Paul Krugman has a very important post showing fast recoveries from previous big recessions.  The 1983-4 recovery was particularly fast.  But lest anyone think Reagan might have done any good he points out that a rapid recovery also occurred in 1976.  So how did they do it? 

BEA

I decided to go back and look at the data on fiscal stimulus, and was quite surprised by what I found.  In both earlier recessions the budget deficit rose by just over 3% of GDP; from a bit under 1% to 4% of GDP between 1973 and 1975, and then from 3% to just over 6% between 1980 and 1982.  I’m no expert on Keynesian economics, but isn’t that mostly the effect of the recession?  I don’t see a lot of room for discretionary stimulus.  And if we look at the especially fast 1983-84 recovery, we find that the discretionary stimulus that did occur was exactly the kind that Krugman says doesn’t do much good—tax cuts for the rich (who have a lower marginal propensity to consume.)
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I’m not sure what more I can say about monetary policy.  The 3rd quarter was another huge disappointment.  NGDP grew at a 4.2% pace.  Not only was it too slow to return us to trend, but we fell even further behind.  So AD continues to fall relative to trend, despite a monetary policy that many continue to wrongly call “expansionary,” not to mention a fiscal stimulus that doesn’t seem to even be able to get NGDP up to its normal rate of growth.  Yes, we got some real growth for a change, but only because wage cuts are shifting SRAS to the right.  You econ teachers out there might want to think about this fact:  You know when you teach the options for recovering from a recession?  One option is for the government to do nothing, just wait for SRAS to shift right.  The self-correcting mechanism.  Well that is what is happening now (and probably in the 4th quarter as well.)  So today let’s take a break from the dreary subject of demand stimulus, or the lack thereof.
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Yesterday’s online version of The Economist, also known as known as Free Exchange, did a nice piece on my recent China post.  They contrasted my views with those of Paul Krugman, and also asked a few questions.  Here I’ll try to respond to those questions, but first I’ll clarify exactly where Krugman and I differ.
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Check out this link that I found in John Taylor’s blog.  The best 3:53 clip in game show history:

http://www.youtube.com/watch?v=p3Uos2fzIJ0

A few reactions (watch the clip first.)  As Taylor says, this is a great example to use when teaching the Prisoner’s Dilemma.
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I have some recent posts bashing Krugman and his pal DeLong.  So maybe it’s time to show that I can be just as “fair and balanced” as Fox News, er, I mean NPR and the BBC.  This won’t be entirely positive, but I think Krugman fans will be very pleased by the ending.  (Bob Murphy may want to skip this one.)  Let’s start with three recent posts by Krugman that show him fighting the good fight against the forces of reaction:
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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.
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They say that in Hollywood any publicity is good publicity.  Thus I was delighted to see Brad DeLong paying attention to my random thoughts on the Krugman/Dubner dispute,  Indeed he officially declared that I had lost my mind.  But that is not all bad, because in America there are always second acts.  On the same day Brad DeLong formally announced that the little known blogger Andrew Sullivan would henceforth be welcomed back into polite society.  Someone may want to inform Andrew in case he hasn’t heard the wonderful news.  So I knew that there was still hope that a similar fate awaited me someday; when and if I adopted the “correct views” I too might be welcomed back, like a reformed mental patient in one of Stalin’s hospitals.  Or just as Fox News can expect to start get interviews again once they “shape up.”  Or just as the insurance industry can expect to get a better deal in the health care legislation once it stops saying those awful things.
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In a comment to my previous post, Statsguy raised a number of objections to geoengineering.  In principle, those objections should be included in the pricing scheme.  Thus if the sulfates approach has more nasty side effects that the cloud creation approach, then the (risk adjusted) estimated cost of those nasty side effects should be incorporated into the relative subsidies (or taxes) on various geoengineering-type strategies.  But I understand that not everyone will find this persuasive, so here I will try to answer my critics with some relatively pragmatic arguments.  Statsguy linked to an article with 20 objections to geoengineering.  How many of these are persuasive?  I’d say only the first one, and even that one is debatable.
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A recent post by Matt Yglesias challenged the libertarian community on their seemingly anti-market approach to global warming:

For basically Popperian reasons I don’t think it makes sense for political pundits to spend a lot of time debating the relative difficulty of developing different hypothetical future technologies.  Instead, I would just say that the best way to find out whether human ingenuity is better at keeping atmospheric CO2 concentrations at a sustainable level by developing artificial trees or by developing better windmills is to . . . implement a binding emissions reduction scheme that puts a price on CO2 emissions.

This isn’t, in other words, an either/or choice. If you had a cap-and-trade system in place, that would put a range of modalities—better efficiency, more clean energy production, more trees & algae, and carbon-scrubbing machines—in a competitive framework. One assumes we’d be looking at some kind of mix. But defining the correct mix in advance seems very hard. Hence the appeal of a basically market-esque mechanism that creates incentives to work on these various ideas without unduly prejudging the appropriate level of investment in speculative technology.

What I think is remarkable is the extent to which people on the right, in their zeal to avoid a market mechanism that the business establishment happens to hate, have a tendency to talk up what instead amounts to a kind of Five Year Plan approach. Instead of regulating carbon, let’s just direct scientists of invent miracle trees! Let’s turn the sky red!

I like his argument, so I am going to take the challenge.  But first let’s diagnose the problem and come up with the right pricing policy.  I’m going wager that Matt’s friends in the environmental community won’t like the outcome. 
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This post was inspired by Bill Woolsey’s recent post on a monetary constitution based on index convertibility.  I’d like to follow a similar procedure, but emphasize slightly different issues.  The goal is to show that we can get to the same place from several different directions, but also that Woolsey’s approach offers some conceptual advantages over the approach that I have been emphasizing.
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I’ve previously complained about how Krugman misrepresented my views, John Cochrane’s views and Milton Friedman’s views.  Now we can add Levitt and Dubner to the list.  That’ right, the following statement made by Krugman is pure fabrication:

The chapter opens with the “global cooling” story — the claim that 30 years ago there was a scientific consensus that the planet was cooling, comparable to the current consensus that it’s warming.

Why does Krugman keep doing this?  Why does he continually misrepresent what others say?  My theory is that he assumes those he disagrees with are either fools or knaves.  Instead of doing a sympathetic reading, trying to discern what others are really trying to say, he looks for the “gotcha.”  I just read the chapter, and it bears little resemblance to his description.  And I have read a lot of scientific papers on geoengineering, on both sides of the issue, so I know a bit about the field. 
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It has come to my attention that the standards of intellectual discourse have been slipping.   Fortunately, Paul Krugman has provided us with a set of ethical standards for blogging in a recent series of posts on global warming.  In the first post he takes Levitt and Dubner to task for their counterintuitiveness on an important issue:

At first glance, though, what it looks like is that Levitt and Dubner have fallen into the trap of counterintuitiveness. For a long time, there’s been an accepted way for commentators on politics and to some extent economics to distinguish themselves: by shocking the bourgeoisie, in ways that of course aren’t really dangerous. Ann Coulter is making sense! Bush is good for the environment! You get the idea.

Clever snark like this can get you a long way in career terms — but the trick is knowing when to stop. It’s one thing to do this on relatively inconsequential media or cultural issues. But if you’re going to get into issues that are both important and the subject of serious study, like the fate of the planet, you’d better be very careful not to stray over the line between being counterintuitive and being just plain, unforgivably wrong.

I could not agree more.  It certainly helped the career of the snarky John Maynard Keynes.  He continually shocked the bourgeoisie with counterinituitive assertions that saving was actually harmful and that we’d all be better off if we buried bottles full of money and paid workers to dig them up.
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You have to be careful when reading Tyler Cowen’s posts.  Whereas I can ramble on and on saying very little, he condenses a lot of ideas into very short posts.  When I first glanced at this post two things stuck out; Tyler didn’t understand the “helicopter drop of cash” and he confused me with Milton Friedman.  On closer examination he does understand the helicopter drop, and I have no complaint if people start associating me with ideas that Friedman actually developed.  In fact there is a long tradition of this in economics, recall the “Phillips Curve” was actually first popularized by Irving Fisher.  Here’s what Tyler has to say:

$250 for each senior or $13 billion in total.  It’s bad precedent to go around a COLA calculation, even on a one-time basis, but you can construct a partial defense of the policy (here is Matt’s semi-defense).  Think of it as a helicopter drop of money, a’la Scott Sumner.  If the helicopter drop substitutes for (part of) a second fiscal stimulus, that’s a net gain.  .  .  .   How will the expenditure be financed?  Obama was vague on that, but as usual the Fed moves both first and last in the monetary policy game.  All Obama has to do is make the second stimulus $13 billion less than it otherwise would have been, wink and nod to Ben B., and it is all (or mostly) for the better.

My first thought was that Tyler was confusing fiscal and monetary policy.  The $13 billion would not directly impact the money supply.  But in the final sentence he alludes to his assumption—a larger fiscal stimulus would lead the Fed to adopt a more accommodative monetary stance.  This raises two questions; precisely what would the Fed have to do to turn it into a helicopter drop, and how plausible is this assumption?
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The Economist just published a piece that looks at the performance of quantitative easing (QE) in Japan from 2001 to 2006.  The article suggests that the policy failed, and provides extensive testimony from The Bank of Japan’s Governor, and one of its top economists.

THE Bank of Japan (BoJ) pioneered the process known as quantitative easing (QE) in 2001-06, when it massively boosted the reserves that commercial banks held at the central bank. Its verdict on how well QE worked then ought to interest policymakers today. It will also discomfort them. For all that it propped up Japan’s creaking banking system, QE did not really improve the economy nor end the country’s deflationary mindset (see chart).

Yes, by all means “see chart.”  In fact, take a very close look at the chart.  I don’t know about you, but to me that looks like perhaps the most successful monetary policy in all of world history.  Can you think of a central bank that did better?  So why is The Economist so pessimistic?  And for that matter why does Paul Krugman keep citing Japan as an example of why QE doesn’t work?  There are two reasons:
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Update 10/15/09:  I was just interviewed by the PBS station in Denver (KGNU.)  I’ll post a link when I get one.  If any PBS listeners wander over here and are curious about my letter to Krugman, here is the link.

Update 10/16/09.  Here is the PBS interview.

I plan to take a break to recharge my batteries.  I know I have been overstressed when I tried to link to Yahoo News this morning, and accidentally stumbled onto a story at The Onion about Obama winning a Nobel Prize.  I can’t recall what field, probably chemistry or something similar.  And the next story had Somali pirates “mistakenly” attacking a French military flagship.  Yeah, I also have trouble distinguishing French naval vessels from tankers.   So I need a break.   In any case, I thought I should provide some links for those who stumble onto my blog by mistake.  I’ll start with one from the AEI’s online magazine, which just appeared this morning:

The American

Here’s my essay at Cato.  The links for the subsequent debate with Hamilton, Selgin and Hummel are in the right margin:

Cato Unbound

Here’s my essay at Vox:

Vox

Here’s my debate with Ohanian at CBS Moneywatch:

Ohanian debate

Here is my debate with John Cochrane:

Cochrane debate

Here is my bloggingheads.tv debate with Mark Thoma

Thoma debate

Here is my piece at Reason magazine:

Reason

And finally, a New York Times article on this blog:

New York Times

I have done a number of posts on two closely related themes.  In this recent post I discussed the common perception during each recession that “it’s different this time.”  In particular, each recession is supposed to have special characteristics that make it unlike the normal garden variety recession—you know what I mean, the kind we learn about in our intro to macro textbooks.  Here are some recent “special” recessions:

1.  1970:  Inflation isn’t falling like other recessions; wages are not responsive this time.

2.  1974:  The big oil shock, this one is supply-side.

3.  1980:  This one is caused by Carter’s credit card restrictions.

4.  1982:  No bounce back this time, the rust belt jobs are gone forever.

5.  1991:  The S&L bubble burst, many banks failed, and commercial real estate was overbuilt.

6.  2001:  This time it was the tech bubble bursting, not a drop in AD.  Plus 9/11.

7.  2008:  The housing/financial crisis.

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Sometimes when I post on an unfamiliar topic, I preface my comments by stating that I am pretty sure that I have overlooked something important, as the standard view can’t be as silly as it seems.  And I have never had greater doubts than in this post.   Mainstream economists can’t have overlooked something so basic.  And fiscal multipliers are something I rarely even think about.  So I hope you guys can set me straight.

Update 10/10/09: Alex and Leigh did set me straight.  I thought the long run multiplier of 1.5 meant that if you increase G by $1, then in the long run Y would rise by $1.50.  Instead, it looks like a long run multiplier of 1.5 means that in the long run the effect of G on real GDP is zero.  Indeed, I am pretty sure that if Alex and Leigh are right, and if G had a permanent effect on the LRAS curve, then the long run multiplier would be positive or negative infinity.  Thus you might want to skip the rest of the post.  (This will teach me to stay out of hydralic Keynesianism.)  Others are free to offer insights, but I no longer have confidence in my interpretation of the paper in question.
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Is the title sentence a logically monstrosity?  I think so.  How can one not expect something to happen, but nonetheless expect to expect it in the near future?  I’ll leave that to the epistemologists but in some weird way I think this post’s title reveals how monetary policy went off course.
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Doc Merlin just left this comment in the post on the German elections:

Keep doing these posts, if only for the reason that Socialists and pessimistic libertarians will always be with us, and need to be shown wrong constantly.

OK, let’s consider the objections raised by those awful pessimists and socialists.  One argument is that these elections don’t mean what I think they mean.  Just because a particular party wins, and just because the stock market is enthusiastic, doesn’t mean reforms actually occur.  And that is the bottom line—are market reforms continuing?  Unfortunately this quotation from The Economist doesn’t use the term “market reforms” but in context it seems to me that that is what they are talking about:

WITH falling sales, rising public indebtedness and surging anti-business sentiment, the past year has been a tough one both for business people and for pro-business policymakers. “It is not just a crisis of the economy,” says Mahmoud Mohieldin, Egypt’s minister of investment. “It is a crisis of economic thinking. It is a crisis that is confusing many reformers.”

Even so, the World Bank’s annual Doing Business report*, which tracks changes to the regulations that affect business, suggests that governments have handled the storm well. In the year since June 2008, 131 countries introduced 287 pro-business reforms—20% more than in the previous 12 months and more than in any year since the World Bank started the survey in 2004.

.   .   .

Encouragingly, reform seems to be contagious. Countries try to emulate leaders in their regions. Many African governments, for example, have taken note of the success of Mauritius’s deregulated economy. They also respond to competition. Germany introduced laws to make it easier to establish joint-stock companies, scrapping ancient regulations, because so many German companies were taking advantage of the single European market and incorporating in Britain. Amazingly, given the fiscal pressure on governments, only one country increased its corporate income-tax rate: Lithuania, from 15% to 20%.

How much does all this reform matter? A good deal, according to a growing body of academic literature (so far there are 405 articles in academic journals and 1,143 working papers devoted to studying the impact of the Doing Business reforms).

And it isn’t just the basket cases, the two most free market economies keep getting freer:

The best reformers have several things in common. Their reforms are part of a broad agenda of boosting competitiveness. Over the past five years such pace–setters as Rwanda, Egypt, Colombia and Malaysia have each implemented at least 19 reforms. And they never stop. Those paragons Hong Kong and Singapore introduce substantial reforms each year.

At first I thought the crisis would be just a temporary setback for neoliberalism.  But I was wrong, it wasn’t even a temporary setback.  Yes, the US isn’t doing well, but there are 199 more countries out there.  We Americans can’t ignore these worldwide trends forever.
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I put the term ‘debate’ in quotation marks, as it is not clear what, if anything, is actually being debated.  Much of the debate proceeds as if “the multiplier” is some sort of objective parameter of the universe, sort of like the cosmological constant.  In fact, there is no such thing as “the multiplier,” and indeed much of the debate is total nonsense.
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