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.

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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.)

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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?

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I just wanted to let you guys know that I am having increasing problems with computer viruses.  Some of you have noticed span in the RSS Google reader.  I have also lost my links information, and now I have lost my ability to write new posts.  The reason for my “Drudge-like” attention-getting update is that since I can’t post anything new, my only way to contact you is by amending existing posts.  I have been working on a new post, one of my “grouchy” ones, but can’t post it yet.  Instead I’ll complain about today’s Fed action, or should I say lack of action.  The S&P fell about 8 points right after the 2:15 announcement.  The 5-year TIPS spread is now back down to 1.42%.  Where’s that hyperinflation everyone on the right keeps promising us?  And by the way, where’s that global warming Al Gore promises?  I’m not comfortable unless it’s at least 85, and it’s been in the 60s in Boston this summer.

Seriously, I have no reason to doubt the science on CO2 and global warming, but the real action is in the economics of global warming.  The new Journal of Economic Perspectives has 3 interesting pieces on the subject.  One thing I took away is that the apocalyptic visions being made of extreme global warming just won’t happen.  I predict a maximum of 2 more degrees centigrade.  Geoengineering is for real.  I’d like to know more about how serious the problem of ocean acidification from CO2 really is—it could become a key issue.  And also more research on the possibilities for technologies that remove CO2 from the air at remote locations where it can be buried.  My hunch is that we’ll try to create clouds from sea water at higher latitudes if temps threaten to rise more than 2 degrees, and then work on a technology to remove CO2 already emitted in the second half of the 21th century (to deal with the ocean acidification problem.)  If I am right, that’s tilts the argument away from Stern’s more ambitious agenda, toward Nordhaus’s less costly approach to the problem.

BTW, I’m told that tomorrow morning my debate with Lee Ohanian (on the issue of deflation/inflation) will begin on CBSMoneyWatch.com.  It will be a three part debate.  Sorry for all the problems here, and thanks to those who have stayed around despite the problems.  I think Austrian economists may like the next post.

Let’s take a look at inflation expectations since the stock market (and TIPS spreads) hit a low in early March:

Date    5 year TIPS yields   5 year T-bond yield   TIPS spread    S&P 500

3/9/09         1.52%                       1.90%                 0.38%           676.53

4/1/09         0.93%                       1.65%                 0.72%           811.08

5/1/09         1.24%                       2.03%                 0.79%           877.52

6/1/09         1.02%                       2.55%                 1.53%           942.87

6/10/09       1.08%                       2.93%                 1.85%           939.15

6/19/09       1.23%                       2.80%                 1.57%           921.23

6/22/09       1.23%                       2.70%                 1.47%           893.04

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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.

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When you read old economic journals you come across lots of empirical studies of things that no longer interest us.  In the interwar period there are lots of studies of the world gold market; estimates of newly-mined gold, industrial use, dishoarding from the Indian subcontinent, etc.  I also seem to recall lots of studies of money demand being published in the 1980s; money demand in Turkey, money demand in South Korea, etc.  My impression is that people are no longer interested in those studies.  They are reread about as often as yesterday’s newspapers.  I wonder whether the same will be true of recent macro studies using techniques such as vector autoregression (VAR.)

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Yes, if you give his remarks a very charitable interpretation.  I am referring to the remarks discussed by Arnold Kling here and here, which have received a lot of attention recently.

To fight this recession the Fed needs more than a snapback; it needs soaring household spending to offset moribund business investment. And to do that, as Paul McCulley of Pimco put it, Alan Greenspan needs to create a housing bubble to replace the Nasdaq bubble.

As everyone knows by now the once kooky and discredited Austrian business cycle model has now become conventional wisdom.  Easy money creates bubbles, which inevitably cause depressions when they pop.  It’s Greenspan’s fault.  Paul and I are still not on board the Vienna express, but we are in an awkward position.  (Thank God I didn’t have a blog in 2002!)

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Apologies to Emile Zola fans for the sophomoric title, but I wanted to get people’s attention as this is important.  In the past I had sort of given the Fed a pass on its behavior in the 3rd quarter of 2008, partly because we didn’t get a major stock market crash until the first 10 days of October, and partly because I hadn’t looked closely at the data.  A couple months back I looked at some graphs and realized that policy was already drifting off course in the third quarter.  I don’t know why it took me so long to look at daily data, but when I did so yesterday I was shocked by what I saw.  There are no excuses for the Fed’s behavior.  Last September they had all the information they needed to act decisively, and blew it.

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The following quotation from Nouriel Roubini seems to express a commonly held view:

Asked to grade the central bank’s job, Roubini gave the Fed a “D” for missing the crisis altogether and downplaying its possible impact, but a “B-plus” after the credit debacle had unfolded.

“I give them credit for being very creative and very aggressive,” he said.

I just don’t get this view.  All the major investment banks with their million dollar Ivy League employees missed this crisis (and its eventual impact), and yet the Fed was supposed to have predicted it?  The Fed pays much lower salaries than Wall Street.

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The Bank of England wants to raise inflation expectations, as it is one way of escaping from a liquidity trap.  But the public is skeptical, and inflation expectations remain below the long run trend for Britain.  The solution is to invest BOE employee assets into “linkers,” the British version of TIPS.

From the Daily Telegraph

Last week’s revelation that the Bank of England had switched 70pc of its own pension fund into index-linked gilts has raised the question of whether these government IOUs could be the answer to savers’ inflation worries.

The bank’s pension fund is the nearest thing to a legal insider trader, because the bank also sets the interest rates that control inflation. If the pension fund thinks inflation will rise, maybe we should all sit up and take notice.

(Thanks to Current for the link.)  A few months ago I discussed the issues raised when the central bank was an “insider trader.”

A few days ago Paul Krugman gave three lectures at the LSE.  I have not heard the final lecture, but I thought I would make a few comments on the first two lectures.  As usual, I will focus on those areas where I disagree with Krugman’s views.  However I should also emphasize that I wouldn’t even waste time analyzing his views if I didn’t regard him as the closest thing we have to Keynes himself.  When Bob Murphy defended me to his Austrian readers with the line “finally, a man worth killing,” I took it as a compliment.  I won’t make the same remark vis-a-vis Krugman because we live in a “brave new world” where one can be arrested for making a joke while waiting to board an airplane.  So I’ll just say Krugman should take my obsession with his every utterance as a compliment.

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The conventional wisdom says that as the economy recovers we need to wind down the fiscal stimulus as quickly as possible.  Krugman makes a very persuasive argument that it is much too soon to pull back on fiscal stimulus, as the economy has not even started to recover.

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One of the things I find most frustrating about this crisis is the way my intellectual allies on the right keep shooting themselves in the foot, and thus unwittingly tend to discredit their otherwise defensible ideologies.  More specifically they continue to warn of high inflation, which is about the last thing we need to worry about right now.  In my previous post I tried to provide a psychological theory for these bad forecasts.  But whatever the reason, when these predictions don’t come true it will (unjustly) tend to discredit both the good and bad parts of their theoretical apparatus.

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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.

Here’s how Paul Krugman answers that question (in an interview with Will Hutton):

WH: In Britain, there is now a new consensus forming that the government’s economic forecasts, which were roundly mocked at the time of the April budget for being wildly optimistic, could be right – that is, growth will start to resume in 2010, albeit at a very low rate.

PK: Well, the UK has achieved a lot of monetary traction in the way that no one else has through the depreciation of the pound. In effect, you’ve carried out a successful beggar-my-neighbour devaluation.

WH: So, the United Kingdom might actually get through this in reasonably good shape?

PK: Yeah. That’s why I’ve been watching with an outsider’s slight puzzlement, your bizarre political circus.

WH: Darling and Brown deserve more credit than they’re given?

PK: If the government can hold off having an election until next year, Labour might well be able to run as “we’re the people who brought Britain out of the slump”.

WH: So your advice to the Labour Party is: hold steady.

PK: Probably.

WH: Probably?

PK: I don’t know enough about the other aspects of politics, but I would guess that the option value is quite high that the economy might actually have turned a corner. That’s unique. That’s a uniquely British thing. None of the other G7 countries has anything like that.

WH: And that’s a combination of our big beggar-our-neighbour devaluation, aggressive monetary policy, successfully recapitalising our banks and our fiscal policy.

PK: There hasn’t been very much discretionary fiscal expansion when all’s said and done.

WH: Well, there was a £20bn temporary cut in VAT.

PK: Yeah.

WH: Which is non-trivial.

PK: Non-trivial. But not much [other spending], as I understand.

WH: Well, there was bringing forward £3-4bn of capital spending. Perhaps together in a full year the stimulus was 1.5% GDP. Maybe 2% at the outside.

PK: Monetary policy has been more aggressive – though maybe less than the Fed – and the depreciation of the pound is a nice thing from a UK point of view.

It’s good to hear that the one country that relied on an aggressive monetary policy, rather than fiscal stimulus, is doing better than the others.  Of course that’s been my argument all along.  I have little to add to Krugman’s comments except two brief points:

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I will eventually get to monetary policy, if anyone can last through my wandering political observations.  I am going to try to show that some of my intellectual opponents are confusing the world as it is with the world as they want it to be.

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The New Yorker recently published a wonderful article on health care in McAllen Texas, America’s poorest metro area.  Only in America would the government spend a fortune insuring certain poor people, and nothing on others:

In 2006, Medicare spent fifteen thousand dollars per enrollee here, almost twice the national average. The income per capita is twelve thousand dollars. In other words, Medicare spends three thousand dollars more per person here than the average person earns.

. . .

I was impressed. The place had virtually all the technology that you’d find at Harvard and Stanford and the Mayo Clinic, and, as I walked through that hospital on a dusty road in South Texas, this struck me as a remarkable thing. Rich towns get the new school buildings, fire trucks, and roads, not to mention the better teachers and police officers and civil engineers. Poor towns don’t. But that rule doesn’t hold for health care.

Suppose McAllen was an independent country with universal health care.  How much would it cost the government to insure the entire population?  If independent, McAllen would be poor relative to the US, but it certainly wouldn’t be poor in any absolute sense.  My guess is that it would come in somewhere around Portugal or Slovenia.  And I would also guess that it would spend less insuring the entire population than we now spend insuring the relatively small share of the population covered by Medicare.

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Suppose your family’s balance sheet has shrunk.  How do you rebuild it?  I suppose you could consume less and/or work more.  Now suppose you are a country and your balance sheet has shrunk, how do you rebuild it?  Wouldn’t the answer be the same?

If I faced a depleted balance sheet the last thing I would do is go on vacation, or switch from a full time job to a part time job.  If anything, I’d want to start working overtime.  But maybe this commonsense view is wrong.  Consider the following observation from The Economist:

And as investors’ panic recedes, so credit markets are beginning to function. This will not be enough to spur a vibrant recovery in America, where households must painfully rebuild their balance-sheets.

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In a post on the New Deal from last December Paul Krugman presented an interesting graph from a paper by Gauti Eggertsson.  The graph showed investment soaring in the first four months of the Roosevelt administration.  I don’t know the exact numbers, but I do know that industrial production rose by 57% over that four month period.  Krugman then links to an AER paper by Eggertsson with the following abstract:

This paper suggests that the US recovery from the Great Depression was driven by a shift in expectations. This shift was caused by President Franklin Delano Roosevelt’s policy actions. On the monetary policy side, Roosevelt abolished the gold standard and—even more importantly—announced the explicit objective of inflating the price level to pre-Depression levels. On the fiscal policy side, Roosevelt expanded real and deficit spending, which made his policy objective credible. These actions violated prevailing policy dogmas and initiated a policy regime change as in Sargent (1983) and Temin and Wigmore (1990). The economic consequences of Roosevelt are evaluated in a dynamic stochastic general equilibrium model with nominal frictions.

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A new paper by Tyler Cowen presents an interesting new take on the economic crisis.  Building on the insights of Fischer Black, Tyler argues that:

In essence, the story of the current financial crisis can be told in three broad chapters:  (1) the growth of wealth, (2) the decision to opt for risky investments, and (3) the underestimation of a new source of systemic risk.

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