Ezra Klein vs. Ezra Klein

Ezra Klein has a long rebuttal to Ramesh Ponnuru’s recent critique of fiscal stimulus.  It contains lots of the usual talking points, but seems to sort of waver between the “Fed can’t” and the “Fed won’t” defenses of fiscal stimulus.  I’ll focus mostly on the “Fed can’t” argument:

Ponnuru nods at this toward the end of his column, but all he says about the difficulty of a policy that would have driven interest rates to negative 6 percent is that “our government was perfectly capable of pursuing a highly expansionary one in 1933, when interest rates were low.”

As far as 1933 goes, part of the expansionary policy was driven by Europeans sending gold to America because they were afraid of Hitler, and part of it came later, when we went off gold altogether. We really can’t do that again. And note that quite a bit of the research on the Fed’s stimulative policies in the 1930s was done by Christina Romer and Ben Bernanke, both of whom happened to be in office in 2009, and both of whom called for massive fiscal stimulus.

There are a number of problems here.  Let’s start with the “we can’t do that again.”  The only reason the gold flows to America mattered is that they allowed a larger money supply.  We don’t even need gold to do that today, we can just print money.  As for going off gold, he’s right that we can’t do that, but what really mattered about going off gold was that FDR used it as a way of hitting a price level target.  And here’s where Klein is giving readers the wrong impression.  Romer is a very strong advocate of the position that monetary policy does not run out of ammunition at the zero bound.  Indeed Romer has recently been calling for NGDP targeting, level targeting.  Bernanke said the BOJ could definitely increase prices if they wanted to, and called on them to show “Rooseveltian resolve.”  He clearly thought the lessons of 1933 had relevance for today.  Bernanke has repeatedly said the Fed is not out of ammunition.

Ezra Klein is right that both Romer and Bernanke have called for fiscal stimulus.  Far enough, but we need to take one issue at a time.  Most of the Klein column is devoted to criticizing Ponnuru’s argument that monetary policy is still effective at the zero bound.  That criticism may correct, but on that issue there is no dispute that both Romer and Bernanke firmly agree with Ponnuru, not Klein.

[BTW, the European gold flows to America occurred well after we left gold, not before.  Indeed we were back on gold by the time they occurred.]

Ezra Klein continues:

Ponnuru concludes that “Obama would have been better off pushing for more Fed action in 2009” and “skipping the unpopular stimulus.” It’s not clear what this would have meant in practice. The Federal Reserve is independent of the president. So Obama couldn’t have ordered Bernanke around in 2009. He potentially could have replaced him with a much more radical Fed chair when Bernanke’s term was up, but by that point, the Republican Party had turned decisively against expansionary monetary policy — Ponnuru fought this turn, I should note — and any attempt to stock the Fed with leaders who would have pushed a vastly more inflationary course would have been quickly blocked by the Republican Party.

Readers of this blog know that I criticized Obama in 2009 for leaving two seats empty on the Board of Governors.  Obama didn’t need to replace Bernanke; he needed to give him allies.  Instead he brushed aside Romer’s argument that monetary policy could do a lot, even at zero rates.  But don’t take my word for it, here’s Ezra Klein in the NYR of Books:

But if the White House couldn’t go through Congress, perhaps it could have done a better job going around it. A major omission in Suskind’s book—which is also a major omission in political punditry more generally—is that it makes little mention of the Federal Reserve. But the Fed is arguably more powerful than Congress when it comes to setting economic policy, and it is certainly more powerful than the president.

The White House made two major mistakes here. One was leaving two seats on the Fed’s Board of Governors unfilled. Congress certainly deserves some of the blame for this—Senate Republicans filibustered Peter Diamond, a Nobel laureate economist whom the Obama administration nominated to fill one of the open slots—but the truth is that the White House was slow to nominate Diamond, passive once it did nominate him, and seemingly lost once his nomination failed. At the moment, the two seats on the Fed’s Board of Governors remain open, and the White House has not put forward any new candidates. Those seats matter because the Federal Reserve is a cautious institution that is more comfortable fighting inflation than pursuing full employment, and if you want it to act with more vigor, you need to bring that energy in from the outside.

Of course, the most straightforward path to energizing the Fed isn’t adding two new members to its Board of Governors, but replacing its chairman. And the White House had an opportunity to do so in 2010, when Ben Bernanke’s term expired. Instead, Obama chose to renominate Bernanke. . . .

This raises the question of whether the Obama administration made a mistake in reappointing Bernanke. If it had managed to install a more activist chairman at the Federal Reserve, then its inaction might have been more effectively offset by the Fed’s actions.

Exactly my argument.  The Fed’s more powerful than Congress, and Obama blew it by not doing more in that area.  And it’s even worse than Klein suggests, as the Diamond filibuster didn’t occur until well into 2010, when Scott Brown’s election gave the GOP the opportunity to filibuster.  But there were two empty seats in early 2009, and Obama didn’t even nominate anyone for them until around mid-2010.  Even now a majority of the Board are Obama appointees, but it should have been an overwhelming majority, not a narrow majority.

I don’t know why Bernanke favored fiscal stimulus.  Perhaps he aims for a 2% inflation target, but would prefer that Congress did the heavy lifting.  In that case Ponnuru is right.  Or maybe he’s committed to X amount of QE, and thinks that even more stimulus is needed.  In that case Klein is right.  But as I watch the Fed zig zag from QE1, to talk of “exits,” to QE2, to more talk of exits, to Operation Twist, to lengthening the duration of zero rates to 2013, then 2014, and always seemingly in response to the ups and downs in the economy, I can’t help but think that Ponnuru’s got the much stronger argument.

Maybe someone should ask Bernanke why he keeps insisting that the Fed is not out of ammunition, and yet also favors fiscal stimulus.  How would the Fed react if Congress did less stimulus?  Would the Fed do more, if Congress doing less reduced inflation below 2 percent?  If not, why not?  All good questions for members of the Washington press corp, and Ezra Klein’s one of the very best.


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14 Responses to “Ezra Klein vs. Ezra Klein”

  1. Gravatar of Dan S Dan S
    13. March 2012 at 17:09

    Hey, at least people on the left are finally pushing for more monetary stimulus. Just think back to when they practically didn’t know what the Fed was: http://www.youtube.com/watch?v=mv7CtLrQ3hU.

  2. Gravatar of John Thacker John Thacker
    13. March 2012 at 17:35

    Peter Diamond was ineligible to fill the slot on the Fed. The law that governs the Fed has strict requirements on geographic balance– put in by farmers who worried that a Fed consisting only of Eastern bankers would be too tight, even!– and he clearly didn’t pass it. They tried to argue around it, but the sophistry was unconvincing.

    The same law that gives the Fed a dual mandate also requires geographic balance. It removes a lot of the power of the objection to the Fed ignoring the dual mandate if the same people who want the dual mandate respected ignore the geographic requirement.

    No wonder the Fed governors are willing to ignore the law and the dual mandate if they feel that it produces policy that they like better.

  3. Gravatar of John Thacker John Thacker
    13. March 2012 at 17:37

    It’s also far from clear to me that Peter Diamond actually favored the kind of monetary policy we need. Can anyone point me to definite statements from him on the point?

  4. Gravatar of ssumner ssumner
    13. March 2012 at 17:48

    Dan, Yes, that’s progress. What film was that?

    John, I don’t know much about the geography issue, it certainly wasn’t why he was rejected. But as you say, rules are rules. If we aren’t going to enforce them, we shouldn’t have them.

  5. Gravatar of Dan S Dan S
    13. March 2012 at 18:45

    It’s from “The Other Guys.” When I saw that I wondered a) how it wasn’t already mentioned in the econ blogosphere and b) what other soul thought it would be good to post a youtube video of just that scene. My best guess is a Ron Paul supporter.

  6. Gravatar of JeffC JeffC
    13. March 2012 at 19:03

    You had me right up to “Ezra Klein’s one of the very best”

    really, the 20 something ex-Journolist ring leader is a one of the very best in the Washington press corps ?

    so one of the best can’t be bother to check when we on and off the gold standard and makes a factual error in his rebuttal ?

    pretty low standard you have for “the very best” …

  7. Gravatar of D R D R
    13. March 2012 at 19:11

    “I don’t know why Bernanke favored fiscal stimulus. Perhaps he aims for a 2% inflation target, but would prefer that Congress did the heavy lifting.”

    Or maybe he thinks that fiscal stimulus will raise RGDP and have little impact on inflation.

  8. Gravatar of Jim Jim
    13. March 2012 at 19:15

    Dan S, we all know for sure who did not have any idea what the Fed is. And the GOP was prepAred to put her a heartbeat away from the Oval Office.

  9. Gravatar of Majorajam Majorajam
    13. March 2012 at 19:26

    *sigh* Sorry, this is just pure mendacity. It’s like argument by accounting identity, but here the argument is by Fed mandate. Firstly, there is a profound dearth of empirical evidence that monetary policy is effective at the 0 lower bound. By contrast, there is plenty of evidence that fiscal policy is, not least out own experience of the Depression’s end with the massive public spending of WWII.

    Secondly, anyone that thinks the phrase ‘just print money’, is a useful contribution to this debate, really ought to investigate the value of Winston Churchill’s famous admonission. The problem is that money is credit and credit is risk. Making reserves available doesn’t increase the supply of credit. Taking on risk does, and in that context it is clear that fiscal policy has several advantages over monetary policy.

    Finally, as fiscal policy was tried in this instance (not on a large scale, given non-federal government retrenchment, but at least to some degree), surely it follows by accounting identity/mandate that the Fed has been less accomodative than it could’ve been. So presumably that restraint can be identified and attributed, right…? I’m all ears.

  10. Gravatar of Bill Woolsey Bill Woolsey
    14. March 2012 at 04:21

    The Keynesian view is that everyone espected inflatioin to be 2% and the output gap to remain zero, but even so, the real interest on safe and short assets necessary to clear markets was less than negative 2%. The reason why the interest rate needed to be so low to clear markets involved deleveraging. People no longer wanted to borrow against houses, and so just borrowed less. People still wanted to lend, but not against houses and instead lent by accumulating some kind of government guaranteed short asset.

    From a market monetarist perspective, this would be much better expressed by the claim that everyone expected nominal GDP to remain on a 5% growth path, but even so, the real interest rate on short and safe assets necessary to clerain markets was less than negative 2%. This might be caused by deleveraging as above.

    Sumner argues that this was in fact false. Nominal GDP was not expected to remain on a 5% growth path. The drop of nominal GDP expectatinos to a lower growth path is why market clearing rate on short and safe assets fell to less than -2%. Worries about scenarios where nominal GDP expectations remain on target, but the real interest rate needed to clearing markets is less than -2% are premature.

    On the other hand, the market monetarist rule is to expand the quantity of base money however much is needed to keep expected nominal GDP on target.

    In the scenario where the market clearing rate on short and safe assets is less than -2% is automatically solved by having the central bank because after the central bank runs out of short and safe assets to buy, it must buy longer and riskier ones. And so, the central bank creates enough short and safe assets to clear up the shortage at the real interest rate of -2%.

    Now, we have a problem of the central bank bearing lots of risk. Base money is very large, and the central bank owns long and risky assets. The earnings the government makes from the central bank are lower, and might even turn negative. That is, the taxpayer might have to cover losses.

    The reason for this is government provision of zero-interest hand to hand currency. Privatize hand-to-hand currency, and don’t protect it with deposit insurance, and this problem goes away. The nominal and real interest rate on short and safe assets can be negative.

    Or, you can have higher inflation always, letting the government borrow some money at an even more negative real interest rate usually, impose more of a cost on those using hand-to-hand currency, and figure that the market clearing real rate on short and safe assets will never go so low.

    Or, you can go with the Keyensian approach of varying inflation, raising it when real interest rates have to be more negative.

    Or, you can use fiscal policy, having the government borrow more in total. This creates more safe and short assets (if the government borrows short.) It also tends to clear up the shortage of such assets at a real interest rate of -2%.

    Again, from a market monetarist point of view, we don’t even know that the market cleraing rate is less than -2% if nominal GDP is expected to be on target. We don’t know that keeping nominal expectations on target would require than the central banks create lots of short and safe assets by purchsing long and risky ones. (DeLong frames this as increasing the risk bearing capacity of the private sector. I would frame it as what is the shortage of short and safe assets at a real interest rate equal to the negative of the inflation rate.)

    What does fiscal policy do? It allows the Fed to shift the blame for the failure of its traditional approach–periodic changes in the federal funds rate according to inflation and the output gap.

    If the governent runs a big enough budget deficit, then the current target value for the federal funds rate will be the “right” one.

    If the government causes too much inflation by its deficit policy, then the Fed can save the day by controlling it.

    Mainstream macroeconomics–sophisticated mathematical approaches to helping the central bank cover its ass.

  11. Gravatar of ssumner ssumner
    14. March 2012 at 04:42

    Thanks Dan.

    JeffC, I think you underestimate how hard his job is. All reporters make mistakes, and the mistakes occur frequently. No one can be an expert on everything. I’ve devoted much of my life to studying the gold standard during the interwar years, so I’m willing to cut him a bit of slack.

    Having said that, I think reporters too often rely on “common sense” notions, like it’s common sense that fiscal stimulus would work.

    DR, You said;

    “Or maybe he thinks that fiscal stimulus will raise RGDP and have little impact on inflation.”

    If the SRAS is really that flat, then why not do more monetary stimulus instead?

    Majorajam, You said;

    “Firstly, there is a profound dearth of empirical evidence that monetary policy is effective at the 0 lower bound. By contrast, there is plenty of evidence that fiscal policy is, not least out own experience of the Depression’s end with the massive public spending of WWII.”

    Are you serious? There’s more evidence that fiscal policy works at the zero bound than monetary policy? You discussed one example. So did I. How’s that more evidence?

    BTW, we were on fixed exchange rates during WWII, and models that predict a positive multiplier under fixed rates often predict a zero multiplier under floating rates. And there are also empirical studies that report that finding as well.

    Bill, You said;

    “The Keynesian view is that everyone espected inflatioin to be 2% and the output gap to remain zero, but even so, the real interest on safe and short assets necessary to clear markets was less than negative 2%.”

    God help us if that was the Keynesian view. That seems crazy to me. What evidence do they have to support that proposition?

    But I basically agree with your comment, it’s just that I can’t figure out where this belief comes from. Are there any cases in world history where NGDP is right on target and Wicksellian real equilibrium rates go negative.

  12. Gravatar of TheMoneyIllusion » But what type of fiscal stimulus? TheMoneyIllusion » But what type of fiscal stimulus?
    14. March 2012 at 09:03

    [...] is a follow up to the earlier post on Ezra Klein.  I think one issue that gets lost in the “does fiscal stimulus work” debate is the [...]

  13. Gravatar of Bill Woolsey Bill Woolsey
    15. March 2012 at 03:52

    Well, I think it is fair to say we have zero episodes of nominal GDP targeting and we don’t have to even get to the issue of whether they were successful and expected to be sucessful.

    I think you would need to look at high inflation equilibriums, where real interest rates were sometimes highly negative. The trick would be to determine if those negative real interest rates were equilibrium. Financial repression is probably the rule in such scenarios. But we do know that the supply of funds doesn’t fall to zero with highly negative real interest rates.

    I can easily think up scearnios where the demand for investment would fall alot while the supply of saving would rise.

    Government debt is still paid off, but real payoffs to capital goods fall. Particularly, after tax or post nationalization returns.

    But these almost always involve reductions in potential output in the future, and with nominal GDP targeting, that is inflatoinary. While you don’t believe in inflation, I think it would raise nominal interest rates and so tend to solve the problem–higher expected inflation would dampen the demand for government demand at a zero nominal interest rate. The real interest rate is lower.

    With inflation targeting, this doesn’t work, however.

    By the way, I think cap and trade might be an example of something that would drive real interest rates below zero. Particularly if it is harsh enough.

  14. Gravatar of ssumner ssumner
    15. March 2012 at 08:47

    Bill, I suppose that’s possible. Then we have two choices; a higher NGDP growth target or a really big monetary base.

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