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Printing Money and Predictions in Print

November 14, 2010 7 comments

I try not to make too many predictions on this blog. If I do the only prediction I’m likely to correctly make is that my predictions will be off. Jonah Lehrer shares the results of a big study that calls into question the ability of experts to accurately forecast.

How did the experts do? When it came to predicting the likelihood of an outcome, the vast majority performed worse than random chance. In other words, they would have done better picking their answers blindly out of a hat. Liberals, moderates and conservatives were all equally ineffective.

The reason so many experts were wrong was due to confirmation bias – they were confident they were right so they ignored evidence that undermined their preconceptions. While reading up on whether or not anyone should be concerned about inflation right now (due to Obama’s or the Fed’s policies) I feared ending up in that pitfall. So in my quest to find diverse viewpoints I discovered some older Art Laffer and others making predictions about future inflation because of Obama’s policies. Determined not to prove Lehrer wrong, who writes, “Famous experts were especially prone to overconfidence, which is why they tended to do the worst,” Laffer and gang’s predictions turned out to be almost exactly antithetical to reality.

On June 11, 2009, Laffer wrote a column Ehrlichianly titled, Get Ready for Inflation and Higher Interest Rates: The unprecedented expansion of the money supply could make the ’70s look benign. Now that we stand over a year later, let’s take a look at accuracy of some of his and other inflation Chicken Littles’ predictions.

It’s difficult to estimate the magnitude of the inflationary and interest-rate consequences of the Fed’s actions because, frankly, we haven’t ever seen anything like this in the U.S. To date what’s happened is potentially far more inflationary than were the monetary policies of the 1970s, when the prime interest rate peaked at 21.5% and inflation peaked in the low double digits.

His primary evidence for his fears is this chart:

[Our Exploding Money Supply]

But let’s now check out this updated chart (upper-right), courtesy of Martin Wolf, from a few days ago.

Martin Wolf charts for Comment

The rate of change in M1 has plummeted and the new data doesn’t look so scary or out of place with history now, does it? M2 (the money in circulation) also dropped to very low levels. We can also see US inflation rate/expectations (lower-left) hit negative levels and currently floats under 2 (below the Fed’s target rate). With all the current talk about QEII and deliberately raising inflation expectations, the inflation alarmists are back, but as Martin Wolf points out, even if we were to see inflation growing too fast (which there is currently no evidence for) we could always just scale it back.

The hysterics then add that it is impossible to shrink the Fed’s balance sheet fast enough to prevent excessive monetary expansion. That is also nonsense. If the economy took off, nothing would be easier. Indeed, the Fed explained precisely what it would do in its monetary report to Congress last July. If the worst came to the worst, it could just raise reserve requirements. Since many of its critics believe in 100 per cent reserve banking, why should they object to a move in that direction?

Mark Thoma at his blog, Economist’s View, discusses further some mistakes that people worried about the growth in currency are currently making. It’s worth reading but here is the graph that he uses, which shows that the currency in circulation is not outside the historical norm.

Logcurr

Over at the American Principles Project, a conservative Christian organization, Samuel Gregg (who cites Laffer) also worries (7 July 2009) Obama’s policies are going to lead to 1970s style inflation – he even mentions Mugabe’s Zimbabwe.

More than one economist believes that it is only a matter of time before the third member of the 1970s trio – growing inflation – will be back to wreck havoc upon us.

Most amazingly, Gregg’s article stumbles onto an important insight about inflation. Since he takes for granted inevitable skyrocketing inflation, he spends the bulk of his article explaining why having to lower inflation will be so terrible.

Seriously fighting inflation entails a willingness to tolerate increasing unemployment. This is the price of reducing the excessive amounts of money sloshing through an economy.

So if lowering inflation will increase unemployment, what might raising inflation do? Yup, increase employment. Considering 15 million sit out of work right now, which is about 4 million people greater than the entire population of Greece, I think we could stand to raise the inflation rate a tad.

We can see that inflation expectations are low right now; it’s also worth going over some other measures of inflation and potential inflation. Here’s the Consumer Price Index.

FRED Graph

And here is core inflation (which is the CPI minus volatile items like food and energy):

FRED Graph

(By the way, you can have more fun data like this at the St. Louis Fed’s great website.)

Here’s our current core inflation overlaid with what happened in Japan (via Krugman):

DESCRIPTION

Here’s the Treasury Maturity Spread (via DiA). Yup, also low.

 

 

 

 

 

 

 

 

 

Many alarmists point to rises in gold and other commodity prices. What about those? First it is important to remember that we don’t usually consider volatile commodities when looking at inflation because unpredictable spikes can occur. They’re also traded on world markets so judging US inflation can be thrown off because of that. Consider if a huge new supply (or disruption) of oil or gold was discovered that could suddenly change the price of those commodities, but that wouldn’t really represent a significant change in inflation. Commodities aren’t entirely useless (they’re not all constantly and extremely volatile) and inflation predictors keep using them, so let’s take look at some of them anyway.

On gold, many have been unnerved by the “record high” of its price. Yet, as David Leonhardt points out, it’s not true.

Gold is at a record only if you fail to adjust for inflation. And you should almost always adjust for inflation.

[…]

This isn’t simply a question of math. Anyone who says gold is at a record high (or who said oil was several years ago) is getting the story wrong. Why? Because $10 today is not more valuable than $9 a few decades ago. Claiming otherwise is tantamount to saying that 10 rupees is more valuable than $9 because 10 is a bigger number than 9.

Here’s a graph (via Krugman) that isolates commodity prices for us.

DESCRIPTION

I don’t know about you, but it doesn’t really look like any historically high jump in commodity prices going on.

Everyone is entitled to make some bad predictions, but I’m not sure what Sarah Palin’s excuse is for her inability to predict the past. Here she is on grocery inflation.

“Everyone who ever goes out shopping for groceries knows that prices have risen significantly over the past year or so.”

The Wall Street Journal reporter who had the gall to question her responded.

The Nov. 4 Wall Street Journal article noted, in its first sentence, “the tamest year of food pricing in nearly two decades.” It does indeed report that supermarkets and restaurants are facing cost pressures that could push their retail prices higher — but it hasn’t happened yet on a large scale. Critics of the Fed’s quantitative easing policy are focused primarily on concerns about potential future inflation.

Let’s now take a look at few other predictions on inflation at about the time Laffer and Gregg wrote their pieces.

Paul Krugman (28 May 2009):

It’s important to realize that there’s no hint of inflationary pressures in the economy right now. Consumer prices are lower now than they were a year ago, and wage increases have stalled in the face of high unemployment. Deflation, not inflation, is the clear and present danger.

Seems he was correct.

Paul La Monica, CNNMoney Editor (4 June 2009):

So with all due respect to the Fed chair, he can talk as much as he wants about how he’s not too worried about inflation. But investors disagree. And Hoenig thinks that the Fed would be unwise to dismiss what’s going on with bond rates, currencies and commodities.

Score that one: Bernanke 1 – La Monica/Hoenig 0.

The Economist (22 Oct 2009):

In short, the likeliest triggers of an acute crisis—a lenders’ strike, a crash in the dollar or inflation—seem remote.

Cheers to the Brits on that one.

None of this should suggest that Krugman or The Economist is always correct or that La Monica, Laffer, and Gregg are always wrong (Palin I’m not so sure about). Remember Lehrer told us that “Liberals, moderates and conservatives were all equally ineffective.” But it does suggest to me that we shouldn’t keep listening to the same voices on a topic they’ve been so utterly wrong about until circumstances change (or they change) and indicate things might be different. For example, here’s Laffer –again in a WSJ Op-Ed– from 2 days ago.

Outlining his growth agenda he recommends,

2) Price stability. Congress should revise the Federal Reserve’s mandate, making it serve only the goal of price stability (and not also full employment). In addition, the Fed should follow a monetary rule, targeting either the quantity of money or the price level. There can be no prosperity without price stability. (my emphasis)

He’s still worried more about inflation than our current unemployment crisis. Can editors explain to me why we keep hearing more and more from those with such bad records? The inverse correlation between the voices of inflation alarmists and the actual inflation rate is surreal. We have plenty to worry about without concerning ourselves with phantoms and problems that only occur if we’re more successful.

I hope I’m not giving the impression that I think I know what will happen with our inflation rate or commodity prices. If I did I’d be in the markets right now, not writing blog posts. But what I can tell is that the bizarro Chicken Littles (“The ground is rising?!”) keep being wrong and the available data suggests we’re not in imminent danger of turning into Zimbabwe. So if you think Greece’s economy is bad and you realize that just because the overall health of our economy is better doesn’t mean that virtual unemployed nation we have living within our borders isn’t feeling real pain. Unconventional ways to further loosen monetary policy aren’t likely to solve all our problems but it could help alleviate a lot of needless suffering.

I’d rather not make a prediction, but I think we should put some money on this.

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The Most Important Lesson For Elected Officials

October 27, 2010 Leave a comment

In Ezra Klein’s recent post juxtaposing David Brooks from 2005 with David Brooks now is worth a read, but Klein writes 2 sentences that every politician should have tattooed to the inside of their eye lids (one on each?).

You don’t win elections in order to win more elections. You win elections in order to solve problems and make the country better.

Most people probably think that is self-evident, but it seems most politicians easily lose sight of that. Here’s Mitch McConnell forgetting,

The single most important thing we want to achieve is for President Obama to be a one-term president.

Don’t think Democrats don’t forget as well. Yglesias reminds Democrats that if they focused on governing better they wouldn’t be losing elections. Even if you’re self-interested enough and want your main goal to be reelection that shouldn’t prevent you from governing better – you just can’t be so myopic.

Speaking to The New York Times‘ Peter Baker for a profile published last week, Obama said his administration “probably spent much more time trying to get the policy right than trying to get the politics right” and drew the lesson that “you can’t be neglectful of marketing and P.R. and public opinion.”

Marketing and public relations are nice, but opinion is fundamentally driven by results. And on this, Obama has it backward.

[…]

The issue is not so much that the administration needed to be more or less moderate, rather that it needed to be more effective in boosting the economy and more mindful of the central role it plays in politics. This matters because, to point out the obvious, the economic outlook is still bleak. Enhanced post-election focus on marketing and PR won’t turn that around. In other words, all the marketing and PR in the world won’t succeed in moving public opinion, meaning Democrats could easily have another round of election losses to look forward to.

Martin Wolf feels similarly,

The president’s willingness to ask for too little was, it turns out, a huge strategic error. It allows his opponents to argue that the Democrats had what they wanted, which then failed. If the president had failed to get what he demanded, he could argue that the outcome was not his fault. With a political stalemate expected, further action will now be blocked. A lost decade seems quite likely. That would be a calamity for the US – and the world.

Every time an elected official compromises what he thinks will be best for the economy for political purposes he’s sowing the seeds of his own defeat. Certainly certain compromises might be necessary to pass a particular bill, but as Wolf points out, when you make it seem like you got what you wanted you’ve trapped yourself. Not only that, but Democrats willingness to give up the rhetorical fight for stronger stimulus (or for any stimulus) weakens them for the future. If they aren’t willing to defend the idea of stimulus (assuming they still actually think it can be productive) how do they think they can gain support for using fiscal policy in the future?

I really don’t understand the long-term strategy of not making the case for the policies you want. Obviously if you want them you think they are the best policies; by undercutting the case for those things you’re just making it harder to get what you want. President Obama continues to make policy compromises that weaken policy only to get no Republican votes, no acknowledgment of compromise, no positive electoral gains, and…. compromised and weakened policy. Here’s my advice.

Stop looking at the next election, close your eyes and recognize why you’re in office.

How Modern Conservatives Aren’t Like Hoover, ctd

Martin Wolf explains the politically brilliant but economically preposterous idea that changed Republicans from minority to majority party and from conservative to “extreme radicals.”

Supply-side economics liberated conservatives from any need to insist on fiscal rectitude and balanced budgets. Supply-side economics said that one could cut taxes and balance budgets, because incentive effects would generate new activity and so higher revenue.

[…]

[T]he Republicans were transformed from a balanced-budget party to a tax-cutting party. This innovative stance proved highly politically effective, consistently putting the Democrats at a political disadvantage. 

[…]

Since the fiscal theory of supply-side economics did not work, the tax-cutting eras of Ronald Reagan and George H. Bush and again of George W. Bush saw very substantial rises in ratios of federal debt to gross domestic product. Under Reagan and the first Bush, the ratio of public debt to GDP went from 33 per cent to 64 per cent. It fell to 57 per cent under Bill Clinton. It then rose to 69 per cent under the second George Bush. Equally, tax cuts in the era of George W. Bush, wars and the economic crisis account for almost all the dire fiscal outlook for the next ten years (see the Center on Budget and Policy Priorities).

[…] 

This is extraordinarily dangerous. The danger does not arise from the fiscal deficits of today, but the attitudes to fiscal policy, over the long run, of one of the two main parties. Those radical conservatives (a small minority, I hope) who want to destroy the credit of the US federal government may succeed. If so, that would be the end of the US era of global dominance. The destruction of fiscal credibility could be the outcome of the policies of the party that considers itself the most patriotic.

 (emphasis is mine)

I couldn’t agree more on the danger of having a 1 of the 2 major political parties being completely untethered to economic reality. We don’t have a mainstream conservative opposition in America today – we’re poorer for it. 

(part 1)

"Walking And Chewing Gum"

June 19, 2010 2 comments

Martin Wolf explains to deficit hawks that tightening fiscal policy too early could cause more problems in global markets.

Despite the most aggressive monetary policy ever, private sectors moved into huge surpluses. Monetary policy was “pushing on a string”. The fiscal offsets – overwhelmingly due to built-in fiscal stabilisers, not the discretionary stimulus – helped sustain demand in the crisis. But they were insufficient, even with monetary support, to prevent deep recessions. The argument that stimulus was unnecessary is hard to accept. It is easier to believe it was too small, albeit also ill-targeted.

So how quickly should deficits be eliminated? We must recognise the danger here: cutting public spending will not automatically raise private spending. The attempted reduction in the structural deficit might lead, instead, to a rise in cyclical fiscal deficits, which would be running to stand still, or to a reduction in the private surpluses only because income fell even faster than spending. Either outcome would be grim. Yet neither can be ruled out.

As long as output remains depressed, the fiscal support is most unlikely to be inflationary. Nor will it crowd out the private sector: it is more likely to crowd it in. The big question, then, is whether deficits can be financed. My answer is: yes. Remember that so long as the private sector runs financial surpluses it must buy claims on the public sector, unless the developed world as a whole is about to move into huge external surpluses.

Deficits are a real problem, just not now. It’s clear that we should reassure private investors and financial markets by setting up long-term policies for controlling the deficit that don’t depress demand in the short-term. A VAT would be one obvious revenue side solution. Controlling health care costs is the biggest on the spending side. The good news is that the best way to curb the deficit is to enact policies that promote economic growth now. Fiscal restraint now isn’t one of those policies.

"Even The Fiercest Free Marketeer Should Accept This"

April 23, 2010 Leave a comment

Martin Wolf argues for the need to regulate our financial institutions and prepare for future problems.  

Does today’s engorged financial system produce gains that justify these costs? In a recent speech, Adair Turner, chairman of the UK’s Financial Services Authority, argues it does not.* Financial systems are important servants of the economy, but poor masters. A large part of the activity of the financial sector seems to be a machine to transfer income and wealth from outsiders to insiders, while increasing the fragility of the economy as a whole. Given the extent of the government-induced distortions in the system, even the fiercest free marketeer should accept this. It is hard to see any substantial benefit from the massive leveraging up of the economy and, above all, the real estate sector, that we saw recently. This just created illusory gains on the way up and real pain on the way down.

Just as Keynes saw the need for government intervention into the economy to save capitalism rather than replace it, we need to reform our financial system so any failure by a bank doesn’t lead to a disruption of the entire economy.  Capitalism depends on creative destruction – we need a system that can deal with 2nd half so we can have the 1st.    

Larry Summers in the Financial Times

My lucky stars: Martin Wolf (!) interviews Larry Summers (!!). 

LS I think there’s a great deal in past policy that will continue to have an impact. One of the things that people most consistently forget is that two generations of studies show that the lag between monetary policy and impact is six to 18 months. So the financial policies that will be affecting the economy over the next nine months are not the contemporaneous ones, but the ones from some time ago. Only about half the resources from the Recovery Act have yet been disbursed. So there is substantial fiscal policy in train.

We are seeing some of the benefits of the financial policies that forced so much capital into major financial institutions in increased levels of lending that are showing up in statistics. We took steps last week to enhance the programmes in support of the housing sector, by enhancing the ability to refinance underwater homes on more favourable terms which should make it significantly easier . . . should reduce pressures in the housing market and should also make it easier for home owners to engage in improvements in their homes of various kinds, all which contribute to aggregate demand.

 I hope rumors of Summers leaving the Obama administration are untrue. 

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