A slightly off-center perspective on monetary problems.
People that develop new ways of looking at the world are most successful if they can create a new language, a new set of metaphors. I don’t have the literary skills of a Keynes or a Freud, but then again I also don’t have such grandiose theoretical objectives.
Den ganzen Beitrag lesen…
My view of the period from mid-2006 to mid-2008 is as follows:
Too much capital was allocated into housing during 2004-06. After the U.S. housing market peaked in mid-2006, for the next two years we had a mildly painful readjustment, as resources were moved out of housing and into other sectors of the economy. Because it is difficult to re-allocate resources, the structural unemployment rate crept up from the mid-4s in mid-2007 to the mid-5s a year later. Other sectors of the economy kept growing. There were no signs of bubbles in U.S. manufacturing, which grew at the normal rate during the previous expansion, and of course manufacturing prices were well-behaved (unlike housing.) The big bubble was in housing, and after 2006 we had to go through a painful readjustment as labor and capital was re-allocated to other sectors.
I woke up today dreading having to write part 2 of my liberalism and utilitarianism post, and then decided to just blow it off. I suppose a blog should be more like jazz improv, rather than the laborious construction of a symphony in parts. So tonight I’ll do shorter pieces on the following 4 questions:
1. Are macroeconomists just a bunch of astrologers?
2. Are Democrats just a bunch of socialists?
3. Do soaps promote liberal values?
4. How many Tyler Cowens are there?
This is inspired by Mankiw’s Pigou Club; and like Mankiw I’m not asking permission—I get to decide who belongs. Surely some of the people who participate in this blog would qualify, but I’ll leave that up to them. I have also clearly hinted that I think George Warren, Earl Thompson and Robert Hall all belong. Warren is dead. My hunch is that Thompson wouldn’t mind being included, whereas Hall would. But they have no choice—all three go in. Today I add another member to this distinguished group:
FREDERIC S. MISHKIN
I am pleased that Greg Mankiw has recently given the interest penalty on reserves idea more visibility. (It is also nice to be called a “prominent economist” by Mankiw.) Unfortunately, like the rings of Saturn, this issue is much more complicated than it appears at first glance. Many economists try to look at the entire liquidity trap issue by boiling it down to a few fundamentals; the perfect substitutibility of cash and T-bills at zero rates, or the problem of credibly promising a permanent expansion in the money supply. Unfortunately none of those easy thought experiments are enough. The problem must be examined from multiple perspectives at once. Hence I plan a long post that will have readers crying “No mas, just try Sumner’s plan so I don’t have to read any more of this.”
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.
Originally I had planned on a post arguing that the best way to understand liberalism in all its various permutations is by equating it with utilitarianism. But I thought it might be better to break it into two posts, to keep the length more manageable. I’ll do the liberalism part next Sunday. Keep in mind that today’s post is intended to be a defense of utilitarianism from the liberal perspective; it is not aimed at objections that non-liberals might have. Thus I don’t address dogmatic libertarian arguments against progressive taxation.
Nick must have come back from his American adventure even smarter than when he left, as he has just posted an excellent essay on the problem with relying on interest rate targets. First I’ll point out a few passages that I particularly liked, and then I’ll provide my thoughts on a few questions that he raised at the end. Let’s start with how he concludes his discussion of the classical dichotomy.
If you take this homogeneity insight, and add the assumption that the supply of money is exogenous, you get the Quantity Theory of Money (a change in the supply of money will cause an equi-proportionate change in all nominal variables), and the Neutrality of Money (a change in the supply of money will affect no real variable).
Post-Keynesian horizontalists (and we are all horizontalists now, unfortunately, because that’s the underlying problem) reject the Quantity Theory because they reject the assumption that the supply of money is exogenous. But that misses the point. A revised Quantity Theory can be re-formulated taking any nominal variable as exogenous — the price of gold, or nominal GDP futures, for example. The homogeneity insight does not depend on any definition of money supply being exogenous.
This might seem like an odd question. Everyone seems to agree that Bernanke has done everything humanly possible to boost the economy. But there is a difference between doing a lot, and doing things that are effective. My hunch is that we will get a recovery soon, or perhaps I should say that is my reading of market expectations. But I see little reason to believe it will be adequate. Last month the Fed promised to buy up to a trillion dollars in bonds as a form of quantitative easing. The monetary base is higher than a month ago, but it is still lower than at the beginning of the year. The single most important thing the Fed can do right now (in addition to an interest penalty on excess reserves) is to clearly communicate its intentions to raise the five year expected inflation rate from 0.8% closer to its target of 2%. See if you think this passage from an April 14 speech by Bernanke effectively conveys the Fed’s determination to reflate:
This post was motivated by a recent piece by Tyler Cowen on why fiscal stimulus is not popular among social democrats in Europe. I am worried than any liberals will come away thinking that my message is simply:
1. Northwest European social democrats–good
2. American liberals–bad
Well, it’s not quite that simple. I am somewhat libertarian and even vote that way. But I would be horrified by the thought of the current libertarian party coming to power. Why do I vote for them? Because I suppose I assume they would become somewhat more responsible as they got closer to power–as did the German Green party. So don’t view this as an ad hominem attack on liberals (some of my best friends are . . . ) but rather an inquiry into how politics shapes ideologies.
I may do a longer post on utilitarianism on Sunday, but since a recent post by Bryan Caplan perked my interest, I thought I would get a brief head start today. The context was a debate between Bryan Caplan and Robin Hanson on liberty vs. efficiency. Although Robin was defending efficiency and not utilitarianism, Bryan’s argument in his blog post is exactly the sort of argument that many philosophers make against utilitarianism, so I will respond on that basis. I should say that just as with my defense of the efficient markets hypothesis, I am not so much pro-utilitarian, as I am unimpressed with arguments against utilitarianism. Indeed, on Sunday I will express some of my own reservations with utilitarianism.
Because of the bloated monetary base there has been much concern recently about the supposed risk of future inflation. There are at least four important misconceptions associated with this issue, and I’ll try to address all four in this post. The first misconception is that it will be difficult to pull the excess reserves back out of circulation after the economy recovers and interest rates rise to a more normal level. As Hall recently pointed out, if we continue to pay interest on reserves it would not be necessary to pull those reserves out of circulation in the future, just pay enough interest for banks to want to continue holding them. But for the moment let’s assume that’s not feasible. In the following quotation from the WSJ, Kenneth Rogoff expresses a widely held fear:
“It’s very difficult to pump this money in and pull it out later,” says Kenneth Rogoff, a professor of economics at Harvard University. “There’s every risk of an overshoot.”
Robert Hall and Susan Woodward posted an essay on the subject of interest on reserves:
Raising the reserve interest rate is a contractionary measure. A higher interest rate on reserves makes banks more likely to hold reserves rather than increasing lending. The Fed’s decision to raise the reserve rate from zero to 75 basis points just as the economy entered a sharp contraction in activity is utterly inexplicable. Fortunately, the Fed lowered the reserve rate subsequently, but the continuation of a positive reserve rate in today’s economy is equally inexplicable. Some economists have proposed that the Fed charge banks for holding reserves, an expansionary policy worth considering. With the Fed funds rate at around 15 basis points, it would take a charge to restore the differential that drives banks to lend rather than hold reserves. Were the Fed to charge for reserves, they would become the hot potatoes that they were in the past, when the reserve rate was zero and the Fed funds rate 4 or 5 percent. Banks would expand lending to try not to hold the hot potatoes and the economy would expand. There is no basis for the claim that the Fed has lost its ability to steer the economy. (However, the Fed would have to go to Congress to get this power, as it did to get the power to pay positive interest on reserves.) [italics in original]
BTW, I am not suggesting that they are referring to this blog, as I’m sure other economists are also making this argument, but I’d like to think we might be having some impact on the conversation. I sent an email to Robert Hall a couple weeks ago.
Thanks to Dilip for two very helpful links. This one, and yesterday’s link to Brad DeLong. BTW, Andrew Sullivan just linked to the global warming post. Make that three, Dilip just sent me the link below.
Update: Mark Thoma just linked to the Hall and Woodward idea here. Mark calls their essay “good, but wonkish,” although it’s not clear if that refers to the interest penalty idea.
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.
Films like Downfall and Letters from Iwa Jima depict the cult of suicide, the tendency of people in cult-like groups to want to take others with them when they end their lives. The most famous American example was Jim Jones’ religious cult. What made me think of this issue was, of course, the recent G-20 meeting in London. I was all set to do a clever piece on the G-20’s announced policy of strongly discouraging countries from engaging in competitive devaluations, when I saw that Barry Eichengreen beat me to it. His piece is well worth reading, but was written before the G-20 meeting, so he was unaware of just how little sympathy they would show for his suggestion that competitive devaluations should be encouraged. Not only did they not encourage them, they issued a communique which positively discouraged competitive devaluations.
I know very little about Indian Ocean piracy, but I have always wondered about a couple of points. First, why don’t ships take a wider berth around Somalia? Are all these ships going through the Suez Canal? And after ships are captured, why don’t war planes move over the spot, and sink the pirates’ boat when they leave? Do the pirates always have hostages, which they later exchange for money somewhere in Somalia? It seems their boats would be very exposed out in the open ocean. I’m sure there are simple answers to these questions, but I have been thinking about the issue because of the recent capture of a ship captain who lives in the same metro area as I do. Here is the Boston Globe story. The father of the second in command teaches a course on anti-piracy techniques here in Massachusetts—what are the odds of something like that? It sounds like the crew members were quite courageous. Hopefully the captain will be released soon, I could even see a Hollywood movie if things turn out well.
There is a common misconception that zero nominal interest rates make monetary policy ineffective. In fact, the reverse is true. Because Paul Krugman is so respected by left-of-center economists, I had assumed that his “expectations trap” was now the accepted explanation of policy ineffectiveness, and that it was generally understood that Keynes’ original liquidity trap argument was faulty. No doubt most macroeconomists are aware of Krugman’s argument, but as this link shows, much of the debate still revolves around the earlier Keynesian model, as formalized by Hicks (1937.) To be fair to Brad Delong, I am sure that he understands the distinction between liquidity traps and expectations traps. And he is merely trying to refute crude monetarist models that also lack rational expectations. So maybe his exercise is defensible. I am not a monetarist, but I imagine they might favor having the central bank do unconventional QE in that situation, i.e. buy interest-bearing assets. But it is clear from his comment section that many of his readers do actually think that Keynes’ liquidity trap still shows monetary expansion to be ineffective at the zero bound.
If you were to rely on the press, you’d think that the purpose of fiscal stimulus was to boost real output, to “get us out of the recession,” and the purpose of quantitative easing (QE) is to boost inflation, to “get us out of the liquidity trap.” I’m sure someone will tell me where I am wrong, but this seems like utter nonsense to me. I had always assumed that the point of both monetary and fiscal stimulus was to boost AD. And that in the short run both policies raise both prices and output. And that the way nominal GDP growth is partitioned depends on the slope of the SRAS curve, not on what caused AD to increase. Did I misunderstand my macroeconomics courses?
I can’t bear to watch myself on TV, so you’ll have to tell me how awkward I look. The format presents several challenges, you don’t see the other person, you have a number of topics to cover, and you want to get certain points across (but also seem conversational.) In addition, the audience is unseen (unlike a seminar) and thus it’s hard to know if the level of discussion is appropriate. Fortunately Mark Thoma is very friendly and easy to talk to, so despite our occasional policy differences it was a very pleasant discussion. Of course I later thought of a 100 points I should have mentioned, and thus below I will link to some posts that new visitors might want to look at if they are interested in a more coherent explanation of my views of the crisis.
For a view of what went wrong with monetary policy look here.
For my policy recommendations look here and here.
For some data supporting the reverse causality view look here and here.
For evidence that tight money causes low interest rates look here and here.
For my views on market efficiency look here.
For my views on forward-looking monetary policy look here.
For my views on the General Theory look here and here.
For my views on fiscal stimulus look here.
I also tend to do non-monetary posts on Sunday. Here is one on neoliberalism and cultural values.
I think that people have a natural level of success, or set point, based on their personal characteristics. Although it is hard to evaluate oneself, I suspect my economic intuition is above average and my poise and presentation skills are below average. The intuition works to my advantage in the blog format, but less so on TV. Of course luck also plays a role in success, and I was fortunate to get some very favorable reviews from people like Tyler Cowen, Will Wilkinson, and Greg Mankiw. Those reviews might have boosted me from below to above my set point. We’ll see if my TV appearance puts me back at my natural set point. (I recall that people used to talk about a “Peter principle,” but I haven’t heard that term recently.)
Here is the link.
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?
