Month: January 2015

One of the nice things about economics as an intellectual discipline is that you can effectively score intellectual-reputation points by taking on the work of giants a generation older than you–something that, IMHO, too-rarely happens in other disciplines. Here smart young whippersnapper Marshall Steinbaum takes on the very sharp Tom Sargent’s “The End of Four Big Inflations” account of Europe’s post-WWI hyperinflations.

…I called it ‘terrible history and questionable economics’… post-World-War-I monetary histories of Austria, Hungary, Poland, and Germany, which they all experienced hyperinflations, on the one hand, and Czechoslovakia, which did not, on the other… highly influential…. The titular Four Big Inflations were actually one big inflation… caused by the near-state-collapse embodied in the Treaties of Versailles, St. Germain-en-Laye, and Trianon… denuding the defeated… of… industrial capability… reparations…. Keynes’ argument is that the reparations… exceeded… the maximum amount of government revenue that can be extracted from the productive economy…. A particularly important aspect of Keynes’ argument is the tension between France and Poland’s abject public finances, only made paper-solvent by ambitious reparations schedules…. [The] hyperinflations ended when the vague commitment to reparations imposed on them was removed by the League of Nations…. The German hyperinflation was a consequence of the postwar settlement, and most importantly, the huge reparations it faced….

Sargent tells a very different story. Each of his four hyperinflations ends when a central bank is reorganized to be politically independent of a national treasury. Thereafter, although the circulation of national currency continued to increase, inflation was kept under control because newly-independent central banks adhered to reserve requirements and only purchased securities on the open market, rather than accepting worthless government bonds from the Treasury. At the same time, national treasuries were disciplined by their lack of access to the money-printing presses to enforce fiscal austerity. That combination of institutional changes constitutes what Sargent calls a ‘regime shift.’… The notion of a regime change might be helpful, but Sargent… mis-deploys it…. There was a regime shift… the US and Britain… prevailed over France and abandoned the most onerous aspects of the postwar settlement.

Before turning to the later intellectual history following Sargent, let’s consider his ‘control’ case of Czechoslovakia… also created at the Treaty of [Saint-Germain-en-Laye], but… well-endowed with the most productive territory of the former Austria-Hungary… a perceived victim… never had to pay reparations….

So what’s the harm in Sargent’s paper?… As I see it, two things: 1. The conflation of inflation and hyperinflation. Sargent seeks economic lessons in the cost to output and employment from ending the sort of stagflation that characterized the 1970s in developed economies…. [But] hyperinflation happens because of state collapse or near-collapse. That’s fundamentally different…. 2. More importantly, ‘The Ends of Four Big Inflations’ propagates the myth that monetary policy is easy to get right, once it’s in the hands of a superman central banker whose force of discipline cows disorderly workers into accepting at least a restraint in wage increases…. Thanks to the Maastricht Treaty, [this] is enshrined in the mandate of the European Central Bank, to devastating effect….

When I TAed undergraduate macroeconomics at the University of Chicago, there was a problem set with the following scenario, presented as a factual historical statement: in order to win the 1980 general election, the government of Brazil decided to fool voters into thinking their wages had gone up by printing money at a greater rate. What is the time path of nominal and real wages? Then, in 1985, a new government decided to tame inflation by appointing a central banker from the University of Chicago. What happens to inflation then?

In 1980 (and until the late 80s-early 90s), Brazil was governed by a US-backed military junta. Needless to say, there was no general election in 1980…. If it suffered from high inflation, that wasn’t because its democratically-elected regime was too spineless to give the voters a dose of UChicago patent medicine. Nonetheless, this idea of the craven politicians and the savior economists/central bankers has been a persistent but useful myth. The actual treatment can start with a dose of historical reality.

Marshall’s central points are:

1. Sargent uses a conventional monetarist model–the price level rises with the central bank-determined stock of money–to analyze a situation to which the fiscal theory of the price level–the price level rises until the real value of the government’s debt falls to a level that can be paid by the taxes that can be collected–applies.
2. As a result he mistakes the “régime change” that brought an end to the post-WWI hyperinflation.
3. The key régime change was not the appointment of a tough, independent central banker, but rather the abandonment of the reparations demands that had made the hyperinflationary countries’ public finances unsustainable.
4. Sargent’s paper played a big and destructive role in the development of the Curse of the Eurozone–the cult of the tough, independent, inflation-averse central banker.

I think Marshall’s (1), (2), and (4) are completely correct. But I think that there is more to be said for Tom on (3) than Marshall allows. Yes, you cannot stop hyperinflation until you have changed the fiscal regime so that it is possible to collect enough taxes to amortize the government’s debt at the current price level. But there is nothing that says that the hyperinflation has to stop then. You also need–after the fiscal régime change–a monetary régime change that both (a) steps up the pace of printing money, but (b) removes the ability of the government to finance its ongoing expenditures via seigniorage, and (c) creates a central bank credibly committed to price stability. Hjalmar Horace Greeley Schacht’s and the other stabilizations could not have been accomplished earlier, before the abandonment of largest-scale reparations demands. But they did require a monetary régime change to put into effect after they were possible.

IIRC, Stanley Fischer essentially made Marshall’s criticism of Tom’s paper when it was presented, and Tom wrote a follow-up–“Stopping Moderate Inflation: the Methods of Poincare and Thatcher” contrasting the French cold-turkey régime change stabilization of 1926-1927 with Thatcherite British gradualist monetary growth rules in the 1980s, to the discredit of the latter. IIRC, it was a little too optimistic on how painlessly the French stabilization was accomplished…

…Today the US is not strong enough to lift the rest of the world out of a downturn. But it is robust enough to continue to motor ahead even if Europe and Japan stall…. The stock market boom has helped revive the housing market and pension valuations…. By historic standards, the US equity markets are not yet in bubble territory. US corporate balance sheets are also strong….

Why, then, are so few people popping the champagne? The answer is simple. Most Americans are worse off than they were at the beginning of the 21st century, while the top sliver are dramatically richer…. The US system still has the wherewithal to generate growth…. But it is neither your parents’ recovery, nor your grandparents’. This coming year will be America’s best in a decade. It will nevertheless elude most Americans.

I ought to write a response to the very sharp Bill Gale’s response to my questions in response to hist paper for Brink Lindsey’s Cato Economic Growth Forum:
William Gale:
Response to DeLong on the Fiscal Sitch….

And it would probably be good if I kept it relatively brief.

Given the extraordinary global demand for the debt of the US federal government as a safe and secure store of value in today’s economy, right now the financing of the expenditures of the federal government should be pushed off, as far into the future as intergenerational equity, to allow us to take advantage of this extraordinary sale price on repayment duration that the world economy’s individual rich, public sovereign wealth funds, and central banks seeking dollar reserves are offering us.

Given the extraordinary gap, as evidenced by a remarkably low employment-to-population ratio and remarkably subdued inflation, between America’s current level of production and potential output, right now is the time for the federal government to spend to soak up this output gap–spend on infrastructure, spend on education, spend on research and development, spend on other things that accelerate economic growth, and, to the extent that intergenerational equity allows, on enhancing the societal welfare of America today.

But as long as interest rates and the output gap remain in their current configuration, sober technocratic fiscal policy would involve substantial increases in the debt-to-annual-GDP ratio and then, after the macroeconomic configuration has changed, debt paydown in the form of a gradual return to the normal-time target debt-to-annual-GDP ratio.

What that normal-time target debt-to-annual-GDP ratio will be and what will be the appropriate share of GDP and mix of federal government expenditures once the macroeconomic configuration has changed will be for future voters to choose legislators and president who will then decide. We cannot dictate to them.

What we can do is assume that they will do their job, in which case we should do our job–which the elementary math says would involve federal government spending and deficits considerably larger than those we have today.

Alternatively, we can assume that they will not do their job, in which case we should try to do their jobs for them. We should pass a long-run slowly-increasing carbon tax. We should preserve the health insurance Cadillac tax against attempts to around it. We should pass symmetric standby tax increases and sequesters to force the future to make in a timely fashion the decisions it faces rather than to delay them further. But do we need to cut Medicare’s spending growth path? Not unless we are confident that Medicare expenditures a generation hence will have low benefits at the margin. Do we need to cut Social Security’s spending growth path? Not unless we are confident that Americans in generations hence will have ample retirement security.

As I see it, calls to “first, put our long-run fiscal house in order!” are calls for us to do what we are already doing (preserve the Cadillac tax), to do what we will not do until the Republican Party as we currently know it vanishes from the page of time (carbon tax and symmetric standbys), to do what we should not do (Medicare and Social Security cuts), and not to do what we should be doing–i.e., running higher deficits with more federal government spending until the macroeconomic configuration changes.

554 words

…I want to stay close to the academic literature, at least as a starting point…. Tony should be very worried that one of the supporters of NGDP targets is Michael Woodford, who literally wrote the book on modern monetary theory. He rightly focuses on the big plus for any levels based target, which is that it can mimic the optimal but time-inconsistent policy…. The welfare gains from following the optimal time inconsistent policy are large… so to wave those away as ‘difficult to communicate’ seems–if I may say so–terribly old school central banking…. One final argument Tony uses… is that simple models show that inflation variability is about twenty times more important than output variability in assessing welfare, and therefore NGDP targets give too great a weight to output….

Having said all this, it is great that Tony is opening up the discussion on the correct level, so we can get away from what often seem like faith-based arguments for NGDP targets…. My one last plea is that arguments make clear whether a NGDP targeting regime is being compared to some form of optimal policy, or policy as currently practiced: as I suggest here these are (unfortunately) different things.

…in the modern sticky price macro model that optimal policy involves stabilising a weighted sum of inflation and output… with a weight an order of magnitude greater attached to inflation than other things…. This weight is controversial. Many… would say that they doubt its literal truth…. The main point is that this weight has to come from a grasp of the frictions in the model…. To dig into the intuition… unplanned inflation erodes their real wage or relative price that they would ideally prefer, and, as a result, firms and consumers end up experiencing volatility in the hours that they work, or the amount they have to produce, and therefore volatility in the wages/ profits that they recoup and the amount they can consume…. That said, in a democracy, one can only give so much weight to opinion of a bunch of math-loving technocrats, and, ultimately, policy choices of all kinds, central bank mandates included, have to be anchored to what people want…

Must- and Shall-Reads:

• Leon Nayfak:
  How the elevator transformed America
• Jonathan Portes:
  “Halving the deficit–however measured–was not the [Osborne-Cameron-Clegg] government’s plan; not even close.  Eliminating it… was…”
• Stephany Griffith-Jones:
  “Sir, The headline to Gideon Rachman is unfortunate: ‘Eurozone’s weakest link is the voters’…. If Greek citizens are democratically voting against policies that are seen as failing, the policies need changing…”
• Trevon Logan

1. Michael Joyce et al.:
   The Portfolio Balance Effect of QE:
   “A key transmission mechanism of QE… has been the ‘portfolio balance’ channel…. Insurance companies and pension funds… [in] the UK…. Investors shifted their portfolios away from government bonds towards corporate bonds. But portfolio rebalancing has been limited to corporate bonds and did not extend to equities…”
2. Paul Krugman:
   Recent History in One Chart:
   “A number of people have been putting up candidates for chart of the year. For me, the big chart of 2014 was… from earlier work (pdf) by Branko Milanovic…. It shows income growth since 1988 by percentiles of the world income distribution… the surge by the global elite (the top 0.1, 0.01, etc. would be doing even better than his top 1), plus the dramatic rise of many but not all people in emerging markets. In between is what Branko suggests corresponds to the US lower-middle class, but what I’d say corresponds to advanced-country working classes in general, at least if you add post-2008 data with the effects of austerity. I’d call it the valley of despond…”
3. Dylan Matthews:
   Greg Mankiw’s Worst Argument Against Piketty Yet:
   “Greg Mankiw has been a vocal critic of Thomas Piketty’s Capital in the Twenty-First Century since its release…. He challenges Piketty’s claim that wealth inequality threatens democracy…. ‘A final possibility is that wealth inequality is somehow a threat to democracy. Piketty alludes to this worry throughout his book. I am less concerned. The wealthy includes supporters of both the right (the Koch brothers, Sheldon Adelson) and the left (George Soros, Tom Steyer), and despite high levels of inequality, in 2008 and 2012 the United States managed to elect a left-leaning president committed to increasing taxes on the rich. The fathers of American democracy, including George Washington, Thomas Jefferson, John Adams, and James Madison, were very rich men. With estimated net worth (in today’s dollars) ranging from $20 million to $500 million, they were likely all in the top 0.1 percent of the wealth distribution, demonstrating that the accumulation of capital is perfectly compatible with democratic values. Yet, to the extent that wealth inequality undermines political ideals, reform of the electoral system is a better solution than a growth-depressing tax on capital…’ Contra Mankiw, the Founding Fathers are a vivid illustration of Piketty’s point, not a refutation of it. The United States in the 1780s was controlled by economic elites that were universally white and male and owned considerable capital, much of it… slaves…. The slave-holding class was able to translate its wealth into political influence, enough to maintain the institution for 77 years after the Constitution was ratified… a system that was, by any reasonable definition, not a democracy…. It’d be preposterous to argue that the staggering wealth gap between white men and women and African-Americans played no role in the latter’s systematic exclusion from political life for most of American history. There was enormous wealth inequality, and the result was a massive betrayal of democratic values in favor of an apartheid system. This is exactly the kind of thing Piketty is concerned about.”
4. Ezra Klein:
   In 2014 Obama Picked Getting Things Done Over Fixing US Politics:
   “2014 was the year that Barack Obama saved his presidency by… abandoning… his 2008 campaign. It was the year that he accepted that the only way to bring the policy changes he had promised was to abandon the political ideals that first got him elected…. The 2008 Democratic primary was, as Mark Schmitt wrote, a ‘theory of change’ primary. The different candidates didn’t disagree all that much about what to do. They disagreed about how to get it done. Hillary Clinton’s argument was that she best understood the conflictual nature of American politics: she had fought these battles before and so she was best positioned to win them in the future. Change would come through mastery of the old politics. Obama’s argument was just the opposite: the conflictual nature of politics, he said, was the product of the people who knew no politics other than conflict. He would win the battle by ending it… ending the partisan divisions and moneyed interests that had broken American politics…. Obama pushed more change through the political system than any serious observer expected…. But he didn’t do all this by fixing American politics…. He’s one of the most polarizing presidents since the advent of polling. There isn’t much Obama could have done about this. Party polarization is bigger than any one president. When the Senate Minority Leader says publicly, as Mitch McConnell did, that ‘the single most important thing we want to achieve is for President Obama to be a one-term president,’ then it’s a safe bet that legislative cooperation isn’t forthcoming…”
5. Michael McCarthy:
   The Power of Bad Ideas:
   “The Power of Market Fundamentalism: Karl Polanyi’s Critique
   by Fred Block and Margaret Somers”
6. Dani Rodrik:
   Fundamental Lessons Economists Have Refused to Learn:
   “This is not the first time that developing countries have been hit hard by abrupt mood swings in global financial markets. The surprise is that we are surprised. Economists, in particular, should have learned a few fundamental lessons long ago. First… governments that can intervene massively to restructure and diversify the economy, while preventing the state from becoming a mechanism of corruption and rent-seeking, are the exception. China and (in their heyday) South Korea, Taiwan, Japan, and a few others had such governments; but the rapid industrialization that they engineered has eluded most of Latin America, the Middle East, Africa, and South Asia. Instead, emerging markets’ growth over the last two decades was based on… fortuitous… high commodity prices, low interest rates, and seemingly endless buckets of foreign finance…. Financial globalization has been greatly oversold. Openness to capital flows was supposed to boost domestic investment and reduce macroeconomic volatility. Instead, it has accomplished pretty much the opposite…. Portfolio and short-term inflows fuel consumption booms and real-estate bubbles, with disastrous consequences when market sentiment inevitably sours…. Floating exchange rates are flawed shock absorbers…. Few economies can bear the requisite currency alignments without pain. Sharp currency revaluations wreak havoc on a country’s international competitiveness. And rapid depreciations are a central bank’s nightmare, given the inflationary consequences…. The Fed’s… quantitative easing… benefited the world as a whole by propping up demand and economic activity in the US…. The rest of the world will benefit when Europeans are able to get their policies right…. The rest is in the hands of officials in the developing world. They must resist the temptation to binge on foreign finance when it is cheap and plentiful…. It is true, but unhelpful, to say that governments have only themselves to blame for having recklessly rushed into this wild ride. It is now time to think about how the world can create a saner balance between finance and the real economy.”

Should Be Aware of:

• Monty Python:
  Oscar Wilde
• Dani Rodrik:
  [“Levels of intellectual responsibility in enabling the steady deterioration of the political climate in Turkey over the last decade.”](http://rodrik.typepad.com/danirodriksweblog/2015/01/levels-of-intellectual-responsibility.html

1. Kevin Drum:
   Quote of the Day: Hooray For Nerdy Details!:
   “The problem is that the internet does help people who are ‘sufficiently motivated and clueful,’ but that’s never been a big part of the population. And sadly, the internet is probably as bad or worse than Dr. Oz for all the people who don’t know how to do even basic searches and don’t have either the background or the savvy to distinguish between good advice and hogwash. Regular readers will recognize this as a version of my theory that ‘the internet is now a major driver of the growth of cognitive inequality.’ Or in simpler terms, ‘the internet makes dumb people dumber and smart people smarter.'”
2. The Onion:
   Lovecraftian School Board Member Wants Madness Added To Curriculum:
   “ARKHAM, MA—Arguing that students should return to the fundamentals taught in the Pnakotic Manuscripts and the Necronomicon in order to develop the skills they need to be driven to the very edge of sanity, Arkham school board member Charles West continued to advance his pro-madness agenda at the district’s monthly meeting Tuesday. ‘Fools!’ said West, his clenched fist striking the lectern before him. ‘We must prepare today’s youth for a world whose terrors are etched upon ancient clay tablets recounting the fever-dreams of the other gods—not fill their heads with such trivia as math and English. Our graduates need to know about those who lie beneath the earth, waiting until the stars align so they can return to their rightful place as our masters and wage war against the Elder Things and the shoggoths!’… West’s plan for increased madness… included field trips to the medieval metaphysics department at Miskatonic University, instruction in the incantations of Yog-Sothoth, and a walkathon sponsored by local businesses to raise money for the freshman basketball program…”

Economics professor vs. Social Studies major. The result is as expected:

I would challenge the inclusion of John Adams in the top 0.1%.

And it is remarkable how the African-American population is simply… invisible to Mankiw, is the only thing one can say…