Poetic License

I know that I promised to stop blogging again.  But when Krugman says something like this:

One of the curious things about economic debate in the later Bush years was the conviction among many on the right that there wasn’t a bubble in housing, but that there was one in oil.

We now know the truth about housing. But what about oil?

Oil prices did spike to triple-digit levels in early 2008, then drop sharply. But think about the fact that right now, with the world economy still seriously depressed, oil is at $80 a barrel. This suggests to me that high oil prices are largely caused by fundamentals.

How can I resist?  So what’s wrong with Krugman’s assertion?  Nothing at all.  You would expect the price of highly cyclical assets like oil or commercial real estate to fall by 40% to 50% in the deepest recession since the Great Depression.  Indeed I made an almost identical argument about both assets in several posts, noting that their prices did not start falling in mid-2006 when housing began decline, but rather in the second half of 2008, when NGDP started falling.

But there’s just one problem; I have a long memory and I seem to recall Krugman making exactly the opposite argument 6 weeks ago in this post on commercial real estate.  Actually, the US recession is worse than the world downturn, so ceteris paribus CRE prices should have fallen further.  On the other hand oil prices are somewhat more volatile in response to demand shifts.  So they fell by roughly equal amounts, as you might have expected.

Why the post title?  Just yesterday Krugman called himself a poet.  In fairness, he was half-joking, and he actually is brilliant at using metaphors to get to the intuition behind economic arguments.  As far as spotting bubbles, however, he’s not so brilliant.  Like most people he calls price patterns bubbles when he can’t explain them in terms of fundamentals.  BTW, what would Hayek think if he came back today and found so many people who confidently knew when markets were overpriced?  Why do we even need markets?  If it so obvious what the correct price is, let’s bring back Soviet-style central planning.  (On the other hand, even the Soviets couldn’t have done much worse than some of our bankers.)

OK, back to my book.


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63 Responses to “Poetic License”

  1. Gravatar of Quote of the Day « The Everyday Economist Quote of the Day « The Everyday Economist
    23. February 2010 at 08:07

    [...] — Scott Sumner [...]

  2. Gravatar of malavel malavel
    23. February 2010 at 08:10

    Whenever you feel the urge to blog when reading Krugman go to the ultimate productivity blog: http://productiveblog.tumblr.com. It’s the only productivity blog you will ever need.

  3. Gravatar of Greg Ransom Greg Ransom
    23. February 2010 at 12:21

    Hayek came up with the communication function of prices picture while thinking about systematic relative price miscommunication during a malinvestment distortion of relative prices across the structure of production through time — implicating credit and interest rates.

    You’re smart enough Scott to put 2 + 2 together here and answer your own question about Hayek and misperceived economic realities across the price structure of relative prices and production through time.

  4. Gravatar of Greg Ransom Greg Ransom
    23. February 2010 at 12:27

    Here’s a hint on Hayek.

    Theory tells us the structure of things can be systematically mispriced — and this can be sustained for a period of time — and we can see all sorts of after the fact evidence of this, and some can skillfully perceive aspects of it in
    advance — if they are looking at things through the lens of valid theory.

    Read Kirzner on the difference between a skilled ability to judge marke conditions vs “knowledge” as justified true belief. Entrepreneurial judgment / knowledge isn’t like knowing there is a beetle in your box.

  5. Gravatar of Doc Merlin Doc Merlin
    23. February 2010 at 12:54

    A good example of systematic mis-pricing is when everyone is using the same imperfect mathematical models to price securities. Sounds familiar doesn’t it? Well, eventually market reality caught up with these folks.

    “Oil prices did spike to triple-digit levels in early 2008, then drop sharply. But think about the fact that right now, with the world economy still seriously depressed, oil is at $80 a barrel. This suggests to me that high oil prices are largely caused by fundamentals.”

    SInce “we are running out of oil” is a dogma of the Progressivist faith, he wouldn’t consider a $147.30 to $80 drop a bubble bursting.

    Also as a side note, the 147+ dollar oil was a result of more of that nonsense that people believed we were close to running out. The market eventually corrected (some say overcorrected) for that nonsense with a $147.30 to below $40 massive swing, and everyone betting on $200 oil was out a lot of money.

  6. Gravatar of B B
    23. February 2010 at 17:53

    If people don’t think oil is worth $147/barrel on fundamental demand they seriously need to remember what it was like to take the bus.

    If poorer countries like China and India wanted to import oil at $147/barrel then surely the spoiled citizens of the more developed economies would and did pay up as well. Certainly in some places fuel prices may be distorted with subsidies, but it doesn’t change the fact that countries as a whole continued to import oil in the first half of 2008.

  7. Gravatar of B B
    23. February 2010 at 17:54

    Incidentally, I believe Krugman was consistent. He posted that CRE may have been a bubble and he suggested the Bush people were wrong to say that it was not a bubble.

  8. Gravatar of ssumner ssumner
    23. February 2010 at 18:38

    Thanks malavel, I’ll keep that in mind.

    Greg, So who did Hayek think was most likely to know the correct price; markets, or governments?

    I’m not a fan of the “justified true belief” definition of knowledge. If it’s a justified belief, then ‘true’ is rather redundant.

    Doc Merlin, I think Krugman is right about oil prices, I think they only fell because of the deep recession. But unlike Krugman, I also think that was true of commercial R.E.

    And I don’t think we are running out of oil. I think the problem in 2008 was demand was rising faster than supply.

  9. Gravatar of ssumner ssumner
    23. February 2010 at 18:42

    B, I agree on oil.

    But how can you say he was consistent? He said CRE was a bubble, and oil was not, even thought the two markets showed the same pattern, dropping sharply when the economy tanked.

  10. Gravatar of Greg Ransom Greg Ransom
    23. February 2010 at 19:29

    Note well, we’re not talking about a particular price here, were talking about the systematic connection between all prices across time and linked via time-taking production processes, etc.

    The government always plays a non-optional role in all this, esp. if th government has control of money and the banking system, via legal tender laws, exchange controls and a central bank, etc.

    I’m guessing you know that ultimately Hayek concluded that private banking would do all this better than government institutions, an argument Hayek got largely from one of his female students.

    “Greg, So who did Hayek think was most likely to know the correct price; markets, or governments?”

  11. Gravatar of Doc Merlin Doc Merlin
    23. February 2010 at 20:39

    @Greg:

    So its like, econlog’s “Markets fail, thats why we need markets” argument?

  12. Gravatar of Jim Glass Jim Glass
    23. February 2010 at 22:30

    The profile did reveal some interesting things about PK apart from penchant for poetry…

    1) Whatever he may say or write, he’s a believer in the Efficient Market Hypothesis:
    ~~
    Krugman and Wells pulled out of the stock market ten years ago and never went back. “It just takes a lot of work to think about it,” Krugman says…

    “We bought a couple of things,” Wells says. “We bought muni bonds and some Ford Motor bonds. The thing is, if you look at it on a historical basis, even back in the two-thousands, stocks are not cheap.”

    “They were a good deal when the average price-earnings ratio for stocks was thirteen or fourteen, but now, except at the very bottoms of recent swings, it’s been over twenty, which means that historical rules probably don’t apply anymore…”

    “I made some money and lost some in the Internet bubble,” Wells says. “You told me to sell and I didn’t sell, and I should have sold, and I never want to go through that feeling again.”

    “Let’s put it this way. I can have fairly high confidence—it’s a personality thing—that a market is overvalued. Somehow I never have the same confidence in saying that it’s undervalued.”
    ~~
    2) “Long ago, in Tel Aviv, his roommates found him attempting to dry his underwear in a frying pan.”

    Hey, I was a student who travelled across Eastern Europe in Communist days, and stayed in hostels and odd places where all kinds of strange things came into view … but never anyone drying underwear with a frying pan.
    ~~
    3) Krugman’s wife is the strident one:

    “she focusses on making him less dry, less abstract, angrier…

    “He had written, ‘As Obama tries to deal with the crisis, he will get no help from Republican leaders,’ and after this she inserted the sentence ‘Worse yet, he’ll get obstruction and lies.’…

    “she suggested things for him to add. ‘This would be a good place to flesh out the vehement objections from the G.O.P. and bankers to nationalization,’ she wrote on page 9. ‘Show us all their huffing and puffing before you dismiss it as nonsense in the following graf.’”…

    “On the rare occasion when they disagree about something, she will be the one urging him to be more outraged …”
    ~~~

    PK dies, reaches Heaven’s Gate, and learns from St Peter that God is a Republican.

    “My wife made me do it!”

  13. Gravatar of Scott Sumner Scott Sumner
    24. February 2010 at 05:45

    Greg, You said;

    “Note well, we’re not talking about a particular price here, were talking about the systematic connection between all prices across time and linked via time-taking production processes, etc.”

    Hayek and I both believe the government can inject noise into the price process. But the more complicated the price making process is, and your comment makes it seem very complicated, then the more I trust markets and the less I trust regulators and pundits to tell me what the correct price is.

    Doc Merlin, Those aren’t all consistent with the EMH, he does say the market is overvalued. But I see your point about some of them.

    Regarding the Republican “lies,” I’m not going to dispute that, but isn’t it rather silly to imply one party lies and the other doesn’t? I’m disappointed when I read partisan pundits. I can’t believe highly intelligent people are not able to stand back and see the world as it is, not as a simplistic or cartoonish battle between good and evil. It shows that a person can be highly intelligent in one area, and yet not have a clue as to what people are actually like.

  14. Gravatar of Scott Sumner Scott Sumner
    24. February 2010 at 05:46

    Oops, my last response was to Jim Glass, not Doc merlin.

  15. Gravatar of Joe Joe
    24. February 2010 at 08:24

    “Like most people he calls price patterns bubbles when he can’t explain them in terms of fundamentals.”

    Are “Bubbles” now synonymous with “The Invisible Hand”?

  16. Gravatar of Jon Jon
    24. February 2010 at 09:44

    Back to your book Scott? But the fed/treasury just anounced the revival of the sfp to further sterilize the mb. Imagine the shock of reAding this in the same issue of the wsj whose front page headline screams “lending falls at epic pace”

  17. Gravatar of Greg Ransom Greg Ransom
    24. February 2010 at 09:48

    The Federal Reserve committee doesn’t have this option. NNeitherndoes the Congess or the President. Note well, the Fed engages in a form of price control — controling the structure of relative prices — and hence production — over time. The President and the Congress do the same via Freddie and Fannie and the CRA, and the SEC, and TARP, etc.

    We are not living in the fairy land of aggragate Keynesian “variables” absent a production structure throught time shaped by price control on credit, interest rates, money, liability, banking, etc.

    Scott wrote:

    “Hayek and I both believe the government can inject noise into the price process. But the more complicated the price making process is, and your comment makes it seem very complicated, then the more I trust markets and the less I trust regulators and pundits to tell me what the correct price is.”

  18. Gravatar of Greg Ransom Greg Ransom
    24. February 2010 at 09:52

    Hayek wasn’t talking about noise — he was talking about a systematic distortion in
    the structure of production / relative prices across time — often produced by price controls in the market for credit, money, interest rates, liability, etc.

    Scott writes:

    “Hayek and I both believe the government can inject noise into the price process. But the more complicated the price making process is, and your comment makes it seem very complicated, then the more I trust markets and the less I trust regulators and pundits to tell me what the correct price is.”

  19. Gravatar of Greg Ransom Greg Ransom
    24. February 2010 at 09:58

    Again, we’re not talking about a correct price, were talking about getting all relative prices closer to systematic order across time and time requiring production, rather than less well coordinated. We’re looking for getting the whole system in better order, we’re not so interest in the philosopher’s stone of identifying the “true” price of any one thing.

    The problem is, the Fed presumes it can do this with the price of money across time — which implicates every time taking production process, variably according to lenght and output size.

  20. Gravatar of Greg Ransom Greg Ransom
    24. February 2010 at 10:04

    Scott, aren’t you the one who believes the Fed can identify
    the philosopher’s stone of the “correct” supply and price of credit and money — WITHOUT looking at the structure of relative prices and production and consumption?

  21. Gravatar of StatsGuy StatsGuy
    24. February 2010 at 14:12

    … At some point, in the past couple years, you made a bet about deflation/hyperinflation with someone. When does that bet come due again?

  22. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    24. February 2010 at 15:14

    ‘I can’t believe highly intelligent people are not able to stand back and see the world as it is, not as a simplistic or cartoonish battle between good and evil. It shows that a person can be highly intelligent in one area, and yet not have a clue as to what people are actually like.’

    No better example than this from the New Yorker piece (and that Krugman drew attention to it):

    ————quote————-
    Once Obama won the primary, Krugman supported him. Obviously, any Democrat was better than John McCain.

    “I was nervous until they finally called it on Election Night,” Krugman says. “We had an Election Night party at our house, thirty or forty people.”

    “The econ department, the finance department, the Woodrow Wilson school,” [his wife Robin] Wells says. “They were all very nervous, so they were grateful we were having the party, because they didn’t want to be alone. We had two or three TVs set up and we had a little portable outside fire pit and we let people throw in an effigy or whatever they wanted to get rid of for the past eight years.”

    “One of our Italian colleagues threw in an effigy of Berlusconi.”

    “I put out some coloring paper and markers so that people could write stuff on it and throw it into the fire. People really felt like there was stuff they wanted to shed! I had little hats and party whistles.”
    ———–endquote———

    Two Angry People?

  23. Gravatar of Simon K Simon K
    24. February 2010 at 17:27

    Greg – The problem with “skilled entrepreneurial judgement” of prices or anything else is that most people who think they have it actually don’t. They were right once (or look right right now), but only in the way a stopped watch is right twice a day. That someone thought prices were wrong and made money when they changed later doesn’t actually prove anything, either about them or the scenario.

  24. Gravatar of Greg Ransom Greg Ransom
    24. February 2010 at 21:05

    Simon, if no one ever adjusted their plans to make them fit better with the rest of the system, buying and selling and investing, etc. no one would eat.

    Your argument proves too much.

  25. Gravatar of rob rob
    24. February 2010 at 21:19

    when the book comes out will you go on The Daily Show or the Colbert Report to promote it?

  26. Gravatar of rob rob
    24. February 2010 at 21:29

    whenever someone mentions peak oil i have to comment. the question is not whether we are running out of oil, but rather what the cost curve for oil extraction will be. for the right price, we could extract a crazy amount of oil. alternatives to oil will become mainstreem the day they cecome cheaper than more oil extraction. mistakenly, peope make analogies from peak US production to peak world oil production, but these analogies are facile. why did the US reach peak oil in 1970? was it due to the lack of supply or due to cheaper foreign competition influencing demand?

  27. Gravatar of scott sumner scott sumner
    25. February 2010 at 05:50

    Joe, Yes.

    Jon, Yes, but I’m not sure this means much. I think the markets had pretty much given up on QE anyway, correctly noting that it was merely temporary, and would thus have no effect.

    Greg, The Fed only controls the relative price of money, it controls the absolute price of other goods. It does influence the relative prices of other goods, because of price stickiness, but it doesn’t control them. If it tries to the price level becomes indeterminate and you get hyperinflation or hyperdeflation.

    Greg#2, I share Hayek’s opposition to price controls in the market for credit.
    BTW, I’ve never argued against the proposition that we can observes prices that are not at their socially optimal level, after all, when there are government distortions like subsidies to housing, then prices will not be socially optimal. Rather I argue that markets set prices correctly based on the supply and demand by the public. They are efficient in a technical sense, not a welfare sense.

    Greg#3, You said;

    “Again, we’re not talking about a correct price, were talking about getting all relative prices closer to systematic order across time and time requiring production, rather than less well coordinated. We’re looking for getting the whole system in better order, we’re not so interest in the philosopher’s stone of identifying the “true” price of any one thing.”

    Look, I agree with Hayek on this, but it had nothing to do with my post on oil prices. I agree with Hayek that we should target NGDP so that relative prices are not distorted in the short run my monetary shocks in the presence of sticky prices.

    Greg#4 , You asked:

    “Scott, aren’t you the one who believes the Fed can identify
    the philosopher’s stone of the “correct” supply and price of credit and money — WITHOUT looking at the structure of relative prices and production and consumption?”

    No, no, 100 times no. You are confusing me with 99% of economists, who do believe this. I’m the one who opposes targeting either the price of credit or the money supply. I’m the one who argues that the market should set the price of credit and the money supply, not the Fed. I favor NGDP futures convertibility. I don’t even think we need to have a Fed. (Although given we have one, I do recommend Fed policies that I think will do the least harm, as do most Austrians I come across, who opposed 1% interest rates in 2003.)

    Statsguy, I did a gentlemen’s bet with Bob Murphy about inflation in the second half of 2009. So I guess I am now a gentleman. Is that what you win in gentleman’s bets?

    I might add that I think it’s too soon to crow about low inflation. But come the end of 2010 and 2011, you can bet I will be rubbing it into the face of conservatives (monetarists and Austrians) who warned high inflation was coming.

    Patrick, Yes, I had just read that article, and he was one I had in mind.

    rob, I agree on peak oil. I think the real question is how quickly does 3rd world demand ramp up in the near to medium future. (Very long term we’ll move on to other energy sources.) Iraq plans to boost production from 2 million bpd to 12.5 million, so 15 years from now we will probably produce more oil than today. Brazil is another promising area. The question is whether demand will rise fast enough for another price spike. And I can’t answer that.

  28. Gravatar of StatsGuy StatsGuy
    25. February 2010 at 07:53

    I found it – adding the word gentlemen helped in the search.

    “Regarding all your comments about fiat money inevitably ending in hyperinflation, I have a gentlemen’s bet with a well known Austrian blogger (Bob Murphy) who predicts double digit inflation in the second half of 2009. I predict single digit inflation, probably under 5%.”

    I’m less inclined to be generous in interpreting Bob Murphy’s prediction. “Second half of 2009″ sounds pretty explicit.

  29. Gravatar of Greg Ransom Greg Ransom
    25. February 2010 at 10:45

    I need to spend more time wrapping my head around this:

    “I favor NGDP futures convertibility.”

    I need to spend more time thinking about how this works.

    I’m guessing the problem is I don’t understand it.

    Scott writes:

    “I’ve never argued against the proposition that we can observes prices that are not at their socially optimal level, after all, when there are government distortions like subsidies to housing, then prices will not be socially optimal. Rather I argue that markets set prices correctly based on the supply and demand by the public. They are efficient in a technical sense, not a welfare sense.”

    The Hayek argument is simple. Distortions in relative prices can take place across time — because production takes time and coordination takes time. The existence of leverage, money, and credit create a “loose hinge” than allow production and consumption to be distorted via central bank policy, “bandwagon” effects, Ponzi-type schemes, false optimism, or by unsustainable government credit policies, etc.

    Hume and Cantillon long, long ago showed how a temporary money expansion spike can temporarily distort the structure of production across time and geography in an unsustainable fashion. Blind faith in the “technical efficiency” of the market can’t overcome the insuperable limits to knowledge which make it impossible for folks to have perfect knowledge of which are a permanent and “real” price relation and production shifts, and which are unsustainable and temporary.

    It was impossible for people buying mortgage backed securities to have perfect knowledge of every and all price relations involved, and every and all local knowledge conditions involved in each and every mortgage in a mortgage security package — such knowledge involves knowledge of the future which we can’t have and knowledge of current local events which it is impossible to acquire.

    And what knowledge people do have can be systematically distorted by all sorts of things — including distortions in the system of credit, leverage, and money that no one can have a perfect knowledge of.

    If “technical efficient markets” economics has no room for this, so much the worse for “technical efficient markets” economics.

    The irony is that “technical efficient markets” economics came as much as anything out of Hayek’s work — and it has been used to block understanding of his deeper economic point.

  30. Gravatar of Jim Glass Jim Glass
    25. February 2010 at 17:03

    Re Krugman and…

    Regarding the Republican “lies,” I’m not going to dispute that, but isn’t it rather silly to imply one party lies and the other doesn’t?

    …I can’t believe highly intelligent people are not able to stand back and see the world as it is, not as a simplistic or cartoonish battle between good and evil. It shows that a person can be highly intelligent in one area, and yet not have a clue as to what people are actually like.

    Now consider that video of all the Democrats rising as one in 2005 to defend the Constitution from the horror of the Repubs using the “nuclear option” of reconciliation to get past the filibuster.

    For that matter consider Krugman 2005

    “the big step by extremists will be an attempt to eliminate the filibuster”

    …versus Krugman this month

    “the way the Senate works is no longer consistent with a functioning government. Senators themselves should recognize this fact and push through changes in those rules, including eliminating or at least limiting the filibuster. This is something they could and should do, by majority vote, on the first day of the next Senate session.”

    Only Republicans are mendacious. :-)

    One can’t see the world as it is? Doesn’t want to? Refuses to? Can’t see oneself?

    Well … I’ll give Krugman this much consideration: Looking at his record, he’s always been this way from earliest days. Even with supposed allies. Laura Tyson, Thurow, Stephen J. Gould(!), he’s always had a need to believe those he disagrees with are “evil”, really bad, have bad motives. And it seems he really believes it contrary to all evidence, as if his genetic code makes him do it.

    Look at the the Fraga episode. PK kept repeating what he’d said, really not understanding there was anything wrong with it, until the laywers put the legal gun to his head and wrote his apology for him. Read what Fraga said then about PK’s method of operation. Is there any difference today, except that he’s been freed from all restraint?

    Maybe congenitally he just can’t help it.

    OTOH DeLong, his biggest disciple, has done a complete 180 from his early blogging days. He has no such excuse.

  31. Gravatar of Scott Sumner Scott Sumner
    26. February 2010 at 10:54

    Statsguy, I think Bob Murphy has recently engaged in some money wagers with a couple of the bloggers at Econlog. So that will be the bet to watch. To be honest, I think Bob will lose, as he overestimates the inflation risk. I generally avoid money bets with individuals–too much risk of misunderstanding. I prefer bets with institutions like casinos or Intrade.

    greg, I think monetary shocks distort the economy precisely because many labor markets and product markets are not efficient. They exhibit price stickiness. So I certainly don’t have “blind faith” about market efficiency, I just happen to believe that asset markets are usually much more efficient than product or labor markets.

    Jim Glass, After reading your post I spent some time on a post making fun of him, but then had second thoughts. I could still post it. But I am wondering whether Krugman would make this argument:

    Krugman could say he called for reform in the next Senate session, not right now. So he might claim he always thought the filibuster was a bad idea, but didn’t think the Republicans should bypass it for partisan reasons. If you can convince me that he doesn’t have that out, I’ll go ahead and post the item, it is still being saved. Are there any other incriminating posts?

    I certainly agree with your general view that his posts are very partisan, and are absurdly biased toward seeing the Republicans as bad guys and the Democrats as passive victims.

  32. Gravatar of Greg Ransom Greg Ransom
    26. February 2010 at 12:13

    Scott, you pretend that two central facts about the market don’t exist — (1) the central fact that changes in money and leverage and credit have effects depending on what part of the structure of the economy gets the money / credit / leverage first, and effects on the time structure of production (changing which production processes are used and what length production processes take); and (2) there are dramatic limits one individual understanding of how everything fits together (relative prices and production structures) and how everything is adjusting over time.

    Your conclusion here is only possible due to the pretense that these massive facts don’t exit — i.e. “price stickiness” is far down the list on the coordination problems caused by large changes in money, leverage and credit:

    “I think monetary shocks distort the economy precisely because many labor markets and product markets are not efficient. They exhibit price stickiness. So I certainly don’t have “blind faith” about market efficiency, I just happen to believe that asset markets are usually much more efficient than product or labor markets.”

  33. Gravatar of Greg Ransom Greg Ransom
    26. February 2010 at 12:16

    Scott, this claim simply doesn’t handle the Hume / Cantillon example:

    “I think monetary shocks distort the economy precisely because many labor markets and product markets are not efficient. They exhibit price stickiness. So I certainly don’t have “blind faith” about market efficiency, I just happen to believe that asset markets are usually much more efficient than product or labor markets.”

  34. Gravatar of Greg Ransom Greg Ransom
    26. February 2010 at 15:26

    Two final thought.

    (1) The only thing which makes “price stickiness” possible is exactly the same thing that makes systematic distortions in the structure of relative prices and production across time unavoidable, in the context of changing leverage, credit and money — insuperable limits on knowledge (i.e. limits on and individual’s understanding of the significance of prices and production relations across time).

    (2) The fact that macroeconomists can imagine the causal process of price stickiness, but they can’t imagine distortions in the structure of relative prices and production across time, is a simple artifact of their modeling strategy (and training) — i.e. it’s a product of their subfield enforced defiance of microeconomic thinking, esp. about economic coordination across time and involving production, and implicating money, leverage and credit.

    If your “glasses” block out whole classes of phenomena from existence, it’s no wonder that those processes can’t “exist” for the purposes of causal explanation.

  35. Gravatar of Scott Sumner Scott Sumner
    27. February 2010 at 06:23

    Greg, You are wrong about price stickiness. Lots of things can make it possible besides limits on knowledge. Menu costs is one example.

    I don’t think it makes any difference where money is originally introduced into the economy. If the Fed introduced $5 billion in new base money into Japan, rather than the US, it would make almost no difference. The Japanese recipients of the $5 billion would simply buy American bonds, and the money would go right back into American banks, just as if it had been injected there in the first place.

    Under normal times when interest rates are positive, new injections of cash are very small relative to GDP. They don’t have important effects on the markets they enter, rather they are important because they affect the expected future price level. That’s something that Hume (who was a great economist) never understood.

  36. Gravatar of Greg Ransom Greg Ransom
    27. February 2010 at 09:19

    Menu costs: with perfect knowledge firms would announce all future price changes in advance.

    Hume: Hume’s example deals with unpredictable changes in gold production at changing geographical points.

    Japan: If banks get billions of new money then the value of the money of store clerks is watered down — the things bankers are interested in get bid up, things clerks are interested no longer have as much relative purchasing power behind them.

    Things are the other way around if the clerks get the billions first.

    The whole structure of relative prices is altered depending on who gets the money first.

  37. Gravatar of Greg Ransom Greg Ransom
    27. February 2010 at 09:33

    When you start with a modeling technique which has no adjusting production, and everything is a relation between the price level, aggregated demand, and labor employment levels, then this conclusion is already dicated by what you’ve assumed going in. You’re arguing in a circle. In the “model” new injections never have any effects, because the causal mechanism for instantiating those effects doesn’t exist — these mechanism are disappeared by the formal necessities of the modeling strategy. The formalism mandates that these effects can’t even be imagined — the reality or , well, reality, does not provide this conclusion.

    Scott writes:

    “Under normal times when interest rates are positive, new injections of cash are very small relative to GDP. They don’t have important effects on the markets they enter, rather they are important because they affect the expected future price level.”

  38. Gravatar of Greg Ransom Greg Ransom
    27. February 2010 at 09:39

    Do insist this is true of the car and housing sectors in the ’00s?

    There’s the macroeconomists model incapable of conceiving an adjusting structure of production across time — and then there are my lyin’ eyes …

    Why shouldn’t I go with my eyes, when the “model” is nonoptionally blind tongue phenomena at hand?

    “when interest rates are positive, new injections of cash are very small relative to GDP. They don’t have important effects on the markets they enter”

  39. Gravatar of Greg Ransom Greg Ransom
    27. February 2010 at 09:40

    “Why shouldn’t I go with my eyes, when the “model” is nonoptionally blind to the phenomena at hand?”

    Sorry for the iPhone fart.

  40. Gravatar of scott sumner scott sumner
    28. February 2010 at 11:46

    Greg, You said;

    “Menu costs: with perfect knowledge firms would announce all future price changes in advance.”

    No they wouldn’t. Menu costs mean it is costly to change prices, as with a company that just prints one catalog per year. It is assumed too costly to put all future prices into the catalog.

    Your comments about store clerks in Japan make no sense to me. I was talking about US dollars. No one spends US dollars at stores in Japan.

    Greg#2; You said;

    “When you start with a modeling technique which has no adjusting production,”

    I don’t start with this kind of model. In my model sticky wages and prices mean monetary shocks cause relative price changes, which affects production.

    Greg#3, Money doesn’t “go into” the car and housing markets. Money isn’t “in” markets at all, it’s held by people. Money is a medium of exchange and a store of wealth. There is no money “in” the stock market right now, hence people can’t take money “out of” the stock market, or put more “into” the stock market.

    Greg#4, The worst thing someone can do in macro is to rely on common sense. It looks like money goes into markets, it looks like low rates cause investment bubbles, but in fact these appearances are deceiving. When rates are low then money is usually tight.

  41. Gravatar of Greg Ransom Greg Ransom
    28. February 2010 at 14:47

    Scott, I was talking about store clerks in America. Imagine a payroll tax cut financed by government borrowing.

  42. Gravatar of Greg Ransom Greg Ransom
    28. February 2010 at 14:50

    Scott, We’re not going to agree on menu costs — every example you give of a “cost” arises only becuse of knowledge problems, e.g. the catalog is printed to fight a knowledge and communication problem

  43. Gravatar of Greg Ransom Greg Ransom
    28. February 2010 at 14:56

    Soctt, prices are bid up differentially in different sectors when money and credit and leverage shifts and expands.

    This isn’t “common sense”. This is a fact and the bidding up process is a bedrock assumption of all economics.

    There have been massive shifts in who buys a house or car and how much they offer and how manynare sold over the last 10 years. These are facts, not “common sense”.

    I haven’t offered claims from pleas to “common sense”, whatever
    that is (an epistemology?).

  44. Gravatar of Greg Ransom Greg Ransom
    28. February 2010 at 15:01

    Is “production” conceived as “K” or does it have a structure? That’s the issue I can’t see that you tackle or even recognize.

    “I don’t start with this kind of model. In my model sticky wages and prices mean monetary shocks cause relative price changes, which affects production.”

  45. Gravatar of Greg Ransom Greg Ransom
    28. February 2010 at 15:33

    I wasn’t talking about store clerks in Japan, but this does take us back to government barriers on money and exchange controls etc. There is no reason store clerks in Japan couldn’t spend dollars, and just not on vacation in
    the U.S.

    “Your comments about store clerks in Japan make no sense to me. I was talking about US dollars. No one spends US dollars at stores in Japan.”

  46. Gravatar of ssumner ssumner
    1. March 2010 at 07:43

    Greg, A payroll tax cut is fiscal policy, not monetary. I agree that the ffect of fiscal policy does depend on whose taxes get cut.

    I also agree that monetary policy can cause the relative price of houses to change in the short run, I just don’t think that the effects depend on where the money is injected.

    Yes, I assume production has a structure, I just don’t talk about that struture.

    Sure sales clerks in Tokyo can spend dollars. But that is equally true whether new money is injected in NYC or Tokyo. Since we don’t observe them spend dollars while shopping in Tokyo today, I am arguing that injecting new money into Japan wouldn’t change that fact. The Japanese would just exchange the dollars for yen and the dollars would immediately flow right back to American banks.

  47. Gravatar of Greg Ransom Greg Ransom
    1. March 2010 at 07:52

    Right. I’m not confused about that, I’m just trying to motivate the idea that clerks could get the money first. I’m playing your game here, trying to illustrate my point about the significance of how money flows through the system. Think of a tsunami wave.

    Scott wrote:

    “Greg, A payroll tax cut is fiscal policy, not monetary. I agree that the ffect of fiscal policy does depend on whose taxes get cut.”

  48. Gravatar of Greg Ransom Greg Ransom
    1. March 2010 at 07:57

    I find this bizarre. Where talking about a thought experiment here, contrasting the thought experiment alternative with the tsunami wave effects of real “injections” we’ve experienced, say between 2002 and 2007 in the housing and car industries / markets.

    “I also agree that monetary policy can cause the relative price of houses to change in the short run, I just don’t think that the effects depend on where the money is injected.”

  49. Gravatar of Greg Ransom Greg Ransom
    1. March 2010 at 08:16

    What I’m suggesting is that your case for the EMH as extended to business cycle theory, and as used as a critique of Hayekian macro in fact assumes that production does not have a structure, and that your assertions do not work if you do acknowledge that fact.

    What if we do take seriously the fact that production does have a time structure, with price sensitive time sensitive compositional structure internal to it, subject to adjustment depending on production / time implicating price changes. And what if no one has perfect knowledge, and often many demonstrably don’t have anything close.

    Time + imperfect knowledge + structure = all the room you need for the strong anti-Hayek EMH thesis to be false, esp. in conjunction with the Hayekian-consistent structural pattern exhibited in the current episode — and peer reviewed econometric studies repeatedly supporting the structural cycle argument over a number of boom / bust cycles.

    Scott writes:

    “Yes, I assume production has a structure, I just don’t talk about that struture.”

  50. Gravatar of Greg Ransom Greg Ransom
    1. March 2010 at 08:20

    So if we loaned / give all the money loaned / created between 2002 -2007 to teen aged boys, there would have been no difference in what happened?

    Just trying to explain why I found this comment bizarre:

    “I also agree that monetary policy can cause the relative price of houses to change in the short run, I just don’t think that the effects depend on where the money is injected.”

  51. Gravatar of Doc Merlin Doc Merlin
    1. March 2010 at 10:46

    “also agree that monetary policy can cause the relative price of houses to change in the short run, I just don’t think that the effects depend on where the money is injected.”

    It is a bazaar comment as really, one of the main effects is from where the money is injected.

  52. Gravatar of scott sumner scott sumner
    2. March 2010 at 06:08

    greg, You said;

    “I find this bizarre. Where talking about a thought experiment here, contrasting the thought experiment alternative with the tsunami wave effects of real “injections” we’ve experienced, say between 2002 and 2007 in the housing and car industries / markets.”

    I don’t know what this means. The Fed didn’t inject money into the car and housing markets, they injected into the T-bond market, if you want to think of it that way. Or you could say they injected it into peoples’ wallets, because more than 90% 0f the new money went into cash, not bank reserves. What people do with money is an entirely different issue.

    Greg#3, The conventional view is that expansionary monetary policy lowers interest rates. The Austrians then claim the lower rates distort the time structure of production. I don’t agree with the premise that easy money lowers the sorts of interest rates that are of interest to producers. It might well raise them.

    Greg#4, You asked;

    “So if we loaned / give all the money loaned / created between 2002 -2007 to teen aged boys, there would have been no difference in what happened?”

    Yes, If we injected the money by swapping $10,000 dollars in cash for $10,000 in T-bonds held by teenage boys, then I agree that nothing interesting would have happened. It would have no different effect from doing OMOs with 60 year old boys.

    (Don’t forget that during 2002-07 the Fed didn’t give money out, nor did they loan it out. They bought T-bonds and bills. That’s how the money was injected.)

  53. Gravatar of scott sumner scott sumner
    2. March 2010 at 06:10

    Doc, See my answers to Greg. The money is “injected” into the T-bond market, not the housing market (excluding recent years where the Fed buys MBS, then it might make a slight difference. But I assumed you guys were referring to 2002-07, the dates mentioned by Greg. The Fed wasn’t buying MBSs.

  54. Gravatar of Greg Ransom Greg Ransom
    2. March 2010 at 09:36

    The Hayekian idea is that this depends on where we are in the trade cycle, as does the meaning of “easy money”:

    “I don’t agree with the premise that easy money lowers the sorts of interest rates that are of interest to producers. It might well raise them.”

  55. Gravatar of Greg Ransom Greg Ransom
    2. March 2010 at 09:43

    Well, if China and Wall Street and Fed money was going to teen aged boys instead of to my neighbors now losing their houses, I’d guess right now we would be seeing teenaged boys loosing their sports cars and electronic toys and motorcycles, etc instead.

    Guess it’s time to wrap this thread up.

  56. Gravatar of Doc Merlin Doc Merlin
    2. March 2010 at 10:09

    @Scott,
    This is somewhat long, but it covers Greg’s story as well as how the Fed’s interest rate’s causes long term effects in housing and money supply, through collateral.

    Due to the nature of retail banking, at the time, any increase in t-bill buying by the fed injects huge amounts of money directly into retail banking. Any drops in the discount rate do the same thing.

    These very quickly (almost instantly) get translated into lower rates on new mortgages, because of competition between banks in the mortgage market. The lower rates cause the “sticker price” of a house to increase substantially, but not necessarily the total cost of ownership (which includes the cost of financing the mortgage). This is why it makes sense to talk about the Fed having a fairly direct effect on mortgage rates.

    The marginal costs involved in housing production don’t really change that much but the sticker price is increasing a lot, so to maximize profit (mc=mp for profit maximizing firms) firms begin building a lot more houses. The red tape and approval processes can make new large scale construction take years in some markets (Cali is notorious for this due to environmental regs). Banks that own these mortgages use them for capitalization requirements. Because the rates are still dropping, the “sticker price” of the houses is increasing, which means the mortgage’s face price in mark to market is higher. This increase in M2M price of a mortgage acts as very much like expansion of M1 for the banks (Due to Basel rules on capitalization and collateral.). Except unlike M1 its denominated in dollars and each unit can change in price with the market.

    Eventually, we have a lot more new housing supply, dropping the sticker price of housing sales. This drops the M2M price of mortgages, owned by the bank. Now the banks have to scramble for money and assets to fulfill their regulatory capitalization requirements. What was the market adjusting to a downward interest rate shock, by adjusting housing production, becomes, years later, a monetary severe monetary tightening. This further constricts money availability (as the Fed isn’t forward looking enough to loosen it again in time). Because loans are harder to get, the sticker price of housing drops again, causing another round of pain. Eventually this settles out with decreased housing prices and a recession (in part due to the monetary effects of this cycle.)

  57. Gravatar of scott sumner scott sumner
    3. March 2010 at 06:41

    Greg, I mighy use the teenage boy example in a future post. It raises some good issues.

    Doc Merlin, You said;

    “Due to the nature of retail banking, at the time, any increase in t-bill buying by the fed injects huge amounts of money directly into retail banking. Any drops in the discount rate do the same thing.”

    Actually, durng 2002-2007 almost of the the new money went into peoples’ wallets, not bank reserves.

    I still think that easy money usually raises rates, rather than lowering them. Australia has much easier money than the US and as a result Australian interest rates are much higher than the US. If you were right that interest rates are the key indicator, then the Australian housing market should be doing much worse than the US market, but it is actually doing much better.

  58. Gravatar of Doc Merlin Doc Merlin
    3. March 2010 at 20:58

    “I still think that easy money usually raises rates, rather than lowering them. Australia has much easier money than the US and as a result Australian interest rates are much higher than the US.”

    This doesn’t apply. You are comparing apples and oranges.

    Well, interest rates by themselves aren’t so key as the /change in time/ in the rates. The interest rates by themselves in my example don’t really play much of a part except to link time preferences.
    It is the exogenous /change in time/ of nominal interest rates that causes real effects (through contracts, debt etc) in my example.

  59. Gravatar of Doc Merlin Doc Merlin
    3. March 2010 at 20:59

    I should clarify about apples and oranges, you can’t compare rates between countries and expect to see the effect I describe, you must look at the non-market change in time of the rates within a country.

  60. Gravatar of ca ca
    3. March 2010 at 21:43

    Scott said:

    “After reading your post I spent some time on a post making fun of him, but then had second thoughts. I could still post it. But I am wondering whether Krugman would make this argument:………….”

    By all means, take on Krugman, very little gives me as much pleasure.

  61. Gravatar of ssumner ssumner
    4. March 2010 at 05:42

    Doc merlin, I don’t know what you mean by “non-market change” in interest rates. The fed funds rate is a market equilibrium.

    ca, Don’t worry, there will be plenty of opportunities in the future. Another good example occurred yesterday when he showed a graph of Chilean real GDP. He argued that it showed free market policies didn’t work very well, even though it looked a lot like (and better than) the graph of GDP under FDR, who he claims did have effective policies.

  62. Gravatar of crljones crljones
    16. March 2010 at 00:08

    The pressure on Krugman of meeting a daily deadline is I suppose what keeping him saying such banal dogma – keep up the good critique though. As to Oil Prices we should be quoting in CHI Reminbi – as they are driving demand, then the rise is not so bad.

  63. Gravatar of scott sumner scott sumner
    16. March 2010 at 11:17

    Thanks crljones.

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