Archive for the Category Monetary Policy


Draghi doesn’t understand what caused the eurozone double-dip

The ECB tightened monetary policy sharply in 2011.  This caused NGDP growth to plunge, and the eurozone fell into a double-dip recession.

Whenever you have a demand-side recession, some people will look at specific industries, and/or specific regions, to see what caused it.  This is mistake.  The US housing industry was hit hard in the recent recession, but didn’t cause it.  The PIIGs were hit especially hard after 2011, but did not cause the eurozone recession.  In any recession, there will be regional and industry variation in intensity, due to supply-side factors.  But those specific factors cannot explain a generalized decline in NGDP growth for an entire currency zone. Only monetary policy can explain that.

Here’s something from a Mario Draghi speech that Vaidas Urba sent me:

From 2011 onwards, however, developments in the two regions diverge. Unemployment in the US continues to fall at more or less the same rate.  In the euro area, on the other hand, it begins a second rise that does not peak until April 2013. This divergence reflects a second, euro area-specific shock emanating from the sovereign debt crisis, which resulted in a six quarter recession for the euro area economy. Unlike the post-Lehman shock, however, which affected all euro area economies, virtually all of the job losses observed in this second period were concentrated in countries that were adversely affected by government bond market tensions (Figure 2).

Is this true?  Consider these graphs, showing that it wasn’t just the PIIGS that experienced a double dip:

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Screen Shot 2014-08-24 at 1.24.02 PMSo the Netherlands, France, Belgium and Austria also had double-dips. The Dutch double-dip was worse than the first dip.  The ECB caused the double-dip recession—even new Keynesian models will tell you that.  (After all, the ECB raised rates twice in 2011, so this wasn’t one of those zero bound issues.)  Odd that Draghi doesn’t understand that the ECB caused the NGDP growth collapse, and that debt crises are the result of NGDP growth crashes.  That doesn’t make me very hopeful that the eurozone’s long nightmare will end anytime soon.

Better late than never, but early is better still

Soon after I started blogging, I suggested that the importance of monetary policy would be clearly exposed by the way the recovery from the Great Recession played out.  That was true in the Great Depression, where the role of money was not noticed during the first couple years of the 1930s, but became clearer as each country started to recover after they left gold.  I don’t think anyone can deny that this prediction has been confirmed in this recovery.  Just look at the varying paths of the US, Japan, Britain and the eurozone.  One side effect is that we are now seeing much more interest on Fed policy from the left:

JACKSON HOLE Wyo. (Reuters) – Reginald Rounds was among those present at the Federal Reserve’s high-flying monetary conference here, enjoying the chance to button hole two top officials of the U.S. central bank.

The St. Louis resident is neither an economist nor a central banker. He’s a 57-year-old unemployed worker, who said he is trained in the green technology field and can’t find a job.

He was among a group of activists who gathered on the sidelines of the Fed’s annual symposium wearing green t-shirts with “What Recovery?” on the front and a chart depicting sluggish U.S. wage growth on the back.

“From the world where I reside, there is no recovery. We need a boost. We need a jump start,” said Rounds. “The key is jobs creation.”

The ten activists, most of whom were unemployed and seeking jobs, were sent as emissaries for a coalition of advocacy groups that has launched an unusual campaign from the left to press the U.S. central bank to keep monetary policy easy.

Of course these advocacy groups ignored the Fed back in 2009, when monetary stimulus really could have done a lot of good.  (Now it can do just a little good.)  A few years ago Matt Yglesias said overlooking the importance of monetary policy was “a major intellectual weakness of the progressive movement.”  Brad DeLong expressed similar a frustration with the Obama administration.

Why did MMs get there first?  Because we have the best model—NGDP growth expectations falling below the implied target is excessively tight money.  Even if it looks like money is “extraordinarily accommodative.”  And we understand that fiat money central banks rarely run out of paper and green ink.

Here’s Peter Diamond back in 2011, pouring cold water on the recommendations of people like Blanchard and Krugman

Nobel laureate Peter Diamond, whom the Obama administration nominated to fill a vacant seat on the Fed’s board, puts it this way: “If the Fed says we are determined to keep going till we have, say, 4 percent inflation, would that really turn around expectations in a way that would stimulate the economy and create higher inflation? I doubt it.”

And here’s Peter Diamond a few days ago:

“Historians are going to tar and feather Europe’s central bankers,” Peter Diamond, the world’s leading expert on unemployment told UK newspaper the Telegraph at the sidelines of the meeting. “Young people in Spain and Italy who hit the job market in this recession are going to be affected for decades. It is a terrible outcome, and it is surprising how little uproar there has been over policies that are so stunningly destructive,” he claimed.”

It seems awfully cruel to tar and feather people who can’t do anything at the zero interest rate bound. Even MMs merely recommend tar, no feathers.

Seriously, I’m glad the left is coming around to the view that monetary policy is of great importance. I hope they’ll take a look at the school of thought that reached this conclusion in late 2008.

PS.  I also have a post on money at Econlog.

The Fed can fix high unemployment, it can’t fix low employment

Tyler Cowen links to Binyamin Appelbaum:

These results,” wrote the economists Stephen J. Davis, of the University of Chicago, and John Haltiwanger, of the University of Maryland, “suggest the U.S. economy faced serious impediments to high employment rates well before the Great Recession, and that sustained high employment is unlikely to return without restoring labor market fluidity.”

Their findings contribute to the growing genre of papers that purport to show that the weakness of the American economy is caused largely by problems that predate the recession — and that the Federal Reserve can’t remedy them with low interest rates.

My response?  I said it all in the post title.

DeLong on the mother of all black swans

Brad DeLong has a post that is mildly critical of Shiller’s stock market model in almost precisely the same way that I am critical of Shiller’s stock market model.  The only difference is that DeLong knows more finance than I do, and makes the case far more effectively than I can.  I was intrigued by his conclusion:

That is a perspective very different from mine, which regards the failure of the CAPE to spend most of its time north of 25 as a mystery.

But given that it does not, it would be very rash for anybody who is not certain that they can wait out the market to invest more than they can afford to lose. And past performance is not only not a guarantee it may not be an indicator of future results. We have had one real Black Swan–World War I–in the past 130 years.

The first part refers to what DeLong and I think is the real mystery—not so much why stocks were so high in 1929, 2000, and now, but rather why they were so low 90% of the time.

I think WWI is a great black swan example, but without really disagreeing with DeLong I’d like to throw out another possible black swan—1968.  And no, I’m not thinking of all the assassinations and political turmoil in the US (as well as many other countries.)  It’s not clear that the political events of 1968 had much permanent effect; 1979 was the real turning point (see the PPS of this post.)  Instead I’m going to argue the shift from gold to fiat money was a black swan.

First let me digress with a bit of history.  It became illegal for Americans to redeem dollars for gold in 1933.  I seem to recall that in 1968 the gold window was closed to foreign individuals, and in 1971 the window was closed to foreign central banks.  (Someone correct me if I am wrong.)  So the gold standard sort of faded away over a 40-year period.  Then why pick 1968?

Even though Americans could not redeem dollars for gold in the 1960s, they could buy foreign currencies, and/or goods in foreign countries.  And there was a free market in gold in some foreign countries.  So up until 1968 gold continued to provide at least a weak anchor to the monetary system, at an international price of $35/oz.

My second point is that switching to a permanent fiat system was much more inconceivable to people in the old days than you might imagine.  Yes there were brief experiments like the greenbacks of the Civil War and the German paper money of 1920-23.  But even Keynes opposed a pure fiat regime, and viewed these historical examples as sort of pathological cases.  If you had told someone in 1968 that by 1980 the price of gold would be over $800/oz. they would have thought you were a lunatic.  It was $20.67/oz. in 1879.  It was still $20.67 an ounce in 1932.  It was $35/oz. in 1934.  It was still $35/oz. in early 1968. I recall that when gold was around $150/oz. in the 1970s, one of my economic professors at Wisconsin predicted the price would soon fall back into the $40s, as it was far overvalued.

DeLong identifies three periods when stock investors did poorly over the following 10 years—right before WWI, the late 1960s and early 1970s, and the late 1990s.  Even today I’m not sure exactly how much of the poor stock market performance of 1968-81 was due to the Great Inflation. Inflation did punish savers given that the IRS taxes nominal capital income.  But does that explain the entire underperformance?  Was there money illusion (confusing real and nominal interest rates) when discounting future profits?  I’m not sure.  I am confident, however, that moving to a fiat money regime was a black swan for the US 30-year Treasury bond market, and pretty much every other bond market as well.

PS.  And take a look at this excellent post over at MarginalRevolution.

Don’t talk about wages and incomes

Here’s a particularly maddening paragraph in a post by Edward Hugh:

And there are plenty of people in Japan who have been pointing this out all along. Seki Obata, a Keio University business school professor for example, who in 2013 published a book “Reflation is Dangerous,” argues exactly this, that “Abenomics” is exposing Japan to considerable risk without any clear sense of what it can accomplish. Obata also makes the extremely valid point that there is simply no way incomes can rise across the entire economy because the baby boomers are now retiring to be replaced by fewer young workers with post labour reform entry-level wages. Japan’s overall consumer spending power will therefore fall, rather than rise as Abe hopes. “Individual companies may offer wage increases, but because of demographics it is simply impossible to increase the total amount that is paid out in wages,” says Obata. “On the contrary, that amount will shrink.” Simple logic you would have thought, but logic in the face of irrational exuberance scarcely stops people in their tracks.

Not only is Obata’s point not “extremely valid” it’s pretty much meaningless.  I really don’t have any idea what Hugh is talking about in this paragraph, because he uses terms like “wages” and “incomes,” which don’t have any clear meaning.  It might as well be written in Korean.  Now the term “nominal wages” has a very clear meaning.  And “real wages” has a very clear meaning, which is totally, completely, entirely different from the meaning of nominal wages.  Nominal wages are as different from real wages as cucumbers are from nuclear power plants.

Now before you say “come on Sumner, the meaning is clear from the context,” read the paragraph again.  The paragraph makes no sense under either interpretation.  Obviously he can’t mean “nominal wages,” because then Obata’s comment would be “extremely invalid.”  But he can’t mean real wages either, because he is talking about demand-side factors.

What makes this Hugh post so frustrating is that just a few days a go I read an excellent post by the same blogger, discussing how a lack of NGDP growth in Italy was worsening the debt situation. Unfortunately this very long post is riddled with confusion from beginning to end.  After each paragraph you scratch your head wondering whether he is talking about real or nominal problems, and when he does make it clear, you wonder whether he has confused the two problems.

Japan has a public debt problem comparable to Italy’s and an even worse NGDP performance over the last 20 years (essentially no growth in NGDP.)  And yet he cites with apparent sympathy a Japanese commentator who fears Japanese monetary policy is too expansionary.  Elsewhere the opposite concern is expressed; Abenomics is failing to generate inflation:

The Bank has had more success with inflation since core inflation was up 3.3% over a year earlier in June. But that number soon shrinks in proportion when you strip out the estimated impact of the recent tax hike. According to the Bank of Japan the ex-tax number for June was 1.3%, down from 1.4% a month earlier. And even this inflation isn’t demand driven: it is largely a carry over from the earlier yen devaluation. As such it is quite likely to disappear with time.

Then later inflation is so high that it is depressing real wages:

Nominal wages have been rising again in Japan.

Average total wages, consisting of base pay, overtime and bonuses covering both regular and part-time workers, grew 0.4% on year in June, following increases of 0.6% for May and 0.7% for April and March. Four straight months of year-on-year rise is the longest stretch since total wages grew for six straight months between June and November 2010. But real wages – which take into account inflation and matter much more to consumers than nominal wages, declined 3.8% on year in June, the fourteenth consecutive month of decline, and the biggest drop since December 2009.

Reading this post you have no sense of what Abenomics is trying to do, or what would constitute success.  And yet it’s clear to me that the “three arrows” are aimed at boosting both AS (economic reforms) and AD (monetary stimulus.)  Here’s another maddening comment:

Part of the reason they might not see it in the same light as the central bank dependent investment community is that there is a solid body of opinion in Japan that recognizes that a large part of the country’s issue is demographic and that simply “jump starting” a bit of inflation won’t make the problem go away..

The question I would ask is this: given all the doubt which exists about the real roots of Japan’s problem, and the fact that it may well be a permanent structural problem and not a temporary liquidity trap one, is it really justified to run such a high risk, all-or-nothing experiment?

What does that even mean?  Clearly Japan has both AS and AD problems.  There is no single “real problem;” there are multiple “real problems.”  One arrow of Abenomics is aimed at the nominal problem, and one is aimed at the real problem (not ‘real’ as in “actual” but real as in not nominal.) And somehow the specific policy that is aimed at the nominal problem is misguided because it doesn’t address the real (i.e. supply-side problem.)  So what?

Monetary policy has its limits. As Martin Wolf so aptly put it, “you can’t print babies”.

I guess in the blogosphere that’s what passes for a profound comment.  Who would have ever guessed that monetary stimulus cannot solve all problems?  (BTW, tight money in the US clearly did reduce the birth rate after 2008.)

Japan needs more NGDP growth to reduce the debt burden and create jobs. It’s that simple.  Japan just instituted a tax increase that if tried in the US would cause a violent revolution—3% more on the national sales tax. The largest sales tax increase the US adopted in my entire life (that I can recall) was a 4 cent gas tax increase under Clinton, and that was highly controversial.  The Japanese tax increase was probably 50 times worse.  So the Japanese people are frustrated with taking a sudden 3% hit to their standard of living from an adverse supply shock?  No kidding.  And this tells us what about monetary stimulus?

BTW, I reluctantly supported the excise tax increase because . . . well because Japan is going broke if they don’t change their ways.