Noah Smith on the state of macroeconomics

Noah Smith’s recent post on the state of macroeconomics has gotten a lot of attention.  Paul Krugman criticizes Noah’s claim that the saltwater and freshwater schools of thought aren’t that far apart.  I think Krugman’s right, and I also agree that the freshwater saltwater school is basically correct on the key issue of demand shortfalls.  But while Krugman might seem pessimistic about the state of macro, he’s a Pollyanna compared to me. I see the field of macro as being completely adrift.

Noah Smith asks some very good questions:

So if collegiality and similarity of technique are measures of a field’s health, then macro is doing quite well. But I feel like there’s a larger question: What has macro done for the human race in the last 40 years? How are we better off as a result of all this macro research effort?

(This is the more general version of the question asked by the Queen of England, when she asked why (macro)economists didn’t see the financial crisis coming. Sure, some people argue that “financial crises” are inherently unpredictable because of the EMH. But there’s no obvious reason why recessions shouldn’t be predictable in advance.)

Today, in 2012, do we know much more about the “shocks” that cause recessions than we knew in 1972? I’m not sure we do. The question of whether these shocks are mainly “real” or mainly “monetary” is not settled within the field (as Bob Lucas mentioned in a recent interview). Nor do we seem to know much about how the shocks actually work – usually, macroeconomists just assume the shocks follow a simple random process like an AR(1).

What this means is that the actual cause of recessions is basically still one huge mystery.

What about the question of how the economy responds to the shocks? Even if we don’t know much about the cause(s) of recessions, do we understand how recessions play out? I’m not sure we do. We have some empirical observations, of course – we know how much investment tends to vary with swings in GDP, etc. But in terms of impulse responses - i.e. the way the economy would move if all the noise were cleared out of the data – we have as many different guesses as we have macro theory papers. And macro theory papers are as numberless as the stars in the night sky.

What about the question of policy? Do we know how governments can damp out the swings in the business cycle? Here there seems to be very little agreement. Even if macro isn’t divided into warring camps shouting at each other, there is nevertheless a huge diversity of opinion on both the efficacy and the proper conduct of monetary policy, fiscal policy, and other recession-fighting measures. That there is no consensus means that the question is still unanswered. Useful technology has not been delivered. It doesn’t take an expert to realize that fact. (Update: Well, actually not quite. Constantine Alexandrakis comes up with a couple of important counterexamples; see below.)

So macro has not yet discovered what causes recessions, nor come anywhere close to reaching a consensus on how (or even if) we should fight them.

Actually mainstream macro does know what causes most recessions in big highly diversified economies—-aggregate demand shocks.  And mainstream macro concluded years ago that it was the central bank’s job to steer AD.  And mainstream macro has all sorts of ways of making monetary policy effective at the zero bound.  Indeed all this stuff is taught to our undergraduates in mainstream textbooks like Mishkin’s money text.

The real problem with mainstream macroeconomists is that they are too influenced by “framing effects” and had a giant brain freeze in late 2008.  Virtually the entire profession forgot that the central bank has the ability and responsibility to provide an adequate level of AD.  Only a fringe group of Aspergy-types looked beyond the framing effects, saw the real problem, and saw what needed to be done.  But the profession (freshwater and saltwater) failed us.  The central banks do pretty much what a consensus of elite macroeconomists think they should be doing. The profession “owns” the Great Recession, or at least that portion of it caused by inadequate AD. The profession has had the tools all along, but doesn’t seem to know how or when to use them.  Only 4 years later is it starting to wake up.

Noah continues:

(As an aside, modern macro models – at least, the DSGE variety – are basically not regarded as useful by private industry, although time-series methods developed for macro, such as vector autoregressions, have seen wide application.)

Of course private industry doesn’t use DSGE models, they are useless.  The macroeconomy is incredibly complex; I recall McCallum once listing 10 types of wage/price stickiness.  Most models assume one type.  And most models fail to incorporate AD/AS interaction, as when adverse demand shocks reduce AS by leading policy-makers to extend unemployment insurance from 26 weeks to 99 weeks.  Most don’t know how to identify monetary policy shocks.  The DSGE models are incredibly simplistic.  I basically “retired” from mainstream macro several decades ago when I saw where things were going, and pursued my own research interests.

There are two possible uses for DSGE type models; identify the costs of macro instability, so that central banks can pick the optimal target, and identify the stance of monetary policy most likely to hit the policymaker’s target.  But the DSGE models cannot do either.  The optimal monetary policy stance is most efficiently resolved by targeting market forecasts of the goal variable.  And given the complexity of the macroeconomy, any attempt to use DSGE models to identify the optimal monetary policy goal will depend entirely on what assumptions are built into the model.

All we really know is what Milton Friedman knew, with his partial equilibrium approach. Monetary policy drives nominal variables.  And cyclical fluctuations caused by nominal shocks seem sub-optimal.  Beyond that it’s all conjecture.  The reason NGDPLT caught on recently is that in this recession (and many others I’d add) fluctuations in NGDP seemed to do better than inflation at identifying what most economists saw as suboptimal levels of demand.

Noah continues:

Given this state of affairs, can we conclude that the state of macro is good? Is a field successful as long as its members aren’t divided into warring camps? Or should we require a science to give us actual answers? And if we conclude that a science isn’t giving us actual answers, what do we, the people outside the field, do? Do we demand that the people currently working in the field start producing results pronto, threatening to replace them with people who are currently relegated to the fringe?

Not all fringe groups are created equal.  Replace the establishment with the one fringe group that correctly anticipated where mainstream macro opinion would end up in December 2012 (i.e. NGDPLT, and “target the forecast”), and did so in late 2008 and early 2009.  Replace Ben Bernanke with David Beckworth.

PS.  My nightmare scenario is nicely described by a recently commenter named John Brown:

I am an 18 year old college student with a strong interest in economics. With regret, I have to say that, based on what I’ve seen, you are totally correct in your assessment of our generation.

When I talk to other people in my age group about economics, there seem to be two groups. One group sees easy money as the root of all economic problems. These are the Ron Paul supporters who talk about gold all the time. They read Mises on a regular basis and constantly use the world “fallacy” (usually accompanied with something about a broken window).

The other group reads Krugman on a daily basis. In their view, the ultimate problem with our economy is that the government isn’t running large enough deficits and that underregulation of the banking industry was the only major cause of the financial troubles in 2008. On top of this, this group scoffs at the thought that high marginal tax rates, overregulation, and even trade protectionism have any negative effect on long term GDP. According to them, the large tax/transfer systems and tightly regulated labor markets had nothing to do with the relative decline of GDP in Western Europe.

There are very few, if you will, centre-right or centre-left economists. I would consider myself centre to centre-right, all things considered. I am a staunch believer in free trade and free markets, but I also support NGDP targeting. Like you, Mr. Sumner, I am of the view that we should have the fed boost AD while we continue to partake in pro growth, neoliberal reforms in the rest of our economy.

Unfortunately, if nothing changes, I would predict we will have a generation of economic policy managed by goldbugs who want to abolish the fed (or peg it to gold) and hard left statists who think 90% tax rates are good and free trade is bad.

But perhaps I should be optimistic that there are people like Brown and Soltas and Wang coming along.


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134 Responses to “Noah Smith on the state of macroeconomics”

  1. Gravatar of flow5 flow5
    21. December 2012 at 13:41

    In Dec 2007 we irrevocably knew that liquidity had to be injected into the commercial banking system before the fall of 2008. It was obvious: unless money flows expanded at least at the rate goods & services were offered, output couldn’t be sold & hence the work force will be cut back.

  2. Gravatar of marcus nunes marcus nunes
    21. December 2012 at 13:46

    Scott
    I hope there are several other Josh´s around…
    Over the last several years I´ve noticed that the best and brightest have run away from Macro as the “devil from the cross”. No wander. It´s become a boring field, locked-up in the DSGE straightjackect. The papers are all the same, differing only in the particular “friction” the authors introduce into the model. The real world “be damned”!

  3. Gravatar of flow5 flow5
    21. December 2012 at 13:49

    Inflation is represented by “actual” prices in the marketplace. The “administered” prices would not be the “asked” prices, were they not “validated” by M*Vt, i.e., “validated” by the world’s Central Banks

  4. Gravatar of Suvy Suvy
    21. December 2012 at 14:01

    On the issue of DSGE models, I agree 100%. They are completely and utterly useless. I think a better way is to model the economy as a dynamic system that constantly fluctuates in a cyclical way. I don’t understand how massive use of Fourier transforms aren’t massively used in economics. I really think the models need to be used in historical time to try and understand some of those cyclical fluctuations. It still baffles me how people look at economic time series without once seriously considering taking something from the time domain to the frequency domain.

    I also think that modeling the economy as in equilibrium with the exception of external shocks is rather absurd. The economy is in a constant state of fluctuation all the time. This was really the essence of Keynes’s work which always gets overlooked. The economic models used must be in historical time where the economy is dynamically moving through. I know a lot of people on this blog don’t like Steve Keen(I don’t share that same feeling), but the kind of modeling that he uses certainly makes the most sense. Same way with the way he uses the modeling to understand the qualitative behavior of the system.

    Also, using mathematical models to predict what/where the macroeconomy will be at a certain time from now is a pipedream and will lead to failure across the board. We cannot predict the future and will never be able to. This idea of trying to use long-term forecasts in policy will lead to disastrous failure (especially when dealing with long-term forecasts). I don’t care what math you use and how sophisticated it is, complicated math cannot replace what we do not know. Complicated math cannot predict the future, nothing can.

  5. Gravatar of Major_Freedom Major_Freedom
    21. December 2012 at 14:02

    John Brown has unfortunately been brainwashed into thinking he is not on the same extreme side as the Krugmanites when it comes to socialist money production.

    Staunch believers in free markets include free market in money.

    Saying “I think people should be free to produce their own food, clothing, shelter, vehicles, education, electronics, books, furniture, energy, textiles, eyeglasses and paper clips, but money…MONEY?….death to free markets!!!

  6. Gravatar of Andy Harless Andy Harless
    21. December 2012 at 14:05

    I think that’s a typo in the first paragraph. You agree that the saltwater school is basically correct on the subject of demand shortfalls.

  7. Gravatar of W. Peden W. Peden
    21. December 2012 at 14:10

    War tends to extremes. Economic crises tend to extreme theories.

    That said, there were certain things bubbling under the surface long before even within mainstream macro: Woodford (2001?) constructed a model which basically took money out of macro altogether, and it’s not surprising that central bankers in 2008 forgot about the supply and demand for money. At that time, the Bank of England was operating with a model of the economy in which (as they took pride in noting in the paper outlining the model) “We have been able to describe the monetary policy process without mentioning the quantity of money at all”.

    We’re undergoing a milder version of the 1910-1940 cycle in macroeconomics: Fisher outlined a theory of the macroeconomy which was surprisingly close to Mankiw’s (1990) summary of the monetarist-Keynesian truce, with exogenous money, sticky prices, long-run money neutrality, and short-run money non-neutrality.

    Then macroeconomics got fat, lazy and distracted by things like the stock market bubble & crash, such that FDR had to turn to an agricultural economist to get any good advice in the 1930s. Austrian economics and Keynesianism stepped into the gap. Keynesianism kept and monopolised the gap, for various reasons. One reason- that the Keynesian message is a fundamentally pleasing one to politicians and the public- is still present today.

    That means that we face the possibility that we’re in for a revival of hardline 1940s-style Keynesianism. Secular stagnation. Euthanasia of the rentier. Maybe an ascendency of Cambridge-style micro- think Sraffa, Robinson and old school development economics. In short, a living hell of economic theory. It took about 20 years from Patinkin and Friedman to the 1976 Nobel Prize drive the demons back below ground last time; it might take longer this time.

    The optimistic perspective is (a) many of the mistakes of the 40 years from the GT have been made, so we SHOULD be able to learn from them e.g. that it’s the rate of change in the inflation rate that correlates with the level unemployment and even then only in the short-run, and (b) while terrible, this recent crisis has been nothing like as severe as the Great Depression, and in many ways compares favourably with the stagflation/disinflation of the 1970s and 1980s.

    If we’re really lucky, many of the insights of the Austrian School regarding malinvestment, moral hazard, and the cognitive challenges of policymaking will be incorporated into mainstream economics over the next few decades.

  8. Gravatar of Catherine Catherine
    21. December 2012 at 14:14

    Well….all I can say is that I recently commented on a terrific scholarship essay that was all about the Fed having failed to generate enough inflation to end the recession.

    The essay did not raise the issue of NGDP-targeting, but it was entirely consistent with NGDP-targeting. I happen to know this student’s politics, too: libertarian-slash-conservative. He’s not reading Mises, and he is certainly not talking gold. He’s talking shortfall in inflation.

    Actually, the fact that he did **not** mention NGDP-targeting intrigued me. He knows about NGDP-targeting, because I’m friendly with his mom and I’d sent her materials on the subject. (I proselytize for NGDP-targeting whenever I see an opening.) She had mentioned that her son was skeptical; at one point, as I recall, she said her son had brought up Friedman’s role in fighting inflation.

    Yet when it came time to write his essay, he focused entirely on inflation: on the idea that increasing inflation is the standard way a central bank gets an economy out of a recession. His word choice implied that raising inflation in response to a recession is consensus policy!

    (I strongly advised him to either soften that wording or come up with a list of macroeconomists who have actually said, repeatedly and out loud, that increasing inflation is the standard way of generating recoveries.)

    My point is: this is a very bright college senior (in the gifted category), his politics are right of center, and he seems to have essentially zero ‘prejudice’ against inflation. He came up with a thesis statement about inflation that was his own, as opposed to ‘signing on’ for the already-developed position of NGDP-targeting.

    He looked up the data on Japan, too, and cited their inflation rate over the past 20 years.

    I have no way of judging how typical or atypical this student might be …. BUT I do teach college freshmen myself, and I always have the perception that NGDP-targeting is a ‘natural’ for that age group. I don’t know why I think that, but I do.

    It was a terrific essay — amazing. I am ***so*** hoping he gets the scholarship.

  9. Gravatar of W. Peden W. Peden
    21. December 2012 at 14:26

    Suvy,

    “I also think that modeling the economy as in equilibrium with the exception of external shocks is rather absurd. The economy is in a constant state of fluctuation all the time.”

    If you were modelling the movements a bowling pin which was continually getting knocked from side-to-side by external factors such that it was never still, then would it be absurd to model its movements in terms of different equilibrium conditions?

    Now, one might argue that market price systems don’t tend towards any sort of equilibrium, and that the shocks are internal to the system rather than external, but that is a logically separate issue from whether economies are constantly fluctuating or not.

    Going back to the bowling pin: we don’t want to ignore its equilibrium conditions, but we also don’t want to ignore the processes of its movements from one equilibrium path to another. Similarly, I see macroeconomics as facing a path between being swallowed up by the analysis equilibria and being swallowed up by the analysis of adjustment processes. So, for example, one wants to bear natural rates in mind, but also sticky wages, real balance adjustments, Kirznerian entrepreneurship, monopolistic competition etc.

  10. Gravatar of ssumner ssumner
    21. December 2012 at 14:36

    Andy, Thanks, that was a typo. Second time I’ve done that.

    w. Peden, Those are good observations.

    Catherine. That story makes me hopeful.

  11. Gravatar of Rien Huizer Rien Huizer
    21. December 2012 at 14:37

    Scott,

    Sad as it may be but you are probably right here. And maybe macro is far too ambitious. There are two ways in which macro (and models) is useful:
    - macro provides politicians with pseudo-scientific discourses that have instrumental value for them. Fall guy-type things.
    - DSGE models: Central banks need formal models to justify decision making. Just acting on whims or using simple doctrines like NGDPLT is probably to skinny to earn the respect of the various audiences. And as you say, those models are both simplistic (but entertaining) and sensitive to assumptions (as is all of economics, it is inherently axiomatic)

    So there is no need to be gloomy about the employment prospects of your students as long as they understand the limitations of the discipline

  12. Gravatar of Catherine Catherine
    21. December 2012 at 14:59

    a very bright college senior

    Sorry – correction – the student whose paper I described above is a HIGH SCHOOL senior.

    He is a gifted high school senior with libertarian-right politics whose scholarship essay argues that the Fed failed to generate enough inflation to produce a robust recovery.

    He came up with this argument on his own, with access to the NGDP-targeting materials I had sent his mom.

  13. Gravatar of flow5 flow5
    21. December 2012 at 15:10

    “We cannot predict the future and will never be able to”

    I guess you didn’t buy IBM calls in Oct? There’s no ambiguity in forecasts (for up to one year) & never has been. The economy peaks 1st qtr 2013. Fed needs to step up POMO’s (from the non-bank public) beginning in May. The “desk” needs to accelerate purchases in July & August. Buy commodity ETFs in August (bottom for price indices).

  14. Gravatar of W. Peden W. Peden
    21. December 2012 at 15:13

    * And the bowling pin’s movements towards its equilibrium path, of course, e.g. price controls close-off many routes to equilibrium.

  15. Gravatar of Joe Hazell Joe Hazell
    21. December 2012 at 16:24

    Hi Scott,

    I’m a freshman economics major at a UK university. I disagree with John Brown’s assessment of our generation, but think of myself as a centrist in much the same way he does. I feel far more positive about a converging consensus on market monetarist macro.

    The current monetary policy debates have had a positive effect on my generation precisely because they illustrate the insufficiency of naïve reductionism in many mainstream macro policy debates. This has not alienated, but attracted me to macro because it has generated such diverse and energetic debate in the blogosphere, and shown the flaws in hard left and hard right thinking. Through reading market monetarist blogs, but also Cochrane, Krugman, Williamson, DeLong, Wren-Lewis etc. I’ve developed from the kind of naïve Krugmanite who John describes into someone who more or less agrees with him.

    Moreover, I am definitely not alone among economics majors and other interested students at my university in reacting this way, and therefore having constructive debate on fiscal and monetary policy. The historical parallels make me pretty optimistic – the 50s-70s were the neo-Keynesian generation, and the 80s onwards were new Keynesian/new Classical precisely because of the economic disturbances that began each era. The Great Recession has given my generation a converging consensus on market monetarist ideas.

    If modern macro is broken, we want to fix it, not shun it. And the debates of the last five years show us that market monetarist ideas are how to do so.

  16. Gravatar of flow5 flow5
    21. December 2012 at 16:34

    The decline in the rate-of-change (roc) in the long-term proxy for inflation (M*Vt) is dramatic in the last half of 2013. I don’t know the magnitude as it was partially the result of depositor’s shifts from savings/investment type accounts (interest-bearing without reserve requirements), into transaction type deposit classifications (largely non-interest-bearing & reservable). These shifts were precipitated by the FDIC’s expanded insurance coverage.

  17. Gravatar of Bill Ellis Bill Ellis
    21. December 2012 at 17:35

    This has been fun to watch.

    Noah has done what I did not think could be done. He united economists… Too bad it was against him.

    I almost always agree with Noah, but I think he is wrong on this in particular and his Macro is Myth bent in general.

    His criticisms of the validity Macro could be just as fairly leveled at all of the social sciences. No one ever claimed the Social Sciences were hard science. But they are useful.

  18. Gravatar of Steve Roth Steve Roth
    21. December 2012 at 17:54

    “The other group reads Krugman on a daily basis … hard left statists who think … free trade is bad”

    Yeah, that’s Krugman all right. What does he know about trade, anyway? Stalin here we come.

  19. Gravatar of mnop mnop
    21. December 2012 at 18:02

    Yikes, false equivalency alert!

    1)
    “hard left statists who think 90% tax rates are good”. Are there ANY mainstream leftist economists left who think this? For good or ill, our politics have shifted far to the right. Perhaps somewhere, up in the Andes mountains, there are some Shining Path Marxist leftovers who still “think 90% tax rates are good” but in the real world we’re talking about increasing Mitt Romney’s effective tax rate of 14% (or was it less?).

    2)
    “this group scoffs at the thought that high marginal tax rates, overregulation, and even trade protectionism have any negative effect on long term GDP.”

    Well again, who are these mysterious leftist economists who think this? On the left, a major narrative has emerged of the “Predator State”, echoing the tea party’s complaints of regulation that only serves to enrich crony capitalists… hence Occupy Wall Street.

  20. Gravatar of Jonathan M.F. Catalán Jonathan M.F. Catalán
    21. December 2012 at 18:04

    Work off what Steve rights above, the “problem” is clearly that Brown is an 18 year old undergraduate, surrounded by other undergraduates, most of which have only recently begun their foray into economic theory. It shouldn’t be surprising that they’re unfamiliar with what’s out there.

  21. Gravatar of ssumner ssumner
    21. December 2012 at 18:37

    Thanks Joe, It’s very gratifying to get that sort of comment.

  22. Gravatar of W. Peden W. Peden
    21. December 2012 at 18:51

    mnop,

    Presumably, “90% tax rate” means the top nominal tax rate. Here’s Paul Krugman-

    ” Needless to say, it wasn’t really innocent. But the ’50s — the Twinkie Era — do offer lessons that remain relevant in the 21st century. Above all, the success of the postwar American economy demonstrates that, contrary to today’s conservative orthodoxy, you can have prosperity without demeaning workers and coddling the rich.

    Consider the question of tax rates on the wealthy. The modern American right, and much of the alleged center, is obsessed with the notion that low tax rates at the top are essential to growth. Remember that Erskine Bowles and Alan Simpson, charged with producing a plan to curb deficits, nonetheless somehow ended up listing “lower tax rates” as a “guiding principle.”

    Yet in the 1950s incomes in the top bracket faced a marginal tax rate of 91, that’s right, 91 percent, while taxes on corporate profits were twice as large, relative to national income, as in recent years. The best estimates suggest that circa 1960 the top 0.01 percent of Americans paid an effective federal tax rate of more than 70 percent, twice what they pay today.

    Along the way, however, we’ve forgotten something important — namely, that economic justice and economic growth aren’t incompatible. America in the 1950s made the rich pay their fair share; it gave workers the power to bargain for decent wages and benefits; yet contrary to right-wing propaganda then and now, it prospered. And we can do that again.”

    http://www.nytimes.com/2012/11/19/opinion/krugman-the-twinkie-manifesto.html?_r=0

    Now, it’s true that Paul Krugman can’t say whether he’d like his morning tea white or black without ambiguity (“White tea is compatible with my happiness, and black tea can’t work in its conventional way in the morning”) but let’s make some charitable interpretations of what Krugman is saying in that article-

    1. 1950s top tax rates reduce deficits.

    2. 1950s top tax rates are compatible with a prosperous economy.

    3. Therefore, we should raise income taxes up to 1950s style levels, i.e. at or above about… 90%.

    Is Paul Krugman wildly unrepresentative of left-wing opinion these days?

    “Well again, who are these mysterious leftist economists who think this?”

    Leaving aside ‘overregulation’ (an irregular noun: regulations I support are a vital framework of rules, regulations you support are excessive regulations, and regulations my opponents support are crushing overregulation) Ha Joon Chang has a post in economics at the best university in the world and is one of few economists who has a book I’ve seen in a normal bookshop recently-

    http://en.wikipedia.org/wiki/Ha_Joon_Chang

    Along with Peter Schiff, Ha Joon Chang is the kind of economist who is appealing in a crisis. And today’s Paul Krugman is not the hard-headed liberal of times past. It’s by no means just a left-wing problem either: many once sublime economists on the right, like Thomas Sowell, beat Krugman onto the “Enough talking and interpreting, more insulting and caricaturing” bandwagon by about 10 years.

    It can’t all be put down to the crisis (I think that the ideological bases of the mainstream right and the mainstream left are both fundamentally different in the US from what they were in the 1950s) but the crisis doesn’t help.

    Furthermore, is it the case that the standard Occupy Wallstreet call is that the system of regulation is that of objecting to a predatory state, or predatory bankers enabled by an absentee state? If the latter, then what one has is more of a reflection, not an echo, and in reflections everything is similar but the other way around…

  23. Gravatar of Greg Ransom Greg Ransom
    21. December 2012 at 20:20

    Why not replace the sterile old bulls of macroeconomics with the macroeconomists who actually anticipated what happened and explained how to avoid it and ameliorate it, ie the Hayekians?

    Put William White & his research team at the BIS in charge of an 10 Ten Graduate program and see what develops. A bit of scientific diversity is just what the good Doctor Thomas Kuhn calls for in a time of Scientific Crisis.

    In facts, many of the top sterile old bulls are trying to bring their dead science back to life reworking their old “tools” to create Hayekian Effects, eg as Woodford and Williamson are working to do in the domain of finance and non-neutral money.

    A hobby-horse policy dogma — NGDP targeting — is not a sound, comprehensive scientific causal explanatory explanatory strategy and mechanism.

    Its a policy that falls out as a footnote of Hayekian macroeconomics in any case, as you find in Hayek’s interviews and popular writings.

  24. Gravatar of Charlie Charlie
    21. December 2012 at 22:09

    According to the Ideas Ranking of Monetary economists, the top three are:

    1. Ben Bernanke
    2. Lars Svennson
    3. Michael Woodford

    Putting aside Bernanke, whose personal views are unknown (and you are more charitable to them than me) and the other two, Svennson and Woodford have been very good on this crisis. Woodford came around to NGDPLT later, but came out in the FT for Inflation level targeting very early. And of course, Svensson is a big champion of targeting the forecast.

    Obviously, you know all this, and have been trumpeting their work, but this is a list of who the profession values through publications and citations. The experts in the profession have been pretty good. To me, the problem may be that we aren’t asking the right experts. Maybe Peter Diamond’s nobel quality work really is so specialized that he can be terrible on monetary matters. Maybe “monetary economists” more generally have been much better than economists.

    Here is the list:

    http://ideas.repec.org/top/top.mon.html#authors

    Mishkin is number 6. Taylor at 7 stands out as a top ranked monetary economist that I know has been terrible on the crisis. And Bennett McCallum comes in at number 8, so maybe market monetarism isn’t quite that fringe after all.

    [Obviously the ranking methodology isn't perfect, but I think it is interesting nonetheless.]

  25. Gravatar of John Brown John Brown
    21. December 2012 at 23:48

    Mr Sumner, Thank you for posting my comment.

    Joe Hazell, I should of course caution that my view on this is based on personal experience. Perhaps my experience is unrepresentative of upcoming economic policymakers as a whole. I certainly hope that is the case.

    Also, I noticed a number of commenters took issue with my characterization of the left in economic discourse. I think these commenters are being too easy on the left. For instance, many took issue with my assertion that Krugman’s readers may support 90% tax rates (I should have specified that I meant a 90% top marginal tax rate). However, it was Krugman who said this in April:

    “Oh, and Hollande is clearly a crazy person for actually calling for tax rates on top incomes that are around as high as leading public finance experts calculate they should be.”

    (http://krugman.blogs.nytimes.com/2012/04/21/a-note-on-the-french-election/)

    Of course, Hollande was calling for a 75% top tax rate. According to Krugman (who is basing this assertion on Diamond and Saez), this is around the optimal top tax rate.

    Now, as far as trade goes, I would never say that top left wing economists are coming out in favor of traditional protectionism. However, and this is just my experience, many of the young people studying economics (who are on the left) have begun embracing certain types of protectionism (in the name of economic or environmental “justice” oftentimes) and luddite type views of technology and employment. I also think it is fair to say that many of the leading economists on the left are far too apologetic for these types of views.

    Again, this is just my experience and my view on the matter.

  26. Gravatar of Integral Integral
    22. December 2012 at 00:54

    “And most models fail to incorporate AD/AS interaction, as when adverse demand shocks reduce AS by leading policy-makers to extend unemployment insurance from 26 weeks to 99 weeks.”

    This seems very wrong to me, so much so that it sticks out as an indication that you aren’t closely reading the models. One major point of a first-year course in business cycle theory is to get students to think in general equilibrium, where shocks affect multiple curves simultaneously. The basic, three-equation New Keynesian model is full of AD/AS interaction, particularly LRAS and AD interaction.

    I take issue with many of the other opinions in your post, but they are too long to fit in a comment section. Maybe it’s time to start my own blog.

  27. Gravatar of Saturos Saturos
    22. December 2012 at 03:10

    The problem of excess money demand (never off topic): http://finance.yahoo.com/blogs/breakout/cash-king-printing-100-bills-soars-132438479.html

  28. Gravatar of RebelEconomist RebelEconomist
    22. December 2012 at 03:21

    “mainstream macro concluded years ago that it was the central bank’s job to steer AD”

    That would not be my view, and if it is true, it was not my impression working inside a central bank from the 1980s, which was careful to avoid raising any expectations regarding its ability to steer AD. Inflation was key, and AD was simply a step in the transmission mechanism.

    I came across a survey yesterday that I found striking, here: http://www.centralbanking.com/ (about halfway down the page on the right). When you vote, you get told the results to date, and I was surprised to see how strong the consensus is among the presumably more rank-and-file central bankers and associates who look at such websites in favour of keeping inflation targets. It seems that the recent consideration of NGDPLT by central bankers is coming more the senior level (who of course have to deal with politicians) than from the grass roots.

    But the bigger objection I have to this statement is that it distracts attention from the many other ways of steering AD, many of which are far more appropriate than using the largely short-run influence of monetary policy on real activity. No doubt politicians in the UK and Japan are loving the heat being turned on the central banks, because it saves them from having to tackle unpopular structural reform.

    I think some of the comments here show how easy it is to drift into this way of thinking – the comments on “tax rate” neglect to mention that they refer to income. To me, it seems obvious that a sensible way to boost AD would be to cut taxes like income taxes that drag on AD, and increase taxes on things which drag less on AD, like taxes on wealth, especially land wealth. I would urge the welcome young commenters here to consider whether they are not being diverted from such options by the stock and real estate owning middle-agers who tend to lead the economic debate (I know Scott hates such questioning of his own motives, so let me say that it is not that I believe that there is a middle-agers’ conspiracy going on here; it is just that they tend to be preoccupied with what matters to them. Despite being busy, Scott will probably write a new post rather than allow this discussion to progress too far!)

  29. Gravatar of Jaap de Vries Jaap de Vries
    22. December 2012 at 04:56

    Hi there Scott,

    I am a student too, in the Netherlands and like to add a few things. Many students here in the Netherlands in the field of economics don’t have an idea how the central bank operates in a practical sense. During macro courses a lot of different models are discussed but this is highly theoretical in nature. When I did a research paper about electoral cycles in the FED there were a lot of students how didn’t exactly know what the job of the central bank is and how it operates. If you want this generation to understand the great importance of monetary policy it should be clear what the central bank is supposed to do. Every single time I try to explain a non-economist how the central bank should operate they refer to loose monetary policy causing inflation blabla Germany 1930. In my view we should make clear what the job of the central bank is, beside the technical models which policy is based on. I do not know very much about the technical part of NGDP targeting but I have learned what mechanisms are important. AD discussions, expectations management by the central bank. These concepts are not particular hard to grasp, especially if you read this blog.

    As John stated I started the same way. I was a Krugman believer at first, recognizing the AD problem we were/are facing. I believed the lower bound could only be faced by stimulative fiscal policy. Besides the fact that Krugman got way too political his blogposts are a lot worse than they used to be. Then I stepped into this blog and it has changed my view about the lower bound. I’ve send your blog about banning the word inflation to a dozen people and I enjoy reading this blog very much and it has changed my macro view in a very positive way.

    What I sometimes think about is what would have happened if I read a conservative hard money style blog. Would I have noticed that the framework is incorrect? I don’t know.

    Lastly I can say that the ground of market monetarists is winning ground. I will be interning at a big asset manager and from their macro-view pieces, in particular the head economist, endorses a NGDP target and I see him argueing in exactly the same way as you. Promoting more AD, giving better guidance etc.

    As I am politically active I’m wondering how I can promote these ideas to the common public. Especially in Europe we need to move away from price stability. If you have any ideas on this let me know.

    Kind regards.

  30. Gravatar of Saturos Saturos
    22. December 2012 at 06:47

    Rebel, how did the central banks think they could control inflation precisely via AD, if they didn’t think they could control AD? And of course the effects of monetary policy (and AD) on real variables is temporary; that doesn’t mean that the effect of monetary policy on AD is temporary…

    Yes, I think Scott was being a little tongue-in-cheek suggesting that “mainstream macro opinion” has now centred on NGDPLT. But it’s getting there.

  31. Gravatar of Negation of Ideology Negation of Ideology
    22. December 2012 at 06:47

    Fantastic comment by John Brown. I have found similar opinions among non-economists. However, I’m more optimistic about economists – particularly those specializing in monetary economics (like the people on the list Charlie linked to.)

    A while back I posted a survey of top economists about the gold standard and it was unanimous that it was a bad idea. The comments were appropriately mocking, like “Why not a 1983 Berdeaux”. No one takes “Austrian Economics” seriously – it’s not a school of economics from a University in Austria. It’s a handful of people on the internet who worship gold and think all paper money and banking is a secret conspiracy by a minority religion to control the world. They are nuts.

    As for the left, they are far more reasonable. Krugman is for free trade and at least open to NGDP targeting. It seems to me the major difference is how high top marginal rates can or should go, how much regulation people need to be protected from themselves, and whether fiscal stimulus is necessary at the zero bound. I’m on the center-right myself – have the Fed target NGDP, use government spending for national needs rather than for stimulus, run surpluses in good years so the debt gradually declines, simple mildly progressive consumption taxes, etc. But I don’t consider the left, particularly those who are economists to be bonkers.

  32. Gravatar of Saturos Saturos
    22. December 2012 at 06:47

    if they didn’t think they could precisely control AD.

  33. Gravatar of Saturos Saturos
    22. December 2012 at 06:49

    Krugman is for free-trade, except during recessions. And the regulation popular on the left goes beyond protecting people from themselves.

  34. Gravatar of Negation of Ideology Negation of Ideology
    22. December 2012 at 07:08

    Saturos -

    I’ll take your word that Krugman makes an exception on free trade for recessions because I’ve found your comments to be accurate – I was not aware of that. And I have other problems with Krugman – his recent post seeming to bash automation was almost as bad as his call for a space alien invasion (he said it was tongue-in-cheek in his book). Also, I find his partisanship grating.

  35. Gravatar of RebelEconomist RebelEconomist
    22. December 2012 at 07:15

    Nice to read a comment from the Netherlands, Jaap, even if I do not agree with your opinion – I would say that price stability has served Germany, and hence the Netherlands, rather well.

    Actually, after a career in central banking market operations, I did try to teach the practicalities of money and central banking (even including topics like repo operations, interest on reserves etc) in a course on monetary economics as a (UK top-tennish) university lecturer a few years ago, and it was not a great success. I had comments back like “irrelevant”, because at the time, the narrative in the world that most of them wanted to join – either financial industry economics or research – was largely model based, and the students presumably feared that they were slipping behind their competitors from other universities in a technical arms race. I eventually quit the job, because my collegues did not seem to value my experience either – their view was that this was not a substitute for the research papers I might have been doing during my formative years.

    Since my last point, of my last lecture drawing the course together, was to predict an impending financial crisis, I often wonder if any of the students subsequently revisited my lecture notes!

  36. Gravatar of Saturos Saturos
    22. December 2012 at 07:19

    OK its official: Paul Krugman is Ebenezer Scrooge: http://krugman.blogs.nytimes.com/2012/12/22/sitcom-kabuki-trivial/

    I don’t understand why people still read that blog, he’s just a bitter and delusional old man. Noah Smith has some good rebuttals on Twitter.

  37. Gravatar of Becky Hargrove Becky Hargrove
    22. December 2012 at 07:26

    Scott, one of the biggest issues for me is a confused definition of supply side possibilities, for they represent areas which in reality are quite different from one another. Interesting that my blind spot is in areas of taxation whereas yours seems to be in structural and local possibilities as they relate to an overall or general equilibrium. The point I want to make: Should we be designating these realms under different terminologies instead of lumping them together? Most people immediately think of taxation when they think of supply side, which tends to create a certain response, pro or con, whereas the supply side that seems to need a new name is more subtle. Is is fair to say, for instance, that the idea of structural change belongs to either one realm or the other? Also, would you agree that expectations as to AD also depend on what actually happens in either of these areas? Maybe this does not get enough attention because of the micro aspects of local activity, but somehow those connections need to be made because they affect overall expectations of what the Fed can do. There seems to be plenty of room for micro and macro as combined elements of an AS/AD model.

  38. Gravatar of RebelEconomist RebelEconomist
    22. December 2012 at 07:47

    I may not be entirely sure what you are getting at Saturos, but let me try to answer. Say, for the sake of argument that the CB is pursuing zero inflation. In that case, if monetary policy has only temporary effects on real variables, is it not true to say that it only has a temporary effect on AD too? Thinking along these lines, central banks wanted to avoid the public getting the idea that their central bank was responsible for, say, unemployment, except for the contribution to employment from predictably stable money.

    Actually central banks do not need to control AD “precisely” to manage inflation. Their economic model tells them what to expect, but the better pre-crisis central banks in my opinion like the Buba or the SNB would use many indicators to judge what to do. While I think the analogy is a bit over-used, it is like driving a car, when you do not know the torque you are applying to the wheels, but you judge how hard to press the accelerator from your speed. The advantage that the Buba and SNB had was that they had the public support to do what they saw fit, and it worked.

  39. Gravatar of RebelEconomist RebelEconomist
    22. December 2012 at 07:50

    By the way Jaap, you might find this old blog post of mine, which draws from the lectures I mentioned, interesting: http://reservedplace.blogspot.co.uk/2009/04/easing-understanding.html

  40. Gravatar of ssumner ssumner
    22. December 2012 at 07:57

    Charlie,

    Bernanke has called policy “extraordinarily accommodative.”

    Svensson has praised Fed policy.

    Mishkin has walked away from the views in his textbook.

    Taylor has argued policy is too easy, and McCallum hasn’t advocated monetary stimulus (as far as I know.)

    Having said all that, I do agree that the individuals named are far better than the average monetary economist. Which is part of the problem.

    Integral, I’ll take your word for it, but I’ve never once seen that sort of interaction in a macro model, nor have I ever seen it discussed by any other macroeconomist. Instead I see them scratching their heads trying to figure out why inflation has not fallen as sharply as they think their models imply it should (given the high unemployment.)

    If you are right, then it’s clear that the leading macroeconomists on both the left and the right don’t understand their own models. How often have you read a leading conservative economist ask “why are wages still sticky after 4 years?” Do they understand the interaction between AS and AD?

    Saturos, Yes I saw that—it’s all about the Benjamins.

    Rebeleconomist, If a central bank targets inflation, then ipso facto it regards inflation as the best indicator of whether AD is on target. So I don’t understand your point. You talk as if central banks believe they should target inflation, and leave AD up to fiscal policymakers. That would obviously be insane, so I don’t quite understand what your point is.

    As for cutting off debate, aren’t you confusing me with those other famous bloggers?

    And as for financial interests, I’ve done very well the last few years with policies that I strongly oppose. I have a steady tenured job, and my investments do very well in a world of ultra-low real interest rates. Most economists with similar financial conditions strongly oppose my views. Pointing to “self-interest” won’t get you very far–it doesn’t make up for weak arguments on your part.

    Jaap, Thanks for those comments. I don’t have any great ideas for promoting these views (other than what I already do.) Perhaps some other commenters can offer advice.

    Negation, Good comment, although I don’t think Krugman is at all typical of the left. Stiglitz’s views on monetary policy are far more typical of the left. Krugman’s actually pretty mainstream on monetary issues.

    Rebeleconomist, I do symptathize with your plight as an academic–the obsession with “models” has become a sort of mental illness. (And I do think models have a role to play, but the profession has gone way overboard. Narrative approaches to monetary policy are more useful–examples include Friedman and Schwartz and Romer and Romer.)

  41. Gravatar of ssumner ssumner
    22. December 2012 at 08:00

    Rebeleconomist:

    “In that case, if monetary policy has only temporary effects on real variables, is it not true to say that it only has a temporary effect on AD too?”

    You are confusing AD with output. AD can and does rise almost endlessly, but most of the increase shows up in higher prices, not higher output.

  42. Gravatar of Suvy Suvy
    22. December 2012 at 08:24

    W. Peden,

    “Now, one might argue that market price systems don’t tend towards any sort of equilibrium, and that the shocks are internal to the system rather than external, but that is a logically separate issue from whether economies are constantly fluctuating or not.”

    That’s precisely the point I was making. We have understand equilibrium for what it is. Equilibrium is a special case; equilibrium is itself a transitory case. I never said equilibrium is not important, but the economy is something that follows a cyclical behavior. An economy is cyclical, which consists of cyclical changes in production, cyclical changes in capital formation, etc etc. We need to start modeling the economy as something that is cyclical. This is one of the reasons why I don’t understand how people don’t break an economic time series into into the frequency domain. I haven’t seen this in many economic papers and it really bugs me.

  43. Gravatar of RebelEconomist RebelEconomist
    22. December 2012 at 08:34

    “You talk as if central banks believe they should target inflation, and leave AD up to fiscal policymakers”. Yes.

    As I have said in the past, Scott, I am weak on fiscal policy, but my thinking is like this. Let’s say that the government is able to boost real output for no increase in inputs simply by reducing income tax and raising land tax – a live issue in the UK. That allows AD to turn out higher than the CB might have expected, but the CB is happy to accommodate the resulting additional transactions demand for base money to keep inflation on track. These are the type of system-efficiency-based AD increases you really want, but if the politicians are able to shift responsibility for AD to the central bank, they can avoid the political cost which is often associated with such reform.

    This is I believe the contribution that the Buba made to Germany’s economic success. The government and business knew that it was pointless to look to the Buba to, say, reduce unemployment, so they diverted their energy into improving the working of their economy, such as by better labour relations.

    Thanks for your sympathy, Scott. I might have another go if the atmosphere in academia ever changes.

  44. Gravatar of jknarr jknarr
    22. December 2012 at 08:35

    Those the gods would wish to destroy, they first make mad.

    There is a clear and present bias in the profession toward Keynes fiscal policy. All the best Econ jobs are in banks and government – saltwater professions. As a result, this (self-interested) keynes position is relentlessly the establishment position. The cash corrupts the profession. Investments are moot – not the point.

    Being empirically correct does not get a ticket into this magic charmed circle. Austrians have been more accurate of late, and have been continually shunned. This makes them crazy/mad, with long rants. this alienates those with otherwise open minds. Advice to Austrians: keep it short, smart, and pithy, highlighting the failures of Keynes. Nobody is convinced by long rants with strange-sounding names.

    Krugman appears mainstream, althought he is a profoundly dishonest writer. He’s nothing but Keynes hammer searching for any and all statist nails. Mainstream is as mainstream is marketed. Give anyone unlimited NYT space and they will direct the mainstream. Nobody doubts his talent at marketing the power of the state. He also wishes to make people mad.

  45. Gravatar of Suvy Suvy
    22. December 2012 at 08:57

    jknarr,

    “keep it short, smart, and pithy, highlighting the failures of Keynes.”

    Most of the “failures of Keynes” that we see are usually a gross misinterpretation of Keynes by these New Keynesians. These mainstream “Keynesians” aren’t really Keynesians in my book. They are people that take bits and pieced of The General Theory while completely ignoring his other works (especially his works on uncertainty, like his other work The Economic Consequences of the Peace and his A Treatise on Probability). I would definitely put Krugman into this camp.

  46. Gravatar of RebelEconomist RebelEconomist
    22. December 2012 at 09:01

    Suvy: “I don’t understand how people don’t break an economic time series into into the frequency domain”. Perhaps because economic cycles are irregular cycles (ie of variable periodicity) arising from stochastic processes better described by difference equations?

  47. Gravatar of jknarr jknarr
    22. December 2012 at 09:02

    I’d also advise Austrians to learn more than teach. Austrians have failed to understand the plumbing of the Fed balance sheet, and so talk crazy inflation and debt liquidation. They are right, but need to know the trigger (it’s not reserves).

    (Former Enron advisor) Krugman understands the plumbing, so he understood no inflation – and will remind you of this at every turn. He’s wrong. Debt will be monetized and liquidated, perhaps even by the end of Os term. But Austrians’ beating their heads against the establishment is a frontal assault against a superior force. They will never gain entrance. They are getting slaughtered, and only gaining discredit– and a larger state — as a result.

  48. Gravatar of jknarr jknarr
    22. December 2012 at 09:09

    Suvy, agreed, but this proves the point that what we call “Keynes” is a quasi-scientific justification for preexisting establishment interests.

    We should simply call it what it is: statism.

  49. Gravatar of W. Peden W. Peden
    22. December 2012 at 09:24

    Suvy,

    Again, cyclicality doesn’t prove the absence of movement towards equilibrium, given there are an infinite number of possible external shocks. As RebelEconomist suggests, the kind of cyclicality we actually see is better explained by irregular shocks that are exogenous to the price system. The research programme of finding regular cycles that could be categorised in even banded periods that was undertaken by people like Schumpeter, Kuznets et al was not successful precisely because of this reason: cycles caused by irregular exogenous shocks will not be regular.

    Modelling market economies as cyclical would be as misguided as modelling the wobbling bowling pin as following cyclical movements.

    jknarr,

    Austrian economists are most effective through mainstream conduits. For example, if you read “Free to Choose”, there’s a lot of Hayek’s ideas in there, because of Hayek’s influence on Friedman. Consequently, Hayekian concepts were spread much more widely by Friedman than by any Austrian School scholar, perhaps including Hayek himself!

  50. Gravatar of anon anon
    22. December 2012 at 09:40

    RebelEconomist, partially replacing the income tax by a tax on land rent is an example of supply-side policy, which has nothing to do with AD, properly understood. The central bank controls AD: under an inflation or price level target, it will expand AD to compensate for the expansion in aggregate supply (AS), whereas under a nominal income target it will simply let the price level fall (relative to expectations) to reflect increasing productivity. Many considerations suggest that stability in the path of nominal incomes (e.g. NGDP) is a better goal than price path stability, including being more resilient to aggregate supply shocks.

  51. Gravatar of RebelEconomist RebelEconomist
    22. December 2012 at 09:55

    anon: “partially replacing the income tax by a tax on land rent is an example of supply-side policy, which has nothing to do with AD” Huh? The whole point of it is to get marginal workers employed and raise real output. The central bank then does the rest by keeping inflation on track.

    As I say, fiscal policy is not my strong suit, but I have never been entirely convinced by Krugman’s arguments against Fama etc – all Krugman does is make jibes about ECON101 etc, and it is hard to make any progress in reaching a conclusion because Krugman does not engage with comments. Moreover, it seems to me that at some point not too far from where we are now, the stock of debt becomes the main problem, and even Krugman dare not deny that austerity does not reduce debt.

  52. Gravatar of Suvy Suvy
    22. December 2012 at 10:02

    “As RebelEconomist suggests, the kind of cyclicality we actually see is better explained by irregular shocks that are exogenous to the price system.”

    I don’t think it is. I think the cyclicality is endogenous to the system. It has, in large part, to do with the change of people’s expectations over time.

    “The research programme of finding regular cycles that could be categorised in even banded periods that was undertaken by people like Schumpeter, Kuznets et al was not successful precisely because of this reason: cycles caused by irregular exogenous shocks will not be regular.”

    The problem is that the cycles that we see are, a lot of the times, nonperiodic. So trying to study the cycles as periodic will get you in trouble. This is very common with nonlinear systems. Edward Peters actually goes into some nonlinear cycles in his book Fractal Market Analysis when studying stock markets. By the way, Edward Peters and other mathematicians have had some success in dealing with periodicity–ditto for Benoit Mandelbrot.

    I actually think that dealing with the macroeconomy as something that is cyclical is certainly something that is in the data. We usually see 5-7 year business cycles while seeing 60-80 year debt supercycles. The problem is that most everyone that uses economic time series only go back about 25-30 years instead of hundreds of years.

    A lot of it also depends on the way you analyze your data and the kind of data sets that you use. If you’re using 5-7 year data sets, you can’t really gauge much from that. I think a good place to start would be to try and use data that is over 200 years old–to be fair, there isn’t really much data out there that is that old. However, to say that people looked at a 30 year data set and that studying cycles in a 30 year data set didn’t work doesn’t mean that it failed.

    Also, I would like to add that technology has really made it much easier in studying cyclicality in data. I don’t think Schumpeter had the ability to download 20 different time series that go back 100 years; then put it R, do some Fourier Transforms and then calculate the way that the cycles persist in the data. Again, this approach still isn’t mainstream, even seen in modern economics.

    I was actually talking to one of my old teachers. He has an electrical engineering background and traded stocks for over 2 decades. Wrote his own program to do this before all of the big hedge funds and firms started to do this. Anyways, he was talking about how economists don’t even think about taking a data set and trying to break it up into different time series. He basically said that economists aren’t trained in that way. I think he’s right.

    Also, when you deal with dynamic systems and chaotic behavior, you see very strange behavior that manifests itself in very weird cycles. The mathematics to deal with this behavior primarily lies in complexity theory/chaos theory. The mathematics was developed very recently and the mathematics hasn’t even permeated in economics. The only economists that I’ve ever seen use any sort of tools to deal with these sorts of things are Steve Keen and Nassim Taleb(if you want to consider him an economist). Taleb doesn’t even use a lot of chaos theory, he uses a lot of what are called Levy-stable distributions. Again, I haven’t seen any other economists use these tools except for a select few that I could count on my hand.

    Also, I really think that people need to take a look at Mandelbrot’s work. In economics and finance, people listened to guys like Myron Scholes and Robert Merton without listening to Benoit Mandelbrot. That is just a joke.

  53. Gravatar of RebelEconomist RebelEconomist
    22. December 2012 at 10:08

    …..should have been “Krugman dare not deny that austerity DOES reduce debt.” of course.

  54. Gravatar of jknarr jknarr
    22. December 2012 at 10:10

    Suvy — it is endogenous. Check out the trailing sharpe ratio for US GDP. It leads debt formation: Minsky proof — stability creates leverage, which creates instability. We can cite exogenous developments that might occur at the tipping point, but it’s turtles all the way down then. You need fractals less than a good analysis of leverage in the economy.

  55. Gravatar of RebelEconomist RebelEconomist
    22. December 2012 at 10:29

    Suvy, I am sure that W.Peden’s intention was good, but he made a bit of a cock up of the explanation! With a stochastic process, the cyclicity IS endogenous; the shocks need not have any periodicity. A classic example is a predator / prey relationship which cycles because the predators do well when there is lots of prey and the prey do well when their numbers have been reduced by the predators and there is more food. On its own, the system might settle down to a perfectly regular cycle, but essentially random exogenous shocks like weather keep shifting the cycle. Such resonance is common in natural systems.

    There has been sufficient computer power to do frequency domain analysis of time-series for years, but I don’t think the early results were very promising.

  56. Gravatar of RebelEconomist RebelEconomist
    22. December 2012 at 10:42

    Actually, Suvy, you are awakening memories that I have not thought about for years. It might be that a maximum entropy method of spectral analysis would be more appropriate for such systems: http://en.wikipedia.org/wiki/Maximum_entropy_spectral_analysis

    Kindly consult your local mathematician for further details!

  57. Gravatar of Integral Integral
    22. December 2012 at 11:01

    Scott,

    “it’s clear that the leading macroeconomists on both the left and the right don’t understand their own models.”

    On that, we surely agree.

    :)

  58. Gravatar of W. Peden W. Peden
    22. December 2012 at 11:12

    RebelEconomist,

    I think part of the confusion is that when I say “shocks are exogenous”, I mean that they are exogenous to the price system. I don’t deny at all that a change in people’s expectations, for instance, affect the economy. Put everything into the model and you won’t get any exogenous variables, so therefore you won’t get any exogenous shocks.

    However, as far as I know, when people use the concept of equilibrium in models, they aren’t trying to model everything, they’re trying to model the way a price system works and how a given economy will tend to work if it has a price system.

    To go back to the bowling pins: if you were trying to model how a bowling pin moves when hit in general, then the things that are hitting the bowling pin would be treated as exogenous variables. If you were trying to model the entire particular process of the bowling pin being knocked back and forth, then the things that happen to be knocking it back and forth would be included in the model.

    Suvy,

    I think that we’re in agreement apart from the point about the regularity of business cycles, and we can agree to leave future research as an empirical & undecided issue there.

    Reading it all over again, we do agree on the central issue that concerned me, i.e. that the market system moves towards equilibrium. We never get there, of course, and blissfully so, because resources, people’s plans, people’s preferences, and entrepreneurial ambitions are always changing. Indeed, as some Austrian School economists have argued, there is a ripple effect in that the equilibriating actions of Kirznerian entrepreneurs itself cause disequilibria, and such a process would continue up until the price system had resolved everyone’s plans into a commensurate collection (equilibrium of the sort one finds in Hayek 1937).

    This is important because it means that the price system itself is not destabilising, but rather that reality itself is not stable, and any economic system that is to be reflective of the way the world really is (“reality-based” to use a familiar heterodox term) should therefore be fluctuating and never in equilibrium.

  59. Gravatar of W. Peden W. Peden
    22. December 2012 at 11:22

    RebelEconomist,

    “Moreover, it seems to me that at some point not too far from where we are now, the stock of debt becomes the main problem, and even Krugman dare not deny that austerity does not reduce debt.”

    2030 is the date one often hears as being a crunch time regarding generational imbalances in the UK. There’s an interesting democratic failure here, in that the political incentive is to exploit the current market for Western debt to maximise current voter satisfaction. This further exploits the voting behaviour of younger voters who either don’t realise they’re being taxed on future earnings or don’t have a vote or both.

    It has been a great achievement of Western civilisation that every generation has been, at the aggregate, better off than the previous generation for hundreds of years. It would be a historically astonishing failure if the generation currently over about 40 fails in this task, especially given the declining birthrate, since it’s much easier to leave a good legacy to fewer children than many children.

  60. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    22. December 2012 at 11:30

    Krugman sez;

    ‘America in the 1950s made the rich pay their fair share; it gave workers the power to bargain for decent wages and benefits; yet contrary to right-wing propaganda then and now, it prospered. And we can do that again.”’

    Let’s hope not…for those workers sake, since according to LIMEW (and just looking around and observing how ordinary people live), things are much better now, and the Golden Age was the Gipper’s presidency;

    http://www.voxeu.org/article/defence-gdp-measure-wellbeing

    ‘The period 1959-72, supposedly the golden age of economic growth, was actually a comparatively poor one for households. And it was followed by a fall in living standards over 1972-82.

    ‘Far and away the best time for households was the period 1982-89, which coincides roughly with the Reagan administration.’

    Oulton also sticks a fork in Easterlin;

    ————quote———–
    I find the results of these happiness surveys puzzling because they are inconsistent with other facts about people’s behaviour. First, if people care mainly about their relative position, why has there been so much fuss about the financial crisis? After all, for most people in the UK, the drop in income has been (on this view) trivially small, no more than 8% – and at least initially, it fell disproportionately on the rich.

    Second, if people care about their relative position, why does this have to be expressed in terms of annual income? After all, most workers today can work part-time if they want. So why can’t A boast that his daily rate of pay is higher than B’s even if B’s annual earnings are higher and this is because smart A works only three days a week while poor dumb B, a slave to the rat race, works five?

    Yet surveys of part-time workers regularly show that many would like to work longer hours if only they could. And while it is true that some leisure activities like skiing require a lot of complementary expenditure on stuff, many other activities – watching TV, surfing the internet, chatting with friends in pubs or cafés or avoiding Betjeman’s regret – do not.

    In fact, people’s leisure choices provide powerful evidence against the view that only relative position matters. The classical economists argued that the amount of time people were prepared to work depended on the range of goods and services available for consumption.
    ————-endquote———–

  61. Gravatar of jknarr jknarr
    22. December 2012 at 11:41

    W Peden – I’d say that the growth of the US Federal Register (and its analogues in Western Europe) over the past 40y has been a historically astonishing development.

  62. Gravatar of jknarr jknarr
    22. December 2012 at 11:50

    Patrick -

    All you’d have to do to return the US labor force to the 1950s is destroy the industrial capacity of the rest of the world!

    Sounds like Krugman stimulus to me, as long as the war is against right-wingers.

  63. Gravatar of JSeydl JSeydl
    22. December 2012 at 12:03

    Yes, leftists like Krugman are so statist that they want to restore Clinton tax rates and open up the healthcare sector to more free trade. Evidently, 39 is the new 90.

    In short, Brown (if that’s really his name) has no idea what he’s talking about, and ppl like him need to stop attacking straw men.

  64. Gravatar of Donald Pretari Donald Pretari
    22. December 2012 at 12:06

    I’m sorry to comment on a thread that involves Professional Issues, but Simons, Knight, Fisher, and others, advocating the Chicago Plan of 1933, got it right.

  65. Gravatar of jknarr jknarr
    22. December 2012 at 12:31

    Jseydl –

    Part of the point re statism is the assumption that policy-wonky tweaking of tax rates and “opening up” free trade in healthcare is what matters.

    Exercising state power is not always the solution. e.g. Medical care was born free, yet everywhere it is in chains.

    Great website, BTW. Consider that tight fed policy causes low yields, and then many of these seeming contradictions resolve cleanly.

  66. Gravatar of Bill Ellis Bill Ellis
    22. December 2012 at 12:49

    The only Statist that matter are the elite.
    Libertinism in practice ensures the elite will control the state.

  67. Gravatar of genauer genauer
    22. December 2012 at 12:56

    1. State of (US) macro: terminally ill

    From a German perspective, the differences between freshwater and saltwater folks are petty, compared to Ordnungspolitik : – )

    Both growth politics and business cycle folks have failed completely.

    In the moment I enjoy reading Deidre McCloskey, who describes most of macro as “cargo cult”

    And please have a look at 101 year old Nobel prize winner Coase
    http://hbr.org/2012/12/saving-economics-from-the-economists/ar/1

    2. Reason for present crisis: price / credit bubble
    That is actually one thing the Austrian got remarkable right, this is nearly always the reason. The only folks still not getting it seem to be US economists.

    See also Warren Brussee: “the Second Great Depression, 2007 – 2020”, printed in 2005. Just ask the engineers : – )

    3. Krugman
    Nobody ever could answer me the following question:
    “Tell me one specific Krugman paper, and a few specific sentences, what YOU think is good about that paper.”

    Not Nick Rowe, Noah Smith, D. Henderson, Brad deLong, Tyler Cowen, a couple of Irish econ profs. Not a single one, all failed. Any takers here?

    4. Cyclicality
    When you plot things like real value of a stock portfolio, with dividends, but after inflation and taxes, basically what realer matters for a long term investor, then you I as a physicist see a very clear 37 year cycle, say plus minus 5.

    You don’t need fancy transformations, nor are they really useful. The interesting thing is that the German / Scandinavian mood swing got anti cyclical with reunification.

    5. Central banks / target
    The Buba forced the 2.0% target onto the ECB. Begin this year the Fed adopted it too, now Japan will go there, and since Carney from the Bank of Canada with their de facto integral 2.0% target will take the helm of the BoE, this looks now very close to total victory : – )

    With the Swiss Franc officially pegged again to the DeutschMark, and the Swedish Krona de facto, not many ways to escape are left.

    It is very easy, folks, in a monetary union like the Eurozone, there can be only exactly one short term interest rate, and all other politics logically has to be national financial policy. And with this largest economic block, the rest will step by step fall in line as well, as in former times all US economic follies were more or less followed.

    Now, listen to the doctors Dr. Schäuble, Dr. Merkel, and Dr. Weidmann , take your financial discipline medicine and get with the BuBa program. We have Dr Rösler and Dr de Maiziere for backup.

    6. Happy Xmas to Scott, Rebel, Rien, and all others !

  68. Gravatar of jknarr jknarr
    22. December 2012 at 13:00

    Bill –

    Freedom is slavery? Seems that i have heard that somewhere. Let the elite have their state, as long as it’s a monkey cage where I can watch them throw stuff at each other.

    What makes you think that they don’t already control the state?

  69. Gravatar of anon anon
    22. December 2012 at 13:40

    RebelEconomist, I’m not sure I understand your response. Are you familiar with the distinction between supply-side (affecting AS) and demand-side (affecting AD) government policy, and if so, do you agree that the distinction is relevant? My view (and I think Scott and most other commenters here would agree) is that most government policies affect the economy primarily via supply-side factors: incidentally, this may be quite compatible with “expanding output and employing more marginal workers”.

    Demand-side government policy (such as a government deficit used as temporary Keynesian stimulus, or a macro-prudential restriction on bank lending) may well be important for individual regions in a currency area and/or regions which adopt a currency peg, but otherwise it just isn’t very relevant. If you don’t think a neutral shift to taxing land rent qualifies as supply-side policy, feel free to choose a different example.

  70. Gravatar of W. Peden W. Peden
    22. December 2012 at 13:57

    jknarr,

    “Free to Choose” was the first economics TV series I saw, so I’ve always taken that as a familiar datum!

    As Friedman says, making regulations is easy, getting rid of regulations is hard. A “One in, two out” rule would be a good policy for fair while.

  71. Gravatar of jknarr jknarr
    22. December 2012 at 15:04

    W Peden-

    The Econ education with the state at the center starts early.

    Even simple teaching about comparative trade advantages tends to gear the discussion around the gains to welfare from the removal of barriers – not the original loss of welfare from state interference in the first place.

  72. Gravatar of ssumner ssumner
    22. December 2012 at 15:45

    Rebeleconomist, You replied to me;

    “You talk as if central banks believe they should target inflation, and leave AD up to fiscal policymakers”. Yes.

    Are you the sort of person who keeps one foot pushing down on the brake as the other foot pushes the accelerator? If you are targeting inflation, then fiscal policy CANNOT affect AD. So I don’t understand your comment at all.

    Jseydl, If you go around claiming Krugman favors a top rate of 39% no one here will take you seriously. I don’t really care what you do, but don’t you think it’s rather pointless to spout such inaccurate information in a post where you are calling an 18 year old uninformed? Look in the mirror.

    Genauer, Yes, the euro experiment with its 2% inflation target is working out just great! Exactly as the German’s planned it. And when the German taxpayers have to pay the bills for all the debt defaults, they’ll do so with pleasure. Because the eurozone is just one big happy family–with 11.6% unemployment and rising. Pith the Scandinavians stayed out, and don’t get to enjoy the party.

  73. Gravatar of anon anon
    22. December 2012 at 16:05

    Scott, from RebelEconomist’s other comments, it seems that he’s just using “AD” as synonymous with something like “current real output”. So any policy which boosts current output can be said to boost “AD”, persay. Normally I’d just say that this is hopelessly confused, except that I have seen some central banks’ reporting (the BoE especially) kind of does the same thing. Can you (or anyone else) clarify? Where does this usage come from?

  74. Gravatar of Mike Sax Mike Sax
    22. December 2012 at 16:18

    W.. Pefen I dont follow how you can claim rhe Great Receessinon compares favorably with the 70s. I dont think Sraffa and Joan Robinson were ever influential at least in Ameeica

  75. Gravatar of Mike Sax Mike Sax
    22. December 2012 at 17:34

    Bill, I’m not so sure Noah was categorically saying all Macro is a myth. If anything Krugman was more negative here. Still I think some real questions can be raised about Macro.

    “His criticisms of the validity Macro could be just as fairly leveled at all of the social sciences. No one ever claimed the Social Sciences were hard science. But they are useful.”

    Part of the problem though is that Macro has always aspired to be more than a mere social science no? The trouble with all social sciences-as opposed to the “hard sciences” like physcis, biology, astronomy, etc-is that there is no ability to conduct a controlled experiment-with the emphasis on controlled.

    I think Noah has a point: the predicitve record of Macro lately has been terrible. Is simply all agreeing about the model all that counts?

  76. Gravatar of Negation of Ideology Negation of Ideology
    22. December 2012 at 18:02

    Donald Pretari –

    Milton Friedman was a supporter of the Chicago Plan, as he wrote in the preface to his “Program for Monetary Stability” in 1992. I’m sympathetic as well, but not totally sure how it would work in practice.

    On another note, Avik Roy agrees with me that we should bring on the fiscal cliff:

    http://www.forbes.com/sites/aroy/2012/12/20/on-the-fiscal-cliff-republican-rebels-are-right-no-deal-is-better-than-a-bad-deal/

    Unfortunately, he says nothing about the Fed offsetting the drop in AD. Those two issues may be related, because if the Fed targets NGDP they can offset any fiscal deficit reduction as well as any increase in bank reserves, even to the 100% Chicago Plan.

  77. Gravatar of Carlaw and Lipsey on Whether History Matters « Uneasy Money Carlaw and Lipsey on Whether History Matters « Uneasy Money
    22. December 2012 at 20:20

    [...] the recent flurry of posts on the current state of macroecoomics by Krugman, Williamson, Smith, Sumner, et al., a topic about which I may have a word or two to say anon.  Here is the abstract of the [...]

  78. Gravatar of W. Peden W. Peden
    22. December 2012 at 21:26

    Mike Sax,

    The 1970s AND 1980s. It’s impossible to understand one decade without the other, because the full costs of inflation only become fully apparent after disinflation.

    It’s true that Sraffa and Robinson were never influential in the US, even indirectly, and I claimed as much: hence “ascendency” rather than “reascendency”.

    jknarr,

    There I have a bit of an absolute advantage over those who learned their economics in the classroom: I was taught the principles of comparative advantage at a very, very young age, with hypothetical Pictish settlements as illustrations. The state never came into it one way or another. Consequently, even at my most socialistic, I think I’ve always been against protectionism.

  79. Gravatar of flow5 flow5
    23. December 2012 at 07:43

    IS=LM equilibrium & cyclicality? S never equals I. Leakages increased as Reg Q ceilings increased – & were eliminated.

    Roc’s in AD equal roc’s in MVt (aggregate monetary purchasing power) “Leland J. Pritchard, Ph.D., Chicago-1933”. Roc’s in AD don’t equal roc’s in nominal gDp (remember the housing bubble?).

    Contrary to economic theory, & Nobel laureate, Dr. Milton Friedman, monetary lags are not “long & variable”. The lags for monetary flows (MVt), i.e. the proxies for (1) real-growth, & for (2) inflation indices (for the last 97 years), are mathematical constants. However, the FED’s target (interest rates), is indirect, varies widely over time, & in magnitude.

    By using the wrong criteria (interest rates, rather than member bank reserves) in formulating & executing monetary policy, going forward it will be impossible for the Federal Reserve to target nominal-gDp. Monetary expansion no longer immediately responds to an injection of reserves into the system (as it did between 1942 & 1994).

  80. Gravatar of flow5 flow5
    23. December 2012 at 07:51

    The FRBNY’s “trading desk” plans to conduct POMOs totaling $480b of newly-issued agency MBS & $540b of 9 year average-duration treasuries for 2013. These purchases won’t have an immediate economic impact unless the secondary market counterparty (clearing & final transfer of securities & funds) is with the non-bank public (as in 3rd party settlement).

    The non-bank public includes every institution (shadow-banks), the U.S. Treasury, the U.S. Government, State, & other Governmental Jurisdictions, & every person (except the commercial & the Reserve banks).

    Transactions between the Reserve banks & the commercial banks (between primary dealers/bank holding co.) directly affect the volume of bank reserves without bringing about any change in the money supply. The trading desk “credits the account of the clearing bank used by the primary dealer from whom the security is purchased”. This alteration in the assets of the commercial banks: (IBDDs) increase – by exactly the amount the PD’s government securities portfolio decrease.

    Purchases & sales between the Reserve banks & non-bank investors directly affect both bank reserves & the money supply.

    The member banks are currently unencumbered in their lending & investing operations (except for bank capital adequacy ratios, eligible borrowers, & investment grade assets). I.e., there’s nothing to stop the CBs from currently expanding new money & credit…so mopping up longer-dated securities isn’t going to expand the system’s capacity or bankable opportunities.

    The Fed’s purchases (allocation of Reserve bank credit) could end up contractionary (just matching the lower-yielding, new Treasury issuance – which is targeted at non-productive recipients). Maybe section 14 (b) of the Federal Reserve Act should be amended to allow direct borrowing (a.k.a., 2009’s economic stimulus payment), or for specific Congressionally approved, job creating projects.

  81. Gravatar of RebelEconomist RebelEconomist
    23. December 2012 at 08:44

    “Scott, from RebelEconomist’s other comments, it seems that he’s just using “AD” as synonymous with something like “current real output”.”

    That is true, I was thinking in terms of demand rising by lowering costs and hence a shift along the AD curve, followed by a shift in the AD curve as the CB responds to lower supply prices.

    I must admit, as someone with a scientific education myself, I tend to be a bit sloppy with such formalities – I am just trying to understand how the economic system actually works. Actually, it occurs to me that Scott’s 2008 monetary shock could be represented as an AS contraction, in that the economy suddenly needed more base money to operate.

  82. Gravatar of Mike Sax Mike Sax
    23. December 2012 at 08:53

    ‘The period 1959-72, supposedly the golden age of economic growth, was actually a comparatively poor one for households. And it was followed by a fall in living standards over 1972-82.

    ‘Far and away the best time for households was the period 1982-89, which coincides roughly with the Reagan administration.’

    I find that pretty dubious. By what measure was 82-89 superiour? Not by GDP. Certainly not by productivity. In any case correlation doesn’t prove causation. If you measure by unemployment 82-89 looks even less impressive

  83. Gravatar of flow5 flow5
    23. December 2012 at 09:05

    “the economy suddenly needed more base money to operate”

    Not suddenly. Bernanke (like Captain Ahab chasing Moby
    Dick) engineered the catastrophe. It was indoubably obvious in Dec 2007 that there would be a recession in the last qtr of 2008. From a monetary perspective, economic prognostications are infallible.

  84. Gravatar of flow5 flow5
    23. December 2012 at 09:12

    indubitably obvious:

    POSTED: Dec 13 2007 06:55 PM |
    10/1/2007,,,,,,,-0.47,,,,,,, -0.22 * temporary bottom
    11/1/2007,,,,,,, 0.14,,,,,,, -0.18
    12/1/2007,,,,,,, 0.44,,,,,,,-0.23
    1/1/2008,,,,,,, 0.59,,,,,,, 0.06
    2/1/2008,,,,,,, 0.45,,,,,,, 0.10
    3/1/2008,,,,,,, 0.06,,,,,,, 0.04
    4/1/2008,,,,,,, 0.04,,,,,,, 0.02
    5/1/2008,,,,,,, 0.09,,,,,,, 0.04
    6/1/2008,,,,,,, 0.20,,,,,,, 0.05
    7/1/2008,,,,,,, 0.32,,,,,,, 0.10
    8/1/2008,,,,,,, 0.15,,,,,,, 0.05
    9/1/2008,,,,,,, 0.00,,,,,,, 0.13
    10/1/2008,,,,,,, -0.20,,,,,,, 0.10 * possible recession
    11/1/2008,,,,,,, -0.10,,,,,,, 0.00 * possible recession
    12/1/2008,,,,,,, 0.10,,,,,,, -0.06 * possible recession
    Exactly as predicted:
    The Commerce Department said retail sales in Oct 2007 increased by 1.2% over Oct 2006, & up a huge 6.3% from Nov 2006.
    —————

    There’s more than 1 model that gives the same projection. But the best metric is bank debits (discontinued in 1996 by its manager Ed Fry, part of Clinton’s deficit reduction efforts).

  85. Gravatar of jknarr jknarr
    23. December 2012 at 09:13

    Flow5. Spot on. Brilliant. You should start MVt up again.

  86. Gravatar of flow5 flow5
    23. December 2012 at 09:21

    The FED’s technical staff doesn’t know how to define money (one of 2 variables used to calculate aggregate demand):

    This is what senior economists said about Fed Policy:

    “Although the evidence is mixed, the MSI (monetary services index), overall suggest that monetary policy WAS ACCOMMODATIVE before the financial crisis when judged in terms of liquidity. —Richard G. Anderson and Barry Jones.

    This was of course a lie.

  87. Gravatar of flow5 flow5
    23. December 2012 at 09:51

    ZEROHEDGE: Keep an eye on the Direct bid in the January auction to see if the trend persists.
    —————

    “Direct bidder” demand (at Treasury auctions) may indicate an increased demand by the “non-bank public” for governments (“qualified investment funds, insurance companies, & foreign governments, etc.).

    Likewise, when the “trading desk” conducts POMOs using its SOMA securities, then the money supply is more likely to expand (whenever the PDs act as a third party for these non-banks).

  88. Gravatar of jknarr jknarr
    23. December 2012 at 11:52

    Flow5 – what is the mechanism for buying from nonCB bond holders? Fed buys bond/provides currency; bank swaps currency for reserves? Or fed buys bond/provides reserves; bank shifts excess into required and produce a demand deposit for seller? The fed does not likely hand out cash, but nonCBs can’t take reserves.

  89. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    23. December 2012 at 12:20

    ‘By what measure was 82-89 superiour? Not by GDP. Certainly not by productivity.’

    As is clearly explained by Oulton, household consumption.

  90. Gravatar of genauer genauer
    23. December 2012 at 12:33

    Scott,

    if you think you can fix french attitudes, like taking foreign managers hostage, or 75% tax rates, or threatening foreign owners (Mittal) with nationalization for closing the most ineifficient overcapacities of blast furnaces with central bank policies, I can not help you.

    To continue to overbuilt McMansions in Spain, despite a 5 year supply of empty ones, pay people 2 years severance packages and expect generous regular hiring, and this financed by german taxpayers, who have no such things, this is just day dreaming.

    What you , like other US introverts dont get, is that the EU is not a nation state, and that the rest of the world does not have the exorbitant privilege.

    The US style focus on monetary policy looks bizarre from the outside.

  91. Gravatar of ChargerCarl ChargerCarl
    23. December 2012 at 13:09

    The Eurozone’s obsession with punishment and pain seems really bizarre from the outside.

  92. Gravatar of PrometheeFeu PrometheeFeu
    23. December 2012 at 13:17

    “Unfortunately, if nothing changes, I would predict we will have a generation of economic policy managed by goldbugs who want to abolish the fed (or peg it to gold) and hard left statists who think 90% tax rates are good and free trade is bad.”

    If those are our choices, I’m hoping for the gold bugs. As long as they leave the nutty Rothbardian FRB-is-theft stuff aside, a free banking system might very well deliver the money supply we need. I think Selgin has the right of it.

  93. Gravatar of flow5 flow5
    23. December 2012 at 14:03

    “what is the mechanism for buying from nonCB bond holders?”

    jknarr:

    All the primary dealers are with bank holding companies. And the primary dealers are the FRBNY “desk’s” only trading counterparties. So the PDs would have to serve as agents for any non-bank public demand. I don’t know that process (although China, Switzerland, etc. are exceptions, also direct bidders, etc.).

    Unless the commercial banks themselves are incentivized to lend & invest, the economy doesn’t receive the immediate benefit of new money & credit.

    Under current economic conditions (short-end of an inverted yield curve), the remuneration rate sterilizes the major portion of open market operations of the buying type (removing some of the existing supply of bonds off the secondary market, thus neutralizing new Treasury issuance). In prior times the CBs would be buying securities.

    According to William Dudley, monetary policy seeks “an IOeR rate consistent with the amount of required reserves, money supply, & commercial bank credit outstanding”.

    I interpret that to mean the FOMC has a deliberate slow-growth policy.

  94. Gravatar of jknarr jknarr
    23. December 2012 at 14:27

    Flow5 – thank you, I am also looking at your Monetarism Hasn’t Been Tried. Great stuff.

    Might there be multiple PD desks counterparties for the Fed, then? One CBco, the other securities co? Most appear to be Sco, so how do they hold reserves?

  95. Gravatar of ssumner ssumner
    23. December 2012 at 15:15

    Anon, See my next comment.

    Rebeleconomist, You replied to anon:

    “Scott, from RebelEconomist’s other comments, it seems that he’s just using “AD” as synonymous with something like “current real output”.”

    That is true,”

    Output can change due to either a change in AD or AS. It makes a big difference which one is causing output to change. It’s already pretty difficult to have a conversation about macro, let’s keep the terms clear . . .

    Genauer, You don’t seem to realize that I oppose those crazy French and Spanish policies, but that has no bearing on the optimal monetary regime for the eurozone.

    You said:

    The US style focus on monetary policy looks bizarre from the outside.

    Europe’s exercise in masochism seems bizarre to the rest of the world. What’s the point of having a huge plunge in NGDP growth? What good does it do?

    Oops I see ChargerCarl got there first.

  96. Gravatar of Bill Ellis Bill Ellis
    23. December 2012 at 16:49

    jknarr,

    Of course the elite already control the state. They always have and always will.
    Libertarianism is impotent to stop it. No system can stop it.

    But some systems allow the common folk to use of the government to blunt the elite… to get a Fair deal. Libertarianism prevents the common folk from using the state to blunt the elite… Ensuring a dictatorship of the elite.

    We have seen this tendency play out all over the world. As our systems moved toward Libertarianism, the elite gained power and wealth while the common man lost wealth and rights. Libertarians preach “Slavery is Freedom.”

    If Libertarians want to convince the common man of the efficacy and morality of their positions … then they should demonstrate that they can keep the elite from using the state for their own ends (good luck doing the impossible ) Do that and then you can ask the common man to not try and make the State his instrument. For if you can not stop the elite from making the state their instrument it is IMORAL to ask the common man to surrender all control the state to the the elite…
    Unless you really believe that “Slavery is Freedom.”

  97. Gravatar of Suvy Suvy
    23. December 2012 at 16:50

    I would just like to add one thing that I think everyone may be missing. The price system in capitalism isn’t really all that destabilizing. I think the key thing to take away from Minsky’s work is that in capitalism, there exists a financial sector that plays a key role in the formation and development of capital. The problem is that the financial sector also creates debt and leverage and can turn the economy from one of robust growth into Ponzi growth by the relationship between increasing leverage and asset prices. I think the reason capitalism is unstable is because there is a financial sector that allows for the possibility of unsustainable credit expansion.

  98. Gravatar of Bill Ellis Bill Ellis
    23. December 2012 at 16:53

    Mike Sax…

    I did not mean to say that Noah was categorically saying all Macro is a myth. I was just trying to come up with short hand to describe a general but persistent tendency of his…Ya know what I mean ?

  99. Gravatar of Bill Ellis Bill Ellis
    23. December 2012 at 16:56

    Off topic but… Does anyone else find it Ironic that a bunch of libertarians want Obama to make sure that the government puts armed forces in all of our schools ?

  100. Gravatar of John Brown John Brown
    23. December 2012 at 17:26

    I really do think that many on the left are guilty of underestimating how “left wing” leading politicians and commentators on the left are.

    I saw one commenter said Krugman was in favor of a 39% top tax rate. As Mr. Sumner noted in a later comment, this is flatly untrue.

    Krugman has spoken kindly of top tax rates that are dramatically higher than 39%… as I mentioned in my last comment. In fact, Krugman even claimed that Hollande’s proposal for a 75% top tax rate was “around as high as leading public finance experts calculate they should be”.

    I’ll also note that, traditionally, those on the right have focused on the importance of having a high amount of predicability in monetary policy. I would agree and argue, as many others have, that NGDP targeting makes for a much more predictable monetary policy.

    When all is said and done, I do hope that my assessment of my generation of economists(or economic policy makers) ends up being wrong.

  101. Gravatar of jknarr jknarr
    23. December 2012 at 17:29

    Bill – I think that most libertarians would be happy with seeing the plain-language enumerated powers of the federal government ( and the rest of the constitution) adhered to.

    When I look at the radical expansion of the federal register since the 1960′s, “our systems moved toward libertarianism” is not the first thing I think of. Quite the opposite, actually.

    Might not this clear expansion of state power be the very vehicle and definition of “the elite” gaining wealth and rights, and the common man losing theirs?

  102. Gravatar of Martin Martin
    23. December 2012 at 17:42

    OK, something about the recent French policies. There is much to dislike about Hollande’s economic policies (if there is anything to like about them at all), but some of the critiques have been exceedingly crazy. First, the government do not believe that the 75 per cent top marginal tax rate will have a huge effect on national debt, they acknowledged it as a merely symbolic act (and, as a matter of fact, not consistent with the Diamond result, as Krugman claims, as that would only hold in the absence of loopholes). Think about it what you will, but this is not a central point of the French government’s economic policies, but an attempt to talk people into accepting an austerity program by playing a bit Robin Hood. Second, the possible privatisation of steel factories is not a sign of an imminent revival of a centrally planned economy, it’s a desperate measure with regard to an economy that seems to disintegrate in front of the eyes of the French public – and no central bank there to counteract!. I don’t think that anybody in the government believes that this would be a long term solution, but they perhaps believe that they can carry this thing over the crisis this way. Still dumb, perhaps, but no reason to flip out about SOCIALISM!!! Perhaps a conservative government would have done nothing the like, but that’s really not the point. The point is that the Hollande administration would have no reason to think about it, either, if just the ECB were allowed to act according to it’s merely nominal status as a friggin’ Central Bank, after all. You can’t just deliberately drive basically all of the economies of a monetary union down to something between slight recessions and youth unemployment rates over 50 per cent – based on purely moralistic convictions that everybody ought to behave more like Germans – and than cry scandal because socialistic governments emerge that act, well, like socialistic governments act in such instances. If you don’t want socialistic measures to be implemented you should probably let the economically viable alternative do its work, rather than block it until hell breaks lose.

    If all Germany has to contribute is to say that the French are balky, and the South is lazy they probably should blow the whole thing up and do it on their own, as an economy and a culture, and see how that works out. You just can’t completely change those people in a matter of some years – apart from the question if this is really desirable. I mean, really, what is this about? One can endlessly lament how wrong-headedly the eurozone was crafted, and that the population wasn’t really asked about it etc. But at the end of the day all the members have committed themselves to a monetary union. And in the first – and foreseeable crisis – the biggest economy simply refuses to act accordingly because they suddenly realise that they really do not want a monetary union with those other, non-German people. With the superb results we are seeing. Like someone who got lost in a desert and refuses to use her water wisely, because, hey, she really doesn’t want to be there and also, too, it’s all the fault of Apple maps. May the whole Eurozone go down, and the first non-disastrous European project since centuries with it – if only those lazy Spanish youth pay for the their huge mansions paid by hardworking German taxpayers by being unemployed forever.

  103. Gravatar of Bill Ellis Bill Ellis
    23. December 2012 at 19:16

    jknarr,

    From 1980 till 2007 the world saw a trend toward deregulation under the banner of free market reforms…. pushed and lauded by libertarians.
    What did we get ? A two tiered system of justice and ever expanding inequity of wealth and POWER.

    Just because more regs are on the books does not mean that there is more regulation. New Regs can gut actual regulation.

    Take what happened to the “Volker Rule” in the last round of financial reforms. As you know the rule itself is pretty strait forward, As a reg it only required a few lines to codify it…. But then came the death by 1000 cuts.
    Every elite who was effected managed to get their own little exemptions. So we get a bunch of little regs to make the big reg meaningless.

    The same kinda thing happens all the time. An industry is faced with a regulation and their lobbyist go to work… permanently and full-time to enact, reg after reg to gut the offending reg.

    So I don’t see a clear expansion of state power…I see a clear expansion of elite power over the state, while the common man loses more and more control over his government.

    Libertarians wanting to keep the government out of the hands of the elite won’t make it so. Libertarians declaring that the elite MAY NOT make the state their instrument won’t stop the elite from doing so…. not as long as we have a representative form of government. The masses are too easily convinced to vote against their own best interest… obviously.

    Like I say… When libertarians can demonstrate that they can keep the elite from making the government theirs… for more than a moment historically speaking… For the first time in history… then they might be on to something.

    But If they can’t solve that problem then they will always be frustrated by the unintended consequences of their policies.

  104. Gravatar of jknarr jknarr
    23. December 2012 at 20:23

    Bill – why stop a Volcker? Indefinite detention, FAA 30,000 drones in the US, extrajudicial assassination of US citizens, TSA crotch grabbing checkpoints, TARP for banks, guns for drug gangs, “war on drugs” wristslap for HSBC — prison for you or me, Patriot Act, extraordinary rendition torture, drone strikes killing 474 – 881 civilians including 176 children, Utah Data Center yottabytes of surveillance storage, warrantless searches and wiretapping…

    A remarkable development of state power, no? I’m really not certain how libertarians are the cause. Most counter-intuitive.

    I’d suggest that the current state needs to prove its compatibility with the constitution more than libertarians need to be held to your self-admitted impossible standard.

  105. Gravatar of flow5 flow5
    23. December 2012 at 20:34

    QE greases the wheels (velocity). It accelerated decision making (financial transactions). It redistributes financial investment (not real investment). It supports the Treasury Market (the FED’s informal mandate). Once you change the risk value (swap or convert assets), you make the markets rebalance & reallocate. Rebalancing alters the asset mix. It makes the market re-examine, & revalue, the linkages between financial & real assets. It changes support & resistance lines. It increases the demand for speculative loan-funds.

    The Central Bank’s distribution channel (a.k.a. monetary transmission mechanism) is comprised of the primary dealers (19 banks & securities brokerages that trade in U.S. Government securities), & their CUSTOMERS (the investment banks & their mutual fund, hedge fund, pension fund, insurance company, sovereign wealth fund, corporate treasury, & wealthy investor, CLIENTS).

    Note that the PDs “purchase the vast majority of the U.S. Treasury securities (T-bills, T-notes, & T-bonds) sold at auction, & RE-SELL them (an established distribution channel), to the public” (or to the FED). – Wikipedia.

    These asset speculators (& their proprietary trading operations) are now horizontally integrated (vastly accelerating the transfer of ownership), under the Gramm-Leach-Bliley Act passed in 1999 (rather than segregated – under the Glass-Steagall Act of 1932 – an act put in place to curb the type of stock market speculation that characterized the late 1920’s).

    Indeed, the distribution channel is international: “according to the Wall Street Journal Europe (2/9/06 p. 20), all of the top ten dealers in the foreign exchange market are also primary dealers, & between them account for almost 73% of forex trading volume” – Wikipedia.

    Note also that: commercial bank trading revenues, can be divided into (1) fixed-income, (2) currency, (3) equity, & (4) commodity classifications. I.e., it is obvious, that if the NY FED trading desk buys securities, then their owners (or their trading partners & clients), will “buy riskier assets”.

  106. Gravatar of Major_Freedom Major_Freedom
    23. December 2012 at 20:54

    Bill Ellis:

    From 1980 till 2007 the world saw a trend toward deregulation under the banner of free market reforms

    No “free market” or “deregulation” rhetoric is justified in a country with communist money production.

  107. Gravatar of W. Peden W. Peden
    23. December 2012 at 23:24

    Suvy,

    Isn’t it interesting how finance (and particularly bank finance) is where we depart most from a market price system, with deposit insurance, barriers to broad monetary competition, a nationalised monopoly of base money, and ample regulatory barriers to entry, yet it’s so destabilising?

    Correlation does not equal causation, but the prima facie burden of proof is on opponents of free market money to explain why (a) here, the equilibriating character of capitalism isn’t found, and (b) here, government intervention is truly exceptionally great in quantity and impact.

    Minsky had the excuse that he was writing before Hayek and White & Selgin revived free banking*, but that’s no excuse for his followers to turn a blind eye to the role of government in banking.

    * Rothbard and some others worked on it contemporaneously with Minsky, I think, but anyone can be forgiven for finding Rothbard wholly unpersuasive, and Rothbard found it hard to disentangle his anti-fractional reserve banking positions from his pro-free market positions.

  108. Gravatar of studentee studentee
    24. December 2012 at 00:51

    “Minsky had the excuse that he was writing before Hayek and White & Selgin revived free banking*, but that’s no excuse for his followers to turn a blind eye to the role of government in banking.”

    What are you on about?

  109. Gravatar of ssumner ssumner
    24. December 2012 at 09:01

    Martin, Great comment.

  110. Gravatar of JSeydl JSeydl
    24. December 2012 at 09:36

    “I saw one commenter said Krugman was in favor of a 39% top tax rate. As Mr. Sumner noted in a later comment, this is flatly untrue.”

    Just because Krugman has previously linked to a Saez paper arguing for a 70% top rate doesn’t mean that’s where Krugman stands. Nevertheless, the point is irrelevant. The statement in question was: “People like Krugman.” This is blanket statement accusing all liberals of favoring 90% top tax rates, which is blatantly false.

  111. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    24. December 2012 at 09:49

    ‘From 1980 till 2007 the world saw a trend toward deregulation under the banner of free market reforms…. pushed and lauded by libertarians.
    What did we get ?’

    A quarter century of unrivaled prosperity. 300 months in which we had only 16 months (5% of the time) of recession.

  112. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    24. December 2012 at 09:51

    ‘These asset speculators (& their proprietary trading operations) are now horizontally integrated (vastly accelerating the transfer of ownership), under the Gramm-Leach-Bliley Act passed in 1999 (rather than segregated – under the Glass-Steagall Act of 1932 – an act put in place to curb the type of stock market speculation that characterized the late 1920’s).’

    You lookin’ at me?

    You believe in a fantasy world.

  113. Gravatar of Hoisted from the Comments: The Culture that is Undergraduate Economics Hoisted from the Comments: The Culture that is Undergraduate Economics
    24. December 2012 at 10:07

    [...] Scott Sumner, here is a comment from Scott Brown: I am an 18 year old college student with a strong interest in [...]

  114. Gravatar of Saturos Saturos
    24. December 2012 at 11:02

    I sympathize with Noah’s reply to this post (as an update to his previous one). Scott is invoking a mainstream consensus around AD as the driver of business cycle, ignoring that there is no mainstream consensus on what exactly AD is or that it can be perfectly preemptively stabilized by pegging NGDP futures or targeting the forecast of an interest rate inflation targeting central bank – I mean NKs recommend these things, but it isn’t absolutely clear in NK theory that these would abolish the business cycle. Our views that “money matters” are highly controversial. Yes Scott could reply to Noah by quoting in more detail the NKs of 10 years ago who thought they had abolished the business cycle, but Noah isn’t convinced that they had a model to prove it and it all looks like hubris now to most people, unless you buy into this fringe untested theory called market monetarism…

    Our main argument against Noah is that if economists had ensured the implementation of the response to AD shocks that the best macroeconomists would themselves have recommended 1o years ago in 2008, correctly identifying the main problem as an AD shock, then none of this would have happened and macro could have saved this reputation. But he is not convinced.

  115. Gravatar of Saturos Saturos
    24. December 2012 at 11:03

    Sorry, that should have been empathize, not sympathize.

    And Merry Christmas everybody.

  116. Gravatar of flow5 flow5
    24. December 2012 at 11:27

    “A quarter century of unrivaled prosperity. 300 months in which we had only 16 months (5% of the time) of recession”

    It wasn’t due to deregulation, rather it was the result of greater price stability (even so, in the aftermath, e.g., Morgan & Goldman were forced to became bank holding companies).

  117. Gravatar of Suvy Suvy
    24. December 2012 at 13:29

    W. Peden,

    “Correlation does not equal causation, but the prima facie burden of proof is on opponents of free market money to explain why (a) here, the equilibriating character of capitalism isn’t found, and (b) here, government intervention is truly exceptionally great in quantity and impact.”

    Wasn’t the purpose of having money versus barter to collect government revenue for taxes? I believe that governments were the ones that pushed economies away from barter into money to increase commerce and collect tax revenue–if I’m wrong, please correct me.

    I don’t think that free banking would solve the problem. You have to change the fact that small movements in investment spending change unemployment a lot and changing an economy into free banking shows none of this for me. Also, I would like to add another point on equilibrium here. Equilibrium tells you nothing about stability. You could have local stability and global instability or vice-versa. You could have an unstable equilibrium point. Stability and equilibria are two very different things.

    Another point is the role that expectations play in determining the amount of investment and the level of debt. We used to have a free banking period in the United States. We still had the Panic of 1857. I personally think, from studying history, that the tradeoff exists between local stability and global stability. I don’t think it is possible to have both without getting rid of fractional-reserve banking. Now, you could make the argument that we’ve never really had “true free banking in the US”(due to issues like corruption) and that’s why it wasn’t truly stable, but I link this to the arguments Marxists make of how we really haven’t had “true Marxism”. Nothing in the world will ever be perfectly ran like it is theoretically ran in a textbook.

    I actually think that free banking won’t solve the problem as it won’t stop speculation on asset prices by the use of debt; debt bubbles have existed for a long, long time. The only solution is to remove the link between increases in the money supply and the issuing of credit. This means that if you want stability, you must get rid of fractional reserve.

    Another thing we have to remember from a macroeconomy is than an economy behaves differently than the sum of its parts. This is because of nonlinearity. I would also like to add that human beings have created macroeconomic issues from finance for many, many years. To say that we could come up with a way that it won’t happen again seems rather absurd to me. Human behavior doesn’t change. Once we go through a crisis, we will remember everything that happened and how too much debt creates problems. However, once we have children, they will forget and continue like nothing ever happened. The only way is to get rid of fractional reserve.

  118. Gravatar of flow5 flow5
    24. December 2012 at 14:06

    We live in a predatory society. Such an environment requires regulated capitalism.

  119. Gravatar of Lorenzo from Oz Lorenzo from Oz
    24. December 2012 at 18:32

    I gave up on macro when I did economics I as a mature age student. It is only reading this blog, and other blogs Scott cited, which enabled me to take macro analysis seriously. I may not comment much any more but I remain a diligent reader and continue to appreciate your efforts greatly. Merry Christmas from rainy Sydney (I am visiting my brother).

  120. Gravatar of Becky Hargrove Becky Hargrove
    24. December 2012 at 19:39

    Yes – Merry Christmas to all, and to all a good night!

  121. Gravatar of genauer genauer
    24. December 2012 at 21:23

    Martin,

    would you be so kind and show us some evidence, like 2 or more links, that some German with a recognizable name, like some politician above county level, or editor of a somewhat news outlet with more than , lets say quarter million readers, says something like your allegation “french balky”, “southerners lazy”?

    Do you know the Maastricht treaty, and its “no bailout, no moneyprinting” provisions? Do you know the IMF models for debt substainability? Would you like to describe your knowledge / view of them in a very few describitive sentences?

  122. Gravatar of W. Peden W. Peden
    25. December 2012 at 01:17

    Suvy,

    “Wasn’t the purpose of having money versus barter to collect government revenue for taxes? I believe that governments were the ones that pushed economies away from barter into money to increase commerce and collect tax revenue–if I’m wrong, please correct me.”

    As far as I know, money originated from credit (i.e. intertemporal barter contracts) and the world’s Second Oldest Profession- religion. Anyway, I don’t think that that implies that money issuance should be controlled by churches, so I also wouldn’t think that there would be many normative to be drawn from the hypothetical fact that government created money.

    “I don’t think that free banking would solve the problem. You have to change the fact that small movements in investment spending change unemployment a lot and changing an economy into free banking shows none of this for me.”

    I’m not sure which is the particular problem you’re saying doesn’t get fixed by free banking.

    I don’t think that panics and bubbles are necessarily bad things. As long as people are speculating with their own money, I have very little problem with it. Purely private monetary credit issuance worries me about as much as stockbuilding.

  123. Gravatar of guest guest
    25. December 2012 at 04:19

    Scott is quite right about European attitudes to “punishment” being a huge problem in the Eurozone. Here is Mario Monti, now PM of Italy, back when he was speaking as an analyst channeling Morgan Warstler on the euro and Greece. (The video is in Italian, with English subtitles)

  124. Gravatar of TheMoneyIllusion » NGDPLT will not eliminate recessions TheMoneyIllusion » NGDPLT will not eliminate recessions
    25. December 2012 at 06:28

    [...] Smith responded to my recent post: Update 6: Scott Sumner comments. He disagrees with my observation that the freshwater/saltwater conflict has waned. His answer to [...]

  125. Gravatar of genauer genauer
    25. December 2012 at 10:17

    @guest

    I see italian subtitles
    and what I understand is not about punishment.

    Some translation somewhere, or some critical second of the 55?

  126. Gravatar of Suvy Suvy
    25. December 2012 at 11:03

    W. Peden,

    “I’m not sure which is the particular problem you’re saying doesn’t get fixed by free banking.”

    The reason that we have fluctuations is because of the use of debt to buy asset prices which creates a positive feedback loop between debts and asset prices–both on the way up and the way down. Due to the shifts in expectations, debt/income ratios rise over time. As debt/income ratios rise, this actually adds to demand on the way up. Then, when debt/income ratios cannot rise any more, you get no private credit demand and you get slow growth until the debt/income ratios correct.

    Much of this is related to herd behavior and shifts in expectations over time. That cannot be changed. What can be changed is leverage that is used to buy it. Leverage acts as an amplifier to shocks. Think about it, if you have a firm that is levered 20:1, a 5% move in the price of assets wipes out the firm’s equity. Similarly, if you have an economy using debt to buy asset prices based on unrealistic expectations, the economy becomes very sensitive to shifts in volatility. A small, normal change in the volatility of asset prices creates a massive impact in the economy due to too much leverage. Free banking does nothing to fix this problem. The only way to fix the problem is to get rid of fractional reserve because you have to make debt bubbles impossible. I don’t really care about bubbles either, I only care about large levels of debt as large levels of debt can be highly destabilizing.

    During the free banking era of the United States, the Panic of 1857 still occurred as many Western currencies were not accepted in the East as there were other issues as well. I don’t think free banking solves the problem of excessive and unsustainable credit expansion.
    http://en.wikipedia.org/wiki/Panic_of_1857

  127. Gravatar of W. Peden W. Peden
    25. December 2012 at 14:48

    Suvy,

    If people in debt bubbles lose their own shirts, what’s the problem?

  128. Gravatar of Suvy Suvy
    25. December 2012 at 16:13

    “If people in debt bubbles lose their own shirts, what’s the problem?”

    Debt bubbles impact the entire economy. It creates a ripple effect because debt acts like an amplifier to shocks. Think about a firm that’s levered 20:1, a 5% move in the price of assets and the firm blows up. Similarly, if you have an economy where a lot of leverage was taken up to buy assets during a period of low asset price volatility, what happens once asset price volatility increases? All of a sudden, everyone’s balance sheet is underwater. Then, you could easily get caught in a debt deflation. This is what happened from 1929-1933. This creates a massive demand side problem and can this is what causes the shifts in unemployment. This doesn’t just affect those who took on debt, it has an effect on everyone.

    Not only that, but you get issues like lots of people that were suckered in to throw their entire life savings to buy a house. Then, when the value of their houses tanks, their entire savings was essentially destroyed. In other words, capital is destroyed in this process.

  129. Gravatar of W. Peden W. Peden
    25. December 2012 at 16:44

    Suvy,

    (1) Insofar as it’s a demand-side problem, it’s dealt with by NGDLPT. (We both seem to agree that NGDPLT mitigates the balance-sheet adjustments.)

    (2) Insofar as it’s a supply-side problem, it’s no different from stockbuilding or indeed just about any economic inactivity. As Lenin put it, “Everything is interconnected”. I see no more reason to adjust monetary policy to shifts in debt markets than to adjust monetary policy to shifts in stockbuilding or oil reserves.

    (3) ‘Suckered’ has implications of fraud. If that’s what’s going on, it’s a legal problem. If what’s going on is imprudent decisions, then that’s part of a free economy: the freedom to make imprudent as well as prudent decisions with one’s own capital. Including one’s own shirt.

  130. Gravatar of The State We’re In « Uneasy Money The State We’re In « Uneasy Money
    25. December 2012 at 20:45

    [...] when Scott Sumner says: while Krugman might seem pessimistic about the state of macro, he’s a Pollyanna [...]

  131. Gravatar of Suvy Suvy
    26. December 2012 at 12:12

    W. Peden,

    The problem is the social instability that comes out as a result of it. An economy cannot grow with a massive debt overhang. Also, it takes time for the debt overhang to be wiped out. If you have a total debt/GDP ratio of 150% vs 350%; that makes a huge difference. It’s much easier to correct the 150% debt/GDP ratio than it is the 350% debt/GDP ratio. The 150% can be brought within normal levels in 4-6 years. The 350% debt/GDP ratio will take a minimum of 10-15 years. That’s also a period where there is slow growth, potential job loss, and all sorts of other things. Not only that, but the higher the debt/income ratio; the more fragile you are to shocks. That means any sort of unexpected event hurts you a lot more at a higher level of debt than a lower one. We cannot predict the future and we do not know what will happen. That means that in order to have a more robust society, we need to keep the debt/income ratios in check.

    Another reason for keeping debt/income ratios in check is structural. When you have debt/income ratios increasing at 5-10 times nominal income or productivity growth, that debt isn’t being used to increase productivity or capital stock–it’s being used to consume. As I said earlier, the creation and destruction of debt is not a zero-sum gain. It makes us “richer” on the way up and on the way down, we feel poorer (mainly because we are). This creates social instability and unrest. The only way for an economy/nation to become richer in the long run is to increase our ability to produce more. This is usually done through an increase in the capital stock. Increases in the amount of capital are largely debt-financed(not entirely, but a good amount of it). If we have a highly indebted society where debts cannot grow any more; this means that growth in the amount of capital cannot increase as much as it otherwise would until the debt overhang is eliminated. Debt being used to finance consumption (this includes people using massive leverage to buy assets/houses) does not make use richer; it just takes away our ability to consume later by consuming more now. What does make us richer is increases in the amount of capital. Basically, excessive debt/credit growth automatically means we’re consuming more now which must not only take away from our consumption later(due to lower growth from the built up debt overhang), but the debt also isn’t used to finance capital formation. The only way for a country/nation to get richer is through the formation of capital and debt must be used to finance the formation of capital rather than consumption.

  132. Gravatar of MichaelM MichaelM
    27. December 2012 at 15:28

    Suvy:

    “Another point is the role that expectations play in determining the amount of investment and the level of debt. We used to have a free banking period in the United States. We still had the Panic of 1857. I personally think, from studying history, that the tradeoff exists between local stability and global stability. I don’t think it is possible to have both without getting rid of fractional-reserve banking. Now, you could make the argument that we’ve never really had “true free banking in the US”(due to issues like corruption) and that’s why it wasn’t truly stable, but I link this to the arguments Marxists make of how we really haven’t had “true Marxism”. Nothing in the world will ever be perfectly ran like it is theoretically ran in a textbook.”

    This is such a terrible argument. If we can point to specific regulations in the US free banking period that increased systemic instability/fragility, then saying that free banking in the US wasn’t really free banking because of X and Y regulation is a valid counter-point.

    Especially because much more free systems existed elsewhere, some contemporaneously, you’re not so much arguing against free banking as objecting to people invaliding your example. I’m a lab tech working in a materials testing lab. We invalidate tests all the time because it wasn’t a perfect enough example of the kind of test we were trying to run. We just pissed one of our biggest customers off because we refused to accept as valid a test that they really, really wanted to be run as valid.

    General points of ‘the US ‘free banking’ period wasn’t really free banking’ might not be that great as arguments, but ‘laws requiring banks to keep state debt as security for their note issues, laws preventing banks from establishing geographically disparate branches (or branches at all in some cases), and other specific regulations caused the non-state banking system of the antebellum United States to be full of small, under-capitalized banks over-exposed to swings in the fortunes of small numbers of debtors’ ARE valid counter-arguments to your citation of antebellum banking in the US against free banking in general.

  133. Gravatar of Suvy Suvy
    27. December 2012 at 22:11

    MichaelM,

    Let’s take a look at this issue from a demand side perspective. The shifts in people’s expectations result in the shifts of both borrowers and lenders willingness to take on risks. The shifts of these expectations(mainly the expectations of earnings from assets) resulted in too much leverage being used to buy assets which in turn drove up the price of assets and drove down their volatility. Once the volatility of assets increases as asset prices fall from unsustainable levels, the debts remain. These debts have to be wiped out in one manner or another. The same thing could happen in an economy with free banking. It doesn’t fix this fundamental problem; if you force fractional reserve in addition to free money/banking, that would solve the problem. The problem is the unsustainable rise in debts relative to incomes and this unsustainable rise in asset prices results from human behavior(at least in the model I’m using–Hyman Minsky’s model). Unless we can fix human behavior or stop the use of leverage to bid up asset prices, we can’t solve this problem. It has nothing to do with free banking so much as it has to do with the demand side implications of the destruction of debt.

  134. Gravatar of Needed for 2013, a paradigm change | Historinhas Needed for 2013, a paradigm change | Historinhas
    30. December 2012 at 07:48

    [...] to Scott Sumner the dominant paradigm is not very useful, in fact quite useless Of course private industry [...]

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