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The most underpaid profession on Earth

Britmouse is back blogging with lots of interesting new posts.  A short one that caught my attention discussed this story from 2010:

I saw the governor of the Bank of England [Mervyn King] last week when I was in London and he told me whoever wins this election will be out of power for a whole generation because of how tough the fiscal austerity will have to be,” Hale said in an interview on Australian TV reported by Reuters.

Of course the Conservatives were recently re-elected, and indeed slightly improved their standing because they no longer rely on support from the Liberal Democrats. BTW, I agree with this comment from Britmouse:

.  .  . sad to see so many true liberal voices leaving Parliament.  You’ll be missed, Vince.

King headed the Bank of England in 2010.  So why was his political forecast incorrect? Perhaps he thought the economy would do poorly during the period of austerity.  But why would he think that?  Perhaps because he’s a Keynesian, like Ben Bernanke and most other central bankers.  Maybe he doesn’t believe in monetary offset.

Of course there are other possibilities, maybe he thought austerity would be unpopular even if the economy did fine.  But I think it more likely that he was making an implied forecast of slow growth and a weak job market.  In fact growth was weak, but during 2013 the job market began improving dramatically:

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Notice that British unemployment was at about 8% at the time of the May 2010 election, and still at about 7.8% in the spring of 2013.  Not much progress in three years.  But then the rate began falling sharply, and was at 5.5% in March, 2015, the same as the US and just slightly above Germany’s 4.9%.  Total employment numbers did far better than the US.  What happened?  There are lots of possibilities:

1.  Maybe the Keynesians are right and monetary offset was impossible in the UK.  Austerity hurt.  Recovery only occurred in 2013 because wage moderation finally allowed for the natural recovery forces in the economy to take hold.

2.  More likely, the BoE felt additional monetary stimulus was risky, due to high inflation during 2010-13, often running at close to 4%.  In that case the fiscal austerity had no impact on growth and employment, as the BoE was unwilling to tolerate higher inflation.

3.  The most interesting hypothesis is that King failed to forecast that he would be replaced in 2013 by a more competent central banker, from Canada of all places.  Mark Carney was appointed in late 2012, but didn’t formally join the BoE until June 2013, so it’s not quite clear where we should see his appointment impacting the economy.

Here’s Carney’s record at the Bank of Canada, from Wikipedia:

Carney’s actions as the Bank of Canada’s governor are said to have played a major role in helping Canada avoid the worst impacts of the financial crisis that began in 2007.[14][15]

The epoch-making feature of his tenure as governor remains the decision to cut the overnight rate by 50 basis points in March 2008, only one month after his appointment. While the European Central Bank delivered a rate increase in July 2008, Carney anticipated the leveraged-loan crisis would trigger global contagion. When policy rates in Canada hit the effective lower-bound, the central bank combated the crisis with the nonstandard monetary tool: the “conditional commitment” in April 2009 to hold the policy rate for at least one year, in a boost to domestic credit conditions and market confidence. Output and employment began to recover from mid-2009, in part thanks to monetary stimulus.[16] The Canadian economy outperformed those of its G7 peers during the crisis, and Canada was the first G7 nation to have both its GDP and employment recover to pre-crisis levels.

The Bank’s decision to provide substantial additional liquidity to the Canadian financial system,[17] and its unusual step of announcing a commitment to keep interest rates at their lowest possible level for one year,[18] appear to have been significant contributors to Canada’s weathering of the crisis.[19]

Canada’s risk-averse fiscal and regulatory environment is also cited as a factor. In 2009 a Newsweek columnist wrote, “Canada has done more than survive this financial crisis. The country is positively thriving in it. Canadian banks are well capitalized and poised to take advantage of opportunities that American and European banks cannot seize.”[20]

Carney earned various accolades for his leadership during the financial crisis. He was named one of the Financial Times ‘s “Fifty who will frame the way forward”,[21] and of Time Magazine ‘s “2010 Time 100″.[22] In May 2011, Reader’s Digest named him “Editor’s Choice for Most Trusted Canadian”.[23]

In October 2012, Carney was named “Central Bank Governor of the Year 2012″ by the editors of Euromoney magazine.[24]

So he’s a talented central banker.  But how do we know the UK wouldn’t have improved even if King had stayed on?  We don’t, and indeed I think the UK would have improved, but not as fast as with Carney.  Mark Carney did take some aggressive forward guidance steps in 2013, and the markets took notice.  Just as in Canada, he got better job market results than his peers at other central banks.  That’s not proof, but I believe the balance of evidence suggests that Carney modestly boosted the speed of the UK recovery.

Years ago I did a post arguing that central bankers are grossly underpaid, and that we should pay whatever it takes to make sure that the FOMC has people like Michael Woodford, not community bankers from Hawaii.  Even if it takes a billion dollars.  Of course a billion dollar salary is not politically feasible, but it’s also not necessary. Carney was reluctant to take the BoE job for family reasons, and the British government eventually lured him over with a fairly generous pay package, including that all-important London housing allowance.  It did get some attention in the press, which points to the difficulty of paying central bankers their marginal product.

BTW, you might wonder why I say central bankers are the most underpaid profession. What about the President, who only makes $400,000, and yet is even more powerful and consequential?  Yes, but have you checked the non-monetary compensation of being President?  Even Bill Gates can’t have state dinners in the White House with a glittering international set of celebrities, or fly in Air Force One with a military escort. The total compensation of being President is plenty high enough to attract talented people.  Unfortunately, the close call on whether Carney was willing to take the BoE job, and the frequency with which Federal Reserve Board members resign before their term is up, suggests that central bankers are grossly underpaid.  I’ve never seen a President resign after 2 years to take a more lucrative job with Goldman Sachs.

PS.  I chose Michael Woodford precisely because he is not a MM.  We need to get best people possible, and this has nothing to do with whether they agree with me, or they don’t.  John Taylor is another person I sometimes disagree with, who is obviously extremely well qualified for being a central banker.

PPS.  Check out Britmouse’s longer new posts, which are also quite interesting.

How does it feel?

Some of my liberal friends have trouble understanding why Paul Krugman is such a lightening rod for criticism from the right.  Everything he says seems so reasonable.  If you are in this group, I strongly suggest reading Niall Ferguson.  Here’s a small excerpt:

The final piece of Krugman’s analysis was that Cameron and Osborne were “so deeply identified with the austerity doctrine that they can’t change course without effectively destroying themselves politically.” They had “to stick it out until something turns up, no matter how many lives it [austerity] destroys.” Cameron was “the English prisoner”of his own “austerity crusade.” In fact, the government did change course, significantly easing the fiscal tightening in late 2012. Krugman was at first dismissive of these changes as “a set of basically minor twiddles involving credit and planning authorizations, which seem highly unlikely to make any significant difference.” When these “twiddles” turned out to make quite a lot of difference, he cried foul. Why, Cameron and Osborne had stopped doing austerity after two years! How dare they not fulfil Krugman’s apocalyptic predictions!

Krugman has spent much of the last two years trying to dismiss the UK recovery – not surprisingly, as it makes nonsense of nearly everything he has written in recent years. It was, he insisted in September 2013, a “dead-cat-bounce.” The government’s claims of success were “deeply stupid.” The economy’s growth was merely the effect of stopping “banging Britain’s head against the wall.” Comically, in January 2014 Krugman sought to argue that France was the role model Britain should have sought to emulate. By April, however, he had thrown in the towel, but in a typically dishonest way. “The fact that the [UK] economy has perked up,” he argued shamelessly, “is actually a vindication of Keynesian claims, whatever the government’s intentions.” The return to growth – the one he had wholly failed to predict – was “not at all surprising.” There was “nothing here that warranted a major revision of framework.” Perish the thought!

.  .  .

In the words of Jeffrey Sachs – hardly a conservative on economic issues – UK economic performance has in fact been “broadly similar” to that of the United States, “with the UK outperforming the United States on certain indicators,” such as the employment rate (now at a record high of 73.3 percent compared with 59.2 percent in the United States). As Sachs notes, “both the U.S. and UK economies have cast considerable doubt on Krugman’s oft-repeated view that a robust recovery would require further fiscal stimulus.” Amen.

Of course, Krugman was not alone. Martin Wolf of the Financial Times made much the same arguments. So did Simon Wren-Lewis, Jonathan Portes and others. However, none of these Keynesian authors could match Krugman’s unique combination of over-confidence and toxic rudeness. It was not enough to sneer at George Osborne’s policies; he had to be compared gratuitously to one of Monty Python’s “upper class twits.” Osborne’s consistency – a trait Krugman greatly prizes in himself – was “the hobgoblin of little minds, adored by little statesmen.” His policy was “a complete conceptual muddle.” Osborne was “the Rt. Honorable Saboteur.” The government was like “the Three Stooges.” Osborne’s 2014 budget was “ludicrous.”

Krugman is of course in thrall to an Englishman who cannot be credibly described as anything but upper class: John Maynard Keynes. In his vainglorious dreams, Krugman is the Keynes of our time – brilliant, caustic, influential. In his journalism, Krugman frequently alludes to his hero’s work – hence “The Economic Consequences of Mr. Osborne.” But to be Keynes you need ultimately to be credible – credible enough for policymakers to pay heed to what you say. In this regard, Krugman’s career is a story of catastrophic failure – a failure only partly explicable by the fact that, unlike Keynes, he is personally obnoxious.

Amongst many offensive traits, Krugman’s chronic inability to acknowledge error is the most troubling to policymakers, who are subjected to far more rigorous scrutiny than he is. Accusing other economists and the Financial Times of “perceptual sleaze,”Krugman recently had the gall to write: “What’s not OK is blurring the distinction between … political analysis and a real analysis of how policy worked. … When people do that kind of blurring to make the case for policies they prefer, it’s deeply sleazy, no matter who they are.” Lack of self-knowledge on this scale borders on the pathological.

It is easy to forget how seriously the British Left once took Krugman. In a speech forBloomberg in August 2010, Ed Balls named him as one of the few intellectuals who were prepared “to stand up now and challenge the current consensus that – however painful – there is no alternative to the Coalition’s austerity and cuts.” Less than a year later, in a speech at the London School of Economics, Balls again made his debt to Krugman clear. And in his 2012 party conference speech, he went the whole way,parroting Krugman’s prediction of a double-dip recession. This was the peak of Krugmania in the UK. In a gushing editorial in January 2013, the Guardian even urged Ed Miliband to appoint Krugman as Shadow Chancellor. Krugman lectures were now attracting throngs of credulous devotees – though Balls was no longer among them. He had belatedly – but too late – woken up to the fact Krugman’s predictions had been worthless.

But you should really force yourself to read the whole thing.  And don’t focus on the content, rather focus on how it makes you feel.  That’s how right-wingers feel when they read Krugman.

For contrast, read Matt Yglesias describing the same set of events:

For Americans who have followed British politics primarily through the lens of American Keynesians complaining that Cameron’s austerity policies destroyed the British economy, the results may come as a bit of a shock. Is the UK economy actually doing great? Was Paul Krugman wrong about everything?

The truth is more complicated than that. Team Austerity didn’t do as well as a superficial read of the returns would suggest — the UK economy is in some ways struggling, the austerity question itself was considerably more complicated than the US media debate about it suggested, and fundamentally the biggest issue in the UK economy has nothing at all to do with austerity or overspending.

Matt mostly agrees with Krugman on fiscal stimulus, although he’s a bit less confident about the net effect.  He’s more aware of the uncertainties involved in any counterfactual:

The real debate concerns the past. Cameron and his coalition partner Nick Clegg say that had they not moved to swift fiscal consolidation in the past, the United Kingdom would have been at risk of a Greek-style financial market panic and total meltdown.

It is difficult, in practice, to see how this would have happened. A loss of investor confidence in the fiscal position of the government would have resulted in a falling value of the pound and an expansion/inflationary monetary environment. A falling pound and an expansionary/inflationary monetary environment are exactly what the UK got under austerity. On the other hand, the success of the Bank of England in achieving an expansionary monetary environment in the context of fiscal austerity suggests that fears of austerity crushing the economy were also somewhat misplaced.

Austerity was neither necessary to avoid a meltdown nor sufficient to wreck the labor market. It was simply a policy choice to emphasize small government, less spending, and more employment in the private service sector rather than a more expansive welfare state with more public sector employment.

But the biggest difference is not content, it’s tone.  Yglesias’s post is 180 degrees different from the Ferguson piece, or from a typical Krugman post.  There’s no name-calling.

Inevitably commenters will want to get into the content of Krugman, Ferguson, and Yglesias.  Unless you have something new to say, I’m not really interested.  That’s not what this post is about.

I also recommend this excellent Evan Soltas post on the next big crisis, student loans.

PS.  In a way I sympathize with Krugman.  I can’t understand how anyone could think a fiat money central bank would be unable to debase its currency at zero rates.  I can’t imagine how anyone could think money was not obviously way too tight in 2008 (recall that interest rates were not at the zero bound.)  So I get the frustration he must feel about his views being ignored by the VSPs.  But I also understand that the part of my brain that tells me that the conventional narrative is stupid, is itself unreliable.

Indeed it’s more than unreliable, it’s a logical contradiction.  The conventional narrative can never, ever be stupid, as ‘stupidity’ is defined as reasoning that falls short of the conventional wisdom.

HT:  Marcus Nunes

A poll of central bankers

Ignacio Morales of the Costa Rica Central Bank sent me the following, which is from a poll of central bankers readers of Central Banking.com:

Screen Shot 2015-04-21 at 10.07.16 AMI will be traveling over the next few days, so blogging will be intermittent.

Recent activity

I’ll try to keep blogging, but things may slow down a bit as tax season approaches. Meanwhile I have a new post at Econlog comparing Asia, Europe and immigrant societies.  I’ve also had some recent luck getting into major news outlets. A few weeks ago it was the WSJ, today I have a piece in the New York Times (on the strong dollar.)  AFAIK, that’s my first, and hopefully not my last.  Which reminds me, after the sad experience of Razib Khan (recently hired and fired by the NYT on the same day), don’t anyone dare send the Times any of my earlier posts criticizing their fine newspaper.  I take everything back.

:)

Krugman on European growth and the euro

In a recent post I responded to this claim by Paul Krugman:

I’ve already argued that the fall in the euro is much bigger than you can explain with monetary policy; it seems to reflect the perception that Europe is going to be depressed for the long term. And if that’s what drives the weak euro/strong dollar, it will hurt US growth.

I said (without reading the linked to post):

I agree with the reasoning process in the last sentence.  But I don’t think it applies to the current case, as it seems very unlikely that lower growth expectations are what is depressing the euro.  Here’s what we do know:

1.  Eurozone growth expectations have been in the toilet for years.

2.  The euro was valued at about $1.35 for years, and then gradually fell to about $1.05 over the past few months.

3.  During the past few months the growth forecasts of the eurozone have been revised upward, as the euro has been falling.

You don’t need to be an EMH fanatic like me to see a problem with Krugman’s argument. Kudos to him for not reasoning from a price change, for not lazily assuming that a weaker euro meant more growth.  But I think’s he’s gone too far in the other direction, in assuming that the cause of the weaker euro was lower growth expectations.

Vaidas Urba suggested I do look at the linked post.  And I was quite shocked to find it began as follows:

Watch that plunging euro! Actually, it’s good news for Europe. European growth numbers have been better lately, and the weak euro — which makes EZ manufacturing and other tradables more competitive — is surely a large part of the explanation. Not so good for Japan or the US. But how should we think about this?

Wait, that’s my argument—the weaker euro is associated with stronger eurozone growth.  Therefore it’s monetary stimulus at work.  But if you read the entire post you’ll see Krugman does actually have a good argument, albeit one that raises as many questions as it answers.  And I might add that it’s one I’m pretty sure that 99% of his readers would not have understood.

Let’s first discuss Rudi Dornbusch’s (1975) overshooting model, which is sort of lurking in the background.  Dornbusch thought about the impact of monetary stimulus in a world of interest parity, PPP and sticky prices.  The result is quite odd. Suppose the ECB does a once and for all permanent 10% increase in the money supply.  The quantity theory says this will raise prices by 10% on the long run.  And PPP says that will depreciate the euro by 10% in the long run.  So far, so classical. But sticky prices imply a liquidity effect, thus the monetary injections lower nominal interest rates for a few years.  And because of the interest parity condition, lower interest rates imply a higher expected rate of appreciation in the euro. But didn’t I just say the euro would depreciate?  Yes I did, and there is no contradiction.  If you are not seeing the answer, you need to think outside the box. First do some brain exercises.  Connect these 9 dots with 4 lines, without taking your felt tip pen off the paper:

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For simplicity, suppose we started with US and eurozone interest rates being equal. After the monetary injection the eurozone rates are lower.  So the euro is expected to appreciate.  But in the long run it’s expected to be 10% lower.  That means the immediate effect of a monetary stimulus shock must be a more that 10% decline in the euro.  Dornbusch called this exchange rate overshooting.  The model is composed of 4 theories (QTM, PPP, IPT, liquidity effect.)  Most of us are not as adept at juggling 4 theoretical balls in the air at the same time as Krugman, so we struggle with the concept.  As for empirical evidence, these things are hard to test. I’d argue that each component is pretty well established, and that’s good enough (and I suspect Krugman would agree.)  In any case, it’s too beautiful a theory not to use once and a while.  Here’s Krugman:

So, can we say anything about how the recent move in the euro fits into this story? One way, I’d suggest, is to ask how much of the move can be explained by changes in the real interest differential with the United States. US real 10-year rates are about the same as they were in the spring of 2014; German real rates at similar maturities (which I use as the comparable safe asset) have fallen from about 0 to minus 0.9. If people expected the euro/dollar rate to return to long-term normal a decade from now, this would imply a 9 percent decline right now.

What we actually see is almost three times that move, suggesting that the main driver here is the perception of permanent, or at any rate very long term European weakness. And that’s a situation in which Europe’s weakness will be largely shared with the rest of the world — Europe will have its fall cushioned by trade surpluses, but the rest of us will be dragged down by the counterpart deficits.

Now, this is not how most analysts approach the problem. They make a forecast for the exchange rate, then run this through some set of trade elasticities to get the effects on trade and hence on GDP. Such estimates currently indicate that the dollar will be a moderate-sized drag on US recovery, but no more. What the economic logic says, however, is that if that’s really true, the dollar will just keep heading higher until the drag gets less moderate.

Krugman’s looking at real rates to abstract from inflation.  While the Dornbusch overshooting model does a nice job of explaining the recent dramatic plunge in the euro, the model also predicts that the real exchange rate is unaffected in the long run. But that’s because interest rates are unaffected in the long run.  Krugman’s readers don’t know this, but unless I’m mistaken he’s arguing that the recent fall in long-term interest rates in Europe is the income effect, not the liquidity effect.  I actually like that argument, but it’s not the way Keynesians usually look at changes in long-term rates occurring in close proximity to QE.  Most Keynesians would say the ECB is driving bond long term bond yields lower.

So Krugman’s arguing that the big fall in the expected 10-year future exchange rate reflects worsening prospects for long term European growth, not just monetary stimulus.  That argument makes sense to me.  But he’s also arguing that this increasing long-term pessimism occurred at almost exactly the same time that expectations of short-term growth became more optimistic.  That might be true, but I kinda doubt it. And yet I can’t think of a better explanation for the fall in the future expected value of the euro.

So I’ll file this under “unresolved problems.”

PS.  He ends up relying on liquidity trap arguments to draw policy conclusions for the US.  But as I argue in today’s Econlog post (later this afternoon), those arguments are rapidly approaching their “sell by date.”

PPS. The eurozone demand side recession is likely to be over in 10 years.  That means Krugman’s hypothesis implies severe structural problems in Europe—bad news for a continent with 7% of the world’s people, 25% of the world’s GDP, and 50% of the world’s social spending.

PPPS.  Oh yeah, the puzzle.  Because Ray claims his IQ is only 120, he probably provided answer #2. But answer #1 is correct.  I’m sure Rudi would have been able to solve the puzzle. My dad did it first in a competition among friends back in 1962.

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