Must-Read: Paul Krugman: Austerity’s Grim Legacy

Posted on by Brad DeLong

Paul Krugman: Austerity’s Grim Legacy: “The consequences of the wrong turn we took look worse now…

…than the harshest critics of conventional wisdom ever imagined. For those who don’t remember (it’s hard to believe how long this has gone on): In 2010, more or less suddenly, the policy elite on both sides of the Atlantic decided to stop worrying about unemployment and start worrying about budget deficits instead. This shift wasn’t driven by evidence or careful analysis… was very much at odds with basic economics. Yet ominous talk about the dangers of deficits became something everyone said because everyone else was saying it… those parroting the orthodoxy of the moment [were the] Very Serious People. Some of us tried in vain to point out that deficit fetishism was both wrongheaded and destructive…. And we were vindicated by events. More than four and a half years have passed since Alan Simpson and Erskine Bowles warned of a fiscal crisis within two years; U.S. borrowing costs remain at historic lows. Meanwhile, the austerity policies that were put into place in 2010 and after had exactly the depressing effects textbook economics predicted; the confidence fairy never did put in an appearance…. [And] there’s growing evidence that we critics actually underestimated just how destructive the turn to austerity would be. Specifically, it now looks as if austerity policies didn’t just impose short-term losses of jobs and output, but they also crippled long-run growth….

At this point… evidence practically screams “hysteresis”. Even countries that seem to have largely recovered from the crisis, like the United States, are far poorer than precrisis projections suggested they would be at this point. And a new paper by Mr. Summers and Antonio Fatás… shows that the downgrading of nations’ long-run prospects is strongly correlated with the amount of austerity they imposed…. The turn to austerity had truly catastrophic effects…. The long-run damage suggested by the Fatás-Summers estimates is easily big enough to make austerity a self-defeating policy even in purely fiscal terms: Governments that slashed spending in the face of depression hurt their economies, and hence their future tax receipts, so much that even their debt will end up higher than it would have been without the cuts. And the bitter irony of the story is that this catastrophic policy was undertaken in the name of long-run responsibility….

There are a few obvious lessons… groupthink is no substitute for clear analysis… calling for sacrifice (by other people, of course) doesn’t mean you’re tough-minded. But will these lessons sink in? Past economic troubles, like the stagflation of the 1970s, led to widespread reconsideration of economic orthodoxy. But one striking aspect of the past few years has been how few people are willing to admit having been wrong about anything…

Noted for the Morning of November 6, 2015

Posted on by Brad DeLong

Must- and Should-Reads:

Might Like to Be Aware of:

Must-Read: Lucy Hornby: Du Runsheng, Chinese Farm Reformer, 1913-2015

Posted on by Brad DeLong

Must-Read: Lucy Hornby: Du Runsheng, Chinese Farm Reformer, 1913-2015: “Du, who has died aged 102, drafted the ‘household responsibility system’…

…that replaced the Communists’ disastrous experiment with farm communes. ‘You could make a case that Du was one of the most influential economists to have ever lived,’ wrote Beijing-based Andrew Batson in an online tribute. ‘If you measure influence by the sheer number of lives affected, then it seems Du would have to rank pretty high.’ In the late 1970s as Deng Xiaoping took power, China was on its knees…. Du, a civil war veteran whom Mao Zedong had purged 20 years earlier when he challenged the shift to Soviet-style communes…. drafted the policy document that, while maintaining the appearance of Communist ideals, let peasants again farm their own plots. ‘An unfair pattern of holding resources had arisen, fostering the rise of vested interests. These interests tended to be conservative, holding back reform in the name of socialist ownership,’ Du wrote in 2006. To avert opposition from within the party, he did not propose dismantling the communes or restoring private ownership. He also agreed to pilot the programme in the poorest areas, where grain warehouses were already empty. The result was electric. Within two years, the most impoverished areas of China were feeding themselves….

Du mentored many current leaders including Wang Qishan, today’s anti-corruption tsar, and an aspiring young cadre in rural Hebei province named Xi Jinping. ‘My grandfather wasn’t just a cadre. He was more like a teacher or a scholar,’ says his grandson, Du Fan. ‘He believed in the long-term principle of a better life for the farmers.’… He was one of only four party elders to oppose Deng’s 1989 military crackdown on student and worker protests in Tiananmen Square. ‘I really respected him,’ says Bao Tong, the most senior official jailed after the protests, adding: ‘He lived life fully.’

At a ripe old age Du enjoyed tennis and was an enthusiastic adopter of the annual flu shot, his grandson says. ‘He really liked the western approach to medicine. He believed in keeping fit through exercise.’ Born on July 18 1913 to a modest family in Shanxi… benefited from the local banking elite’s practice of sponsoring… education… entered Beijing Normal University… moved to a remote guerrilla base in the jagged Taiheng mountains… led the local land redistribution movement. On his return to Beijing he belonged to a group of officials who backed western-style agricultural co-operatives over Mao’s Soviet-inspired communes.

Like many rehabilitated party elites, Du did not like to discuss the turmoil he had lived through, his suffering in the Cultural Revolution or indeed his own part in the bloody land redistribution of the early 1950s. ‘There’s no way he would talk about that,’ says his grandson…. But crucial to his ultimate approach was a belief that ‘in order to have a prosperous countryside, you needed peasants’ voluntary participation’, says Mr Bao. The household responsibility system, allowing farmers to grow what they liked for themselves as long as they met their grain quotas, proved Du right.

The U.S. labor market and the health of workers

Posted on by David Hudson
A job fair at Dolphin Mall in Miami, Florida, October 6, 2015. (Photo by Wilfredo Lee, Associated Press)

Employment growth was strong in October, with the U.S. economy adding 271,000 jobs last month, according to the latest employment and earnings data released today by the U.S. Bureau of Labor Statistics. The unemployment rate, however, changed little, from 5.1 percent to 5.0 percent, and the employed share of the prime-age population (ages 25 to 54) remained stuck at 77.2 percent.

Last month, the hourly pay for private-sector workers was up 2.5 percent compared to the same time last year. Although this jump in wages may reflect true wage growth acceleration, there is some worry that this sudden jump is mostly a data correction given that hourly earnings were essentially unchanged between August and September. Earnings data for November and December will help clarify whether this jump was more of a correction or a true acceleration.

Most of the wage growth in October appears to be in the retail and wholesale trade sectors as well as utilities, where wages grew by 3.2 percent and 5.0 percent, respectively, at an annual rate. Wage growth continues to be slower for production and nonsupervisory workers, a group that comprises about 80 percent of the workforce. For these workers, wages grew by only 2.2 percent relative to last year, in contrast to 2.5 percent overall—an indication that wage inequality is on the rise. The rate of wage growth for production workers has been slower than the overall wage growth rate every month of 2015.

The U.S. economy added 271,000 jobs last month, with large increases in health care (56,700), food services (42,000), and retail (43,800). These three sectors accounted for more than half of the total job gains in October. The average monthly change over the past three months is now 187,000. The mining sector continued to shrink, losing 4,000 jobs last month, due in no small part to low energy prices. After some jobs gains in 2014, the mining sector has contracted every month of 2015.

In contrast to the positive growth in the establishment survey, the household survey found that unemployment in October fell only slightly to 5.0 percent, and the employed share of the prime-age population (ages 25 to 54) remained stuck at 77.2 percent. After increasing nearly a percentage point over 2014, the prime-age employment rate has stalled, staying in the range of 77.1 percent to 77.3 percent every month this year. The U.S. economy has not seen consistently strong, nominal wage growth in the past 25 years without prime-age employment rates close to 79 percent.

What’s more, the weaker employment-to-population rates in general may well be related to worker health, such as the recent rise in mortality uncovered by economists Anne Case and Angus Deaton of Princeton University. Case and Deaton found a striking increase in U.S. mortality rates since 1999 among white, non-Hispanic individuals between the ages of 45 and 54. The significant increase in suicides and poisonings for this group coincides with the general worsening of the U.S. labor market beginning around the 2001 recession. The employed share of the white population ages 45 to 54 rose relatively consistently until the year 2000, when it peaked at close to 82 percent. After the 2001 recession, the employment rate never recovered to its prior peak, and then fell sharply again during the Great Recession of 2007–2009. Now, it stands at less than 78 percent.

Incomes also fell very sharply for the group that Case and Deaton identified as seeing the largest increase in suicides and poisonings: white, non-Hispanics ages 45 to 54 with no college education. For this group, inflation-adjusted median family income rose by less than 3 percent between 1990 and 2000, before plummeting by almost 18 percent between 2000 and 2010, according to Current Population Survey data.

There is obviously a complex relationship between the health of individuals and conditions in the labor market—health-harming job losses could perhaps be offset by less pollution during a recession—but one common finding is that suicides are more frequent when the labor market is slack. There are many economic factors for policymakers to consider before raising interest rates, especially when it is not clear that there will be consistent, strong wage gains and employment growth going forward, but Case and Deaton’s research highlights another factor—the potential health costs of a weaker labor market.

History: John Maynard Keynes Getting One Very Right: There Is No Medium-Run Full-Employment Sheet-Anchor for the Economy

Posted on by Brad DeLong

Here we see Keynes getting one, I think, very right: denying that the full-employment equilibrium serves as a medium-run sheet anchor sharply damping short-run fluctuations:

John Maynard Keynes (1937): The General Theory of Employment: “Money, it is well known, serves two principal purposes…

…By acting as a money of account it facilitates exchanges without its being necessary that it should ever itself come into the picture as a substantive object. In this respect it is a convenience which is devoid of significance or real influence.

In the second place,it is a store of wealth. So we are told, without a smile on the face. But in the world of the classical economy, what an insane use to which to put it! For it is a recognized characteristic of money as a store of wealth that it is barren; whereas practically every other form of storing wealth yields some interest or profit.

Why should anyone outside a lunatic asylum wish to use money as a store of wealth? Because, partly on reasonable and partly on instinctive grounds, our desire to hold Money as a store of wealth is a barometer of the degree of our distrust of our own calculations and conventions concerning the future. Even though this feeling about Money is itself conventional or instinctive, it operates, so to speak, at a deeper level of our motivation. It takes charge at the moments when the higher, more precarious conventions have weakened. The possession of actual money lulls our disquietude; and the premium which we require to make us part with money is the measure of the degree of our disquietude.

The significance of this characteristic of money has usually been overlooked; and in so far as it has been noticed, the essential nature of the phenomenon has been misdescribed. For what has attracted attention has been the quantity of money which has been hoarded; and importance has been attached to this because it has been supposed to have a direct proportionate effect on the price-level through affecting the velocity of circulation. But the quantity of hoards can only be altered either if the total quantity of money is changed or if the quantity of current money-income (I speak broadly) is changed; whereas fluctuations in the degree of confidence are capable of having quite a different effect, namely, in modifying not the amount that is actually hoarded, but the amount of the premium which has to be offered to induce people not to hoard. And changes in the propensity to hoard, or in the state of liquidity-preference as I have called it, primarily affect, not prices, but the rate of interest; any effect on prices being produced by repercussion as an ultimate consequence of a change in the rate of interest.

This, expressed in a very general way, is my theory of the rate of interest. The rate of interest obviously measures–just as the books on arithmetic say it does–the premium which has to be offered to induce people to hold their wealth in some form other than hoarded money. The quantity of money and the amount of it required in the active circulation for the transaction of current business (mainly depending on the level of money-income) determine how much is available for inactive balances, i.e. for hoards. The rate of interest is the factor which adjusts at the margin the demand for hoards to the supply of hoards.

Now let us proceed to the next stage of the argument. The owner of wealth, who has been induced not to hold his wealth in the shape of hoarded money, still has two alternatives between which to choose. He can lend his money at the current rate of money-interest, or he can purchase some kind of capital-asset. Clearly in equilibrium these two alternatives must offer an equal advantage to the marginal investor in each of them. This is brought about by shifts in the money-prices of capital-assets relative to the prices of money-loans. The prices of capital-assets move until, having regard to their prospective yields and account being taken of all those elements of doubt and uncertainty, interested and disinterested advice, fashion, convention and what else you will which affect the mind of the investor, they offer an equal apparent advantage to the marginal investor who is wavering between one kind of investment and another.

This, then, is the first repercussion of the rate of interest, as fixed by the quantity of money and the propensity to hoard, namely, on the prices of capital-assets. This does not mean, of course,that the rate of interest is the only fluctuating influence on these prices. Opinions as to their prospective yield are themselves subject to sharp fluctuations, precisely for the reason already given, namely, the flimsiness of the basis of knowledge on which they depend. It is these opinions taken in conjunction with the rate of interest which fix their price.

Now for stage three. Capital-assets are capable, in general, of being newly produced. The scale on which they are produced depends, of course, on the relation between their costs of production and the prices which they are expected to realize in the market. Thus if the level of the rate of interest taken in conjunction with opinions about their prospective yield raise the prices of capital-assets, the volume of current investment (meaning by this the value of the output of newly produced capital-assets) will be increased; while if, on the other hand, these influences reduce the prices of capital-assets, the volume of current investment will be diminished.

It is not surprising that the volume of investment, thus determined, should fluctuate widely from time to time. For it depends on two sets of judgments about the future, neither of which rests on an adequate or secure foundation–on the propensity to hoard, and on opinions of the future yield of capital-assets. Nor is there any reason to suppose that the fluctuations in one of these factors will tend to offset the fluctuations in the other. When a more pessimistic view is taken about future yields, that is no reason why there should be a diminished propensity to hoard. Indeed, the conditions which aggravate the one factor tend, as a rule, to aggravate the other. For the same circumstances which lead to pessimistic views about future yields are apt to increase the propensity to hoard.

The only element of self-righting in the system arises at a much later stage and in an uncertain degree. If a decline in investment leads to a decline in output as a whole, this may result (for more reasons than one) in a reduction of the amount of money required for the active circulation, which will release a larger quantity of money for the inactive circulation, which will satisfy the propensity to hoard at a lower level of the rate of interest, which will raise the prices of capital-assets, which will increase the scale of investment, which will restore in some measure the level of output as a whole.

This completes the first chapter of the argument, namely, the liability of the scale of investment to fluctuate for reasons quite distinct (a) from those which determine the propensity of the individual to save out of a given income and (b) from those physical conditions of technical capacity to aid production which have usually been supposed hitherto to be the chief influence governing the marginal efficiency of capital.
If, on the other hand, our knowledge of the future was calculable and not subject to sudden changes, it might be justifiableto assume that the liquidity-preference curve was both stable and very inelastic. In this case a small decline in money-income would lead to a large fall in the rate of interest, probably sufficient to raise output and employment to the full. In these conditions we might reasonably suppose that the whole of the available resources would normally be employed;and the conditions required by the orthodox theory wouldbe satisfied.

My next difference from the traditional theory concerns its apparent conviction that there is no necessity to work out a theory of the demand and supply of output as a whole. Will a fluctuation in investment, arising for the reasons just described,have any effect on the demand for output as a whole, and consequently on the scale of output and employment? What answer can the traditional theory make to this question? I believe that it makes no answer at all, never having given the matter a single thought; the theory of effective demand,that is the demand for output as a whole, having been entirely neglected for more than a hundred years.

My own answer to this question involves fresh considerations. I say that effective demand is made up of two items–investment-expenditure determined in the manner just explained, and consumption-expenditure. Now what governs the amount of consumption-expenditure? It depends mainly on the level of income. People’s propensity to spend (as I call it) is influenced by many factors, such as the distribution of income, their normal attitude to the future and-though probably in a minor degree–by the rate of interest. But in the main the prevailing psychological law seems to be that when aggregate income increases, consumption-expenditure will also increase, but to a somewhat lesser extent. This is a very obvious conclusion…

Must-Read: John Thornhill: Lunch with the FT: Mariana Mazzucato

Posted on by Brad DeLong

John Thornhill: Lunch with the FT: Mariana Mazzucato: “The first time I saw Mariana Mazzucato in action…

…she intellectually eviscerated a guileless American venture capitalist at an economic conference in Italy. Anyone who has read… The Entrepreneurial State… could have probably guessed it would be a bad idea to argue within her earshot that Silicon Valley’s success was due solely to brilliant entrepreneurs doing whizzy things. But the venture capitalist was sloppy on his due diligence and was whacked by a formidable Mazzucato…. It was electrifying, especially if, as I do, you appreciate intellectual blood sports…. She chooses to meet at the Gilbert Scott restaurant in the renovated St Pancras hotel, right by the Eurostar rail terminal, close to her London home…. For the next three hours she talks at mind-spinning speed….

My mission was to change that debate. If we want to have more sustainable, long-run growth, rather than finance-driven, speculative growth, then we had better understand where growth comes from. If we actually look at the few countries that have achieved smart, innovation-led growth, you’ve had this massive government involvement. How can we square that with the whole austerity discourse?… As soon as I started looking at these issues, I started realising how much language matters. If you just talk about the state as a facilitator, as a de-risker, as an incentiviser, as a fixer of market failures, it ends up structuring what you do…. [But] you always require the state to roar….

One of the original engines of Silicon Valley’s creativity, she argues, was the Defense Advanced Research Projects Agency (Darpa), founded by President Dwight Eisenhower in 1958 following the alarm caused by the Soviet Union’s launch of the Sputnik rocket. Darpa, run by the US Department of Defense, has since pumped billions of dollars into cutting-edge research and was instrumental in developing the internet. According to Mazzucato, the publicly funded National Institutes of Health has played a similar role in nurturing the US pharmaceuticals industry. The Advanced Research Projects Agency-Energy (Arpa-E), set up by President Barack Obama and run by the US Department of Energy, is designed to stimulate green technology….

Mazzucato is talking so fast that she rarely has time to eat and only picks at her duck…. As we order two macchiatos, we turn to Europe, which she believes is learning all the wrong lessons from Silicon Valley’s success. Governments have rashly asked business what they should do to promote growth. Encourage venture capital, cut taxes and red tape, comes the reply. In many cases, Mazzucato argues, this amounts to no more than corporate welfare.

The irony, if not the tragedy, of what we have today is that not only do we not understand the Silicon Valley story correctly but we are also increasing the risk of free- riding, which worsens inequality. Businesses invest only where they really see future technological and market opportunities. If you bring their tax to zero, you’ve just made them richer, they will golf more. They will not invest…

Must-Read: Maury Obstfeld: Deflation Risks May Warrant Radical New Central-Bank Thinking

Posted on by Brad DeLong

Must-Read: The asymmetry created by the zero lower bound on short-term safe nominal interest rates is not a difficult concept to grasp. The resulting optionality preserved by aiming at policies that overshoot on employment, growth, and inflation, and then dialing-back if necessary, is both important and relatively simple. Yet since the end of 2008, at every stage, this principle has been grossly neglected by economic policymakers. Hank Paulson was the last person to understand–that is why he went for $700 billion for the TARP even though he (wrongly) thought he would not need it.

Maury understands:

Maury Obstfeld: Deflation Risks May Warrant Radical New Central-Bank Thinking: “I worry about deflation globally…

…It may be time to start thinking outside the box…. You can always, always deal with high inflation… [but] at the zero lower bound, our options are much more limited. In order to bring inflation expectations firmly back to 2% in the advanced countries, where we’d like to see it, it’s probably going to be necessary to have some overshooting of the 2% level, or at least to entertain that as a possibility…

Must-Read: Josh Marshall: Our Big Series On Inequality

Posted on by Brad DeLong

Must-Read: Josh Marshall: Our Big Series On Inequality: “Bob Dylan’s line that ‘he who is not busy being born is busy dying’…

… [we] need to constantly reinvent, experiment and never settle into the comfort of the deathly hand of the past. So this is something… new…. We were able to get AFSCME to sponsor the series which gave us the funds to really do it right… polished… go deep without the standard need… to sweat whether… [it] pays off in page views and clicks….

Half a century ago… wealth and income inequality were at historically low levels. The US… [was] the factory for rebuilding the world… unions were… pervasive…. So how did we get from there to here?… Our aim is to provide some of the building blocks to to think critically about the question…. Teasing apart this often chicken and egg interplay between economic forces and political change is critical to understanding the unfolding story. The first installment… kicks off next week with Rich Yeselson… [on] the politics of the left and the decline of organized labor…. But it is only part of the story….

Next John Judis looks at the complicated politics of inequality… how those who are in many ways most affected by the flattened economic prospects of the middle class have become increasingly skeptical about government’s ability to shift the trend…. Next, Jared Bernstein looks at the numbers…. Finally, Brad DeLong looks at the debate over Thomas Picketty’s book Capital in the 21st Century. Piketty argues… that we have the question basically wrong. What is happening now is simply how capitalism works, says Piketty…. DeLong looks at Piketty’s thesis through the prism of economic and politics and surveys the reactions his work has generated over the last year…

Intellectual broker: Secular stagnation vs. Ben Bernanke

Posted on by Brad DeLong

Let me put here my first, much longer draft to what appeared on Project Syndicate: The Tragedy of Ben Bernanke

Ben Bernanke has published his memoir, The Courage to Act.

I am finding it difficult to read. I am finding it hard to read it as other than as a tragedy. It is the story of a man who found himself in a job for which he may well have been the best-prepared person in the world. Yet he soon found himself overmastered by the situation. And he fell and stayed well behind the curve in understanding what was going on.

Those of us with even some historical memory winced when, back in 2003, Robert Lucas flatly declared that the problem of depression-prevention had been solved “for all practical purposes, and has in fact been solved for many decades”. We remembered 1960s Council of Economic Advisers chairs Walter Heller and Arthur Okun saying much the same thing. Indeed, we remembered Irving Fisher in the 1920s saying much the same thing. Fisher’s hubris was followed by nemesis in the form of the Great Depression. Heller’s and Okun’s hubris was followed by nemesis in the form of the 1970s inflation. The joke was on Lucas.

But in a deeper sense the joke was on those of us who winced at Lucas–and also on the people of the North Atlantic. For, as we know, the economy since 2007 has not been a very funny joke the people of the North Atlantic.

Those of us with historical memory knew that the problem of preventing severe macro economic instability had not been solved. But even we believed that even sharp downturns would be transitory and short. Rapid recovery to full prosperity and the supply side-driven trend growth was all but guaranteed. Perhaps full prosperity could be delayed into an extended medium-run by actively-perverse and destabilizing government policies. Perhaps the full-prosperity equilibrium-restoring forces of the market would work quickly.

But they would work.

Indeed, back in 2000 it was Ben Bernanke who had written that central banks with sufficient will and drive could always, in the medium-run at least, restore full prosperity by themselves via quantitative easing. Simply print money and buy financial assets. Do so on a large-enough scale. People would expect that not all of the quantitative easing would be unwound. Thus people would have an incentive to use the extra money that had been printed to step up their spending. Even if the fraction of quantitative easing that thought permanent was small, and even if the incentive to spend was low, the central bank could do the job.

It is to Bernanke’s great credit that the shock of 2007-8 did not trigger another Great Depression. However, what came after was unexpectedly disappointing. Central banks in the North Atlantic–including Ben Bernanke’s central bank, the Federal Reserve–went well beyond the outer limits of what we had thought, back before 2008, would be the maximum necessary to restore full prosperity. And full prosperity continued and continues to elude us. Bernanke pushed the US monetary base up from $800 billion to $4 trillion–a five-fold increase, one that a naïve quantity theory of money would have seen as enough stimulus to create a 400% cumulative inflation. But that was not enough. And Bernanke found himself and his committee unwilling to take the next leap, and do another more-than-doubling to carry the monetary base up to $9 trillion. And so, by the last third of his tenure in office, he was reduced to begging in vain for fiscal-expansionary help closed-eared Congress, which refused. Some leading figures in the dominant Republican party made political hay by calling what he had done “almost treasonous”, and threatening, in the coded language applied a generation ago to civil rights and other agitators, to lynch him should he show up where he was not wanted.

So what went wrong? I have been thinking about this with mixed success, most recently for the Milken Institute Review. So let me try yet again to summarize:

As I understand Ben Bernanke’s perspective, he thinks that nothing fundamental went wrong. It is just that the medium-run it takes for aggressively-expansionary monetary policy to restore full prosperity has been artificially lengthened, and seems long to us indeed. Interventions by non-market–or perhaps it would be better to call them non-risk adjusted return maximizing–financial players have created a temporary global savings glut. Sovereign wealth funds for which loss aversion is key, the emerging-market rich seeing their positions in the North Atlantic as primarily insurance against political risk, and governments seeking to ensure freedom of action have pushed full-prosperity interest rates down substantially, and lengthened the medium-run it takes for shocks to dissipate. But, I believe Bernanke believes, these disturbances are ending. And so, if he were still running the Fed, he would think it appropriate to raise interest rates now.

An alternative view is held by the very sharp Ken Rogoff. He believes, I think, that Bernanke’s cardinal error was to focus on money when he should have been focusing on that. In our simple models which you focus son does not matter: when the money market is in full-prosperity equilibrium, the debt market is too. But in the real world a central bank and a broader government that focused not on expanding the stock of safe money but on buying back and inducing the writing-down of the stock of risky debt would have boosted private spending much more effectively and restored full prosperity much more quickly.

Yet a third possible view is that the Fed could have done it: if it had committed to a higher target inflation rate than 2%/year, and promised to do as much quantitative easing as needed to get to that target, it would have produced full prosperity without requiring anywhere near as much quantitative easing as has been, so far, undertaken without that favorable result.

And then there is fourth view, one that I associate with Larry Summers and Paul Krugman, that we have no warrant for believing that monetary policy can restore full prosperity not only not in the short-run, but not in the medium-run and probably not even in the long-run. As Krugman put it most recently:

In 1998… I envisaged an economy in which the… natural rate of interest… would return to a normal, positive level… [and so] the liquidity trap became a [monetary-]expectations problem… monetary policy would be effective if it had the right kind of credibility…. [But if] a negative Wicksellian [natural] rate… permanent… [then] if nobody believes that inflation will rise, it won’t. The only way to be at all sure… [is] with a burst of fiscal stimulus…

Their position is, after a long detour through the post-World War II neoclassical-Keynesian synthesis, a return to a position set out by John Maynard Keynes in 1936:

It seems unlikely that the influence of [monetary] policy on the rate of interest will be sufficient by itself…. I conceive, therefore, but a somewhat comprehensive socialization of investment will prove the only means the securing an approximation to full employment; though this not need exclude all manner of compromises and of devices by which the public authority will cooperate with private initiative…

The government, that is, will have to be infrastructure-builder, risk-absorber, safe debt-issuer, debt workout-manager, and to a substantial degrees sectoral economic planner of last resort to maintain full prosperity. Milton Friedman’s dream that strategic interventions by the central bank in the quantity of high-powered money would then be just that—a dream. And our confusion, and the attractiveness of Milton Friedman’s monetarism in the half-century starting with a World War II would be an accident of the particular circumstances of the uniquely rapid North Atlantic-wide demographic and productivity growth of the transient post World War II era.

I cannot claim—we cannot claim—to know whether Bernanke he will Rogoff or Krugman and Summers are correct here, or even weather if Bernanke he and his committee had found the nerve, and rolled double-or-nothing one more time to boost the American high-powered money stock to $9 trillion, we might have been back to full prosperity a couple of years ago. But I do think that the debate over this question is the most important debate within macroeconomics since the debate—strangely, a very similar debate, at least with respect to its policy substance—that John Maynard Keynes had with himself in the decade around 1930 that turned him from a monetarist into a Keynesian.

Noted for the Morning of November 5, 2015

Posted on by Brad DeLong

Must- and Should-Reads:

Might Like to Be Aware of: