Archive for the Category Monetary History


Multiplier mischief

Multipliers are ratios. That’s really all they are. There is the money multiplier (M2/MB), the fiscal multiplier (1/MPS) and the velocity of circulation (NGDP/MB, or NGDP/M2). If you assume these ratios are stable, you can derive some very interesting policy results. Of course the ratios are not completely stable, but may be stable enough to be of some value. Sometimes. My own view is that multipliers aren’t particularly useful, but today I’d like to assume the opposite, and show that the implications are not necessarily what you might assume.  (And please, no comments from MMT zombies “explaining” to me that multipliers don’t exist.)

Milton Friedman faced a quandary when trying to explain how bad government policies led to the Great Depression. If he defined the money supply as “the monetary base” (as I prefer), people would have pointed out that the base increased sharply during the Great Depression. Alternatively, he could have adopted the market monetarist practice of defining the stance of monetary policy in terms of changes in NGDP. Thus falling NGDP during 1929-33 was, ipso facto, tight money. His critics would have objected that this begged the question of how could the Fed have prevented NGDP from falling.

So he split the difference, and settled on M2 as both the definition of money, and the indicator of the stance of monetary policy. He suggested that, “What is money?” was essentially an empirical question, not to be determined on theoretical first principles. His statistical analysis led him to conclude that M2 (which unlike the base did fall during the early 1930s) was the preferred definition of money. And also that growth in M2 should be kept stable at roughly 4%/year.

In my view M2 no longer represents a good definition of money, using Friedman’s pragmatic criterion. Look at M2 growth in recent years:

Screen Shot 2015-10-05 at 3.38.24 PMI don’t know about you, but I see almost no correlation with the business cycle. Indeed M2 growth soared in the first half of 2009, making money look “easy”, which is obviously crazy. So if Friedman were alive today, how would he define money? The base still doesn’t work, as reserves also soared in 2008-09. Nor does M2. I don’t have a good answer, but I suspect that coins might be the best definition. Unlike the base and M1, periods of illiquidity probably don’t lead to massive hoarding of coins.  They are primarily useful for making transactions (although a sizable stock is held in piggy banks.)

Unfortunately, I could not find any data for the stock of coins in circulation. (Which is a disgrace, when you think about the 100,000s of data series the St Louis Fred does carry. As I recall, back in the 1990s coins were almost as important a part of the base as bank reserves.) But I did find data on annual coin output. For simplicity, I chose unit output, but value of output (which counts quarters 5 times more than nickels) would almost certainly lead to broadly similar results. In the list below I will show the change in annual coin output, compared to the year before, and also the change in the unemployment rate at mid-year (June) compared to the year before. The unemployment rate change is in absolute terms:

Year  * Coin Output  * delta Un

2000:   +28.1%           -0.3%
2001:    -30.9%          +0.5%
2002:    -25.7%          +1.3%
2003:    -16.5%          +0.5%
2004:    +9.5%          -0.7%
2005:   +16.1%          -0.6%
2006:    +1.4%           -0.3%
2007:    -6.9%             0.0%
2008:    -29.8%        +1.0%
2009:   -65.0%          +3.9%
2010:   +79.6%          -0.1%
2011:    +28.7%         -0.3%
2012:   +13.9%          -0.9%

Unfortunately my data ends at 2012, but that’s a really interesting pattern. Especially given that I don’t have the data I’d actually prefer.  I’d like the change in the size of the coin stock; instead I have the change in the flow of new coins (but not data on old coins withdrawn.)  It’s more like a second derivative.

In any case, it’s an amazing correlation. The signs are opposite in every case except the one where unemployment doesn’t change at all.  Coin output falls during years when unemployment is rising, even years like 2003 when unemployment is rising during a non-recession year.  And even better, the biggest change by far in coin output (proportionally) is in 2009, which also saw the biggest change by far in unemployment.

If you are not good at math then you’ll have to take my word for 2010 being a smaller change in proportional terms.  Indeed if you look at actual coin output in levels, 2010 was the second smallest in the sample, 2011 the third smallest, and 2012 the 4th smallest.  The decline in 2009 was so great that we never really climbed out of the hole.

Now let me emphasize that there’s an element of luck here.  If we had coin data for 2013 and 2014 I doubt the relationship would hold up.  Coin output seems to be in a steep secular decline.  So it’s partly coincidence that the signs are reversed in virtually every case.  But not entirely coincidence.  Perhaps someone could do a regression (using first differences of logs of coin output—so that the 2009 change will be larger than 2010) and confirm my suspicion that this relationship does show something real.  Falling coin output is associated with recessions.

But does it cause recessions?  If only you knew how tricky the term ’cause’ really is!  Krugman basically called Friedman a liar (soon after Friedman died) for claiming that tight money caused the Great Depression, whereas in Krugman’s view Friedman’s data pointed to the real problem being a non-activist Fed—they didn’t do enough to prevent M2 from falling. But they didn’t cause it to fall with concrete steppes.  The base didn’t fall.

I’ve always believed we should think of “causation” in terms of policy counterfactuals.  Suppose the Fed had acted in such a way that M2 didn’t fall.  And suppose that in that case there would have been no Great Depression.  Then if the Fed was capable of preventing M2 from falling (which is itself a highly debatable claim) then there is a sense in which Friedman was right, the Fed did cause the Great Depression.  Again, that’s if they could have prevented M2 from falling, and if stable M2 would have prevented a depression–both debatable (but plausible) claims.

My claim is that if we use Friedman’s pragmatic criterion for defining money, then coins might possibly be the best definition of money for the 21st century.  If the Fed had acted in such a way that coin output was stable in 2007-09, or at worst declined along its long run downward trend, then there would have been no Great Recession.  So in that sense the fall in coin output “caused” the Great Recession. But I could also find a 1000 other “causes,” such as plunging auto sales.

Can the Fed control the coin stock?  I’d say they could in exactly the same way they can control M2 (or nominal auto sales), via a multiplier.  The baseline assumption is that both the coin stock and M2 move in proportion to the base.  That would be the case if the M2 and coin multipliers were stable.  If the multipliers change, then the Fed simply adjusts the base to offset the effect of any change in the coin multiplier.

No let me quickly emphasize that I view the preceding as an extremely unhelpful way of thinking about monetary policy and the Great Recession.  I still prefer to define money as the base, as the base is directly controlled by the Fed.  And I prefer to define the stance of monetary policy as NGDP growth expectations.  And I prefer to think of tight money as setting the monetary base at a level where NGDP growth expectations fall below target, as in 2008-09.  I’d just as soon leave coins to children with piggy banks and nerdy collectors.  But if you insist on defining money using Friedman’s pragmatic criterion, then coins are my definition of the money stock.

A penny for your thoughts?

PS.  I have a new post on the Phillips Curve at Econlog.

On welcoming hatred

Greek finance minister Varoufakis got a lot of attention a few months back with this tweet:

FDR, 1936: “They are unanimous in their hate for me; and I welcome their hatred.” A quotation close to my heart (& reality) these days

There are indeed a number of striking similarities between FDR and Syriza.  The one I’ve been thinking about most recently occurred in June 1933. FDR’s representatives had been in Europe trying to negotiate a restoration of fixed exchange rates at the World Monetary Conference.  They were getting close to agreement when FDR issued a shocking statement favoring flexible rates that undercut his representatives and blew apart the conference.  Sound familiar?  FDR took pleasure in outraging the VSPs of his day.  Yes, in temperament Varoufakis is something like FDR.

I’m a big fan of FDR’s policy of devaluation, so why am I not a big fan of Varoufakis?  My critics think it’s all mood affiliation.  Maybe so, but recall that I am also a market monetarist.  And the “market” part refers to the fact that I believe markets provide the best indicator of the likely effect of policy shocks.

In 1933 the Wall Street elite were horrified by FDR’s replacing the gold dollar with a “rubber” dollar, having a flexible value.  And yet US stock prices soared on each and every outrageous statement by FDR, such as when he torpedoed the WMC in late June.  The Greek stock market was closed during the recent vote (and remains closed) but both Greek and European stocks responded negatively to information suggesting that Syriza was unwilling to deal during the month of June, and then rose on hopes for an agreement.  Those contrasting market reactions are probably telling us that there are small but important differences between the US in 1933 and Greece today.

To end on a fair and balanced note:

1.  The market would probably also welcome more European flexibility in striking a deal.

2.  The fact that FDR was right when all the VSPs thought he was wrong should make us cautious about judging the Greek situation.  It’s certainly possible that Varoufakis is right and I am wrong.

PS.  Between mid-April  and mid-July 1933, US stocks were even rising sharply in gold terms, despite rapid depreciation of the US dollar against gold.

Brad DeLong needs to reread the Monetary History

Bob Murphy directed me to a Brad DeLong post bashing Milton Friedman:

In A Monetary History of the United States, published in 1963, Friedman and Anna Jacobson Schwartz famously argued that the Great Depression was due solely and completely to the failure of the US Federal Reserve to expand the country’s monetary base and thereby keep the economy on a path of stable growth. Had there been no decline in the money stock, their argument goes, there would have been no Great Depression.

I can’t understand how a brilliant economic historian like DeLong could make such a totally erroneous statement.  Milton Friedman and Anna Schwartz clearly documented the fact that the Fed increased the monetary base sharply during the Great Depression. They discussed the Fed’s QE policy of 1932.  So the preceding statement is flat out wrong.

And indeed the entire post is confused.  DeLong argues that the Great Recession was partly caused by the influence of Friedman’s ideas.  Actually, one could argue that the Great Recession happened because we did not pay enough attention to Milton Friedman.  Indeed this Friedman insight from 1998 was totally ignored in late 2008 by all but a tiny band of market monetarists:

Low interest rates are generally a sign that money has been tight, as in Japan; high interest rates, that money has been easy.

.   .   .

After the U.S. experience during the Great Depression, and after inflation and rising interest rates in the 1970s and disinflation and falling interest rates in the 1980s, I thought the fallacy of identifying tight money with high interest rates and easy money with low interest rates was dead. Apparently, old fallacies never die.

In early 2009 I wrote a piece sharply criticizing DeLong for claiming that monetary policy was ineffective at the zero bound and that we therefore needed fiscal stimulus. He finally got the message, and a few years later he was bashing the Fed for letting NGDP growth plunge.  Now he’s back to claiming there was nothing the Fed could do at the zero bound.

When I was in grad school in the 1970s, anyone claiming a fiat money central bank would be unable to debase its currency would have been laughed at.  As recently as the early 2000s mainstream economists like Mishkin, Bernanke, Svensson, etc., were still scoffing at that idea.  It’s a sad comment on modern macro that this bizarre theory has suddenly become mainstream without a single shred of evidence in support.  Even worse, most macroeconomists don’t even seem to know what evidence in support of monetary policy ineffectiveness would look like.

PS.  Bob Murphy also has a post on the same topic.  David Glasner criticizes the DeLong post for other reasons.

PPS.  I strongly believe that if the FOMC had been composed of 12 Brad DeLongs, the Great Recession would have been considerably milder.  Which means Brad is wrong.  :)

The biggest basher of them all

Ramesh Ponnuru has a very good article pushing back against Robert Samuelson’s criticism of Fed bashers.  While Mr. Samuelson is certainly right that much of the criticism is a bit nutty, sometimes I think there is a tendency for what Paul Krugman calls “Very Serious People” to be overly protective of institutions such as the Fed.  I am perfectly willing to accept the claim that the Fed is an institution full of very talented people.  I believe that its leadership is well intentioned. I believe Fed policy partly explains why the US has done better than the eurozone in the past 4 years.  I believe that, on average, Fed policy has improved over time.

But . . . no institution should be immune from criticism, as there is always room for improvement.  Today I’d like to talk about the biggest Fed basher of them all: Ben Bernanke.  Here’s Bernanke blaming the Fed for the Great Inflation:

Monetary policymakers bemoaned the high rate of inflation in the 1970s but did not fully appreciate their own role in its creation.

And here’s Bernanke attributing the performance of the Fed during the Great Moderation to improved Fed policy:

With this bit of theory as background, I will focus on two key points. First, without claiming that monetary policy during the 1950s or in the period since 1984 has been ideal by any means, I will try to support my view that the policies of the late 1960s and 1970s were particularly inefficient, for reasons that I think we now understand. Thus, as in the first scenario just discussed (represented in Figure 1 as a movement from point A to point B), improvements in the execution of monetary policy can plausibly account for a significant part of the Great Moderation. Second, more subtly, I will argue that some of the benefits of improved monetary policy may easily be confused with changes in the underlying environment (that is, improvements in policy may be incorrectly identified as shifts in the Taylor curve), increasing the risk that standard statistical methods of analyzing this question could understate the contribution of monetary policy to the Great Moderation.

And here’s Bernanke blaming the Fed for the Great Depression:

Let me end my talk by abusing slightly my status as an official representative of the Federal Reserve. I would like to say to Milton and Anna: Regarding the Great Depression. You’re right, we did it. We’re very sorry. But thanks to you, we won’t do it again.

That’s a pretty serious charge, given that the economic collapse of 1929-33 turned the Nazis from a small fringe party to the dominant political force in Germany.  And Bernanke is not just a Fed basher; he lashes out at any other central bank that doesn’t do what he thinks they should be doing:

Japan is not in a Great Depression by any means, but its economy has operated below potential for nearly a decade. Nor is it by any means clear that recovery is imminent. Policy options exist that could greatly reduce these losses. Why isn’t more happening? To this outsider, at least, Japanese monetary policy seems paralyzed, with a paralysis that is largely self-induced. Most striking is the apparent unwillingness of the monetary authorities to experiment, to try anything that isn’t absolutely guaranteed to work. Perhaps it’s time for some Rooseveltian resolve in Japan.

So the Fed is to blame for the Great Depression, deserves praise for producing low inflation during the 1950s and early 1960s, deserves praise for producing a stable macroeconomy during the Great Moderation (1984-2007), and is to blame for the Great Inflation of 1966-81.  In this set of PowerPoint slides Bernanke blames the Fed for the severe 1981-82 recession.  Are we to assume that beginning in 2008 the Fed suddenly stopped being responsible for macroeconomic outcomes?  After being to blame or deserving credit for virtually every single major macroeconomic twist and turn since it was created in 1913?

Not according to William Dudley, current New York Fed President and close Bernanke ally.  He argues the Fed continued to make mistakes after 2008:

I would give each of these four explanations some weight for why the recovery has been consistently weaker than expected. But I would add a fifth, monetary policy, while highly accommodative by historic standards, may still not have been sufficiently accommodative given the economic circumstances.  .  .  .

My conclusion is that the easing of financial conditions resulting from non-traditional policy actions has had a material effect on both nominal and real growth and has demonstrably reduced the risk of particularly adverse outcomes.  Nevertheless, I also conclude that, with the benefit of hindsight, monetary policy needed to be still more aggressive. Consequently, it was appropriate to recalibrate our policy stance, which is what happened at the last FOMC meeting.

As I argued in a recent speech, simple policy rules, including the most popular versions of the Taylor Rule, understate the degree of monetary support that may be required to achieve a given set of economic objectives in a post-financial crisis world. That is because such rules typically do not adjust for factors such as a time-varying neutral real interest rate, elevated risk spreads, or impaired transmission channels that can undercut the power of monetary policy.  [emphasis added]

So from the vantage point of October 2012, William Dudley suggests that monetary policy over the previous 4 years was insufficiently expansionary.  He’s “bashing” the Ben Bernanke Fed, and he’s almost a clone of Bernanke in his policy views!

I wonder if Dudley is also admitting that, in retrospect, a certain group of monetary cranks that were bashing the Fed in 2008 and 2009 for inadequate nominal growth might have been right.

I don’t know if “Fed basher” is the right term to apply to Ben Bernanke.  All I can say is that if Bernanke is a Fed basher, then I’m proud to be one too.

Research bleg

In this post I’m going to throw out a bunch of graphs, and ask for advice.  First let me briefly discuss real wage cyclicality.  Many of the early macroeconomists believed that real wages should be countercyclical.  They held a sticky-wage theory of the business cycle.  When prices fell sharply, nominal wages seemed to respond with a lag (even in 1921.)  Thus deflation temporarily raised real wages, even as unemployment was rising.

Real wages were quite countercyclical between the wars, but after WWII many studies found them to be acyclical, or even procyclical.  Most economists thought this was inconsistent with sticky wage models of the price level, and new Keynesian models ended up focusing on price stickiness and inflation targeting.  Greg Mankiw and Ricardo Reis have a 2003 paper that shows that you generally want to target the stickiest price.

In 1989 Steve Silver and I published a paper in the JPE that showed real wages were somewhat countercyclical during demand shocks and strongly procyclical during supply shocks. We suggested that this finding was supportive of sticky wage models of the cycle.  It even got cited in some intermediate macro texts (Mankiw’s textbook and also Bernanke’s.)  But after a while it was ignored.  In the graph below I show real wages during the post war years:Screen Shot 2015-01-27 at 1.55.46 PM

You can see why people didn’t find much cyclicality. And if you look closely you can also see some support for the paper I did with Steve Silver.  When real wages rise during recessions (1981-82, 2001, 2008-09) it’s a demand-side recession. When they clearly fall (1974, 1980) it’s a supply-side recession.  However there are some smaller demand-side recessions with almost no change in real wages.

Now let’s switch over to the “musical chairs” version of the sticky-wage model.  In the real wage model discussed above, firms lay off workers because production is less profitable at higher real wages.  In contrast, in the musical chair version of the sticky-wage model real wages don’t matter, what matters is revenue.  When firms receive less revenue they have less income to pay wages, so they employ fewer workers.  This would even apply to a socialist economy.  Imagine all firms were owned by workers, who shared revenues.  Also assume sticky nominal hourly wages.  Then when revenues fell, hours worked at the firms would decline. That might mean a shorter workweek (as occurred in 2008-09 in Germany) or it might mean fewer workers (as occurred in 2008-09 in the US.)

If we are looking to explain total hours worked, we might divide nominal wages by NGDP.  If trying to explain the unemployment rate, it makes more sense to divide nominal wages by NGDP/Labor force.  Previously I’ve showed that this cycle fits the musical chairs model quite well:

Screen Shot 2015-01-27 at 2.20.45 PM

Unfortunately, we lack good wage data before 2006.  For earlier business cycles, all I could find was wages in goods-producing industries:

Screen Shot 2015-01-27 at 2.41.08 PM

Notice that the ratio of hourly wages to NGDP/Labor force has a level trend from the late 1940s to 1982, and then plunges by a third.  That could reflect many factors, such as a change in hours worked per worker, but I think it more likely reflects three other factors:

1.  More fringe benefits (good for workers)

2.  Smaller share of NGDP going to workers (bad for workers)

3.  More inequality within labor income (bad for non-managerial factory workers)

But what really impressed me is the strong correlation between wages/(NGDP/LF) and the unemployment rate.  And by the way, even if you just used W/NGDP, you’d still see a strong correlation, as labor force changes are fairly “smooth.”  But there would be even more trend issues to deal with.  In my view, the weakest correlation appears to occur during the 1991 recession.  But even there you see a brief flattening of what had been a steep fall in W/(NGDP/LF) during the 1980s and 1990s.

Here’s one question.  How would you test for a correlation?  I suppose you could compute changes in W/(NGDP/LF) minus a ten year moving average of the same variable, and correlate that with change in unemployment.  Just eyeballing the graphs, I’d expect a reasonably close fit, even for 1990-91.

I know what you are thinking, how about the interwar years?  I could not find unemployment data, so I used industrial production.  Unfortunately that makes eyeballing the graph tougher as the predicted correlation is negative.  Also, the NGNP data for 1921 at the St. Louis Fred is total crap.  If someone over there is reading this, please replace your prewar NGDP estimates with Balke/Gordon, which is far superior, and goes back even further.

Screen Shot 2015-01-27 at 3.06.16 PMWith the Balke/Gordon data, even 1920-21 would be a nice fit.  But you can see the W/NGDP ratio rise in 1929-33 and 1937-38 as IP falls sharply.

PS.  I was a bit surprised by the real wage series.  The fall in real wages from 1978 to 1993 didn’t surprise me—the rust belt took a toll on factory wages.  But the uptrend after 1993 was a bit better than I had expected, given all the gloomy articles on real wage growth.