Ryan Avent quotes from a very interesting paper by Guillermo Calvo, Fabrizio Coricelli, and Pablo Ottonello:

This paper documents that, for a sample of post-war recession episodes in advanced and emerging market economies (EMs), financial crises tend to be followed by jobless recoveries in the presence of low inflation and by “wageless” recoveries in the presence of high inflation…

In advanced economies, where inflation in the post-war era has been relatively low, financial crises have been followed by jobless recoveries of intensity significantly stronger than “normal” recessions…

In EMs, heterogeneity in inflation allows us to divide the sample in “high” and “low” inflation episodes. We find again a sluggish adjustment of labor markets during the recovery from financial crises, but the nature of such adjustment depends on inflation. “High inflation” recession episodes are not associated jobless recoveries but wageless recoveries. This is consistent, empirically, with the findings in Calvo et al (2006), in which EMs that suffer a systemic sudden stop experience wageless recoveries, and, theoretically, with the model by Schmitt-Grohé and Uribe (2011), whereby in the presence of nominal wage rigidities, economies that generate inflation (for instance through a nominal exchange rate depreciation) are able to restore full employment in the labor market. In contrast, low inflation EMs display a pattern similar to the one observed in advanced economies, with financial crises associated to more intense jobless recoveries.

In the low-inflation rich world, recessions associated with financial crises produce jobless recoveries. In the emerging world, low-inflation episodes after such recessions look like rich-world recoveries while in high-inflation scenarios wages are stagnant but employment bounces back quickly.

Ryan comments as follows:

In the low-inflation rich world, recessions associated with financial crises produce jobless recoveries. In the emerging world, low-inflation episodes after such recessions look like rich-world recoveries while in high-inflation scenarios wages are stagnant but employment bounces back quickly.

So financial crises tend to lead to slow recoveries only when accompanied by tight money.  One more nail in the conventional wisdom about the recent recession. Ryan also makes the following observation:

My mental model of the link between jobless recoveries, post-crisis, and low inflation is a bit different than the one used in the paper. My supposition has been that the main link between the two is the zero lower bound.

That’s certainly possible (although it didn’t seem to be a big problem for FDR in 1933), but I don’t recall many cases of developing countries hitting the zero bound in the post-war data.  Perhaps someone can help me; prior to 2008 were there many developing countries facing the zero interest rate bound?  I’m inclined to see the problem as simply tight money, nothing more.

Unless you think the slow recoveries are structural.  I.e., unless you believe those developing countries with high inflation are remarkably free of structural problems.  Given what you know about developing countries with high inflation that are recovering rapidly from financial crises (say Argentina post-2002), does that explanation seem intuitively plausible?

Nearly 15 years ago Milton Friedman was shocked to discover that he was one of the very few economists who understood that low rates don’t mean easy money, something he had assumed was pretty obvious:

Low interest rates are generally a sign that money has been tight, as in Japan; high interest rates, that money has been easy.

.   .   .

After the U.S. experience during the Great Depression, and after inflation and rising interest rates in the 1970s and disinflation and falling interest rates in the 1980s, I thought the fallacy of identifying tight money with high interest rates and easy money with low interest rates was dead. Apparently, old fallacies never die.

More recently Brad DeLong was shocked to discover than most economists didn’t think there was an obvious need for more monetary stimulus, even when NGDP had suddenly plunged 10% below trend:

And I thought that economists had an effective consensus on macroeconomic policy. I thought everybody agreed that the important role of the government was to intervene strategically in asset markets to stabilize the growth path of nominal GDP. I thought that all of the disputes within economics were over what was the best way to accomplish this goal. I did not think that there were any economists who would look at a 10% shortfall of nominal GDP relative to its trend growth path and say that the government is being too stimulative.

I’m not going to criticize the naivete of these two outstanding economists, as I made both mistakes.  But I’m increasingly convinced that there is a connection between these two complaints.

Ask yourself why poll after poll shows that most economists do not think monetary policy is too tight.  Indeed economists were skeptical of the need for additional monetary stimulus even before QE3, which means the Fed is actually more stimulative than what the median economist would prefer.  I have to think that the only reason most economists believe the Fed has done enough is that they (wrongly) believe the Fed has already done a lot.  What other explanation could there possibly be? Surely if the fed funds target was currently 8.25%, most economists would favor lowering it to at least 8.0%.  They see the need for more AD, they just don’t want the Fed (and perhaps Congress as well) to do any more.

So that’s the connection; because economists don’t understand that money is tight they are content to let NGDP languish at low levels, without demanding additional monetary stimulus.

It wasn’t just Milton Friedman who said low rates don’t mean easy money, so did Mishkin and Bernanke.  I thought if the number one money textbook author, the number one monetary policymaker, and the number one monetary economist all emphasized that low rates don’t mean easy money, then the profession would have absorbed that message.

I was wrong.

Milton was right; apparently old fallacies never die.

PS.  There’s a new study that contains the actual transcripts of the Bretton Woods Conference.  The editors are Kurt Schuler and Andrew Rosenberg.  I look forward to reading it after the semester is over.

Nicolas Goetzmann sent me the following report from Deutsche Bank:

The FOMC’s meeting will also be a key event to watch today after some market chatter yesterday of the possibility of changing the extended period language into nominal GDP targeting. For the record, DB’s Peter Hooper noted that the Fed will have no inclination to make any notable changes today following the QE3 announcement last month. Maintaining a low profile given the upcoming Presidential election is also a reason for keeping the status quo intact.

And I was also intrigued by this:

While on the subject of the FOMC, the New York Times reported that Ben Bernanke will not stand for a third term even if President Obama wins the November 6th election. Bernanke’s current terms ends on Jan 2014. The news didn’t help gold prices, which finished 1.21% lower, in its largest one-day loss since July 10th.

Stocks also fell yesterday, although I have no evidence that the Bernanke news played a role.

Yesterday the Mercatus Center published my latest paper advocating NGDP targeting.  Coincidentally, on the same day David Beckworth and I presented the case for NGDP targeting on Capitol Hill.  Bob McTeer moderated and the turnout was larger than usual.

Saturos pointed out (correctly) that I am inconsistent in my use of the term ‘bubble’, sometimes arguing that NGDP targeting can reduce bubbles, and sometimes arguing that they don’t exist.  This has also bugged sticklers for accuracy like Bob Murphy.  I plead guilty.  I don’t believe in bubbles in the sense of asset price movements that obviously diverge far from a rational expectation of fundamental value.  I do believe there are asset price movements that look like bubbles to the average person, and which are regarded as bubbles.  Those are big increases in asset prices, followed by big decreases.  Most people (wrongly) assume those big swings obviously do not represent changes in a rational expectation of fundamental value.

Generally whenever I use terms like ‘bubble’ or ‘income’ or ‘inflation’ you should think of them in terms of scare quotes; “bubbles” or “income” or “inflation,” even if I forget to use the quotation marks.  I am using the terms as they are generally regarded by society.  I believe in the EMH, not bubbles, I believe in consumption, not income, and I believe in NGDP growth, not inflation.

Oh and one other thing.  Whenever I talk about “wages” I mean hourly wages, not wages per employee.

PS.  Obviously NGDP is national “income.”  I don’t believe income data for individuals is meaningful.  Look at consumption.

Here’s Karl Smith quoting Tyler Cowen, and then commenting:

Tyler Cowen asks

“The economist Scott Sumner stated the case against fiscal policy another way on his blog The Money Illusion. Sumner noted that no one believes fiscal policy (unlike monetary policy) could be used to target a price inflation rate of say 4 per cent a year. The implication is that fiscal policy is not very effective in managing overall demand in an economy, so why should we so trust it as a tool of crisis management?”

The simple answer is that knowing exactly what you are doing is far less important in a crisis than near full employment.  Near full employment, not only does the optimal quantity of stimulus vary highly in percentage terms but it actually changes sign. Sometimes you want negative stimulus to keep the economy from overheating.

Far away from full employment much blunter tools can be used. You may not really know what the stimulus effect of fiscal policy is, but you don’t need to know. In a depression for example, optimal quantity of stimulus is big and positive, so you just do something big. You just fling resources in the general vicinity of the problem.

Obviously, I am attracted to this question because I think it is premised on a falsity of “far thinking”, that important situations call for carefully thought-out actions. This is not actually case.

Sometimes the net return-to-action is positive over the entire relevant range. In those cases smart finely tuned action is worthless and getting the most bang for your buck is actively harmful.

You always maximize simply by going full throttle regardless of the cost. This is because marginal benefit always exceeds marginal cost over your range. Note that this will generally not be the point that maximizes the rate-of-return or “bang for the buck.”

.  .  .

This is the perfect realm for something like fiscal policy. Efficiency is not something that central governments are good at. On the other hand, really-freaking-huge, is something that central governments are good at it.

First let me say that I can see lots of possible objections to my argument, but I am pretty sure that Karl misunderstood my claim.  I wasn’t so much arguing that fiscal policy lacked the precision to deliver 4% inflation, I was claiming that it lacked the ooomph, to use Deirdre McCloskey’s term.  I agree that precision is overrated when in an emergency.

Suppose real GDP growth is 2%.  Then if the fiscal authority wants to get 4% inflation, you need 6% NGDP growth.  And if the fiscal authority is getting no help from the monetary authority, then you’d need to deliver 6% velocity growth.

It is true that an expansionary fiscal policy can boost velocity, but it quickly runs up against a huge problem (which is nicely explained in Mishkin’s text.)  You don’t just need big deficits to raise velocity at 6% per year; you need rapidly rising deficits.  Thus a deficit of say 8% of GDP, maintained year after year after year, will only provide a one-time boost to velocity.  In that case you need a deficit of 16% of GDP the second year, then 24% the third.  (Those numbers are illustrative; I don’t know how large the deficit would have to be.) Relatively quickly you’d run out of money, and then you would get assistance from the monetary authority, as Congress would order them to monetize the debt to prevent bankruptcy.  But without help from the monetary authority, fiscal policy is far too weak to target inflation at 4%/year, or indeed even 2%/year.

In contrast, as long as the central bank is independent, and not forced to monetize the debt, it can target many different inflation rates and pretty much ignore what Congress is doing.  Fiscal authorities can’t do it without help from the central bank, but the monetary authority can do it without help from the Congress.  That’s the way our system works in America.  The Fed determines the track for NGDP, and Congress must learn to live with those constraints.  Zimbabwe is different.

Now of course that doesn’t mean there aren’t arguments for fiscal stimulus at the zero bound, but there’s no point in rehashing that debate here.

PS.  David Beckworth and I advocated NGDP targeting in front of about 70 staffers on Capitol Hill earlier today.  Former Dallas Fed President Bob McTeer moderated.  I’m told the crowd was larger than normal—SRO.  Later there’ll be a link put up on the internet.

PPS.  There’s a recent debate about whether money is a bubble.  It can’t be a bubble, as there is no such thing as bubbles.