Category: Equitablog

Danny Vinik: Richard Fisher Has Wrongly Warned of Inflation 5 Times Since 2011: “This isn’t the first time Fisher…

…has been at odds with his colleagues. When the Fed undertook ‘Operation Twist’ in 2011, Fisher was one of three members of the Federal Open Market Committee… to dissent. He’s… been the committee’s staunchest inflation hawk… Monday’s… was just the latest of many warnings…. April 8, 2011: ‘Having done our job, I see many risks to the Federal Reserve overstaying its position…’ September 27, 2011: ‘I might conclude by sharing my concerns about the prospect of temporarily allowing more inflation as a means of unlocking expansion in final demand…. [O]nce unleashed, inflation combines with stagnation to make stagflation…’ April 10, 2012: ‘I’m just reporting what I hear on the street, which is a real concern that with our expanded balance sheet, we are just a little bit in an ember of what could become an inflationary fire.’  September 20, 2012: ‘I do not see an overall argument for letting inflation rise to levels where we might scare the market…’ 5. June 4, 2013: ‘I argue that the Fed is, at best, pushing on a string and, at worst, building up kindling for speculation and eventually, a massive shipboard fire of inflation.’ So take Fisher’s predictions with a grain of salt. More than anyone else on the FOMC, he has been wrong about the economic implications of Fed policy…

I have been waiting to post this until now, when there are only twelve months before the end date of my bet with Noah Smith on whether inflation would break 5% over any twelve-month period without a high-pressure labor market. I took the “no”. He took the “yes” and did so, from my perspective, irrationally–he only took 50-1, while he should have demanded odds an order of magnitude greater. That the final twelve-month window of our bet is now running means it is time to set out my thoughts on the trahison des clercs of so much of the academic economics profession over the past seven years.

The way I put it is this: We academic economists knew what to do do deal with the financial crisis that started in 2007 and to quickly restore normal levels of output relative to potential and of potential output growth. It was (a) not to do what Japan did in the 1990s, and (b) take the advice of a long line of policy-oriented economists starting from the Say-Malthus debate of the 1810s and 1820s (which Malthus won) and continuing through Mill, Bagehot, Wicksell, Keynes, Minsky, Kindleberger, Tobin, and many many others about what caused and how to deal with a “general glut”. But even though we knew what to do, we were not allowed to speak with one voice. Other academic economists–including many whom I formerly counted as of note and reputation–elbowed their way into the debate. They had either never bothered to learn the literature from Malthus to Tobin, had forgotten it, or were blinded by ideology. They reached for simplistic models and methods that were clearly wrong: (a) a crude quantity theory by which spending was proportional to the money stock and deviations of velocity from its technological trend were temporary–neglecting what John Hicks wrote in 1937 that “on pure value theory the sacrifice… [of] holding… money is a sacrifice of interest, and it is hard to believe the marginal principal does not hold”–(b) an even cruder fiscal theory of the price level, (c) a crude Lafferism by which very small changes in net-of-tax rates were supposed to have effects on potential output two orders of magnitude larger than anything in the literature, (d) an even cruder belief that operating business confidence was the key variable in the business cycle and depended on little other than confidence in balanced-budgets, or (e) the Method of Colonel Kurtz–that is, the only rational response is that of Captain Willard: “I don’t see any method at all, sir.”

• The Bet
• Before
• The Situation, Even Today
• Current Examples of Unwarranted Inflation Fear: Semi-Rational
• Current Examples of Unwarranted Inflation Fear: Unhinged
• Current Examples of Unwarranted Inflation Fear: “Balanced”
• Three Examples
• Conclusion

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First, an item of business:

I hereby announce that I wish to change the terms of my bet with Noah Smith on U.S. inflation, and whether the U.S. is at immediate risk of becoming “Argentina”:

“IF at any time between 7/28/2012 and 7/28/2015 core consumer prices, as recorded in the FRED database series CPILFESL, are up more than 5% in the preceding 12 months, and if over the same 1-year period monthly U3 unemployment (as recorded in FRED database series UNRATE) has not averaged below 6%…

…THEN Brad DeLong agrees to buy Noah Smith one dinner at Zachary’s Pizza at 1853 Solano Ave. in Berkeley CA, and to pay Noah 49 times the cost–including tax but excluding tip–of Noah’s meal at Zachary’s in Federal Reserve notes, or in alternative means of payment accepted by Zachary’s should Zachary’s Pizza no longer be accepting Federal Reserve notes at the date of the dinner. This cost will be assessed as the total cost of the dinner to all, divided by the number of people present, regardless of how much pizza is consumed by or how much alcohol is drunk by specific individuals. If however, the above condition is not satisfied, Noah agrees to buy Brad one dinner at Zachary’s.

Miles Kimball will be the judge in charge of refereeing the bet. The decisions of the judge will be final and unappealable.

Furthermore, Noah’s brave and gracious willingness to take the John Cochrane-Argentina side of this bet at odds of only 50-1 will not be construed as a statement of his confidence in or of his support for any economist or position of economic analysis that judges expansionary fiscal policy at the zero lower nominal interest rate bound to be “insane”, or that judges “1932” to currently be a less dire risk for the U.S. than “Argentina”.

The Zachary’s Pizza on College makes better pizza than the Zachary’s Pizza on Solano. I do note that the last twelve-month period in which Noah Smith might possibly win his pizza bet starts now. And I do note that his bet was irrational–that in my view producing an inflation rate more than 5%/year by 2015 without a high-pressure economy would have most likely required a supply shock twice as big as those of 1973 and 1979, and the odds against such a thing were not 50-1 but considerably greater.

This is of interest to me because I now have the prospect of free pizza and good dinner-time company in a little more than a year.

I have written about this before:

• Noah Smith Bravely Takes the Cochrane-Argentina Side of the Bet That the U.S. Is at Risk of Becoming “Argentina”

As has Noah:

• Noah Smith: Dinner at Zachary’s

This is of interest to you because there are still, even now, even after seven years of this, a lot of people out there who think the big danger facing the U.S. economy is not the Lost Decade (or more) that we are now 70% of the way through, but rather a sudden outbreak of inflation.

Now let me next set out what a rational analysis of our situation would be.

Walras’s Law tells us that expenditure has to be equal to income: people take the resources they have–including what they have socked into their mattresses–plus their income and have to do something with it–either socking it away in the mattress or using it to buy or to keep holding something. Thus you can only have a general glut–an excess supply of currently-produced goods and services, high unemployment, idle factories that are cost-effective in normal times, etc.–if there is an excess demand for something else. And your general glut can only be persistent if there is something that keeps the price of that “something else” wedged–that keeps the price of what is in excess demand from rising fast quickly relative to the prices of other commodities and so quickly ironing-out the excess demand and the general glut of currently-produced goods and services that is its Walras’s Law counterpart. Conversely, you only get rising inflation–the opposite of a general glut of currently produced goods and services–(a) when inflation expectations become de-anchored and rising inflation is a self-fulfilling prophecy, (b) when some adverse supply shock reduces potential output substantially or some sharp capacity constraint stops actual output growth, or (c) when there is an excess supply of something else. And in both cases the “something else” is some set of financial assets, invariably or almost invariably including as its main or one of its main components the liquid money stocks that greases the economy.

The Malthus-Tobin line of analysis thus has been asking always–especially over the past seven years–two questions:

1. Where is there the potential for an excess demand for financial assets whose prices can wedge themselves and fail to adjust and so cause a general glut?
2. Where is there the potential for rising inflation–either in deanchored expectations, sharp capacity constraints, or an excess supply of financial assets whose prices can wedge themselves and fail to adjust and so cause too much money to chase too few goods?

The answer to (1) is and has been obvious. The collapse of the housing bubble in an environment of gross overleverage produced (a) a collapse in risk-tolerance and thus a great increase in the desire to hold safe assets, (b) an enormous reduction in the supply of assets seen as safe, (c) a wedged price of safe assets produced by their inability to go to more than par–the zero lower bound on safe short-term nominal interest rates, you know–and thus (d) a general glut.

The answer to (2) also is and has been obvious. Nowhere. Inflation expectations are well-anchored. There are no signs of supply shocks or of hitting capacity constraints in natural resources, in industrial capacity, or in labor markets. And there is no sign that the Federal Reserve intends to or might accidentally or would even tolerate any pegging of any possible market rate of interest below the natural Wicksellian rate and so creating an excess supply of finance.

And yet I still hear–over and over again, from place after place, as I have heard every single year since 2007–that the Federal Reserve is dangerously behind the curve and that an outburst of inflation is in our future. The method is, variously:

1. The crude quantity theory that looks at the very large money stock, and claims that must be an excess supply–without bothering to look at what is going on in the rest of asset markets that boosts and is expected to boost demand for the large money stock that the Federal Reserve has reluctantly supplied.
2. The even cruder fiscal theory of the price level by which the real debt capacity of reserve currency-issuing sovereigns is tightly limited–a point of view that fails to acknowledge the extraordinary exorbitant privilege that reserve currency-issuing sovereigns have.
3. An even cruder Lafferism by which very small changes in net-of-tax rates are supposed to have effects on potential output two orders of magnitude larger than anything in the literature.
4. An even cruder confidence–without any evidence whatseover– that business confidence is about to collapse and de-anchor inflation expectations.
5. But usually the method of Colonel Kurtz (in the movie, not the book): that is, no method at all.

Here are three of the less irrational examples:

From the Cato Institute–of which I used to expect better:

Gerald P. O’Driscoll: Where’s the Inflation? Coming to Your Neighborhood: “In December 2008, the Federal Reserve drove down the overnight federal funds rate to near zero. In March 2009, it announced an aggressive program to purchase mortgage backed securities… successive rounds of monetary easing… unprecedented in size and scope. Economists have been predicting an outbreak of inflation. Were they wrong? Critics say the absence of inflation proves the doomsday forecasts were wrong. Some critics, like Paul Krugman, argue even more monetary stimulus is needed….

Prices are rising faster than the CPI suggests…. The process of reserve creation should in normal times have led to rapid growth in money, and then price inflation. Based on history and theory, the predictions were sound. The deleveraging process put a spanner in the works of money creation…. There has been money growth. The 12-month growth rate as of April 2013 for M1… was about 12%; the 12-month growth rate for M2… was 7%…. And there has been price inflation, here and around the world….

CPI (or alternate measures of consumer prices) have not been accurate gauges of monetary stimulus for decades…. In an inflationary episode, prices of goods often increase sequentially, and not in tandem…. Home prices are once again on an upward march, and we will see whether the Fed is helping inflate another housing bubble…. Bond prices are a bubble from any historical perspective. I leave it to the readers to exercise their own judgments on equity prices…. Monetary expansion has effects beyond domestic consumer prices. There is no presumption that an expansionary monetary policy affects consumer goods prices first. Inflation is already here, and more is coming to your neighborhood soon. If the past is prologue, the Fed will wait too long to react to inflation.

From Peter Schiff, of whom I never expected better:

Peter Schiff: Yellen: Where No Man Has Gone Before: Janet Yellen… is very different from any of her predecessors… the most dovish and politically leftist Fed Chair in the Central Bank’s history…. She does not seem to see the Fed’s mission as primarily to maintain the value of the dollar, promote stable financial markets, or to fight inflation. Rather she sees it as a tool to promote progressive social policy and to essentially pick up where formal Federal social programs leave off…. [Yellen] likely has a greater understanding of how the Fed’s monetization of government debt (through Quantitative Easing) has prevented the government from having to raise taxes sharply or cut the programs she believes are so vital to economic health. But as these policies have also been responsible for pushing up prices for basic necessities such as food, energy, and shelter, these “victories” come at a heavy cost. Recent data shows that consumers are paying more for the things they need and spending less on the things they want. But Yellen simply brushes off this evidence as temporary noise….

If Yellen and her dovish colleagues do not receive the kind of open-ended international support that we have enjoyed thus far in 2014, the full inflationary pain of her policies will fall heaviest on those residents of Main Street for whom she has expressed such deep concern…

From Larry Kudlow:

Larry Kudlow: Fed’s Talk Of Low-Flation Is Dangerous Nonsense: If today’s 1 percent inflation rate continued for 25 years, you’d have a 28 percent inflationary hike. But if you move to a 2 percent yearly inflation rate, which is what some Fed people seem to be targeting, wage earners and all the rest of us would experience a 64.1 percent compounded, cumulative inflation rise over 25 years. At 2.5 percent inflation, which is what some other Fed folks are saying, we would experience an 85.4 percent inflation gain over the next quarter century.

Is that what we really want? Is the central bank willing to take that risk? Don’t they know that historically a little more inflation turns into a lot more inflation, which then goes out of control?… Janet Yellen is using the wrong model…. Forward-looking market-price signals, such as gold, commodities, the Treasury yield curve, and the dollar exchange rate are recently showing a tiny bit of inflation risk, but not very much. These are the indicators the Fed should watch–not the unemployment rate or a basket of other labor indicators…. And while we’re at it, let’s keep the dollar sound. In fact, I’d like to see King Dollar appreciate by 10 to 15 percent…. Get rid of QE3, move to the 1.5 percent Taylor rule fed funds rate, and institute pro-growth economic reforms. This policy package will keep inflation low and drive economic growth higher. It worked in the ’80s and ’90s. But it’s been forgotten in recent years…

Plus, of course, there are the unhinged howlings from the Fever Swamp:

Newsweek:

Niall Ferguson: The Great Inflation of the 2010s: ‘I can’t eat an iPad.’ This could go down in history as the line that launched the great inflation of the 2010s…. William Dudley, was trying to explain to the citizens of Queens, N.Y., why they had no cause to worry about inflation. Dudle… put it this way: ‘Today you can buy an iPad 2 that costs the same as an iPad 1 that is twice as powerful. You have to look at the prices of all things.’ Quick as a flash came a voice from the audience: ‘I can’t eat an iPad.’… The Fed… points to the all-urban consumer price index (CPI-U)…. To ordinary Americans, however, it’s not the online price of an iPad that matters; it’s prices of food on the shelf and gasoline at the pump…. The CPI is losing credibility… as economist John Williams tirelessly points out, it’s a bogus index…. Double-digit inflation is back. Pretty soon you’ll be able to figure out the real inflation rate just by moving the decimal point in the core CPI one place to the right…. Maybe high fuel prices will, as Goldman Sachs predicts, slow the economy and revive the specter of deflation. Maybe. Or maybe inflation expectations started shifting when the guy from Goldman—a Marie Antoinette for our times—seemed to say: let them eat iPads!

Red State:

Erick Erickson: The Real World and the Chart: Paul Krugman wishes to disprove something I wrote the other day…. Krugman uses a chart to try to disprove the reality that Americans with small kids actually experience at the grocery store. It’s written like a man who does not have kids at home…. If he hung around moms and dads with kids more often he’d hear a lot more real world complaining about the cost of bread, milk, and other grocery item prices going up while paychecks are staying the same…. It is an ongoing issue and has been since late in the Bush Presidency when these conversations became more routine at the playground and around the dinner table with friends. Not everything is academic or chartable and sometimes the accuracy of the chart isn’t as real to people as the perception they have that their grocery store bills are getting more expensive though their shopping habits haven’t changed. That’s the point, Paul, but I appreciate the charts. Next time another parent brings this up, I’ll be sure to pass along the chart and tell them to look at that, not their grocery bill…

National Review:

Amity Shlaes: Inflation Vacation: There’s one nuisance that can interrupt your seven-day idyll… the price zap…. Your daughter wants a haircut… $45…. What? A haircut used to be $20…. A gallon of gas is $4.00, when it was $1.30 back in 2000. You expected gas to be high. But not this high…. The ticket is $10.00, not $5.00, like it was when you went to see Gladiator back in 2000…. Coffee. A pound is $5.20, not $3.40…. Your pay certainly hasn’t doubled since 2000, like the price of the movie ticket….

All the official numbers, especially the Consumer Price Index, say that inflation is reasonable…. Janet Yellen, the new Fed chairman, says she’s not worried. Maybe she will have a good vacation. But other numbers suggest that inflation is higher than what the official data suggest…. John Williams[‘s] contention is that several alterations in the way we measure inflation have caused distortion…. Which takes us back to Rick Santelli. What Santelli is really talking about is getting the Fed back to a point where it cares about inflation. If you study the… video, where the CNBC host gets bullied into silence by Steve Liesman, you’ll see the problem. The price today for talking about inflation is itself too high. Santelli doesn’t really need a vacation, but he sure deserves one. Then he and maybe some others can return to argue again. It’s time for a real debate on inflation to commence…

The American Thinker:

Rich Danker: Janet Yellen and the Phillips Curve: Janet Yellen, a disciple of predictive modeling, dismisses the notion that the Fed could go too far. To her the record shows that ‘tuning works even if it is not “fine”‘… the belief that economic policymaking is the practice of top-down management of the economy, informed by the assumed tradeoff between inflation and unemployment. It isn’t just the 1970s, but the last few years, that show how money creation does not produce permanent employment gains. This was raised time and time again at Yellen’s recent Senate Banking Committee hearing, when several Democrats bemoaned the absence of any “trickle down” effect from quantitative easing. Do we want the Fed to double-down on that folly with Janet Yellen at the helm?…

The Federalist:

Sean Davis: American Families Are Right To Be Worried About Inflation: The subtext to all of the inflation critiques from the likes of Perry, Pethokoukis, and Ponnuru is that we should leave the Federal Reserve alone. Stop blaming the Fed for inflation, you guys. Please ignore that QE, QE2, QE3, and a multi-year zero interest rate policy, etc. were all intentionally designed to increase inflation, you guys. Just ignore all the different goods for which prices are rising really rapidly, you guys. Ignore the fact that higher prices and middling wages are eroding standards of living, you guys…

And, of course, ZeroHedge:

ZeroHedge: The Fed Just Lost Any Shred of Credibility on Inflation: [Janet yellen] has got to be the most dovish Fed chairperson in the history of the institution going into the most important policy initiative withdrawal phase ever to be recorded since the inception of the Federal Reserve! She will probably step down in a year at this rate, as she obviously was the wrong person for the job!… We are now going to have to resurrect Paul Volcker`s spirit to the Federal Reserve to dig us out this hyperinflation mess, once inflation I mean Noise gets so unbearable that Janet Yellen is forced to embarrassingly resign by the president as the bond market takes matters into its own hands!…

Janet Yellen and the Federal Reserve are so behind the inflation curve, and many other market implication curves, that we probably are staring at a 35% chance of a Hyper-Inflationary period by the time the Federal Reserve realizes that Noise is actually real inflation! The surprising thing is that she backed herself into a corner on the data, and I expect the inflation and employment data to keep coming in much hotter and well ahead of the Feds own forecasts, and she didnt even leave herself any real wiggle room. With each new data point she and the Fed are going to look increasingly out of touch and well behind the curve that it is going to be shockingly laughable. If the sky is cloudy gray, and you keep saying that the sky is clear blue, people are going to stop listening to what you have to say…. The loss of credibility is by far worse than the actual policy decisions at this point, and after listening to Janet Yellen`s press conference, I am not sure she is a rational, logical, empirical thinking human being with her ridiculous comments regarding the stock market and inflation as she seems borderline senescent and incapable at best, and there is no doubt she is completely over her head at the Fed in this powerful position. I cannot wait to hear the Fed minutes of this latest Fed Meeting!

There is no hope for an elegant exit now from this monetary experiment, inflation will be at 4.5% before they even start raising rates! The bond market will be so far ahead of the Federal Reserve in terms of bond vigilantism that they are what will bring the Fed to finally realize that they have lost control of financial markets, and then it is endgame for interest rates! Once the bond vigilantes take control of markets because they have no faith in the Federal Reserve, it is time to seriously reevaluate what the makeup and role the Federal Reserve should play in future monetary decisions going forward!…

And this infects those who seek above all to be very very “balanced”. Three examples:

Bloomberg News:

Yuval Rosenberg: The Metaphor That Dramatically Captures Janet Yellen’s Interest Rate Dilemma: “Janet Yellen… remains very much in the hot seat. As the Fed winds down its bond-buying stimulus program… and with inflation edging higher…. Yellen, in her testimony, burnished her dovish credentials by suggesting the Fed still has more work to do before it turns to tightening…. Critics worried about the those risks and the disruptive market effects of the Fed’s ultra-low interest rates, including some of Yellen’s fellow Federal Reserve officials, have been arguing that the Fed should act sooner…. Otherwise, the Fed could be inflating bubbles that could threaten to again destroy… economic stability and improvement…

Dallas Federal Reserve Bank President Richard Fisher:

Richard Fisher: Monetary Policy and the Maginot Line: Given the rapidly improving employment picture, developments on the inflationary front, and my own background as a banker and investment and hedge fund manager, I am finding myself increasingly at odds with some of my respected colleagues…. The Fed as the nation’s monetary authority has been running a hyper-accommodative monetary policy… [boosting] the Fed’s balance sheet to $4.5 trillion… 75 percent of Federal Reserve-held loans and securities have remaining maturities in excess of five years, and we own roughly 40 percent of the stock of U.S. Treasury bonds and a similar proportion of MBS. This is an unprecedented profile…. To get a sense of some of the effects of excess liquidity, you need look no further than Neil Irwin’s front-page, above-the-fold article in the July 8 issue of the New York Times, titled “From Stocks to Farmland, All’s Booming, or Bubbling.” “Welcome to … the Everything Bubble,” it reads. “Around the world, nearly every asset class is expensive by historical standards. Stocks and bonds; emerging markets and advanced economies; urban office towers and Iowa farmland; you name it, and it is trading at prices that are high by historical standards relative to fundamentals.”…

There are some who believe that “macroprudential supervision” will safeguard us from financial instability. I am more skeptical…. There is a legitimate question as to whether these safeguards represent no more than a financial Maginot Line, providing us with an artificial sense of confidence…. One has to consider the root cause of the “Everything Boom.” I believe the root cause is the hyper-accommodative monetary policy of the Federal Reserve and other central banks…. At some point you cross the line from reviving markets to becoming the bellows fanning the flames of the “Booming and Bubbling” that Neil Irwin writes about. I believe we have crossed that line. I believe we need an adjustment to the stance of monetary policy…. My sense is that ending our large-scale asset purchases this fall, however, will not be enough…. A bourbon addict doesn’t go from Wild Turkey to cold turkey overnight…. I believe the time to dilute the punch is close upon us…

The National Journal:

Michael Hirsh: How Janet Yellen’s Agenda Could Transform Washington: Janet Yellen… [is] the product of an old progressive tradition of activist, pro-government economics… represents a strain of interventionist thinking that has not found expression at such a high level in Washington in decades–at least since Ronald Reagan and his Milton Friedman-inspired attempt to shrink the size of government…. Yellen already appears to be settling the Fed’s eternal debate about the relative threats of unemployment and inflation; she declared bluntly in her testimony that joblessness is the issue of the moment….

Already she is describing the central bank’s job in ways that have stunned some traditional Fed watchers—and made them uneasy. Yellen’s very first statement after Obama nominated her in October suggested she intends to extend Bernanke’s revolutionary expansion of the Fed’s role, not ratchet it back. “While we have made progress, we have further to go,” she said, adding that the Fed’s job was not just to keep the dollar sound but “to serve all the American people … [and] ensure that everyone has the ability to work hard and build a better life.” The statement, which indicated that Yellen is focused on boosting employment, “knocked me over. It was a political statement which fits perfectly with her [academic] upbringing,” says David Jones, a veteran Fed analyst and the author of the forthcoming book Understanding Central Banking: The New Era of Activism.…

By her own account, Yellen represents the government-activist “Yale School” of economics, which believes that there are “clear answers to key questions dividing macroeconomists, along with policy prescriptions,” as she put it in a 1999 speech at Yale. “Will capitalist economies operate at full employment in the absence of routine intervention? Certainly not. Are deviations from full employment a social problem? Obviously.” She is, more than previous Fed chiefs, an old-style “hydraulic Keynesian” who believes she can act as a control engineer over the economy…

The net result of all of this is our economic policy discussion is much more focused than it should be on avoiding inflation dangerous that simply do not threaten, and much less focused than it should be on further policies to boost aggregate demand; to recoup some of the enormous investment gap in private business, government infrastructure, and human capital investment that has emerged; and to unwedge asset markets that are still profoundly dysfunctional both in mobilizing society’s enormous potential tolerance for holding diversified risky investments and improperly classifying, diversifying, and managing risks in order to restore credit access to all those now rationed out of the capital markets who should not be. And one cause of this is the trahison des clercs we saw–from people who really should have known better.

Let me give three examples from the truly remarkable and extraordinary day-long conference that Sebastian Mallaby put together in March of 2009. All three of these economists should, I think, really not have said what they said. And all three, I think, owe us an intelligible explanation of just what they were thinking and why–and why they were so wrong. And while it is always possible that I have missed it, none of the three has offered any intelligible admission of error, explanation of their thinking, or–and here I am aware that I am asking too much–any marking of their beliefs to market.

We heard from Robert Lucas:

Robert Lucas: Why a Second Look Matters: “I’ve been going to all the sessions…

…and it’s a great conference.  My head’s spinning.  Some of you will probably hear some of your best lines in my talk, for that matter…. One of the lessons of the Great Depression… is that a side effect of depression is a proliferation of ill-conceived, hastily put together policies that serve to postpone the recovery. By 1940, seven years after the 1933 trough, the U.S. economy still had not gotten back to 10 percent below trend….

The more urgent task of organizing our thinking about what, if anything, should be done right now to deal with the recession.  So I’m going to… just think about the basic arithmetic of what we might call–and this is a–the due irony–‘monetarist fine tuning.’…  

When it began [in 1930], it was a reduction in velocity, a ‘flight to cash’…. Now, the Fed could have responded to that situation by… creating the reserves… to supply the added liquidity…. But the Fed didn’t do anything to relieve this liquidity. They sat by. And they cut interest rates to zero. They were, I guess, the believers that… once interest rates get to zero, you’re over….

Now, the additional reserves the Fed has put into the system have induced double-digit growth in M1 and M2 domain monetary aggregates. And these are rates which, I think if they were sustained, would soon yield inflation at 1970s levels or higher.  And, moreover, as confidence returns, which it will, velocity is going to return to pre-crisis levels and people are going to start spending more out of their cash balances.  So, inflation’s going to–that too is going to add to the inflationary pressures. So, it’s absolutely necessary for the Fed to be able and willing to reverse course and sell off the assets…. I don’t see any reason to start cutting back now…. But, it’s something you might as well think about it because we’re going to get there….

We had some lively sessions this morning about fiscal stimulus.  Now, would a fiscal stimulus somehow get us out of this bind, or add another weapon that would help in this problem?… I just don’t see this at all. If the government builds a bridge, and then the Fed prints up some money to pay the bridge builders, that’s just a monetary policy. We don’t need the bridge to do that. We can print up the same amount of money and buy anything with it.  So, the only part of the stimulus package that’s stimulating is the monetary part….

But if we do build the bridge by taking tax money away from somebody else, and using that to pay the bridge builder–the guys who work on the bridge–then it’s just a wash.  It has no first-starter effect.  There’s no reason to expect any stimulation.  And, in some sense, there’s nothing to apply a multiplier to.  (Laughs.) You apply a multiplier to the bridge builders, then you’ve got to apply the same multiplier with a minus sign to the people you taxed to build the bridge. And then taxing them later isn’t going to help, we know that….

Christina Romer–here’s what I think happened. It’s her first day on the job and somebody says, you’ve got to come up with a solution to this–in defense of this fiscal stimulus, which no one told her what it was going to be, and have it by Monday morning.

So she scrambled and came up with these multipliers and now they’re kind of–I don’t know. So I don’t think anyone really believes. These models have never been discussed or debated in a way that that say–Ellen McGrattan was talking about the way economists use models this morning. These are kind of schlock economics…

We heard from Ed Prescott:

Ed Prescott: The 1920s: Bubble, Growth, or Gold?: “The period of the ’20s was one of healthy growth…

…until Hoover’s anti-market, anti-globalization, anti-immigration, pro- cartelization policies were instituted, brought this expansion to an end, and created a great depression.  Roosevelt’s policies prolonged the Depression for over six additional years….

What about the great U.S. depression?  Well, you can depress an economy two ways. You can depress productivity–output per hour–or you can depress the number of hours worked per working-age person. The big thing in the Depression was not the productivity. Productivity was quite healthy. Growth was healthy during that decade…. High tax rates were not the problem in the ’30s.  We looked at that, and that’s only a small part.  Has to be something else. What’s that something else?  There’s really only one candidate that I know of that is consistent and–theoretically and empirically, and that is the Cole and Ohanian cartelization policies. I emphasize lack of government spending was not the reason for the big fall in employment. But the economy only recovered and it started recovering in 1939, when there’s a major shift in policies. That was the year when Roosevelt said the New Deal is dead. That was the year he called up the businessmen who had fled to England because–and said please come back; we got to get ready for war. It was not expenditures….

What about my predictions for the United States now? Last–the growth from 2007 to 2008, fourth quarter over fourth quarter, was 1 percent. In the Great Depression we had about four years where the growth rates were minus 5 or 6 or 7 percent. This is plus 1.  It would have been normal year if it was not for that fourth quarter…. I do predict the U.S. will lose a decade of growth…. Why?  Marginal tax rates will be increased. The productivity–depressing policies will be adopted in this country. A lot of people don’t know the current administration has abandoned the use of cost-benefit analysis by rescinding the 1981 executive order requiring all regulations to be evaluated before being implemented…

John Cochrane:

John Cochrane: The New Financial Deal: “The danger now is inflation…

…And I would say it’s a greater danger than most of the other people have said.  Our danger now is a run on Treasury debt.  It’s not just can the Fed soak this stuff back up again, but can it soak this enormous amount of debt back up again when people don’t want either money or Treasury bills or anything labeled ‘U.S. Government.’ The danger is not 1932; the danger is Argentina, a massive run from Treasury debt.  And then monetary policy will not be able to do anything. You can fool around with interest rates all you want.  When people don’t want Treasury bills or money you’re stuck.

Banks…. Unfortunately, I think we’re in the danger of fighting the last war here.  Bernanke has said, no large bank or financial institution will fail. We’re in the business of an astonishing bailout and credit guarantee, unimagined by the Great Depression…. Now, nobody in the Great Depression–we don’t–some of our essential problems we don’t have a historical antecedent for.  Nobody was fooling enough to think that toxic assets were the problem or that the government, by somehow stirring up the liquidity of $10 trillion of toxic assets, was going to make the banks look all right again.  This is an amazing fairy tale we’ve been telling ourselves for eight months now.  Think of every step of the chain. Stirring the pot is going to make everything more valuable. Making everything more valuable is going to make the banks look solvent again. Making the banks look solvent again means people are going to start buying bank stocks. Banks are just dying to go and lend if only they had more equity–it’s not just going to happen.  Well, that one we’re inventing on our own….

There’s almost no economics that describes how the Federal Reserve, by monkeying around with three months of Treasury bills and reserves, can lower long-term interest rates, but absolutely no economics that says how the Federal Reserve is in charge of the risk premium, and that’s what was going on. People were willing to hold mortgages, stocks, risky bonds at amazingly low premiums on the way up and now they want very high premiums on the way down.  That’s not something the Federal Reserve is in charge of….

General–well, a last couple of general comments.  Many things are depressingly the same.  Policy is chaotic.  Who would invest in this climate? It’s not about toxic assets; it’s about who wants to go in on a deal with Darth Vadar, who can change his mind at any moment? That’s the uncertainty that’s keeping things from getting going and that’s what’s slowing the rebuilding of financial markets. We’re facing growth-destroying marginal tax rates, an excuse for the government takeover of large and completely unrelated sectors, class warfare, vindictive ex post taxations. This is the chance for a credit crunch–which normally resolves itself fairly quickly–to turn into a Great Depression. 

And perhaps most of all there is the danger of learning the wrong lessons; that our grandchildren will have to come back to the next meeting to say, what were the lessons–the lessons mis-learned of the last time around?

My great hope is that the bounce-back will be quick before the quack medicine can be said to have worked. (Chuckles.) Just as we sort of–as people think that this insane idea of fiscal stimulus–which I’ll go on with later if I get a chance–came from Roosevelt’s experience with no reason why it should work, there is a danger of thinking all of the crazy stuff they’re doing now will have caused the bounce-back, if that happens, in five years, but my only hope is that it happens quickly and doesn’t leave us with another Great Depression…

And do note that these three are not unrepresentative. As just one of many additional examples, consider also the usually sharp-witted Martin Feldstein writing in April 2009:

Martin Feldstein: Inflation is looming on America’s horizon: The unprecedented explosion of the US fiscal deficit raises the spectre of high future inflation…. There is ample historic evidence of the link between fiscal profligacy and subsequent inflation. But historic evidence and economic analysis also show that the inflationary effects can be avoided if the fiscal deficits are not accompanied by a sustained increase in the money supply and, more generally, by an easing of monetary conditions…. The potential inflationary danger is that the large US fiscal deficit will lead to an increase in the supply of money…. Now the large US fiscal deficits are being accompanied by rapid increases in the money supply and by even more ominous increases in commercial bank reserves….

The link between fiscal deficits and money growth is about to be exacerbated by ‘quantitative easing’…. This… cannot be distinguished from a policy of directly monetising some of the government’s newly created debt…. The Fed is also creating a massive increase in liquidity by its policy of supplying credit directly to private borrowers…. When the economy begins to recover, the Fed will have to reduce the excessive stock of money…. This will not be an easy task…. It is surprising that the long-term interest rates do not yet reflect the resulting risk of future inflation…

I found–I still find–this last particularly surprising, because it was Marty who back in the spring of 2009’s instantiation of Econ 2010c taught me to read very carefully James Tobin on asset demand, and how asset markets could become truly pathological at very low interest rates.

Still, only last month:

Martin Feldstein:* Warning: Inflation Is Running Above 2%: Inflation is rising in the United States and could become a serious problem sooner than the Federal Reserve and many others now recognize. There are three basic reasons why the Fed is too optimistic…. First, data indicate that prices are already rising faster than 2% and have accelerated in recent months. Second, the low rate of short-term unemployment may be creating pressure for faster inflation…. And third, the rhetoric of Fed officials indicates that the central bank may not react quickly and aggressively enough if inflation continues to rise above 2%….

Recent price increases may be a temporary surge that will recede in the months ahead. But they could be a response to increased demand…. Although the level of real GDP fell from the fourth quarter of 2013 to the first quarter of 2014, in the most recent three months real consumer spending rose at a 4% annual rate.

Will unemployment limit wage inflation?…. Because the long-term unemployed are less connected with the active job market, they may provide less downward pressure on wage inflation…. Is the Krueger research an accurate warning that labor markets are now closer to the threshold at which inflation begins to rise despite the substantial total number of people who aren’t working? By the time we do know if he’s right, it may be much more difficult to contain inflationary pressures.

More generally, Federal Reserve officials have made statements that suggest the Fed may not act quickly and strongly enough to limit a rising rate of inflation. Mr. Dudley expressed a common Fed opinion when he said recently that he believes the federal funds rate will rise relatively slowly…. A misinterpretation of labor-market slack, and a failure to create a positive real federal-funds rate, could put the economy on a path of rapidly rising inflation.

As I understand–and everybody else I talk to here at Berkeley at least understands–William Dudley, his belief that the federal funds rate will rise relatively slowly is conditional on inflation behaving according to the Federal Reserve’s forecast and remaining low. I do not think you can or you should take a statement about what the Federal Reserve expects that it will do if inflation remains low as a guide to what the Federal Reserve would do if inflation were to leap upward.

The issue of how much “hysteresis” there is in the economy–of how much damage to potential output growth has been done by the Lesser Depression–is a serious and important and terrifying one. But why should inflationary pressures be hard to contain? It is no longer the 1970s, and the Federal Reserve chair is no longer an Arthur Burns fearful that the Congress Will take his independence away if he raises interest rates too far too fast.

Over the past four quarters nominal Gross Domestic Product has risen at a rate of 2.9%/year and nominal Gross Domestic Income has risen at a rate of 2.6%/year. Over the past six months, real consumer spending has increased at a rate of only 0.7%/year. And over the past twelve months, real consumer spending has increased at a rate of only 1.9%/year. I am just not seeing this as any sign of an inordinate rate of increase in spending on currently-produced goods and services.

I look at this whole michegas, and I cannot but be bewildered at the origins, the strength, and the persistence of what I can only regard as an ordinary intellectual deformation. It astonishes, Confounds, and confuses me.

Oh well. At least I get to eat a free pizza dinner in a year. What wine should we bring in in a brown bag to drink at Zachary’s? And who else should we invite to share the pizza?

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7472 words

I have said this before. But I seem to need to say it again…

The very intelligent and thoughtful David Beckworth, Simon Wren-Lewis, and Nick Rowe are agreeing on New Keynesian-Market Monetarist monetary-fiscal convergence. Underpinning all of their analyses there seems to me to be the assumption that all aggregate demand shortfalls spring from the same deep market failures. And I think that that is wrong.

Simon Wren-Lewis writes:

I really like David Beckworth’s Insurance proposal against ‘incompetent’ monetary policy. Here it is: 1) Target the level of nominal GDP (NGDP). 2) “The Fed and Treasury… agree… should a liquidity trap emerge anyhow… quickly work together to implement a helicopter drop….” Market Monetarists and New Keynesians [do not] suddenly agree about everything… for David this is an insurance against incompetence by the central bank, whereas Keynesians… view hitting the ZLB as unavoidable if the shock is big enough. However this difference is not critical…

And Nick Rowe concludes:

How much money should the central bank print and buy things with? As much as is necessary to hit the NGDP target. And if it runs out of… government bonds [to buy]… it should buy newly-produced things…. What particular things should be bought and held on the asset side of the consolidated balance sheet of the government plus central bank? That is a micro public finance question. What particular things should be held on the unconsolidated central bank’s balance sheet rather than on the government’s balance sheet? That is a public choice question…. I don’t think there’s anything left to argue about. Except a lot of micro public finance and public choice stuff.

But I’m sure we will think of something.

I, however, find myself unsatisfied with this convergence. Finally summarize it, it seems to go like this: In a depression in which the problem is that not enough stuff is being bought, (i) the central bank should buy bonds for cash in order to put more cash in people’s pockets so that they will buy more stuff, and (ii) if that doesn’t work–if for some reason people still don’t buy enough stuff even though the Federal Reserve has driven interest rates to zero–the central bank should print money and give it away so that people will buy more stuff, and (iii) if that doesn’t work, the central bank and government should jointly print money and buy more stuff.

This seems to me to be largely unexceptionable. But I think it misses a couple of subtleties. And I think these subtleties are important because they undermine the lexicographic preference for (1) open-market operations, (2) helicopter drops, and (3) fiscal expansion in that order that is at the base of this Oxford-Bowling Green-Ottawa compact. I suspect that the reason that Simon, David, and Nick are able to reach agreement is that they do not foreground the issues that I learned when Olivier Blanchard forced me to study that key paper of the greatest of University of Chicago macroeconomists, [“Wealth, Saving, and the Rate of Interest” by Lloyd Metzler][4].

Whether you want to use fiscal or monetary (or banking!) policy to fix the depression depends critically on why not enough stuff is being bought–on where the market failure is.

1. The problem could be Monetarist. If the problem is a scarcity of liquid cash money (with associated sticky-price and nominal-debt-contract market failures, so that dropping the price level to instantaneously raise real money balances to their first-best level just isn’t a good option), then, yes, conventional open-market operations can do the job–but whether you want to use monetary or fiscal policy hinges on what you want the post-depression real interest rate to be.

2. The problem could be Keynesian. If the problem is a scarcity of savings vehicles for transferring purchasing power from the present into the future (with the same associated sticky-price and nominal-debt-contract market failures)–a shortage of money-plus-bonds–then conventional open-market operations will not do the job: they get you to the zero lower bound, and once there your swapping of cash for bonds has no effect on anything. What you need to do is either (a) increase the supply of bonds by summoning the Confidence Fairy and getting private entrepreneurs to issue more bonds as they borrow-and-spend, (b) decrease demand for bonds by summoning the Inflation Expectations Imp and thus imposing a tax on nominal assets, or (c) increase the supply of bonds directly by having the government buy stuff. And there are a host of issues as to which is the best to do.

3. The problem could be Minskyite. If the underlying market failure is that the credit channel has broken down, so that savers do not trust the securities that financial intermediaries originate to be of the safety that they seek, then there are definite drawbacks to summoning the Inflation Expectations Imp or indeed to keeping interest rates low: the economy then winds up with an incentive to produce too many long-duration assets and to invest too little in risky projects. A better solution is to have the government bear risk. And the best solution is to restore the credit channel.

So let us start with Metzler’s basic model: three commodities and two prices, one of them sticky;

• Commodity: liquid cash money M–in order to create the trust that you need to transact.
• Commodity: bonds B–savings vehicles for transferring purchasing power from the present into the future.
• Commodity: currently-produced goods and services Y.
• Price: the sticky price of currently-produced goods and services in terms of money P.
• Price: the interest rate i, the inverse of the price of nominal bonds in terms of money.

A Monetarist depression is then when there is not enough money M in the system. The interest rate i is then high–the price of bonds is low because the marginal utility of holding the scarce money is high–and is high enough to equalize supply and demand for bonds at that i. But because P is sticky, there is an excess demand for money and so, by Walras’s Law, an excess supply of currently-produced goods and services.

You can fix a Monetarist depression by having the central bank buy bonds for cash until the stock of money M is high enough to balance supply and demand. But is that what you want to do? You could also (a) summon the Confidence Fairy and so get private businesses to issue more bonds, (b) summon the Inflation Expectations Imp and so reduce demand for both money M and bonds B relative to currently-produced goods and services, or (c) have the government issue more bonds. Such expansions of B would drive the interest rate i up further, and with enough bonds the interest rate would be high enough that the sticky value of P would also be the Walrasian equilibrium value of P, and there would be neither excess demand nor excess supply for money M or for currently-produced goods and services Y.

In order to decide whether you want to fix a depression characterized by a high interest rate i on bonds via monetary expansion or fiscal expansion (or by summoning the Confidence Fairy and getting a private investment boom going), you need a way to rank full-employment equilibria. What share of production on currently-produced goods and services Y should take the form of government purchases G? What cost should we put on businesses undertaking private capital formation I via the value of the interest rate i? Robert Solow’s chapter for the 1962 Economic Report of the President argued, I think wisely, for easy money and tight fiscal policy–that there was no obvious reason for an anti-depression policy to have the side effect of reducing the post-depression capital stock below what it would otherwise be. But it is possible to imagine situations in which the Wicksellian natural rate of interest consistent with full employment when the government’s budget is balanced is below the proper social rate of time preference, and induces private investments that do not cover their properly-measured social costs. It’s not a slam dunk.

A Keynesian depression is then when there is not enough money plus bonds M+B in the system, when businesses are not confident enough to undertake enough investment projects to back enough bonds to meet private-saver demand for savings vehicles. Because bonds are scarce people bid their price up to par, and bid the interest rate i down to zero. And there the price of bonds becomes sticky too–it cannot go any higher, and money and bonds become perfect substitutes, and open market operations do nothing because they simply swap a zero-interest asset for another. Then there is an excess demand for the aggregate that is money-plus-bonds M+B, and an excess supply for currently-produced goods and services Y.

Since open-market operations no longer do anything, policies are down to:

• (a) summon the Confidence Fairy and so get private businesses to issue more bonds.
• (b) summon the Inflation Expectations Imp.
• (c) have the government issue more bonds.

Summoning the Confidence Fairy to get private businesses to print up more bonds and so increase the supply of M+B will work, as long as you can actually summon spirits from the vasty deep. Raise M+B enough, and there will be no excess demand for M+B at the sticky price P, and so no excess supply of currently-produced goods and services. Raise B even more and i will start to rise and the infinite elasticity of demand between B and M will break.

Summoning the Inflation Expectations Imp to reduce the demand for the money-and-bonds aggregate M+B will also work–once again, as long as you can actually summon spirits from the vasty deep.

Having the government issue more bonds, however, works directly on the supply of the aggregate M+B.

Which is preferable? Well, how good are your spirit-summoning skills? What are the costs of accumulating government debt? What are the costs of raising the inflation target if you can summon the Inflation Expectations Imp?

We have by now a number of balls in the air: a (sticky) price of currently-produced goods and services in terms of money P, an expected rate of inflation π, a degree of business confidence, an interest rate on bonds, a supply of money M, a supply of bonds B, and a division of the bond supply between bonds that fund private investment and government debt. And there is a shadowy concept of the “first best”–of what the full-employment economy ought to look like in terms of the proper incentive to invest, the proper supply of liquidity services, and the proper inflation target.

But we have still more: we have a Minskyite depression, in which on top of our other market failures–our sticky-wages and our nominal-debt contracts that make deflation impossible or unwise, and our zero lower bound that makes the price of bonds become sticky too–we also have a collapse of the credit channel, an inability of financial intermediaries to do the risk transformation and so turn claims on the risky investment projects that make up the private capital stock into bonds of a high-enough quality for private savers to want to hold. We now have a fourth commodity: in addition to money M, (safe) bonds B, and currently-produced goods and services Y, we now have junk bonds J. Now our economy gets wedged with an interest rate i=0 at the zero lower bound and a price level P such that there is an excess demand for the perfect-substitutability aggregate M+B, with a high interest rate j on the junk J, and by Walras’s Law with an excess supply of currently-produced goods and services Y.

Now our admissible policies are:

• (b) summon the Inflation Expectations Imp.
• (c) have the government issue more (safe) bonds.
• (d) summon a different Confidence Fairy and restore saver confidence in the ability of financial intermediaries to properly do the risk transformation and originate not junk J but safe bonds B.
• (e) reform and recapitalize the financial intermediaries so that they can in fact do the risk transformation and originate not junk J but safe bonds B.
• (f) use the government as a loan guarantor and use its own (or, rather, the taxpayers’) risk-bearing capacity to do the risk transformation.

And what about (a), summoning the (business) Confidence Fairy? It is not a solution: getting businesses to issue more debt does not help matters as long as financial intermediaries are unable to sell it as safe bonds B rather than junk J.

Now note that our first-best has required an additional dimension. We had been thinking about the proper incentive to invest, the proper supply of liquidity services, and the proper inflation target. Now we are thinking about the proper inflation target the proper supply of liquidity services, the proper real societal rate of time preference (the interest rate on safe bonds), and the proper risk spread between safe bonds and junk.

And if the root market failure is the collapse of the credit channel–a greatly enhanced spread between B and J, or, indeed, credit rationing–that (b)-(d) no longer look as attractive. When the problem is an inability of financial intermediaries to do the risk transformation, restoring full employment by reducing the real rate of time preference on safe bonds (which is what (b) does) provides the economy with too-great an incentive to produce long-duration assets. Having the government issue more (safe) debt (c) produces an economy with too much current government spending on social welfare or on infrastructure and too little on risky private investment projects. And (d) restoring saver confidence in financial intermediaries is not a good thing unless savers should in fact have confidence in financial intermediaries.

There is a very large number of different positions you can take on what set of macroeconomic policies will get the economy closest to its first-best when it is subject to what kinds of shocks–Monetarist shocks to liquidity demand and supply, Keynesian shocks to business investment committee animal spirits, or Minkyite shocks to the ability of financial intermediaries to do the risk transformation. And to sideline them–as Nick Rowe does–as “micro public finance and public choice stuff” seems to me to overlook several large elephants that are not just in the room but on the couch and pressing the remote…

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[4]: “http://delong.typepad.com/1825743.pdf” title=”1825743.pdf (Lloyd Metzler (1951): “Wealth, Saving, and the Rate of Interest”, Journal of Political Economy 59:2 (April), pp. 93-116. Cf. also James Tobin, passim.)

Gabriel Chodorow-Reich: Financial stability and monetary policy: “In the winter of 2008, the Federal Reserve…

…began an unprecedented campaign to combat the economic downturn…. A near zero federal funds rate, explicit communication regarding the forward path of the funds rate, and a balance sheet that ballooned to more than $4 trillion as of this writing. With memories of the 2008-09 financial crisis still fresh, the policies have prompted concern for their effect on financial stability…. The policies pursued by the Federal Reserve since late 2008 have… [had a] cumulative effect on life insurance companies appears to have been stabilising, as the benefit to legacy asset values and demand for new products outweighed any reaching for yield. While some money market funds did engage in reaching for yield in 2009-11, the compression in spreads in recent months has sharply limited the scope for such behaviour…. Financial-stability concerns for monetary policy should not stem from concerns about the riskiness of these sectors.

Fabian Pfeffer et al.: Wealth Levels, Wealth Inequality, and the Great Recession: 

Simon Wren-Lewis: Synthesis!? David Beckworth’s Insurance Policy: “I really like David Beckworth’s insurance proposal…

…against ‘incompetent’ monetary policy. Here it is…. 1) Target the level of nominal GDP (NGDP). 2) ‘The Fed and Treasury sign an agreement that should a liquidity trap emerge… they would then quickly work together to implement a helicopter drop. The Fed would provide the funding and the Treasury Department would provide the logistical support to deliver the funds to households. Once NGDP returned to its targeted path the helicopter drop would end and the Fed would implement policy using normal open market operations. If the public understood this plan, it would further stabilize NGDP expectations and make it unlikely a helicopter drop would ever be needed.’… Jonathan Portes and I proposed something very like it…. Now this does not mean that Market Monetarists and New Keynesians suddenly agree about everything…. For David this is an insurance against incompetence by the central bank, whereas Keynesians are as likely to view hitting the ZLB as unavoidable if the shock is big enough. However this difference is not critical…

Should-Reads:

1. Emmanuel Saez: Optimal Income Transfer Programs: Intensive versus Extensive Labor Supply Responses: “When behavioral responses are concentrated along the intensive margin, the optimal transfer program is a classical Negative Income Tax program with a substantial guaranteed income support and a large phasing-out tax rate. However, when behavioral responses are concentrated along the extensive margin, the optimal transfer program is similar to the Earned Income Tax Credit with negative marginal tax rates at low income levels and a small guaranteed income. Carefully calibrated numerical simulations are provided…” Via Owen Zidar

2. David Beckworth: A Surprising Look Back at the Fed’s QE Programs: “If anything… QE programs raised long-term financing costs for the government. One way to explain this outcome is that the QE programs actually raised expected economic growth and that pushed up treasury yields…. It is as if the term premium needed QE to stay propped up. Here is one possible explanation. The QE programs increased the economic outlook and that, in turn, reduced the risk premium on other assets. Investors, therefore, were more willing to hold other higher-yielding assets and this meant they had to be compensated more to hold the low-yielding treasuries…. By failing to restore full employment to the economy, the Fed has allowed risk premiums to stay elevated and interest rates on safe assets to stay depressed…. Now one could conclude from this that the QE programs did not make that much difference. I disagree. The evidence above suggest the Fed at least put a floor under long-term interest rates (and by implication a floor under the economy) with its QE programs…. So goodbye QE. It was good knowing you…”

3. Adair Turner: High tide for house prices is engulfing our economy: “A beach hut in Dorset is on sale for £250,000. The UK’s housing obsession is as great as ever…. In France, housing wealth grew from 120 per cent of national income in 1970 to 371 per cent in 2010. More than half of Canada’s wealth and all of the increase in its wealth-to-income ratio is explained by property prices…. Further technological progress, in particular in IT and telecoms, will continue to drive down the price of many goods and services. But paradoxically, an increasingly high-tech economy will be one in which the relative value of the oldest and most physical thing of all–land–will probably rise. Expectations of rising prices generate responses that make economies less stable…. Property will inevitably play a more important role in economies as incomes grow. We need to manage the consequences–and there is no silver bullet…. If the fundamental problem is that desirable property is scarce, the obvious answer is to lift planning constraints and build more houses. But more construction is no panacea: Ireland’s relaxed planning rules did not prevent a devastating property boom and bust. And the motivations that drive increased competition for desirable locations also produce strong opposition to unrestricted development…. Transport and environmental policies that enable people to live in more densely populated areas without jeopardising their quality of life could be as important to financial stability as bank capital requirements…”

4. Scott Sumner: Jonathan Gruber on federal exchanges and subsidies: “Several commenters pointed to a statement made by Jonathan Gruber in 2012…. ‘What’s important to remember politically about this is if you’re a state and you don’t set up an exchange, that means your citizens don’t get their tax credits — but your citizens still pay the taxes that support this bill. So you’re essentially saying [to] your citizens you’re going to pay all the taxes to help all the other states in the country. I hope that that’s a blatant enough political reality that states will get their act together and realize there are billions of dollars at stake here in setting up these exchanges.’… The quote was taken out of context, and that the comments immediately preceding the quote tells a very different story: ‘Yes, so these health insurance exchanges… will be these new shopping places and they’ll be the place that people go to get their subsidies for health insurance. In the law it says if the states don’t provide them the federal backstop will. The federal government has been sort of slow in putting up its backstop in part because I think they want to sort of squeeze the states to do it.’ That seems to imply the federal backstops would provide health subsidies. So how can we reconcile these two statements? I believe Gruber was trying to say that the federal government was being slow in setting up the exchanges, because until they did so, those states without state exchanges would get no subsidy. Once the federal exchanges were set up, they would all get the subsidy. What I don’t understand is why commenters were providing me with the quote on top, but not the second quote, which provides important context…”

And:

• Robert Rubin: How ignoring climate change could sink the U.S. economy
• Nick Rowe: Three growth stages of the New Keynesian model
• Ladonna Pavetti: Ryan’s Rhetoric Doesn’t Match His Proposal’s Reality
• Carter C. Price and Ben Zipperer: Designing a research agenda to move the minimum wage forward
• Mark Zastrow: Satellites reveal swift groundwater loss in western United States
• Jose Antonio Ocampo: The IMF’s Special Drawing Rights as a global reserve currency
• Christine Monahan: Halbig v. Sebelius and State Motivations to Opt for Federally Run Exchanges

Should Be Aware of:

1. Ed Kilgore: The Two Paul Ryans: “Ezra… probably feels he’s providing an incentive for the Good Ryan to subdue the Bad Ryan once and for all, and even hints that the Bad Ryan’s work was mainly a product of the days when deficits and debt were taken more seriously by everybody. But… there is a very long history of ‘reform-minded’ Republicans talking big and expressing compassion about poverty, and then screwing the poor the first opportunity they get…. It’s going to take a lot more than a ‘poverty plan’ to make me treat the Ryan Budget as anything less than his central enduring legacy…”

2. Norman Ornstein: The Existential Battle for the Soul of the GOP: “What began as a ruthlessly pragmatic, take-no-prisoners parliamentary style opposition to Obama was linked to constant efforts to delegitimize his presidency, first by saying he was not born in the U.S., then by calling him a tyrant trying to turn the country into a Socialist or Communist paradise. These efforts were not condemned vigorously by party leaders in and out of office, but were instead deflected or encouraged, helping to create a monster: a large, vigorous radical movement that now has large numbers of adherents and true believers in office and in state party leadership…. A Rasmussen survey shows that 23 percent of Americans still believe Obama is not an American, while an additional 17 percent are not sure. Forty percent of Americans! This is no longer a fringe view. As for the radicals in elected office or in control of party organs, consider a small sampling of comments: ‘Sex that doesn’t produce people is deviate.’–Montana state Rep. Dave Hagstrom. ‘It is not our job to see that anyone gets an education.’–Oklahoma state Rep. Mike Reynolds. ‘I hear you loud and clear, Barack Obama. You don’t represent the country that I grew up with. And your values is not going to save us. We’re going to take this country back for the Lord. We’re going to try to take this country back for conservatism. And we’re not going to allow minorities to run roughshod over what you people believe in!’–Arkansas state Sen. Jason Rapert…. ‘I don’t want to get into the debate about climate change. But I’ll simply point out that I think in academia we all agree that the temperature on Mars is exactly as it is here. Nobody will dispute that. Yet there are no coal mines on Mars. There’s no factories on Mars that I’m aware of.’–Kentucky state Sen. Brandon Smith…. ‘Although Islam had a religious component, it is much more than a simple religious ideology. It is a complete geo-political structure and, as such, does not deserve First Amendment protections.’–Georgia congressional candidate Jody Hice…. ‘God’s word is true. I’ve come to understand that. All that stuff I was taught about evolution and embryology and the big-bang theory, all that is lies straight from the pit of hell. It’s lies to try to keep me and all the folks who were taught that from understanding that they need a savior.’–U.S. Rep. (and M.D.) Paul Broun of Georgia. ‘Now I don’t assert where he [Obama] was born, I will just tell you that we are all certain that he was not raised with an American experience. So these things that beat in our hearts when we hear the National Anthem and when we say the Pledge of Allegiance doesn’t beat the same for him.’–U.S. Rep. Steve King of Iowa…. One might argue that these quotes are highly selective—-but they are only a tiny sampling…. Importantly, almost none were countered by party officials or legislative leaders, nor were the individuals quoted reprimanded in any way. What used to be widely seen as loony is now broadly accepted or tolerated…”

Already-Noted Must-Reads:

1. Matt Bruenig: How Reform Conservatives Like Reihan Salam and Paul Ryan Misunderstand Poverty: “Oh boy. Reihan Salam has a piece riddled with confusions, some conceptual, some technical, and some just downright strange…. Poverty measurement that also includes tax credits (like the EITC) and non-cash benefits (like SNAP) called the Supplemental Poverty Metric… the only thing that has reduced poverty since 1967 is non-market benefits. That’s it. Those advocating non-market benefits to cut poverty are not the crazy ones. Those thinking the market will do it are…. Let’s just make some things clear…. Market income is not distributed according to desert (i.e. each get what they produce). Nobody produces nature, yet its massive marginal productivity flows to random private owners…. The majority of the national output each year is attributable to inherited technology and knowledge (aka TFP) that nobody alive produced…. Nobody is economically independent from the government…. If you want to make people’s flow of material resources independent of the government, you must repeal property law first and foremost, the biggest government welfare program in history…. More disposable income doesn’t solve all of the problems in the society, but it does solve the problem of inadequate diposable income…”

2. Barry Eichengreen: The ECB Tries Again: “In June the European Central Bank announced a series of new steps to counter deflation…. Rather than bemoaning the failure of President Draghi & Co. to move earlier, it is more productive at this stage to ask: are the central bank’s measures now up to the task?… The ECB’s conventional measures, reducing its benchmark interest rate from 0.25 to 0.15 per cent and charging commercial banks 0.1 per cent on the money they deposit with the central bank, will make little difference…. Conventional monetary policy has run its course…. Thus, if policy is going to make a difference, policy will have to be unconventional. Here the ECB unveiled… one and a half… initiatives in June… ‘Targeted Long-Term Refinancing Operation’… €400 billion, or some US$550 billion, cumulatively over four months. Recall that the Federal Reserve, under QE3, had been injecting $85 billion a month into U.S. financial markets before starting to taper in December. This makes TLTRO look like a substantial commitment…. The additional ‘half an initiative’ announced in June was that the ECB would study the possibility of security purchases…. These cautions should not be taken as a council of despair. If ECB officials conclude that the impact of TLTRO and securities purchase will be marginal, they should not give up hope; rather, they should strive to do more…”

3. Barry Ritholtz: Cognitive Dissonance: “Of all of the failings of human wetware, the one I find most intriguing is cognitive dissonance… [which] occurs in the mind of an individual when a theoretical belief system is confronted by factual evidence demonstrating outcomes contrary to what theories dictate should occur. Stated more plainly, when facts conflict with beliefs people find ways to ignore those facts, rationalizing them in a way that allows the disproven ideas to survive. John Kenneth Galbraith famously referenced cognitive dissonance before it was even called that, stating: ‘Faced with the choice between changing one’s mind and proving that there is no need to do so, almost everyone gets busy on the proof’….
    
   “Examples are many and varied…. Radical deregulation resulting in bad outcomes rather than the free market nirvana its believers espoused; Austrian economists warning of imminent hyperinflation and the collapse of the fiat dollar that never arrives. Rather than question the theory, the person suffering from cognitive dissonance ignores the facts in front of their very eyes and instead devises rationales for why any specific expected outcome never occurred. The blame is laid elsewhere…. It wasn’t the wildly irresponsible behavior of non-bank lenders and junk mortgages securitized and rated AAA that caused the problems. Rather, it had to be something else, and if we can find a government entity to blame, so much the better…. There is a fine line between having confidence in your methodologies and living in your own private fantasy world. Like it or not, this is the human condition. Recognizing it at least gives us a chance to avoid getting caught in its pernicious grasp…”

4. Ricardo Hausmann: The Real Raw Material of Wealth: “Poor countries export… materials such as cocoa, iron ore, and raw diamonds…. Rich countries export–often to those same poor countries… chocolate, cars, and jewels…. Some ideas are worse than wrong: they are castrating, because they interpret the world in a way that emphasizes secondary issues–say, the availability of raw materials–and blinds societies to the more promising opportunities that may lie elsewhere…. Consider Finland…. A classical economist would argue that, given this, the country should export wood… a traditional development economist would argue that it should… add value by transforming the wood into paper or furniture…. But wood opened up a different and much richer path to development. As the Finns were chopping wood, their axes and saws would become dull and break down, and they would have to be repaired or replaced. This eventually led them to become good at producing machines that chop and cut wood…. From here, they went into other automated machines…”

Ricardo Hausmann: The Real Raw Material of Wealth: “Poor countries export… materials such as cocoa, iron ore, and raw diamonds…

…Rich countries export–often to those same poor countries… chocolate, cars, and jewels…. Some ideas are worse than wrong: they are castrating, because they interpret the world in a way that emphasizes secondary issues–say, the availability of raw materials–and blinds societies to the more promising opportunities that may lie elsewhere…. Consider Finland…. A classical economist would argue that, given this, the country should export wood… a traditional development economist would argue that it should… add value by transforming the wood into paper or furniture…. But wood opened up a different and much richer path to development. As the Finns were chopping wood, their axes and saws would become dull and break down, and they would have to be repaired or replaced. This eventually led them to become good at producing machines that chop and cut wood…. From here, they went into other automated machines…

Karl Polanyi, Classical Liberalism, and the Varieties of “Neoliberalism”: Virtual Office Hours:

Karl Polanyi’s The Great Transformation is certainly the right place to start in thinking about “neoliberalism” and its global spread. But you are right to notice and do need to keep thinking that Polanyi is talking about pre-World War II classical liberalism, and that modern post-1980 neoliberalism is somewhat different.

First, as I, at least, see it, there are three strands of thought that together make up the current of ideas and policies that people call “neoliberalism”:

1. The revived and restored classical liberals, via the Mont Pelerin society and so forth—-and they do indeed have an attachment to the gold standard.

2. The Milton Friedman neoliberals—-who believe that the gold standard was a disaster and the government needed to guarantee full employment (and low inflation) via activist monetary policy. But, they go on, attempts by the government to do more than simply maintain full employment and price stability would inevitably come to grief. Government policies would be turned to enrich the politically powerful rather than to enhance social welfare, and so almost always do more harm than good. (Why he thought that activist monetary policy was different—-why Milton Friedman believed government could be successful there while it could not be successful anywhere else—-was never something that he could explain very well.)

3. The Washington Monthly neoliberals, who argued that 1945-1980 had demonstrated that central planning of all kinds had grave deficiencies, and the governments that wanted to achieve social democratic ends were more often than not better off doing so through market means and market incentives than with bureaucracy.

There are also differences with respect to the value put on democracy and liberty. The classical liberals wanted limited and representative government, which is a very different thing than modern political democracy, and were as likely or not to approve of traditional deference traditional social authority structures. Washington Monthly neoliberals are social liberals, and are democrats first and neoliberals second. Milton Friedman neoliberals tend to be true libertarians–social liberals–and want democracy constrained to preserve both social and economic liberties. Mont Pelerin neoliberals tend to be social conservatives, and to at least play with endorsing fascist and authoritarian dictators like Mussolini and Pinochet.

Of these three currents the second was, I think, always the most powerful. But the other two have not been negligible in the mix. And there has been a tendency as people age for people in the second camp to slide into the first and people in the third camp to slide into the second.

To those of us so eat, breathe, sleep, and live this stuff every day, the differences between these three currents seem large. To others the differences may seem much smaller.

I have always thought of myself as a Washington Monthly neoliberal, and I am trying to resist the transformation into a Milton Friedman neoliberal. That still seems to me to be wrong: it seems to me that a government that is corrupt and incompetent at running and urban water system will be even more corrupt and incompetent at conducting a privatization auction. But I do recognize that there are deep issues of political economy and of governmental confidence that us Washington monthly neoliberals have tended to avoid thinking about.

Second, the baseline against which various forms of market liberalism is reacting are very different. This was brought home to me a couple of days ago when I was rereading George Dangerfield’s excellent The Strange Death of Liberal England about British politics on the eve of World War I, where Dangerfield writes about the anti-classical liberal and social democratic politician David Lloyd-George. To quote Dangerfield:

Lloyd George… one July evening in 1909… went down to Limehouse… a packed and partisan audience of East End cockneys…. England has scarcely known a greater demagogue than this pre-war Lloyd-George…. Without the magic of face and voice to support them, his speeches are not likely to survive; and one can only imagine the effect of this, the most famous passage in that famous Limehouse speech:

I was telling you I went down a coal-mine the other day. We sank into a pit half a mile deep. We then walked underneath the mountain, and we did about three quarters of a mile with rock and shale above us. The earth seemed to be straining–around us and above us–to crush us in. You could see the pit props bent and twisted and sundered until you saw their fibers split in resisting the pressure. Sometimes they give way and then there is mutilation and death. Often a spark ignites, the whole pit is deluged in fire, and the breath of life is scorched out of hundreds of breasts by the consuming flame. In the very next colliery to the one I descended, just a few years ago three hundred people lost their lives that way.

And yet when the Prime Minister and I knock at the door of these great landlords and say to them—-’Here, you know these poor fellows who have been digging up royalties at the risk of their lives, some of them are old, they have survived the perils of their trade, they are broken, they can earn no more. Won’t you give them something [Page 23] towards keeping them out of the workhouse?’—-they scowl at us and we say—’Only a ha’penny, just a copper.’ They say, ‘You thieves!’ And they turn their dogs on to us, and you can hear their bark every morning….

Lloyd George was having the time of his life. He kept his audience howling with alternate rage and laughter; moment by moment, sentence by sentence, he assaulted the landlords, and outraged the gentry, and invited the dispossessed, and cozened the dissatisfied; he shouted and implored and wheedled and mimicked. It was a great performance.

And yet this spirited voice was not quite the voice of revolution–though thus it sounded in the anxious imagination of the Conservative press…. It was also Liberalism’s extravagant last will and testament. All it really said was this–that the rich, who are beginning to get too much in their own hands, have got to pay… his revolutionary language [was] nothing more than the language of super-taxes and old age pensions.

But in the meantime, the speech had done its work. If their lordships had been violent about the Budget before, they were twice as violent now. Mr. Lloyd-George redoubled his efforts… and up and down the country certain noblemen emerged from the rustic obscurity to which history had consigned them and began to trade public insults with their persecutor…

That was class war!

Or was it?

As Dangerfield points out, while the Tory squires and the titled members of the House of Lords in 1909 heard David Lloyd-George and thought “REVOLUTION!!”, the policies of the so-called People’s Budget of 1909 involved less income-tax progressivity (“supertaxes”) and less social insurance (“old age pensions”) than even the old Paul Ryan budget. And now even Paul Ryan has begun talking about how he wants to expand the EITC, and keep anti-poverty funding at levels far elevated beyond David Lloyd-George’s wildest dreams, and how the Ryan budget wasn’t his budget but rather the House Republican Conference’s budget.

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