What George Warren would tell the Japanese (if he were alive today)
Early in my blogging career I did a post entitled “My Role Model, George Warren.” Warren was the brains behind FDR’s dollar depreciation program of 1933 (Irving Fisher was also a proponent of the policy.) Here’s a portion of the post:
One reason FDR abandoned the program is that many economists told him that the devaluation was already plenty big enough to restore the 1926 price level. They said that gold would flood into the U.S. after the gold standard was restored, and the monetary base would soar. They were right about the gold flows and the base, but not about commodity prices. Only Warren understood that the rational expectations hypothesis implied that expected future growth in the money supply was already embedded in commodity prices, and the markets were telling FDR that more inflation was needed. Here is a quotation from Warren’s personal notes a few months later (describing FDR’s disappointment when commodity prices stopped rising in 1934):
“The President (a) wanted more inflation and (b) assumed or had been led to believe that there was a long lag in the effect of depreciation. He did not understand-as many others did not then and do not now-the principle that commodity prices respond immediately to changes in the price of gold.”
I don’t have the data at home, but I believe the WPI rose over 20% during the devaluation, and then only another 5% or so between 1934 and mid-1940.
Today it seems like the Fed is just waiting around to see if their low interest rate policy will work. And pundits endlessly debate whether the fiscal stimulus package will succeed. As far as I’m concerned the verdict is already in. What matters for policy is not whether something “will work,” but rather whether the optimal forecast suggests it is expected to work. As Lars Svensson (another guy recently praised by Krugman) emphasizes, policy should adopt a stance that it expected to hit the policy goal. Right now the stock, commodity, and bond markets are signaling that the current policy stance is woefully inadequate. Indeed, even the Fed’s internal forecast suggests that we will fall short of their own implicit target.
Four years later and the Fed is still behind the curve. But this example reminds me of Japan in 2013, which has been following FDR’s playbook—reflation through currency depreciation. They’ve done a lot already, and it will help. But I’m inclined to agree with Charles Dumas in the Financial Times, it’s still not enough:
At just over Y100 to the dollar the yen is cheap enough to get Japan’s economy back to its trend level from 2.5 per cent below it, with growth of 3 per cent this year and perhaps 1 per cent in 2014, and to eliminate deflation. Sharp increases in import costs could raise CPI inflation to 2 per cent (the new long-run target) by year-end or early 2014, but domestic costs are now still falling. That may stop by the end of next year, but CPI inflation could also fall back to zero unless there is a further yen devaluation, perhaps to Y120 versus the dollar. Inflation of 2 per cent is unlikely to last with the measures adopted so far.
A hundred yen to the dollar will deliver some growth—but if they are serious about getting domestic reflation they probably need an even sharper currency depreciation. Japanese bond yields are still too low.
HT: Saturos
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4. June 2013 at 06:36
Forgotten today is that Japan tried sustained QE 2001-6 and John Taylor raved about it, called it a success. In fact, the BoJ 2001-6 QE coincided with Japan’s longest postwar expansion, though not particularly robust. Inflation was nearly dead, and when they stopped, they went back to ZLB-land perma-gloom.
This is what bothers me: The BoJ stuck with QE four years, and obviously they quit too soon.
I think the Market Monetarism community is not owning up to this: That QE may have to become permanent.
Sumner has pointed out the sustained global movement to lower interest rates. We have decades of downward drift, and are converging in ZLB land.
Why? Perhaps global capital gluts, caused by savers who want or have to save, regardless of interest rates. This abetted by increasing numbers of people who can save, rather than spend every penny on just surviving.
So Fed Tool #1 is dead. They cannot lower interest rates anymore.
This leads to important questions: If QE must be sustained, then who should run the Fed? It will assume a larger revenue function than before.
I suspect most people will answer by saying QE need not be sustained. The record in Japan, and emerging here in the USA, says otherwise. We are running PCE deflator at 0.7 percent y-o-y now. You want to quit QE? When?
4. June 2013 at 06:37
The insight that you can immediately judge the effectiveness of a policy by market reaction is probably the most important thing I’ve learned all my time spent reading this blog. Whatever the flaws of rational expectations and EMH, and in my opinion there are many, there are important kernels of truth that people really need to think about (most people assume markets are very dumb when the opposite is the case).
4. June 2013 at 06:38
Ben Cole,
I think Scott is going to respond that the Fed just needs to work on getting expectations up through decisive action rather than sustaining a policy of QE that has already failed to do enough.
4. June 2013 at 06:42
Ben, Good point about 2006—they backed off too soon then as well.
Thanks John.
4. June 2013 at 06:46
Scott
Seems “scare” is a ‘directional thing’. Nobody cried out when Gov Bonds in Japan went from 0.9% to 0.4% in a few months or while the yen went from 100 to 76. But cry ‘foul’ when bond yields climb back to 0.9% or the yen jumps back to 100!
4. June 2013 at 06:50
If the only way that the BOJ can get 2% inflation is by targeting *higher* than 2% inflation (and hoping to miss the target), then it seems the theory of central bank omnipotence is shattered.
4. June 2013 at 07:23
Stanley Fischer was speaking today:”Targeting nominal GDP is not practical. The GDP data we have is not stable. That’s why I think we target nominal GDP.”
http://www.themarker.com/news/1.2038038 (hebrew)
4. June 2013 at 07:24
Corrected – Stanley Fischer was speaking today:”Targeting nominal GDP is not practical. The GDP data we have is not stable. That’s why I think we should not target nominal GDP.”
4. June 2013 at 07:39
Further depreciation of the yen will only be endorsed once policymakers realize that boosting domestic consumption and not necessarily exports are the primary goal.
4. June 2013 at 07:56
Jonathan,
What matters just as much as which variable you target (inflation or NGDP) is whether you are targeting expectations or reacting to past data. The point of this post is that central banks are reacting to past data instead of targeting the forecast.
For instance, I think Scott would argue that the 2008-2009 crisis would have been much better if the Fed had been acting based on inflation forecasts in the TIPS market instead of passively tightening because they were looking at high past inflation due to soaring energy prices that later plummeted. Looking at the forecast instead of the past, the Fed could’ve acted sooner and the whole debacle might not have happened or been so bad.
BTW, I wonder if that guy thinks that inflation data is more stable or more scientific than GDP data. The Fed seems comfortable talking about an inflation target but inflation is not measurable in any precise way. Different prices rise or fall at different rates and each person’s consumption preferences will determine how they experience price changes. To paraphrase Ludwig von Mises, a diligent housewife could tell you as much about inflation as any economist.
4. June 2013 at 08:49
Any comment of what seems to have changed in perceptions in the last week.
In Japan – the NKY dropped about 2000 point ~ 7% the Yen stengthened about 3%
US had a smaller sell off at the same time. All of the rumor in both countries seems to be focused on possibly less QE than forecaset. But there is little new information from any sort of reliable source.
4. June 2013 at 11:42
Marcus, That’s right.
Max, They need to target market forecasts of 2%–that’s the point.
Jonathan, You’ll have to be more specific. What does “unstable” mean?
Doug, Yes, probably rumors of less monetary stimulus. I did a post a few days ago that pointed to news stories in Japan suggesting that stimulus might be reduced.
4. June 2013 at 16:35
Slight correction: Charles Dumas of Lombard Street Research (a macroeconomic forecasting consultancy) He happens to do articles for the FT on occasion.
Also, Mr. Dumas is the author of several books. He was way out front on the global savings glut with “The Bill from the China Shop: How Asia’s Savings Glut Threatens the World Economy published in Jan 2006.”
5. June 2013 at 12:25
Thanks Ricardo, I’ll change it.