Krugman on NRFPC

Paul Krugman has weighed in on my “never reason from a price change” argument.

[And of course NRFPC it isn’t my idea; it’s a part of EC101 that many economists never learned, or forget on occasion.  Over at Econlog I cited a great Krugman essay where he claimed that one reason he became successful is that he took the stance of a rebel, while using arguments out of standard econ textbooks.  I suggested someone else who had modest success doing exactly that.]

Here’s Krugman:

Sumner says that you can’t reason from a price change; the dollar doesn’t just move for no reason, so you have to go back to the underlying cause and ask what effect it has. Actually, asset price moves often have no clear cause “” they’re bubbles, or driven by changes in long-term expectations, so you really do want to ask about the effects of price changes you can’t explain very well.

Obviously I don’t agree about the existence of bubbles–Fama shoots that idea down in his Nobel lecture.  But even if I’m wrong about bubbles, Krugman is wrong about the relevance of never reason from a price change to bubbles.  It matters very much why prices change, even if those reasons are irrational.  For instance, stock prices may be driven to irrational heights because:

A.  People are irrationally pessimistic about NGDP growth, and this depresses bond yields to unreasonably low levels, and this discounts a given flow of earnings at a higher valuation.

B.  People are unreasonably optimistic about the economy, and expect a highly implausible rate of growth in NGDP and profits.

Surely you can’t argue that it doesn’t matter which of those two types of irrationality cause the stock price “bubble”?  And surely you can’t have confidence that something is a bubble without having some sort of view as to what market thinking is leading to the excessive price movements?

Krugman continues:

More specifically, Sumner is right that if the euro’s fall is being driven by expansionary monetary policy, this affects the U.S. through the demand channel as well as competitiveness, so it may be a wash. But I’ve already argued that the fall in the euro is much bigger than you can explain with monetary policy; it seems to reflect the perception that Europe is going to be depressed for the long term. And if that’s what drives the weak euro/strong dollar, it will hurt US growth.

I agree with the reasoning process in the last sentence.  But I don’t think it applies to the current case, as it seems very unlikely that lower growth expectations are what is depressing the euro.  Here’s what we do know:

1.  Eurozone growth expectations have been in the toilet for years.

2.  The euro was valued at about $1.35 for years, and then gradually fell to about $1.05 over the past few months.

3.  During the past few months the growth forecasts of the eurozone have been revised upward, as the euro has been falling.

You don’t need to be an EMH fanatic like me to see a problem with Krugman’s argument. Kudos to him for not reasoning from a price change, for not lazily assuming that a weaker euro meant more growth.  But I think’s he’s gone too far in the other direction, in assuming that the cause of the weaker euro was lower growth expectations.

Having said that, I’ll admit I’m a bit puzzled by the timing of the euro’s fairly steady decline.  Some of that was associated with easy money statements coming out of the ECB, but not all. So there may be some other factor depressing the euro that I don’t see. I just don’t see any evidence that slower growth in the eurozone is that mysterious X factor.  It’s not new information.  On the other hand Krugman’s right that weaker growth might be the cause, so I’m willing to revise my views as new information comes in, such as another growth pause in Europe.  There is no theoretical issue at stake here, separating our two views.

Off topic, don’t read too much into my statements on Fed policy over the next few years.  Unlike in past years, when the Fed was clearly much too tight, I don’t think they are far off course.  Some of my statements might suggest I think policy is not far off course, others might suggest I think policy is a bit too tight to hit the Fed’s dual mandate.  There is no contradiction between those statements.  It’s hard to evaluate current policy without knowing where the Fed wants to go, and they refuse to tell us where they want to be in 10 years, either in terms of the price level or NGDP.  If they would tell us, I’d recommend they go there in the straightest path possible.

Also, I see people talking like it’s perfectly obvious that Fed policy is now much tighter than ECB policy.  That’s not at all obvious.  What causes that perception?

1.  The ECB has recently loosened, and the Fed may have slightly tightened.

2.  Rates are lower in Europe, and they are doing QE.

Neither of those are good reasons.  During 2011-14 ECB was far tighter than in the US. So even though they have loosened, it doesn’t mean that ECB policy is looser in absolute terms. The deeper into a liquidity trap you fall, the more “concrete steppes” you need to achieve a given policy stance.  And the eurozone has fallen very, very deeply into their liquidity “trap.”  Of course neither interest rates nor the monetary base are good indicators of the stance of policy, unless you want to argue that the Fed’s highly deflationary policy of 1932 was actually easy money because rates were near zero and the Fed was doing QE. That claim would have been viewed as wacky 10 years ago, although I admit that many economists now seem hopelessly confused about how to define the stance of monetary policy.

As always, NGDP futures markets in the two regions would best establish the relative stances of monetary policy.  TIPS markets suggest the ECB is still effectively tighter.

HT:  Foosion, Edward


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51 Responses to “Krugman on NRFPC”

  1. Gravatar of Steve Roth Steve Roth
    15. March 2015 at 07:41

    How about NW&S futures markets?

    (Wages and salaries.)

  2. Gravatar of ssumner ssumner
    15. March 2015 at 07:57

    Steve, Good idea, but I suspect it would closely track NGDP futures.

  3. Gravatar of Jason Jason
    15. March 2015 at 07:59

    Indeed, Steve.

    If you look at wage growth, it has been unusually weak in this recover, look at Core CPI, it has been under 2%. The REAL Nairu, not the one the Fed estimates, is still ways off. The fed is tightening in June because what… Exactly? “Normalization”???!!!

    Please, how absolutely disgusting. The fed is going give the shaft to workers, and sabotage real wage growth in the absence of meaningful indicators of inflation, and contribute to growing inequality.

  4. Gravatar of E. Harding E. Harding
    15. March 2015 at 08:26

    @Jason
    Why would nominal wage growth translate into real wage growth, anyway? And real wages have not been especially weak this recovery; neither have nominal wages. Also, QE contributes to inequality, as richer people tend to own more assets. QE is stimulus, but it’s not a magic elixir.

  5. Gravatar of Jason Jason
    15. March 2015 at 09:05

    E Harding,
    If the fed tightens before there are any signs of inflation breaking through the 2% core CPI barrier, in response to falling unemployment and rising nominal wages,, then it is effectively sabotaging real wage growth and preventing millions of jobs from being created when inflation is not even on the horizon. I don’t know why you find this so difficult to understand if nominal wages rise much faster than the inflation rate m, that means real wages are growing. (Say 4%-1% equals 3% real wage growth.) to add insult to injury, nominal wages throughout this recovery have been growing at a very meager rate, I don’t know where you are getting your data from.

  6. Gravatar of E. Harding E. Harding
    15. March 2015 at 09:27

    There is nothing extraordinary going on here:
    http://research.stlouisfed.org/fred2/graph/?g=14dO
    Also, real wages fall much faster in inflationary than in disinflationary recessions. During the past recession, real wages strongly rose due to falling inflation. So why would Fed tightening lead to slower growth in real wages?
    http://research.stlouisfed.org/fred2/graph/?g=14dP

  7. Gravatar of Radford Neal Radford Neal
    15. March 2015 at 09:32

    I don’t understand the question. Is it purely predictive – “Does observing the rise in the Euro vs. the US dollar mean that we should revise downwards our prediction of growth in the US, compared to our prediction before observing the rise?” Or is it a policy question – “If the US takes steps to prevent the Euro rising vs. the US dollar, growth in the US will be higher than if they don’t take such steps?” For the policy question, I’d think it would depend on which of various possible steps are being considered…

  8. Gravatar of Assorted links Assorted links
    15. March 2015 at 10:43

    […] 4. Paul Krugman argues you sometimes should reason from a price change.  And Scott in response. […]

  9. Gravatar of Assorted links – Freedom's Floodgates Assorted links - Freedom's Floodgates
    15. March 2015 at 11:15

    […] 4. Paul Krugman argues you sometimes should reason from a price change. And Scott in response. […]

  10. Gravatar of collin collin
    15. March 2015 at 11:26

    I am guessing the dollar moves against the Euro has the least effective on US jobs and growth compared to other major currencies. (It is not the dollar vs. yuan/ruppee/petrostates) My guess the fall in the Euro is overreaction to the Greece situation and other depressed economies while the current German economy is inducing deflation.

    That said, I also take the dollar moves are in reflection of worsen global situation in the Middle East, Russia, and South America. Companies are being more careful of investing and selling in these countries and thus forcing companies to purse US growth.

  11. Gravatar of Vaidas Urba Vaidas Urba
    15. March 2015 at 11:43

    Scott,

    did you notice how Krugman reasoned from interest rates in his post?

  12. Gravatar of ssumner ssumner
    15. March 2015 at 15:11

    Jason and E. Harding. FWIW, I think easier money is likely to lower real wages slightly, in hourly terms, but overall I think it helps labor because real wages in yearly terms rises due to much more employment. So I agree with each of you, depending on how you define real wages.

    Radford, Purely predictive.

    Vaidas, Where did he mention interest rates?

  13. Gravatar of benjamin cole benjamin cole
    15. March 2015 at 16:29

    Excellent blogging. But until I see 6% NGDP growth for three years running, I say money is too tight.

  14. Gravatar of Major.Freedom Major.Freedom
    15. March 2015 at 16:47

    Even if the Fed credibly promised that the price level or NGDP in 10 years time will be X, that will mean very little to the average business.

    The revenues and prices of goods sold by a business firm cannot be assumed as rising at any mathematical function of aggregate spending or price level increases.

  15. Gravatar of Michael Byrnes Michael Byrnes
    15. March 2015 at 17:04

    Major Freedom wrote:

    “The revenues and prices of goods sold by a business firm cannot be assumed as rising at any mathematical function of aggregate spending or price level increases.”

    Absolutely true, but completely irrelevant. The rationale for nominal income targeting is not based on the above being true.

  16. Gravatar of Major.Freedom Major.Freedom
    15. March 2015 at 17:23

    “Obviously I don’t agree about the existence of bubbles-Fama shoots that idea down in his Nobel lecture.”

    Obviously I agree about the existence of bubbles-Hayek explains that idea in his Nobel Prize winning work.

    “But even if I’m wrong about bubbles, Krugman is wrong about the relevance of never reason from a price change to bubbles. It matters very much why prices change, even if those reasons are irrational.”

    What if stock market bubbles are rational in the sense that even if an individual investor knows they are caused by the Fed, and knows they are temporary as long as the Fed remains in control of money, and knows Austrian theory of business cycles, and knows the music will come to an end at some point, that he can still potentially make gains by investing and then getting out before his future buyers do the same?

    There is no need to call investors in MBS “irrational” simply because there existed investors who thought they could get in and out before the music stopped, but they ended up being the last.

    “And surely you can’t have confidence that something is a bubble without having some sort of view as to what market thinking is leading to the excessive price movements?”

    Again, there is no one single “market view” that has one monolithic single view on all prices. There are many independent and separate investors who each have independent separate views and expectations. There is no need to explain the entire market as if the market were an individual investor. Such a thing does not even exist.

    Surely you realize that Fama’s antagonism against bubbles is grounded on his metaphysical notion that something can only exist if it is predictable, right? That bubbles don’t exist because they cannot be predicted? Surely both you and Fama believe in the existence of Earthquakes I hope. Earthquakes cannot be predicated, but they are still very much real. Bubbles are also real, even though we cannot predict when they occur.

    Robert Lucas had this to say about EMH:

    Mr Fama arrived at the EMH through some simple theoretical examples. This simplicity was criticised in The Economist’s briefing, as though the EMH applied only to these hypothetical cases. But Mr Fama tested the predictions of the EMH on the behaviour of actual prices. These tests could have come out either way, but they came out very favourably. His empirical work was novel and carefully executed. It has been thoroughly challenged by a flood of criticism which has served mainly to confirm the accuracy of the hypothesis. Over the years exceptions and “anomalies” have been discovered (even tiny departures are interesting if you are managing enough money) but for the purposes of macroeconomic analysis and forecasting these departures are too small to matter.

    Lucas has admitted that markets depart from what EMH predicts.

  17. Gravatar of Major.Freedom Major.Freedom
    15. March 2015 at 17:34

    Michael Byrnes:

    “Absolutely true, but completely irrelevant. The rationale for nominal income targeting is not based on the above being true.”

    You might want to tell that to the posters here who have claimed otherwise.

    Also, if nominal income targeting does not tell any individual business firm what their own revenues will be, then it provides zero information and cannot serve as anything that will alter individual firm behavior. As a result, it will only be the other effects of the same cause of changed NGDP that will affect firm behavior.

  18. Gravatar of Philo Philo
    15. March 2015 at 18:29

    “It’s hard to evaluate current policy without knowing where the Fed wants to go, and they refuse to tell us where they want to be in 10 years, either in terms of the price level or NGDP. If they would tell us, I’d recommend they go there in the straightest path possible.” But why accept the Fed’s objective, whatever it may be, as valid? If they wanted to take us to hell, would you recommend that they do so as efficiently as possible? I think the Fed needs your advice about *what objective to aim for*, as well as about how to achieve that objective.

  19. Gravatar of Larry Larry
    15. March 2015 at 18:50

    I think it’s about Greece and what Greece says about the future of the Euro, which is all bad. I’m expecting a chaotic Grexit and that everybody will then say “what about the rest of southern Europe? They’re all messed up and not fixing anything meaningful.”

  20. Gravatar of Jose Romeu Robazzi Jose Romeu Robazzi
    15. March 2015 at 19:32

    Mr. Sumner, I don’t understand your statement “Obviously I don’t agree about the existence of bubbles-Fama shoots that idea down in his Nobel lecture.” . What do you mean? You mean 1. Bubbles are impossible given EMH, or 2. Abrupt asset prices can happen, but we can fix that with monetary policy ? As a practirioner I tell you, asset prices may be very far from what can be justified by “fundamentals”, e those discrepancies can last a really long time, so, the idea that a bubble (incorrectly over priced assets for a long time that suffer an abrubt correction) may happen is very real to me …

  21. Gravatar of Ray Lopez Ray Lopez
    15. March 2015 at 19:58

    @MF, well said. @Robazzi – see below on Sumner’s warped idea of a ‘bubble’, but let’s see if Sumner sticks to his definition or changes things, as he is wont to do.

    Sumner: “And of course NRFPC it isn’t my idea; it’s a part of EC101 that many economists never learned, or forget on occasion. …Obviously I don’t agree about the existence of bubbles-Fama shoots that idea down in his Nobel lecture.”

    So Krugman does not know elementary economics? And humans are never irrational? In another post, years ago on this blog, Sumner says a bubble cannot exist if, if the future, the prices return to the bubble level (absurd if you think about it, since 1000 years from now, with constant money growth, prices will of course be much higher than today, even exceeding today’s bubble prices, but that does not mean you cannot have a bubble today)

    The rest of Sumner’s post is a confusing mish-mash of red herrings, non sequitors and off-topics.

  22. Gravatar of Vaidas Urba Vaidas Urba
    16. March 2015 at 01:18

    Scott,

    Krugman writes: “But I’ve already argued that the fall in the euro is much bigger than you can explain with monetary policy”, and this sentence has a link to a post which is a pure fallacy of reasoning from interest rate change.

  23. Gravatar of Jussi Jussi
    16. March 2015 at 01:44

    About EMH:

    https://medium.com/bull-market/the-last-time-i-saw-richard-thaler-speak-he-talked-about-the-beauty-contest-game-in-the-beauty-2e0b767d9098

  24. Gravatar of Derivs Derivs
    16. March 2015 at 05:31

    “I’ll admit I’m a bit puzzled by the timing of the euro’s fairly steady decline. Some of that was associated with easy money statements coming out of the ECB, but not all. So there may be some other factor depressing the euro that I don’t see.”

    Of course you can’t. Despite turning on a TV and seeing all those monitors on traders desks, filled with charts. Despite me pointing out that daily volume on WTI exceeds physical demand by 9 to 1. You refuse to accept the fact that price is generally being moved by very large momentum (technical) traders for whom the scent of weakness is like blood to a shark and will pound away on price until, like physics, momentum runs into an equal or greater force. Force often being themselves covering gains at major technical levels.
    I would not have considered myself as having been a directional trader, but who/what moves price became clearly obvious to me.

  25. Gravatar of ssumner ssumner
    16. March 2015 at 06:12

    Philo, You said:

    “I think the Fed needs your advice about *what objective to aim for*, as well as about how to achieve that objective.”

    And I’ve given them that advice, a NGDP level target, at 4% or 5% per year. But my current policy advice should NOT be consistent with that long run target, if that is not in fact their long run target.

    Ray, I think it’s fair to say that Krugman understands NRFPC. He may occasionally slip up in that area, as do I, but he understands it.

    Jose, I mean closer to number 1.

    Vaidas, OK, I’ll follow up on the link.

    Derivs, So you think it is easy to get rich, because markets are not efficient?

  26. Gravatar of Kenneth Duda Kenneth Duda
    16. March 2015 at 06:15

    > Surely you can’t argue that it doesn’t matter which of those two types
    > of irrationality cause the stock price “bubble”?

    I thought “bubble” means more than just “higher than a reasonable
    value”. I thought “bubble” means people buying at a price they believe
    is too high with a specific plan to sell to a near-future buyer at an
    even higher price, sort of a spontaneous pyramid scheme.

    If you buy that, then there is one and only one reason people would buy
    in a bubble market: the expectation of selling in the near future at an
    even higher irrational price.

    I have never understood how “easy” money could lead to bubbles. The
    only thing looser money leads to is more spending.

    -Ken

    Kenneth Duda
    Menlo Park, CA

  27. Gravatar of Andy Harless Andy Harless
    16. March 2015 at 07:10

    Excellent point about different possible reasons for irrational price movements.

    But I take some issue with your interpretation of the second Krugman quote. To me, “Europe is going to be depressed for the long term” is not a statement about growth prospects per se. It’s a statement about excess aggregate supply. Obviously this is related to growth, both because growth prospects affect the natural interest rate (hence the possibility of excess aggregate supply when the actual rate is at a lower bound) and because sufficiently strong growth in demand would eliminate excess aggregate supply. But in the case of Europe today, I don’t think it’s unreasonable to expect ongoing problems on both the supply side (which would be, in some sense, a continuation of earlier weak growth prospects) and the demand side (which could be consistent with above-trend growth in the medium run, as Europe works off some, but not all, of its current excess aggregate supply).

    I find it quite plausible that the reason for the weak euro is an expectation that the EZ is expected to remain below full employment for a very long time even as the US reaches it. Since the US is much closer to full employment than the EZ right now, this expectation is consistent with nearly at-trend growth in the US and above-trend growth in the EZ.

  28. Gravatar of Randomize Randomize
    16. March 2015 at 07:37

    I suspect the collapse of oil prices has something to do with the dollar’s overall strength compared to the Euro et. al. these past few months. With oil traded almost exclusively in US dollars even in international markets, it’s easy to imagine how what we perceive to be a collapse in the price of oil could be perceived as an increase in the value of the dollar by those outside of the US.

  29. Gravatar of Steven Kopits Steven Kopits
    16. March 2015 at 09:06

    You’re going to expect me to make an oil comment, and I am.

    With the surge of shale oil production from the middle of 2011, the US trade deficit began to improve. Thus, while European countries were under duress to reduction oil consumption after the Arab Spring, the US was able to respond with import substitution and minimal reductions in oil consumption, particularly after mid-2013.

    Now, after the beginning of 2014, the overall US trade deficit stabilized, but the oil portion of it continued to fall. Thus, in the last year, the savings in oil imports are being directed, pretty much one-for-one, into imports of goods from manufacturing countries, like Europe, China and Japan.

    I suspect this settling of the US trade deficit into a ‘comfort zone’ is a function of the demand for US debt abroad. Thus, exporting countries seek to induce the US to produce debt, and are willing to export goods to the US to create this debt as payment for said exports. The inducement to for the US to buy these goods is lower import prices, ie, currencies depreciating broadly against the US dollar.

    I leave it for the economists to debate, but such an explanation has some intuitive appeal from my perspective.

  30. Gravatar of Steven Kopits Steven Kopits
    16. March 2015 at 09:07

    See the second graph down:

    http://www.calculatedriskblog.com/2015/03/trade-deficit-decreased-in-january-to.html

  31. Gravatar of Carl Carl
    16. March 2015 at 09:13

    When you say that bubbles don’t exist, do you mean that there is not a deterministic way to identify when the market is overpriced?
    If that’s right, what conditions have to exist for a market to be bubble proof?

  32. Gravatar of Michael Byrnes Michael Byrnes
    16. March 2015 at 09:21

    Andy Harless,

    That all seems perfectly reasonable. But doesn’t Scott’s point still stand: things have looked bad in the Eurozone (with regard to reaching full employment, etc) for quite some time now – how does that explain the recent price change?

  33. Gravatar of ssumner ssumner
    16. March 2015 at 09:40

    Ken, I’m not a bubble expert, but my impression is that you have provided one of several competing theories of what causes bubbles. But AFAIK the term ‘bubble’ just means price has risen without good (rational) reasons. The theory you mention implies irrationality among those who buy near the peak, as a rational person would know that bubbles eventually crash. You are right that this is one popular theory.

    Andy, That’s a good argument, but I’d encourage you to take another look at my paragraph starting “Having said that”. Especially the part about the lack of new information in recent months (on lower future GDP.) We are not that far apart.

    I also have a new post on this, written before I read your comment. I do acknowledge in the new post that Krugman has a decent argument, however I’m still not fully convinced.

    Steven, It just doesn’t seem like oil is big enough to have much effect, but I suppose it could be a factor in the “butterfly effect” sense of chaos theory.

    Carl, I’d encourage you to look at some of my earlier posts on bubbles. It’s not easy to test the theory. I’d look for evidence that others have discovered market irrationality, such as serially correlated excess returns.

  34. Gravatar of Derivs Derivs
    16. March 2015 at 12:01

    “Derivs, So you think it is easy to get rich, because markets are not efficient?”

    No, I would say the survival rate of an active directional trader is well under 5%. Chance of being REALLY successful would be a few more decimals out.

    EMH would suggest 50/50?

    As for overvalued and undervalued – There’s no god who knows the fair value of any traded asset.

    Regardless, ignoring the tech guys (directionally), even if it is only self fulfilling, is a bad idea if you want to understand price movements. They just make up too much of the daily volume traded.

  35. Gravatar of Derivs Derivs
    16. March 2015 at 14:02

    “EMH would suggest 50/50?” I did not mean 50 eventually successful / 50 eventually losing
    I meant you can trade actively all day and if you are active enough you should be flat. Or at least that’s the idea of random walk.

  36. Gravatar of Jose Romeu Robazzi Jose Romeu Robazzi
    16. March 2015 at 15:37

    all, I think that asset prices can be over/under valued, given a certain set of “fungamental” information. I agree with Soros on this topic, markets are always wrong, but I also agree with Summner, makind has not found any other better way to try to find prices, which lead us back to the Austrian theory of prices, one of an ever evolving process rather than an equilibrium. But I don’t think that prices that are very distant from a valuation that can be justified by “fundamental” information is a good definition of a bubble. I think that a good definition of a bubble is when in a particular sector you have asset prices that could potentially be very different from what “fundamentals’ would suggest, AND they are financed poorly, either with very little capital to absorb losses and/or with a large liquidity mismatch (i.e. long term assets financed by short term funds) AND is big enough to have a systemic impact. Asset prices have leptokurtotic distributions, when an adverse shock happens, aggressive price corrections can happen, as we all know, and if the problem is just mismatch in financing, monetary expansion surely can solve the problem, but when we have losses that cannot be covered by capital in the system, well, then loose money helps, but maybe it will not solve the problem.

  37. Gravatar of Derivs Derivs
    16. March 2015 at 16:02

    Jose,
    So you are saying that 2 different products with equal price moves and equal distances from what you perceive as “fundamental” value, only if you have the knowledge of how much leverage is involved can you determine it to be a bubble.

    Personally I think it’s semantics non-sense, call it manic or call it overly enthusiastic or call it a bubble, but remember that simultaneously, to the guy short it feels like a bubble and to the guy long it does not.

    Why not agree with all 3. The market is always incorrect in its search for equilibrium but it is by far the best system for price discovery that one can come up with. I have said here before about markets …all the market is, is a big feedback mechanism trying to find equilibrium.

  38. Gravatar of Jose Romeu Robazzi Jose Romeu Robazzi
    16. March 2015 at 17:01

    Derivs,

    I think that to call a phenomenon a bubble ex-ante is very hard, even if my hypothesis is in the right direction, and you have the information (that maybe is not public), because it’s all about confidence. You may have a lot of leverage and stretched valuations and still not see a market plunge. Ex-post, many (if not all) historical events often qualified as “bubbles” did have large leverage and streteched valuations, followed by tight money periods…

  39. Gravatar of Major.Freedom Major.Freedom
    17. March 2015 at 02:53

    All:

    Bubbles are encapsulated in REAL phenomena. They are not prices or spending or anything in terms of nominal statistics.

    A bubble takes place when projects in a diviion of labor are started that do not and will not have sufficient real resources, complimentary or otherwise, to complete. It is the interim stage before realization on a sufficiently wide scale and subsequent corrections take place.

    Central banks typically refrain at some point from accelerating inflation which is necessary to prolong (and central banks can only prolong, they cannot eliminate) the bubble in order to maintain its control over the economy’s money. Economists call this “saving the currency”. It is really central banks maintaining their power.

    As a result, history looks as though depressions and recessions are caused by those episodes of monetary contraction (or reduction in inflation), when in reality they are caused by what made the contractions perceived a necessary, namely, the previous periods of inflation of the money supply that take the form of credit expansion and alters the real economy’s temporal structure to not match what consumers are willing to set aside for long term projects.

    The US economy, to become sustainable, should have went through a very steep depression 2008. Savings are among all time lows. Rather than deal with the political fallout, meaning Fed heads losing their jobs, and possibly their control, they flooded the economy with even more money, hoping to replace the virtually absent savings to consumption rate with fake savings. Greenspan and Bernanke have both said this was an important reason for why the Fed had to do what it did in their opinion.

    But what the Fed ended up doing was creating the mother of all economic bubbles. The real economy could not even fake recover like the Fed wanted it to, however. We all see how fragile the economy has become to even verbal statements from the Fed of reducing inflation. Capital owners have unwittingly, and from the individual’s perspective unwillingly as well, become addicted to inflation like a crack addict is addicted to crack.

    Sumner and monetarists in general are, and I say this strictly in terms of “economic function”, which I trust enough people here have heard Milton Friedman explain what it is, the Fed’s marketing dept for this “crack.”

    The real economy is what is in a bubble. Bubbles not price movements. Price movements are just one more manifestation of bubbles increasing and decreasing.

  40. Gravatar of Tom Tom
    17. March 2015 at 04:28

    MF, I mostly agree with you over Sumner about the realities of “bubbles” and near bubbles.

    The Tulip craze was a bubble; stock buying in 1927-29 was a bubble; dot.com stock buying was a bubble 1996-2000; house buying 2002ish – 2005 was a bubble.

    There was mass investment in some asset, which caused the price to rise, and many folk to become paper-price rich because of the price rise, which led to mass OVER-Investment. Often the over-investment is enabled by loose money — the ease of folk borrowing cash, especially including further investment in the rising asset.

    When a company or even many companies, over-invest, this is seen by negative returns on investment. Then when the expected positive return is “realized” as a negative return, the investing company loses money. If they lose enough money, they go bankrupt.

    “Easy money” means it is easy to borrow money. Not the interest rate, altho often a lower rate by a bank means they are more eager to lend, and more willing to.

    I am constantly annoyed that monetarists don’t keep and publish statistics on how many loan applications were approved and rejected, and in what amounts. Disappointed even here – maybe the statistics are easy to see, but I just don’t know.

  41. Gravatar of Daniel Daniel
    17. March 2015 at 05:34

    “Easy money” means it is easy to borrow money.

    No it doesn’t. Go away.

  42. Gravatar of Steven Kopits Steven Kopits
    17. March 2015 at 05:47

    Scott –

    The effect of oil could come through two channels.

    First, discipline could come through the current account. For many countries, oil imports are several percent of GDP. I think for India it was something like 7% pre-price drop, if I recall correctly. Thus, if oil rises in price, then an economy must adjust either through i) decreased imports of other goods; ii) increased exports of other goods; iii) import substitution; or iv) increased borrowing on the capital account. The European economies essentially adjusted by reducing oil consumption drastically and by improving their trade balance in other categories, that is, after 2008. Prior to 2008, many responded by increasing borrowing.

    The US, uniquely, was able to solve this problem with import substitution. And its economy was able to prosper uniquely as well.

    The other theory is the Volume Theory of Oil. In some sense, this follows from ‘don’t reason from a price change’. What matters, in this view, is the volume of oil available to the economy. Oil is embedded in a huge variety of goods and services. Therefore, if oil is scarce, then GDP growth depends on efficiency gains, and these are hard won. If you take a look at oil consumption as a share of GDP in the high oil price environment, you’ll see that countries were almost uniformly unsuccessful in reducing their oil import bills. For example, oil consumption in Greece fell by 32% (!) after 2005, and yet in 2013 Greece was paying almost twice as much as a pct of GDP for oil imports as it was in 2003.

    Both these lines of reasoning have their own weaknesses, but I feel the truth is somewhere in there.

  43. Gravatar of Carl Carl
    17. March 2015 at 12:22

    Thanks Scott.
    If it’s a big enough market with enough players, surely the probability of someone having “serially correlated excess returns” due purely to chance increases. In which case you still wouldn’t be able to tell if someone had identified a bubble or just won the lottery.
    Anyway, I’m reading through your previous posts in hopes that they’ll clarify the matter for me. I’m not as yet convinced that there aren’t bubbles. It seems to me a way of saying that nobody can know more than the vast majority of people who have money to invest.

  44. Gravatar of ssumner ssumner
    17. March 2015 at 14:06

    Tom, Easy money has nothing to do with what’s going on in the banking system. You are confusing easy money with easy credit.

    Steven, I agree that global oil supply shocks can impact global output, although I believe the effect is fairly small.

    Carl, You set up the test in such a way to as to avoid the data mining problem you mention. Maybe you can search for my “alchemy” post.

  45. Gravatar of Major.Freedom Major.Freedom
    17. March 2015 at 15:14

    Tom:

    Sumner’s response to you:

    “Tom, Easy money has nothing to do with what’s going on in the banking system. You are confusing easy money with easy credit.”

    Is highly misleading.

    He wants to have you believe that easy money from the Fed has no effect on credit expansion, and that the resulting easy credit expansion that increases the supply of money pyramided on top of the central bank’s easy reserves is the total supply money that we can say was caused by “The Federal Reserve *System*”, which is the system of the central bank plus its “member” banks that it directly issues new reserves to.

    Easy money in the broader economy is the total stock of money which is typically composed for the most part of credit expansion which is a multiple of the increase in newly issued reserves from the central bank.

    You have it right. Easy money is not independent from easy credit. You are not confusing the two.

  46. Gravatar of Eric Eric
    17. March 2015 at 15:32

    I think the largest reason for the appreciating dollar is Oil related but not necessarily fundamentally oil itself. The 2 things I would mention are the increase demand for $ denominated assets worldwide. Some of this is other centeral banks holding $$ instead of Euros. The other effect is that the drop in oil revenue has reduced the availability of $ denominated assets that originate outside of the US. The savings of oil states drove the availability of $$ to foreign borrowers. Now that source of $$ is falling and there is an increased demand for $$ at the same time driving demand for the dollar worldwide which has the effect of tightening.

  47. Gravatar of Major.Freedom Major.Freedom
    17. March 2015 at 15:33

    Easy money has a LOT to do with the banking system. The banking system is significantly affected by easy money. The Fed needs the banks to expand credit by large degrees if the Fed’s increase in reserves is going to affect the total money supply and aggregate spending.

    Ironically, Sumner’s theory *presupposes* a dependency on bank credit to bring about an increase in NGDP. For if the Fed kept printing and printing, but the banks did not expand lending, or even shrank it, then there would be little to no positive effect on total spending.

    In fact, with a significant enough decline in credit expansion from the banks, including an outright decline in outstanding credit, there can arise a decline in the total supply of money and a decline in total spending…even as the Fed is creating new reserves like gangbusters! This is what took place after 1929 and after 2008.

    Sumner was watching the result of credit collapsing, which consisted of a decline in the total supply of money. Broad money aggregate (M3, etc) growth actually went *negative* after 1929 and after 2008. The total stock of money declined after accelerating to high levels (which was itself caused by the central bank).

    What Sumner mistakenly believes is that the decline in credit (which was then followed by the Fed reacting in a way that Sumner’s social plan regards as not ideal) had nothing to do with the central bank’s previous undue inflation of reserves that distorted the real economy and caused calculation errors which then manifested in subsequent “credit contractions”.

    He wants us to believe, falsely, that there are no significant distortionary effects caused by a rate of inflation within his socialist plan, that later require deflation to cure. He wants us to believe, falsely, that a socialist money system, which is unbounded in money stock changes and bounded within a constant “modest” NGDP increase, will have no long term adverse effects on the capital structure of the economy.

    He wants to have us believe in a fairy tale, communicated of course with the usual technocratic jargon, and safe sounding ethics.

  48. Gravatar of Major.Freedom Major.Freedom
    17. March 2015 at 15:52

    Tom:

    “MF, I mostly agree with you over Sumner about the realities of “bubbles” and near bubbles.”

    Be advised that agreeing with me to any positive degree will let loose the hounds on this blog. The sensitivities and vanities of the regulars here interpret it as a jab at their own beliefs. Already resident troll Daniel finds a single sentence to dispute, ignores the rest, and tells you to “go away”. Perhaps you forgot to pay him tribute? Trolls need to be fed after all.

    “The Tulip craze was a bubble; stock buying in 1927-29 was a bubble; dot.com stock buying was a bubble 1996-2000; house buying 2002ish – 2005 was a bubble.”

    Agreed, but I would interpret these events as real bubbles. That is, too many resources that went into tulips, dot.coms, and housing. The stock prices are the monetary aspect of the bubble. I don’t define accelerating stock prices as bubbles. If the accelerating stock market prices are not associated with the real economy shifting to unsustainable configurations, then in principle stock prices can keep accelerating forever. Of course, that is unlikely, which is why we have heretofore always seen economic booms and busts correlated with stock market increases and decreases.

    “There was mass investment in some asset, which caused the price to rise, and many folk to become paper-price rich because of the price rise, which led to mass OVER-Investment. Often the over-investment is enabled by loose money “” the ease of folk borrowing cash, especially including further investment in the rising asset.”

    I would not call it “over” investment. That phrasing can easily lead to the mistaken notion that there is a finite space available for investment, beyond which it cannot be profitably invested.

    I would call it the wrong kind of investment.

    Too many houses were invested in, yes. But that doesn’t mean too much investment was made in general. For a sustainable investment could have seen fewer houses, and more of other things that could have been sustained with the savings made available.

    Bastiat had a good lesson on how to think like an economist. We must take into account not only what we see, but also what we can’t see. So if you see what seems to be an overinvestment in almost everything, with inventory piling up in almost all warehouses, and so on, then Bastiat’s lesson would enable us to look at that and not conclude “Uh oh, we invested in too much stuff!”, no, we would look at that and say “We should have invested differently, then the bottlenecks and discoordinations would have been avoided, and we would not have had to invest in less stuff in general.”

    “When a company or even many companies, over-invest, this is seen by negative returns on investment. Then when the expected positive return is “realized” as a negative return, the investing company loses money. If they lose enough money, they go bankrupt.”

    Investing too much in anything, always and everywhere means less investment elsewhere. A company that invests too much, signals that the capital should have been invested elsewhere. Then the real economy would have kept going and there would be no sudden widespread decline in profits and spending.

    |”Easy money” means it is easy to borrow money. Not the interest rate, altho often a lower rate by a bank means they are more eager to lend, and more willing to.”

    It depends on how those rates compare to whatever baseline(s) you are using to determine whether or not those rates signify “easy” money.

    “I am constantly annoyed that monetarists don’t keep and publish statistics on how many loan applications were approved and rejected, and in what amounts. Disappointed even here – maybe the statistics are easy to see, but I just don’t know.”

    Not sure either. Maybe you can consider the changes made in lending standards. Loosening standards might mean more applications are accepted, and tightening standards might mean fewer applications are accepted.

    We know that during the height of the housing bubble, it was easier then than it was prior. You can trace out the trends in lending standards. The political pushes for “ownership society”. The easy money from the Fed. And so on.

  49. Gravatar of Carl Carl
    18. March 2015 at 09:54

    MF:
    “For a sustainable investment could have seen fewer houses, and more of other things that could have been sustained with the savings made available.”
    How are you defining sustainable? Consistent prices? Consistent demand? Consistent supply? Prices, demand or supply conforming to some percentage annual growth that you determine?

  50. Gravatar of Bob Bob
    19. March 2015 at 10:50

    Concrete Steppes? Did Hungary just urbanize their share of the Pannonian Basin? It’s probably the only way the EU can claim to have a concrete steppe 🙂

  51. Gravatar of ssumner ssumner
    20. March 2015 at 05:53

    Bob, I see you haven’t keep up with the latest slang. Check out Nick Rowe on People of the Concrete Steppes.

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