Category: Equitablog

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.

Paul Krugman: Money in a Time of Zero: “People who spend too much time…

…[saying] monetary policy doesn’t matter…. Contractionary monetary policy is working just fine; all the central banks that mistakenly decided that it was time to raise rates… [are now] realizing their error and reversing course. But what about the fact that vast increases in the monetary base have failed to do much to the economy?… The irrelevance of the monetary base is… something that happens when you’re in a liquidity trap…. I get annoyed both by people who declare that nobody could have predicted the failure of balance-sheet expansion to cause inflation, and by those who claim that conventional economists like me just don’t understand that money is endogenous. Guys, I laid it all out 16 years ago. And as for the idea that the absence of a clear definition of money, plus the fact that most money is created by financial institutions, means that central banks don’t matter, James Tobin dealt with all that more than fifty years ago…. If you think something deeply disturbing from an analytical perspective has taken place… you basically weren’t paying attention. If you read your Tobin… [and what] Woodford and I had to say about the liquidity trap, you expected to see exactly what we’re seeing.”

The extremely-sharp Jérémie Cohen-Setton has a roundup:

Jérémie Cohen-Setton: Blogs review: The bond market conundrum redux: “Are we seeing a new version of the Greenspan 2005 conundrum?… Fed tapering was widely expected to push up US yields. Instead, US yields have fallen since the beginning of the year…. A successful explanation of this new conundrum cannot just rely on a flight to safety… it also needs to rationalize why 5-year… and 10-year yield[s] have diverged….

Jeff Sommer… David Beckworth… Marc to Market…. James Hamilton writes that as the U.S. economy returns to healthier growth, many of us expected long-term interest rates to return to more normal historical levels. But the general trend has been down…. In… 2005… Greenspan noted that long-term interest rates [had] trended lower in recent months even as the Federal Reserve [had] raised the level of the target federal funds rate by 150 basis points… [in apparent contradiction] to the expectations theory of interest rates were long rates are the geometric average of expected future short rates plus a risk premium that would usually increase with duration of the instrument….

David Beckworth uses a decomposition of the long term interest rate into an average expected real short-term interest rate, average expected inflation, and a term premium to argue that it’s the term premium has been steadily falling…. James Hamilton writes that… while the… 10-year Treasury has been falling… the 5-year yield has held fairly steady…. Something happened this year to persuade people that rates in the future (for 5 to 10 years from now) were going to be lower than they had been expecting. Robin Harding and Michael Mackenzie write that this is unprecedented…. James Hamilton writes that it’s hard to attribute it to changing perceptions about the Fed…

We are very far away from anything I would like to call “social science” or even “forecasting” here–“haruspicy”, or perhaps “plastromancy” captures it better…

With that caveat, I have been struck for a while by what we see when we break up the 10-Year TIPS rate into its 5-Year TIPS and its 6-10-Year Forward TIPS components:

If you read this graph as showing the expectations of Ms Market over the next five and the subsequent five years, we get the following for the market’s ideas about the real interest rate:

1) Over 2003 to mid-2005, a constant 0-5 year rate and a 6-10 year expected rate+term premium that falls from 3%/year to 2.3%/year, presumably as Ms Market adjusts to the idea that there might actually be a global savings glut and hence a lower Wicksellian real natural interest rate in the long run:

2) Over mid-2005 to 2006, a rise in the 0-5 year rate to 2.3%/year or so and a 6-10 year expected rate+term premium that remains steady, presumably as Ms Market now expects more of a full-employment economy and a stronger demand for funds to finance real investment than had seemed likely before mid-2005:

3) Over 2007 to mid-2010, a constant 6-10 year expected rate+term premium of 2.3%/year (save for the height of the financial crisis itself, with the yield spike from fears of TIP illiquidity). Ms Market appears confident that whatever happens, by 6-10 years out the ocean will be calm and flat again at the global savings glut Wicksellian real natural rate of 2.3%/year. And over 2007 to 2010 we have (a) the steep fall in the 5-Year TIPS yield as Ms Market expects aggressive monetary policy over a five-year horizon, (b) the step rise in the yield as Ms Market thinks something very bad might and then is happening to TIPS liquidity, (c) the return to normal slow-recovery views of the 5-Year TIPS yield like these previously seen over 2003 to mid-2005, and (d) the further collapse of the 5-Year TIPS yield to zero as Ms Market recognizes that this is not your normal slow recovery, that there are few if any of Tim Geithner’s “green shoots”, and that it will be a long slog:

4) Over mid-2010 to mid-2013, the collapse in the 5-Yr TIPS yield to -1.4%/year and the collapse in the 6-10 year expected rate+term premium to 0%/year as Ms Market recognizes that this time–with QE∞, permanent underemployment, and secular stagnation–really is different:

4) In 2013, taper-talk: Bernanke’s announcements interpreted as signaling that the FOMC thinks the question is not whether but when to normalize, and the consequent rapid semi-normalization of the 6-10 year expected rate+term premium and rapid rise of the 5-Year TIPS to near 0%/year:

5) Since late 2013, a belief by Ms Market that the Federal Reserve is still planning to start serious normalization–but with a start date that seems to be pushed out an extra week for every week that passes–coupled with a dawning recognition that we are unlikely to be anywhere close to normal in years 6-10, hence the late-2013 belief that you should bet on the economy being at a semi-normal Wicksellian real natural interest rate in 2020 was probably wrong:

Is there actually an intelligent entity–some kind of distributed anthology intelligence suffering from some sort of aphasia–that we call Ms Market that actually has expectations and whose expectations we can read off of bond yields? And if there is such an entity, is there any reason we should pay any attention to her expectations either as guides to some central tendency of investor sentiment or as forecasts that are in their own right worth incorporating into our own information sets, and hence into our own forecasts? Who knows? I don’t.

What I do know is that if we are willing to divine some market-sentiment-macro-expectations factor out of TIPS and other yields, the past eight months or so have seen Ms Market become much more pessimistic about the state of the real economy and thus of real interest rates six to ten years hence.

The one thing casting doubt on this interpretation is the failure of the 6-10 year inflation break-even to decline. It has been hanging out there at 2.5%/year (with notably rare exceptions) since 2004:

If I were an inflation hawk I would say that right now Ms Market expects us to get the economy in five years to a place where it is then doing its normal thing that it does when we target 2%/year inflation–and that is a powerful sign that our current taper policy is on the right track. But when I look at the sub-zero 5-Year TIP and at the 0.6%/year 6-10 Year TIP I read that as Ms Market decoupling its inflation expectations from its real growth and real interest rate expectations, and not in a good way.

The new bond market conundrum is thus yet another reason for the sun to appear dark in my eyes…

Yi Wen and Maria Arias appear to say that the Federal Reserve has done two independent things since 2008:

1. Increased the stock of money at 33%/year.
2. Pursued an unconventional exceptionally-low interest-rate policy that has reinforced the recession.

The extremely strong implication of their piece is that the Federal Reserve could have (a) kept money growth strong and produced a high money stock while (b) keeping interest rates from falling to the zero lower bound, or, alternatively (a) kept the money growth rate low and produced a relatively small money stock constant while still (b) pursuing an exceptionally-low interest-rate policy.

Can somebody please tell me how the Federal Reserve was supposed to strongly decouple the rate of money growth, the level of the money stock, and the level of interest rates over a period as short as five years? Yes, a period of high money growth is consistent with high interest rates at its end if it is accompanied by even higher inflation that reduces that real money stock. And yes, a period of low money growth is consistent low interest rates at its end if it is accompanied by deflation that raises the real money stock.

But that’s not what they are talking about, is it? What are they talking about?

Yi Wen and Maria A. Arias: What Does Money Velocity Tell Us about Low Inflation in the U.S.?: “The following equation: MV = PQ…. M stands for money. V stands for the velocity of money (or the rate at which people spend money). P stands for the general price level. Q stands for the quantity of goods and services produced. Based on this equation, holding the money velocity constant, if the money supply (M) increases at a faster rate than real economic output (Q), the price level (P) must increase to make up the difference. According to this view, inflation in the U.S. should have been about 31 percent per year between 2008 and 2013, when the money supply grew at an average pace of 33 percent per year and output grew at an average pace just below 2 percent. Why, then, has inflation remained persistently low (below 2 percent)?… The answer lies in the private sector’s dramatic increase in their willingness to hoard money…. And why then would people suddenly decide to hoard money instead of spend it?…. 1. A glooming economy…. 2. The dramatic decrease in interest rates…. The unconventional monetary policy has reinforced the recession… through pursuing an excessively low interest rate policy…

Must- and Shall-Reads:

• Jonathan Chait: Feast of the Wingnuts
• Steven Greenhouse: More Workers Are Claiming ‘Wage Theft’
• Peter Watts: Are We There Yet? En Route to Dystopia with the Angry Optimist

 

1. 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…. 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?… The one percent (or actually the 0.01 percent)… have much more to gain from asset appreciation than they have to lose from the small chance of runaway inflation. In fact, if you compare stock prices in the US, with its aggressively easing Fed, with Europe, you can see the difference…. An alternative is selective historical memory. Some time ago Kevin Drum suggested that it’s all about septaphobia, fear of the 1970s…. Finally, there’s the notion that it’s implicitly about politics: 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. The thing is, it sure looks like a form of false consciousness on the part of elite. But I’m still trying to figure it out.”

2. Bloomberg View: Stopping Europe’s Descent Into Deflation: “Until recently it was debatable whether Europe’s economy was recovering. No longer. Its recovery has stopped. The question now is whether the stagnation will tip over into something worse…. The preliminary estimate of euro-area inflation in August from a year earlier is 0.3 percent…. There’s no growth in the euro area…. What can the ECB do? Draghi says the bank has already acted…. Yet the package of measures the ECB unveiled in June didn’t amount to much…. It’s past time for Draghi to push through those difficulties and test the limits of what politics and the law will allow…. Europe also needs to rethink its fiscal policy…. If Europe’s long recession gets worse, it will be because its leaders saw what was happening yet chose not to act.”

3. Mark Thoma sends us to Justin Fox: What Unions No Longer Do: “Forty years ago, about quarter of American workers belonged to unions, and those unions were a major economic and political force…. This isn’t exactly news… What doesn’t get talked about so much, though, are the consequences…. Jake Rosenfeld,… is out to change that. His book What Unions No Longer Do…. [H]ere, for Labor Day, are the four big things that, according to Rosenfeld, unions in the U.S. no longer do: 1. Unions no longer equalize incomes…. 2. Unions no longer counteract racial inequality…. 3. Unions no longer play a big role in assimilating immigrants…. 4. Unions no longer give lower-income Americans a political voice…. The decline of unions in the U.S. has often been painted as inevitable…. But… that still leaves those tasks unions once accomplished–which on the whole seem like things that are good for society, and good for business–unattended to. Who’s going to do them now?”

4. Free Exchange: Germany’s Hyperinflation-Phobia: “John Maynard Keynes, as early as 1919, recognised the threat inflation posed to modern capitalist societies: ‘Lenin is said to have declared that the best way to destroy the capitalist system was to debauch the currency… [he] was certainly right. There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose.’ The German public, it seems, is particularly fearful of letting inflation getting out of control. This is, in part, due to the legacy of the German hyperinflation of 1922-3…. Present discomfort within Germany with policies designed to reflate the euro-zone economy has been stoked by the assertion of a linkage between hyperinflation and the rise to power of the Nazis…. Yet academics paint a very different picture… than the story… in the German press. The Nazi party did not become a popular political force until long after the hyperinflation period ended. The Nazis only won 32 Reichstag seats in the election of May 1924, and just 12 in 1928. As Paul Krugman has pointed out, ‘the 1923 hyperinflation didn’t bring Hitler to power; it was the Brüning deflation’ of the early-1930s…. The hyperinflation of 1923 created winners and losers among the middle classes…. Middle-class votes subsequently splintered between several different parties…. Yet virtually all classes lost out when Brüning’s government reacted to a projected fiscal deficit and gold outflows in 1930 with deflationary policies…. The experience of deflation made Hitler’s promises to conquer unemployment and stabilise prices by any means necessary attractive to a wide range of groups…. Deflation is now a greater risk than inflation in Europe…. A selective memory of the past may prove worse than no memory at all…. [See:] T. Balderston (2002): Economics and Politics in the Weimar Republic… A. Fergusson (1975): When Money Dies: The Nightmare of the Weimar Hyper-Inflation… J. M. Keynes (1919): The Economic Consequences of the Peace… A. Tooze (2006): *The Wages of Destruction: The Making and Breaking of the Nazi Economy… F. Taylor, (2013): The Downfall of Money: Germany’s Hyperinflation and the Destruction of the Middle Class“

5. Jared Bernstein: On Labor Day, a call for courage: “especially by those of us, and I include myself, who are shy to the point of apologetic about what needs to change, about re-balancing labor’s power with respect to that of capital. That framing itself… has become a ‘no-no’ in polite company… ‘class warfare’… Marxism. Rep. Paul Ryan (R-Wis.) argues that framing the argument this way is akin to ‘preying on the emotions of fear, envy and resentment’ and ‘sowing social unrest’. It’s a fascinating counterattack…. It is not incidental that budgets written by Ryan propose to cut trillions in spending on those in need and trillions in taxes on the wealthy. And to do so at a time when the share of income going to the top 1 percent is twice what it was before inequality began inexorably climbing (households in the top 1 percent now hold 22 percent of the national income compared with 10 percent in 1979). I reject the arguments of those bemoaning class warfare when they themselves are envoys of the winning class…”

6. Morgan Housel: You Are the Problem: “Here’s the truth: The last five years will probably be the best five-year period you’ll ever experience as an investor. The last decade has been average. If you’ve struggled through this period, or keep telling yourself that buy and hold doesn’t work, or that the market is a scam, it’s your own fault. Stocks have done over the last decade what stocks have done for countless decades: offered a pretty decent return with lots of volatility mixed in the middle. The fact that the average investor has been oblivious to this progress shows that the average investor is participating in a game he or she does not understand and doesn’t agree with. That’s unfortunate. But it means there’s a simple answer to all the stories you hear about investors not trusting the market: the market isn’t the problem. You, and your expectations, are the problem. You are your own worst enemy…”

Should Be Aware of:

• Ken Liu: The Litigation Master and the Monkey King

 

1. Sam Youngman: Mitch McConnell’s campaign manager resigns after Iowa bribery scandal deepens “Jesse Benton, the campaign manager for U.S. Senate Minority Leader Mitch McConnell, will resign his post as a bribery scandal from the 2012 presidential campaign threatens to envelop Benton and become a major distraction for McConnell’s campaign…”

2. Stanley Kurtz: How the College Board Politicized U.S. History | John Holbo: American Exceptionalism–A Double-Edged Word: “I’m not surprised some conservatives are upset about the AP American History test. But I am bemused by the strength of the axiom Stanley Kurtz would oblige us to adopt, to keep things from getting politicized: ‘America is freer and more democratic than any other nation’…. This is a comparative thesis about the international order, so it is noteworthy that Kurtz simultaneously forbids the ‘internationalization’ of US history. Comparative ‘transnational narratives’, the only sort of thing that could empirically support the validity of Kurtz’ exceptionalist axiom, are out! But I suppose Kurtz is just trying to avoid confusion. (It is wrong to allow that there could be empirical disconfirmation of any aspect of a result that has been transcendentally deduced from an impulse to amour-propre.)…. What we obviously want is: 3) It makes sense to single out for special study features that make (or seem to make) the US an outlier, among nations, relatively speaking. Culturally, politically, geographically, in terms of not having its industrial base shattered after W.W. II, on and on and on. Studying 3), in a serious way, is incompatible with catechizing students… while depriving them of any comparative basis for judgment…. [This] is only good for doing the one thing Kurtz says he doesn’t want to do: ‘ensure that students think a certain way about contemporary events’…. Kurtz is just kicking up partisan dust, obviously…. While penning the present post, I find this post at Powerline (wow, haven’t visited in years!)…. As G. K. Chesterton remarks: ‘”My country, right or wrong”, is a thing that no patriot would think of saying except in a desperate case. It is like saying, “My mother, drunk or sober”.'” | John Quiggin: “Interestingly, while insistent that the USA is more democratic than any other country, the National Review is also partial to the line that the USA is a republic, not a democracy, which is important when justifying restrictions on the right to vote. As with ‘people’s democratic republics’, the ‘republic’ bit is needed to ensure that a truly democratic government represents the genuine Will of the American People, rather than the transient preference of a mere majority (who might, for example, be Democrats)…”

3. Chico Harlan: America’s coal heartland is in economic freefall–but only the most desperate are fleeing: “For 51 years he’d lived in the same hollow and for two decades he’d performed the same job, mining coal from the underground seams of southern West Virginia. Then, on June 30, Michael Estep was jobless…. What has come since… a job-hunt in a region whose sustaining industry is in an unprecedented freefall…. Miners, modestly educated but accustomed to high pay, are among the hardest group of American workers to retrain. They also tend to challenge one of the tenets of economics logic–that people will go elsewhere to find jobs…. ‘This is where you grew up; you can fish, you can hunt. Land is cheap. Chances are your grandfather owned that property’, said Ted Boettner, executive director of the West Virginia Center on Budget and Policy. ‘So leaving that to go somewhere else where you’ll be stuck in Toledo doesn’t sound very attractive’…. Estep often talks about… the cave-ins he escaped, the safety regulations his bosses never heeded, the neck and back injuries he sustained and never officially claimed, for fear of losing his nonunionized job…”

Bloomberg View: Stopping Europe’s Descent Into Deflation: “Until recently it was debatable…

…whether Europe’s economy was recovering. No longer. Its recovery has stopped. The question now is whether the stagnation will tip over into something worse…. The preliminary estimate of euro-area inflation in August from a year earlier is 0.3 percent…. There’s no growth in the euro area…. What can the ECB do? Draghi says the bank has already acted…. Yet the package of measures the ECB unveiled in June didn’t amount to much…. It’s past time for Draghi to push through those difficulties and test the limits of what politics and the law will allow…. Europe also needs to rethink its fiscal policy…. If Europe’s long recession gets worse, it will be because its leaders saw what was happening yet chose not to act.

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…. 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?… The one percent (or actually the 0.01 percent)… have much more to gain from asset appreciation than they have to lose from the small chance of runaway inflation. In fact, if you compare stock prices in the US, with its aggressively easing Fed, with Europe, you can see the difference…. An alternative is selective historical memory. Some time ago Kevin Drum suggested that it’s all about septaphobia, fear of the 1970s…. Finally, there’s the notion that it’s implicitly about politics: 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. The thing is, it sure looks like a form of false consciousness on the part of elite. But I’m still trying to figure it out.

A Baker’s Dozen of recent keepers:

1. Keystone Fight a Huge Environmentalist Mistake
2. Why I’m So Mean
3. Wasting Away in Hooverville
4. Greg Mankiw Loves One Percent, Doesn’t Know Why
5. Fear of a Female Fed Chief
6. Why Is Obama Caving on Taxes?
7. The Lonely Death of the Republican Health Plan
8. What Caused The Deficit?
9. The Morality Of Political Hostage-Taking
10. Paul Ryan Is Making Things Up Again

And three that require excerpting:

(11) Jonathan Chait: Why Washington Accepts Mass Unemployment: “The recovery looks safe for those of us…

…who are not already screwed. That, sadly, has come to be the primary focus of our economic policy. In the years since the collapse of 2008, the existence of mass unemployment has stopped being something the economic powers that be even pretend to regard as a crisis… viewed… from a perspective of detached complacency….

There are signs we’ve hit bottom. Nothing to worry about here. Why risk the possibility of a small outlay merely to provide relief to hundreds of thousands of desperate people? This is such a perfect statement of the way the American elite has approached the economic crisis. They concede that it is a problem. But there are other problems, you know.

It’s important to respond to arguments on intellectual terms…. Yet it is impossible to understand these positions without putting them in socioeconomic context…. For affluent people, there is essentially no recession…. Unemployment is also unusually low in the Washington, D.C., area….

For millions and millions of Americans, the economic crisis is the worst event of their lives. They have lost jobs, homes, health insurance, opportunities for their children, seen their skills deteriorate, and lost their sense of self-worth. But from the perspective of those in a position to alleviate their suffering, the crisis is merely a sad and distant tragedy.

(12) Jonathan Chait (2013): World’s Wrongest Man Ventures Latest Prediction: “Michael J. Boskin–former George W. Bush economic adviser, Hoover Institute fellow…

…and staunch advocate of conservative anti-tax doctrine appears… to warn that the Democratic president’s economic policies will lead us to misery…. Four years ago, Boskin penned a Journal op-ed whose thesis was captured in the headline, “Obama’s Radicalism Is Killing The Dow”…. His career is a mighty testament to the power of enduring, invincible wrongness. In 1993… Boskin… accused Clinton’s administration of ‘fundamental distrust of free enterprise’… made… predictions:

The new spending programs will grow more than projected, revenue growth will be disappointing, the economy will slow, and the program will reduce the deficit much less than expected.

Boskin repeated his prophecies of doom in a summerlong media blitz… labeled Clinton’s plan ‘clearly contractionary’, insisted the projected revenue would only raise 30 percent as much as forecast by dampening the incentive of the rich, insisted it would ‘take an economy that might have grown at 3 or 4 percent and cause it to grow more slowly’, and insisted anybody who believed in it would ‘Flunk Economics 101’….

Boskin… spotted a brilliant new economic mind in Texas governor George W. Bush:

These people were immensely impressed with him, how quick he was to pick stuff up. His instincts were all very good, very much market-oriented; that created a very, very favorable impression.

Boskin… insist[ed] that George W. Bush’s tax cuts would reduce revenue by far less than the official forecasts predicted…. In addition to being in thrall to a rigid and disproven ideology, Boskin suffers from unbelievably bad timing. Any investors who have actually put real money on the line after listening to him deserve the punishment they’ve received.

(13) Jonathan Chait (2012): Sally Quinn Forced to Dine With Non-Fake Friends: “Pretty much the entire journalistic world…

…has made fun of Sally Quinn’s weekend Washington Post essay declaring the End of Power, further abuse may seem unnecessarily cruel. And yet even the fulsome stream of disparagement… has not adequately conveyed the full…. Her essay broadly belongs to a particular genre that I think of as a cargo cult of bipartisanship focused on dinner parties… she adds her own uniquely mortifying touches. Her mourning of the decline of the Georgetown dinner party sweeps together such disparate trends as the appearance of a Kardashian at the White House Correspondents’ Dinner, Citizens United, hard times at newspapers, and the appearance on the scene of ’25-year-old bloggers’. The result of all these baffling developments is that Quinn now has to have dinner with actual friends….

When assessing Quinn’s sense of the Lost Eden of Washington, we should also have a firmer sense of what the culture was actually like. Here is one scene from Quinn’s inculcation into the Washington elite:

Washington writer Sally Quinn told of a 1950s reception where: ‘My mother and I headed for the buffet table. As we were reaching for the shrimp, both of us jumped and let out a shriek. Senator Strom Thurmond, grinning from ear to ear, had one hand on my behind and the other on my mother’s. As I recall, we were both quite flattered, and thought it terribly funny and wicked of Ol’ Strom’.

Once Washington was a happy place where a girl and her mother could be groped simultaneously in good fun by a white supremacist. Sadly, it has all been ruined by Kim Kardashian and Ezra Klein.