Archive for the Category Monetary Policy


Why is Krugman so forgiving of the ECB?

Yesterday I posted that the ECB just doesn’t “get it,” secure in the knowledge that Paul Krugman totally agrees with me on at least that one point.  And then look at what commenter Vaidas Urba sends me:

Paul Krugman from a week ago:

The good news is that the ECB does, I think, understand the problem. The bad news is that it has limited options. Europe needs something like Abenomics as badly as Japan does; but the political and institutional setting is not favorable.

And then more recently:

The thing is, I don’t believe that current management at the ECB is that different in its understanding of what policy should be doing from leadership at the Fed. But it has to struggle against an economy that is weaker in its underlying fundamentals, bad history, and a much more powerful contingent of monetary hawks.

It really is quite scary.

Over the years Krugman and I have both bashed the ECB for their almost unbelievable incompetence.  The ECB that has repeatedly raised interest rates in the midst of the biggest recession since the 1930s.  The ECB that says inflation should be targeted at 2% and we should forget about unemployment, and then later says don’t worry about the 2% target, deflation is actually healthy because it restores competitiveness.

So why is Krugman suddenly so forgiving?  Yes, the “underlying fundamentals” are weaker, due to “bad history.”  But the bad history is a tight money ECB policy that created 0.8% annual NGDP growth over 6 years.  Those are the “underlying fundamentals” that led to a negative Wicksellian equilibrium rate.  Remember that guy who killed both his parents, and then asked the judge for leniency because he was an orphan?

Krugman’s usually not so forgiving in this situation, so let’s consider some alternative explanations. This is from his recent Vox article:

And now we are talking seriously about secular stagnation in Europe and the US as well, which means that it could be a very long time before ‘normal’ monetary policy resumes. Now, even in this case you can get traction if you can credibly promise higher inflation, which reduces real interest rates. But what does it take to credibly promise inflation? It has to involve a strong element of self-fulfilling prophecy: people have to believe in higher inflation, which produces an economic boom, which yields the promised inflation. A necessary (though not sufficient) condition for this to work is that the promised inflation be high enough that it will indeed produce an economic boom if people believe the promise will be kept. If it is not high enough, then the actual rate of inflation will fall short of the promise even if people do believe in the promise, which means that they will stop believing after a while, and the whole effort will fail.

If you are confused don’t feel bad.  He’s saying that under certain liquidity trap assumptions there is no rational expectations equilibrium at 2% inflation rate.  Now that’s clearly wrong, you could peg CPI futures contracts at 2% inflation.  So what’s he really saying?  He’s saying that you can’t get 2% inflation in his particular Keynesian model.  If you got it in the real world it would be for some other reason, perhaps they ran out of government securities to buy while pegging CPI futures, and then had to buy other assets.  Viola, redefine that as “fiscal policy.”  QED.  I’ve never found those arguments at all persuasive for reasons I’ve discussed ad nauseum.  In any case, it has no bearing on what’s going on the real world, where the ECB has been doing “normal” monetary policy for most of the past 6 years, raising and lowering interest rates, and has refrained from QE.  The ECB doesn’t have to buy stocks and corporate bonds.  They need a more expansionary monetary policy.

And I’m completely confused by his comparison of US and eurozone fiscal policies in the August 13 post.  Whenever people point to the fact that Britain has run huge deficits, Keynesians like Krugman say they’ve got it all wrong; it’s the change in the deficit that matters.  And the Cameron government reduced the deficit somewhat.  But the data he presents shows the US deficit shrinking faster than the eurozone deficit since 2010.  And yet it was the eurozone that had the horrible growth performance after 2010, not the US.  (Both regions did about the same in the initial downturn.)  How does Krugman react?  Now he’s back to comparing levels–the eurozone has a smaller deficit than the US.  Either deficits matter, or changes in deficits matter; I wish Keynesians would make up their minds.

Of course market monetarists aren’t at all confused by the fact that the US has done much better than the eurozone since 2010.

PS.  Perhaps he’s soft on the ECB because they are sophisticated city people, like him.  He’s only just arrived in NYC and is already ridiculing the foolish life choices of small town Americans who don’t share his love of strolling though Manhattan:

People should get enough exercise — they will, in general, be happier if they do — but they tend not to get exercise if they live in an environment where it’s easy to drive everywhere and not as easy to walk. People should limit their caloric intake — again, they’ll be happier if they do — but have a hard time resisting those giant tubs of popcorn.

I can personally attest to the importance of these environmental effects. These days, I walk around with a pedometer on my wrist — hey, I’m 61, and it’s now or never — and it’s obvious just how much more natural it is to get exercise when I’m in New York than when I’m in Princeton; just a few choices to walk rather than take the subway fairly easily gets me to 15,000 steps in the city, while even with a morning run it can be hard to break 10,000 in the suburbs. Also, the Bloomberg nanny-state legacy, with calories displayed on practically everything, does help curb my vices (greasy breakfast sandwiches!).

The interesting and difficult question is how, and whether, these kinds of behavioral issues should be reflected in policy. There are some conventional externality arguments for promoting walkable development — less pollution, etc.. But can we, should we, also favor walkability and density because it promotes good habits? How far should regulation of fast food go? Etc., etc.

Also, isn’t it kind of interesting that these days big-city residents on average lead more “natural” lives, being outside and getting around on their own two feet, than “real Americans” who live in small cities and towns?

Yup, small town Americans sure are stupid.  They’d be much happier if only they’d listen to Paul Krugman’s advice.

There are two types of central bankers . . .

Those who “get it” and those who don’t.  Commenter James of London sent me some interesting information on how Mark Carney is doing:

He’s certainly flexible. Before arriving in the job, but after the appointment was announced he made the speech mentioning NGDP targeting being interesting. In itself it caused a monetary easing in the UK, but I detected a lot of very ruffled feathers in the UK amongst the important people, and those on the MPC who were very keen to emphasise their independence.  The important people got a study commissioned by the Treasury into monetary policy targets that proceeded to inelegantly kill the idea of NGDP targeting and reinforced the status quo view of Inflation Targeting.

On arrival in the job he found his MPC stuffed full of internal and external (independent) dyed-in-the-wool Inflation Target’ers (“Ceiling’ers”). So, he pinned them down to a new idea of forward guidance, but couldn’t chose the right target and had to compromise on unemployment as a main trigger.  When unemployment fell more quickly than expected he broadened the range of triggers, including wage growth.

Now things are looking better as both unemployment and employment do better than expected he has focused on average wage growth. Average wage growth is important as it captures the huge mix changes taking place in the UK labour force, that in turn explains the paradox of rapidly rising employment and no average wage growth. The market recognises it very clearly as shown by the reaction to average wage growth numbers and the latest Inflation Report.

Section 4.3 on page 33 and the box on page 34 is a specially commissioned investigation into the complexities of measuring wage growth. Although some surveys like that from the Recruitment and Employment Confederation provide headlines for very robust pay growth, this is not the same as average wage or income growth. And the “robustness” is only relative, the growth they refer to is merely back up towards the more long run normal pay growth of 3%-4% rather than the job destroying 0% seen during the worst years of the recession.

At the same time, he has managed to change the MPC too. A number of internal members have retired or been forcefully moved (eg the former Chief Economist Spencer Dale, who is now leaving the Bank of England altogether), and a few external members have reached the end of their terms too, allowing Carney to appoint more open minded people, many with more international experience.

All very exciting, and great news for the young and unemployed, and the employed. The number of young jobless fell by the biggest number “since records began in 1992”. It’s also great news for immigrants, who are clearly not taking British jobs, but making them. No reputable economist would have predicted the big increase in immigrant workers and a rising participation rate. That is the wonder of a good, right, monetary policy.

Britain is starting to catch up to Germany in the jobs/growth stakes.   Some people who are sympathetic to my ideas wonder why I wasn’t tougher on Ben Bernanke.  Perhaps because I see his role as being similar to Carney’s—pushing the Fed to move as far as he could, given the institutional inertia.  At the other extreme you have the ECB, and also the new head of the Indian central bank:

David Glasner has a field day talking about these comments by Raghuram Rajan:

Reserve Bank of India Governor Raghuram Rajan warned Wednesday that the global economy bears an increasing resemblance to its condition in the 1930s, with advanced economies trying to pull out of the Great Recession at each other’s expense.

The difference: competitive monetary policy easing has now taken the place of competitive currency devaluations as the favored tool for playing a zero-sum game that is bound to end in disaster. Now, as then, “demand shifting” has taken the place of “demand creation,” the Indian policymaker said.

Let me just add that I doubt you’d find any serious scholars of the Great Depression who would agree with Rajan, Keynesian or monetarist.  In particular, Ben Bernanke would be horrified by these views, and indeed I recall he had a debate with Rajan a few months back on a related point. Ditto for Christina Romer, Barry Eichengreen, and even Milton Friedman, if he were still alive. Rajan (who was a brilliant finance professor at Chicago) has too much of a finance view and not enough of a macro view.  India should have put him in change of regulating India’s banking system (a job he’d be great at), not running monetary policy.  (Perhaps his current job is both–but that’s asking a lot of one person.)

I no longer have time to post on all the great stuff that is sent to me.  Marcus Nunes has a wonderful post criticizing Frederic Mishkin for adopting what you might call the “interest rates reflect the stance of monetary policy” view, just a few years after the very prescient warning he gave the Fed at his last FOMC meeting, in 2008:

What I’d like to spend some time on—because I feel this is sort of my swan song, but maybe because I’m a classy guy, I’ll call this my “valedictory remarks”—are three concerns that I have for this Committee going forward. I’m not going to be able to participate, but I have a chance now to lay them out.

The first is the real danger of focusing too much on the federal funds rate as reflecting the stance of monetary policyThis is very dangerous. I want to talk about that.

HT:  David Levey

Kevin Erdmann is becoming a must read blogger, and has some very interesting observations about a recent study of home ownership and unemployment:

It is strange to me how difficult it is for us to imagine that, on the margin, some workers might have discretion about the duration of their unemployment.  Here is an article on the effect of homeownership on unemployment duration. (HT: EV)  They find that homeowners with mortgages have unemployment behavior more similar to non-homeowners.  The extended duration and the tendency to exit the labor force come from homeowners with high equity ownership.  Yet, oddly, they seem to stick with the explanation that homeowners are less mobile and are tied to limited labor markets.

To me, this finding obviously comes from the fact that high equity home owners have more savings, more discretion, and more flexibility about how to re-enter employment or about making work-leisure trade offs.  I don’t see any mention of this obvious factor in the paper.  We all know people who have discretion in their labor force decisions.  Why do they disappear when we start thinking about the big picture?

Who had a better first half, the US or Japan?

The US had 4% real GDP growth in the second quarter, whereas Japan just announced a 6.8% annualized decline in second quarter RGDP.  So which country had the better first half?  Over the entire first half US GDP rose by 0.475% (not annualized) whereas Japanese RGDP fell by 0.175% (not annualized.)  So the US looks better.

But shouldn’t you adjust for different trend rates of population growth?  Isn’t per capita GDP what matters?  The most recent 6 month growth rate in working age population for the US was up 0.113% (not annualized) whereas it was down 0.64% (not annualized) for Japan.  So in the first half of 2014 RGDP per working age adult rose slightly faster in Japan than the US.

Even so, there’s no sugar-coating the weak Japanese first half.  I’ve consistently argued that the BOJ needs to do more to hit its 2% inflation target, and also that they should target NGDP, not inflation. If they target prices, they really need to do level targeting.

Given the rapid fall in the Japanese population, even a 2% or 3% NGDP growth target, level targeting, would be much better than the pre-Abe policy regime of falling NGDP. The NGDP growth rate should be at least high enough so that the Wicksellian equilibrium nominal rate is not negative (as it is today). Japan needs to raise the denominator of the debt/GDP ratio.

PS.  I also have a post on Japan over at Econlog.

Monetary offset in Australia

Stephen Kirchner quotes from Treasurer Wayne Swan’s briefing notes from August 8, 2008:

There are three broad considerations the Government would need to keep in mind in taking a decision to engage in discretionary [fiscal] action:

The Reserve Bank through its control over interest rates, determines the overall level of aggregate demand in the economy, and the Bank would likely take account of any fiscal stimulus in its monetary decisions – that is, more spending would keep interest rates higher than otherwise…

The bottom line is that in the event of a shallow downturn, discretionary [fiscal] action may not achieve any noticeable outcomes in terms of growth and unemployment, but would leave rates higher, erode the [budget] surplus and put at risk the Government’s fiscal credibility.

These costs of course need to be weighed against the potential political costs of being seen to do nothing…

Then Stephen comments:

Needless to say, the ‘political costs’ argument won in the end, with the first discretionary fiscal stimulus announced in October 2008.

Because rates have never been at zero in Australia, I presume Paul Krugman would agree with Stephen and I on this point.  Perhaps someone can search to see if Krugman commented on Australian policy.

Is New Zealand once again leading the way?

In 1990 the Kiwis were the first to adopt inflation targeting, and now there is a report that they may be the first to give the central bank control over both monetary policy and an important tool of fiscal policy:

New Zealand’s main opposition Labour Party plans to change legislation governing the country’s central bank in its first term if it wins next month’s election, finance spokesman David Parker said.

The plans, which include giving the Reserve Bank of New Zealand an alternative tool for managing inflation, have been discussed with Governor Graeme Wheeler, though “not in detail,” Parker told reporters in Auckland today after Labour began its election campaign. The vote takes place Sept. 20.

Labour wants to give the central bank the ability to recommend changes to the rate of contribution to the national pension savings program, Kiwisaver. The RBNZ could use the new tool as an alternative to the official cash rate to “take the heat out of the economy,” Parker said in April, when the policy was announced.

Quick reactions:

1.  It would be better to rely 100% of monetary policy, particular as NZ doesn’t face the zero bound problem.

2.  But if others insist we need a combined monetary/fiscal approach, then this is far, far better than other forms of fiscal policy.  I would think it would appeal to people like Brad DeLong, who focus a lot on the savings/investment imbalance perspective.