A high school student refutes the world’s most famous economist. (And then shows how to save the world economy.)

Last year I did a post criticizing this statement by Paul Krugman:

Oh, and about the exchange rate: there’s this persistent delusion that central banks can easily prevent their currencies from appreciating. As a corrective, look at Switzerland, where the central bank has intervened on a truly massive scale in an attempt to keep the franc from rising against the euro — and failed:

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I argued Krugman was wrong, that the Swiss national Bank was able to depreciate the franc whenever they wanted to.  That was July 2011.  Soon after the SNB again faced an attack from speculators.  This time they decided to depreciate the franc and then cap it at 1.2 SF/euro.  And as Evan Soltas showed in this post, it worked.

The SNB made a bold surprise promise: we will not let the swiss franc appreciate any more; we will hold the exchange rate at 1.2 CHF to 1 euro. And, in short, it worked. The appreciation of the swiss franc came to an immediate halt. The CHF-EUR exchange rate stabilized at 1.2. Even during this current turmoil in the Eurozone — which one might think would lead the currency to appreciate as capital flowed into Switzerland’s financial safe haven assets — the Swiss central bank has kept the exchange rate steady, fulfilling its promise.

.   .   .

Switzerland has the ability to stabilize its currency from upward pressure because its monetary policy tool is unlimited — it could always print out more swiss franc to satisfy market demand. This is, in other words, the opposite of trying to prop up a currency, which strains the foreign currency reserves of the central bank. The result is that the Swiss intervention is entirely credible.

Its credibility is so powerful, in fact, that the SNB has stopped having to buy up foreign currencies with new swiss franc, which it did in earnest to prove its commitment in 2011, increasing its foreign exchange reserves by 177 billion from July to September. It hasn’t had to defend at all the value of its currency against appreciation since September, despite what should be enormous pressures. (See here and here for the data.) That is truly remarkable, when you zoom out for the macroeconomic big picture.

That is the power of credible monetary promises. And we can do the same thing with the price level path, of course, managing correctly the striking strength of market expectations. All it takes is the appropriate use of the expectational channel; re-establish 5 percent annual NGDP growth as did the SNB for its currency, and then the market will do the rest for you.

It’s easy to say “I told you so,” but what Evan is doing here is far more interesting.  He isn’t just disproving Krugman’s liquidity trap hypothesis; he’s showing that Krugman is wrong in a very interesting way.  Krugman saw the huge SNB purchases during the period of policy failure as a sign that the effort required to achieve policy success would be even more monumental.  What Soltas shows is that exactly the opposite is true.  As soon as the SNB set a firm exchange rate target, they no longer had to buy foreign exchange to defend the target.  Why invest in Switzerland at zero interest if you aren’t going to at least get some currency appreciation?  The bloated Swiss monetary base wasn’t stimulus that failed; it was stimulus that was never seriously attempted.

Then Evan makes the very astute observation that the same logic applies to US monetary policy, where NGDP level targeting would be equivalent to the pegged Swiss franc.  Krugman sees the large increase in the US monetary base during recent years as monetary stimulus that failed.  In fact, it’s just the Fed accommodating the high demand for base money when tight money and ultra-low NGDP growth drove nominal rates to zero.  Evan is right that with much faster expected NGDP growth there would actually be less demand for base money in the US.  How much QE would it take to get back to the old NGDP trend line?  Roughly negative $1.6 trillion.

Update: Evan has a new post that provides more information on just how effective the expectations channel has been in Switzerland.  BTW, I deleted the previous lame attempt at humor in the postscript.  It occurred to me that Evan is just a high school student, and doesn’t need me generating problems for him in the future.


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63 Responses to “A high school student refutes the world’s most famous economist. (And then shows how to save the world economy.)”

  1. Gravatar of Josiah Josiah
    31. May 2012 at 06:21

    Perhaps the folks at Princeton should just give Evan his economics degree now, and save themselves the trouble.

  2. Gravatar of Full Employment Hawk Full Employment Hawk
    31. May 2012 at 06:31

    “And in 2014 another will be Ben Bernanke”

    Then you expect Obama to be reelected? It would seem plausible that Romney would keep Bernanke on. But if Obama wins, hopefully he will have the sense to replace the guy who almost caused him to lose the election. Although given the bad advice he has gotten during this term from many of his economic advisors, that is not guaranteed. An advisor similar to Geithner would probably advise him to give him another term.

  3. Gravatar of johnleemk johnleemk
    31. May 2012 at 06:40

    Arnold Kling has a hair-tearing-out post about Simon Wren-Lewis: http://econlog.econlib.org/archives/2012/05/really.html

    In this case I think Wren-Lewis is much more egregiously wrong than he ever was (or might have been) in that S = I dust-up some months back. This “fiscal policy is less inflationary than the monetary equivalent” nonsense is, if you’ll pardon my French, total bullshit. Those on the left who continue to chirp about this are the only people standing between us and the paleoconservative “beatings will continue until morale improves” economic policy, and they still don’t have a clue.

  4. Gravatar of Full Employment Hawk Full Employment Hawk
    31. May 2012 at 06:45

    “re-establish 5 percent annual NGDP growth”

    But would Bernanke want that high a rate of NGDP growth? It is clear that Bernake and the FOMC are not trying to even give lip service to the maximum employment part of the Fed’s mandate. The New classical mantra is that all a central bank should do, as a matter of fact all that it can do is to achieve price stability.
    While Bernanke probably does not adhere to the second part of this and understands that the Fed can, in the short run, affect the level of output and employment, Bernanke and the FOMC appear to strongly adhere to the first part of it, that all a central bank should do is to stabilize the price level. Bernanke and the FOMC is not even making any pretense to adhere to the maximum employment part of the mandate. Getting the inflation rate down to, and probably below, 2% is clearly the objective. And a NGDP growth target of 5% would fail to achieve this target. A lower NGDP target would be needed for this purpose.

  5. Gravatar of StatsGuy StatsGuy
    31. May 2012 at 07:05

    Sometimes, Chuck Norris needs to break some bones just to prove:

    1) He really meant it when he made the threat

    2) His fists do in fact cause damage

    As Machiavelli noted, the more one hesitates, the worse the long term pain that must be suffered to re-establish credibility.

  6. Gravatar of UnlearningEcon UnlearningEcon
    31. May 2012 at 07:12

    Scott,

    Keynes already gave the ‘Sumner Critique’ 76 years ago – just replace ‘full employment’ with ‘NGDP’. Check your copy of TGT, last chapter.

  7. Gravatar of dwb dwb
    31. May 2012 at 07:40

    i wish i were even 1/10 as smart as Evan when i was his age. well, maybe i was, but too many hormones. good job!

  8. Gravatar of lupus400 lupus400
    31. May 2012 at 07:55

    Scott,

    Greatly appreciate your blog, and I admire your evangelization work to bring NGDP targetting to mainstream.
    When we cut to the chase it seems that Krugman/DeLong/etc. are pretty willing to push for NGDP targetting, while mostly people on the right are against it. People like Tyler, Mankiw, etc, on the other hand, never give any (public) indication of support.
    Aren’t you barking at the wrong tree with this Krugman’s fixation?

  9. Gravatar of Frank Frank
    31. May 2012 at 07:56

    Princeton is not going to make Evan take Intro to Econ, are they?

  10. Gravatar of Saturos Saturos
    31. May 2012 at 08:00

    Even Arnold Kling is unimpressed with Simon Wren-Lewis’ latest: http://econlog.econlib.org/archives/2012/05/really.html

    Oh, and three cheers for Evan.

  11. Gravatar of Saturos Saturos
    31. May 2012 at 08:01

    Scott, this is why you should get Twitter: http://marginalrevolution.com/marginalrevolution/2012/05/tylertweets.html

  12. Gravatar of Saturos Saturos
    31. May 2012 at 08:02

    Oh, I see you got there first, johnleemk.

  13. Gravatar of Luis H Arroyo Luis H Arroyo
    31. May 2012 at 08:33

    I agree, in te case of Swisszerland… Or any other sovereing Nation.
    But not in te euro case, because there is an internal exchange rate problem.
    In this case Krugman is right. A QE of the ECB Will be not sufficient in the euro zone.

  14. Gravatar of Steve Steve
    31. May 2012 at 08:33

    All of this is obvious to people who actually trade stuff. Too bad some professors understand this (Sumner) and others do not (Krugman).

    For a policy to work, you need a WILL and a WAY.

    If you have WILL but NO WAY (Spain) markets bet against you.
    If you have a WAY but NO WILL (FOMC) markets bet against you.
    If you have both WILL and a WAY (CHF) markets will do your work for you while you summer at Lake Geneva.

  15. Gravatar of Steve Steve
    31. May 2012 at 08:39

    I hope you are ready to accept Evan’s transfer application to Bentley if the Big Egos at Princeton can’t handle getting schooled by a teenager.

    If I could do it all over again, I’d probably choose a good professor at a little name school for undergraduate, and save the big name school for graduate. Of course there are trade-offs to that approach.

  16. Gravatar of Matthias Matthias
    31. May 2012 at 08:42

    Good post by Evan although he confused some numbers. Foreign curreny reserves went up just a few bn in that period, not 177bn. That number sounds like the increase in sight deposits. That’s also why the peg wasn’t THAT surprising, the surprise was when, not if.

  17. Gravatar of ssumner ssumner
    31. May 2012 at 08:44

    Josiah, Good idea.

    FEH, Believe it or not Bernanke’s more likely to stay with Obama being re-elected. Obama’s pleased with his performance. Romney has said he’d fire Krugman.

    Johnleemk, I’ve been expecting that for quite some time–I’m surprised it hasn’t happened sooner.

    Statsguy, The SNB didn’t even work up a sweat.

    Unlearningecon, Why would I want to replace ‘full employment’ with “NGDP.” The terms have completely different meanings. I’ve read plenty of Keynes, he certainly didn’t think fiscal stimulus was ineffective at the zero bound if a central bank is inflation targeting, indeed he never discussed inflation targeting in his entire career.

    dwb, I was so far behind him it’s ridiculous.

    lupus400, I suppose it seems that way, but:

    1. I’ve been very critical of Taylor.
    2. Mankiw doesn’t post much on money–presumably because he’s advising Romney.
    3. Krugman is the best blogger on macro. The one others take their lead from. He’s the most consistently interesting macro blogger to read. He also claims he’s been right about everything. So that’s probably why I seem to have a fixation.

    I’m not saying you are wrong, but I just go with my instincts as to what seems interesting to blog on. There’s lots of bloggers where picking on them would be like shooting fish in a barrel.

    Frank, If they were smart, they’d have him teach it.

    Saturos, Those Karl Smith examples were pretty amusing.

  18. Gravatar of ssumner ssumner
    31. May 2012 at 08:48

    Steve, I think we’d give him a scholarship.

    Mattias, It looks to me like they went up by well over 100 billion, or am I looking at the wrong category?

  19. Gravatar of ssumner ssumner
    31. May 2012 at 08:50

    Luis, It wouldn’t solve all their problems, but it would make them much smaller.

  20. Gravatar of Jim Jim
    31. May 2012 at 08:54

    Hopefully all the pointless economic models he has to learn won’t discourage him too much — of course, he may want to become a mathematical economist, if not now then after a few years

  21. Gravatar of Mike Sax Mike Sax
    31. May 2012 at 09:05

    Yeah FEH these days the GOP hates Bernanke much more than the Dems who don’t really hate him at all.

  22. Gravatar of o. nate o. nate
    31. May 2012 at 09:41

    SNB not breaking a sweat? There’s a post on FT Alphaville this morning that says the opposite:

    “The Swiss have made it abundantly clear that they will defend the 1.20 floor against the euro no matter what. But keeping the Swiss franc structurally undervalued against the euro is becoming costlier than ever.

    The act of having to put its money where its mouth is — via that permanent 1.20 bid — has not only reduced Switzerland to ‘currency manipulator’ status, but also into one of the biggest acquirers of euro-denominated assets in the world.

    And nobody wants coffers full of euros-denominated assets at this point.

    No wonder the Swiss are busy coming up with alternative plans … some of which, we might add, are remarkably Chinese in flavour.”

    http://ftalphaville.ft.com/blog/2012/05/31/1023881/why-switzerland-is-the-new-china/

  23. Gravatar of happyjuggler0 happyjuggler0
    31. May 2012 at 09:50

    PPPPS: April 1, 2013 In news today, an economics student at Princeton apparently caused Paul Krugman’s head to explode when he asked him, “which one of those variables in your fiscal stimulus equation represents the central bank reaction function?”. The district attorney is considering manslaughter charges, and considering arresting Scott Sumner as an accomplice before the fact.

  24. Gravatar of B B
    31. May 2012 at 09:57

    Evan Soltas wrote: All it takes is the appropriate use of the expectational channel; re-establish 5 percent annual NGDP growth as did the SNB for its currency, and then the market will do the rest for you.

    Not really analogous. The SNB had a very clear mechanism to support their target: print francs to buy euros. Buying foreign currency is a familiar activity for a central bank.

    The 5% NGDPLT doesn’t have anything so simple. Perhaps it can be made credible with QE-style purchases, but those purchases seem somewhat arbitrary (e.g. the meaningless “twist”). Markets are much more likely to test the Fed’s resolve if they try to defend the target with QE3,4,5,… Which is why Krugman still stomps his feet about the ZLB and fiscal stimulus. NGDPLT needs NDGP futures or something similarly novel to have credibility.

  25. Gravatar of Luis H Arroyo Luis H Arroyo
    31. May 2012 at 10:10

    Sure, sure, sure…

  26. Gravatar of catbert catbert
    31. May 2012 at 10:14

    > As soon as the SNB set a firm exchange rate target, they no longer had to buy foreign exchange to defend the target.

    Not really… http://www.snb.ch/ext/stats/statmon/pdf/deen/B1_Notenbankgeldmenge.pdf

    They really had to sell a lot of franks to get to that target.

  27. Gravatar of Steve Steve
    31. May 2012 at 10:14

    ssumner wrote: “Krugman is the best blogger on macro. The one others take their lead from. He’s the most consistently interesting macro blogger to read.”

    No, Krugman is the 2nd most interesting macro blogger :)

    Krugman had an interesting debate against British Austerians. I actually like Krugman these days and mostly agree with him on austerity, but I’m also hypercritical of nobel laureates who misunderstand markets.

    At the end of the debate he says “currency devaluation doesn’t work when there’s no one strong to devalue against.” I hate that line.

    Q: What’s it called when every country engages in competitive currency devaluation at the same time?
    A: Raising the NGDP target.

    http://www.bbc.co.uk/news/business-18281669

  28. Gravatar of Major_Freedom Major_Freedom
    31. May 2012 at 10:17

    ssumner:

    Krugman sees the large increase in the US monetary base during recent years as monetary stimulus that failed. In fact, it’s just the Fed accommodating the high demand for base money when tight money and ultra-low NGDP growth drove nominal rates to zero.

    The Fed doesn’t “accommodate” demand for money. There is no such thing as demand for money only. The demand for money is actually a demand for purchasing power. Falling prices on the basis of productivity in the market is what naturally accommodates this. Central bankers, let alone laymen on the street, cannot know what the future or even current desire for purchasing power is or will be. You’re assuming central bankers have far more knowledge than they actually do. Central bankers don’t know anything except past data history, and they don’t have any interpretation of that past data history other than the distorted one that is a result of them using a false theory of the market.

    The demand for more money, which is actually a desire for more purchasing power, more on this below, is always practically infinite. Ceteris paribus, people will accept more money if you ask them. The desire for more money is always greater than the money that exists.

    Therefore, central bankers can never “accommodate” such a desire. It is a chimera. The only way that market participants can achieve their desires is through exchanges. It is through exchanges that the desire for more purchasing power can be, temporarily, gratified. Once that desire is met, new desires are had, in a sequential pattern. Thus, market participants gradually, but never fully, (which by the way is the mistake market monetarists make when they say “accommodate”, as if a final state of rest is possible) satisfy their desire for more purchasing power on the side of earning money from others through exchanges. This makes money more valuable and it increases purchasing power of money.

    Central banks cannot ever mimic this by increasing the supply of money. The fallacy market monetarists believe here is that central banks can increase everyone’s cash balances beyond the constraint of exchanges, as if by helicopters, when in reality new money creation can only spread throughout the economy, where the desires for more purchasing actually reside, via exchanges, which means the money in exchanges has to rise in order to increase people’s cash. Well, when the amount of money in existing exchanges rises, then, of course, purchasing power GOES DOWN. It does the exact opposite of what market monetarists claim is possible via inflation.

    What the desire for more money does in a free market, as market participants constantly seek to make more money over time, is to enable their natural productiveness to result in a gradual, healthy, price deflation over time, or at least lower prices than what would have otherwise existed at the time. A higher purchasing power is actually what market participants want, and their actions of seeking to acquire more money will enable them to get what they want in the form of falling prices, NOT the same prices and higher cash balances. The latter is impossible with inflation. The constraint of exchanges as being the carrying mechanism by which money spreads throughout the economy raising cash balances results in lower purchasing power of money, not higher purchasing power which is what people actually want. The market gives people what they want, while the central bank does not, and only gives itself what it wants, at the expense of everyone else.

    Market monetarists and monetarists have it backwards. They recognize that there is a desire for money, that is, purchasing power, greater than what exists. This much is true. But because they require an excuse for the central bank to print money, they claim that printing money is “accommodating” a need, as if market participants ONLY want more money, rather than a higher purchasing power of money.

    A rather easy way to see that the central bank isn’t merely “accommodating” an increased demand for money when they print money, is to notice that prices have risen since 1913, and by a large margin. Or, just look at prices since 2010. If printing money were merely about satisfying a floating concept idea of “more money”, then prices should have remained the same, whilst cash balances rose to whatever extent monetarists would have us believe is just people getting what they want, which is just more cash to hold onto. But no, prices have in fact risen, which means the money the Fed is introducing into the economy is not in fact “accommodating” a desire for more cash. This desire as we have seen cannot ever be met anyway. It presumes two errors, one that people only want more cash and not more purchasing power, and two, that a final state of rest is attainable.

    When monetarists play innocent and say “The central bank is just giving the people what they want! More money!” they are just using people’s desire for more purchasing power against them, in order for monetarists to justify their own desire for the central bank to print money to achieve some silly aggregate statistic that no investor and no seller cares about. That’s the function these court intellectuals serve. They serve those who control the central bank. They don’t serve the market. The market is not their focus. You know this is the case when market monetarists have to put the word “market” in their namesakes. Market monetarism is like saying competitive monopoly government.

    Look at this chart.

    AAA and BAA bonds were rapidly rising before the late 2008 financial crisis, and before NGDP started to fall, as the recalculation was already long under way since at least 2007, when the Fed started slowing its money printing and thus raising the fed funds rate (corrected of course for policy makers leaking their plans to their friends, which made interest rates change juuuuuust before the fed funds rate change). Interest rates were already readjusting by the time Bernanke hit CTRL-P again in late 2008. The “Interest rates change because NGDP changes” story is false.

    Interest rates fell because Bernanke printed massive quantities of money for the banking system. If he didn’t, AAA and BAA rates would have went through the roof. It’s not because NGDP fell that rates fell.

    Once it was clear the Fed was going to act big in late 2008, meaning once the market learned the Fed was going to “rescue” the banking system by massively increasing reserves, rates started their downward trend, and haven’t looked back since, because the Bernanke Put, even larger than the Greenspan Put, is now in effect.

    As soon as the SNB set a firm exchange rate target, they no longer had to buy foreign exchange to defend the target.

    The Bank of England seems to be targeting national income, not prices:

    http://www.bankofengland.co.uk/monetarypolicy/Documents/pdf/cpiletter110816.pdf

    http://blogs.telegraph.co.uk/finance/jeremywarner/100011568/bank-comes-close-to-admitting-its-targeting-nominal-gdp-growth/

  29. Gravatar of Steve Steve
    31. May 2012 at 10:22

    Here’s another:

    Q: What are the true “long and variable lags” of monetary policy?

    A: When AS moves up (or down) a year or two after increases (or decreases) in AD.

  30. Gravatar of Saturos Saturos
    31. May 2012 at 10:31

    MF – How much cash do you have in your wallet right now? We call that a stock demand for money balances. At the same time you have a flow demand for monetary expenditures. Indeed the stock demand is really a “slow flow” demand. But nonetheless the stock demand exists, as all money must be held by someone, and anyone can get rid of money they don’t want to hold.

  31. Gravatar of CA CA
    31. May 2012 at 10:34

    Simon Wren-Lewis just posted a new post clarifying his position.

    http://mainlymacro.blogspot.com/2012/05/austerity-nominal-gdp-targets-and-zero.html

  32. Gravatar of Morgan Warstler Morgan Warstler
    31. May 2012 at 10:40

    Wren Lewis senses it COMING!!! Just like DeKrugman yesterday…

    “I do not think targeting nominal GDP means that the monetary authorities can achieve that target at all points in time. The main way I think it overcomes the zero lower bound (ZLB) for nominal interest rates is by promising to create higher inflation in the future, which is itself a cost. The more austerity reduces current demand, the more inflation we will have in the future to counteract it.”

    Everybody gets it now.

    The more austerity we get, IF it effects demand, no worries we can always print money.

    But the trick here is, we will only REALLY clamor for the austerity when we are running a tad over target, and don’t want inflation.

    Fear of inflation, or the desire to make room for more RGDP will causes us to want to be “austere” – it will make us want to cut govt.

  33. Gravatar of Major_Freedom Major_Freedom
    31. May 2012 at 10:48

    Saturos:

    MF – How much cash do you have in your wallet right now? We call that a stock demand for money balances. At the same time you have a flow demand for monetary expenditures. Indeed the stock demand is really a “slow flow” demand. But nonetheless the stock demand exists, as all money must be held by someone, and anyone can get rid of money they don’t want to hold.

    This is the problem with thinking about only states of rest, of equilibria.

    Instead, consider the processes of the market. Ask how the purchasing power of the money in my wallet can increase.

  34. Gravatar of marcus nunes marcus nunes
    31. May 2012 at 11:10

    Simon Wren Lewis´s “clarification” obfuscates the argument with so many “today´s” and “tomorrow´s” – and even some “after tommorow´s” – that it´s difficult to keep track of the period you´re in! Since you´re beffudled, it´s easy for him to “conclude” that Fiscal Stimulus is better than NGDPT. And hiding in the background the “sacrosant” role of (real) interest rates!

  35. Gravatar of Major_Freedom Major_Freedom
    31. May 2012 at 11:20

    Morgan:

    Fear of inflation, or the desire to make room for more RGDP will causes us to want to be “austere” – it will make us want to cut govt.

    Some portions of the market love inflation of the money supply. For example real estate, banking, stocks, etc.

  36. Gravatar of Major_Freedom Major_Freedom
    31. May 2012 at 11:23

    In other words, why should the market participants whose incomes typically rise faster than consumer prices, worry about inflation? They are benefited by it.

    You’re making it seem like everyone are on fixed incomes, and everyone pays higher consumer prices. That’s silly.

  37. Gravatar of ssumner ssumner
    31. May 2012 at 12:01

    o. nate, Good point, after I posted this I realized that the current eurozone crisis could put upward pressure on the SF.

    If these problems are likely to reoccur frequently, then Switzerland might want to have a higher inflation target, so they have more room to cut real interest rates.

    They can also diversify out of euros into dollars. Still it’s up to the SNB, I suspect they do what it takes to hit their domestic price level objectives. I certainly don’t recommend that they keep the exchange rate at 1.20 forever.

    B, Why would markets test their “resolve?” Has any fiat money central bank in all of world history set out to inflate and failed. And if they were actually serious about NGDP targeting (they aren’t) they’d create and peg NGDP futures contracts.

    catbert, Doesn’t the data show they sold those before they set the 1.20 target?

    CA, Thanks for that link.

    Steve, And no discussion of tax cuts.

  38. Gravatar of ssumner ssumner
    31. May 2012 at 12:10

    Marcus, I’m with you. It seems to me that this is where you end up when you assume monetary policy drives NGDP via interest rates, and that the liquidity effect is more important than the income effect. And when you assume demand shocks just “happen,” rather than resulting from suboptimal monetary policy that lacks an NGDLT

  39. Gravatar of David Pearson David Pearson
    31. May 2012 at 12:29

    o. nate (and FT Alphabille) above has it right. This Sumner post is somewhat ironic, as a tsunami of Euro’s is headed the SNB’s way.

    I would say the jury is still out. The SNB’s strategy of buying Euro’s may eventually go down as a major policy error. If the EU banking crisis accelerates into a broad run on banking system liabilities (a la ’08), the SNB will have a difficult choice:

    -massive Euro buys at the very time when the Euro’s future is in question

    or

    -abandonment of the peg

    How soon before the Soros of the world notice this “damned if you do…” policy dynamic?

    There is no peg that can’t be challenged. Central banks can manufacture unlimited liabilities, but there is no inherently “safe” asset for central banks to purchase with those funds. Count on speculators to find the point of weakness and attack. This is how markets work.

  40. Gravatar of Full Employment Hawk Full Employment Hawk
    31. May 2012 at 12:38

    “Romney has said he’d fire Krugman.”

    I think you meant he’d fire Bernanke.

  41. Gravatar of ssumner ssumner
    31. May 2012 at 12:41

    David, You said;

    “I would say the jury is still out. The SNB’s strategy of buying Euro’s may eventually go down as a major policy error. If the EU banking crisis accelerates into a broad run on banking system liabilities (a la ‘08), the SNB will have a difficult choice:”

    I think you missed the point of this post. I agree that it was a bad idea to buy lots of euros last year. I’m glad they pegged the franc in September and stopped doing so. If they are worried about the euro depreciating, then switch them into dollars. and peg to the dollar. I certainly agree that there may come a time when the euro peg no longer makes sense. After all, the ultimate goal is stable NGDP, not a stable exchange rate.

    Whatever happens in the future, Krugman will have been wrong in his analysis of 2011. He implied an even greater effort would have been necessary to stop the euro from rising, when in fact a much smaller effort was what was required (we now know.) The SNB policy of buying lots of euros wasn’t monetary stimulus that failed, but rather monetary stimulus that was never tried. If you are doing the right thing it will look very easy.

  42. Gravatar of ssumner ssumner
    31. May 2012 at 12:42

    FEH, That too! Well that pretty much proves the point of the commenter who said I’m obsessed with Krugman.

  43. Gravatar of Full Employment Hawk Full Employment Hawk
    31. May 2012 at 12:51

    “Obama’s pleased with his performance.”

    Obama’s economic advisors are clearly Obama’s worst enemies.

    If Obama loses, it is because the unemployment rate is not coming down at a solid rate. If it were, he could run on an “It’s morning in America” theme and he would have the reelection sown up. Also the Democrats would probably regain control of both houses. And the reason it is not coming down at a solid rate is because the Fed, instead of abiding by its mandate to achieve maximum employment, is concentrating exclusively on getting the unemployment rate down to 2% or below 2%. Therefore it is holding back on monetary stimulus to an amount that lets the economy grow slowly so as to bring the inflation down, but this is a rate too slow to bring the unemployment rate down significantly. Bernanke and the FOMC are doing Obama in politically. If he loses, this will be the reason and he does not realize this. INCREDIBLE!

  44. Gravatar of Major_Freedom Major_Freedom
    31. May 2012 at 12:51

    ssumner:

    The SNB policy of buying lots of euros wasn’t monetary stimulus that failed, but rather monetary stimulus that was never tried.

    Can you explain that second part? If the monetary stimulus of buying lots of Euros actually took place, how can what actually took place also be a monetary stimulus that was never tried? Doesn’t a monetary stimulus that was never tried have to be something that didn’t actually take place?

  45. Gravatar of Full Employment Hawk Full Employment Hawk
    31. May 2012 at 12:57

    The mistaken belief by many progressives that the economy is in a liquidity trap is giving the Fed cover for what it is actually doing: Intentionally denying the economy of sufficient monetary stimulus to bring the unemployment rate down at a solid rate. If they believe that the Fed cannot give the economy the needed stimulus to get the unemployment rate coming down at a solid rate, they cannot see what the Fed is actually doing.

    The reality they do not see is that rather than being in a liquidity trap, we are under a regime of monetary austerity designed to bring the inflation rate down without any intention of getting the unemployment rate down.

  46. Gravatar of Lulu Lulu
    31. May 2012 at 12:58

    I think what this analysis ignores is the possibility of a sudden regime change causing more problems. The currency peg is only sustainable as long as it satisfies the objective of monetary policy. However, this then spirals out of control when the currency peg has to move or be removed to allow for external rebalances. We shouldn’t be so confident about suppressed volatility; it often hides sudden changes that we couldn’t foresee.

    I explicate on this topic a bit more here:
    http://synthenomics.blogspot.com/2012/05/danger-of-promises.html

  47. Gravatar of Full Employment Hawk Full Employment Hawk
    31. May 2012 at 12:59

    “Obama’s economic advisors are clearly Obama’s worst enemies.”

    Economic histrians writing on this after the fact may want to call Obama: Obama the ill advised.

  48. Gravatar of Bill Ellis Bill Ellis
    31. May 2012 at 13:20

    Professor Sumner and Major_Freedom,

    I can’t get over the feeling that this debate somehow boils down to differences in Semantics, Syntactics, Pragmatics, something related.

    Head spins.

  49. Gravatar of Britmouse Britmouse
    31. May 2012 at 13:30

    I think Evan has typoed the CHF177bn increase in fx investment, the correct value is CHF117bn. But the relevant data is the second link he posted, not the CHF value of Euros, but the EUR value of Euros on the balance sheet, which is this:

    2011 Q1: €92bn
    2011 Q2: €89bn
    2011 Q3: €127bn — ad hoc expansions up to peg at Sep 6th
    2011 Q4: €120bn
    2012 Q1: €103bn

    Though that series ignores derivative contracts so it could be misleading about the change in total Euro assets.

    (It looks like they bought a lot of dollars at the same time as buying Euros, to keep the currency portfolio allocation stable, which I found interesting.)

    The Gnomes of Zurich – central bankers par excellence.

  50. Gravatar of Bill Ellis Bill Ellis
    31. May 2012 at 13:42

    Full Employment Hawk,

    The whole of the western world has largely been, “Ill Advised” economically.
    The success of any system breeds confidence among the elite…no matter if their prescriptions are responsible for the success or not.
    Unfounded confidence is hubris. Too much confidence in economics in anything but the short term is always hubristic. The longer the hubris goes untested the more complex and all encompassing it will become.
    Welcome to today.

    Ten or twenty years from now when Market Monetarism is mainstream a whole hubristic reality will be formed around it too. All the while, people following basic human nature will be reshaping the game to undermine it to gain advantage.

    You can count on people finding a way around any limiting factor.

  51. Gravatar of David Pearson David Pearson
    31. May 2012 at 14:48

    Scott,
    The SNB temporarily stopped buying Euros when it promised to buy them in unlimited quantities. I say temporarily because it may soon have to buy them in unlimited quantities if the EU banking system faces a run. I don’t know if this is what Krugman had in mind, but if he did, he may yet turn out to be right.

    I can imagine a number of different end-games to the SNB Euro peg, and most of them are not likely to make Swiss voters happy.

    In theory a central bank can withstand a speculative attack on a peg maintained by issuing liabilities in its own currency in exchange for a safe asset. In practice, this is only true insofar as markets continue to view that asset as “safe”. Any asset can be rendered unsafe through leverage or policy error, even (especially?) Treasury bonds.

  52. Gravatar of Krugman the infalliable Krugman the infalliable
    31. May 2012 at 15:27

    You guys are so 2011 – check out what is happening recently…SNB is going to get creamed…

    http://www.zerohedge.com/news/has-snb-restarted-printing-press

  53. Gravatar of ssumner ssumner
    31. May 2012 at 16:04

    FEH, You said;

    “Obama’s economic advisors are clearly Obama’s worst enemies.”

    I’ve been saying that for 3 years.

    And I also completely agree with your second post.

    Lulu, I tend to oppose currency pegs, so I presume the SNB will need to change it at some point, maybe soon. But that’s up to them.

    Britmouse, The column I was looking at rose by well over 100 billion, but I can’t be sure which one is right. Check out his new post as well.

    David, Krugman was wrong in 2011, regardless of what happens next. He implied that it would have taken much more effort to hold down the franc, whereas it actually took much less effort.

    Switzerland is certainly an interesting case, and it’s true that the Swiss voters do want the impossible (ultra low inflation, open capital markets, non-negative interest rates and no losses on OMOs). Market monetarism can’t perform magic. One option would be for the Swiss to have higher inflation, and other would be more closed capital markets. Another option would be negative IOR. Another would be to hold dollars rather than euros. The dollar might also fluctuate, but it won’t collapse entirely like the euro just might.

    Interestingly, the issues that make Switzerland a difficult case apply much less to the US, so Evan’s argument is actually strongest there (and he has a new post that makes that point more forcefully.)

  54. Gravatar of Matthias Matthias
    31. May 2012 at 18:10

    Scott: As I understand it, that ~125bn increase is mainly due to FX Swaps, impemented in August to drive implied FX rates into negative territory. As those were mainly 3m (and later 1m swaps) I am a bit surprised myself as in how big the number still is, so I wonder if they really bought up 60bn new foreign currency or if some of it is just renewing the swaps. In any case I was right about the 177bn, that is the sight deposits number. The “few bn” I had in mind earlier were the estimated (by the UBS economist) 10bn the SNB needed during September to establish/keep their lower boundary in place.

    The increase in sight deposits is mainly due to unsterilizing the previously sterilized intervention (in 2010) by not renewing/buying back their SNB Bills and not offering any new reverse repos. So in that respect, the interpretation from zerohedge looks majorly flawed as it under/overestimates the amount of currency bought at the respective interventions.

    Also by looking at the IMF Special Data Dissemination Standard, it really looks like about 50bn were added since July, although those data also include FX-Swaps. So assuming none has renewed, 50-60bn foreign currency were added so far, depending which statistics one likes better. Just hard to tell in which timeframe (before or after boundary introduction) as data is distorted by those swaps.
    http://www.snb.ch/ext/stats/imfsdds/xls/de/imfsdds_S1_D1_M6.xls

  55. Gravatar of Peter N Peter N
    1. June 2012 at 02:49

    Scott,

    [I accidentally attached this to your Krugman-Hamilton post, but it obviously belongs here]

    The Swiss situation is rather interesting, since they can maintain a peg on the euro or the dollar, but not both.

    Maintaining the euro peg requires severe financial repression in Switzerland to make franc assets unattractive, which the Swiss have said they will engage in as needed. The more expensive dollar will make non-eurozone imports more expensive and the added value of exports (exports – import inputs) more attractive.

    Releasing the peg would push the franc up against both the euro and the dollar (though more so the euro) and probably cause asset price inflation. The cheaper imports and less competitive exports would erode national industry (think China and the US), and Switzerland has no compensating natural resources.

    Neither of these prospects is very attractive. The best policy is probably to let the peg crawl just enough to counter the worst of the peg side effects, but since the peg and non-peg side effects work to some extent on different parts of the economy, some distortion seems inevitable.

    There’s a fascinating paper in this for some lucky economist.

  56. Gravatar of UnlearningEcon UnlearningEcon
    1. June 2012 at 03:09

    As Jonathan Catalan notes, Keynes really used ‘full employment’ to mean ‘maximum effective demand’, which is incredibly similar to what you’re saying.

    http://www.economicthought.net/blog/?p=1593

    Keynes got there first! Stop trying to evade the issue.

  57. Gravatar of Morgan Warstler Morgan Warstler
    1. June 2012 at 03:42

    “I tend to oppose currency pegs,”

    lulz.

    Without currency pegs, free trade isn’t really free trade.

  58. Gravatar of Breakfast Links | Points and Figures Breakfast Links | Points and Figures
    1. June 2012 at 03:49

    [...] Paul Krugman should take classes from this person instead of teaching [...]

  59. Gravatar of Major_Freedom Major_Freedom
    1. June 2012 at 04:46

    Bill Ellis:

    I can’t get over the feeling that this debate somehow boils down to differences in Semantics, Syntactics, Pragmatics, something related.

    Yes, it is “something” related, but it isn’t semantics, syntactics, or pragmatics related. It’s epistemology. Most disagreements about fundamentals boil down to that.

  60. Gravatar of Full Employment Hawk Full Employment Hawk
    1. June 2012 at 07:10

    “Bernanke’s more likely to stay with Obama being re-elected. Obama’s pleased with his performance.”

    Hopefully after today’s report on jobs and the unemployment rate Obama (and his advisors) will finally stop being pleased with Bernanke’s performance and recognize him as their most dangerous enemy.

    But even before this, Obama being pleased with Bernanke’s performance once again shows Obama’s fatal achilles’ heel: His total failure to understand that making the unemployment come down as rapidly as possible had to be his number one priority, and that he had to do everything he could to achieve this goal, even if it meant doing things that were initially politically unpopular. If that meant higher inflation, so be it. If that meant bigger deficits, so be it. If the unemployment rate had been coming down at a strong solid rate, he would not have lost control of Congress in 2010 and his reelection would be in the bag.

    Obama’s reappointment of Republican, and former member of the Bush administration, Bernanke was, with the benefit of hindsight, Obama’s biggest single mistake. (But at the time even Krugman supported the decision, so this was, at least to a degree, an understandable mistake. But Obama’s economic advisors should have done much more due diligence here and extensively questioned Bernanke about how he planned to proceed. That might have prevented the error.) Christina Romer would have been the optimal choice for this position from Obama’s standpoint.

    If Obama loses the election, as is becoming more and more likely, the single person most responsibe and therefore getting the most blame or credit, depending on where one stands politically, is Bernanke.

    IT’S THE JOBS, STU er MR. PRESIDENT!

  61. Gravatar of Full Employment Hawk Full Employment Hawk
    1. June 2012 at 07:26

    “[...] Paul Krugman should take classes from this person instead of teaching [...]”

    But note this comment from Scott in another post.

    “And since I’ve been needling Paul Krugman about small issues in recent posts, how about a big round of applause for Dr. Gloom; the only major nationally-known pundit who’s been 100% right about the AD shortfall from the beginning.”

    Scott and Krugman may disagree on technical issues, such as the importance (or unimportance) of expansionary fiscal policy, but in the big picture, they are on the same side.

  62. Gravatar of ssumner ssumner
    1. June 2012 at 19:04

    Mattias, Thanks for the info. Too much for me to keep up with.

    Peter N, If they insist on targeting exchange rates, I agree that a crawling peg is best, where the SF gradually depreciates until the crisis is over.

    Unlearningecon, You are clueless, the Sumner critique has nothing to do with full employment or maximum demand, it’s equally applicable at high levels of unemployment, like right now.

    FEH, Why would Obama be upset today? Interest rates fell, and Obama believes interest rates ARE monetary policy.

  63. Gravatar of Mechanical vs. Intentional Economics « azmytheconomics Mechanical vs. Intentional Economics « azmytheconomics
    7. June 2012 at 07:41

    [...] Reading NPR update on the peg Sumner on the peg Evan Soltas on the peg Nick Rowe and the Chuck Norris Theory of Central Banking Share [...]

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