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Ride of the Volckery

September 20, 2011 7 comments

I’ve returned from my hike across the beautiful Crawford Path. Sunday night, slightly sore and groggy, I read Paul Volcker’s warning in the New York Times to not pursue an inflationary monetary policy to solve our employment crisis.

My point is not that we are on the edge today of serious inflation, which is unlikely if the Fed remains vigilant. Rather, the danger is that if, in desperation, we turn to deliberately seeking inflation to solve real problems — our economic imbalances, sluggish productivity, and excessive leverage — we would soon find that a little inflation doesn’t work. Then the instinct will be to do a little more — a seemingly temporary and “reasonable” 4 percent becomes 5, and then 6 and so on.

What we know, or should know, from the past is that once inflation becomes anticipated and ingrained — as it eventually would — then the stimulating effects are lost.

Reading his op-ed left me slightly more sore and groggy. It is important to notice that Volcker implies that inflation would be stimulating in the short-run. I can’t for the life of me understand why he doesn’t consider 9% unemployment a “real problem,” but let’s move on. Volcker never explains why keeping inflation at 1 or 2 percent is optimal policy – he only worries that 3 or 4 percent will lead policymakers to try higher and higher rates. I guess once the Fed gets a little hit of that inflation soon they’ll be desperate for more only to keep up with those expectations. It’s only a matter of time, I suppose, that the abuser will be stagflating on the treasury room floor.

But is this gateway drug theory of inflation accurate?

I can’t be the only one that notices that inflation goes up and down. Every time we hit 3% inflation, we didn’t get hooked and ruin our longterm economy, right? Every person that takes a painkiller doesn’t become an oxycontin addict. Even though Volcker knows some junkie from the ’70s we shouldn’t conclude that sick people shouldn’t take medicine.

Here’s some other commentary on Volcker’s column:

Read more…

Newt Gingrich: Bizarro Historian

September 8, 2011 Leave a comment

During the Republican presidential debate Newt Gingrich made one of the more absurdly anti-factual statements of the night, which is saying something. Asked about Fed Chairman Ben Bernanke, Gingrich said,

I’d fire him tomorrow. I think he’s been the most inflationary, dangerous and power-centered chairman of the Fed in the history of the Fed.

Calling Ben Bernanke the most inflationary chairman in Federal Reserve history was especially curious given the debate’s location at the Reagan Library.

What sort of bizarro history is Gingrich championing where high is low and low is high?

Events like these should just remind Chairman Bernanke that he shouldn’t worry about what inflationistas think because they’re just going to make up their own version of events anyway.

Categories: Monetary Policy Tags:

GTSCW: Golden Edition

In this week’s Graphs that Subvert Conventional Wisdom we see why monetary policy shouldn’t be run by gold standard cranks that think it’s just obvious that the Fed’s loose monetary policy is debasing the dollar and causing commodity prices to spike. Only a gold standard can prevent that! Ahem.

David Andolfatto of the St. Louis Fed:

Imagine that you are 50 years old in September 1980. Imagine that a trusted friend of yours–oh, let’s say your doctor–convinces you to put all your savings into gold. The reason he offers is that the Fed is pursuing a policy of “relentless money expansion.” He warns you that the money supply is set to grow by 300% over the next 20 years. So you listen to him.

You buy gold at $673 per ounce. And then you wait. You wait until you turn 70. And then you go to withdraw your savings. You discover that the gold price in March 2001 is $263 per ounce. That’s a whopping rate of return of…wait for it… -60% over 20 years. That’s a minus sixty percent. 


(graph via MacroMania)

Scott Sumner Vs. The World of Progressives

March 30, 2011 2 comments

In a recent post Scott Sumner challenges a number of progressive assumptions and calls them out for the “”faith-based” reasoning that they tend to deride in conservatives.” Sumner is a monetary economist that progressives should be required to read to see that rational critiques actually exist of their fiscal policies. Sadly, the mainstream conservative movement gave up on dispassionate evaluation of public policy.

Sumner’s “progressive wishful thinking” criticism defends Greg Mankiw’s posts that upset the standard liberal story on the progressiveness of the US tax regime and on fiscal stimulus. The defense credibly knocks down some of the more fragile volleys from the Left flank.

Lindert showed that Europeans were able to raise more tax revenue only by having more regressive tax systems than the US, i.e. tax systems that relied more heavily on consumption taxes. This is now pretty much common knowledge in the public finance area.

That is an important point to disrupt some common progressive assumptions, but I don’t think it directly counters Ygelsias’s and others’ point that the wealthiest “pay a huge share of the total taxes in the United States because they have a huge share of the money.” But it seems to me that Sumner is largely right that the US tax code has a progressive rate structure even compared to Europeans.

Sumner also weighs in on where the US sits on the Laffer curve:

I’d argue that this data is strongly supportive of the view that both the US and Europe are near to tops of the Laffer Curve for total taxation.  I did not say then, nor do I claim now, that we are precisely at the top.  But I also don’t see any reason to believe that if we raised taxes from 28% to 40% of GDP, that revenue would rise anywhere near proportionately, with no change in GDP per capita.

I do think the Laffer curve is “far-fetched” but I don’t deny that revenues always rise “proportionately, with no change in GDP per capita.” It is illustrative that Sumner doesn’t quote anyone making that claim he’s rebutting. Most popular proponents of the Laffer curve like to claim that tax cuts actually raise revenue not just that tax increases dampen receipts a bit. But the Left should think harder about challenging their assumptions with reference to European models if they’re going to argue for a much more progressive tax code. I’m with him on a progressive consumption tax.

Most interesting, and surprising, to me was Sumner’s claim that “for decades our best macroeconomists have been saying that that fiscal stimulus is a bad idea.” I really wish he cited something here because if true I’m embarrassed that I wasn’t aware of this. I always assumed economists like Christina Romer were true authorities on this, but I willing to confront a counter consensus of experts if it exists. Not that a consensus of experts is always correct but we should be giving more deference to it, as Bertrand Russell makes clear in Let People Think:

(1) that when the experts are agreed, the opposite opinion cannot be held to be certain; (2) thet when they are not agreed, no opinion can be regarded as certain by a non-expert; and (3) that when they all hold that no sufficient grounds for a positive opinion exist, the ordinary man would do well to suspend his judgment.

Sumner correctly emphasizes the need for more monetary action, which could be even more important than fiscal stimulus to help our economy. I haven’t neglected monetary policy but have focused mainly on the fiscal side because (1) it’s easier to convey (2) it’s more direct (3) it’s something that politicians (and, therefore, the public) have more influence over. Matt Yglesias is certainly right that progressives need to grapple more with Fed policy (must read) and that Obama’s biggest mistake might be his lack of focus staffing the Fed.

I’m extremely disappointed Sumner is taking a break from blogging. I hope he returns soon and continues to offer insightful and challenging commentary. I’ll be sure to rummage through his archives – others should too.

The Socratic Method and Right-Wing Talking Points

November 22, 2010 Leave a comment

Whenever evaluating policies, I find it useful to form a logical model in my mind of how different scenarios should plausibly work out. Doing so requires I walk through various alternatives through their logical steps. I hope some Socratic questioning can be illuminating for us.

Questions for inflationists:

Do you think inflation, currently at historical lows, would be higher, lower, or the same had we not used fiscal stimulus and the first round of quantitative easing?

The Fed has already loosened monetary policy and previously tried the first round of quantitative easing which expanded the money supply in the economy. The Bush and Obama administrations expanded the money supply through fiscal stimulus. Presumably we’d have lower inflation had those policies not happened. At 0.6% annual increase in CPI, wouldn’t deflation have been a likely possibility?

Given all their rhetoric about soaring inflation and the dangers of flooding the economy with cheap money, you’d think they’d answer it’d be lower. But if it was any lower it’d be outright deflation.

Finally for all those worried about the dangers of printing money to fight off potential deflation, what would the inflation picture have to look like for you to argue that the government or the Fed should add more money into the economy?

Questioning uncertainty:

There is no doubt that there is uncertainty in our markets. Advocates of fiscal and monetary stimulus are under no obligation to deny that uncertainty can negatively affect the economy. In their popular Keynesian book, Animal Spirits, George Akerlof and Robert Shiller approvingly quote Washington Post writer Anna Youngman from the Great Depression:

At present, Mr. Dupont [president of the chemical company] notes, there is uncertainty about the future burden of taxation, the cost of labor, the spending policies of the Government, the legal restrictions applicable to industry-all matters affecting computations of profit and loss. It is this uncertainty rather than any deep-seated antagonism to governmental policies that explains the momentary paralysis of industry…

If it actually exists to the level some conservatives now say it does (I’m still waiting on the evidence: here and here), how far does this etherial “uncertainty” go?  And to what extent should it affect our policy decisions?

This is how I come at the question. Currently aggregate demand is very low. Small businesses are reporting in greater numbers that “poor sales” is a major problem. Personal consumption and retail sales remain low.

Graph: Retail Sales: Total (Excluding Food Services)

Earlier last year government consumption was offsetting some of the drop in private consumption, but as fiscal stimulus fades that has also dropped off.

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So imagine you own a company that produces shoes. You’re uncertain how different legislation will affect your future costs – you may believe your taxes could go up, so maybe you shouldn’t hire another worker despite receiving lots of applications. You’re making decent money now and your workers are producing more than enough shoes to satisfy their current customers. You have plenty of excess capacity to make more shoes but, since labor costs a lot (healthcare, taxes, salary, training, etc) you may even be keeping your workers’ hours fairly limited and may even cut back. I think that largely encapsulates the uncertainty picture for a business.

Now let’s assume that all of a sudden there is a big spike in demand for your product (which is what stimulus advocates want to create). You’re selling your supply out. There is NO CHANGE in healthcare legislation, tax rates, labor costs, and shoe material costs, although you’re still uncertain about the future of those costs. If you were the shop owner, can you imagine yourself still not hiring new workers if doing so would be the only short-term way you could satisfy the increased demand for your product?

I submit that businesses aren’t going to forgo making more money now to sell customers more of what they want because they are “uncertain” about various potential future problems. This scenario doesn’t suggest that uncertainty doesn’t matter at all; it just suggests that when looking at the policy prescriptions it seems to have little value for our short-term unemployment crisis.

Now consider another scenario. You’re a business owner that has poor sales, but the congress decides to repeal the healthcare bill, permanently continue all the Bush tax cuts currently in place, cut unemployment benefits, cancel any unspent stimulus money, downsize the federal employment roles, and will promise not to add any new regulations on business. Furthermore, the Fed decides not to add any more money into the economy.

I can’t prove that businesses wouldn’t upon hearing this news and rush out and hire lots of new workers, but let’s just say I’m skeptical of how strong that changes the incentive of businesses to hire new workers.

In our economy we have poor sales and, according to many, policy uncertainty created by the Obama administration and the Fed. In scenario 1, there are poor sales and uncertainty. If poor sales change to strong sales while uncertainty continues, it seems businesses will still hire new workers. In scenario 2, there are poor sales and uncertainty. Nothing was done to directly shift demand rightward by increasing consumption, but some supply side and other right-wing wishes were granted. So we supposedly tackled “uncertainty” but not sales. I personally don’t see how that clearly answers the unemployment problems in our economy. Yet this is the position of some on the political right (via Kevin Drum).

What am I missing? What’s Phase 2?

Monetary Policy isn’t a Radical Left-Wing Idea

November 17, 2010 3 comments

Just in case people think quantitative easing is some left-wing wacky idea, here are some conservative economists that favor it.

Scott Sumner:

When I started my blog in early 2009, fiscal stimulus was the hot issue.  Many conservatives were opposed to fiscal stimulus, arguing (correctly in my view) that it would fail.  And they made it quite clear that “failure” meant deficit spending would fail to boost nominal spending.  The implicit assumption was (almost everyone agreed) that more nominal output would be desirable, and the argument was that fiscal stimulus could not deliver it.  With monetary stimulus, the right is making exactly the opposite argument—they are opposed to QE because it might succeed in boosting NGDP.  Both fiscal and monetary stimulus boost NGDP (if they work at all) by shifting AD to the right.  Whether that extra spending shows up as inflation or real growth is of course an important issue.  But it makes no sense to argue fiscal stimulus would fail because it would not boost NGDP, and simultaneously argue that monetary stimulus would fail because it would increase NGDP.  I’m sure the right doesn’t think of its views in those terms, but that is essentially the message they are sending out, and it is an extremely incoherent message.

Greg Mankiw:

My view is that QE2 is a modestly good idea.  I say it is a “good idea” because, like Ben Bernanke, I am more worried at the moment about Japanese-style deflation and stagnation than I am about excessive inflation.  By lowering long-term real interest rates below where they otherwise would be, QE2 should help expand aggregate demand.  I include the modifier “modestly” because I don’t expect these actions to have a very large effect.

Milton Friedman:

Well, it is impossible to say whether he’d support QEII specifically because he’s dead, but he certainly didn’t have a problem with using monetary policy as a tool to increase the money supply to remedy the economy.

“The Bank of Japan can buy government bonds on the open market…” he wrote in 1998. “Most of the proceeds will end up in commercial banks, adding to their reserves and enabling them to expand…loans and open-market purchases. But whether they do so or not, the money supply will increase…. Higher money supply growth would have the same effect as always. After a year or so, the economy will expand more rapidly; output will grow, and after another delay, inflation will increase moderately.”

Fed Up

September 19, 2010 Leave a comment

The legislature is clearly impotent to do much to improve the economy right now. It looks like the best it can hope for is piecemeal bills to keep things from getting much worse. Given that it seems the Fed really needs to step in, stop worrying about its image, and do what it can to help the economy. Here’s a few ideas that seem worth trying to me.


If the Fed promises to keep increasing the money supply until prices rise by, say, 3 percent a year, people should eventually start spending. Otherwise, if they just held the money, it would be worth 3 percent less each year.

In a self-fulfilling prophecy, the Fed could stimulate spending and the economy, and at no cost to the Treasury

Mark Thoma seconds Cowen’s own questions about that policy:

As for Tyler’s (and others’) call for monetary policy instead of fiscal policy, here’s the problem. It relies upon changing expectations of future inflation (which changes the real interest rate). You have to get people to believe that the Fed will actually be willing to create inflation in the future when it comes time to do so. However, it’s unlikely that it will be optimal for the Fed to cause inflation when the time comes. Because of that, the best policy is to promise that you’ll create inflation, then renege on the promise when it comes time to follow through. Since people know that, and expect the Fed will not actually carry through, it’s hard to get them to change their expectations now. All that credibility the Fed has built up and protected concerning their inflation fighting credentials works against them here. 

Bruce Bartlett:

Thus many economists believe that the Fed has unwittingly encouraged banks to sit on their cash and not lend it by paying interest on reserves. Eliminating interest on reserves would therefore encourage lending. A rumor that the Fed might do so caused the stock market to rise earlier this week, according to press reports. But the policy remains in place.

Discouraging Excess Reserves 

Some economists go further and suggest that the Fed impose a penalty rate on excess reserves. This is what Sweden’s central bank does. There, banks currently pay 0.25 percent on reserves — called the deposit rate — rather than receiving 0.25 percent as they do here. This may be a key reason why Sweden has bounced back much more rapidly from the worldwide economic crisis than the United States has.

Scott Sumner enlists Milton Friedman to support monetary stimulus:

I forget to mention the interest on reserves policy, which is very similar to the 1936-37 policy of doubling reserve requirements.  Both programs only raised short term rates by about a 1/4 point, but Friedman (and Schwartz) understood that the 1937 policy was highly contractionary despite the tiny interest rate increase, because it sharply reduced the money multiplier.  He would have been a severe critic of the current IOR policy.

[update 09/20]: Here’s a David Leonhardt column from about a month ago that should help squelch some readers fears about inflation.

(Bureau of Labor Statistics, via Haver Analytics) (Six-month change in the Consumer Price Index.)

Over the last two years, inflation has been zero. Over the last year, it has been just 1.3 percent. Over the last six months, it has been below zero — negative 0.7 percent.

[…]

The Fed — especially the regional Fed banks — is filled with economists and bankers who have strong memories of the 1970s and 1980s inflation. They’re always on guard against it.

There is no question that inflation can be terrible. Right now, though, it sure looks like the last war. 

By the way, can we at least fully staff the Federal Reserve!? 

The Great Revision

September 8, 2010 Leave a comment
Every time I argued with Keynes, I felt that I took my life in my hands and I seldom emerged without feeling something of a fool. Bertrand Russell 



In the past few days I’ve come across some common misunderstandings of what actually happened during the The Great Depression and what lessons it should provide us for monetary and fiscal policy today. One came from my uncle’s coworker and another from a fellow blogger. So readers here get a better sense of my thoughts on both with a risk of being slightly unfocused, I’ll just include some parts from my private email correspondences in with my response to “Rick.” 



Oh Rick, I’m almost sorry to have to chip away at the icon you’ve placed a top the pedestal. Maybe your love of one-dimensional Randian characters explains it, but Amity Schlaes and The Forgotten Man are hard for most of us to sympathize with. You ask your readers to “compare the two statements against easy to find historic facts and decide for yourself whose opinion is the most accurate.” Well, I did. I can understand the appeal of a novel like Atlas Shrugged, but I can’t get behind any of Schlaes’ fiction. 

First and most glaring is her pathological undercounting of jobs during the New Deal. She doesn’t count “work relief jobs” even though these jobs actually help living people and help generate more spending; the only reason I can see not counting them is because they make her argument even worse. Her whole thesis is basically torpedoed with one glance at a graph of the economic performance under the New Deal. 

So there’s your “easy to find historic facts.” No matter how many anecdotes she can cram into her revisionist history, they won’t blind us to the data. When Roosevelt came into office unemployment was over 20% and he cut it by more than half. Not really a glaring indictment. 

I’m also not sure she actually understands that critiquing the New Deal or FDR isn’t the same thing critiquing Keynesian economics or even Keynes himself. Knowledgable Keynesians don’t even make the argument that FDR ended the Great Depression, he helped in some ways and hurt the cause in others. The spending from the WWII and getting off the gold standard, which broke loose the contracting money supply, were far more instrumental. Drop Amity Schlaes and pick up some Milton Friedman at least

Here’s Bruce Bartlett, policy advisor to Ronald Reagan’s and a former treasury department economist.

I am not dogmatic on this issue. I am willing to look at evidence or analysis that recovery from the Great Depression would have been faster if spending had been cut to the level of revenues or even lower or whatever, but I have been unable to get any conservative critic of the New Deal to say that this is what they believe. They always change the subject to various other things Roosevelt did, much of which I agree was mistaken. I just want a simple answer from Amity Shlaes, Jim Powell, and Burt Folsom, all of whom have recent books critical of Roosevelt, to this question: Would recovery have been faster if spending had been cut and deficits had been smaller during the 1930s? If the answer is yes, please provide some logical and empirical evidence supporting this view. (my emphasis)

It also becomes clear trying to read her buckshot critique of Krugman that she doesn’t understand the dynamics of labor price. First of all, rampant deflation is the major cause of real wage rises and real interest rates. So monetary policy, not fiscal or labor policy is the culprit here. Also, when a depression is happening and interest rates are at the lower bound, lowering wages for all workers would be coupled with a lower real price level so demand for labor wouldn’t necessarily change that much.

Suppose that wages across the US economy had been, say, 20 percent lower than they actually were. You might be tempted to say that this would make hiring workers more attractive. But to a first approximation, prices would also have been 20 percent lower — so the real wage would not have been reduced. So how would lower wages lead to higher demand for labor?

What Keynes realized by applying the concept of “sticky prices/wages” (which Shlaes largely ignores) is that the government needs to intervene and push aggregate demand rightward while expanding the real money supply.


Don’t forget too that Keynes wasn’t a marxist, he wanted to save capitalism. Here he is on Hayek’s Road to Serfdom

I find myself moved, not for the first time, to remind contemporary economists that the classical teaching embodied some permanent truths of great significance, which we are liable today to overlook because we associate them with other doctrines which we cannot now accept without much qualification. There are in these matters deep undercurrents at work, natural forces, one can call them, or even the invisible hand, which are operating toward equilibrium. If it were not, we could not have got on even so well as we have for many decades past. 

The point here is that these extreme government interventions are only necessary during specific recessionary conditions. The government isn’t taking private capital out of the economy when it is jump starting idle factories and workers. The whole point is that the resources aren’t being used at all. If we don’t use them we’d get what happened in Japan, a lost decade. 
Let’s see why “simply printing” money can lead to prosperity during these types of economic conditions. When the government prints money it causes inflation, but since we’re well below inflation targets (we actually have a bigger potential problem with deflation right now) more inflation is a good thing. What more money in the economy will do right now is combine “together unemployed workers and idle factories. Remember a recession is a time when we have increasing unemployment and declining capacity utilization. We have factories without workers and workers without factories. Those are resources that could be used to produce things but are not being used.” 

The problem is that since there isn’t enough money in the economy right now consumers can’t spend enough of what’s available to push businesses into hiring more workers. Fortunately, the government can print more money and spend it directly to put those idle resources to use. Interest rates also happen to be at historically low levels so it won’t even cost us that much in future (less valuable) dollars to do so. 

Here’s another helpful way to look at it: “Long-term economic prosperity is determined by how much value a country is capable of creating. […] But in the short-term, gaps can arise between what could be produced and what’s actually being produced. If that gap is small or nonexistent, efforts to “stimulate” production will lead to inflation or mere shifting of resources around. But if the gap is large, then policy needs to induce people who are currently not doing anything to start producing goods and services again.” Stop caring about dollars and start caring about wealth. 


Another common criticism that keeps turning up is the “uncertainty” critique. It argues that businesses are uncertain what certain legislation and other government policies will result in so they won’t hire new workers, but will sit on their profits until they have a better idea of what is going to happen. Aside from not having much evidence (herehere) to support this claim, I’m also baffled that people somehow think the free market is more certain. The free-market does a lot of good things, but certainty isn’t really what defines it. Also, will sweeping reform that pulls the government out of huge portions of the economy really make things more certain? If you think it’d be better, than make that argument – just don’t tell me it’d make things less uncertain. 


Don’t trust Amity Schlaes and others that don’t seem to even understand the arguments for stimulus. Seek out actual economists on the left and the right for more useful arguments for and against stimulus; after reading “historian” Schlaes, it seems we should trust them more on history as well. 


Krugman’s column.
Schlaes’ response.

Better Fed than Dead

September 29, 2009 Leave a comment

Ron Paul, famously, wants to End the Fed. Well, here’s a rejection of that view from Bruce Bartlett.

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