Pick-Up Symposium: Why the Love of Hard Money?: Wednesday Focus for September 3, 2014

My four biggest intellectual mistakes over the past decade–and all four are huge–are:

1. My belief from 2003-2007 that the serious threat to the American financial system came from universal banks that had used their derivatives books to sell lots of unhedged puts against the dollar rather than universal banks accepting lots of house-value puts without doing any due diligence about the quality of the underlying assets.

2. My fear from 2008-2010 that although nominal wages were downward-sticky they were not that downward-sticky and we were on the point of tipping over into absolute deflation.

3. My confidence in 2009-2010 that the major policymakers–Bernanke, Obama, and what turned out to be Geithner–both understood how to use the ample monetary, fiscal, banking, and housing finance tools at their disposal to effectively target nominal GDP and understood the urgency of doing whatever it took to return nominal GDP to its pre-2008 growth path.

4. My failure to even conceive that “Washington” starting in 2010 could possibly be sufficiently happy with the pace of recovery that serious measures to further boost demand would vanish from the agenda.

(1) and (2) and (3) I have written about elsewhere. Today we have a piece of (4) to deal with–why do so many people prioritize low-pressure economy policies that they regard as the only safeguard of hard money over economic recovery?

Paul Krugman constitutes himself the συμποσιαρχ, decides that we will be drinking κρασί ακρατος, and poses the question:

Paul Krugman: Three Roads to Hard Money: “A hedge fund manager, a right-wing politician, and a freshwater economist walk into a restaurant…

…and order wine. No, this isn’t the setup for a joke–it’s a real story…. All three [of Cliff Asness, Paul Ryan, and John Cochrane] have been prominent in warning that the Fed is embarked on a dangerously inflationary path…. This inflation paranoia has proved remarkably resilient… despite five-plus years of utter empirical failure. Why?… Three seemingly different stories….

[1] The wealthy… [fear] monetary expansion… reduce[s]… returns and erode[s] their wealth…. [3] Movement conservatism[‘s]… closed intellectual space… [where] political figures… imagine… economic [truth is]… in Atlas Shrugged. [3] And… the internal…devolution of… economics… [the] great forgetting of even the most basic macroeconomic concepts….

These seem like disjoint stories, with their convergence at precisely the moment they could do the most harm a coincidence. But there has to be more. I’m thinking, I’m thinking. Maybe some wine will help.

My view is that [3] is simply unprofessionalism at work, plus an eagerness to provide academic support for politicians who share ideology. As Simon Wren-Lewis says, the naive quantity-theory of fiscal-price-level-theory models you need to construct an inordinate fear of inflation today are simply not serious:

Simon Wren-Lewis: Simplistic theories of inflation: “Monetarism [was] so popular until governments actually tried it…

…[because of] its simplicity… a stable demand for… M/P, so if you can control M you must control P…. There are lots of problems…. Money can be saved as well as buy goods… even if there was a stable long run demand… we cannot say what the future quantity of money will be… base money and… Quantitative Easing…. The Fiscal Theory of the Price Level is… another simplistic theory…. But… future primary surpluses [and the real factors at which they are discounted] are not fixed…. The Fiscal Theory of the Price Level, like monetarism, is not a terribly helpful way of thinking about future inflation… one variable, or one equation [economics]… is a fantasy. What is surprising is that this fantasy has been, and still remains, so attractive for some economists.

My view is that [2] is in some ways a corollary of [3]. In my time in and around Washington I have seen many Democratic economists pull a Martin Luther and refuse to give politicians the advice they want, preferring: Hier stehe ich, Ich kann nicht anders, Gott helfe mir! Amen!

It is my impression–and I may be wrong–that on the Republican side of the aisle it is more like: Of course we didn’t advise that. If we had it would have been a very short conversation…

I am still actively looking for examples of Republican economists besides Martin Felstein and Glenn Hubbard who have done otherwise.

As for [1]… that is the puzzle. To the extent that Cliff Asness’s clients suffer from inflation illusion, he should like inflation. To the extent that his clients do not suffer from inflation illusion, since he is long real risk and long real assets, a high-pressure economy is his and his clients’ friend. As I said to Barry Eichengreen in my office last week:

I used to teach that before World War I with restricted suffrage and difficulties of political mobilization the working-class was effectively disenfranchised, and there was a very large rentier component of the upper classes whose assets were in nominal bonds or in land rented out on long-term nominal leases to serve as a heart money lobby. Thus the attachment to the gold standard. But with the coming of universal suffrage and of broad portfolio diversification the material interest of the rich in hard money vanished, the material interest of the working-class and the entrepreneurial class in a high-pressure economy advanced, and we acquired a strong political bias toward fiat money and moderate inflation and against price stability or deflation. But what do I teach now?

Barry’s comment:

You are not the only one who has taught that…

The American Federation of Labor-Congress of Industrial Organizations, the National Association of Manufacturers, and the American Bankers Association–who need an inflation spread between the real interest they must pay to depositors and the real interest they can charge to borrowers–should make up a powerful pro-moderate-inflation pro-high-pressure-economy lobby. And nobody should be on the other side.

So what gives?

Nick Rowe thinks that it is all inflation illusion:

Nick Rowe: It’s the Inflation Fallacy, Duh!: “Paul Krugman is wasting his time trying to figure out…

…why the rich and powerful don’t like inflation….. Just ask a non-economist…. ‘Because if all prices rise 10% we will only be able to afford to buy 10% less stuff. Duh!’… That’s the inflation fallacy…. Economists… talk about shoeleather costs, menu costs, relative price distortions, difficulties of indexing taxes, confused accountants, etc [as costs of inflation]. How many non-economists have you heard mentioning any of those things as the reason why inflation is a bad thing? Ours the task eternal…

But it didn’t used to be that way. I cannot remember anybody in the 1990s or 2000s complaining that inflation–2.2%/year from January 1990 to January 2000, 2.3%/year from January 2000 to January 2008 according to the PCE–was too high. (Inflation has averaged 1.5%/year since January 2008.) It’s true that with the collapse of the union movement only a small minority of America’s politicians ever meet seriously with anyone out of the top 5%, and most of their one-on-one time is spent with the top 0.1%. But why are they so attached to hard money? And why are so many not in the top 5% who have no serious assets and for whom the major threat to their well-being is joblessness fodder for goldbugs?

False consciousness sounds good to me.

Steve Randy Waldmann, however, thinks it is risk aversion plus the fact that the top 0.1% are playing not for absolute but for relative wealth:

Steve Randy Waldmann: Hard money is not a mistake: “Krugman tentatively concludes that ‘it… looks like a form of false consciousness’…

…I wish that were so, but it isn’t…. “Wealth”… [is] bundles of social and legal claims derived from… the past…. Unexpected inflation is noise in the signal…. “Inflation”… unsettle[s] the value of past claims…. Almost by definition, the status of the past’s “winners”–the wealthy–is made uncertain by this…. Regression to the mean is a bitch. You have managed to put yourself in the 99.9th percentile, once. If you are forced to play again in anything close to a fair contest, the odds are stacked against you….

The moderately affluent… rationally prefer to tilt towards debt… because they will need to convert their assets into liquid purchasing power over a relatively short time frame…. To the extremely rich, wealth is primarily about status and insurance, both of which are functions of relative rather than absolute distributions… [thus] a booming economy offers little upside unless they are positioned to claim a disproportionate piece of it…. Soft money types–I’ve heard the sentiment from Scott Sumner, Brad DeLong, Kevin Drum, and now Paul Krugman–really want to see the bias towards hard money and fiscal austerity as some kind of mistake. I wish that were true. It just isn’t…

Steve’s points are powerful, but I think ultimately wrong. Yes, policies that run risks of inflation disrupts the current ordering of wealth. But policies that guard against risks of inflation by creating a low-pressure economy that manifests itself in either high real interest rates or an output gap or both also disrupt the current ordering of wealth, and do so in a negative-sum fashion as opposed to the zero-sum effects of inflation. “False consciousness” is still the favorite, in my view at least.

And, to back me up, just in time around the turn comes Ken Rogoff–neither a votary of the simplistic, rigid quantity theory that Milton Friedman denounced nor a worshipper of the naive fiscal theory of the price level–to tell us that even country with floating exchange rates possessing the exorbitant privilege of issuing reserve currencies should fear inflation right now:

Ken Rogoff: The Exaggerated Death of Inflation: “Is the era of high inflation gone forever?…

…Today, high inflation seems so remote that many analysts treat it as little more than a theoretical curiosity. They are wrong to do so…. A country’s long-term inflation rate is… the outcome of political choices…. As the choices become more difficult, the risk to price stability grows. A quick tour of emerging markets reveals that inflation is far from dead…. Yes, advanced economies are in a very different position today, but they are hardly immune. Many of the same pundits who never imagined that advanced economies could have massive financial crises are now sure that advanced economies can never have inflation crises….

I am not arguing that inflation will return anytime soon in safe-haven economies such as the US or Japan. Though US labor markets are tightening, and the new Fed chair has emphatically emphasized the importance of maximum employment, there is still little risk of high inflation in the near future. Still… there is no guarantee… any central bank will be able to hold the line in the face of… slow productivity growth, high debt levels, and pressure to reduce inequality through government transfers…. Recognizing that inflation is only dormant renders foolish the oft-stated claim that any country with a flexible exchange rate has nothing to fear from high debt, as long as debt is issued in its own currency…

What Ken is doing here is resorting to not a naive but a sophisticated fiscal theory of the price level: if (a) central banks fail to hold the line and prevent governments from resorting to the inflation tax, well then the inflation tax is one way that governments can get hold of resources–and governments that find that their finances have become unbalanced because of (b) slow productivity growth reducing the tax base, (c) higher demands for redistribution to fight rising market income and wealth inequality, or (d) high debt today may resort to it. My natural next question is: how big are the numbers we are talking about? Suppose that we want to amortize all of the U.S.’s current debt over, say, 50 years. How much of a claim on resources does today’s 69% of potential GDP’s worth of debt impose? At today’s 30-year TIPS rate of 0.8%/year and with a potential GDP growth rate of 2.5%/year, we get 0.86% of GDP as the burden–the share of GDP that must be raised in taxes as a real surplus–to completely retire our current debt by 2064.

And if we were happy with our debt at 69% of potential GDP? Then we could afford to run a real deficit of 1.2% of GDP per year and a nominal deficit of 2.6% of GDP per year.

Those are not big numbers. Those are not big threats. Those don’t justify a focus on today’s current debt levels–rather than a focus on, say, exploding medical-care costs, the desirability of funding pensions through Social Security given the manifest inadequacies of 401(k)s, and the fear that if education is not funded by the government it will become a tool of social status rather than of opportunity as the true sources of our long-run fiscal dilemmas.

Debt as a threat to price stability and inflation dormancy is not what I would write about. It’s not what I do write about. From what dark star comes the gravitational attraction that makes it what Ken wants to write about today?

That remains a mystery to me…

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More:

Steve Randy Waldmann on the place of the 1970s:

Steve Randy Waldmann: “Krugman cites Kevin Drum and coins the term…

…“septaphobia” to describe the conjecture that elite anti-inflation bias is like an emotional cringe from the trauma of 1970s. That’s bass-ackwards…. Prior to the 1970s… soft money had an overt, populist constituency…. The “misery” of the 1970s has been trumpeted by elites ever since, a warning and a bogeyman…. The 1970s were unsurprisingly underwhelming on a productivity basis for demographic reasons…. The economics profession… ignored demographics, and the elite consensus… was allowed to discredit a lot of very creditable macroeconomic ideas. Ever since, the notion that the inflation of the 1970s was “painful for everyone” has been used as a cudgel by elites…

Peter Dorman on the Kaleckian business cycle:

Peter Dorman: Big Money Wants Hard Money–But Why?: “It is an indisputable fact that the rich have a strong bias in favor of tight monetary policy…

…In no country today is there a significant portion of the capitalist class that is willing to align with working class movements (if they even exist) in favor of aggressive full employment policy…. Krugman’s question–why don’t the rich recognize a positive effect of expansionary monetary policy on their equity holdings?–converges with this second one–why has the Keynesian coalition vanished from modern politics?…

Is Krugman right to see a predictable positive response of profits, and therefore equities, to Keynesian fiscal and monetary policy in the slump? Consider the profit boom of the last few years…. Demand has remained weak… investment is paltry…. But… workers settle for less and less. The upshot is a much higher profit share of a non-growing pie…

More musings from Paul Krugman:

Paul Krugman: Inflation, Septaphobia, and the Shock Doctrine: The bad news from Europe is a reminder…

…that the basic insight some of us have been trying to convey, mostly in vain, ever since 2008 remains valid: the great danger facing advanced economies is that governments and central banks will do too little, not too much. The risk of elevated inflation or fiscal difficulties is dwarfed by the risk of ending up trapped in a deflationary vortex. This view has been overwhelmingly supported by recent experience–if you acted on what they were saying on CNBC or the WSJ editorial page, you would have lost a lot of money. Yet the power of the hard money/fiscal austerity orthodoxy (yes, market monetarists want one without the other, but they have no constituency) remains immense. Why?…

One thought I’ve had and written about is that the one percent (or actually the 0.01 percent) like hard money because they’re rentiers. But… this is foolish… they have much more to gain from asset appreciation than they have to lose from the small chance of runaway inflation… compare stock prices in the US, with its aggressively easing Fed, with Europe, [and] you can see the difference…. Kevin Drum suggested that it’s all about septaphobia, fear of the 1970s…. But weren’t the one percent equally devoted to the gold standard in the 1930s, with no Jimmy Carter?… And why does the inflation of 1979 remain seared in memory, while the boom after Volcker loosened money in 1982 is forgotten? (This is like the question of why Germans remember 1923 but not Bruening.) Finally, there’s the notion that… crises are a chance to force “reforms” that strip away worker protections and the welfare state, and any suggestion that technical solutions, monetary or fiscal, could do the job is rejected…. It sure looks like a form of false consciousness on the part of elites…

And:

Paul Krugman: Class Interests and Monetary Policy, Take II: “Steve Randy Waldman has a long, thoughtful take…

…While monetary expansion might be expected on average to be a good thing in a weak economy, that’s a risky proposition for wealth holders…. Loose money, despite its direct adverse effects on creditors, will produce large gains indirectly; but those indirect effects are less certain than the direct effects, and assessing them depends on your model of the economy. So wealthy creditors may go for the direct stuff…. But I’m not entirely prepared to give up on the false consciousness notion, in part because I keep being struck by the enormous appetite of the one percent for really bad economic analysis. Think about CNBC economics (aka Santellinomics, aka the finance macro canon). This stuff, with its prediction of soaring inflation and interest rates, has been utterly wrong for more than five years. Yet it remains very popular among wealthy investors.

I think this may in part reflect the problem that always comes with wealth and power: people tell you what you want to hear. CNBC economics stays on the air….

What I’m doing here is groping toward a story about why policy botched the Lesser Depression so badly. More…

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UPDATE: And there are four more contributions worth reading on the Equitable Growth: Pick-Up Symposium: Why the Love of Hard Money?: Wednesday Focus for September 3, 2014:

Paul Krugman sums up what he thinks he knows and doesn’t know:

Paul Krugman: The Deflation Caucus: “Europe… is…

… in the grip of a deflationary vortex… [Its] central bank understands that. But its epiphany may have come too late…. And there but for the grace of Bernanke go we…. We seem (at least for now) to have steered clear of the kind of trap facing Europe. Why?… The Federal Reserve started doing the right thing years ago, buying trillions of dollars’ worth of bonds…. The Fed should have done even more. But Fed officials have faced fierce attacks all the way…. The predicted surge in inflation has never arrived, but despite being wrong year after year, hardly any of the critics have admitted being wrong, or even changed their tune. And the question I’ve been trying to answer is why. What is it that makes a powerful faction in our body politic–call it the deflation caucus–demand tight money even in a depressed, low-inflation economy?

One thing is clear: Like so much else these days, monetary policy has become very much a partisan issue…. Inflation paranoia has, to a remarkable extent, become a matter of conservative political correctness, so that even economists who should know better have joined in the chorus…. Leading politicians get their monetary theory from Ayn Rand novels…. Class interest. Inflation helps debtors and hurts creditors, deflation does the reverse. And the wealthy are much more likely than workers and the poor to be creditors…. You could argue that big investors should like the Fed’s expansionary policies, which have been very good for the stock market. But the wealthy may not trust that connection, in part because the inflationary ’70s were very bad for stocks….

The dominance of creditor interests on both sides of the Atlantic, supported by false but viscerally appealing economic doctrines, has had tragic consequences. Our economies have been dragged down by the woes of debtors, who have been forced to slash spending. To avoid a deep, prolonged slump, we needed policies to offset this drag. What we got instead was an obsession with the evils of budget deficits and paranoia over inflation–and a slump that has gone on and on.

Simon Wren-Lewis does the full Michel Kalecki:

Simon Wren Lewis: Class Interests: “[That] the wealthy want to raise interest rates, even when the economy remains depressed…

…is not just a US phenomenon. In the UK the right wing Institute for Economic Affairs set up what they call the ‘shadow MPC’, and they were voting for higher interest rates before the recovery began! The highly influential FT journalist Chris Giles, who has become a bellwether for right wing interests, has been championing the cause of an early rise in rates for many months…. Is it any wonder… that the ‘1%’ who started to become much richer in the 1980s should see tight money as an essential condition of their new found wealth? But what about the ‘interests of capital’: surely the owners of business should see that firms will be less prosperous if demand is kept too low through tight money? Here I can only quote Michal Kalecki: ‘But “discipline in the factories” and “political stability” are more appreciated than profits by business leaders. Their class instinct tells them that lasting full employment is unsound from their point of view, and that unemployment is an integral part of the “normal” capitalist system.’…

This sets up two areas of political tension between the interests of the wealthy and, of all people, academic macroeconomists. First academic macroeconomists… see monetary policy as a means of achieving the natural unemployment rate and steady inflation. The wealthy see monetary policy as a means of maintaining a degree of unemployment that reduces the political threat to their wealth. Second, when monetary policy stops working in a liquidity trap, most academic macroeconomists want to use fiscal policy to take its place. To the wealthy this… seems unnecessary… [and] calls into question their ideology about the failure of pre-neoliberal times….

The aftermath of financial crisis is extremely threatening to the neoliberal political consensus and the position of the 1%. I remember saying shortly after the crisis that the neoliberal position that government regulation was always bad and unregulated markets always good had been blown out of the water by the crisis. This was politically naive, in part because a crisis caused by unregulated markets was morphed by the right into a crisis caused by too much government debt, or too many immigrants. But that fiction will not be sustainable once a strong recovery has reduced both government debt and unemployment. For the 1%, these are very dangerous times, and they want to be on favourable territory for the battles ahead.

Nick Rowe dodges the question–which is why do the arguments for austerity have so much more traction than they deserve to, and why are the austerians so allergic to in any way marking their beliefs to market?

Nick Rowe: How to destroy the “neoliberal consensus”: “C’mon guys. If you are going to put forward a lefty conspiracy theory…

…to explain why monetary policy is tighter than you (and I) think it should be, you at least need to get your story straight. How many times have I heard the lefty argument that it was ‘Keynesian policies”‘… that saved capitalism from itself [in the 1930s]?… Or just look at those Eurozone countries which have very high unemployment today. Which political parties have gained votes? The communists and near-communists; and the fascists and near-fascists. Not the neoliberals, or near-neoliberals….

<sarc> Right. So the aftermath of the financial crisis is an especially dangerous time for the “neoliberal consensus”. OK. So to save the neoliberal consensus, let’s make unemployment temporarily even higher to make it even more dangerous for the neoliberal consensus??? </sarc> This makes no sense whatsoever. If you are trying to avoid having an accident, while keeping your average speed the same, you don’t increase your speed on the dangerous bits of the road, and slow down on the safer bits….

Look. We think that monetary policy is too tight. And some other people disagree with us. You don’t need to cook up some daft conspiracy theory to explain why people disagree with us. They just do. They have their reasons for thinking they are right, just like we have our reasons for thinking we are right. They are wrong and we are right (I think), but they don’t know that. Those disagreements are what happen all the time in a free society. Get over it. Conspiracy theories are a cop-out.