Tag: Macroeconomics

Must-read: Paul Krugman (2013): “Friedman and the Austrians”

Posted on by Brad DeLong

Must-Read: Paul Krugman (2013): Friedman and the Austrians: “Still thinking about the Bloomberg Businessweek interview with Rand Paul…

…in which he nominated Milton Friedman’s corpse for Fed chairman. Before learning that Friedman was dead, Paul did concede that he wasn’t an Austrian. But I’ll bet he had no idea about the extent to which Friedman really, really wasn’t an Austrian. In his ‘Comments on the critics’ (of his Monetary Framework) Friedman described the ‘London School (really Austrian) view’

that the depression was an inevitable result of the prior boom, that it was deepened by the attempts to prevent prices and wages from falling and firms from going bankrupt, that the monetary authorities had brought on the depression by inflationary policies before the crash and had prolonged it by ‘easy money’ policies thereafter; that the only sound policy was to let the depression run its course, bring down money costs, and eliminate weak and unsound firms.

and dubbed this view an ‘atrophied and rigid caricature’ of the quantity theory. [His version of the] Chicago School, he claimed, never believed in such nonsense. I have, incidentally, seen attempts [by Larry White and company] to claim that nobody believed this, or at any rate that Hayek never believed this, and that characterizing Hayek as a liquidationist is some kind of liberal libel. This is really a case of who are you gonna believe, me or your lying eyes. Let’s go to the text (pdf), p. 275:

And, if we pass from the moment of actual crisis to the situation in the following depression, it is still more difficult to see what lasting good effects can come from credit expansion. The thing which is needed to secure healthy conditions is the most speedy and complete adaptation possible of the structure of production to the proportion between the demand for consumers’ goods and the demand for producers’ goods as determined by voluntary saving and spending.

If the proportion as determined by the voluntary decisions of individuals is distorted by the creation of artificial demand, it must mean that part of the available resources is again led into a wrong direction and a definite and lasting adjustment is again postponed. And, even if the absorption of the unemployed resources were to be quickened in this way, it would only mean that the seed would already be sown for new disturbances and new crises. The only way permanently to ‘mobilize’ all available resources is, therefore, not to use artificial stimulants—whether during a crisis or thereafter—but to leave it to time to effect a permanent cure by the slow process of adapting the structure of production to the means available for capital purposes.

And so, at the end of our analysis, we arrive at results which only confirm the old truth that we may perhaps prevent a crisis by checking expansion in time, but that we can do nothing to get out of it before its natural end, once it has come…

If that’s not liquidationism, I’ll eat my structure of production…

Regress in macroeconomic knowledge over the past 83 years

Posted on by Brad DeLong

Today, in 2016, Raghu Rajan thinks helicopter drops are “a step too far into the dark…”

His predecessor 83 years ago at the University of Chicago, Jacob Viner, thought they were one of the obvious technocratic steps to take, along with further raising the monetary base (i.e., in his day going off of the gold standard) even with short-term safe nominal interest rates at the zero lower bound (as they also were in his day).

Here’s Raghu:

Raghuram Rajan 2016): “If you read the writings of economists…

…it is not clear what’s keeping us still so slow, seven or eight years after the crisis. Ken Rogoff would say it is still the debt overhang and the deleveraging. [Robert] Gordon and others might say it is low productivity and still others may say it is the poorly understood consequences of population aging. But what do we do? And here I think there is more of a consensus that monetary policy pretty much has run its course. There are still guys who are looking for helicopter drops of money but I think that is a step sort of too far into the dark, where I am not sure there is a political consensus to do that in the major economies, if it comes to that…

Here’s Jacob:

Jacob Viner (1933): Balanced Deflation, Inflation, or More Deflation: “If going off the gold standard were as simple a matter for us…

…as for England and Canada, I would not only advocate it, but if [it]… did not suffice to lower substantially the internal purchasing power of the dollar I would recommend its accompaniment by increased government expenditures financed by the printing press or by loans…. England and… the other countries which went off the gold standard in 1931… [made] too restrained use of the freedom which the departure from the gold standard gave them them…. The countries that went off the gold standard have nevertheless weathered the economic storm much better…

We all agree that economies today are “so slow” and inflation pressures are by and large absent. What does Raghu think he knows today that Jacob did not–what have we learned in the past 83 years–that has turned helicopter drops from an obvious technocratic step to take to “a step too far into the dark”? What did Jacob think he knew that Raghu does not–what doctrines, true, false, or uncertain–because we have forgotten them?

Anyone? Anyone? Bueller?

Must-read: Olivier Blanchard: The US Phillips Curve: Back to the 60s?

Posted on by Brad DeLong

Must-Read: Olivier Blanchard says that he and Paul Krugman differ not at all on the analytics but, rather, substantially on “tone”…

It looks as though the center of the Federal Reserve is working today as if the slope of the Phillips-Curve relationship is still what it was in the years around 1980, and that the gearing of expected inflation to recent-past inflation is still what it was in the years around 1980.

Why this is so is a mystery.

Olivier Blanchard: The US Phillips Curve: Back to the 60s?: “The US Phillips curve is alive…

…(I wish I could say “alive and well,” but it would be an overstatement: the relation has never been very tight.) Inflation expectations, however, have become steadily more anchored, leading to a relation between the unemployment rate and the level… rather than the change in in inflation… [that] resembles more the Phillips curve of the 1960s than the accelerationist Phillips curve of the later period. The slope of the Phillips curve… has substantially declined…. The standard error of the residual… is large…. Each of the last three conclusions presents challenges for the conduct of monetary policy…

Www piie com publications pb pb16 1 pdf Www piie com publications pb pb16 1 pdf Www piie com publications pb pb16 1 pdf

We Are so S—ed. Econ 1-Level Edition

Posted on by Brad DeLong

As I told my undergraduates yesterday:

Y = μ[co + Io + NX] + μG – μIrr

where:

  • Y is real GDP
  • μ = 1/(1-cy) is the Keynesian multiplier
  • co is consumer confidence
  • cy is the marginal propensity to consume
  • C = co + cyY is the consumption function–how households’ spending on consumption goods and services varies with consumer confidence, with their income which is equal to real GDP Y, and with the marginal propensity to consume
  • Io is businesses’ and banks’ “animal spirits”–their confidence in enterprise
  • r is “the” long-term risky real interest rate r
  • Ir is the sensitivity of business investment to r
  • NX is foreigners’ net demand for our exports
  • And G is government purchases.

And as I am going to tell them next Monday, real GDP Y will be equal to potential output Y* whenever “the” interest rate r is equal to the Wicksellian neutral rate r*, which by simple algebra is:

r* = [co + Io + NX]/Ir + G/Ir – Y*/μIr

If interest rates are low and inflation is not rising it is not because monetary policy is too easy, but because r* is low–and r* can be low because:

  • consumers are terrified (co low)
  • investors’ animal spirits are depressed (Io low)
  • foreigners’ demand for our exports inadequate (NX low)
  • or fiscal policy too contractionary (G low)

for the economy’s productive potential Y*.

The central bank’s task in the long run is to try to do what it can to stabilize psychology and so reduce fluctuations in r. the central bank’s task in the short run is to adjust the short-term safe nominal interest rate it controls i in such a way as to match the market rate of interest r to r. For only then will Say’s Law, false in theory, be true in practice:

Martin Wolf: Negative Rates Not Central Banks’ Fault: “It is hard to understand the obsession with limiting public debt when it is as cheap as it is today…

…Almost nine years after the west’s financial crisis started, interest rates remain ultra-low. Indeed, a quarter of the world economy now suffers negative interest rates. This condition is as worrying as the policies themselves are unpopular. Larry Fink, chief executive of BlackRock, the asset manager, argues that low rates prevent savers from getting the returns they need for retirement. As a result, they are forced to divert money from current spending into savings. Wolfgang Schäuble, Germany’s finance minister, has even put much of the blame for the rise of Alternative für Deutschland, a nationalist party, and on policies introduced by the European Central Bank. ‘Save the savers’ is an understandable complaint by an asset manager or finance minister of a creditor nation. But this does not mean the objection makes sense. The world economy is suffering from a glut of savings relative to investment opportunities. The monetary authorities are helping to ensure that interest rates are consistent with this fact….

The savings glut (or investment dearth, if one prefers) is the result of developments both before and after the crisis…. Some will object that the decline in real interest rates is solely the result of monetary policy, not real forces. This is wrong. Monetary policy does indeed determine short-term nominal rates and influences longer-term ones. But the objective of price stability means that policy is aimed at balancing aggregate demand with potential supply. The central banks have merely discovered that ultra-low rates are needed to achieve this objective…. We must regard ultra-low rates as symptoms of our disease, not its cause….

[But is] the monetary treatment employed… the best one[?]…. Given the nature of banking institutions, negative rates are unlikely to be passed on to depositors and… so are likely to damage the banks…. There is a limit to how negative rates can go without limiting the convertibility of deposits into cash…. And this policy might do more damage than good. Even supporters agree there are limits…. [Does] this mean monetary policy is exhausted? Not at all. Monetary policy’s ability to raise inflation is essentially unlimited. The danger is rather that calibrating monetary policy is more difficult the more extreme it becomes. For this reason, fiscal policy should have come into play more aggressively….

The best policies would be a combination of raising potential supply and sustaining aggregate demand. Important elements would be structural reforms and aggressive monetary and fiscal expansion…. Monetary policy cannot be for the benefit of creditors alone. A policy that stabilises the eurozone must help the debtors, too. Furthermore, the overreliance on monetary policy is a result of choices, particularly over fiscal policy, on which Germany has strongly insisted. It is also the result of excess savings, to which Germany has substantially contributed…

One way of looking at it is that two things went wrong in 2008-9:

  • Asset prices collapsed.
  • And so spending collapsed and unemployment rose.

The collapse in asset prices impoverished the plutocracy. The collapse in spending and the rise in unemployment impoverished the working class. Central banks responded by reducing interest rates. That restored asset prices, so making the plutocracy whole. But while that helped, that did not do enough to restore the working class.

Then the plutocracy had a complaint: although their asset values and their wealth had been restored, the return on their assets and so their incomes had not be. And so they called for austerity: cut government spending so that governments can then cut our taxes and so restore our incomes as well as our wealth.

But, of course, cutting government spending further impoverished the working class, and put still more downward pressure on the Wicksellian neutral interest rate r* consistent with full employment and potential output.

And here we sit.

Must-read: Duncan Black: “Time to Increase Interest Rates!”

Posted on by Brad DeLong

Must-Read: And Duncan Black comes up with a very good phrase to describe what we think the Federal Reserve is doing based on what we think is its misspecified and erroneous view of the inflation process: “taking away the punchbowl before the DJ even shows up to the party”:

Duncan Black: Time To Increase Interest Rates!: “As I’ve said, I don’t think small upticks in interest rates by the Fed…

…will really destroy the economy. They just signal that the Fed will never let wages (for most of us) rise ever again. They’re taking away the punchbowl before the DJ even shows up to the party. Killing inflation is easy and you don’t have to pre-kill it. The best argument for Fed actions is that they need to increase rates so that they’ll be able to decrease them again if the economy sours. There’s a bit of an obvious problem with this reasoning. Exciting days at the dog track probably do get their attention. Wonder why that is.

More musings on the fall of the house of Uncle Milton…

Posted on by Brad DeLong

This, from Paul Krugman, strikes me as… inadequate:

Paul Krugman: Why Monetarism Failed: “Right-wingers insisted–Friedman taught them to insist–that government intervention was always bad, always made things worse…

…Monetarism added the clause, ‘except for monetary expansion to fight recessions.’ Sooner or later gold bugs and Austrians, with their pure message, were going to write that escape clause out of the acceptable doctrine. So we have the most likely non-Trump GOP nominee calling for a gold standard, and the chairman of Ways and Means demanding that the Fed abandon its concerns about unemployment and focus only on controlling the never-materializing threat of inflation.

What about the reformicons, who pushed for neo-monetarism? We can sum up their fate in two words: Marco Rubio. There is no home for the kind of return to realism they were seeking…. The monetarist idea no longer serves any useful purpose, intellectually or politically. Hicksian macro–IS-LM or something like it–remains an extremely useful tool of both analysis and policy formulation; that tool is not helped by trying to state it in terms of monetary velocity and all that. And if you want macro policy that isn’t dictated by Ayn Rand logic, you have to turn to a Democrat; on the other side, there’s nobody rational to talk to.

Sad!

This is an issue I have worried at like a dog at a worn-out glove for a decade now. So let me worry at it again:

There were gold bugs and Austrians in the 1950s, 1960s, 1970s, and even 1980s too. But Arthur Burns, Milton Friedman, Alan Greenspan and company kicked them up and down the street with gay abandon. And the Ordoliberal Germans would, when you cornered them, would admit that somebody else had to take on the job of stabilizing aggregate demand for the North Atlantic economy as a whole for their doctrines to work.

But in 2009 the Lucases and the Prescotts and the Cochranes and the Famas and the Boldrins and the Levines and the Steils and the Taylors and all the others and even the Zingaleses (but we can excuse Luigi on the grounds that if you are (a) Italian and (b) view Berlusconi as the modal politician a certain reluctance to engage in fiscal policy is understandable)–crawled out from their caves and stood in the light of day. And the few remaining students of Milton Friedman got as little respect as the Stewards of Gondor gave to the leaders of the Dunedain.

Yes, there is an intellectual tension between believing in laissez faire as a rule and believing in activist monetary management to set the market interest rate equal to the Wicksellian neutral interest rate. But why is that tension unsustainable? Once you have swallowed a government that assigns property rights, sustains contracts, and enforces weights and measures, why is this extra step a bridge too far?

Must-read: Jérémie Cohen-Setton, Joshua K. Hausman, and Johannes F. Wieland: “Supply-Side Policies in the Depression: Evidence from France”

Posted on by Brad DeLong

Must-Read: Jérémie Cohen-Setton, Joshua K. Hausman, and Johannes F. Wieland: Supply-Side Policies in the Depression: Evidence from France: “The effects of supply-side policies in depressed economies are controversial…

…We shed light on this debate using evidence from France in the 1930s. In 1936, France departed from the gold standard and implemented mandatory wage increases and hours restrictions. Deflation ended but output stagnated. We present time-series and cross-sectional evidence that these supply-side policies, in particular the 40-hour law, contributed to French stagflation. These results are inconsistent both with the standard one-sector new Keynesian model and with a medium scale, multi-sector model calibrated to match our cross-sectional estimates. We conclude that the new Keynesian model is a poor guide to the effects of supply-side shocks in depressed economies.

The disappearance of monetarism

Posted on by Brad DeLong

I just hoisted a piece I wrote 15 years ago1—a follow-up to my “Triumph of Monetarism” that I published in the Journal of Economic Perspectives. I think of it as my equivalent of Olivier Blanchard’s “The state of macro is good” piece…

However, it is, I now recognize, clearly inadequate. It is quite good on how today’s New Keynesians are really Monetarists and how today’s Monetarists are really Keynesians. But it misses completely:

  • How use of the DSGE framework was morphing from (a) a rhetorical step to emphasize that assuming that agents in models behaved “rationally” did not entail any laissez-faire inclusions to (b) an unhelpful methodological straitjacket.
  • How there were about to be no Monetarists—how the right wing of macroeconomics, the Republican Party in the United States, the Tory Party in England, and all of Germany were about to, when confronted with the choice between following Milton Friedman’s well-grounded and empirically based arguments on the one hand and a mindless lemming-like devotion to austerity on the other hand, reject both empirical evidence and coherent thought and plump enthusiastically for the second.

I am still not sure how that happened…

Must-watch: Joe Gagnon et al.: Event: “Macroeconomic Policy Options for the World Today”

Posted on by Brad DeLong

Must-Watch: Joe Gagnon et al.: Event: Macroeconomic Policy Options for the World Today: “Joseph E. Gagnon… Jay Shambaugh… Patrick Honohan… Carlo Cottarelli…

…The Peterson Institute will hold an event on April 12, 2016, to discuss the capacity and prospects for macroeconomic stimulus ahead of the spring meetings of the International Monetary Fund (IMF) and World Bank… possible monetary policy options for major central banks… the Obama administration’s perspective on the fiscal space globally and potential stimulus policies…

Yes, in some (many) ways, our macro debate has lost intellectual ground since the 1930s. Why do you ask?

Posted on by Brad DeLong

Last September, the illustrious Simon Wren-Lewis wrote a nice piece about the Bank of England’s thinking about Quantitative Easing: Haldane on Alternatives to QE, and What He Missed Out.

Simon’s bottom line was that Haldane was not just thinking inside the box, but restricting his thinking to a very small corner of the box:

[neither] discussion of the possibility that targeting something other than inflation might help… [nor] any discussion of helicopter money…

And this disturbs him because:

We rule out helicopter money because its undemocratic, but we rule out a discussion of helicopter money because ordinary people might like the idea…. Governments around the world have gone for fiscal contraction because of worries about the immediate prospects for debt. It is not as if the possibility of helicopter money restricts the abilities of governments in any way…. [While] it is good that some people at the Bank are thinking about alternatives to QE, which is a lousy instrument…. It is a shame that the Bank is not even acknowledging that there is a straightforward and cost-free solution…

It disturbs me too.

One reason it disturbs me is that a version of “helicopter money” was one of the policy options that Milton Friedman and Jacob Viner endorsed as the right policies to deal with the last time we were at the zero lower bound, stock Great Depression. Back in 2009 I quoted Milton Friedman (1972), “Comments on the Critics of ‘Milton Friedman’s Monetary Framework'”, quoting Jacob Viner (1933):

The simplest and least objectionable procedure would be for the federal government to increase its expenditures or to decrease its taxes, and to finance the resultant excess of expenditures over tax revenues either by the issue of legal tender greenbacks or by borrowing from the banks..

And Friedman continued:

[Abba] Lerner was trained at the London School of Economics [stock 1930s], where the dominant view was that the depression was an inevitable result of the prior [speculative] boom, that it was deepened by the attempts to prevent prices and wages from falling and firms from going bankrupt, that the monetary authorities had brought on the depression by inflationary policies before the crash and had prolonged it by “easy money” policies thereafter; that the only sound policy was to let the depression run its course, bring down money costs, and eliminate weak and unsound firms…. It was [this] London School (really Austrian) view that I referred to in my “Restatement” when I spoke of “the atrophied and rigid caricature [of the quantity theory] that is so frequently described by the proponents of the new income-expenditure approach and with some justice, to judge by much of the literature on policy that was spawned by the quantity theorists” (Friedman 1969, p. 51).

The intellectual climate at Chicago had been wholly different. My teachers… blamed the monetary and fiscal authorities for permitting banks to fail and the quantity of deposits to decline. Far from preaching the need to let deflation and bankruptcy run their course, they issued repeated pronunciamentos calling for governmental action to stem the deflation-as J. Rennie Davis put it:

Frank H. Knight, Henry Simons, Jacob Viner, and their Chicago colleagues argued throughout the early 1930’s for the use of large and continuous deficit budgets to combat the mass unemployment and deflation of the times (Davis 1968, p. 476)… that the Federal Reserve banks systematically pursue open-market operations with the double aim of facilitating necessary government financing and increasing the liquidity of the banking structure (Wright 1932, p. 162)….

Keynes had nothing to offer those of us who had sat at the feet of Simons, Mints, Knight, and Viner. It was this view of the quantity theory that I referred to in my “Restatement” as “a more subtle and relevant version, one in which the quantity theory was connected and integrated with general price theory and became a flexible and sensitive tool for interpreting movements in aggregate economic activity and for developing relevant policy prescriptions” (Friedman 1969, p. 52). I do not claim that this more hopeful and “relevant” view was restricted to Chicago. The manifesto from which I have quoted the recommendation for open-market operations was issued at the Harris Foundation lectures held at the University of Chicago in January 1932 and was signed by twelve University of Chicago economists. But there were twelve other signers (including Irving Fisher of Yale, Alvin Hansen of Minnesota, and John H. Williams of Harvard) from nine other institutions’…

“Helicopter money”–increases in the money stock used not to buy back securities but instead to purchase assets that are very bad substitutes for cash like the consumption expenditures of households, roads and bridges, the human capital of 12-year-olds, and biomedical research–could be mentioned as a matter of course as a desirable policy for dealing with an economy at the zero lower bound by Jacob Viner in 1933. But, apparently, central banks do not even want to whisper about the possibility. One interpretation is that, confronted with Treasury departments backed by politicians and elected by voters that have a ferocious and senseless jones for austerity even though g > r, central banks fear that any additional public recognition by them that fiscal and monetary policy blur into each other may attract the Eye of Austerity and so limit their independence and freedom of action.

If I were on the Federal Reserve Board of Governors or in the Court of the Bank of England right now, I would be taking every step to draw the line between fiscal policy and monetary policy sharply, but I would draw it in the obvious place:

  • Contractionary fiscal policies seek to lower the government debt (but with g > r or even g near r and hysteresis actually raise the debt-to-GDP ratio and possibly the debt).
  • Expansionary fiscal policies seek to raise the government debt (but with g > r or even g near r and hysteresis actually lower the debt-to-GDP ratio and possibly the debt).
  • Policies that neither raise or lower the debt ain’t fiscal policy, they are monetary policy.
  • Contractionary monetary policies reduce the money stock (and usually but do not have to raise the stock of government debt held by the private sector).
  • Expansionary monetary policies raise the money stock (and usually but do not have to lower the stock of government debt held by the private sector).

And if helicopter money leads Treasuries to protest that the money stock is growing too rapidly? (They cannot, after all, complain that the government debt stock is growing too rapidly because it isn’t.) The response is: Who died and put you in charge of monetary inflation-control policy? That’s not your business.