction in the world? I’ve written a paper on this. That’s still not clear to me. Sticky prices as opposed to sticky wages or sticky nominal debt contracts or sticky information. No one’s done a head-to-head comparison of all these different frictions. I think that’s desperately needed. Though, it’s not clear how you do that. Otherwise, I would have written the paper. . . .
That’s the core logic of what we show to be optimal in the model. The way that gets you NGDP targeting or nominal wage targeting or this countercyclical inflation is that if this firm was having a positive productivity shock, it’s producing more stuff. Output’s going up. Y is going up. It’s cutting its price. Every other firm is keeping prices constant, but that one firm is lowering its prices. The average level of prices in the economy is then falling. Y up, P down. In a baseline setup, those are one for one. P times Y, nominal GDP, is kept constant. You can also see this as nominal wage targeting. Stabilizing nominal wages ensures that the nominal costs of all those unaffected firms is stabilized so that they don’t want to change their prices. Nominal wage targeting is another way we frame optimal policy in the paper. All of these terms—NGDP targeting, nominal income targeting, nominal wage targeting—all of these things are pointing to this countercyclical inflation, looking through shocks rather than aiming for strict inflation stabilization, which is the baseline new Keynesian logic. . . .
The way I think about this is that NGDP targeting or something like it is eclectically optimal.
Back in 2011, I had this to say about Bennett McCallum:
McCallum first proposed NGDP targeting some time around 1980. McCallum has an interesting position within the field of macroeconomics. Unlike me, he is comfortable with the IS-LM approach. Unlike me, he is comfortable working with rather sophisticated new Keynesian models. But unlike people like Michael Woodford, he has always insisted on the importance of the quantity of money (rather than merely the effects of monetary policy on interest rates.) And unlike most new Keynesians, he’s argued that NGDP targeting is superior to the various flexible price inflation targets that are frequently proposed. I think this is rather unusual, as when your model includes both P and Y separately, there is no obvious reason to put the same coefficient on the reaction function for each variable. So I’ve always seen him as being in the mainstream of modern macro research, but a little off to the side of that mainstream.
I met him only once, and that was at a conference in March. He has a very appealing personality; quiet and very polite. . . . I have great respect for his intuition. He seems to have a good sense of which developments in macro are fruitful and which are not.
Like McCallum, Basil Halperin seems to have absorbed both the best of New Keynesian economics and the best of Milton Friedman thought. He also favors NGDP targeting. He also seems to have excellent intuition about which sort of macro models are plausible and which are not—a skill that’s hard to teach. Even their personalities seem a bit similar, as both come across as being very polite. (Here’s a much longer post explaining McCallum’s excellent intuition.)
Next, I’ll offer some related observations on the current state of the economy.
