Tag: Monetary Policy

Must-Read: Ryan Avent: Ben Bernanke’s Big Blunder

Posted on by Brad DeLong

Must-Read: I find myself thinking about six things:

  1. The failure of the Bernanke Fed to focus on the unwinding housing bubble and learn about the outstanding sources of systemic risk in 2006 and 2007.
  2. The decision by the Bernanke Fed in September 2008 that it was time to demonstrate that it did not guarantee the debt of money-center shadow banks, step aside, and allow the uncontrolled bankruptcy of Lehman Brothers.
  3. In fact, the earlier decision by the Bernanke Fed to stand by rather than to handle the situation when, in the summer of 2008, Lehman Brothers crossed the line from solvent to insolvent and thus the Federal Reserve arguably lost the legal power to handle a Lehman-centered crisis.
  4. The failure of the Bernanke Fed to commit to a policy of catching-up to 2%/year inflation should prices fall below its inflation target.
  5. The failure of the Bernanke Fed to choose a more appropriate, higher inflation target than 2%/year.
  6. The failure of the Bernanke Fed to admit that the 2%/year inflation target had proved to be a mistake, and shift to a more sensible nominal GDP target.

These are six major failures of technocratic rationality in monetary policy. Is there anything to offset them, other than “we stopped another Great Depression from happening”?

Ryan Avent: Ben Bernanke’s Big Blunder: “Two weeks ago, The Economist repeated its endorsement of a change in the Fed’s monetary policy target…

…from an inflation rate to a growth rate for nominal GDP (NGDP): or total spending and income in an economy in dollar terms. In November of 2011, during Mr Bernanke’s chairmanship of the Fed, the monetary-policy committee considered a change to an NGDP target, but opted to stay with the old, inflation-focused framework. Mr Bernanke writes:

For nominal GDP targeting to work, it had to be credible. That is, people would have to be convinced that the Fed, after spending most of the 1980s and 1990s trying to quash inflation, had suddenly decided it was willing to tolerate higher inflation, possibly for many years.
And so in January of 2012 the Fed reiterated its inflation-targeting stance and officially designated a 2% rate of inflation, as measured by the price index for personal consumption expenditures, as the target.

We all know what happened next. Since then, the Fed has spectacularly undershot its inflation target…. Markets suspect rates might not rise to 0.5% until well into 2016, and most Fed members think rates will never get any higher than 3.5%. Treasury prices suggest that inflation will be closer to 1% than 2% over the next five years. There is good reason to believe that Mr Bernanke’s Fed made a big mistake, in other words. An NGDP target would have worked out better… helped the Fed choose policy more appropriately at a tricky time in the recovery. In 2011 high oil prices drove headline inflation above 2%… the central bank sensibly shrugged aside calls to raise rates in response to rising prices. Yet it also took no additional action to boost the economy. The recovery subsequently lost pace, inflation fell, and by the end of 2012 the Fed was forced to restart QE. Had the Fed instead focused its attention on NGDP, it would have been forced to react to an economy that was well below an appropriate level of output and which was growing too slowly…. Instead it took the costly choice to dither.

Just as importantly, a switch to an NGDP target would have sent a strong signal about Fed priorities…. Mr Bernanke notes that the Fed spent the 1980s and 1990s trying to quash inflation. It did not arrive at that policy strategy passively…. Paul Volcker… [did not say] that the Fed couldn’t possibly rein in double-digit inflation because it lacked credibility as an inflation-fighter after a decade of neglecting the problem. Instead, he used the tools available to him to demonstrate the Fed’s credibility. Mr Bernanke’s Fed could have, and should have, taken similarly bold action….

Instead, it made itself a prisoner of its own complacency. As a result, inflation and interest rates will spend most of the 2010s at dangerously low levels, leaving the American economy disconcertingly vulnerable to new economic shocks. The book, by the way, is titled The Courage to Act

Must-Read: Paul Krugman: Puzzled By Peter Gourevitch

Posted on by Brad DeLong

Must-Read: Over the past twenty years, Paul Krugman has a very good track record as an economic and a political-economic analyst. His track record is so good, in fact, that any even half-rational or half reality-based organization that ever publishes a headline saying “Paul Krugman is wrong” would find itself also publishing at least five times as many headlines saying “Paul Krugman is right”. And when any organization finds itself publishing “Paul Krugman is wrong” headlines that are not vastly outnumbered by its “Paul Krugman is right” headlines, it is doing something very wrong.

Thus note this “Paul Krugman is wrong” headline from the Washington Post’s Monkey Cage:

In the article, the well-respected Peter Gourevitch puzzled and continues to puzzle Paul Krugman:

Paul Krugman: Puzzled By Peter Gourevitch: “Peter Gourevitch has a followup… that leaves me, if anything…

…more puzzled…. He notes that….

The Federal Reserve is not a seminar… not only about being ‘serious’ or ‘smart’ or ‘finding the right theory’ or getting the data right. It is… a political… multiple forces of pressure: the… Committee; Congress and the president… political parties… interest groups… media… markets… foreign governments and countries.

But how does that differ from what I’ve been saying?…

[My original] column… was all about trying to understand the political economy of a debate in which the straight economics seems to give a clear answer, but the Fed doesn’t want to accept that…. I asked who has an interest… my answer is that bankers have the motive and the means….

I talk all the time about interests and political pressures; the ‘device of the Very Serious People’ isn’t about stupidity, it’s about how political and social pressures induce conformity within the elite on certain economic views, even in the face of contrary evidence. Am I facing another version of the caricature of the dumb economist who knows nothing beyond his models? Or is all this basically a complaint that I haven’t cited enough political science literature? I remain quite puzzled.

I agree.

It puzzles me too.

So let’s look at the arguments: In what respects does Peter Gourevitch think that Paul Krugman is wrong about the Federal Reserve?

(1) Here we have, for one thing, a complaint that Paul Krugman should not believe that there is even a “correct” monetary policy that the Fed should follow. This criticism seems to me to take an “opinions of the shape of the earth differ” form. I reject this completely and utterly.

(2) Here we have, for another thing, Peter Gourevitch saying–at least I read him as saying–that: “Paul Krugman is wrong! Political science has better answers! Political science better explains the Federal Reserve’s actions than Paul Krugman does!”

Yet Gourevitch does not actually do any political science.

He does not produce any better alternative explanations than Krugman offers.

In lieu of offering any such better alternative explanations, at the end of his follow-up post he provides a true laundry list of references for further reading:

  • William Roberts Clark, Vincent Arel-Bundock. 2013. “Independent but not Indifferent: Partisan Bias in Monetary Policy at the Fed.” Economics & Politics 25, 1 (March):1-26.
  • Lawrence Broz, The Federal Reserve’s Coalition in Congress. Broz looks at roll calls in Congress to explore left and right influences on the Fed.
  • Chris Adolph, Bankers, Bureaucrats and Central Bank Policy: the myth of neutrality, Cambridge University Press 2013
  • John T. Woolley. Monetary Politics. The Federal Reserve and the Politics of Monetary Policy. 1986. * Thomas Havrilesky. The Pressures on American Monetary Policy. Kluwer 1993.
  • Cornelia Woll, The Power of Inaction.
  • Kelly H. Chang. Appointing Central Bankers: The Politics of Monetary Policy in the United States. Cambridge UP 2003.
  • Jeff Frieden, Currency Politics: The Political Economy of Exchange Rate Policy
  • Roger Lowenstein, America’s Bank: The Epic Struggle to Create the Federal Reserve (suggested by Jeff Frieden).
  • Bob Kuttner’s Debtors’ Prison
  • Mark Blyth, Austerity.
  • Paul Pierson and Jacob Hacker, American Amnesia: Rediscovering the Forgotten Roots of Prosperity.
  • Greta R. Krippner, Capitalizing on Crisis: The Political Origins of the Rise of Finance
  • Marion Fourcade, Economists and Societies: Discipline and Profession in the United States, Britain, and France, 1890s to 1990s; 2015
  • Marion Fourcade, “The Superiority of Economists” (with Etienne Ollion and Yann Algan), Journal of Economic Perspectives; 2013
  • Marion Fourcade, “Moral Categories in the Financial Crisis.”
  • Marion Fourcade, “Introduction” (with Cornelia Woll)
  • Marion Fourcade, “The Economy as Morality Play” Socio-Economic Review 11: 601-627.

18 references. Some of them are quite long. Figure roughly 3000 pages. Or roughly 1,000,000 words. Offered without guidance.

As one of my Doktorgrossväter, Alexander Gerschenkron, used to say: “to tell someone to read everything is to tell him to read nothing.”

So let me provide some guidance: If you are going to read one thing from Peter Gourevitch’s list, read Mark Blyth’s excellent Austerity. I do think it is the place to start.

And if you do read it, you will find a very strong book-length argument–an argument which carries the implications that Paul Krugman’s screeds against and anathemas of VSPs are not, as analytical explanations, wrong, but rather profoundly right.

Must Read: Steven B. Webb (1984): The Supply of Money and Reichsbank Financing of Government and Corporate Debt in Germany, 1919-1923

Posted on by Brad DeLong

Steven B. Webb (1984): The Supply of Money and Reichsbank Financing of Government and Corporate Debt in Germany, 1919-1923: “During the five years of inflation, price stability, and hyperinflation in Germany after World War I…

…three factors determined the growth of the money supply. First, the Reichsbank freely issued money in exchange for whatever government or corporate debt the private sector did not wish to hold at the official discount rate. Second, the government persistently ran large deficits. Political instability and the inflation itself prevented taxation adequateto pay for social programs, subsidies to the railroad and businesses, and reparations to the Allies. The third factor was expectations of inflation, which, as they became more pessimistic, led people to hold less and monetize more of the outstanding stock of debt. Thus, the money supply was partly endogenous and partly dependent on government fiscal policy. The monetary policy of the Reichsbank, although essential to the inflation process, was a constant and passive one until stabilization at the end of 1923…

Is there a “correct” monetary policy? Yes!

Posted on by Brad DeLong

In what way does Peter Gourevitch think that Paul Krugman’s analysis of the Federal Reserve is wrong?

Here we have, first, Gourevitch saying: “opinions of the shape of the earth always differ”:

Peter Gourevitch: This is why Paul Krugman is wrong about the Federal Reserve: “The second set of criticisms reflects a more fundamental disagreement between economics and political science…

…Economists tend to assume that there is a single right answer (even if they disagree bitterly among each other about what the right answer is)…. Political scientists… assume that there is more than one interpretation of what is correct, and try to come up with theories about which “correct” answer is chosen…

I reject this.

I reject this completely.

I reject this utterly.

For more than a hundred years there has been a broad near-consensus among economists that there is such a thing as a “correct” monetary policy.

To quote Keynes (1924):

Rising prices and falling prices each have their characteristic disadvantages. The Inflation which causes the former means Injustice to individuals and to classes,–particularly to investors; and is therefore unfavorable to saving. The Deflation which causes falling prices means Impoverishment to labour and to enterprise by leading entrepreneurs to restrict production in their endeavour to avoid loss to themselves; and is therefore disastrous to employment, The counterparts are, of course, also true,–namely that Deflation means Injustice to borrowers, and that Inflation leads to the over-stimulation of industrial activity. But these results are not so marked… borrowers are in a better position to protect themselves than lenders… labour is in a better position to protect itself from over-exertion in good times than from under-employment in bad times.

Thus Inflation is unjust and Deflation is inexpedient. Of the two perhaps Deflation is, if we rule out exaggerated inflations such as that of Germany, the worse; because it is worse, in an impoverished world, to provoke unemployment than to disappoint the rentier. But it is not necessary that we should weigh one evil against the other. It is easier to agree that both are evils to be shunned. The Individualistic Capitalism of to-day, precisely because it entrusts saving to the individual investor and production to the individual employer, presumes a stable measuring rod of value, and cannot be efficient–perhaps cannot survive–without one…

Paul Krugman’s point is that the consensus of the 1980 MIT macroeconomics posse is that right now a higher inflation target than 2%/year is appropriate and that raising interest rates is not appropriate. “Opinions of shape of earth differ” or even “There is no correct answer when there are competing rival views that are not easily testable in a complex world where one cannot readily carry out controlled experiments with obvious real world interpretations…” simply does not clear the bar as a criticism.

As I like to put it, back in 1820 Thomas Robert Malthus identified a “general glut” as a problem independent from and much more dire than a simple misallocation of productive resources that produced excess supply in one industry and excess demand in another:

Thomas Robert Malthus: The “General Glut” (1820): “[T]he effect of falling [manufacturing export] prices in reducing profits…

…is but too evident at the present moment. In the largest article of our exports, the wages of labour are now lower than they probably would be in an ordinary state of things if corn were at fifty shillings a quarter. If, according to [Ricardo’s] new theory of profits, the prices of our exports had remained the same, the master manufacturers would have been in a state of the most extraordinary prosperity, and the rapid accumulation of their capitals would soon have employed all the workmen that could have been found. But, instead of this, we hear of glutted markets, falling prices, and cotton goods selling at Kamschatka lower than the costs of production.

It may be said, perhaps, that the cotton trade happens to be glutted; and it is a tenet of the new doctrine on profits and demand, that if one trade be overstocked with capital, it is a certain sign that some other trade is understocked. But where, I would ask, is there any considerable trade that is confessedly under-stocked, and where high profits have been long pleading in vain for additional capital? The [Napoleonic] war has now been at an end above four years; and though the removal of capital generally occasions some partial loss, yet it is seldom long in taking place, if it be tempted to remove by great demand and high profits…

And back in 1829 the young John Stuart Mill identified the key cause as our possession of a monetary economy, and in a monetary economy Say’s Law–that supply creates its own demand–is false in theory: a general excess supply of pretty much all currently-produced goods and services, Malthus’s “general glut”, is the metaphysically-necessary consequence of an excess demand for whatever currently counts as money:

John Stuart Mill (1829): Essays on Some Unsettled Questions: “[In a non-monetary economy] the sellers and the buyers…

…for all commodities taken together, must, by the metaphysical necessity of the case, be an exact equipoise to each other; and if there be more sellers than buyers of one thing, there must be more buyers than sellers for another….

If, however, we suppose that money is used, these propositions cease to be exactly true…. Although he who sells, really sells only to buy, he needs not buy at the same moment when he sells; and he does not therefore necessarily add to the immediate demand for one commodity when he adds to the supply of another….

There may be, at some given time, a very general inclination to sell with as little delay as possible, accompanied with an equally general inclination to defer all purchases as long as possible. This is always actually the case, in those periods which are described as periods of general excess… which is of no uncommon occurrence….

What they called a general superabundance, was… a superabundance of all commodities relatively to money…. Money… was in request, and all other commodities were in comparative disrepute. In extreme cases, money is collected in masses, and hoarded; in the milder cases, people merely defer parting with their money, or coming under any new engagements to part with it. But the result is, that all commodities fall in price, or become unsaleable. When this happens to one single commodity, there is said to be a superabundance of that commodity; and if that be a proper expression, there would seem to be in the nature of the case no particular impropriety in saying that there is a superabundance of all or most commodities, when all or most of them are in this same predicament…

And ever since then, every monetary economist worthy of the name has sought a government and a central bank that will pursue a monetary policy that makes Say’s Law true in practice even though it is false in theory. Everyone has sought for a policy that makes the demand for money in conditions of full employment equal to the supply, so that we have neither an excess demand for money and Keynes’s inexpedient Deflation, nor an excess supply of money and Keynes’s unjust Inflation.

There is a single right answer in monetary policy. It is the policy that hits this sweet spot.

Must-Read: Charles Evans: Thoughts on Leadership and Monetary Policy

Posted on by Brad DeLong

Must-Read: Three people so far have told me that Chicago Fed President Charlie Evans’s “Leadership” speech is superb, and the kind of speech that the Fed Chair really ought to be giving these days–what with 10-year Treasury rates kissing 2%/year and the 10-year inflation breakeven below 1.5%/year:

Graph 10 Year Treasury Constant Maturity Rate FRED St Louis Fed

Charles Evans: Thoughts on Leadership and Monetary Policy: “Sometime during the gradual policy normalization process…

…inflation begins to rise too quickly. Well, we have the experience and the appropriate tools to deal with such an outcome. Given how slowly underlying inflation would likely move up from the current low levels, we probably could keep inflation in check with only moderate increases in interest rates relative to current forecasts. And given how gradual the projected rate increases are in the latest SEP, the concerns being voiced about the risks of rapid increases in policy rates if inflation were to pick up seem overblown.

Furthermore, as I just outlined, there is no problem in moderately overshooting 2 percent. After several years of inflation being too low, a modest overshoot simply would be a natural manifestation of the Federal Reserve’s symmetric inflation target. Moreover, such an outcome is not likely to raise the public’s long-term inflation expectations either — just look at how little these expectations appear to have moved with persistently low inflation readings over the past several years. So, I see the costs of dealing with the emergence of unexpected inflation pressures as being manageable.

All told, I think the best policy is to take a very gradual approach to normalization. This would balance both the various risks to my projections for the economy’s most likely path and the costs that would be involved in mitigating those risks.”

Must-Read: Torsten Slok: DB: Expect More Hawkish Fedspeak

Posted on by Brad DeLong

Must-Read: Remember, relative to Fed beliefs less than four years ago, we have already seen 75 basis points of tightening relative to the benchmark of the estimated natural rate:

NewImage

The more likely it is that we are in a régime of secular stagnation, the more important it is to take the 2%/year inflation target as an average rather than a ceiling, and the less-wise is the Federal Reserve’s expressed commitment to start raining interest rates come hell or high water. The markets appear to think–quite reasonably–that the Federal Reserve is gradually moving month-by-month toward a more reality-based Larry Summers-like view of the macroeconomic situation, and that when December comes around the current FOMC consensus for raising interest rates then will have sublimed away.

And if the market is wrong, the most likely reason for it to be wrong is if the Federal Reserve decides to be contrary and to stop its ongoing rethinking process, just to show that it can and that it is boss…

Torsten Slok: DB: Expect More Hawkish Fedspeak: “Before Yellen’s speech last week, the probability of a rate hike by the end of 2015 was 42%…

…Today it is 41%. The market continues to believe that the Fed will not hike rates later this year despite 13 out of 17 FOMC members expecting a hike in 2015. Why does the market not believe the Fed? One reason is likely that the Fed for several years now has been too optimistic… has had to revise down their forecasts of not only near-term growth but also longer-term growth prospects…. This one-way revision in forecasts over many years has probably had an impact on how market participants interpret Fed communication…. We continue to expect a rate hike in December and we continue to expect Fedspeak in the coming weeks will repeat their expectation of liftoff coming in 2015..

Must-Read: Scott Sumner: The Case for Tightening Is Getting Weaker and Weaker

Posted on by Brad DeLong
Graph 10 Year Breakeven Inflation Rate FRED St Louis Fed

Scott Sumner: The Case for Tightening Is Getting Weaker and Weaker: “The recent plunge in TIPS spreads is reaching frightening proportions…

…5 year = 1.09%. 10 year = 1.42%. 30 year = 1.61%. Yes, I know they can be distorted by illiquidity, but they are not THAT far off market expectations. And don’t forget they predict CPI inflation, which runs about 0.3% above the Fed’s preferred PCE. In essence, the Fed has a 2.3% inflation target. They aren’t likely to hit it. Also recall that since 2007 the Fed’s been consistently overly optimistic… markets have been more pessimistic, and more accurate. Also recall that Fed policy has a big impact on the global economy. Also recall that the global economy seems to be moving into a disinflationary cycle…. Given there is basically no upside from tightening now, the Fed’s got to ask itself one question: “Do I feel lucky today?”

Could We Have Had a Severe Recession Without the 2008 Financial Crisis?

Posted on by Brad DeLong

Over at Grasping Reality: Monday DeLong Smackdown: Scott Sumner: Could We Have Had a Severe Recession Without the 2008 Financial Crisis?: “I have trouble with DeLong’s implicit assumption is that the financial crisis caused the Great Recession….

The years leading up to 1990 saw Australian-level NGDP growth, if not more. So even if lending standards tightened sharply in the wake of the 1989-90 crisis, there was no possibility of hitting the zero bound…. With no zero bound in prospect, there’d be no reason for markets to expect an NGDP collapse…. Even if we had managed the 2007-08 subprime crisis very well from a regulatory/resolution perspective, there is no question that banks would have tightened lending standards sharply. That effectively reduces the demand for credit…. It’s quite plausible that the Wicksellian equilibrium natural rate would have fallen to zero in late 2008, even with a better resolution of the banks….

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