Archive for April 2017


Keynesianism as religion

If there is any intellectual framework that should have been discredited over the past decade it is old-style Keynesianism.  Unfortunately, just the opposite has happened.  Marcus Nunes directed me to a Noah Smith post that discusses the revival of old Keynesian ideas:

Another way of putting this is that Paul Krugman was right. Krugman has long advocated that macroeconomists learn to once again think in terms of simple simple Keynesian theory. And when more fully developed, complex models are needed, Krugman uses the kind of models that Christiano endorses.

As Christiano mentioned, the New Keynesian revolution isn’t so new. Even in the 1990s, economists like Greg Mankiw and Olivier Blanchard were arguing that monetary policy had real effects on demand. And at the same time, international macroeconomists were realizing that Japan’s post-bubble experience of slow growth, low interest rates and low inflation implied that demand shortages could last for a very long time unless the government rode to the rescue. Krugman, Adam Posen, Lars Svensson, and others were already referring to a Japan-type stagnation as a liquidity trap in the late 1990s, and warning that standard monetary policy of cutting interest rates wouldn’t work in that sort of situation. .  .  .

If economists gravitated toward anti-Keynesian theories, it was at least in part because evidence wasn’t strong enough to push them in the right direction. It’s just very hard to assess the impacts of fiscal stimulus. For example, Japan’s tremendous government spending binge in the 1990s looks to a casual observer like it had no effect, since the economy didn’t recover until years later — but government spending might have been the only thing saving the country from a deeper recession.

I certainly agree that Japan tells us a lot about the validity of old Keynesian thinking.  Here are some things it tells us:

1.  Depreciating the yen is a foolproof way of creating inflation.  Thus Keynes was wrong about monetary policy being ineffective at the zero bound.

2.  From 1993 to 2013 Japan ran up by far the largest peacetime fiscal deficits ever seen by a major economy.  And all that “stimulus” led to by far the worst growth in AD over 20 years ever seen by a major economy.  Roughly zero growth in NGDP over two decades.  And the Keynesian takeaway is that this was a great success, as it prevented an even more record-breaking fall in NGDP.  This is like a religious person who believes in the efficacy of prayer, prays for peace in 1939, and then later argues that his prayers prevented an even bigger war and Holocaust. Okaaaay . . .

3.  Then in 2013 Abe takes office and raises consumption taxes.  This fiscal tightening causes the debt to GDP ratio to level off at 250%.  Instead Abe relies on monetary stimulus, raising the inflation target.  And both inflation and NGDP growth actually increase, the opposite of the prediction of the old Keynesian model.

Of course I could go on and on.  There’s the letter signed by 350 Keynesians warning that the fiscal austerity of 2013 risked recession (growth actually sped up.) Or the fact that Keynesians don’t even know how to estimate the multiplier (as documented recently by Ryan Murphy.)

Smith points out that Paul Krugman realized in the late 1990s that the standard policy of cutting interest rates would no longer work at zero.  But he doesn’t tell you that everyone already knew that, even Milton Friedman.  AFAIK, not one economist in the entire world in the late 1990s thought that cutting interest rates when they were already zero would work. Perhaps you think I’m being too picky; what Smith really meant is that Krugman discovered that monetary stimulus no longer worked in Japan, and that fiscal stimulus was needed. Except that’s not true, in the late 1990s and early 2000s Krugman ridiculed the idea of using fiscal stimulus in Japan, and suggested that monetary stimulus was the obvious solution. Whatever “new facts” caused Krugman to revert to old Keynesianism more recently; it certainly wasn’t his famous 1998 study of Japan’s liquidity trap.  So what caused Krugman to change?  I’m not sure, but Smith hints at one possibility:

When evidence is sparse or inconclusive, things like sociology and politics often fill the gap.

Trump on poison gas

Here is Trump:

Trump didn’t just praise Hussein for keeping terrorists at bay, but seemed to tacitly accept the dictator’s use of chemical weapons. During a December rally in Hilton Head, South Carolina, Trump took a cavalier attitude toward Iraq’s use of chemical weapons under Saddam.

“Saddam Hussein throws a little gas, everyone goes crazy, ‘oh he’s using gas!'” Trump said.

But then he was shown pictures of beautiful babies who had been cruelly murdered.

PS.  Think of Trump as God.  People often ask, “How could an all-powerful God have allowed X to happen.”  Last year Trump was just a private citizen.  Syria was just a small country far away about which Trump knew little.  Now Trump is omniscient and all-powerful.  He has the intelligence services to show him awful pictures from all over the world.  He has weapons to crush tyrants who cruelly murder little babies.  Will he just stand by (as our universe’s actual God just stands by) and allow all this carnage?  What would you do if you were God?  How about if you were President?  Are the two answers different?  If so, why?

(FWIW, I don’t know the correct answer to any of those questions.)

HT:  Matt Yglesias

Did the US cause the Great Japanese deflation?

Commenter Jim Glass provided another Paul Krugman op ed, this one from 2001 2011:

Nonetheless, Mr. Koizumi is right about one thing: Japan cannot go on like this. Swelling public debt will eventually threaten the government’s solvency; the festering financial problems of the banks will soon require a government bailout that will swell that debt even further. Something must be done. But the actions Mr. Koizumi has proposed could tip Japan into full-blown depression.

There is an answer to this dilemma, one that has become almost orthodoxy among economists who have tried to think seriously about Japan’s plight. This answer involves unconventional monetary expansion, with the Bank of Japan buying dollars, euros and long-term government bonds; it also involves accepting and indeed promoting mild inflation and a weak yen. I could explain why this would probably work, but what’s the point? It’s not about to happen.

For the real tragedy right now is that however innovative and open-minded Mr. Koizumi may be, he will fail unless other important players — mainly the Bank of Japan, but also the U.S. Treasury Department — are prepared to learn from Andrew Mellon’s mistake. And all the evidence is that they are not. The head of the Bank of Japan insists that the country’s continuing slump is the result of inadequate reform — that is, insufficient purging of the rottenness. And although the details are in dispute, the U.S. Treasury secretary, Paul O’Neill, appears to have warned Japan not to let the yen weaken too much.

Poor Japan. It is the victim of those who refuse to learn from the past, and thereby condemn others to repeat it.

So even three years after the famous 1998 liquidity trap paper, Krugman was still favoring monetary stimulus over fiscal stimulus for countries at the zero bound. But I’d like to focus on the comment regarding our Treasury officials.  Krugman’s right that they have consistently warned the Japanese not to engage in “currency manipulation”.  What our Treasury doesn’t understand is that all central banks manipulate currencies—-that’s their job!  The only question is how.  And don’t say “It’s OK to manipulate the purchasing power of a currency but not the foreign exchange value.”  If the manipulation is done via central bank policy, then the two types of manipulation are identical. For decades, the US Treasury has been (unknowingly) warning the Japanese not to manipulate their economy out of deflation.

Ironically, a healthier Japanese economy would also be good for the US, boosting our exports and creating good jobs.  Pity that we are so dense.

PS.  Over at Econlog you’ll find a Trump post that is perhaps a bit less “unhinged” than usual.  At least I hope so.

When did Krugman change? And why?

Paul Krugman frequently suggests that his famous 1998 article (“It’s Baaack, Japan’s Slump and the Return of the Liquidity Trap”) led him to rethink the role of monetary and fiscal policy.  He says that the “expectations trap” model in that paper convinced him that monetary policy might be ineffective at the zero bound, and that fiscal policy might then become necessary.

Previously I’ve pointed to a 1999 Krugman essay that advocated monetary stimulus for Japan, and was quite dismissive of the idea of fiscal stimulus.  While cleaning out my office, I came across a Krugman editorial from the year 2000, which made similar arguments:

Japan has the dubious distinction of being the first major nation since the 1930’s to experience a “liquidity trap,” in which even cutting the interest rate all the way to zero doesn’t induce enough business investment to restore full employment. The result is an economy that has been depressed since the early 90’s, and that in 1998 seemed to be on the verge of a catastrophic deflationary spiral.

The government’s answer has been to prop up demand with deficit spending; over the past few years Japan has been frantically building bridges to nowhere and roads it doesn’t need.

In the short run this policy works: in the first half of 1999, powered by a burst of public works spending, the Japanese economy grew fairly rapidly. But deficit spending on such a scale cannot go on much longer. Japan’s government is already deeply in debt (about twice as deep, relative to national income, as the U.S. was before our own budget turned around). For the policy to do more than buy a little time, the recovery must become “self-sustaining”: consumers and businesses have to start spending enough to allow the government to return to fiscal responsibility without provoking a new recession.

Carping critics (like me) warned that there was no good reason to think this would happen. Sure enough, it hasn’t; as the big public works projects of early 1999 have wound down, so has the economy. . . .

Although the Bank of Japan has already reduced the short-term interest rate to zero, Western economists have pointed out that there are other things it can and should do: buy longer-term bonds, announce a positive target for inflation to encourage businesses to borrow. Indeed, textbook economics tells us that to adhere to conventional monetary rules in the face of a liquidity trap is not prudent; it is irresponsible. (Full disclosure: I personally have been the most visible and vociferous advocate of inflation targeting).

But the current government has actually slowed the pace of reform, and the Bank of Japan — which only recently acquired Federal Reserve-style autonomy — has adamantly refused to do anything unconventional. (When I was in Japan in December, I witnessed an argument between former B.O.J. officials and current officials of the Ministry of Finance. The former declared that it would be wrong to do anything risky; the latter reminded them, to no avail, that the current policy of running up huge debts to finance public works is already very risky.)

Of course Krugman turned out to be absolutely correct.  The fiscal stimulus never got Japan out of the liquidity trap, and it was only in 2013 that Japan finally adopted a 2% inflation target—and then prices started rising.  Krugman was very worried about Japanese debt levels when their national debt was less than 150% of GDP—now it’s 250%.  All those “bridges to nowhere” were a monumental waste of money, when a 2% inflation target back in 2000 would have been far more effective.

Later in 2000, Krugman wrote more articles on Japan, which criticized the BOJ decision to raise rates.  Again, Krugman turned out to be completely correct—Japan fell back into recession and had to cut rates again.

So when did Krugman become “Krugman”?   It seems like the turning point was around 2002, when he started advocating fiscal stimulus for the US:

Not many people realize that in some ways Japanese economic policy responded quite effectively to a sustained slump. It’s easy to make fun of the country’s enormous spending on public works — all those bridges to nowhere in particular, highways with no traffic, and so on. Without question enormous sums have been wasted. But it’s also clear that all that spending pumped money into the economy, preventing what might otherwise have been a full-fledged depression.

So what will be the U.S. equivalent? Right now we are in effect following the reverse policy: slashing domestic spending in the face of an economic slump. Some of this is taking place at the federal level; the Bush administration is nickel-and-diming public spending wherever it can, shaving a billion here, a billion there off everything from veterans’ benefits and homeland security to Medicare payments. More important, the federal government is doing nothing to help as state and local governments, their revenues savaged by recession, make deep cuts in spending on everything that isn’t urgently necessary, and many things that are.

This is a radically different Paul Krugman from the 1999-2000 version:

1.  Now Krugman is making things up—for instance suggesting that Bush had adopted a contractionary fiscal policy, when Bush’s policy was actually quite expansionary (huge tax cuts, massive increases on federal spending on education, homeland security, Medicare drug benefit, military build-up.)  This is a more ideological Krugman than the neoliberal of 2000.

2.  Krugman says it’s easy to make fun of the Japanese public works, but doesn’t tell his readers that back in 1999 he was one of those people ruthlessly mocking the Japanese public works spending:

What continues to amaze me is this: Japan’s current strategy of massive, unsustainable deficit spending in the hopes that this will somehow generate a self-sustained recovery is currently regarded as the orthodox, sensible thing to do – even though it can be justified only by exotic stories about multiple equilibria, the sort of thing you would imagine only a professor could believe. Meanwhile further steps on monetary policy – the sort of thing you would advocate if you believed in a more conventional, boring model, one in which the problem is simply a question of the savings-investment balance – are rejected as dangerously radical and unbecoming of a dignified economy.

Will somebody please explain this to me?

One possibility is that Krugman turned left due to “Bush derangement syndrome.” In fairness, however, you could see a similar pattern in Ben Bernanke, who was a Republican during this period.  In 1999, Bernanke was also contemptuous of the view that the BOJ was out of ammunition, but by late 2008 Bernanke was also advocating fiscal stimulus.  Indeed right about the turn of the century there was a gradually shift to the left in many places.  Regulations started ramping up in the US (i.e. Sarbanes-Oxley).  The British Labour Party abandoned their fiscal austerity, as did the Dems in the US.  So perhaps Krugman was merely a part of this gradual change in the zeitgeist.  I haven’t changed, so I’m not well placed to understand what caused so many other people to become more sympathetic to fiscal stimulus and regulation.

Same old same old

Back in February, I did an Econlog post predicting that not much would change. Let’s look at some recent events:

1.  Healthcare reform failed—we are sticking with Obamacare.

2.  Early (conservative) enthusiasm about the economy has faded, as job growth for the first three months has been slower than under Obama’s last few years in office.  The Great Stagnation will continue.

3.  Alt-right enthusiasm for a US exit from the Middle East and a bromance with Putin seems to be fading.

4.  There has been some deregulation of coal, but most utilities are not expected to go back to coal (with natural gas prices so low.)

Over the years I’ve gotten a lot of grief for my claim that Gore would have gotten us into Iraq, because that’s what the establishment wanted after 9/11.  He foreign policy czar was expected to be (the pro-Iraq War) Richard Holbrooke.  I’ve always believed that Presidents are less influential than most people assume–they mostly do what they are told, and today I believe that more strongly than ever.

One thing that I did not anticipate was just how incompetent Trump would be, and that this incompetence would turn out to have silver lining.  Trump is not even capable of doing the bare minimum, staffing an administration.  His ignorance is so deep that he must almost entirely rely on experts.  (Today he tweeted that discouraged workers who have given up looking for work are counted as “employed”.  So why do people complain when I call him an idiot?)  Trump is like one of those kings/sultans/emperors in the history books who assumed power as a child and had various ministers conduct governance while they spent time in their harem or engaged in falconry.

Because there are so few alt-righters with enough competence to staff top government positions, the staff will eventually be dominated by establishment types and the Steve Bannons of the administration will become increasingly marginalized.

My takeaways:

1.  When someone like Trump becomes President, it’s actually good to be living in the age of complacency.  A Trump elected in 1932 would have been a much scarier proposition.

2.  The establishment (now called the deep state) is a good thing, as it reduces the risk of a dangerous demagogue causing major problems.

3.  I still think that Trump will eventually get a few things enacted, such as corporate tax reform.  But it will be the sort of stuff that would have occurred under any GOP president.  Matt Yglesias pointed out that Trump does not even have a tax proposal. (Wait, didn’t he campaign on a big tax cut?)  Presidents usually lead Congress on those sorts of major policy issues—it’s a really good thing that Trump is not capable of leading.

4.  Trump is still a net negative, as in his opposition to TPP and his new H1-b policy.  He’s done very little, but what he has done is mostly bad (and anti-growth.)

4.  While Trump himself is a paper tiger, Trumpism is still a very worrisome problem.  Throughout the developed world, conservative parties are gradually moving from libertarian conservatism towards racist, xenophobic, nationalistic, big government spending conservatism.  Trump is a symbol of that change, and thus remains a very evil figure.  My worry is that eventually there will be a lot of alt-righters who are qualified to fill a government.  My worry is that the GOP will eventually become the party that is opposed to trade, opposed to immigration and in favor of Obamacare.  An American version of Le Pen.

PS.  I have a pretty open commenting policy, even allowing most personal insults directed at me (I figure they actually help me and hurt the attacker.)  But I do ban terms like ‘n****r’ and ‘c**t’ and ‘k***servative’.   One other point.  Just because I don’t ban a comment doesn’t imply I think it’s OK.  I find huge numbers of comments to be morally disgusting, but that doesn’t make me ban them.  So don’t play the game of “Why do you ban X but not Y.”  I’ve chosen to ban just the very worst stuff, so deal with it.  I have a very polite comment section at Econlog, where I put my better posts.  Go over there if you don’t like it here.