Tag: Say’s Law

Note to Self: I Still Fail to Understand Ken Rogoff’s Medium-Long Term Macroeconomic Optimism…

Posted on by Brad DeLong

Ken Rogoff: “In nine years, nobody will be talking about ‘secular stagnation’. I’ve been debating Larry on this for a year, and I started saying ‘in ten years…, and so for consistency I now say ‘in nine years…”.

10 Year Treasury Constant Maturity Rate FRED St Louis Fed

This is a wager that the full-employment long-run in which money and its associates are a veil that does not affect or disturb the Say’s Law operation of the economy will come not more than 18 years after the shock of 2017–or at least that whatever remnants of the effects of that shock on the business cycle come 2025 will be dwarfed the effects of other business cycle shocks subsequent to now.

I do know from experience that one disagrees with Ken Rogoff at one’s grave intellectual peril. But is he correct here? I really cannot follow him to the conclusion he wants me to reach…

Things to reread and chew over:

  • Paul Krugman (2015): The Inflationista Puzzle: “Traditional IS-LM analysis said that the Fed’s [expansionary QE] policies would have little effect on inflation; so did the translation of that analysis into a stripped-down New Keynesian framework that I did back in 1998, starting the modern liquidity-trap literature. We even had solid recent empirical evidence: Japan’s attempt at quantitative easing in the naughties…. I’m still not sure why relatively moderate conservatives like Feldstein didn’t find all this convincing back in 2009…”

  • J. Bradford DeLong (2015): New Economic Thinking, Hicks-Hansen-Wicksell Macro, and Blocking the Back Propagation Induction-Unraveling from the Long Run Omega Point

  • Paul Krugman (2015): Backward Induction and Brad DeLong: “Brad DeLong is, unusually, unhappy with my analysis in a discussion of the inflationista puzzle–the mystery of why so many economists failed to grasp the implications of a liquidity trap, and still fail to grasp those implications despite 6 years of being wrong. Brad sorta-kinda defends the inflationistas on the basis of backward induction; I find myself somewhat baffled by that defense…”

  • Paul Krugman (2015): Rethinking Japan: “Secular stagnation and self-fulfilling prophecies: Back in 1998… I used a strategic simplification… [assumed] the Wicksellian natural rate… would return to a normal, positive level at some future date. This… provided a neat way to deal with the intuition that increasing the money supply must eventually raise prices by the same proportional amount; it was easy to show that this proposition applied only if the money increase was perceived as permanent, so that the liquidity trap became an expectations problem… [so] that if the central bank could “credibly promise to be irresponsible,” it could gain traction even in a liquidity trap. But what is this future period of Wicksellian normality of which we speak?… Japan looks like a country in which a negative Wicksellian rate is a more or less permanent condition. If that’s the reality, even a credible promise to be irresponsible might do nothing…. The only way to be at all sure of raising inflation is to accompany a changed monetary regime with a burst of fiscal stimulus…. While the goal of raising inflation is, in large part, to make space for fiscal consolidation, the first part of that strategy needs to involve fiscal expansion. This isn’t at all a paradox, but it’s unconventional enough that one despairs of turning the argument into policy…”

  • Paul Krugman (2015): St. Augustine and Secular Stagnation: “The assumption here is that the neutral rate will eventually rise so that monetary policy can take over the job of achieving full employment. What if we have doubts about whether that will ever happen? Well, that’s the secular stagnation question… a situation in which the neutral interest rate is normally, persistently below zero. And this raises a puzzle: If we worry about secular stagnation, should we then say that St. Augustine no longer applies, because better days are never coming? No. The way to deal with secular stagnation, if we believe in our models, is to raise the long-run neutral interest rate…. If we can do this via structural reform and/or self-financing infrastructure investment, fine. If not, raise the inflation target. And how do we get to the higher target inflation rate, when monetary policy is having trouble getting traction? Fiscal policy! If you’re really worried about secular stagnation, you should advocate a combination of a raised inflation target and a burst of fiscal stimulus to help the central bank get there. So the St. Augustine approach is right either way, with secular stagnation suggesting the need to be even less chaste in the short run.”

  • J. Bradford DeLong (2015): Must-Read: Paul Krugman: Rethinking Japan: “Paul Krugman’s original argument assumed that the economy would eventually head towards a long-run equilibrium in which flexible wages and prices would make Say’s Law hold… [with] the price level would be proportional to the money stock. That now looks up for grabs. It is the fact that that is up for grabs that currently disturbs Paul. Without a full-employment Say’s Law equilibrium out there in the transversality condition to which the present day is anchored by intertemporal financial-market and intertemporal consumer-utility arbitrage, all the neat little mathematical tricks that Paul and Olivier Blanchard built up at the end of the 1970s to solve for the current equilibrium break in their hands…. There is… more. Paul Krugman’s original argument also assumed back-propagation into the present via financial-market… and consumer-satisfaction intertemporal… arbitrage of the effects of that future well-behaved full-employment equilibrium. The equilibrium has to be there. And the intertemporal arbitrage mechanisms have to work. Both have to do their thing…”

  • J. Bradford DeLong (2015): The Scary Debate Over Secular Stagnation: Hiccup… or Endgame?

  • Paul Krugman (2015): On Being Against Secular Stagnation Before You Were for It

  • Duncan Weldon (2016): Negative Yields, the Euthanasia of the Rentier, and Political Economy: “I understand the mechanics of engine that took us here but not what the driver was thinking…”

  • J. Bradford DeLong (2015): Just What Are the Risks That Alarm Ken Rogoff?: “This part of Ken Rogoff’s piece appears to me to be very much on the wrong track: ‘Ken Rogoff: Debt Supercycle, Not Secular Stagnation: Robert Barro… has shown that in canonical equilibrium macroeconomic models small changes in the market perception of tail risks can lead both to significantly lower real risk-free interest rates and a higher equity premium…. Obstfeld (2013) has argued cogently that governments in countries with large financial sectors need to have an ample cushion, as otherwise government borrowing might become very expensive in precisely the states of nature where the private sector has problems…’ We need to be clear about what the relevant tail-risk states that Ken Rogoff is talking about are…. [They are that] even though it was sold at a high price and carries a low interest rate, the issuing of government debt is very expensive to the government [because] when the time comes in the bad state of the world for it to raise the money to amortize the debt, it finds that it really would very much rather not do so. It is clear if you are Argentina or Greece what the risk is: it is of a large national-level terms-of-trade or political shock, something that you can insure against by investing in the ultimate reserves of the global monetary system. If you are the United States or Germany or Japan or Britain, what is the risk? What is the risk that cannot be handled at low real resource cost by a not-injudicious amount of inflation, or of financial repression?”

  • J. Bradford DeLong (2015): Watching a Discussion: The Omega Point

Is there a “correct” monetary policy? Yes!

Posted on by Brad DeLong

In what way does Peter Gourevitch think that Paul Krugman’s analysis of the Federal Reserve is wrong?

Here we have, first, Gourevitch saying: “opinions of the shape of the earth always differ”:

Peter Gourevitch: This is why Paul Krugman is wrong about the Federal Reserve: “The second set of criticisms reflects a more fundamental disagreement between economics and political science…

…Economists tend to assume that there is a single right answer (even if they disagree bitterly among each other about what the right answer is)…. Political scientists… assume that there is more than one interpretation of what is correct, and try to come up with theories about which “correct” answer is chosen…

I reject this.

I reject this completely.

I reject this utterly.

For more than a hundred years there has been a broad near-consensus among economists that there is such a thing as a “correct” monetary policy.

To quote Keynes (1924):

Rising prices and falling prices each have their characteristic disadvantages. The Inflation which causes the former means Injustice to individuals and to classes,–particularly to investors; and is therefore unfavorable to saving. The Deflation which causes falling prices means Impoverishment to labour and to enterprise by leading entrepreneurs to restrict production in their endeavour to avoid loss to themselves; and is therefore disastrous to employment, The counterparts are, of course, also true,–namely that Deflation means Injustice to borrowers, and that Inflation leads to the over-stimulation of industrial activity. But these results are not so marked… borrowers are in a better position to protect themselves than lenders… labour is in a better position to protect itself from over-exertion in good times than from under-employment in bad times.

Thus Inflation is unjust and Deflation is inexpedient. Of the two perhaps Deflation is, if we rule out exaggerated inflations such as that of Germany, the worse; because it is worse, in an impoverished world, to provoke unemployment than to disappoint the rentier. But it is not necessary that we should weigh one evil against the other. It is easier to agree that both are evils to be shunned. The Individualistic Capitalism of to-day, precisely because it entrusts saving to the individual investor and production to the individual employer, presumes a stable measuring rod of value, and cannot be efficient–perhaps cannot survive–without one…

Paul Krugman’s point is that the consensus of the 1980 MIT macroeconomics posse is that right now a higher inflation target than 2%/year is appropriate and that raising interest rates is not appropriate. “Opinions of shape of earth differ” or even “There is no correct answer when there are competing rival views that are not easily testable in a complex world where one cannot readily carry out controlled experiments with obvious real world interpretations…” simply does not clear the bar as a criticism.

As I like to put it, back in 1820 Thomas Robert Malthus identified a “general glut” as a problem independent from and much more dire than a simple misallocation of productive resources that produced excess supply in one industry and excess demand in another:

Thomas Robert Malthus: The “General Glut” (1820): “[T]he effect of falling [manufacturing export] prices in reducing profits…

…is but too evident at the present moment. In the largest article of our exports, the wages of labour are now lower than they probably would be in an ordinary state of things if corn were at fifty shillings a quarter. If, according to [Ricardo’s] new theory of profits, the prices of our exports had remained the same, the master manufacturers would have been in a state of the most extraordinary prosperity, and the rapid accumulation of their capitals would soon have employed all the workmen that could have been found. But, instead of this, we hear of glutted markets, falling prices, and cotton goods selling at Kamschatka lower than the costs of production.

It may be said, perhaps, that the cotton trade happens to be glutted; and it is a tenet of the new doctrine on profits and demand, that if one trade be overstocked with capital, it is a certain sign that some other trade is understocked. But where, I would ask, is there any considerable trade that is confessedly under-stocked, and where high profits have been long pleading in vain for additional capital? The [Napoleonic] war has now been at an end above four years; and though the removal of capital generally occasions some partial loss, yet it is seldom long in taking place, if it be tempted to remove by great demand and high profits…

And back in 1829 the young John Stuart Mill identified the key cause as our possession of a monetary economy, and in a monetary economy Say’s Law–that supply creates its own demand–is false in theory: a general excess supply of pretty much all currently-produced goods and services, Malthus’s “general glut”, is the metaphysically-necessary consequence of an excess demand for whatever currently counts as money:

John Stuart Mill (1829): Essays on Some Unsettled Questions: “[In a non-monetary economy] the sellers and the buyers…

…for all commodities taken together, must, by the metaphysical necessity of the case, be an exact equipoise to each other; and if there be more sellers than buyers of one thing, there must be more buyers than sellers for another….

If, however, we suppose that money is used, these propositions cease to be exactly true…. Although he who sells, really sells only to buy, he needs not buy at the same moment when he sells; and he does not therefore necessarily add to the immediate demand for one commodity when he adds to the supply of another….

There may be, at some given time, a very general inclination to sell with as little delay as possible, accompanied with an equally general inclination to defer all purchases as long as possible. This is always actually the case, in those periods which are described as periods of general excess… which is of no uncommon occurrence….

What they called a general superabundance, was… a superabundance of all commodities relatively to money…. Money… was in request, and all other commodities were in comparative disrepute. In extreme cases, money is collected in masses, and hoarded; in the milder cases, people merely defer parting with their money, or coming under any new engagements to part with it. But the result is, that all commodities fall in price, or become unsaleable. When this happens to one single commodity, there is said to be a superabundance of that commodity; and if that be a proper expression, there would seem to be in the nature of the case no particular impropriety in saying that there is a superabundance of all or most commodities, when all or most of them are in this same predicament…

And ever since then, every monetary economist worthy of the name has sought a government and a central bank that will pursue a monetary policy that makes Say’s Law true in practice even though it is false in theory. Everyone has sought for a policy that makes the demand for money in conditions of full employment equal to the supply, so that we have neither an excess demand for money and Keynes’s inexpedient Deflation, nor an excess supply of money and Keynes’s unjust Inflation.

There is a single right answer in monetary policy. It is the policy that hits this sweet spot.