. . . words fail me

In my previous post I discussed the recent VAT increase in Spain, and wondered how the ECB would respond.  My excellent commenters quickly provided an answer.  But first a bit of background.  Suppose you had a country that raised its VAT rate by 10%, and suppose it applied to all goods and services.  In that case, the central bank would have two choices; allow the price level to rise 10%, or try to deflate all prices net of VAT by 10%.  Of course the deflation option would be a disaster, pushing the economy not just into recession, but into depression.  I think we can all agree it would be utterly mad to target the price level including the VAT.

Unfortunately it seems the ECB does exactly that.  Commenter Gregor Bush quoted this passage from an ECB statement:

“Taking into account today’s decisions, risks to the outlook for price developments continue to be broadly balanced over the medium term. The main downside risks relate to the impact of weaker than expected growth in the euro area. Upside risks pertain to further increases in indirect taxes, owing to the need for fiscal consolidation, and higher than expected energy prices over the medium term.”

I thought to myself; “poor ECB, those moronic politicians gave them the wrong mandate!”  A few comments later I discovered it’s even worse than I thought.  This was from commenter dwb:

 from a paper on the ecb website:
“The prices, which should be used in the HICP, are consumer prices (or final demand prices) rather than producer prices. Thus harmonized prices should include commodity and value added taxes in principle.”

In principle!?!?!  What sort of principle calls for that sort of insanity?  Commenter Mark Sadowski expressed eurozone policy perfectly:

The Euroausterity torture machine is like a head vice with the ECB on one side, and the fiscal authorities on the other, each frantically tightening as the other’s actions make it harder and harder for each of them to hit their own respective targets of inflation and fiscal responsibility.

And here’s Nick Rowe from my comment section:

Maybe there is something to this “you can’t have totally different cultures in a single currency area” idea after all. I wouldn’t want to be in a common currency area with people who were so….words fail me.

Lars Christensen has a post showing that GDP deflator inflation in the eurozone has absolutely collapsed over the past 4 years.  In the US even headline CPI inflation is running about 1.1% over the past 4 years, and is expected to show the same increase over the next two.  It’s an epic failure. 

I don’t even think we should be targeting inflation, but for God’s sake if we do then at least choose a metric that makes some sense in terms of the basic economic theory we teach on EC101.  Deflating the price level to offset a VAT shock?  That’s foolish.  Doing so when you also are suffering a severe recession because of single currency problems, that really foolish.  And doing so when you also have the greatest debt crisis in world history.  Like Nick Rowe, words fail me.

I recall a lot of people saying “well, you can’t expect the Fed to do more, after all inflation is unpopular with the public.”  Don’t they know that inflation is actually much lower than under President Clinton?  Does anyone recall consumers complaining of high inflation when Clinton was President?  I recall one newspaper article after another praising Greenspan for bringing us low inflation.  If America had simply replicated Greenspan’s “low inflation” over the fast 4 years, instead of the actual 1.1% rate, this recession would have been much milder.

People need to get off the sidelines and start screaming.  What’s wrong with our profession?  Roughly 75% of academic economists in America vote Democratic.  Why aren’t all of them outraged by Fed and ECB policy?  Why aren’t they out there demanding action?  Are they stupid?

Update:  Scott N says the following in the comment section:

It’s easy to say they are stupid, but I don’t think that is it. They are just like everyone else. They won’t change their opinions until they are presented with overwhelming and undisputed contrary evidence. These people have spend their lives advancing New Keynesianism and they aren’t about to change on a dime and admit their life’s work might have been wrong.

I certainly don’t think they are stupid, I’m throwing that inflammatory term out there to try to provoke an answer.  (‘Ignorant’ would have been more appropriate.)   Scott implies that new Keynesianism is about fiscal stimulus.  That’s wrong. The new Keynesian model calls for monetary policy to steer the economy.  So I’ll ask the question again; why aren’t economists demanding the ECB cut rates?  Why don’t they demand the Fed do level targeting, and try to make up for the ultra low inflation over the last 4 years?  Why the silence?

 

 


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59 Responses to “. . . words fail me”

  1. Gravatar of foosion foosion
    12. July 2012 at 07:38

    >>What’s wrong with our profession? Roughly 75% of academic economists in America vote Democratic. Why aren’t all of them outraged by Fed and ECB policy? Why aren’t they out there demanding action? Are they stupid?>>

    Those Democratic economists who are publicly outraged have to contend with the publicity given to Republican economists who are shouting that Fed policy has been too loose and that inflation and debt will shortly kill us all.

  2. Gravatar of Scott N Scott N
    12. July 2012 at 07:50

    “Roughly 75% of academic economists in America vote Democratic. Why aren’t all of them outraged by Fed and ECB policy? Why aren’t they out there demanding action? Are they stupid?”

    They are out there demanding action … more fiscal stimulus. I follow the markets closely and I am bombarded daily with articles from Krugman et al. and his liberal followers about how almost every economy needs more and more fiscal stimulus. Case in point, from this morning: http://goo.gl/a2o0V

    I get almost no articles about the need for monetary stimulus. In fact, if monetary stimulus is mentioned, the most common response is that QE suffers from diminishing returns and is reaching its limit in what it can do.

    It’s easy to say they are stupid, but I don’t think that is it. They are just like everyone else. They won’t change their opinions until they are presented with overwhelming and undisputed contrary evidence. These people have spend their lives advancing New Keynesianism and they aren’t about to change on a dime and admit their life’s work might have been wrong.

  3. Gravatar of Zorblog Zorblog
    12. July 2012 at 07:59

    If the ECB does not even know which deflator makes sense, do you think it’s got a solution for the euro crisis?

    “What’s wrong with our profession? [...] Why aren’t all of them outraged by Fed and ECB policy? [...] Are they stupid?”

    Please, save the world, elaborate on that question.

  4. Gravatar of Scott N Scott N
    12. July 2012 at 08:01

    It looks like the Fed may also believe QE is offering ever diminishing returns. Tim Duy analyzed the FOMC minutes released yesterday in this post. http://goo.gl/q0A9M

    Tim’s conclusion:
    “Bottom Line: The minutes leaves me with the sense that it isn’t so much the outlook that is holding back the Fed from further stimulus, but a lack of faith in the beneficial effects of further quantitative easing. That lack of faith may be why the bar to QE3 seems so high. So high that Fed officials are searching for other tools as the next step.”

    Jon Hilsenrath(the Fed’s unofficial mouthpiece) wrote this in the WSJ on 19 June 2012: “Fed officials have been frustrated in the past year that low interest rate policies haven’t reached enough Americans to spur stronger growth, the way economics textbooks say low rates should. By reducing interest rates-the cost of credit-the Fed encourages household spending, business investment and hiring, in addition to reducing the burden of past debts. But the economy hasn’t been working according to script.” http://goo.gl/aL5ZB

    I think this is bad news because a confused Fed is likely to act conservatively, which is what Congress and the public wants, and not engage in further monetary easing until things get really bad. Not good, not god.

  5. Gravatar of John John
    12. July 2012 at 08:16

    A VAT does not directly raise the general price level because it does not directly affect the supply of money, the demand for money, or the quantity of products produced. Sellers of goods will have to cut the underlying price of their products in order to restore a profitable supply and demand schedule in line with the addition of the VAT increase.

    I’m surprised that Scott is referring to price levels here instead of the two bigger issues with raising the VAT.

    1. It’s contractionary for NGDP unless the government correspondingly increases spending which defeats the point of raising taxes. Even worse, the contraction to NGDP affects the real economy and negatively changes the SRAS/LRAS curves.

    2. It hurts the ability of consumers to buy the products they need during a very tough economic period.

  6. Gravatar of dwb dwb
    12. July 2012 at 08:23

    maybe 75% of academic economists in America vote Democratic, but i would guess that 75% of private economists vote R. from what i can see, most academic bloggers like Thoma are calling for the fed to do more, and more than half private banking economists think it would speed growth as well.

    the real question is why Bernanke is allowing the few dissenters to have an effective veto over policy by requiring a near unanimous vote (rather than just a super-majority). Its pretty clear to be that we could get 8 of 12 votes for more action.

  7. Gravatar of Gabe Gabe
    12. July 2012 at 08:26

    Of course there are multiple reasons, but I know one important reason. Many think “the Fed is doing all it can already”…I’ve seen it in surveys and hear about first hand as well.

    Now I agree with Scott that the Fed obviously is not doing all it can anyone who reads and examines closely can see that. So of the 30% who believe the Fed is doing all it can…I’d say 60% don’t give a damn enough about the real economy to care and the other 40% really are stupid(yes even though they have PHDs in economics, they are still stupid).

    And that is all good to the Power Elite, because if more people were smart we wouldn’t even have a Fed. The people who make Ben Bernanke jump to attention when they call his office certainly don’t want more close inspection or thought about the magical money printing powers entrusted to a few secretive groups.

    Gabe

  8. Gravatar of Vivian Darkbloom Vivian Darkbloom
    12. July 2012 at 08:27

    This is from the BoE website on *their* inflation targeting policy:

    “Having a target for annual inflation of 2.0% does not mean that the Monetary Policy Committee is expected to hold inflation at 2.0% all the time. That would not be possible or, in fact, desirable. Inflation might change month to month for all kinds of reasons, many of which will only have a temporary influence.

    stormy weather…

    The inflation rate might change, for example, because of the weather. If there had been a very wet or very dry summer, we might expect this to result in bad food harvests. Any resultant fall in the supply of food might push some food prices higher for a time, and raise the overall inflation rate. But we would not expect interest rates to be changed because of this.”

    http://www.bankofengland.co.uk/education/Pages/targettwopointzero/mpframework/currentinflationtarget.aspx

    That, of course, sounds quite sensible and, while the BoE does not specifically mention VAT rate increases, it stands to reason that VAT increases would be taken into account, too. I have no doubt the BoE does. It is, after all, much easier to identify the extent of increase in the CPI (previously called HICP which the BoE also uses) than it is to estimate the effects of stormy weather. As to the “temporary nature” of such changes that, too, is fairly straightforward. If year-over-year inflation is targeted, the effect of a VAT rise is temporary—about 1 year and less if month-on-month is viewed.

    Of course, what we are talking about here is the ECB; however, I would be quite surprised if they did not follow the same common sense approach by making these type modifications to the inflation target to account for one-off events.

  9. Gravatar of orionorbit orionorbit
    12. July 2012 at 08:27

    I also agree with your posters stating that the ECB targets inflation without any particular regard to whether it’s the result of VAT hikes or cost push shocks.

    You are right in your claim that NK macro calls for monetary stimulus, but if you look at the ECB body that takes mon policy decisions you will see that there are very very few persons in it capable of grasping even the simplest versions of NK macro… Draghi gets it for sure, Orphanides too (but he got replaced a month ago), perhaps Novotny and 2-3 more are ECB board members that get NK econ. The rest are a bunch of lawyers and civil servants that don’t get anything written after 1920. Appointment at the ECB board has nothing to do with being a good economist, take the bank of Finland for instance. Its head of research is a very good NK economist, used to be my open macro teacher during a semester I did in U Helsinki, has even published in AER, yet the Bank of Finland is ran by some lawyer… I have no idea if this has to do with political connections, i’m just stating that a background in econ helps you get appointed at the ECB board as much as a background in 19th century a-modal classical music.

  10. Gravatar of Scott N Scott N
    12. July 2012 at 08:42

    “Scott implies that new Keynesianism is about fiscal stimulus. That’s wrong. The new Keynesian model calls for monetary policy to steer the economy.”

    Does the NK model call for monetary policy to steer the economy at the zero lower bound? If so, then the vocal NK economists I hear day after day demanding more fiscal stimulus must not believe the model or perhaps they have moved on to a new model where monetary policy is ineffective at the lower bound.

  11. Gravatar of Michael Michael
    12. July 2012 at 08:51

    Scott N, maybe it is true that QE *as implemented by the Fed* (i.e. 1) without an NGDP target, 2) without a level target, 3) with a 2% cap on inflation , and 4) with IOR) is not going to get the job done.

    That Tim Duy blog post also had this quote:

    “Several participants commented that it would be desirable to explore the possibility of developing new tools to promote more-accommodative financial conditions and thereby support a stronger economic recovery.”

    Hmm… if only someone, somewhere has some ideas for new tools the Fed could use…

  12. Gravatar of 123 123
    12. July 2012 at 09:03

    Scott:
    “why aren’t economists demanding the ECB cut rates?”

    No, no, no. The problem is that economists ARE demanding the ECB cut rates. The problem is that economists say it is TOO EARLY to start printing money.

    On 29 June 2012, 13 of the 15 economists on the shadow ECB council had recommended a 50 bps repo rate cut with a description “Most members think that the effect of such a rate cut will be rather limited and mostly symbolic.”.
    http://www.handelsblatt.com/politik/konjunktur/shadow-council/shadow-ecb-council-sees-ecbs-options-reduced-to-a-largely-symbolic-rate-cut/6824676.html

    In any case, debates on the optimal lower bound of the IOR rate (whether it is +25bps as the Fed is doing now, 0bps as the ECB has done recently, or a bit negative as in Denmark) will do very little to save the Eurozone. It is important to print money, it is not so important if the IOR rate is a bit higher or lower.

    They also said: ” While a majority considered that the ECB should be ready to deploy measures already tried in the past, like offering new long term refinancing opportunities to banks, only a minority favoured doing so immediately.” This is shameful.

    This also confirms that BoE with its forthcoming “funding for lending” program is ahead of the consensus of economists.

  13. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    12. July 2012 at 09:12

    Is this movie starring Marcello and Sophia;

    http://www.telegraph.co.uk/finance/financialcrisis/9395245/Debt-crisis-Italys-statisticians-threaten-stats-black-out.html

    ———–quote———–
    Mr Giovannini warned that if Istat stopped putting out statistics the government faced “heavy fines” from Brussels.

    “Around 70pc of our production of statistics is based on commitments with the European Union,” he said.

    “We will not issue data on inflation, deficit, household income, job data. That will trigger very high EU fines for our country for every day of delay.

    “I do not think the government and the parliament will want to get to that point.”
    ———–endquote———-

  14. Gravatar of Ravi Ravi
    12. July 2012 at 09:25

    I think there might be something to Lars Christensen’s idea of a “Calvinist” doctrine at work. Most people subscribe explicitly or implicitly to some version of the Minsky model, and believe that this slow recovery is our just punishment for overconsumption, housing stupidity etc. Likewise, the lazy, profligate Europeans deserve what they’re getting. It’s a hard mindset to break out of, even for academic economists. I think another reason is that few academic economists are experts on money. I am shocked when I listen to Joe Stiglitz about monetary policy that he has a Nobel prize.

  15. Gravatar of Scott N Scott N
    12. July 2012 at 09:34

    Michael, I agree that the Fed’s new found uncertainty could lead it to embrace Market Monetarism, but I think that’s unlikely. The more likely outcome is that the Fed gets a bunker mentality so that it won’t do anything until things get really bad.

    I also agree that QE as implemented by the Fed isn’t working great. The big problem is that the Fed thinks it needs to lower long term interest rates. Well, they are dramatically lower but the economy isn’t rebounding, thus causing the Fed to wonder what is going on.

  16. Gravatar of Saturos Saturos
    12. July 2012 at 09:38

    “why aren’t economists demanding the ECB cut rates? Why don’t they demand the Fed do level targeting, and try to make up for the ultra low inflation over the last 4 years? Why the silence?”

    It’s probably partly the Sumnerian money illusion, but I think it’s also a more general problem that has kept macroeconomics in the dark as a science for so long – cogent, pragmatic, intuitive logical reasoning, judicious appraisal of evidence, and recollection and synthesis of past experience goes out the window when a crisis hits, as everyone decides it’s time to play tug-of-war over the size of governments. Or as Yudkowsky says, politics is the mindkiller:

    Politics is an extension of war by other means. Arguments are soldiers. Once you know which side you’re on, you must support all arguments of that side, and attack all arguments that appear to favor the enemy side; otherwise it’s like stabbing your soldiers in the back—providing aid and comfort to the enemy. People who would be level-headed about evenhandedly weighing all sides of an issue in their professional life as scientists, can suddenly turn into slogan-chanting zombies when there’s a Blue or Green position on an issue.

    “Blue or Green” links to this: http://lesswrong.com/lw/gt/a_fable_of_science_and_politics

    This is also relevant: http://lesswrong.com/lw/hu/the_third_alternative/

    I want to link to other posts to, but I’m afraid I’ll just end up rereading the whole blog – which everyone should read, btw.

  17. Gravatar of Doug M Doug M
    12. July 2012 at 09:53

    Interesting stuff on the VAT and inflation targets. I see many Fed watchers make comments that are almost in the reverse of that. They will say things like “oil prices are up, and that acts like a tax increase. The Fed will need to ease.” I guess they are saying that higher prices are deflationary.

    “Lars Christenson has a post showing that GDP deflator inflation in the eurozone has absolutely collapsed over the past 4 years.”

    What numbers do you have? I see 1.3% up from 0.5% a year ago, but certainly below the 2% ECB target.

    Alan Greenspan — I remember reading an interview with “the maestro” in the early 90s. Inflation was running 2-3% for a couple of years and Mr. Greenspan was suggesting that there was still for inflation to move lower. He seemed to be suggesting that if employment continued to hold up, he would be content to drive inflation to zero.

    Fed policy — I would like to hear some ideas of what you think the Fed should be doing. Rates are already a zero. QE1 and 2 seemed to have little effect. Were they too small? “Operation twist” seems to me to be exactly the wrong policy. I was taught that a steeper curve encouraged banks to lend money. The logic behind operation twist is that a flatter curve will encourage people to borrow money.

    “So I’ll ask the question again; why aren’t economists demanding the ECB cut rates?”

    The ECB cut rates just last week.

    It seems to me that the fundamental problem is too much bad debt, and too much debt overall. The Europeans are trying to turn bad debt into good debt by issuing loan guarantees. That doesn’t solve to problem of too much overall debt. One way to get rid of too much debt it to deflate it. However, the chronic debtors will face higher borrowing costs and more debt service it time if they follow this path. The other way to get rid of bad debts is to write it down either through modification or forgiveness or through bankruptcy.

    Why does Spain need its own banks anyway? Suppose they were to have let the Spanish banks fail. Let the German banks step in to fill in the void.

  18. Gravatar of Leo Leo
    12. July 2012 at 10:13

    The Fed doesn’t care about unemployment. There’s no mystery.

  19. Gravatar of Major_Freedom Major_Freedom
    12. July 2012 at 10:23

    Suppose you had a country that raised its VAT rate by 10%, and suppose it applied to all goods and services. In that case, the central bank would have two choices; allow the price level to rise 10%, or try to deflate all prices net of VAT by 10%.

    This is false. You are incorrectly assuming that the taxes are not spent. If VAT increases by 10%, then the private sector would spend less, and the state would spend more. That won’t change AD, and hence there cannot be any pressure on prices in general to rise.

    What will happen is that there will be a change in relative prices, but relative price changes are ghost town phenomena on this blog.

  20. Gravatar of Shane Shane
    12. July 2012 at 10:55

    One explanation for the persistent weak economy in the US and Europe is that Central Banks lose their footing at the zero lower bound. A quick Google search, however, reveals that the ECB has never hit the zero bound. In fact, they’ve behaved *exactly* like the Fed, massively expanding their balance sheet but keeping the core rate unchanged (more or less at 1%) since late 2008. This suggests to me that the zero lower bound story is a red herring. Rather, the crisis is 100% due to failed leadership.

    However, I don’t think it’s failed leadership in the sense that the Fed isn’t doing what people want them to do. Rather, I think most people, when asked whether they want lower unemployment at the risk of higher gas prices, would say no. Maybe once they experienced the benefits of Fed stimulus concretely, they would feel differently. But never underestimate the tendency to prefer the devil you know over the devil you don’t. If anything, the Fed is not too distant and unaccountable, but too obsessed with the smallest changes in public opinion.

  21. Gravatar of Sina Motamedi Sina Motamedi
    12. July 2012 at 10:59

    Amen to that. Where’s the outrage?

  22. Gravatar of Major_Freedom Major_Freedom
    12. July 2012 at 11:26

    Shane:

    One explanation for the persistent weak economy in the US and Europe is that Central Banks lose their footing at the zero lower bound.

    You don’t think the zero bound itself represents a problem? How can recovery take place if the nominal rates that exist are close to zero, despite the fact that real savings by people would almost certainly bring about higher rates?

    Why do you keep viewing the health of the economy as a lack of what the Fed does?

  23. Gravatar of Major_Freedom Major_Freedom
    12. July 2012 at 11:34

    Leo:

    The Fed doesn’t care about unemployment. There’s no mystery.

    Then let’s keep praying to it. Let’s pray for it to have sole control over people’s spending. Let’s pray that it will be merciful and to give us our daily bread.

    Obviously the problem is that the Fed is controlled by unbelievers who lack the faith. Let’s find these angels that are so plentiful and pray that they do what we are too stupid to do on our own.

  24. Gravatar of Failed monetary policy – the one graph version « The Market Monetarist Failed monetary policy – the one graph version « The Market Monetarist
    12. July 2012 at 11:37

    [...] Scott Sumner has a related post. Share this:EmailLike this:LikeBe the first to like this. 31 Comments by Lars Christensen on May [...]

  25. Gravatar of JimP JimP
    12. July 2012 at 12:41

    Leo

    I think that is what it comes to. With Roosevelt – he had to act or the country might just blow up. The weakness of the left now means that neither Bernanke nor Obama has to care about unemployment so neither of them does. Obama is no more of a Democrat than Hoover was – and Bernanke is pure deflationist Republican.

    Obama now defines the Democratic party as the party of the “middle class”. The Republicans are, as always, the party of the upper class. So the lower class has no political voice at all.

  26. Gravatar of JimP JimP
    12. July 2012 at 12:55

    Or – it was the war spending that got us out of the depression – not the new deal. Absent the war we might have been stuck in a Japanese bad equilibrium forever – as we apparently now are. The voice of the deflationists can only be overcome by a President who wants to fight it. Obama does not want to.

    Scott could overcome the voice of the deflationists because he is not calling for more inflation. Unfortunately for us however, the voice of the left is not Scott but rather Krugman, and what Krugman calls for is so insane that no polity would ever do it.

  27. Gravatar of Gabe Gabe
    12. July 2012 at 13:42

    I see no evidence that the Fed is thoughtfulyl weighing the arguments of Freidman, Krugman, Delong, Sumner, Keynes etc and then making their decisions based off what they think is best for the median person.

    When the crisis hit and thereafter they have let it be known clearly through their actions that their first priority is to protect TPTB and if possible do whatever they can to make everyone else pay.

  28. Gravatar of Assorted Links « azmytheconomics Assorted Links « azmytheconomics
    12. July 2012 at 13:50

    [...] 3. One of the greatest problems with modern economic policy is that it is so complex, people don&#8217… [...]

  29. Gravatar of Orionorbit Orionorbit
    12. July 2012 at 14:07

    Vivian D, the BoE is way better than the ECB in that respect, if I remember correctly mervin king cited VAT hikes among the reasons he kept rates on hold in the face of 4% inflation, rightly so. The ECB in his place would have been raising the repo right which is why we, over here, keep our fingers crossed that France and Germany won’t get any silly ideas like raising VAT to finance bailout related costs.

    Ravi, you are wrong on two counts. First, there’s nothing about morality and punishment in Minskys financial instability hypothesis, that economies collapse as a result of excessive banking leverage is a prediction of his model, but there is no crime&punishment of the sort you seem to assume. Second, yes, Stiglitz has said a few silly things about macro, but A. He’s old, B. his Nobel is for his work on micro and C. Bob Lucas has been saying even sillier stuff, and he’s a macroeconomist. Of course both of them are not stupid, as one could infer by looking at a few isolated quotes, just maybe blinded by the political views somewhat, but this is consistent with their age so I think ridiculing either of them is just wrong.

  30. Gravatar of Doug M Doug M
    12. July 2012 at 14:13

    JimP,
    Was it the War spending or the new deal?

    Or was it the war itself, taking 1mm working-age people shipping them to foreign locations, and creating a shortage of labor stateside.

  31. Gravatar of Doug M Doug M
    12. July 2012 at 14:20

    Unemployment in the Rosevelt era.

    Unemployment
    1932 23.6
    1934 21.7
    1936 16.9
    1938 19
    1940 14.6
    1942 4.7
    1944 1.2
    1946 3.9

    Was it the new deal or was it the war?

  32. Gravatar of Britmouse Britmouse
    12. July 2012 at 15:28

    Vivian and Orion, the UK CPI at constant taxes (CPI-CT) was below 2% for the entire of 2010, so they did not entirely offset the VAT rise in that year. In 2011 they allowed the CPI-CT to rise by 2.8%, so allowing the VAT rise, though commodity shocks are mixed in there. In 2012 they got cold feet about allowing current CPI above 2% with no supply shocks in sight and NGDP falling through the floor, but may have reversed that position.

    In the long run… all central bankers are inflation nutters?

  33. Gravatar of Mark A. Sadowski Mark A. Sadowski
    12. July 2012 at 15:42

    Lorenzo from Oz,

    Bruce Bartlett recently had this to say in the NYT article called “In Lost Opportunity of 1932, Are There Lessons for Today?”:

    “In testimony before the Senate Banking Committee on May 13, Fisher strenuously disagreed. He noted that the economy was showing some signs of life because of an expansion of the money supply that the Fed had adopted in the spring. But businesses had no assurance that it would continue, which was their prime source of uncertainty. The Goldsborough bill would guarantee a continuation of easy money until recovery had been achieved, Fisher argued.

    He was prescient. In July, the Fed halted its policy of quantitative easing and the recovery was quickly aborted. In a March 2006 article in the Journal of Economic History, the economists Chang-Tai Hsieh and Christina Romer suggest that pressure from the regional Federal Reserve bank presidents was instrumental in ending the easing. With ample reserves in the banking system and very low interest rates there was nothing to be gained by further easing, they asserted.”

    From Chang-Tai Hsieh and Christina Romer (Pages 169-170):

    “Why Did the Federal Reserve End the Monetary Expansion?

    If the Federal Reserve was not concerned about a speculative attack, why did it cease its open market purchases after only five months? Our reading of the Harrison papers suggests that the Federal Reserve decided to slow the monetary expansion in mid-June in part because its model of monetary policy led it to believe that monetary conditions were already loose and that further purchases would be of little use. As discussed by Elmus Wicker, David Wheelock, and Allan Meltzer, Federal Reserve officials in the 1930s focused on bank borrowing and excess bank reserves as their main indicators of monetary ease or tightness. 85 For example, on 12 May Harrison told the Board of the Federal Reserve Bank of New York that: “The best yardstick to use [for measuring the success of monetary policy] … would be the figures of member bank reserves.” 86 More importantly, policymakers at the Federal Reserve believed that once excess reserves were plentiful, further monetary easing could do little to stimulate recovery. At the same meeting, Harrison stated that:

    “When the figures of member bank reserves are sufficiently high to produce adequate pressure upon the banks and to provide adequate credit for business as recovery sets in, we shall probably have done our part. If the commercial banks can’t or don’t use the credit which we provide, that is another problem.” 87

    A related view was that, because expansion would be ineffective when there were already large quantities of excess reserves, it did not make sense to expand when the demand for funds was low. Instead, Federal Reserve officials believed that the best time to expand was when confidence was high, or at least improving. For example, in reviewing the origin of the open market purchase program on 30 June, Harrison said: “It was thought best, however, not to use our ammunition until the chances of effective response from the banking and business community would favor the success of our undertaking.” 88

    This model of the economy hastened the end of the open market purchase program in two ways. First, in late May and early June, some Federal Reserve officials believed that the program had already worked. The program had made excess reserves plentiful and so further expansion was not needed. On 26 May Harrison told his directors that “excess reserves of member banks are now at about the point where it had been thought they should be maintained.” 89 Goldenweiser recounts that “Federal Reserve authorities felt that their monetary policy had made bank credit expansion possible and that they were powerless to induce banks to lend more freely or even to arrest loan liquidation.” 90 Second, when a wave of banking panics in Chicago in late June led Federal Reserve officials to fear that widespread banking difficulties were about to begin again, some monetary policymakers concluded that further open market purchases would have no impact. Harrison, for example, said that: “There is no sense … in our purchasing Government securities merely as an offset to currency hoarding. That is an impossible task and an inversion of our program, which was based on a revival of confidence in the banking and credit structure.””

    From their conclusion:

    “But, our evidence from the one time that the Federal Reserve undertook monetary expansion in the early 1930s is that the Federal Reserve actually had substantial room to maneuver. For this reason, we are inclined to agree with Friedman and Schwartz that the Federal Reserve’s failure to act was a policy mistake of monumental proportions, not the inevitable result of the U.S. adherence to the gold standard.”

    http://elsa.berkeley.edu/~cromer/JEH_March06.pdf

    I find the then apparently prevalent argument that the Fed had done a great deal and any more would be unnecessary, as demonstrated by the ampleness of reserves and the low interest rates, as well as the intermittent targetless mode of quantitative easing, to be chillingly similar to our own times. It’s hard to believe that less than two years later FDR would devalue the dollar by 40% and set off the greatest peacetime economic expansion in US history.

  34. Gravatar of Matt Matt
    12. July 2012 at 15:42

    The blame falls squarely on the ECB for this, the Maastricht Treaty (reaffirmed in the subsequent treaty revisions) specified that the legal mandate of the ECB would be to maintain price stability over the medium term but it left it up to the ECB governing council to decide on the quantitative definition of price stability. The ECB governing council made the decision to target ‘year on year HICP increases of below 2%’ – they could have chosen to target a measure of core inflation, or a GDP deflator, or even NGDP if they’d made the case that it was consistent with maintaining price stability. They could also have chosen to do level targeting, but they chose the rate of increase of the headline HICP and now they’re sticking to it.

    Additionally there’s nothing in the primary legislation of the EU that would suggest that the ECB cannot unilaterally change it’s own target as long as the new target is consistent with the price stability mandate.

  35. Gravatar of Mark A. Sadowski Mark A. Sadowski
    12. July 2012 at 15:45

    I meant to put that elsewhere.

  36. Gravatar of Dan Kervick Dan Kervick
    12. July 2012 at 16:08

    Most people subscribe explicitly or implicitly to some version of the Minsky model, and believe that this slow recovery is our just punishment for overconsumption, housing stupidity etc.

    That’s not the Minsky model.

  37. Gravatar of Orionorbit Orionorbit
    12. July 2012 at 16:57

    Britmouse, thanks for the numbers. Coming to your question, probably, but then again there’s Lars Svensson…

  38. Gravatar of B B
    12. July 2012 at 21:16

    People need to get off the sidelines and start screaming. What’s wrong with our profession? Roughly 75% of academic economists in America vote Democratic. Why aren’t all of them outraged by Fed and ECB policy? Why aren’t they out there demanding action? Are they stupid?

    More than 75% don’t know squat about monetary policy. I can tell more than 75% of PhD students I know suffered through a brief bit of monetary economics in first year macro and gladly forgot it all when it was over.

    This battle is fought among a few hundred economists. Maybe 1,000 tops.

  39. Gravatar of Benny Lava Benny Lava
    13. July 2012 at 05:05

    Real talk: what if, every day on your way to work, you crossed picket lines. And those picket lines had people shouting that you did a terrible job. Would you question if they had a point?

    I have seen them outside the fed with my own eyes. They have end the fed signs. They scream about inflation. They are perhaps a vocal minority, but there is no doubt they influenced the 2010 midterms. Remember when Rick Perry threatened bodily harm to Bernake?

    My best guess is that the pressure from protesters and politicians has gotten to the Fed. They feel the heat. Why else would they hold off on helicopter drops and whatnot?

  40. Gravatar of Mark A. Sadowski Mark A. Sadowski
    13. July 2012 at 07:15

    B,
    “I can tell more than 75% of PhD students I know suffered through a brief bit of monetary economics in first year macro and gladly forgot it all when it was over.”

    That had me go and think back through my fairly recent experience in grad school. Introductory Macro (required of MA and PhD students) covered monetary policy but not anywhere at the level one could hope to keep up with the current debates. Advanced Macro (required of PhDs) was basically an RBC based course in DSGE so prices and consequently monetary policy was completely ignored as it was considered as meaningless and archaic as reading tea leaves.

    Fortunately for me I chose Applied Macro for my field. Monetary policy was treated obliquely in two of the required courses for the field (International Economics and Public Economics). The only course that really waded into monetary policy in depth was Monetary Economics of course. Although many issues were addressed, our attention was focused on the 1965-present period. With all due respect to my instructor (he’s also my dissertation advisor) monetary policy was treated largely as a closed issue. All the problems had been solved and the Great Depression could never happen again (a la Bernanke). Inflation Targeting was treated as the only new thing and it was assumed that the US was joining the rest of the world in implementing IT. Consequently the vast majority of what I know about monetary policy I learned outside of my university.

    However, thinking back, it’s interesting how few of the entering PhD students from my year actually became Doctoral Candidates (only about 30%). And of those, all took that course as all chose Applied Macro as their field (I was the only American although Europe was my region of focus). In retrospect I find that rather odd and I wonder why there is such a correspondence.

  41. Gravatar of ssumner ssumner
    13. July 2012 at 07:26

    John, A VAT raises prices by reducing the demand for money. It’s an adverse supply shock.

    dwb, The intellectual elite of the economics profession is completely, 100%, dominated by academic economists. They set the policy agenda. They create the models, they win all the Nobel Prizes.

    Vivian, I agree the BoE is better.

    123. Good point.

    Saturos, Good point, but even Democratic economists aren’t calling for monetary stimulus (with a few notable exceptions.)

    Doug, I link to Christensen’s graph.

    Once and a while it’s fun to read the latest nonsense from MR, who seems to confuse AS and AD:

    “This is false. You are incorrectly assuming that the taxes are not spent. If VAT increases by 10%, then the private sector would spend less, and the state would spend more. That won’t change AD, and hence there cannot be any pressure on prices in general to rise.”

    Shane, I agree.

    Matt, Thanks for the info.

    Everyone, Lots of good observations, I don’t have time for all of the comments today.

  42. Gravatar of o. nate o. nate
    13. July 2012 at 08:44

    Although the immediate effect of VAT is an increase in prices inclusive of VAT, it seems that the eventual effect should be a fall in aggregate demand and hence a fall in consumer prices, since most of the government revenue will be used to retire debt, thereby driving up the price of sovereign debt, which is not included in the consumer price index.

  43. Gravatar of o. nate o. nate
    13. July 2012 at 08:58

    Even if you assume that a VAT increase is passed through directly to an equal consumer price increase with no indirect effects – it’s still only a one-time increase so the rate of inflation would increase in that one period but then in the following period it would fall back to the previous equilibrium rate, so the monetary impact should be limited.

  44. Gravatar of IVV IVV
    13. July 2012 at 09:26

    “I recall a lot of people saying “well, you can’t expect the Fed to do more, after all inflation is unpopular with the public.” Don’t they know that inflation is actually much lower than under President Clinton? Does anyone recall consumers complaining of high inflation when Clinton was President? I recall one newspaper article after another praising Greenspan for bringing us low inflation. If America had simply replicated Greenspan’s “low inflation” over the fast 4 years, instead of the actual 1.1% rate, this recession would have been much milder.”

    What consumers complain about isn’t inflation per se, as much as consumables inflation with respect to nominal wage inflation. As long as nominal wages keep pace with consumables inflation, people are happy. Since present nominal wage inflation is flat to negative, consumable prices need to be negative to keep consumers happy. Any inflation will be seen as bad, because “inflation” to the average consumer means consumable inflation, with the expectation that wages will remain stagnant.

  45. Gravatar of Major_Freedom Major_Freedom
    13. July 2012 at 09:29

    What consumers complain about isn’t inflation per se, as much as consumables inflation with respect to nominal wage inflation. As long as nominal wages keep pace with consumables inflation, people are happy. Since present nominal wage inflation is flat to negative, consumable prices need to be negative to keep consumers happy. Any inflation will be seen as bad, because “inflation” to the average consumer means consumable inflation, with the expectation that wages will remain stagnant.

    In other words, people’s actual complaints about inflation are justified.

  46. Gravatar of RebelEconomist RebelEconomist
    13. July 2012 at 09:44

    Usual readers will not be surprised that I do think that there can be a case for monetary tightening in response to a VAT rise. To a certain extent, taxes are the price of government services (the volume of government services comes into it too). To that extent, a VAT rise does represent inflation, and monetary policy should be tightened accordingly.

  47. Gravatar of B B
    13. July 2012 at 15:35

    Mark,

    I imagine every school graduate student body is different. Monetary policy certainly isn’t my school’s strength. Still, there is a fair amount of interest in macro, but very little in monetary policy. Right now it boils down to one student out of 50+ that I know of. And he’s from South Asia and hopes to return home to work at his country’s central bank. That’s the state of monetary policy at my university. Pretty depressing.

  48. Gravatar of Benny Lava Benny Lava
    13. July 2012 at 17:41

    IVV,

    You mean purchasing power is salient. More salient than inflation, and people are confusing purchasing power with inflation. I agree, to an extent.

  49. Gravatar of Vivian Darkbloom Vivian Darkbloom
    14. July 2012 at 03:23

    “Vivian, I agree the BoE is better.”

    The point of my comment was not that the BoE approach is “better” than that of the ECB; rather, it was that the two approaches are likely the same.

    In fact, I’m very surprised at the “shock” that the ECB would use HICP (CPI) that includes VAT. The practice is pretty much universal, as far as I can tell, among all central banks. Not only do the CPI measures used by central banks include VAT and similar taxes such as sales tax, they also include excise taxes. The CPI as calculated by the BLS and as used by the Federal Reserve generally includes all sales and excise taxes. In this respect, the increase of the VAT rate in Spain is no different from a sales tax increase in one or several of the states within the United States.

    The more significant issue is whether the ECB (or the BoE, the Federal Reserve, etc) would have the ability to detect such a temporary distortion, determine if it is statistically significant and, if appropriate, adjust their policy to account for it.

    In this respect, it is important to note that, contrary to the impression left in the original post, the ECB does not “target inflation”. Rather, the ECB targets “price stability”. The difference, while subtle, is important, as the ECB takes great effort to point out in its publications. Like most other central banks, the ECB’s price stability target is aimed at the “medium term” (the duration of which is not defined; however, it is generally understood to be more than one year). The stated purpose of the “medium term” goal is to allow the bank to ignore temporary price shocks particularly given the lag in time it takes for monetary policy to take effect.

    The ECB mentions temporary oil shocks as an example where this principle might be relevant; the BoE mentions bad weather; however, the operating principles appear to be exactly the same.

    The ECB also acknowledges that, by necessity, it must address “average” price stability within the Euro Zone. Thus, a three percent rise in the VAT rate in Spain might have a measurable increase in the inflation rate within Spain, it would not likely have a significant effect on the entire Euro Zone. If it did, or it did in combination with other rises in VAT rates, excise taxes, etc, in other Member States, then the ECB’s official policy would appear flexible enough for that to be taken into account in its price stability target. Here, I see no difference between what the ECB can do and what the BoE can do. What they may do in practice given a given set of circumstances may be another matter.

  50. Gravatar of dtoh dtoh
    14. July 2012 at 04:27

    Scott,
    You need to do more to explain the transmission mechanism of monetary policy. That is the greatest stumbling block to wider acceptance of your views on optimal monetary policy.

  51. Gravatar of ssumner ssumner
    14. July 2012 at 08:18

    IVV, You said;

    “What consumers complain about isn’t inflation per se, as much as consumables inflation with respect to nominal wage inflation.”

    That’s exactly what I’ve been saying, but you don’t understand the implications. people don’t care about inflation, they care about real income. And you boost RGDP with higher NGDP growth.

    Vivian, But the ECB argued that the inflation rate including VAT is the “right one.” That’s what I’m criticizing.

    dtoh, I’ve done that a million times. More money reduces the value of money for exactly the same reason that more apples reduces the value of apples.

  52. Gravatar of Vivian Darkbloom Vivian Darkbloom
    14. July 2012 at 09:44

    “Vivian, But the ECB argued that the inflation rate including VAT is the “right one.” That’s what I’m criticizing.”

    I’m guessing that this “argument” of the ECB is derived from passage, but please correct me if I’m mistaken:

    “I thought to myself; “poor ECB, those moronic politicians gave them the wrong mandate!” A few comments later I discovered it’s even worse than I thought. This was from commenter dwb:

    from a paper on the ecb website:

    “The prices, which should be used in the HICP, are consumer prices (or final demand prices) rather than producer prices. Thus harmonized prices should include commodity and value added taxes in principle.” ”

    While the ECB has made this “argument” explicitly on its website, they would appear to be in very large company because, as I’ve pointed out, nearly every central bank uses consumer prices rather than producer prices as a measure of inflation. Thus, implicitly, all central banks implicitly make this same “argument” that the prices to be measured include consumer taxes, excise taxes and so forth that are contained in end prices to consumers. The ECB is merely expressly stating what is implied in the policies of all other central banks. Thus, your criticism should be directed at all the “morons” of central banks globally, and not merely the ECB.

    Your comment about morons, though, was directed at politicians giving the wrong mandate–not at central bankers. Am I to assume that the policy decisions to use consumer prices rather than producer prices have been made by politicians directing their mandate to the ECB to use consumer rather than producer prices? But, I’m curious: where is the evidence that politicians directed the ECB to use consumer prices rather than producer prices? Didn’t the ECB come up with this on their own?

    Here’s the “mandate” given to the ECB in the Statute on the System of European Central Banks and the European Central Bank”:

    “In accordance with Article 105(1) of this Treaty, the primary objective of the ESCB shall be to maintain price stability. Without prejudice to the objective of price stability, it shall support the general economic policies in the Community with a view to contributing to the achievement of the objectives of the Community as laid down in Article 2 of this Treaty. The ESCB shall act in accordance with the principle of an open market economy with free competition, favouring an efficient allocation of resources, and in compliance with the principles set out in Article 4 of this Treaty.”

    Price stability (not inflation targeting). That’s it.

    As far as I know, the decision was made by the Governing Council of the ECB (The equivalent of the FOMC) in 1998, not by the politicians establishing the ECB. Again, they enjoy wide company. The same is true of the Federal Reserve Board and, as far as I know, the Bank of England.

  53. Gravatar of RebelEconomist RebelEconomist
    15. July 2012 at 00:02

    To me, the quantity theory PT=MV suggests that the ideal measure of inflation should be a weighted average of all transactions prices, including direct and indirect taxes, wages and asset prices.

    And my point is not entirely theoretical. In the UK, the asset price boom, especially as it affected houses, made it difficult for government to recruit workers in the most expensive areas. This played a part in increasing public sector pay and hence the UK fiscal deficit, which in turn motivated the increases in VAT seen in the UK. So I would argue that rising VAT is part of the inflationary process.

  54. Gravatar of Mike Sax Mike Sax
    15. July 2012 at 04:15

    Rebel

    In saying the rising VAT is part of the inflationary process you mean this was done to mitigate it. Surely we can’t go from there to including VAT taxes as part of inlfation…

    There of course has been a long debate on whether asset prices should be considered with price and wages.

    Have you ever heard of the idea that different income levels have different inflation rates?

  55. Gravatar of ssumner ssumner
    15. July 2012 at 10:06

    Vivian, It seems to me that your last paragraph confirms my point–it was the ECB, not the politicians, that is to blame. Regarding the Fed, it’s a moot point because we don’t have a VAT. I’ve read that the BoE tends to look at inflation net of VAT, but am not an expert. The difference may be a matter of degree. In any case showing other central banks are equally moronic is not much of a defense for the ECB.

    Rebeleconomist, You said;

    To me, the quantity theory PT=MV suggests that the ideal measure of inflation should be a weighted average of all transactions prices, including direct and indirect taxes, wages and asset prices.”

    First of all, an identity like MV=PT has nothing at all to do with the quantity theory, which is a theory, not a identity. Second, that equation has nothing to tell us about policy, as it totally ignores wage and price stickiness, which is the reason we look at transactions involving final goods, not all transitions. If you looked at all transaction, GDP would disappear, as it’s less that one percent of transactions. The other 99% plus are things like futures, forex, etc.

  56. Gravatar of Vivian Darkbloom Vivian Darkbloom
    15. July 2012 at 10:32

    Scott,

    You wrote (originally):

    “I thought to myself; “poor ECB, those moronic politicians gave them the wrong mandate!”

    You now write:

    “Vivian, It seems to me that your last paragraph confirms my point–it was the ECB, not the politicians, that is to blame.”

    So, what, exactly, is your point?

    ” Regarding the Fed, it’s a moot point because we don’t have a VAT.”

    Are you serious? Whether it is a sales tax, a VAT tax, an excise tax, or a Canadian GST is immaterial: the effect of a rise in rates on consumer prices is the same.

  57. Gravatar of RebelEconomist RebelEconomist
    16. July 2012 at 01:18

    Scott, the aim of the monetary authority should be to provide sufficient money to facilitate transactions, making allowance for other uses of money such as demand for a low risk store of value. Why should the monetary authority care whether a transaction represents final demand or whether its price is affected by price stickiness?

    Clearly, you hold a different paradigm from me; in your paradigm, monetary policy is mainly about regulating economic activity. Since it is hard to justify your view in the face of the theoretical and historical evidence (not surprisingly, given that this is how we arrived at the present approach to monetary policy), you resort to ridiculing opposing views. You know there is something wrong when an academic writes a post entitled “…words fail me”.

  58. Gravatar of ssumner ssumner
    16. July 2012 at 10:40

    Vivian, Nice try, but you left out the following sentence where I discovered it wasn’t the politicians, it was the ECB that was to blame:

    “I thought to myself; “poor ECB, those moronic politicians gave them the wrong mandate!” A few comments later I discovered it’s even worse than I thought.”

    When people quote me out of context, you can be sure I’ll notice!

    As far as the VAT, in principle I agree with you, but in practice the US does not have any sales taxes at all that would have a material effect on inflation. So I’ve never even given the issue any thought in the US context. I’m a pragmatist.

    Rebeleconomist,

    “Scott, the aim of the monetary authority should be to provide sufficient money to facilitate transactions, making allowance for other uses of money such as demand for a low risk store of value.”

    I strongly disagree. Even in 1932 there was no shortage of money. People could get money whenever they needed to make a transaction. The problem was that the equilibrium price level had plummeted, causing mass unemployment.

    In your second paragraph you talk about “regulating economic activity” I don’t even know what that means. Real or nominal? As you know, I favor stabilizing a nominal aggregate, not regulating real activity.I prefer to let the market “regulate” real variables, whatever that means.

    As far as YOU accusing me of being rude, given your track record, well, “. . . words fail me.” I treat all commenters with respect, as long as they treat me with respect.

  59. Gravatar of Skepticlawyer » Going for gold: perils of entering the goldzone Skepticlawyer » Going for gold: perils of entering the goldzone
    16. July 2012 at 17:01

    [...] European Central Bank is even currently giving us an object lesson in how stupid a central bank can be. (As Nobel laureate Thomas Sargent says, the euro is [...]

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