Tag: Macroeconomics

Why Not the Gold Standard? Hoisted from the Archives from 1996

Posted on by Brad DeLong
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From 1996: Why Not the Gold Standard? Talking Points on the Likely Consequences of Re-Establishment of a Gold Standard:

Consequences for the Magnitude of Business Cycles:

Loss of control over economic policy: If the U.S. and a substantial number of other industrial economies adopted a gold standard, the U.S. would lose the ability to tune its economic policies to fit domestic conditions.

  • For example, in the spring of 1995 the dollar weakened against the yen. Under a gold standard, such a decline in the dollar would not have been allowed: instead the Federal Reserve would have raised interest rates considerably in order to keep the value of the dollar fixed at its gold parity, and a recession would probably have followed.

Recessionary bias: Under a gold standard, the burden of adjustment is always placed on the ‘weak currency’ country.

  • Countries seeing downward market pressure on the values of their currencies are forced to contract their economies and raise unemployment.
  • The gold standard imposes no equivalent adjustment burden on countries seeing upward market pressure on currency values.
  • Hence a deflationary bias, which makes it likely that a gold standard regime will see a higher average unemployment rate than an alternative managed regime.

The gold standard and the Great Depression: The current judgment of economic historians (see, for example, Barry J. Eichengreen, Golden Fetters is that attachment to the gold standard played a major part in keeping governments from fighting the Great Depression, and was a major factor turning the recession of 1929-1931 into the Great Depression of 1931-1941.

  • Countries that were not on the gold standard in 1929–or that quickly abandoned the gold standard–by and large escaped the Great Depression
  • Countries that abandoned the gold standard in 1930 and 1931 suffered from the Great Depression, but escaped its worst ravages.
  • Countries that held to the gold standard through 1933 (like the United States) or 1936 (like France) suffered the worst from the Great Depression
  • Commitment to the gold standard prevented Federal Reserve action to expand the money supply in 1930 and 1931–and forced President Hoover into destructive attempts at budget-balancing in order to avoid a gold standard-generated run on the dollar.
  • Commitment to the gold standard left countries vulnerable to ‘runs’ on their currencies–Mexico in January of 1995 writ very, very large. Such a run, and even the fear that there might be a future run, boosted unemployment and amplified business cycles during the gold standard era.
  • The standard interpretation of the Depression, dating back to Milton Friedman and Anna Schwartz’s Monetary History of the United States, is that the Federal Reserve could have, but for some mysterious reason did not, boost the money supply to cure the Depression; but Friedman and Schwartz do not stress the role played by the gold standard in tieing the Federal Reserve’s hands–the ‘golden fetters’ of Eichengreen.
  • Friedman was and is aware of the role played by the gold standard–hence his long time advocacy of floating exchange rates, the antithesis of the gold standard.

Consequences for the Long-Run Average Rate of Inflation:

Average inflation determined by gold mining: Under a gold standard, the long-run trajectory of the price level is determined by the pace at which gold is mined in South Africa and Russia.

  • For example, the discovery and exploitation of large gold reserves near present-day Johannesburg at the end of the nineteenth century was responsible for a four percentage point per year shift in the worldwide rate of inflation–from a deflation of roughly two percent per year before 1896 to an inflation of roughly two percent per year after 1896. In the election of 1896, William Jennings Bryan’s Democrats called for free coinage of silver as a way to end the then-current deflation and stop the transfer of wealth away from indebted farmers. The concurrent gold discoveries in South Africa changed the rate of drift of the price level, and accomplished more than the writers of the Democratic platform could have dreamed, without any change in the U.S. coinage.
  • Thus any political factors that interrupted the pace of gold mining would have major effects on the long-run trend of the price level–send us into an era of slow deflation, with high unemployment. Conversely, significant advances in gold mining technology could provide a significant boost to the average rate of inflation over decades. Under the gold standard, the average rate of inflation or deflation over decades ceases to be under the control of the government or the central bank, and becomes the result of the balance between growing world production and the pace of gold mining.

Why Do Some Still Advocate a Gold Standard?

  • A belief that governments and central banks should not control the average rate of inflation over decades, and that the world will be better off if the long-run drift of the price level is determined ‘automatically.’
  • A belief that bondholders and investors will be reassured by a government committed to a gold standard, will be confident that inflation rates will be low, and so will bid down nominal interest rates.
  • Of course, if you do not trust a central bank to keep inflation low, why should you trust it to remain on the gold standard for generations? This large hole in the supposed case for a gold standard is not addressed.
  • Failure to recognize the role played by the gold standard in amplifying and propagating the Great Depression.
  • Failure to recognize that the international monetary system functions best when the burden-of-adjustment is spread between balance-of-payments ‘surplus’ and ‘deficit’ countries, rather than being loaded exclusively onto ‘deficit’ countries.
  • Failure to recognize how gold convertibility increases the likelihood of a run on the currency, and thus amplifies recessions.

Must-Read: Paul Krugman: The Investment Accelerator and the Woes of the World

Posted on by Brad DeLong

Must-Read: I must say, I want to go back to Larry Summers’s and my discussants for our 2012 paper, and ask them whether they want to amend their remarks, or whether they still stand by them.

Valerie Ramey: Do you still believe that any valid inferences can be made about long-run properties from AR models that match the first several autocorrelations? And do you still believe that the rate of long-run potential output growth is invariant to whether the short-run sees depression or boom?

Marty Feldstein: Do you still believe that a downturn like the one that began in 2008 is “cleansing” and leads potential output onto a higher growth path in the long run?

Paul Krugman: The Investment Accelerator and the Woes of the World: “Jason Furman… refuting the ‘Ma! He’s looking at me funny!’ school…

…which attributes US economic weakness to the way the Obama administration has created uncertainty, or hurt businessmen’s feelings, or something…. It’s a global slowdown, very much consistent with the ‘accelerator’ model, in which the level of investment demand depends on the rate of growth of overall demand…. If weak demand leads to lower investment, which it does, and if fiscal austerity is contractionary, which it is, then in a depressed economy deficit spending… crowds investment in…. Austerity policies [then] don’t release resources for private investment… [but] reduce future capacity in addition to causing present pain, [while] stimulus… supports, not hinders, long-run growth…

And let me say two further things to Jason Furman:

  1. Housing: the failure of the Obama administration to do anything to set the pattern of housing finance in stone may well be boosting uncertainty, and retarding investment in housing

  2. Investment and interest rates: If you are unhappy with a Federal Reserve that thinks that investment is growing too rapidly and needs to be cooled-off with interest rate increases, there is, on January 4, 2017, a recess of the Congress, during which recess appointments can be made.

Must-Read: Menzie Chinn: “Inflation Expectations Can Change Quickly…”

Posted on by Brad DeLong

Must-Read: It is not clear to me that inflation expectations would undergo a “rapid and dramatic shift” even if we had a “drastic regime change”. Or rather, as Stan Fischer told me when we were discussing Tom Sargent’s “Stopping Moderate Inflation” and “End of Four Big Inflations” papers, we say after the fact that we had a drastic regime change if and only if inflation expectations underwent a rapid and dramatic shift. It’s not something that one can do–especially living, as we do, not in Plato’s Republic but in Romulus’s Sewer…

Menzie Chinn: “Inflation Expectations Can Change Quickly…”: “One of the arguments for acting sooner rather than later on monetary policy…

…is that if the slack disappears, inflationary expectations will surge… [aA] in this quote from reader Peak Trader’s comment…. I am sure if there is a drastic regime change, one could see a rapid and dramatic shift in measured expectations; the question is whether that scenario is relevant and/or plausible…. I will let readers decide whether expectations turned on a dime. They seem pretty adaptive to me.

Inflation expectations can change quickly Econbrowser

Question: Neel Kashkari to Replace Narayana Kocherlakota at the Minneapolis Fed?

Posted on by Brad DeLong

Can somebody remind me: where was Neel Kashkari in September 2008 on letting Lehman go into uncontrolled bankruptcy?

History: John Maynard Keynes Getting One Very Wrong

Posted on by Brad DeLong

Here it is plain to me that Keynes has simply not understood John Hicks–call this Keynes “Keynes the Pre-Hicksian”:

John Maynard Keynes (1937): The General Theory of Employment: “There are passages which suggest that Professor Viner is thinking too much…

…in the more familiar terms of the quantity of money actually hoarded,and that he overlooks the emphasis I seek to place on the rate of interest as being the inducement not to hoard. It is precisely because the facilities for hoarding are strictly limited that liquidity preference mainly operates by increasing the rate of interest. I cannot agree that “in modern monetary theory the propensity to hoard is generally dealt with, with results which in kind are substantially identical with Keynes’, as a factor operating to reduce the ‘velocity’ of money.” On the contrary, I am convinced that the monetary theorists who try to deal with it in this way are altogether on the wrong track.

Again, when Professor Viner points out that most people invest their savings at the best rate of interest they can get and asks for statistics to justify the importance I attach to liquidity-preference, he is over- looking the point that it is the marginal potential hoarder who has to be satisfied by the rate of interest, so as to bring the desire for actual hoards within the narrow limits of the cash available for hoarding. When, as happens in a crisis, liquidity-preferences are sharply raised, this shows itself not so much in increased hoards–for there is little, if any, more cash which is hoardable than there was before–as in a sharp rise in the rate of interest, i.e. securities fall in price until those, who would now like to get liquid if they could do so at the previous price, are persuaded to give up the idea as being no longer practicable on reasonable terms. A rise in the rate of interest is a means alternative to an increase of hoards for satisfying an increased liquidity-preference.

Nor is my argument affected by the admitted fact that different types of assets satisfy the desire for liquidity in different degrees. The mischief is done when the rate of interest corresponding to the degree of liquidity of a given asset leads to a market-capitalization of that asset which is less than its cost of production…

It seems very clear that this Keynes has not yet read–or has not understood–John Hicks (1937), “Mr. Keynes and the ‘Classics’: A Suggested Interpretation”.

Keynes thinks that money demand consists of three terms:

  • kPY, the amount of money needed to grease the amount PY of total nominal spending,
  • S, the liquidity-preference speculative demand for money, and
  • -jr, a term that depends on increases in the interest rate r curbing the speculative demand for money, and also inducing people to economize on their transactions balances.

For a given money supply, M, this gives us a money demand-money supply equation:

M = kPY + S – jr

Jacob Viner wants to take this equation and rewrite it in quantity-theory terms as an LM-curve relation:

kPY = M – S + jr

Y = [M – S + jr]/Pk

Y = (M/P)V, with V = [1-(S/M)-(jr/M)]/k

An increase in Keynes’s liquidity preference S is thus a reduction in the velocity of money V associated with any interest rate r. This is what Viner means when he writes that:

In modern monetary theory the propensity to hoard is generally dealt with, with results which in kind are substantially identical with Keynes’, as a factor operating to reduce the ‘velocity’ of money.

And he is correct.

Keynes says he disagrees. He claims that the key effect of a rise in liquidity preference is not to reduce the velocity of money–to produce “increased hoards”–but rather to raise the interest rate r. And working through the IS-curve relation:

Y = C + I
C = co + (cy)Y
I = io – (ir)r
Y = [co + io]/(1-cy) – [ir/((1-cy)]r

This rise in r reduces real spending Y.

Keynes is right when he says that an increase in liquidity preference S reduces Y working through the IS-curve relationship. But Keynes is wrong when he says that implies that Viner is wrong. Viner is right too. The LM-curve and the IS-curve relations jointly determine Y and r. You can use either. In fact, you have to use both in order to get an answer, even if you are not aware that you are using both. That is what Hicks made clear. But Keynes does not know it. And I see no signs that Viner knows it either.

Must-Read: Ricardo Caballero, Emmanuel Farhi, and Pierre-Olivier Gourinchas: Welcome to the ZLB Global Economy

Posted on by Brad DeLong

Must-Read: Am I wrong in seeing all this as basically: Triffin Dilemma II?

Ricardo Caballero, Emmanuel Farhi, and Pierre-Olivier Gourinchas: Welcome to the ZLB Global Economy: “Via expenditure-switching effects, the exchange rate affects the distribution…

…of a global liquidity trap across countries… fertile grounds for ‘beggar-thy-neighbour’ devaluations…. By the same token, our analysis implies that if a currency appreciates, possibly because it is perceived as a ‘reserve currency,’ then this economy would experience a disproportionate share of the global liquidity trap…. Arguably, this mechanism captures a dimension of the exchange rate appreciation struggles of Switzerland during the recent European turmoil, of Japan before the implementation of ‘Abenomics’, and of the US currently….

It is possible for some regions of the world to escape the liquidity trap if their inflation targets are sufficiently high…. Both issuing additional debt or a balance budget increase in government spending can potentially address the net shortage of assets and stimulate the economy in all countries, alleviating a global liquidity trap. They are associated with large Keynesian multipliers…. World interest rates and global imbalances go hand in hand: countries with large safe asset shortages run current account surpluses and drag the world interest rate down. Once at the ZLB, the global asset market is in disequilibrium: there is a global safe asset shortage that cannot be resolved by lower world interest rates… [that] is instead dissipated by a world recession… propagated by global imbalances…. Unfortunately, this state of affairs is not likely to go away any time soon. In particular, there are no good substitutes in sight for the role played by US Treasuries in satisfying global safe asset demand…

New thinking: Larry Summers puts in his 2 cents on “hysteresis” and “superhysteresis”

Posted on by Brad DeLong

Let me point out that, to the extent one recognizes even the possibility of hysteresis or superhystesis, obvious optimal control policy when you approach the zero lower bound is to dial up current monetary expansion to the max and call for more fiscal expansion as well. The long-run damage from not generating a V-shaped recovery in the short-run is then immense, and you always dial policy down to be less expansionary should it look like you were about to overshoot. Yet such arguments had no purchase in the Bernanke Fed or the Geithner Treasury, and little inside the Obama White House.

I must confess that I have never understood why people ever thought it reasonable to believe that the pace of potential output growth was the same in a low pressure as an high-pressure economy. And, indeed, it is not:

Larry Summers: Advanced Economies Are so Sick We Need a New Way to Think About Them: “There appear to be more cases where recessions reduce the subsequent growth of output…

…than where output returns to trend. In other words ‘super hysteresis,’ to use Larry Ball’s term, is more frequent than ‘no hysteresis.’… We look at… recessions with different precursors. We find that even recessions that are associated with disinflationary monetary policies or the drying up of credit have substantial long-run output effects–suggesting the presence of hysteresis effects…. [Moreover,] fiscal policy changes have large continuing effects on levels of output suggesting the importance of hysteresis…

But we knew all this back in 1936, no? John Maynard Keynes:

John Maynard Keynes (1936): The General Theory of Employment, Interest and Money, chapter 24: “The enlargement of the functions of government…

…[is] the only practicable means of avoiding the destruction of existing economic forms in their entirety and as the condition of the successful functioning of individual initiative…. If effective demand is deficient, not only is [there] the public scandal of wasted resources… but the individual enterpriser… is operating with the odds loaded against him… many zeros, so that the players as a whole will lose if they have the energy and hope to deal all the cards. Hitherto the increment of the world’s wealth has fallen short of the aggregate of positive individual savings; and the difference has been made up by the losses of those whose courage and initiative have not been supplemented by exceptional skill or unusual good fortune. But if effective demand is adequate, average skill and average good fortune will be enough…

Only in a high-pressure economy, Keynes says, will the “increment of wealth”–the value of productive capital and organizations created–match “the aggregate of positive individual savings”–the amount of resources devoted to trying to boost productive capacity. In a low-pressure economy, a lot of investments that could pay off from a tastes-and-technologies standpoint won’t because of slack demand, and so perfectly-productive factories and organizations will be scrapped and shut down.

And we have to add on to this the perspective, derived from Granovetter, that a great deal of the societal resource-allocation capital of the labor market is the social network of loose ties generated that nobody gets paid for, and is thus a spillover; the perspective, derived from Saxenian, that a great deal of the societal resource-allocation capital of the value chain is the social network of overlapping communities of engineering practice generated that nobody gets paid for, and is thus a spillover; and the perspective derived from Hayek that a great deal of the societal resource-allocation capital of the price system is the revelation by market prices of societal scarcities and values that nobody could calculate on their own, and that nobody gets paid for generating, and is thus a spillover. Externalities all over the place here!

The question is: why did people ever assume otherwise? Yes, a linear Phillips Curve is simple to work with. Yes, the assumption that the rate of inflation expected next year is simply actual inflation last year seems like a not unreasonable rule-of-thumb. But you have to put very great weight on both–weight that the past decade has conclusively proven they cannot bear–to even conclude the business cycles are fluctuations around rather than falls below sustainable levels of production. And you are still absolutely nowheresville with respect to the invariance of potential growth to cyclical conditions.

Thoughts: Unconventional Monetary and Exchange Rate Policies: The Final Jacques Polak Annual Research Conference Panel

Posted on by Brad DeLong

Live from the Sixteenth Jacques Polak Conference: Sixteenth Jacques Polak Annual Research Conference: “Unconventional Monetary and Exchange Rate Policies”

Adam Posen: To talk about misallocation of capital and added financial risk at great length without mentioning “regulation” once. And to talk about how quantitative easing has greatly added to systemic risk when its principal disappointment has been the failure of quantitative easing to persuade pension funds and corporations to extend themselves out the yield curve.

The argument that ultra-low interest rate policies add to systemic risk seems to be based on a view that they do both of:

  • inducing people to create more long-duration assets
  • increasing the duration of existing assets.

And that a world with a lot of long-duration assets is one of great systemic risk.

As we move into our post-December world, the Federal Reserve will have three levers to control 2.5 dimensions of policy:

  • The federal funds rate.
  • The rate of interest on reserves.
  • The size of its balance sheet.

What is our thumbnail measure of monetary policy in such a world?

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…