Questions for readers

I’d like to get some reader input on a couple issues I noticed in the blogosphere:

1.  The Gretsky Strategy

As you know I have long advocated a policy of targeting the forecast.  Preferably NGDP targeting, level targeting.  But even price level targeting would be better than the so-called “inflation targeting” that we now have.  In contrast, John Taylor is famous for having proposed a backward-looking policy that calls for the Fed funds target to be adjusted according to historical data on inflation and output.  (BTW, the difference between the policy goals, NGDP vs. a weighted average of inflation and output gaps, is much less important than the difference between backward- and forward-looking regimes.)

Last month Taylor did a post that cited this Plosser analogy using hockey great Wayne Gretsky:

So I was pleased that Philadelphia Fed President Charles Plosser, in a speech last Tuesday in Rochester, came up with an even better analogy: hockey. He tells the story of how “Hockey great Wayne Gretzky was once asked about his success on the ice. He responded by saying, ‘I skate to where the puck is going to be, not to where it has been.’ He didn’t chase the puck. Instead, Gretzky wanted his hockey stick to be where the puck would be going next. He scored many goals with that strategy, and I believe monetary policymakers can better achieve their goals, too, if they follow the Gretzky strategy.”

Here is my question to you guys.  Whose monetary policy proposal is most similar to the Gretsky strategy?   Mine, or John Taylor’s?

In a more recent post Taylor asked for improvements in his plan based on sound monetary theory.

DeLong is wrong about what he claims “John Taylor in the long run wants.” Don’t we all want good monetary policy? If there is a better policy rule that improves economic performance, then I am all for it, and I don’t much care what you call it. In 2008 I proposed adjusting the Taylor rule with the Libor-OIS spread to deal with the turbulence in the financial markets. The Curdia and Woodford papers analyzed that proposal and improved on it by changing the coefficient on the Libor-OIS spread. Their analysis was not based on statistical curve fitting, but rather on good monetary economics, which is what we need more of right now.

I’d gladly call my plan the Taylor Rule 2.0.  And I think it is based on the “good monetary economics” of Svennson (target the forecast), the EMH (markets forecast better than experts) and Woodford/Bernanke (the market forecast should predict the instrument setting expected to hit the policy goal, not the goal variable itself.)

HT:  Justin Tapp

Part 2.  Do you like bullies?

I was intrigued by these comments by Matt Yglesias and Felix Salmon on the Iceland banking situation:

Felix Salmon on the UK’s shameful bullying of Iceland:

“I’m quite ashamed of the bullying tactics being used here by the UK government. What happened was that an Icelandic bank, Landsbanki, started attracting UK depositors through its Icesave brand. When Landsbanki failed, the UK government bailed out those depositors in full. And now it wants that money back from the Icelandic government, which never guaranteed the Icesave deposits. If you thought the cod wars were bad, this is much worse.

If the UK were picking on a country its own size, here, I wouldn’t feel so bad. But Iceland is tiny, and has no real means to fight back, other than essentially saying “OK, then, hit me.” Which is what it’s just done. I hope that the UK doesn’t follow through on its threats — even if that means damaging its own credibility going forwards.”

You can make a decent case for the policy decision of the UK government. Failing to bail out the Landsbanki depositors could have launched a panic and caused runs on other banks—British banks—with British depositors. The costs of dealing with that would plausibly have been higher than the costs of bailing out the Landsbanki depositors. But either way, the choice was made by the UK government. The idea that the government of Iceland somehow owes an obligation to make it up is bizarre.

The really outrageous thing, however, isn’t the behavior of the UK—people want money—but the IMF, which seems to be making emergency loans to Iceland contingent on knuckling under. The IMF is supposed to prevent international finance crises by throwing lifelines to countries in need of help. Instead it’s acting like a member of an extortion racket.

By now you know that I am a contrarian, so you probably expect me to take Britain’s side.  But my initial reaction was sympathetic to Yglesias’ and Salmon’s arguments.  There is a very informative comment section after Salmon’s post.  The commenter at 1/7/10 12:50am is pro-UK, but point 10 on his list does favor Iceland.  Here are a few questions I have:

1.  Do countries have an ethical obligation to pay debts if doing so would hurt their citizens in utilitarian terms, even taking account of future punitive actions by others?

2.  The same question, but now from a global utilitarian perspective?  (Say a $200 billion dollar debt from Bangladesh to the US.)

3.  Is the UK trying to recover money on bank accounts that exceed 20,000 euros?   (The UK covered a much higher amount.)

4.  Is the 5% interest penalty fair?

5.  Is the UK partly liable for prematurely closing the Icelandic banks to save its own system from a bank run?

6.  Is the UK partly liable for lax regulation of these banks?  Or are the banks completely regulated under Icelandic law, and under no obligation to adhere to UK banking regulations?

7.  Would the UK’s attitude be the same if these losses were incurred by banks from a small, poor, less well-educated, less democratic country?  Should the attitude be the same?  (Assume equal legal obligations.)

I should know the answers to some of these questions, but I don’t.  Any help would be appreciated. 

BTW:  I’m not fan of the IMF, but Yglesias makes one observation that I am very skeptical about:

The harsh treatment the IMF inflicted on several countries in the nineties when they needed help did an enormous amount of human damage. Then by encouraging Asian countries to rack up massive piles of reserve dollars to prevent future punitive IMF conditionality wound up doing even more harm by introducing distortions into the global economy.

I don’t understand this comment at all.  Perhaps he is referring to the high interest rates adopted by many of the crisis countries.  But that wasn’t tight money, rather it reflected collapsing currencies.  The only Asian countries that pursued deflationary policies at that time were HK, China and Japan.  And what do you notice about those three?  None are under the thumb of the IMF.  Maybe Yglesias relied on Joseph Stiglitz’s account.  He thought the high interest rates in SE Asia during the period of collapsing currencies was a sign of excessively tight money.  And that the IMF was somehow captured by “market fundamentalists.” For those that enjoy partaking in schadenfreude, check out this Rogoff demolition of Stiglitz

Part 3.  Another argument for stimulus.

I have never favored bailing out debtors.  Rather I prefer a policy of stable NGDP growth, level targeting.  Getting NGDP back on the track that was expected when loans were incurred is not a bailout, it is simple fairness.  And it would also help reduce unemployment, boost stock prices, and reduce the national debt.  And it would lead to better government policies on the supply side.  Robert Shiller provides another advantage that I had not considered:

Strategic default on mortgages will grow substantially over the next year, among prime borrowers, and become identified as a serious problem. The sense that ‘everyone is doing it’ is already growing, and will continue to grow, to the detriment of mortgage holders. It will grow because of a building backlash against the financial sector, growing populist rhetoric and a declining sense of community with the business world. Some people will take another look at their mortgage contract, and note that nowhere did they swear on the bible that they would repay.

Again, I don’t favor bailouts.  Here I am only referring to the section of the quotation that I italicized.

HT:  Alex Tabarrok

Part 4.  Nick Rowe on AS/AD.

Nick Rowe has a very educational post on the AS/AD model.  Reading it helped clarify some things that I sort of understood, but only vaguely.  He explains things beautifully.  If I was in Abu Ghraib, and forced to take a course in Keynesian economics, I’d choose Nick as my instructor.

This is near the end of his post:

Suppose the Canadian economy were perfectly competitive, rather than monopolistically competitive. Start in long run equilibrium. Now suppose there’s a shock to relative demand. Half the firms get a 10% decrease in demand, and the other half get a 10% increase in demand. No change in Aggregate Demand.  Hold prices temporarily fixed.  Half the firms cut output 10%, the other half hold output constant and ratio sales. On average, output declines by 5%. We see a recession.

Now repeat the experiment assuming monopolistic competition. Half the firms cut output 10%; the other half increase output 10% (assuming MC<P). On average, output stays the same. No recession.

It doesn’t end there, of course. In the longer run, firms with declining demand will cut their prices relative to firms with rising demand, and resources will flow from the former to the latter. And those flows will involve some real costs, and might involve higher than normal unemployment rates during the adjustment. There is such a thing as structural unemployment.

But monopolistic competition might explain why AD shocks seem to matter much more than recalculation for market economies.

P.S.1: This post is sort of a response to Scott Sumner, Tyler Cowen, and Arnold Kling.

A few comments.  Arnold Kling’s recalculation story is a real model of the business cycle.  I have a nominal shock model.  Tyler Cowen thinks real shocks account for about 2/3 of the problem, and falling NGDP for the other 1/3.  All of us agree that ‘aggregate demand’ is a misleading term. 

I actually agree with everything in Tyler’s post, except I would estimate the relative shares differently.  I’d say the first 1%, or maybe 1.5% percent rise in unemployment was mostly structural problems in housing and energy intensive industries.  This was roughly the period from 2007 through mid-2008.  The next 4.0% to 4.5% increase in the unemployment rate (mid-2008 to November 2009) was due to falling NGDP.  Indeed I think the recent fall in output and rise in unemployment is about what you’d expect from a negative 8% NGDP shock.  Some might argue that the intensification of the banking crisis after Lehman was a sort of real shock.  I agree, but I think that part of the banking crisis was an endogenous response to expectations of falling NGDP.

One reason I don’t like the Keynesian model is that I regard it is providing an excessively simplistic model of what’s inside that black box known as the macroeconomy.  I think monopolistic competition with sticky prices is an excellent model, and explains a portion of market economies.  But I also think perfect competition with sticky wages is a good model for commodities.  And I think that monopolistic competition with flexible prices and sticky wages is a good model for big capital goods.  (Unless I am mistaken, the prices of big capital goods are not usually sticky, rather they are negotiated at each transaction.)  The standard Keynesian model cannot explain the interrelationship between wages, prices and output in 1933, or indeed in the Great Depression as a whole.  And since I have devoted most of my life to studying the Great Depression, and consider an explanation of the Great Depression to be the sine qua non of demand-side macroeconomics, I consider that to be a pretty big flaw.

But don’t view that comment as reflecting negatively on Nick’s post.  Even I agree that most American firms are in monopolistically competitive industries and that they exhibit some price stickiness.  And I have never seen a clearer explanation of that aspect of the Keynesian model. 

Part 5.  Scott Sumner, China pessimist

Check out this prediction from a Nobel Prize-winning economist.  Twice Europe’s per capita GDP in 2040?  This is great!  Now I can position myself equi-distant between China optimists like Fogel, and China pessimists like Tyler Cowen.  I’m the reasonable guy.

Part 6.  Life is unfair!

I am not a student at GMU.

 


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29 Responses to “Questions for readers”

  1. Gravatar of malavel malavel
    7. January 2010 at 10:16

    1. Countries (like companies) are not moral entities. So it’s pointless to talk about ethical obligations for them. The citizens might have that obligation though. But I would argue that they usually don’t have it since few states are created or run in a morally justifiable way. If I lived in Iceland I would ignore are moral issues and vote purely from a cost benefit point of view.

    3. Is the UK trying to recover money on bank accounts that exceed 20,000 euros?
    A: Someone who seemed to know a lot about the issue claimed that they only wanted to recover up to 20,000.

    I actually considered depositing money in an Icelandic bank shortly before the crash. However, in Sweden they were using a Swedish registered company and where therefore covered by the Swedish insurance. In their ad they still claimed that if, for some weird reason, a customer couldn’t get money from that insurance, the Icelandic one would still cover it. So they were twice as secure. As it happened, the depositors got money from the Swedish insurance.

  2. Gravatar of azmyth azmyth
    7. January 2010 at 11:33

    4: AS/AD is possibly the most misleading model in all of economics. I am opposed to it in the same way you are opposed to inflation. Normally, the y axis is listed as “Price”, but what does that mean? In micro supply and demand, prices are relative prices, but the relative aggregate price of everything is always 1 (price of everything/price of everything). The nominal price level is meaningless as well, since no one cares what the numbers on the currency are, only what they can buy. Tyler’s inflation model is only slightly better, but theoretically any steady state of inflation is equivalent to any other, since people will simply index it into their contracts.

    What about expected inflation? Inflation higher than what was expected is just a symptom of higher than expected demand or a supply shock. Too many dollars chasing too few goods. If expected inflation is on the Y axis, this would make the AD curve slope upward as higher than expected inflation is typically associated with high AD. Maybe this is what Krugman is always talking about when he says AD slopes upward. With expected inflation on the Y axis, the AS curve is a curve sloped like “)”. Producers supply less when inflation is far lower than they expect, but also when inflation is far higher than they expect. Furthermore, expected inflation is not connected to the opportunity costs of agents like a microeconomic demand curve. While a consumer compares the cost of a good to their alternatives to decide whether to buy a single good, they have no alternative when it comes to spending on aggregate.

    …or do they? The alternative to spending money is not investment, since that is just another type of spending. The alternative to spending on aggregate is holding currency. My final alternative for the Y axis of a AS/AD graph is prices relative to the demand to hold currency. If people are holding more currency than they want to, they increase their demand until they achieve equilibrium. The downward slope of AD is then restored with high real cash balances near the origin and low real cash balances (high prices relative to cash balances) further up the axis.

    Even with all of these formulations, we still fall short of the standard graph, because suppliers don’t care about cash balances. They just care how much people will buy at each price. I don’t have an answer as to what the graph should be, but I don’t think anyone else does either (including Nick Rowe).

    He writes:
    “D is the (aggregate) quantity of output that people (and firms, and government) are willing to buy; AS is the quantity of output that people (etc.) are willing to sell; Y is the quantity of output that is actually bought and sold.”

    I think “willing to buy” just means that they would buy something if conditions were different. Someone either buys something or doesn’t buy it. If the price sticker says $1, but the good isn’t available, the price is effectively infinite. Maybe he’s just saying something I don’t understand.

  3. Gravatar of jj jj
    7. January 2010 at 12:36

    re: #1 The Gretsky Strategy

    While agreeing that price level targeting is ideal, I still think the distinction between forward- and backward-looking rules needs to be analyzed in the context of expectations. It’s a complicated feedback system, not an obvious linear extrapolation.

    Here’s a Carlstrom/Fuerst (2000) paper that looks relevant.
    Abstract: This paper analyzes the restrictions necessary to ensure that the policy rule used by the central bank does not introduce real indeterminacy into the economy. It conducts this analysis in a flexible price economy and a sticky price model. A robust conclusion is that to ensure determinacy, the monetary authority should follow a backward-looking rule where the nominal interest rate responds aggressively to past inflation rates.

    http://www.clevelandfed.org/research/workpaper/2000/Wp0009.pdf

  4. Gravatar of jj jj
    7. January 2010 at 12:37

    (Note: I couldn’t follow all of the terminology, so maybe it’s not relevant at all!)

  5. Gravatar of OGT OGT
    7. January 2010 at 13:06

    Gretsky’s being a bit facile here. Every kid in pee-wee hockey is taught to skate to where the puck is going to be. Gretsky was just better at it than anyone else, because it’s actually a little hard to do. Whether or not that says anything about futures based monetary policy is another matter.

  6. Gravatar of 123 123
    7. January 2010 at 13:14

    Part 1. – 100% agree with you.
    Part 2. – Iceland and UK belong to common economic area (EEA). As a member of EEA, Iceland received some benefits, and so should be at least partly responsible for repayment of insured deposits.

  7. Gravatar of azmyth azmyth
    7. January 2010 at 13:19

    After reading the post again, I think I understand what he’s trying to say. Different market structures react very differently to demand shocks. The closer you get to perfect competition, the more Y will adjust if you hold prices constant. If that is his message, I completely agree. Firms can use market power to cushion themselves against shocks. I still think his terminology is confusing.

  8. Gravatar of thruth thruth
    7. January 2010 at 14:03

    Maybe I’m reading too much into it, here’s a thing that I find particularly revealing and wrong headed about Plosser’s Greztky analogy. The objective of the Fed is not to beat the market players, it’s to provide a stable environment for them to play in, more like a ref. So just like a ref, the Fed should be watching all the market players. The best aggregator of the players actions we have is the market. On the other hand, Plosser, seems to want to be Gretzky: “Let’s out-guess those b****ards”

  9. Gravatar of Doc Merlin Doc Merlin
    7. January 2010 at 14:34

    1. Prediction is necessarily a risky strategy. However, I agree its better. And yes, I agree that market based predictors would be more Gretsky-an than centralized predictors. However, in order to design a good market predictor, you have to get the micro incentives right otherwise its very, very bad, because you are predicting something other than what you think you might be.

    2. This is not the only example of English bullying. Far worse was using antiterrorism laws to shut down Icelandic banks in the UK which accelerated the damage for iceland.

    3. I think it is a bit late for a more inflationary monetary policy to bail us out of this mess. At this point all it would fix is the idiocy congress imposed by raising the min wage.

    4. It is a good post.

    5. I am no where near as optimistic about china as some. I see some huge icebergs of problems lurking in China’s economic seas. Foremost are these:
    A. China’s economy is very reliant on fiscal stimulus and on trade subsides (mostly monetary ones). This makes them in the short term achieve great growth, but it makes their growth brittle, for similar reasons to Japan in the 80′s.
    B. China’s demographic pyramid is slowly inverting. While this is happening growth often speeds up, but after it happens, it seems things stagnate very quickly. Here the US is far better positioned than China.

    In short, I see China as the current big future, like Japan was in the 80′s, but the next big future won’t be China.

    6. Yah, GMU seems like a very neat place. :-)

  10. Gravatar of rob rob
    7. January 2010 at 15:48

    I enjoy partaking in schadenfreude and thank you. I read Stiglitz’s Globalization and Its Discontents. As a non-economist I am unable to evaluate his policy prescriptions, but his bitter, crybaby tone rendered a lot of his “account” highly suspect to me.

  11. Gravatar of RebelEconomist RebelEconomist
    7. January 2010 at 16:16

    A UK point of view on Iceland:

    My understanding is that Iceland is only being expected to pay the standard deposit guarantee of about 20K euros. The decision to cover a larger amount was made by the UK government, and the cost will be borne by the UK taxpayer. If it had been thought that Iceland would not be good for this guarantee, Icelandic banks would not have been able to take deposits in the EU. Apparently, by nationalising their banks, the Icelanders ensured that their own depositors were fully protected. I believe that the UK used anti-terrorist legislation as an emergency measure only, to freeze the assets of the Iceland banks in the absence of a clear commitment from the Icelandic government to cover the deposit guarantee. The burden for Icelanders is painful, but not terminal – say of a similar size to the cost of a US university education.

  12. Gravatar of RebelEconomist RebelEconomist
    7. January 2010 at 16:39

    While I generally deplore Balkan-style history-based nationalist points, lest anyone view Iceland as being bullied by a larger country, I cannot resist pointing out that the population of Iceland today is approximately the same as the population of Kingston-upon-Hull BEFORE Iceland established its 200-mile fishing boundary, and its per capita income is still much higher even after last year’s slump.

  13. Gravatar of Jim Glass Jim Glass
    7. January 2010 at 17:56

    Part 5. Scott Sumner, China pessimist. Check out this prediction from a Nobel Prize-winning economist…

    Imagine China had never gone communist and its growth had started a couple generations sooner. Would we already be in the Chinese Century?

  14. Gravatar of Jon Jon
    7. January 2010 at 18:21

    Scott: On the surface the Taylor rule is entirely backward looking, but there are some mathematical/macroeconomic reasons why that simply surface impression is not entirely correct.

    The Taylor rule purports to set the nominal-rate i to close a feedback with the real growth in GDP. Of course the only way this can work is for the CHANGE prescribed by the Taylor rule to be a surprise. Which is to say, essentially that the economy (mathematically) differentiates the application of the Taylor rule.

    i.e., some of the effects of the Taylor rule arise from the derivatives of the output and inflation gaps not from the differences alone as naively appears to be the case.

    In so much as the overall system is locally-linear, the appearance of such a derivative in the formulation implies that the feedback stabilization is ‘forward’ looking.

  15. Gravatar of ssumner ssumner
    7. January 2010 at 18:51

    malavel, And from Sweden! I see where you got your name. Seriously, when I say what should Iceland do, I mean what should its policymakers decide to do. Utilitarianism is a perfectly fine ethical system, as long as you remember to include all costs and benefits, not just monetary.

    azmyth, I agree that AD has nothing to do with demand as a function of relative prices. But this can’t be right:

    “If expected inflation is on the Y axis, this would make the AD curve slope upward as higher than expected inflation is typically associated with high AD.”

    This confuses shift in the AD curve with a movement along the AD curve. If AD shifts right, both AD and prices rise (even if the AD curve slopes downward.)

    You said;

    “I think “willing to buy” just means that they would buy something if conditions were different. Someone either buys something or doesn’t buy it. If the price sticker says $1, but the good isn’t available, the price is effectively infinite. Maybe he’s just saying something I don’t understand.”

    If you read Nick’s whole post, he does address that issue.

    jj, I am not certain, but I think their paper suggests that price level targeting is better than inflation targeting. Under price level targeting you respond to past inflation errors, but can also set policy to target the forecast.

    OGT, I wasn’t trying to use Gretsky to prove a point, Taylor was. I was just trying to figure out whether the point Taylor proved was my point or his.

    123, I agree. I think they should negotiate a face saving compromise. Maybe have Iceland cover all deposits under 20,000 euros, but allow 40 years to repay at an extremely low interest rate (which makes it an implict repudiation of part of the debt.)

    In general I think countries should honor their debts unless the burden is intolerable. Iceland is a borderline case. they could probably handle this with some difficulty. But it’s hard for me to work up much indignation about the British not being repaid, when we are still waiting for them to repay us the money they borrowed to fight WWI. Heh, that’s an idea! Since the Icelanders are angry at the UK right now, just give us the money, and tell the Brits that they paid off a part of their WWI debts for them.

    azmyth#2, Yes, that’s right.

    thruth, I guess there are lots of ways of looking at the analogy, but when I first read it I thought it sounded more like my proposal of a forward-looking policy.

    Doc Merlin, You said;

    “5. I am no where near as optimistic about china as some. I see some huge icebergs of problems lurking in China’s economic seas. Foremost are these:
    A. China’s economy is very reliant on fiscal stimulus and on trade subsides (mostly monetary ones). This makes them in the short term achieve great growth, but it makes their growth brittle, for similar reasons to Japan in the 80’s.
    B. China’s demographic pyramid is slowly inverting. While this is happening growth often speeds up, but after it happens, it seems things stagnate very quickly. Here the US is far better positioned than China.”

    I am no where near as optimistic as Fogel. I really can’t understand how someone so smart could think China will be twice as rich as France in 30 years. It just boggles the mind. I think there is a small chance they could catch up to France by then, but twice as rich? And he is a Nobel laureate. Indeed I usually like his stuff. Perhaps he was misquoted.

    I don’t think their economy is at all dependent on trade subsidies and fiscal stimulus. Their companies can easily export without any subsidies, they are really efficient. And they would actually grow faster without fiscal stimulus, as it pumps up the less efficient parts of their economy.

    The do have demographic problems. But the biggest one isn’t ageing, it is the shortage of females. Their birth rate is much higher than the Japanese, so the inverted pyramid problem is far smaller.

    rob, There is a longer version out there that is even more effective.

    rebeleconomist, I partly agree (see my answer to 123 above.)

    You said;

    “The burden for Icelanders is painful, but not terminal – say of a similar size to the cost of a US university education.”

    This is the kind of thing people use when then want it to make something seem small. But you could also say its 60% of GDP, roughly the size of the US or UK national debts. That makes it seem big.

    But I do see your point, it is manageable (with difficulty.)

  16. Gravatar of ssumner ssumner
    7. January 2010 at 18:54

    Jim Glass, Yes.

    Jon, For some reason I had trouble following that point. I don’t see why monetary changes have to be unexpected to affect the economy. Unexpected at the time wage contracts are signed, but not unexpected as of the new data on prices and output.

  17. Gravatar of thruth thruth
    7. January 2010 at 20:42

    Scott Sumner said “thruth, I guess there are lots of ways of looking at the analogy, but when I first read it I thought it sounded more like my proposal of a forward-looking policy.”

    Oh, don’t get me wrong I see it that way too. Thinking about how much the Fed admires its own forecasting made me see the analogy in another light.

  18. Gravatar of Jon Jon
    7. January 2010 at 22:21

    Scott: How do changes in nominal variables couple into real variables? … by violating expectations… i.e., surprise.

    When new data on prices and output emerges and a policy is set, that policy differs in some way from the expectations when contracts were made. That’s what matters. Consequently, the absolute value of the Taylor rule is not what couples to real-effects, but rather the difference between the taylor rule in this period and the expectations of what the Taylor rule would be for period as anticipated at the prior time.

  19. Gravatar of malavel malavel
    8. January 2010 at 01:42

    Scott, I have no idea what malavel has to do with Sweden. It’s just a random name I came up with for a pen & paper role playing game. But it seems like it’s a real name in the south eastern parts of Europe.

    I’m not a utilitarian, even though I believe it’s important to look at issues from a utilitarian perspective. But do you make a distinction between ethical obligations and moral obligations? The morally correct thing for the Icelandic policymakers would be to disband the state. But I’m not sure that that would be a good thing to do. It depends on whether there are morally acceptable alternatives that works (like anarcho-capitalism).

  20. Gravatar of Icelandic dilemma « Freethinking Economist Icelandic dilemma « Freethinking Economist
    8. January 2010 at 03:36

    [...] Scott Sumner has a good look at this here.  His summary of the cost-benefit side is quite pithy: ‘1.  Do countries have an ethical [...]

  21. Gravatar of Marcos Marcos
    8. January 2010 at 04:31

    I’m wanting to post a question here for a long time, but didn’t know how to frame it before… Make no mistake, I’m not an economist, but I’m quite interested on economics, so I’m an unualy informed uninformed person :)

    About #1, is there any evidence that any kind of nominal prices growth stabilization would avoid such kind of downturns, and by what amount? By nominal stabilization I mean your NGPD targeting proposal, nominal price targeting, inflation targeting or any similiar measure. I understand that theory says that prices, wages and interest are sticky, consequently, stabilization is good, but what exists on practice? Is there any comparison?

    Now my opinion: As I see it, foward looking may be overated. I belive that (given that nominal price targeting works) the mix of foward and backward looking that central banks do everywhere works better, that is modeling a not very different from usual behaviour based on fundamentals, act on it, but correct the model all the time with the measured data. That way an absurd model won’t stay absurd for too long.

  22. Gravatar of OGT OGT
    8. January 2010 at 09:01

    Scott- I clicked through to the actual Fogel article through your link and it’s no misquote. His analysis is very weak Faith Popcorn like stuff, the one pertinent point he makes is about the growth of education in China. Other than that he completely misses the actual shape of China’s demographic curve (not mention the relationship of that curve to growth in educational attainment) and expresses unbounded optimism in China’s top down leadership.

    See that’s how you get a pay check out of the People’s Party, they’re not paying for any of this glass half full stuff.

    BTW, in previous comment my quibble was with Gretsky, not you or Taylor.

  23. Gravatar of Nick Rowe Nick Rowe
    8. January 2010 at 15:29

    Scott: Thanks!

    If prices are sticky, and we have monopolistically competitive firms, then it doesn’t matter much if wages are sticky too, because labour demand is constrained by output demand.

    But if wages are sticky and prices are flexible (or much more flexible than wages, which I think is your general view), then it gets interesting. If the labour market were perfectly competitive, then half the time wages would be above equilibrium, and employment would be demand-constrained, and half the time wages would be blow equilibrium, and employment would be supply constrained.

    Most importantly, if we start in equilibrium, hold money wages fixed, then increase AD, there would be a FALL in real output and employment. That is because P would rise, so W/P would fall, so we would move down along the (assumed) upward-sloping labour supply curve. The SRAS curve would be upward-sloping till it hit the LRAS curve, then BACKWARD-BENDING above that point. Sort of like this: > .

    To escape this unhappy prediction then you too would need to assume some sort of monopoly power, only in the labour market, so that wages are on average above the competitive equilibrium.

    I have no problem with assuming a monopolistic labour market in Europe, or Canada, but it’s a harder stretch in the US, at least recently (since President Reagan destroyed PATCO). But maybe the union threat effect? Dunno.

    azmyth: “4: AS/AD is possibly the most misleading model in all of economics. I am opposed to it in the same way you are opposed to inflation. Normally, the y axis is listed as “Price”, but what does that mean? In micro supply and demand, prices are relative prices, but the relative aggregate price of everything is always 1 (price of everything/price of everything). The nominal price level is meaningless as well, since no one cares what the numbers on the currency are, only what they can buy.”

    I handle this question in a follow-up post, http://worthwhile.typepad.com/worthwhile_canadian_initi/2010/01/macroeconomics-with-monopolistic-competition-in-pictures.html where I add some pictures too. Firms care only about relative prices, and relative prices are 1 in macroeconomic equilibrium. But the nominal price level matters because it affects the real money stock M/P, and the AD curve is an equilibrium locus of points in {P,Y} space such that the excess demand for money relative to goods is zero.

    “I think “willing to buy” just means that they would buy something if conditions were different.”

    By “the quantity people are willing to buy” i just mean what microeconomists mean when they say “quantity demanded”. It’s the quantity they *would* buy (at that price) if the seller were also willing to sell.

  24. Gravatar of scott sumner scott sumner
    9. January 2010 at 09:47

    Jon, That sounds right, assuming the Taylor Rule policy was credible and built into expectations.

    Malavel, No, moral and ethical mean the same thing.

    Marcos, There is lots of evidence, both time series and cross sectional. RGDP tends to be more stable over time and across countries when NGDP growth is kept more stable.

    I think forward-looking is better, indeed backward-looking is what got us into this recession.

    OGT, Thanks for checking. It really doesn’t matter what assumptions he makes, it seems really far-fetched that China would quickly became twice as rich as France. I think Luxembourg might be the only one to have done it, and I don’t see Luxembourg as a plausible model for a half-communist country with a billion poor people.

    And I’d say that even if their demographics looked great.

    Nick, I am pretty sure that all you need is monopolistically competitive labor markets, which describes almost all US labor markets. Even in non-union auto factories their are 100 job applicants for each job (even in boom times.) The US labor market isn’t even close to perfect competition. Indeed it is far more monopolistic than our product markets.

  25. Gravatar of Nick Rowe Nick Rowe
    9. January 2010 at 10:50

    Scott: OK. If US labour markets are approximately monopolistic, then it is fairly easy to transform my model into “your” model. The demand curve facing an individual firm becomes the labour demand curve facing an individual union. The firm’s marginal revenue curve now becomes the union’s marginal revenue curve. The firm’s marginal cost curve becomes the labour supply curve. P becomes W. It all works out.

    And one key (surprising) point of such a model is that whereas the individual union faces a downward-sloping demand curve at the micro level, at the macro level the trade-off between real wages and employment will be much less steep. It might easily be horizontal, or even upward-sloping. An increase in employment at the macro-level need not require a fall in real wages, even if it does require a fall in real wages at the micro-level.

  26. Gravatar of scott sumner scott sumner
    9. January 2010 at 11:16

    Nick, I’m still confused (but it is probably my fault.) In “my model” wages are sticky and prices are not (actually are less sticky.) So an AD shock raises P and lowers W/P due to sticky wages. So how can you say P becomes W?

    Regarding your second paragraph, here’s how I like to think about things:

    1. Monetary policy determines NGDP.
    2. For any given NGDP, lower wage rates raise output in the short run (obviously assuming at least some slack in the economy.)

    Does that sound right? I presume krugman would nto agree with ny assumption that monetary policy determines NGDP.

  27. Gravatar of 123 123
    9. January 2010 at 13:49

    Scott,
    you did not mention one important thing about Iceland. Wikipedia says that when Landsbanki failed, Iceland guaranteed domestic depositors by stripping assets and domestic deposits from the old Landsbanki, and depositors of foreign branches were left with almost nothing.

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

  28. Gravatar of Mark A. Sadowski Mark A. Sadowski
    9. January 2010 at 15:39

    Scott,
    You wrote,
    “I don’t understand this comment at all. Perhaps he is referring to the high interest rates adopted by many of the crisis countries. But that wasn’t tight money, rather it reflected collapsing currencies.”

    My perception is that Yglesias is referring to the IMF’s establishing of tight standards for fiscal policy for those countries in exchange for assistance. Interestingly this is the opposite of what the IMF is advising the developed world today. Tight fiscal policy during the 1990s currency crisis may have exacerbated their economic downturn. Those countries vowed never to be in a position where they needed IMF assistance ever again.

    In response many of these countries have since followed a policy of maintaining large current account surpluses induced by currency debasement so that they could accumulate huge dollar reserves. This was the beginning of the large surge in current account imbalances that have plagued the world to this day.

  29. Gravatar of scott sumner scott sumner
    10. January 2010 at 19:00

    123, I presume that is what triggered the anti-terrorism action by the UK. I don’t know the legality of what they did, but it sounds fishy.

    mark, You may be right, but I don’t see how these current account surpluses “plague the world today.” If countries want to build up some reserves, then why shouldn’t they? I don’t see why that hurts other countries. Australia has run huge CA deficits for as long as I can remember, and they are doing fine.

    I don’t think we even need an IMF, countries should borrow from commerical banks if they need loans. But my suggestion to these countries is to follow in the footsteps of Singapore, and become a high saving society, then you won’t have to kowtow to the IMF during a financial crisis.

    I am not convinced that tight fiscal policies were the main problem either, but I am not an expert on that issue. You might be interested in Rogoff’s letter, he said the IMF quickly changed their mind on the fiscal issue. And small open economies cannot rely on fiscal stimulus to get out of a recession, they need to export more–especially when the world economy was booming, as was the case in 1998.

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