Last shots of 2011

1.  Conservatives tend to believe in market efficiency.  They also believe that high inflation is just around the corner, because of the Fed’s “easy money” policy.  But the TIPS markets don’t seem to agree.  Conservatives often respond by pointing to the sharp rise in gold prices during recent years.  Unfortunately, the increase in demand for gold is occurring in all the wrong places.  Here’s a WSJ article on the skyrocketing demand for gold in Thailand:

There is a longer-term trend toward gold across the rest of Asia, too. The region now makes up around 58% of the global market for gold, according to statistics gathered by the World Gold Council, compared with 35% in 1970, while the combined demand from Europe and North America has fallen from 47% to 27% in the same period.

2.  Tyler Cowen recently had this to say, in response to a commenter who argued that interest and dividends should receive the same tax treatment:

Contrary to common impression, the tax deductibility of interest payments does not give a tax advantage to borrowing, not if the return to savings is taxed.

That’s right, but of course it implies that dividends should also be tax deductible.  And if they aren’t, there’s a good argument for making neither interest nor dividends deductible, but then lowering the corporate tax rate to make the reform revenue neutral.  It seems odd that we are explicitly favoring debt over equity. What public policy goal does that advance?

3.  Tyler Cowen wrote a New York Times column that commented on the large amounts of excess reserves in the banking system:

THE Fed’s stockpiled liquid reserves have met some heavy criticism. Hard-money advocates contend that they are a prelude to hyperinflation — although market forecasts and bond yields don’t bear this out — while proponents of monetary expansion have wished that banks would more actively lend out those reserves to stimulate the economy. That second view assumes that the financial crisis is essentially over, but maybe it’s not. As the euro zone crisis continues, it seems that Ben S. Bernanke has been a smarter central banker than we had realized.

I don’t know if the “proponents of monetary expansion” refers to market monetarists, but I’d be horrified if more than 10% of the excess reserves were to suddenly leave the banking system, as it could lead to excessive growth in NGDP and prices.  I also have no desire to see banks “lend out” the reserves; I’d be happy to see them sell off a tiny percentage of their excess reserves.  The last thing we should be encouraging right now is more bank lending.  The issue of the optimal level of excess reserves is separate from the issue of where to set the IOR right now.  We could get 6% NGDP growth next year with ERs of $200 billion or $2 trillion, it all depends on where the IOR is set, and hence what happens to the demand for ERs.  Don’t confuse demand with quantity demanded.  Tyler probably understands that distinction, but I’m sure many NYT readers do not.

4.  For what it’s worth I think Krugman, Williamson, Noahopinion, DeLong, Andolfatto, and Lucas are all wrong.  Lucas’s basic macro model treats changes in M and V as being equivalent.  Sudden M*V shocks cause business cycles.  That’s my view too.   So although he said he was holding M constant, his comments make sense only if you hold M*V constant.  In which case he expressed his reservation about fiscal stimulus in an exceedingly inept fashion, as that policy is based on the notion that government spending will boost M*V (perhaps by boosting V).

David Romer recently pointed out that the fiscal multiplier was roughly zero during the Great Moderation:

As Robert Solow stresses in his remarks in this session, we should not be trying to find “the” multiplier: the effects of fiscal policy are highly regime dependent.  One critical issue is the monetary regime. Consider estimating the effects of fiscal policy over the period from, say, 1985 to 2005. Central banks were actively trying to offset other forces affecting the economy, and they had the tools to do so. Thus if they were successful, one would expect the estimated effects of fiscal policy to be close to zero.

My hunch is that Lucas understood this intuitively (multipliers had faded from view in recent decades) but at the moment he criticized Christina Romer he forgot why, as he hadn’t even thought about the issue for many years.  That’s basically what DeLong said, except I have a different view of the model Lucas would defend if he had thought about it.  I think it would have been my model of the near-zero multiplier.

5.  Lots of people worry about persistent US current account deficits.  But what if these deficits do not exist?  If we are running current account deficits, then you’d expect the net outflow of investment income to be rising faster (indeed much faster) than the net inflow.  Instead, Paul Krugman shows that the two series are quite closely correlated during normal times, and the US inflow lead has actually widened during the recent recession (when rates on our T-securities plunged.)

The US has a big saving problem.  We save too little (due to multiple distortions in our tax and benefit systems.)  But we don’t have a current account problem.  “Unsustainable imbalances” can be sustained forever.  Those who bet the other way will be disappointed.

Happy New Year!


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12 Responses to “Last shots of 2011”

  1. Gravatar of Lorenzo from Oz Lorenzo from Oz
    31. December 2011 at 18:15

    The Asian middle class gets bigger and richer fast than the gold supply increases, so the price of gold goes up. I fail to see what is remotely surprising about this, to anyone who knows the South and East Asian fascination for gold.

    But, it is a striking feature of those who think they have “special” insights, how often their thinking can be remarkably parochial. And so many “gold bugs” seem to have the view that “I want to give great authority to a particular yellow metal because I don’t want any humans to have such authority”. Misanthropic metallism.

  2. Gravatar of StatsGuy StatsGuy
    31. December 2011 at 18:25

    “Conservatives tend to believe in market efficiency.”

    They say they do, but if you believe in revealed preference theory, then this statement is empirically false, even in the US.

    “I also have no desire to see banks “lend out” the reserves; I’d be happy to see them sell off a tiny percentage of their excess reserves. The last thing we should be encouraging right now is more bank lending.”

    You need to explain this a bit. Also, how does monetary policy by itself create conditions that cause banks to want to sell off excess reserves (and buy what?) without also creating conditions that cause banks to want to make more loans? Or are you suggesting monetary policies augmented with regulatory changes?

  3. Gravatar of StatsGuy StatsGuy
    31. December 2011 at 19:05

    Lorenzo:

    http://www.minyanville.com/businessmarkets/articles/Mr-T-Gold-Indicator-economic-a/2/22/2010/id/26505

    Written in 2010:

    “we’ll have to wait till June 2011 to re-test the Mr. T Gold Indicator’s prowess” (A-Team relaunch)

    Peak date (so far): August 2011… Damn, Mr. T is good.

    Meanwhile, extractive resource pessimists seem to always underestimate technology, when appropriately motivated by high prices. I note that the gold mining industry hasn’t been so keen on releasing gold mining projection for 2013 and beyond based on current project completion and mine openings.

  4. Gravatar of Steve Steve
    31. December 2011 at 21:00

    Happy New Year!

    Hear’s to 2012: the year of NGDP targeting and Market Monetarism!

  5. Gravatar of Kevin Donoghue Kevin Donoghue
    1. January 2012 at 03:50

    For what it’s worth I think Krugman, Williamson, Noahopinion, DeLong, Andolfatto, and Lucas are all wrong.

    That’s the spirit! Hell, I’m sure all of them are wrong about something, anyway. I learn via Greg Mankiw that John Cochrane has started blogging, so the supply of wrongness will surely grow.

  6. Gravatar of W. Peden W. Peden
    1. January 2012 at 07:09

    Statsguy,

    “Also, how does monetary policy by itself create conditions that cause banks to want to sell off excess reserves (and buy what?) without also creating conditions that cause banks to want to make more loans?”

    Most of monetary policy involves creating such conditions. In particular, the Fed can alter the quantity of appreciating assets outside itself. People sometimes talk about the Fed “just” engaging in asset swaps, but the qualitative differences between assets are very important; after all, almost all expenditure is “just” an asset swap.

    Pedantic point: loans are only one kind of bank lending. When a bank buys a security, it creates a deposit that the seller can use i.e. it lends to the seller of the security. Bank asset sheets are actually quite complex and worth looking at during a recession-

    http://www.cato.org/images/pubs/hanke-globeasia-sept-2011-4.jpg

  7. Gravatar of StatsGuy StatsGuy
    1. January 2012 at 07:23

    W. Peden – I’m still a bit confused. That chart has 5 types of assets – reserves, treasury securities (loans to the federal govt.), and real estate/interbanc/commercial loans. Using only the tools of monetary policy (not banking regulation or pro-savings fiscal policy), the primary mechanism of impacting the real economy is (as discussed in many posts here) changing expectations about future AD. Wouldn’t monetary actions that would cause banks to want to sell off reserves also increase AD expectations, and thus cause them to want to make more loans?

  8. Gravatar of DW DW
    1. January 2012 at 07:53

    Ok, so how do you bet FOR it, then?

  9. Gravatar of ssumner ssumner
    1. January 2012 at 08:23

    Lorenzo, Very well put.

    Statsguy, You said;

    “They say they do”

    That’s actually what I was thinking.

    You said;

    “Also, how does monetary policy by itself create conditions that cause banks to want to sell off excess reserves (and buy what?) without also creating conditions that cause banks to want to make more loans?”

    They probably would make more loans, but my point was that this is not something that we should be encouraging. It’s not a goal of monetary policy. The goal would be less demand for excess reserves.

    Thanks Steve.

    Kevin, Yes, Now I have another blog I need to follow. Cochrane already had an interesting critique of Krugman on Ricardian equivalence.

    DW, I’d rather not give investment advice, but I suppose you’d want to be long dollars. However I believe markets are efficient so they already know our “trade deficit” can go on forever.

  10. Gravatar of OGT OGT
    1. January 2012 at 08:56

    If we have a savings problem, why are interest rates so low? And I am not just talking about during the recent unpleasantness, real interest rates have been falling in the US and the rest of the developed world for twenty years. If savings was “too low” for desired investment why haven’t we seen interest rates rise to incentivize more saving?

    A quick look at Rodrik’s Growth Diagnostics makes me very skeptical that your tax/regulation story is accurate.

    http://rodrik.typepad.com/dani_rodriks_weblog/WindowsLiveWriter/image_19.png

  11. Gravatar of dtoh dtoh
    1. January 2012 at 17:46

    Scott,
    You said – “They probably would make more loans, but my point was that this is not something that we should be encouraging. It’s not a goal of monetary policy. The goal would be less demand for excess reserves.”

    Some questions and comments -

    1) This presumes you are below the desired trendline on NDGP…. correct? If you are over the level target, you want more demand for excess reserves… correct?

    2) I think you assume the primary mechanisms for boosting AD are through expectations and through the hot potato effect of putting more money into the economy. In a sense you are boosting V by increasing M….a kind of virtuous circle. Is this a correct way of thinking about it?

    3) It also seems that part of the way Fed policy effects an increase in AD is by increasing demand by financial institutions for other (non reserve) assets while at the same time shifting (via expectations) the IS curve for businesses. Net result is that you get increased investment. Is this what happens? How important is this.

    4) Finally, I’ve suggested in past comments that a policy of NDGP level targeting could be achieved in part by having the Fed regulate financial institutions by setting minimum and maximum asset/equity ratios by asset class. Your response has usually been a bit pro laissez-faire, but when you say we should not be encouraging more lending this seems contradictory.

  12. Gravatar of ssumner ssumner
    2. January 2012 at 18:57

    OGT, Never reason from a price change. Because we save so little our tax rates are excessively high, which makes our economy less efficient. We should adopt a fiscal regime more like Singapore, in which case Americans would save to pay their health bills. Singapore has universal coverage at a cost of 5% of GDP, because of high saving rates.

    BTW, lots of progressives want to see much more infrastructure spending. They may be right, but that won’t happen without lots more saving.

    dtoh,

    1. Yes.

    2. Yes, especially future M.

    3. Yes.

    4. I don’t see the contradiction. I prefer to treat monetary policy and banking policy separately. We may want to discourage lending for reasons of prudence, because banks take excessive risks. We do that with things like capital ratio regs. But meanwhile we use open market operations to always keep expected future NGDP on target. Because we do that, we don’t want any of our other banking regs to affect expected NGDP, rather we want them to lead to the right about of risk taking. If our current interventions (FDIC, TBTF, etc) lead to moral hazard, then other regs must discourage lending.

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