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.
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.