I’m getting whiplash from reading Free Exchange. Soon after Matthew Klein posted “Scott Sumner is Wrong,” Ryan Avent posted “The Wisdom of Scott Sumner.” (At least I’m told it was Matthew Klein, someone correct me if that’s wrong.)
At one point Ryan Avent responds to this statement by Klein:
[T]he evidence suggests that the Fed and other central banks can in fact use monetary policy tools to restrain credit growth without crushing the economy—if they want to…In practice, this approach would likely trade somewhat slower GDP growth during booms for much milder downturns and brisker recoveries. I suspect that most people today would have gladly taken that deal had it been offered to them in 2001.
You should read Ryan Avent’s very good response to this, but I will offer a slightly different take. Just one day after criticizing Krugman’s “Keynesian counterintuitive cleverness” I’m going to engage in the market monetarist equivalent. But first a bit of history. When I was younger the recovery from recessions was quite rapid. Both RGDP and NGDP grew far more rapidly in the initial recoveries from recessions of the 1920s through the 1980s, than during the recoveries from 1991 and especially 2001. Indeed if you’d like the Fed to be cautious, if you’d like for a slow rate of demand growth during the recovery, so that the recovery can last longer, then 2001-07 is your model. It was one of the slowest recoveries I’ve ever seen. So slow that the unemployment rate in early 2003 was still going up, despite the fact that the recession trough was in November 2001.
If we use the Bernanke/Sumner benchmark for the stance of monetary policy (NGDP growth and inflation) then monetary policy was unusually contractionary during these last two recoveries. So if you want a slow recovery to prevent the buildup of bubbles, then 2001-07 is close to an ideal.
What about the low interest rates? The low nominal interest rates reflected the slow recovery in NGDP. Interest rates are mostly endogenous. However other factors also reduced rates during this period, particularly the high rates of saving in Asia.
If the Fed had adopted an even tighter monetary policy, resulting in even lower NGDP growth, then US interest rates might well have resembled those in Japan—in other words they might have been even lower. Of course in the very short run a more contractionary policy would have raised rates in early 2002, but by 2003 and 2004 the rates might have been even lower than otherwise.
Ryan begins his post quoting me, and then responding:
“The young people today have grown up in a world dominated by two giant bubbles… Any thoughtful person today can predict that the macroeconomics policy failures of 2040 will be produced by a generation of late middle-aged policymakers obsessed with preventing bubbles.”[me]
One should be careful to note his point: it is not that concern over financial excess (like concern over demand- or supply-side disaster) is improper. It’s that our simian brains will naturally worry most about the last disaster to strike, effectively overweighting its potential costs in cost-benefit calculations and underweighting those of other possible macroeconomic troubles. [Ryan]
I’m already seeing this happen. I see increasing concern that the current low interest rate policy will lead to bubbles, and indeed concern that bubbles are already forming in everything from gold to stocks to farmland to Phoenix real estate. (Not Klein and Stein, but others.) This despite the lowest NGDP growth (mid-2008 to today) since Herbert Hoover was president. It’s very easy to see how people wedded to the interest rate view of policy (which is most people) could mistake low interest rates being caused by a weak economy, for low interest rates caused by easy money. This could lead to even tighter money, even weaker NGDP growth, and (over time) even lower interest rates.
Don’t think this can happen? Check out the data for Japan over the past 22 years . . . and counting.
And then notice that Japan recently faced criticism from the Very Serious People of Europe for its “easy money” policy. I kid you not.
PS. I was asked about this Tyler Durden post, which claims that depreciation of the yen hurts the US stock market. I’d be inclined to file this under “don’t reason from a price change.” There’s no doubt that depreciation of the yen caused by tighter than expected monetary policy in the US (which reduced expected NGDP growth) would reduce US stock prices. But I’d like to see data showing that depreciation of the yen caused by easier money in Japan also causes falling US stock prices. In not convinced. One policy reduces global output and the other raises global output. Macro is not a zero sum game.
PPS. Over the years I’ve argued that the Japanese let the yen get too strong. I got lots of push-back from commenters who suggested the US government wouldn’t allow the BOJ to run non-deflationary policies, because it would depreciate the yen. I’ve always been skeptical that the US was that evil, but now the essential goodness, the sweetness, the kindness of the US government has been confirmed:
Japan’s Nikkei (Nihon Kenzai Shinbun: .N225-JP) share average gained 1.9 percent on Tuesday and the yen weakened to a 33-month low against the dollar after a U.S.Treasury official seemed to voice support for Japan’s aggressive policies to combat deflation and bolster growth.
The U.S. Under Secretary for the Treasury for International Affairs, Lael Brainard, said that that U.S. supported proposals by the Bank of Japan (BoJ) to introduce anti-deflation policies that weaken the yen.
The market reaction suggests that a bit of uncertainty on the issue was dismissed by the kind-hearted
Mr. Ms. Brainard. But let’s face it; the yen had already appreciated depreciated strongly without any US complaints–so I really don’t see much evidence that the US was the cause of Japan’s 20 year deflation.
HT: Saturos, TravisV
Update: Britmouse sent me a report that “clarifies” the US comments on Japan. It seems we want them to adopt an easy money policy to end deflation, even if this causes the yen to fall. We just don’t want them publically talking about their policy:
Lael Brainard, the top US Treasury official for international affairs, sent the yen plummeting on Monday evening after commenting publicly that the US supported “the effort to reinvigorate growth and end deflation in Japan”.
The dollar gained further ground after the G7 statement was published in London on Tuesday. The statement – from finance ministers and central bank governors in the US, Japan, UK, France, Germany, Italy and Canada – said they would “consult closely” on any action in foreign exchange markets.
“We reaffirm that our fiscal and monetary policies have been and will remain oriented towards meeting our respective domestic objectives using domestic instruments, and that we will not target exchange rates,” the ministers and governors said. “We are agreed that excessive volatility and disorderly movements in exchange rates can have adverse implications for economic and financial stability.”
But an unidentified official from a G7 country later said the statement had been misinterpreted. “The G7 statement signalled concern about excess moves in the yen,” the official told Reuters in Washington. “The G7 is concerned about unilateral guidance on the yen. Japan will be in the spotlight at the G20 in Moscow this weekend.”
The dollar promptly gave back its earlier gains against the yen, falling back to Y93.2 in a volatile day on the currency markets.
In private, the US has been pressuring Japan’s new government to refrain from mentioning the yen as it attempts to revive growth and end deflation. The US Treasury refused to comment.
Of course monetary policy is less effective without communication. But what do you expect from an administration that has been brain dead on monetary policy from day one?
And for a few minutes I thought America really was a kind-hearted country. Silly me.