Update:  Here’s my EconTalk with Russ Roberts, where I describe my views on macro.

A few weeks back someone suggested that I describe how my views differ from the mainstream.  A few days ago I did a post describing what I thought was wrong with the standard models of monetary economics.  I ended up with a call for a new paradigm and left the impression that I’m about to provide it.  One commenter said my last paragraph was “remarkably ambitious,” which is a polite way I suggesting it’s crazy for a Bentley professor to be talking about new paradigms.  And he’s right.  So I’ll just list some of the areas where my views differ from others, provide lots of links, and then let others decide whether there is anything coherent in my approach.
Den ganzen Beitrag lesen…

The best thing that happened to the world economy in 1933 was that FDR sharply devalued the dollar against gold.  Prices and output started rising rapidly, and the US began to suck in a lot more imports from the rest of the world.  Our trade surplus got smaller.  Even better, this policy inspired other countries to devalue as well.  Paul Krugman knows all this, and often cites FDR’s actions with approval. 

The best thing that happened to the world economy this year, indeed just about the only good thing, was the V-shaped recovery in Asia, almost certainly led by China.  This recovery was aided by the Chinese government’s decision to stop appreciating its currency.  The Asian growth spurt was also a major factor behind the recovery in the US, which began in asset markets in March and spread to the real economy a few months ago (although we need a much faster recovery.)  Paul Krugman does not seem to know this, indeed he is now arguing that the Chinese need to reverse the very policies that provided green shoots to the world economy in the dark days last winter.  Here is what Krugman has to say:

Although there has been a lot of doomsaying about the falling dollar, that decline is actually both natural and desirable. America needs a weaker dollar to help reduce its trade deficit, and it’s getting that weaker dollar as nervous investors, who flocked into the presumed safety of U.S. debt at the peak of the crisis, have started putting their money to work elsewhere.

But China has been keeping its currency pegged to the dollar — which means that a country with a huge trade surplus and a rapidly recovering economy, a country whose currency should be rising in value, is in effect engineering a large devaluation instead.

And that’s a particularly bad thing to do at a time when the world economy remains deeply depressed due to inadequate overall demand. By pursuing a weak-currency policy, China is siphoning some of that inadequate demand away from other nations, which is hurting growth almost everywhere. The biggest victims, by the way, are probably workers in other poor countries. In normal times, I’d be among the first to reject claims that China is stealing other peoples’ jobs, but right now it’s the simple truth.
Den ganzen Beitrag lesen…

I wasn’t invited to participate, but since I have a blog I’ll put in my 2 cents worth anyway.  In my view both sides of the debate are wrong.  I disagree with pundits like DeLong, Krugman and Skidelsky, who have used this crisis to argue that mainstream macroeconomics is fundamentally flawed.  Of course there are a few things I’d like to tweak, NGDP targeting rather than inflation targeting, for instance, but the basic building blocks of modern macro are sound.  These include the need for explicit nominal targets for monetary policy, an assumption of efficient markets, and skepticism about using fiscal stimulus as a countercyclical tool.  But what this crisis did clearly demonstrate is that most mainstream economists, indeed nearly all of them, do not know how to apply these tools to a real world crisis.

Den ganzen Beitrag lesen…

Because I picked on Ahamed a bit in the previous post, I want to make up for it by pointing out some excellent passages in his fine book.  Here he discusses the common misconception that money “goes into” markets:

There was the erroneous notion [in the 1920s] that a rising stock market “absorbs” money from the rest of the economy.  This is sheer nonsense, because for every buyer of stock there is a seller and whatever money flows into the stock market flow immediately out.

This issue has come up a lot in this blog, with some people claiming that expansionary monetary policy blows up bubbles, because the money “has to go somewhere.”

Update 7/20/09,  I misread the quotation.  In the comments below Jon points out that Ahamed ignores the increased demand for transactions balances that often accompanies a rising market.  (Although steeply falling markets also can see increases in transactions.)

Den ganzen Beitrag lesen…

Wars make people think and do stupid things.  So does deflation caused by tight money.  The intellectual low point of 20th century macro occurred in 1938, when a promising recovery in 1936 turned into renewed depression and deflation.  Interest rates fell to zero, feeding the view that money was irrelevant.  A 1938 EJ article by Joan Robinson provides a good example of the zeitgeist.  Here she criticizes Bresciani-Turroni’s argument that the German hyperinflation was caused by their government printing too much money:

“An increase in the quantity of money no doubt has a tendency to raise prices, for it leads to a reduction in the rate of interest, which stimulates investment and discourages saving, and so leads to an increase in activity.  But there is no evidence whatever that events in Germany followed this sequence.”

So easy money couldn’t possibly have caused the German hyperinflation because German interest rates were not very low.  And everyone knows that easy money is associated with low interest rates.  I won’t insult the intelligence of my readers by explaining what is wrong with her reasoning.

Den ganzen Beitrag lesen…

I just added a FAQ section on the right side of the blog.  But I don’t plan to answer comments over there.

Today I’ll start with a very brief bio of four uber-important economists who were together at Princeton back around the turn of the century.   Since I can’t go five minutes without talking about myself, I’ll add a brief explanation of how their work relates to mine.  Then I’ll use their careers to speculate about what an ideal FOMC would look like.  Keep in mind I don’t know any of these people, and thus the portraits will be very sketchy.

Den ganzen Beitrag lesen…

I got a very good question from saifedean, and thought my answer might be worth a separate post.  He asked:

I am, however, surprised that you, of all people, think that Harding’s handling of the 1921 depression was good. According to your Monetarist rule-book, shouldn’t Harding have expanded the money supply to fight the depression? Yet he didn’t. And there was a fast recovery.

Doesn’t that make you doubt the veracity of the monetarist view? Doesn’t that support more the Austrian deflationist liquidationist view?

This is a very good question.  And although I can and will answer the question, my answer will raise deeper questions that may undercut part of my Great Depression story.  But that will be for you guys to decide.  Your views may influence how I revise my Depression manuscript.

Den ganzen Beitrag lesen…

I may not post much for the next week, but if you are interested you can tune in to my debate with Lee Ohanian at CBSMoneyWatch.com.

I just posted my first column, and three more are planned.  Professor Ohanian will also provide three responses.  I should mention that I was restricted a bit by the format.  I did slightly run over the 500 word limit, but I was also asked to take the side that “deflation is a currently a bigger risk than inflation.”  As you may know, I am more worried about prices rising at too slow a rate than too high a rate.  However I also think that outright deflation is less likely than “disinflation.”  In any case I don’t have much fear of high inflation, so I decided to take the “deflation” side of the debate.  It also needed to be written at a level for the average educated reader, not economists, so it wasn’t always possible to quickly sketch out these subtle distinctions.  In any case I did the best I could under those constraints, and will have two more shots.  There is much more I would have liked to say (and have said throughout this blog.)

Den ganzen Beitrag lesen…

Let me say first that I like history.  I think historians have a lot of interesting things to say and I don’t think historians should be economists.  But . . .

I  It depends on the definition of “great.”

Go to the following link and scroll down to the Ranking of presidents by historians in a 1996 poll.  Wilson is ranked 6th whereas his successor Harding is ranked 41st.  That’s 41st out of 41 presidents when the poll was conducted.  Where does one even start?

Den ganzen Beitrag lesen…

1.  JimP sent me this link showing that I am not the only one who thinks tight money is the cause of our current predicament:

Tim Congdon – a hard-money Friedmanite from International Monetary Research – says the Fed is still not easing enough, perhaps because it is spooked by so much criticism or faces a mutiny by its own hawks. “If Ben Bernanke and his officials are listening to this sort of stuff and taking it seriously, they are making the same mistake as the Fed in the early 1930s,” he said. The US “output gap” is near 7pc. That is a powerful lid on inflation.

The sin has been to let M2 money growth wither since January, to let bank lending contract at a 5pc annual rate, and to let 10-year bond yields rise to nearly 4pc. The Fed pays lip service to the Friedman-Schwartz theory of the Depression, but has not digested the lesson.

Mr Congdon’s prescription is what Britain did in 1931 and 1992: monetary stimulus à l’outrance (today: bond purchases), offset by spending cuts. This mix – easy money/tight fiscal – would halt debt deflation without ruining the public finances of the US, Britain, and Europe in the way that Keynesian schemes ruined Japan. “The markets would rocket,” he said.

My doppelganger.  BTW, those of you who think I’m an inflation dove should note that Tim Congdon is described as a “hard money” guy.

Den ganzen Beitrag lesen…

JimP sent me this really neat video.  It’s the best explanation of the crash of 2008 that I have yet seen on video.  This shlocky, crude piece of pro-FDR propaganda from 1933 shows a more sophisticated understanding of the current crisis than what you get from 99% of contemporary economists.  As you watch, note the following similarities:

1.  The rise in the value of the dollar (1929-33 and late 2008) caused the price level to fall, and NGDP to fall even faster as output also declined.

2.  A policy of mild inflation will reverse this process.  NGDP, output, and employment will rise, and debts will be easier to repay as dollar incomes start rising again.

They knew that in 1933, why have we forgotten?  BTW, don’t tell me things are different now because we have a severe financial crisis.  They had one in early 1933 as well.  But at least they understood that their crisis was caused by falling nominal incomes, and not vice versa.

Today all we hear economists talk about is the symptoms of falling NGDP, not the causes.

Update 6/19/09,  I just noticed that Tim Cavanaugh at Reason had the same video.  Tim seemed slightly less impressed than I was.

This is ambitious post.  Quite frequently people ask me to provide data supporting my hypothesis that the Fed (and ECB and BOJ) caused the crash of 2008.  Whenever I get that question I always have a sinking feeling, a feeling that people don’t really understand what I am driving at.  In the first part of this post I will try to explain the success of Friedman and Schwartz’s Monetary History of the U.S. But the real goal will be to use that explanation to help you see why if you are asking for data, you probably don’t see the problem as I do.

Den ganzen Beitrag lesen…

My normal Sunday post will have to wait, as Brad DeLong has a recent post where he asks why I don’t like IS-LM.  Since I get annoyed when people don’t take my open letters seriously, I can hardly ignore his post.  Plus it’s a very good question.  Because I don’t have complete confidence in any of my answers, I will go for quantity rather than quality.  But I’ll say right up front that I doubt there are any theoretical flaws in the IS-LM model.  As Brad DeLong puts it:

But I have not yet seen a theory of nominal spending or real output determination that does not have an IS-LM representation…

I think he is probably right, and most of my reply will be on pragmatic grounds, not theoretical.  Nevertheless, let me start off by taking a stab at a theoretical argument.

Den ganzen Beitrag lesen…

For the past 25 years one of commuting’s little pleasures has been waiting at the traffic light in Watertown Square and admiring the architecture of the local bank (built in 1921.)  Unfortunately the links here and here don’t even come close to doing it justice, as it has the sort of deeply recessed arches associated with Alberti’s church in Rimini.  By the 1950s and 1960s, bank architecture had begun to reflect the aesthetics of the strip mall.  How did that happen?

Den ganzen Beitrag lesen…

There are endless interpretations of what Keynes “really meant” in the General Theory.  In my view there is no answer to this question; Keynes’ thinking was too muddled and contradictory to be understandable in terms of modern monetary theory.  But now that some of our leading macroeconomists are showing equally muddled and contradictory thinking, it might be time to revisit this famous book.  In my view page 207 holds the key to the entire book—indeed two keys.  It explains why the book is so misunderstood by modern readers, and then just a few lines later, how Keynes misunderstood his own argument.

Den ganzen Beitrag lesen…

I’m referring to 1929, 1937, 2008, which all saw severe stock market crashes, accompanied by falling commodity prices.  We can better understand our current crisis if we first step back and look at the two earlier October crashes, which bear some interesting resemblances to recent events.

Although in each case the problem was “monetary” broadly defined, in none of these three episodes can modern monetary economics easily identity the problem.  In contrast, the monetary model sketched out in the previous post will allow us to see the subtle forces that pushed the economy into severe recession.  For instance, in 1929 the problem was central bank hoarding of gold, in 1937 it was private hoarding of gold, and in 2008 it was banks hoarding reserves.

Den ganzen Beitrag lesen…

[Finally spring break!  I will do the Depression piece this weekend, but I am doing this first, as I hope it will give people a better idea of where I am coming from.  To non-economists, it may seem weird and off-topic at first, to economists it may seem simplistic and off-topic, but bear with me, there is a method to my madness.]

Lesson 1.   Nominal GDP measured in apples:

Before playing tennis, you are supposed to stretch your muscles (although I never do), so this is a mental stretching exercise to help you see monetary theory differently.  Let’s take a good with a roughly unit elastic demand, pretend it is apples.  I want to estimate nominal GDP measured in app
Den ganzen Beitrag lesen…

It seems like I have seen the title phrase of this post in almost every economic report for the last 6 months.  This time it was in a Yahoo article about job losses in February.   Early last October when stocks and commodities crashed, and inflation expectations in the indexed bond market started falling sharply, it was pretty obvious that the markets expected a sharp drop in nominal GDP.  It’s been my impression that the private consensus forecast, and especially the Fed, has trailed far behind the markets in understanding the severity of the crisis.  The private consensus forecast has seemed to fall almost every month for over a year, whereas under Ratex it should be a random walk (or have I misunderstood something here?)

Den ganzen Beitrag lesen…

One can learn a lot about monetary theory from studying either commodity standards or fiat money regimes.  But perhaps the most illuminating examples come from an in between system, a transition from one commodity regime to another.  Although most of this (very long) post will seem far removed from current issues, in the end I will argue that there are important lessons.  We will look at 1933, the year of transition from one gold standard (1879-1933) to another (1934-68.)

Den ganzen Beitrag lesen…

When I discuss the effect of monetary stimulus on aggregate demand with other economists, I notice that they often want an explanation couched in terms of the major components of GDP.  I find this very frustrating, as this approach does more to conceal than illuminate.  Suppose you were policy czar in a liquidity trap (such as right now), and you were asked to increase nominal GDP by 3-fold (i.e. 200%) in the next five years.  If you were given a choice of only one tool, which would it be–monetary or fiscal policy?  Any economist with an ounce of common sense would take monetary policy.  OK, so how would you explain its effect in terms of the 4 components of GDP?

Den ganzen Beitrag lesen…