Archive for January 2018


Friedman on monetary policy

At the recent AEA meetings in Philadelphia, there was a panel discussing Friedman’s famous AEA presidential address, which occurred 50 years ago. Rereading the paper, I found it to be just as impressive as I remember.

Here Friedman discusses the relationship between money and interest rates:

These subsequent effects explain why every attempt to keep interest rates at a low level has forced the monetary authority to engage in successively larger and larger open market purchases. They explain why, historically, high and rising nominal interest rates have been associated with rapid growth in the quantity of money, as in Brazil or Chile or in the United States in recent years, and why low and falling interest rates have been associated with slow growth in the quantity of money, as in Switzerland now or in the United States from 1929 to 1933. As an empirical matter, low interest rates are a sign that monetary policy has been tight-in the sense that the quantity of money has grown slowly; high interest rates are a sign that monetary policy has been easy-in the sense that the quantity of money has grown rapidly. The broadest facts of experience run in precisely the opposite direction from that which the financial community and academic economists have all generally taken for granted.

Paradoxically, the monetary authority could assure low nominal rates of interest-but to do so it would have to start out in what seems like the opposite direction, by engaging in a deflationary monetary policy. Similarly, it could assure high nominal interest rates by engaging in an inflationary policy and accepting a temporary movement in interest rates in the opposite direction.

These considerations not only explain why monetary policy cannot peg interest rates; they also explain why interest rates are such a misleading indicator of whether monetary policy is “tight” or “easy.” For that, it is far better to look at the rate of change of the quantity of money.2

The “financial community and academic economists” still have a lot of catching up to do, even after 50 years.

Notice the italics Friedman used for “has been” in the first paragraph.  It’s almost like 50 years ago Friedman anticipated the rise of NeoFisherians, and wanted to disassociated himself from that group, (while also disassociating himself from the Keynesians.)

In 2003, Ben Bernanke stood on Friedman’s shoulders and saw the picture a bit more clearly:

The imperfect reliability of money growth as an indicator of monetary policy is unfortunate, because we don’t really have anything satisfactory to replace it. As emphasized by Friedman (in his eleventh proposition) and by Allan Meltzer, nominal interest rates are not good indicators of the stance of policy, as a high nominal interest rate can indicate either monetary tightness or ease, depending on the state of inflation expectations. Indeed, confusing low nominal interest rates with monetary ease was the source of major problems in the 1930s, and it has perhaps been a problem in Japan in recent years as well. The real short-term interest rate, another candidate measure of policy stance, is also imperfect, because it mixes monetary and real influences, such as the rate of productivity growth. . . .

Ultimately, it appears, one can check to see if an economy has a stable monetary background only by looking at macroeconomic indicators such as nominal GDP growth and inflation. On this criterion it appears that modern central bankers have taken Milton Friedman’s advice to heart.

Now another 15 years have gone by, and I can try to advance the ball a tiny bit further downfield.  Inflation is not a good monetary policy indicator, for standard “never reason from a price change” reasons.  Rising inflation can mean rising demand (easy money) or a reduction in aggregate supply (not easy money.)  In contrast, rising NGDP growth is almost always easy money, at least in the US (maybe not Ireland.)

Interestingly, I had never noticed footnote 2 in Friedman’s 1968 article, which seems to anticipate why inflation or NGDP might be superior to money:

This is partly an empirical not theoretical judgment. In principle, “tightness” or “ease” depends on the rate of change of the quantity of money supplied compared to the rate of change of the quantity demanded excluding effects on demand from monetary policy itself.  However, empirically demand is highly stable, if we exclude the effect of monetary policy, so it is generally sufficient to look at supply alone.

If you view money demand as M/PY, not M/P, then this is exactly my view.

Interestingly, the empirical relationship Friedman cites broke down about a decade after his paper was published in 1968:

Recessions are no longer preceded by sharp slowdowns in M2 growth.  (It’s an open question as to whether alternative monetary indicators, such as divisia indices, can fill the gap.  I’m a bit skeptical.)

The breakdown in the empirical relationship that motivated Friedman’s advocacy of money supply targeting helps to explain why late in his life he became more supportive of Greenspan’s inflation targeting approach.  Friedman was a pragmatist.  When the facts changed, he changed his views.

PS.  I have another post on this paper over at Econlog.


Do demographics explain disinflation?

No they don’t; monetary policy determines the rate of inflation.  But the Wall Street Journal’s “Daily Shot” sees things differently:

Over the long run, economists think that demographics dictate inflation trends. The collapsing US labor force growth is expected to be a drag on the CPI.

Really?  I’ve never met an economist who thinks demographics determine inflation.  Now let’s look at the graph the WSJ uses to back up this claim:

People are far too impressed by this sort of simple correlation.  Let’s look at what the statistician had to do in order to make labor force growth and inflation look correlated:

1.  The scales for the two lines are completely different.  The left scale shows labor force growth, and tops out at 2.8%.  The right scale shows inflation, and tops out at nearly 9%.

2.  Both graphs use 10 year moving averages, which smooths out a lot of the short term volatility.

3.  The civilian labor force graph uses a 4 year lead, to make the peak growth rate line up with the peak inflation rate.

If the data were any further massaged it would turn into a bloody pulp.

Here’s what people often do.  They find two time series that each have a long period of upswing, followed by a long period of downswing.  They could have just as well have used interest rates, or some other variable.  But they chose inflation and labor force growth.  Then they smooth the data, adjust the two scales so that each peak has the same height, then use leads or lags to make the peaks line up on the horizontal axis as well.

Even worse, they use two series that are not linked according to any economic theory that I am aware of.

This is too sloppy to get published in an academic journal.  But the stuff that does get published is often flawed in a similar way, just to a much lesser extent.  The errors are more subtle.

PS.  Check out US labor force growth rate from 1865-96 (high).  Then check out the rate of inflation (negative).

HT:  Daniel Griswold

Another “bad hombre” being deported

From the Detroit Free Press:

His wife, Cindy Garcia, cried out while his daughter, Soleil, 15, sobbed into Garcia’s shoulder as they hugged. Two U.S. immigration agents kept a close watch nearby.

After 30 years of living in the U.S, Garcia, a 39-year-old Lincoln Park landscaper, was deported on the Dr. Martin Luther King Jr. holiday from metro Detroit to Mexico, a move supporters say was another example of immigrants being unfairly targeted under the Trump administration.

Jorge Garcia was brought to the U.S. by an undocumented family member when he was 10 years old. Today he has a wife and two children, all of whom are U.S. citizens.

Remember when Trump said he was going to focus on the “bad hombres”?

His supporters say he has no criminal record — not even a traffic ticket — and pays taxes every year. . . .

Garcia is too old to qualify for DACA, which allows the children of undocumented immigrants to legally work and study in the U.S.

A question for restrictionists.  How about a person who came to America illegally at age 2, and was 93 years old.  Assume no criminal record.  Should she be deported?  If so, why?  If not, why should this guy be deported?

“It’s heartbreaking,” Bonesatti said. “If you’re going to pick someone who’s ideal,” he would be it. . . .

Moreover, Mexico is a foreign place to Garcia.

But at least Trump is reducing regulations on coal companies that want to poison our air and water, so everything’s fine.

PS.  I’m guessing that the truly bad hombres don’t dutifully report to the immigration authorities like this guy did:

She said that when her husband reported to ICE in November as part of a regular check-in, he was informed that he had to leave the U.S. and would be detained immediately.

PPS.  Over at Econlog I have a new post on the war on drugs:

As a candidate, Trump promised to leave the marijuana question up to the states. In his confirmation hearings, Jeff Sessions promised not to make marijuana a priority for federal law enforcement. It turns out that all of those promises were meaningless.

PPPS.  And speaking of Trump, I don’t agree with every single charge on this NYT list, but the cumulative impact is pretty convincing.

Was the dotcom mania “mad”? (And let’s lower the relative status of pessimists)

Tim Harford has a very good piece on bubbles in the FT.  This caught my eye:

Yet even with hindsight things are not always clear. For example, I first became aware of the incipient dotcom bubble in the late 1990s, when a senior colleague told me that the upstart online bookseller was valued at more than every bookseller on the planet. A clearer instance of mania could scarcely be imagined.

But Amazon is worth much more today than at the height of the bubble, and comparing it with any number of booksellers now seems quaint. The dotcom bubble was mad and my colleague correctly diagnosed the lunacy, but he should still have bought and held Amazon stock.

I wish I had bought Amazon in the 1990s, just as I wish I had bought Bitcoin at $12, when I was writing posts claiming that it was not a bubble.  But I didn’t, and given what I knew at the time there was really no reason for me to do so.  But what about the claim that “the dotcom bubble was mad”?  I do recall people saying that in 2002, after the bubble had burst and the NASDAQ fell to 1200.  But is that true?

The argument made in 2002 is that tech valuations made no sense unless you believed that tech companies would push aside old stalwarts like GE, GM and Walmart, and that companies like Apple and Amazon would become the most dominant corporations on Earth.  Well, hasn’t that happened?  Another argument was that you’d have had to believe that all the dotcom companies would be successful.  Actually, if you didn’t know which ones would be successful, it would have made sense to buy an index fund in the NASDAQ.

The NASDAQ peaked at just over 5000 in early 2000, but that was for just a very brief period.  The average “mad” dotcom investor would have purchased stock at some time during 1999 or 2000, probably at a NASDAQ level closer to 3500 or 4000.  NASDAQ is now above 7200, and if you add in dividends it would not be unusual for an investor to have doubled their money over 18 years.  That’s not particularly good for a risky investment, but it’s not horrible.  It’s a higher rate of return than T-bills, but lower than T-bonds.  But keep in mind that T-bond investors lucked out, as actual NGDP growth was far less than expected when T-bonds were yielding 6%, and if people had known what was going to happen to the US economy, yields would have been far lower in 2000.  Alternatively, if NGDP had grown as expected, the NASDAQ would be far higher today.

Just to be clear, even today it seems like the tech market was a bit frothy at the peak in March 2000, I’m not denying that.  But my point is that all of these judgments are provisional.  If people really believe that markets are irrational, they ought to be writing posts in the FT talking about the negative bubble of 2002.  What were those morons thinking when they sold tech stocks when NASDAQ was at 1200?  Were they insane? Were they idiots?  Instead, pessimism is intellectually respectable so the pessimists get off scot-free, while optimists are ridiculed for being wrong.  Why?

Here’s how the FT article starts out

“Prices have reached what looks like a permanently high plateau.” That was Professor Irving Fisher in 1929, prominently reported barely a week before the most brutal stock market crash of the 20th century. He was a rich man, and the greatest economist of the age. The great crash destroyed both his finances and his reputation.

The fact that Fisher’s wrong prediction had any impact on his reputation is a sad commentary on our society.  His forecast should have attracted no more attention than his forecast as to who would win the World Series.  Would Fisher’s reputation have been damaged if he got a baseball game wrong?

And if we really should trash people for their bad calls on the market, why isn’t Robert Shiller’s reputation damaged for his claim that stocks were overpriced in 2011, when in fact it was near the beginning of one of the great bull markets in US history?  Why trash the optimists but not the pessimists?

And why aren’t the Chinese bears being called to account for all their predictions of a crash in the Chinese economy, or of 3% average real GDP growth during the decade of the 2010s?

Just to be clear, I’m not saying anyone’s reputations should be trashed.  My complaint is that other people are trashing great economists like Irving Fisher with no justification at all.

Speaking of China, remember all those predictions that it would get stuck in the middle-income trap?  Read the following from another FT story, and ask yourself how often you read those sorts of things about Turkey, Brazil or other countries that are actually stuck in the middle-income trap:

Here, too, China is catching up. Chinese internet leaders Tencent and Alibaba have a combined valuation of $1tn. Add in another $200bn or so for Baidu, and Netease plus other listed or unlisted companies, such as Toutiao, Meituan and Didi, and the scale of the Chinese market becomes apparent. Trends emerging in China are beginning to shape the future of the global tech landscape. To its dominant role in the supply chain we can now add a “demand chain” aspect to the country. . . .

Massive investments in mobile broadband and a highly competitive handset market means that nearly all of China’s approximately 750m internet users use smartphones. Payments via QR codes, led by Tencent’s WeChat and Alibaba’s Alipay, are making cash obsolete. Dockless bikes line the streets of Chinese cities. The country’s physical infrastructure — roads, high-speed trains and airports — are facilitating as big a boost to consumption as President Eisenhower’s roll out of the Interstate Highway System in the US in the 1950s.

I have lived in Beijing for more than 20 years, yet only in the past year have I felt on returning to London or Silicon Valley that I’m going backwards in time. For urban residents, China is increasingly a study in frictionless living. Hopping on a bike, ordering a meal from a huge range of restaurants, paying for utilities, transferring money to friends — all can be done at the touch of a button. Internet services in the west offer increasing convenience no doubt — but nothing beats the experience in China.

What part of “developed country” is China not going to be able to do by 2035?  Be specific.

Liberals were right about conservatives (and I was wrong)

For years, liberals used to accuse conservatives of having hidden racist motives, often in response to conservative advocacy of things like welfare reform or being tough on crime.  I thought those accusations were unfair, and even today I don’t think they are good reasons to call someone a racist.  However, because of the way that much of the conservative movement in America has rallied around Trump, I’ve now sadly concluded that many conservatives do in fact have a hidden racist agenda.

To give you a sense of how far down into the gutter our politics have descended, Fox News recently compared Trump to a racist drunk spouting off in a bar, and viewed that as a defense of the President.

After The Washington Post on Thursday afternoon first reported Trump’s remarks at a White House meeting with lawmakers, “The Five” co-host Jesse Watters shrugged off the slur as the way ordinary Americans talk about “Haiti people.”

“If it’s true, this is how the forgotten men and women in America talk at the bar,” Watters said. “This is how Trump relates to people. If you’re at a bar, and you’re from Wisconsin, and you’re thinking, ‘They’re bringing in a bunch of Haiti people, or El Salvadorians, or people from Niger.’ This is how some people talk.”

It’s sad that so many conservatives can’t understand why Trump’s remarks are a really big deal.

Another theme is that these countries really are bad places.  I don’t necessarily agree (El Salvador scores higher than Italy, Japan or South Korea on happiness rankings), but certainly all of these countries have lots of problems.  Even so, this fact has no bearing on Trump’s remarks.  Trump wasn’t just calling certain countries bad places, he was implicitly calling immigrants from those places pieces of shit.  Even a drunk in a Wisconsin bar knows what Trump meant when he said we shouldn’t be taking in immigrants from those sorts of places. He was talking about the characteristics of the individual people.  (I’ve spent at least 100 hours in Wisconsin bars listening to drunks (when I was a teenager), so I’m speaking from some experience.)  Over at Econlog I have a post showing that Indian-Americans earn more than any other ethnic group, and of course they come from a country that could have easily made the Fox News list of bad places.

PS.  Yes, Fox did not say the patron was “drunk”.  But let’s be real.  The whole point of referring to things said in a bar is to identify the things that people really think, when alcohol has removed inhibitions about being “politically correct”.  Thank God that Trump never drinks, I don’t want to even imagine him after a few martinis.