Archive for the Category Monetary Policy


What do the VSP think about the current economy?

This is a sincere question.  Do the Very Serious People think the US economy is deeply depressed, or nearing full employment?  I see conflicting evidence:

1. As far as I can see the policy of tapering has overwhelming support among the VSP, suggesting they think it’s time for the economy to stand on its own two feet, without a crutch from the Fed. Is that correct?

2. As far as I can see most of the press and pundits, and moderate politicians, seem to support an extension of the emergency unemployment benefits? Recall that the proposal would y currently extend them to 73 weeks, which is far more generous than the emergency benefits under Bill Clinton in early 1993, when unemployment was even higher. The call for an emergency extended unemployment benefits program would imply emergency level unemployment rates, where monetary tightening (when inflation is also below target) would be utter madness.

I’m not interested in arguing these two perspectives.  Both are defensible.  Rather I’m trying to get a sense of where the VSP opinion is on this issue. I honestly cannot tell.  Do they think the economy is deeply depressed?  Or not?

PS.  I’m a bit less sure on point two, but a number of GOP lawmakers recently indicated that they would support extended unemployment benefits, which suggests that the center of gravity political was for extension–that’s certainly the overwhelmingly popular view among press and pundits.

PPS.  Totally off topic, but this comment by Greg Mankiw intrigued me:

In this case, the issue is the reduction in capital taxes during the George W. Bush administration.  Paul [Krugman] says that the goal here was “defending the oligarchy’s interests.”

Really? As Paul well knows, there is a large literature in economics suggesting that an optimal tax system imposes much lower taxes on capital income than on wage income (or consumption).

Why should we assume that Paul Krugman is aware of that literature?  You would think he would be aware of the literature—other progressive bloggers like Matt Yglesias and Brad DeLong obviously are.  But I don’t recall reading a single Krugman column that showed any awareness of the need for replacing our current tax system with a progressive consumption tax.  I don’t recall a single post pointing out that taxes on capital should be much lower than taxes on labor income, if not zero.  I don’t recall a single post pointing out that nominal tax rates on capital income are meaningless, and that real tax rates on (for instance) Treasury bonds are now well over 100%.  Or that corporate income is triple taxed, making nominal corporate tax rates utterly meaningless as indicators of progressivity.  Or that Warren Buffet was spouting utter nonsense when he claimed his tax rate was lower than that of his secretary.  If such Krugman posts exist then please show them to me, I’d love to read them.

Either he is unaware of the literature, or he is aware of it and is knowingly spouting misinformation. I’d prefer to be charitable and assume that he’s not aware of the literature.

Mark Sadowski on Cullen Roche

Here’s Mark Sadowski (much of the following is Mark quoting Cullen):

I want to focus on one particular claim by Cullen Roche which he repeats three times in various forms at two different posts.

Cullen Roche
“Depends on the banking system and the “money” you’re referring to. “Federal Reserve Notes” are not actually issued by the CB even though they’re a liability of the CB. They are purchased by the CB and printed up by the Bureau of Engraving. Reserve Banks purchase coin at face value from the US Mint (who is determining your “conversion” rate there – a branch of the US Tsy or the Fed?). So, in a strange sort of way, the Treasury acts as a banker to its own bank and charges that bank quite a bundle in fees to deal in “legal tender”. There is this circuitous/hybrid relationship here that I think gets bungled by a lot of people.

So, when Scott Sumner refers to reserve notes as “paper gold” he’s really not referencing the power of a Central Bank. He’s actually referring to the issuer, the US Treasury which makes Sumner an ironic/funny kind of way. And this is the problem with parts of Market Monetarism. If you don’t respect specific institutional arrangements you end up saying things that make no sense when you consider the actual design of the system.”

Cullen Roche:
“…1) I think you overstate the exchange rate concept given that the Fed buys coin and currency from the US Tsy and the fact that there’s deposit insurance via FDIC. US bank deposits are at a very low risk of ever trading below par. The “value” of commercial bank money has been backstopped for all intents and purposes and the Fed is far from the only cause of this effect…”

Cullen Roche
“I understand Nick’s point. The thing is, the “unit of account” in Sumner’s theory is not even created by the CB. It’s created by the Bureau of Engraving. All cash and coin is sold to the Fed at face value by the Bureau, a department of the US Tsy. The alpha bank, if we’re going to use such a term, is actually the US Treasury in the Market Monetarist model and they don’t know it because they don’t actually describe the reality of how money is created. Sumner’s “paper gold” is a creation of the US govt, not the Fed…”

For this point forward it’s mostly Mark’s reply:

In a word, this is wrong.

“The distribution of coins differs from that of currency in some respects. First, when the Fed receives currency from the Treasury, it pays only for the cost of printing the notes. However, coins are a direct obligation of the Treasury, so the Reserve Banks pay the Treasury the face value of the coins…”

The cost of printing the notes has averaged approximately 0.325% of their face value in the past 11 years:

Of course the Federal Reserve pays 100% of the face value for coins. What proportion of the value of the currency in circulation consists of coins?

“…The value of U.S. coins in circulation as of May 31, 2010, was approximately $40.4 billion, or about 4.3 percent of total currency and coin in circulation.”

So the Treasury only gets paid about 4.6% of the face value of the nation’s currency in circulation by the Federal Reserve, which is appropriate if the Treasury is really in the role of performing a service for the Fed.

As Cullen says:
“If you don’t respect specific institutional arrangements you end up saying things that make no sense when you consider the actual design of the system.”

Kind of “ironic/funny”, eh?

I just have one question for Mr. Roche.  If the Fed buys currency at par, how did the Fed earn its seignorage prior to 2008?

Could we have had a severe recession without the 2008 financial crisis?

Paul Krugman argues that it would have taken a dramatically different set of policies back in 2007 to prevent the Great Recession, and Brad DeLong argues that a much more modest set of initiatives might have sufficed.  There is much to agree with in both posts.  First here’s Krugman, quoted by DeLong:

What It Would Have Taken: “Think of it this way: what would a really effective set of policies be right now? First… aggressively reverse the fiscal austerity of the last few years…. Monetary policy should accommodate that boost; interest rates should not go up even if inflation goes somewhat above 2 percent. In fact, there’s an overwhelming prudential case for raising the inflation target…. Say for the sake of argument that the right policy is two years of fiscal expansion amounting to 3 percent of GDP each year, plus a permanent rise in the inflation target to 4 percent. These wouldn’t be radical moves in terms of Econ 101 — they are in fact pretty much what textbook models would suggest make sense given what we have learned about macroeconomic vulnerabilities. But they are completely outside the bounds of respectable discussion. That’s the sense in which we are “doomed” to long-term stagnation. We have met the enemy, and it’s not the economic fundamentals, it’s us.

And here’s DeLong’s reply (or more precisely the response of Brad’s Greek friends):

Thrasymakhos: Oh, Krugman’s 100% right about today…

Khremistokles: He is indeed. We are totally tracked…

Thrasymakhos: Very few members of congress or FOMC participants seem to spend any significant time talking to anybody who is not a plutocrat…

Khremistokles: But he is wrong about how aggressive and radical the needed policies back in 2007 were. As a share of GDP, the bad shopping-mall and office-tour debts of Houston, etc, in 1989 were as large as the bad mortgages of 2007…

Thrasymakhos: But back in 1989 the political power of the princes of finance was much less than in 2007…

That’s probably right, but I have trouble with DeLong’s implicit assumption is that the financial crisis caused the Great Recession.  DeLong points out that the recession of 1990-91 was far milder, despite equivalent bad debt (as a share of GDP.)  And that the 1990 crisis was handled better. Krugman’s comment points to one overlooked factor.  In 1990 we did have a de facto 4% inflation target.  The years leading up to 1990 saw Australian-level NGDP growth, if not more.  So even if lending standards tightened sharply in the wake of the 1989-90 crisis, there still would have been no possibility of hitting the zero bound.  Rates fell to about 3% in the recession, still a bit higher than in Australia this time around.  With no zero bound in prospect, there’d be no reason for markets to expect an NGDP collapse.  Elsewhere I’ve argued that growing realization of plunging NGDP tanked the asset markets in the second half of 2008.

Even if we had managed the 2007-08 subprime crisis very well from a regulatory/resolution perspective, there is no question that banks would have tightened lending standards sharply.  That effectively reduces the demand for credit. And of course house prices were plunging even before Lehman, and then we got a “secondary deflation” of house prices when NGDP plunged.  It’s quite plausible that the Wicksellian equilibrium natural rate would have fallen to zero in late 2008, even with a better resolution of the banks.  On the other hand if we’d gone into 2007 with Paul Volcker’s de facto 4% inflation target (a policy he now opposes), then the Great Recession would have been a 1990-style mild recession.

One area where I slightly disagree with Krugman is his focus on inflation.  A 5% NGDPLT target path would have been enough; we didn’t need 4% trend inflation.  Nor do we need fiscal stimulus. On the other hand the supply side fundamentals of the economy were so poor after 2008 (for reason I don’t fully understand) that 5% NGDP growth would have led to some unpleasant stagflation. So we might have gotten Krugman’s 4% inflation anyway.  Indeed if my preferred policy had been adopted, it would have been widely judged a failure, partly because (as DeLong correctly pointed out) almost nobody back in 2007 envisioned a recession as severe as the one we got.

People see bad outcomes, and have trouble envisioning it could have been much worse.  That’s one reason why my preferred policy was not politically feasible in 2008.  But thanks to the NGDP targeting boomlet, it will be somewhat more feasible next time around.  Next time people will be able to envision a worse alternative.

All stabilization policies eventually fail, just as all presidents are judged failures in their 6th year in office.  The trick is to have a modest failure like Clinton or Obama, not a serious failure like FDR or Nixon.  NGDPLT would have given us just that in 2008-09.

PS.  I have a new post on Jeremy Stein over at Econlog.

HT:  TravisV

“Under NGDPLT, it becomes the job of Fiscal policy to control inflation.”

The title of this post was left in a recent comment by Morgan Warstler.  What he means is that NGDPLT takes nominal spending off the table, all that’s left is for the government to try to influence the split between P and Y.  And that means demand policies don’t work, all fiscal policy must be supply-side, aimed at more growth and hence less inflation.

If conservatives understood this then market monetarism would go from being a fringe movement eyed suspiciously by those on the right, to a position where we’d be headline speakers at CPAC.

While we’re at it, Morgan’s wage subsidy scheme makes the minimum wage and welfare obsolete.

PS.  I have a bubble post (with Shiller bleg) over at Econlog.

Now that Ben Bernanke is free to speak his mind . . .

What does Bernanke now say about the market monetarist claim that monetary policy was not expansionary enough during the 2008-09 crisis?  This:

(Reuters) – Former Federal Reserve Chairman Ben Bernanke said the U.S. central bank could have done more to fight the country’s financial crisis and that he struggled to find the right way to communicate with markets.

“We could have done some things on the margin to mitigate somewhat the crisis,” Bernanke, 60, said on Tuesday in his first public speaking engagement since he stepped down in January after eight years heading the Fed.

“Although we have been very aggressive, I think on the monetary policy front we could have been even more aggressive.”

Bernanke said he could now speak more freely about the crisis than he could while at the Fed – “I can say whatever I want” – and in remarks to over 1,000 bankers and financial professionals in the capital of the United Arab Emirates, he made clear that he had regrets.

Janet Yellen has only been in charge for a few weeks, and yet I think we are already discovering that Ben Bernanke was not the problem.

It’s the zeitgeist, stupid.

PS.  Marcus Nunes sent me a post by Philip Pilkington:

A revolution in how we understand economic policy is now visible – but the question remains as to whether the Bank will seize the moment. Monetarism, you see, has two components. The first is that the central bank should try to control the money supply. In light of the Bank’s report that part of the monetarist doctrine is now a dinosaur fit only to be displayed in the museum of failed economic ideas.

The second component, however, is alive and well. That is the idea that the central bank should use unemployment to control inflation. Although the central banks of the world rarely say it in public, since the monetarist era they have used interest rate hikes to generate recessions and increase unemployment any time they fear an uptick in inflation.

I’m not sure what the “second component” refers to, perhaps new Keynesianism (which is loosely related to monetarism.)  This quote provides a good opportunity to distinguish market monetarism from either the original or new Keynesian varieties.  We don’t favor controlling the money supply (he means aggregates), nor do we favor using unemployment to control inflation.  Indeed we don’t want the central bank to control inflation at all, but rather target NGDP growth.

PS.  His comment about the money supply after Thatcher took office is slightly misleading.

Inflation began to subside, not because the money supply stopped growing – it didn’t – but rather because wage growth was contained through high rates of unemployment and the demolition of trade unions.

Yes, it didn’t stop growing, but consider this data:  In 1969 the UK base was 3618 million pounds.   By 1979 it had soared to 10446 million pounds, up 189%.  Then the BoE stopped printing money at such a furious pace and growth slowed, so that the base reached 17621 million pounds in 1989, up 69%.  That’s certainly a significant slowdown, and largely explains why prices rose only 85% during the 1980s, after rising 222% during the 1970s.