The first liquidity “trap” (1932, pt. 4 of 5)

Today I’ll consider the first liquidity trap, which spawned that mutant monster known as Keynesian macroeconomics.  But first you need to wade through more of my rantings on politics.

My last post brought up the touchy subject of racism.  Big mistake.  Then last night I saw a short bloggingheads discussion where Matt Yglesias and Jonathan Chait debated whether and/or when it was acceptable to accuse people you disagree with of being racist or anti-Semitic.  I have mixed feelings on this, although my views are a bit closer to those of Chait.  There is a tendency to assume that those you disagree with have bad motives.  My problem with Yglesias is that I think he fails to see both sides of the coin.  Right-wingers are going to make the same sort of judgments about the left.

Here is an example.  I think it is fair to say that lots of progressives are strongly anti-racist, and lots of conservatives are mildly anti-anti-racist.  What do I mean by anti-anti-racist?  Conservatives and progressives disagree about the amount of racism faced by minorities, especially African-Americans.  They disagree about whether certain remedies are justified.  Conservatives tend to see differences in socio-economic status as reflecting cultural problems within the black community.  In general, conservatives tend to minimize the problem of racism in America.  These views lead progressives to believe that conservatives are somewhat tribal, and have less empathy for those outside the white “tribe.”  Thus progressives interpret the anti-anti-racism of conservatives as hidden support for racism itself.

Now let’s look at anti-communism.  Right-wingers like myself are extremely proud of our longstanding anti-communism (just as progressives are proud of their anti-racism.)  If we are old (like me) we were anti-communist before it was cool to be anti-communist.  When I was younger, anytime a progressive used the term “anti-communist” it was with sarcasm or scorn.  In the middle third of the 20th century, most progressive intellectuals made at least one comment about communism that looks very embarrassing today.  Often the statements were supportive of figures like Lenin, Stalin, Mao, Ho Chi Minh, etc.  Or showed enthusiasm for economic policies undertaken by Mao.  Of course the right had its own problems.  In the middle third of the 20th century there were a lot of statements about race and civil rights made by conservative intellectuals, at one time or another, that look very embarrassing today.

[Isn't it great to be a classical liberal!   Actually, we also have some skeletons in our closets.  Remember that Jefferson owned slaves.]

One thing I have noticed about progressives is that while they pay lip service to having rejected communism, their real passion is for anti-anti-communism.  They seem more outraged that a few Hollywood screenwriters lost their jobs in anti-communist witch hunts decades ago, than they do that policies advocated by those screenwriters, such as “to each according to their needs,” led to the starvation of tens of millions of people.  One thing I have noticed about conservatives is that while they pay lip service to opposing racism, their real passion is for anti-anti-racism.  They seem more outraged about a white firefighter who was passed over for a promotion then they do for all of the tragic history of African Americans (and Native Americans.)

Just so that I won’t be misunderstood, I want to be clear about one thing.  I do not believe that most modern progressives secretly favor communism, nor do I believe that most modern conservatives secretly favor Jim Crow laws.  I think both groups have absorbed at least some of the lessons of the 20th century.  Both have been somewhat enlightened.  But as long as each side continues to talk the way they do, then progressives will continue to suspect that conservatives are secret racists, and conservatives will continue to think that progressives are secret Marxists.  And speaking of Marxists, what do you make of this recent item in Yglesias’s blog, which discusses economic policies in Nigeria:

Of course to progressive blog readers “business-friendly” doesn’t always come across as a good thing. But when thinking about the developing world, it’s worth keeping in mind Karl Marx’s point that a constructing a functioning capitalist economy is a huge step forward from crushing poverty.

Let’s see if we can deconstruct this interesting quotation.

1.  Start with the fact that Yglesias is much too smart to be a Marxist.

2.  And yes, I realize that quoting Marx on a single point is not equivalent to endorsing Marxism as a system.

3.  Nevertheless, I think it is slightly revealing that Yglesias didn’t just say “If you read publications like The Economist, which pay a lot of attention to economic development, you’ll find that most developing countries are actually better off pursuing free market reforms.”  Presumably his progressive readers would not find that argument convincing.  But Marx is someone worth paying attention to; after all he was the one that predicted that communist revolutions would happen first in backward countries like Russia and China.  (Or did I get that backward?)  In any case, Yglesias’ progressive readers know how to read this reference to Marx, as they understand that Marx’s argument is that capitalism is not the final step, but just an unfortunate stop on the path towards . . .  no wait, that can’t be right, since 1989 the left has given up all their utopian dreams.  Capitalism is the last stop.  Nevermind.  I promise to stop being suspicious of progressives.

Memo to progressives—this was a joke.  Please don’t explain Marxism to me.  My point was that it is easy for one side to become suspicious of the other’s motives, regardless of the facts.

What’s my point.  I guess Yglesias is free to continue calling conservatives “racists.”  But if he does, he shouldn’t get indignant when conservatives accuse progressives of being a bunch of closet Marxists.

During the health care debate I noticed that a lot of progressive bloggers said something to the effect of ”Don’t worry about the lack of a public option.  This plan will expose the weakness of the private insurance system, leading to its eventual collapse and replacement with a single-payer system.”  Eventually Republicans picked up on this meme, and began accusing Obama of trying to bring socialized medicine to America.  Of course the progressives were outraged—”There’s no socialism in the bill!  The word isn’t even mentioned.”

Each side of the debate should try to be less suspicious of the other side, but also should try to reflect on how its own statements can fan the flames of the suspicion.  Have progressives truly learned the lessons of the failure of communism, and have conservatives really tried to think of race from the perspective of minorities?  I’m going to try to avoid calling people commies and racists, but I do believe that many progressives and conservatives have not yet fully absorbed the lessons of their deeply embarrassing histories.

I’d also wager that each side knows more embarrassing facts about the other side’s history, than about their own history.  We tend to read what we enjoying reading.

A few other points before beginning.  Yglesias argues that there is no diversity of opinion on domestic policy among conservatives:

At any rate, Julian Sanchez did a great piece on the incentives pushing toward ideological conformity on the right and the myth of the “Georgetown Cocktail Party Circuit.” I think that the same dynamic Sanchez identifies exists on the left, but it winds up having totally different results because there are actual competing sets of institutions on the left. Everywhere you go there’s pressure to follow the “line” but CAP and EPI have very different lines on teacher compensation. What’s striking about the right is that on domestic and economic policy issues it’s formed a comprehensive set of ideological points from which there’s no escape.

I’d like to make two (seemingly contradictory) points about this comment.  At one level it is beyond silly, especially when you consider that progressives like Yglesias regard libertarians as being on “the right.”  On issues like monetary policy there is far more diversity among right wing intellectuals than among the left (who tend to be broadly Keynesian.)  There is great diversity on supply-side economics (whereas the left are all opposed.)  Many on the right think our health care system is wonderful, and must be protected from the evil Democrats.  Others (like Robin Hanson and I) think it is massively inefficient, wastes over a trillion dollars, and we need to blow it our and start over.  The Republicans allow both pro-life and pro-choice speakers at their conventions, the Dems only tolerate one point of view.  When the Massachusetts health plan was adopted the Heritage Institute said nice things about the basic idea, whereas Cato was strongly opposed.

But that last point brings up an uncomfortable truth about the modern GOP, it has become so partisan that a health plan quite similar to the Massachusetts plan is now so beyond the pale that it seems that think tank people are being fired and muzzled (at the AEI) for even considering the Obama plan as a possible starting point for further compromise.  Just to be clear, I am so right wing that I strongly oppose even a slightly modified Obama plan—rather I support Brad DeLong’s HSA approach.  But it is intellectually dishonest to support an idea when Republicans are in office and completely trash similar ideas when Dems are in power.  This is a week where all the worst things Krugman and Yglesias said about the right came true.

Here’s a quotation from our new Massachusetts senator:

“We’re all in favor of the catastrophic care coverage and coverage for children,” Brown told “Good Morning America.” “But what about the backroom deals? What about all the bad things?”

Mitt Romney is spouting similar nonsense.  I’m not naive; I understand that if Romney wants to get the 2012 Presidential nomination then he almost has to try to find meaningless distinctions between his plan and Obama’s.  But why is that?  I think all of this nonsense further supports my earlier point about a disturbing anti-intellectualism in the modern GOP.  The message seemed to be “sure we support all of the individual big government elements of Obama’s plan, when considered one by one, but we think the overall plan is dangerous socialism.  In the long run that approach will insult the intelligence of voters with even half a brain, and will turn thoughtful independents away from the GOP.  David Frum is being ostracized for correctly diagnosing a disease affecting the modern GOP.  And I say this as someone who, if a Senator, would not have been able to find common ground with Obama on a compromise health care plan.

America desperately needs a parliamentary system with a centrist party that is pragmatically right wing on economic issues and liberal on social and foreign policy issues.  (Something like Germany’s Free Democrats.)  I’d guess that at least 25% of the American electorate fit that broad description.  Many are well-educated independents.  Under a parliamentary system they would form a coalition government with either the Democrats or Republicans.  We’d have universal health care, but it probably would have been a better plan.  Right now, it’s hardly worth me even going to the polls (although I do out of a perhaps misplaced sense of loyalty to the democratic system I champion.)

6.e  Was there a Liquidity Trap in 1932?

          At the time the spring 1932 OMPs were widely seen as being almost completely ineffective.  To see why, consider some of the macroeconomic data in Table 6.1.  In many respects, the period from April to July 1932 was the worst three months of the entire Depression.  Commodity prices continued to fall, and both stock prices and industrial production reached their Depression lows in July.  Even the M1 money supply declined, despite the massive OMPs.  It would be decades before monetary policy was again viewed as an effective stabilization tool.

Table 6.1  Economic Indicators During 1932, monthly.[1]

Month        Output       WPI            Dow            Gold           MB             M1__

Jan.             12.9            67.3            85.88          11,374        7704           21,507

Feb.            12.5            66.3            82.18          11,454        7537           21,310

Mar.            12.4            66.0            81.02          11,535        7539           21,110

Apr.            11.6            65.5            64.49          11,551        7644           20,882

May            11.2            64.4            53.96          11,452        7710           20,531

June            10.8            63.9            50.62          11,384        7788           20,449

July             10.5            64.5            45.47          11,456        7858           20,152

Aug.            10.8            65.2            66.51          11,599        7850           20,189

Sept.           11.5            65.3            67.94          11,730        7897           20,211

Oct.             11.9            64.4            64.22          11,825        7896           20,256

Nov.           11.9            63.9            65.26          11,897        7978           20,555

Dec.            11.6            62.6            61.16          11,933        8028           20,341

I have not mentioned the term “liquidity trap” in this chapter, nor have I provided any evidence for the existence of such a phenomenon.  Indeed under the gold market approach to aggregate demand it makes no sense to argue that “a country” is stuck in a liquidity trap.  Either policy is constrained by a loss of gold reserves (which is a quite different concept) or the entire world is stuck in a liquidity trap, as would occur if large reductions in the world demand for gold had no impact on the purchasing power of gold.

Regardless of whether the U.S. was actually in a liquidity trap during the early 1930s, it appears that the Keynesian concept of monetary policy ineffectiveness was at least partly based on the perception that the Fed’s spring 1932 open market purchases had failed to revive the economy.  Scholars often cite Keynes’ remark that “I know of no example of [absolute liquidity preference] hitherto.” Less well known is that just a few lines later he provides the only real world example of a liquidity trap in the entire General Theory:

“The most striking examples of a complete breakdown of stability in the rate of interest, due to the liquidity function flattening out in one direction or the other, have occurred in very abnormal circumstances. . . .  in the United States at certain dates in 1932 there was a . . . financial crisis or crisis of liquidation, when scarcely anyone could be induced to part with holdings of money on any reasonable terms” (pp. 207-08.)

Keynes developed much of the General Theory in 1932 and 1933, and thus it would not be surprising if the failed 1932 OMPs were on his mind when he lost confidence in the efficacy of monetary policy during depressions.  Nor was Keynes alone.  Conservatives within the powerful financial community saw this as showing the folly of monetary cranks who thought the Depression could be cured by printing money.[2]  Even Irving Fisher, who was to the left of Keynes on monetary issues, temporarily lost faith in the efficacy of Fed policy.[3]  Whether or not one sees the policy as having been a failure, it is clear that this event played an important role in shaping the public’s views on monetary policy efficacy for the remainder of the 1930s.[4]

Friedman and Schwartz (p. 324) rejected the standard Keynesian view that monetary policy was ineffective during the early 1930s.  They argued that the business upswing in the late summer of 1932 was a delayed reaction to the spring OMPs, and that the Fed abandoned the OMPs prematurely.  It should be clear from the analysis in this chapter that I have some problems with this view.  Monetary policy may impact macroeconomic aggregates with a lag, but it is difficult to reconcile the behavior of stock and commodity prices with the Friedman-Schwartz view.  Indeed, one might have expected stock and commodity prices to have risen during the spring OMPs, and then fallen back later in the year when the Fed reverted to a more contractionary policy.  Instead, stocks and commodities moved in tandem with shifts in the demand for gold; plunging in the spring when public and private gold hoarding was intense, and then rising when the dollar panic ended and gold demand declined.

If the evidence is not entirely supportive of Friedman and Schwartz’s views on monetary policy effectiveness, the same could be said for the Keynesian view of this episode.  The term ‘liquidity trap’ generally refers to a scenario where increases in the money supply fail to boost aggregate demand.  But that is not quite what happened in the spring of 1932, as the impact of the open market purchases was mostly negated by gold outflows.  During this period the monetary base rose by only about $300,000,000, despite the open market purchases totaling roughly a billion dollars, and M1 and M2 actually declined.  Thus the 1932 OMPs provide little support for the view that large increases in the money supply might fail to boost a depressed economy.  It is certainly ironic that the only real world example of a liquidity trap in the entire General Theory actually shows something entirely different, the constraints imposed on policymakers by the international gold standard.[5]

It is not surprising that Keynes would have confused absolute liquidity preference with the constraints of the gold standard.  Both concepts ultimately rest on policy instruments constrained by a zero lower bound (nominal interest rates in a liquidity trap and the gold reserve ratio under a gold standard regime.)  In contrast, if under a fiat money regime the central bank uses either a “quantity of money” or  a “price of money” instrument (i.e. exchange rate targeting), then expansionary policy faces no meaningful barriers; there is no upward limit to either the money stock or the nominal price of foreign exchange.[6]

In chapter 4 I argued that Johnson and Mundell’s gold undervaluation hypothesis ultimately relies on a peculiar assumption; that policymakers would have been able to effectively manage gold demand in 1920, but not in 1929.  Now we can see one justification for this seeming inconsistency.  A coordinated set of devaluations in 1920 (aimed at price stability) would have required central banks to increase their gold demand in the short run, in order to prevent inflation.  In contrast, a managed gold standard after 1929 (also aimed at price stability) would have required central banks to lower their demand for gold.  Only the 1929 policy counterfactual is in danger of running up against the zero lower bound constraint on gold reserve ratios.

6.f  Interpreting 1932

Even though Friedman and Schwartz viewed the 1932 OMPs as being modestly effective, they also saw the policy as being too little, too late.  The more important question, and the issue that separates them from critics like Temin and Eichengreen, is whether monetary policymakers in 1932 were constrained by the international gold standard.  Although I don’t believe there is any way to definitively answer this question, Friedman and Schwartz’s optimistic view is at least plausible.

The U.S. still held massive gold reserves in 1932, and there is no reason why those reserves shouldn’t have been used more aggressively in an emergency such as the Great Depression.  In fact, Timberlake (1993, p. 272) pointed out that “In the true sense of Walter Bagehot’s prescriptions, all the Fed banks’ gold was excess.”  Meltzer (2003, p 276) makes a similar point and also observes that the Fed was well aware of the techniques used by the Bank of England during the nineteenth century to protect its gold holdings during a panic.[7]  And it’s hard to argue with Timberlake’s maxim (p. 273) that “A proper central bank does not fail because it loses all its gold in a banking crisis.  It only fails if it does not.”  It is difficult to imagine a more shocking indictment of U.S. monetary policy than the fact that on the day FDR took the U.S. off the gold standard it still held over 37 percent of the world’s monetary gold stock.

But even if it can be shown that the Fed should have done more, the ultimate success or failure of an even more expansionary policy during 1932 would have hinged on the extent to which the expansionary impact of this policy would have been offset by central bank gold hoarding, private gold hoarding, and currency hoarding.  If, as seems likely, the gold bloc had essentially completed its replacement of paper assets with gold reserves by mid-1932, then the ability of the Fed to have further increased the U.S monetary base would have depended upon the response of private gold hoarders.  Although this response would be difficult to predict, there is no evidence that private hoarding ever reached large enough levels to exhaust U.S monetary gold stocks.  But even if the Fed successfully increased the monetary base, there is also the possibility that such a policy would have driven nominal interest rates close to zero, triggering the sort of massive increase in the demand for currency and bank reserves that occurred in the late 1930s, or more recently in Japan and perhaps the US as well.[8]

Keynes viewed a liquidity trap as a situation where further increases in the money supply would have no impact on aggregate demand, or prices.  We have no real evidence that such a trap existed in 1932.[9]  Instead, the problem was that the gold standard limited the amount by which central banks could increase the base. More recently, a number of economists[10] have argued that monetary injections that are viewed as being temporary might fail to boost aggregate demand, even under a fiat money regime.  This sort of ‘expectations trap’ is even more likely to form under an international gold standard regime, where monetary injections can lead to gold outflows.  The public may have understood this and thus been skeptical of any proposal to inflate within the confines of a gold standard regime.[11]

Friedman and Schwartz’s central hypothesis is that the Federal Reserve should have, and could have, done much more to prevent the Great Contraction.  Although the gold market model developed in this book is not capable of refuting this hypothesis, it does suggest that they may have placed too much emphasis on specific policy steps that might have been more effective under a fiat money regime, including the discount rate increases of October 1931, the OMPs of 1932, and the reserve requirement increases of 1936-37.  And more importantly, placed too little emphasis on events that changed expectations of the future path of monetary policy, such as private and central bank gold hoarding, Glass-Steagall, and especially changes in the price of gold during 1933-34.

A recent study Hsieh and Romer (2006) supports Friedman and Schwartz’s view that the Fed policy was not constrained by gold outflows during 1932.  They argue that the 1932 OMPs did not lead to fears that the dollar would be devalued, and thus did not cause a run on the dollar.  Although I find this conclusion to be plausible, I don’t think the evidence they produce is quite strong enough to refute the alternative view of Temin, Eichengreen, and Bernanke (which is that the gold standard constrained policymakers during 1932.)  And later I will suggest that both sides of the debate are asking the wrong question.

The most important piece of evidence cited by Hsieh and Romer is that changes in the (three-month) forward discount on the dollar did not closely track changes in the open market purchase program.  The forward discount against the French franc rose sharply after Britain left the gold standard, but then quickly fell back after the Fed’s discount rate increases temporarily restored faith in the dollar.  During the first half of 1932 the forward discount on the dollar zigzagged up and down, while generally remaining well above its pre-September 1931 levels, and more importantly well above its levels during the last half of 1932.

Hsieh and Romer (p. 153) focused on the fact that the forward discount fell sharply “following the passage of the Glass-Steagall Act and the first rounds of open market purchases in late February”.  Another way of looking at this same data would focus on the fact that the dollar’s forward discount rose after the announcement of Glass-Steagall in early February (which was clearly when the news hit the stock market) and then fell back in late February and March when markets were reassured by the modest size of the early open market purchases.  Then the forward discount began rising in April and eventually peaked in early June.

Hsieh and Romer are on firmer ground when they observe that the forward discount on the dollar fell briefly after the OMPs accelerated in mid-April, and then again in mid-June before the end of the program had been announced.  Even here one must be careful, however, as it is quite plausible that the market had some ability to anticipate these developments.  While Hsieh and Romer rejected the hypothesis that OMPs had led to a run on the dollar, they gave some credence the contemporaneous press reports that agitation in Congress for deficit spending and especially the Goldsborough bill had contributed to the gold outflow.

It is probably true that fluctuations in both the forward discount on the dollar and the stock market correlate more closely to Congressional turmoil than to OMPs.  But recall that the Goldsborough bill would have required the Fed to reflate the economy; presumably the sort of policy that modern day critics think the Fed should have adopted.  It must give some pause to those critics that even a slight possibility that such a bill might pass apparently contributed to a speculative attack on the dollar.

The biggest problem with Hsieh and Romer’s analysis is their conclusion (p. 172) that during the OMPs there was “virtually no sign of expectations of devaluation.”  I would argue exactly the opposite.  There were four major runs on the dollar during the Depression, the fall of 1931, the spring of 1932, the winter of 1933, and the fall of 1937.  In all four cases the press was full of rumors of the dollar being under stress.  In each case there was a massive increase in private gold hoarding (which did not occur prior to mid-1931.)  Yes, the forward discounts on the dollar were never very large in any of these crises, but that simply reflects that fact that traders never viewed dollar devaluation as a particularly likely outcome, especially within the next three months.[12]  Forward discounts were even low during early 1933, when almost everyone agrees there was a run on the dollar (and the imminent inauguration of FDR made a near term devaluation somewhat more likely than in mid-1932.)  And recall that with very low nominal interest rates even a small probability of devaluation could trigger hoarding.

The bigger question is what does this all mean for the policy counterfactuals that are of such interest to economic historians.  Bordo, Choudhri, and Schwartz (B/C/S, 2002) run some policy simulations which suggest that the U.S economy was large enough that Fed had sufficient leeway to take major expansionary steps at key dates during the early 1930s.  They specifically criticize Eichengreen for linking gold reserves with U.S. monetary aggregates such as M1, i.e. implicitly ignoring the money multiplier.[13]  While this is a valid point, taken at face value it also seems to suggest that the monetary base is the relevant monetary policy tool.  Of course the base rose substantially in 1932, with little discernable effect on the economy, and fell after March 1933, even as production soared.

B/C/S might reasonably argue that the broader monetary aggregates, not the base, are the appropriate policy indicators, and that these aggregates fell in 1932.  Of course this reflected the extreme instability of the money multiplier during the early 1930s.  If one is to have any confidence in the B/C/S simulations, however, one has to assume that more expansionary policies would not have led to substantially more private hoarding of either cash or gold.  But like Hsieh and Romer, they overlook evidence of massive private gold hoarding during 1932 (and 1931) and thus end up doubting whether there really was a run on the dollar.

B/C/S also implicitly assumed that their policy counterfactuals would not have affected the money multiplier (i.e. would not have led to more cash hoarding.)  Maybe so, but one doesn’t have to believe in absolute liquidity preference to note that during the early 1930s runs on the dollar were often associated with banking panics and currency hoarding.  I don’t think we can simply assume that base money injections would have led to proportionate increases in the monetary aggregates.  And finally, in their conclusion B/C/S argue that adherence to the gold standard was only a bar to recovery in smaller nations.  Although I think this is a defensible argument, in the next chapter we will see that an explosive increase in output occurred right after the U.S. abandoned the gold standard, even without much change in the money supply.

As with the Hsieh and Romer study, I find the B/C/S policy conclusions to be plausible.  Well-timed monetary injections by the Fed might have been helpful in 1931 and 1932, given their massive gold holdings it was certainly worth a try.  But all of these policy counterfactuals may be asking the wrong question.  If we assume interwar policymakers to have been well-intentioned proponents of fiscal and monetary stabilization, then surely they would have found a way to prevent the Depression.  They probably could have done so without America being forced to devalue, but if not, they would have moved toward a fiat money regime.[14]  But the more interesting questions are; were the actual OMPs of 1932 helpful?  Did they account for the delayed economic bounce in the late summer?  And what explains the severe economic downturn during the spring of 1932?  Here I think the supporters of Friedman and Schwartz are on much shakier ground.

It is difficult to know what to make of the market reaction to the spring 1932 OMPs.  There were some significant increases in stock prices in response to news of the OMPs, especially the announcement of Glass-Steagall.  And yet the stock and commodity markets performance was abysmal during the period of rapid purchases, and then prices soared right after the policy was abandoned.  Admittedly a strict application of the efficient market view would favor the former evidence (that the OMPs helped.)  But it would be difficult to claim that the markets thought the OMPs would have a significant impact on the course of the Depression.  And even if they had less direct impact on the gold outflows than did Congressional agitation for expansionary policies, they might well have been a contributing factor in European fears that America would adopt inflationary policies.  Brown (1940, p. 1233) saw these events first hand and argued that:

           “The uninterrupted large scale purchases of government securities by the Federal Reserves banks seemed in the eyes of foreigners to be evidence of approaching inflation in the United States.  The gold outflow to the continental creditor countries was consequently sharply accelerated as this policy was vigorously pressed forward.”

When the economic recovery began in late summer, it was accompanied by a sharp slowdown in OMPs.  The recovery might conceivably have been a delayed response to the spring OMPs (although in 1933 the economy responded immediately to an expansionary monetary policy) but policy lags can hardly account for the sharp fall in commodity and equity prices during the spring, and the equally powerful rally that began in late July.  More importantly, the financial markets rallied at almost the exact moment when the private gold hoarding subsided and the dollar crisis ended.  With regard to the issue of causality, appendix 6a provides strong evidence that private gold hoarding was far less correlated with the stock market during periods where there were no fears of dollar devaluation, and thus causality almost certainly ran from gold to stocks.[15]  Private gold hoarding led to bearish policy expectations, which led to falling stock prices.  When dishoarding began, stocks soared.  It was exactly the same pattern that occurred in the fall of 1931, and it would happen again in 1937 and 1938.

6.g  What About Real Interest Rates?

Thus far I have described the entire Great Contraction without any reference to interest rates playing a causal role.  Temin (1976) suggested that because interest rates were declining during 1930, it is unlikely that the concurrent decline in output was caused by a tight monetary policy.  He also argued that the deflation of 1930 was largely unanticipated, and hence even (ex ante) real interest rates were probably declining during this period.  I find Temin’s assumption about low real interest rates to be plausible, but not his conclusions about the important of monetary policy.

In August and September 1929 the U.S. and Britain raised interest rates to their cyclical peak just as the economy was about to contract, and then lowered rates throughout late 1929 and 1930.  This pattern occurs frequently during U.S. business cycles.  If it is evidence against money playing a causal role in the 1930 downturn, it is equally so for monetary policy playing any important cyclical role in the U.S. economy.  The problem with Temin’s argument is that interest rates (real or nominal) are simply not a very good indicator of the stance of monetary policy.  During the Great Contraction it was central bank gold hoarding that best illustrated the contractionary stance of monetary policy.

In contrast to Temin, Cecchetti (1992) argued that investors were able to partially forecast deflation over 3 to 6 month horizons, and in a similar vein Nelson (1991, p. 2) suggested that “while commodity prices fell very rapidly during 1929-1930, cost-of-living indices fell much more slowly.  Commentators expected the cost of living to follow commodity prices downward.”  Once again, I accept their evidence but question the implication that real interest rates were high.

Barsky (1987) found little or no evidence that price level changes were forecastable under the classical gold standard, and in an earlier paper (1999) I argued that most economists only began paying attention to the Fisher effect after the world moved to the post-WWII fiat money regimes, when the trend rate of inflation moved from the near zero levels of the classical gold standard to the positive and significant levels of the 1960s and 1970s.  And we need to be especially careful when looking at real interest rates movements over business cycle frequencies, where many prices are in disequilibrium.  For instance, entrepreneurs considering an investment project are presumably interested in some sort of price level estimate showing expected market conditions for products that they plan to sell when their project is completed.  But when there is a sudden decrease in aggregate demand, the measured price level may not provide an accurate reading of those market conditions.  As an example, measured rents are quite sticky, even during periods when housing prices are falling fast and new apartment buildings stand empty.

Consider the following example: aggregate demand falls unexpectedly by 10 percent.  In the short run output falls 5 percent and the (somewhat sticky) price level also falls by 5 percent.  Market sensitive commodity and asset prices immediately fall by roughly 10 percent.  Investors (correctly) forecast an additional 5 percent fall in the general price level, as sticky prices gradually fall to their long run equilibrium.  Assuming no further decrease in aggregate demand, output returns to its natural rate once these prices fully adjust.   I would suggest is that the additional 5 percent by which the measured price level is expected to decline (as the economy moves from disequilibrium to equilibrium) is not a meaningful indicator of the expected change in market conditions facing sellers when the quantity of sales is restricted by a sticky price level.

In my scenario the (unexpected) fall in flexible asset prices may provide a better indicator of movements in the price level.  Since commodity and asset price movements are generally regarded as being unanticipated, this might at first glance seem to deny any possibility of a Fisher effect under any scenario.  But this is not the case, in the U.S. during the 1960s and 1970s persistent inflation was so built into expectations that, even in auction-style markets, the trend rate at which prices changed was partly forecastable.

The preceding thought experiment finds some support in the research of Hamilton (1992), who found evidence from the commodity futures markets that that the deflation of 1930 was unanticipated, and hence that real interest rates were falling.  In addition to finding that commodity prices were essentially unforecastable during the Great Depression, Hamilton (1987, p. 167) also estimated that:

          “knowledge of the actual course of commodity prices would have reduced the forecast variance for the CPI by 70% . . . and we would seem to have a solid basis for inferring that much of the overall deflation during 1929-1933 was unanticipated.”

While I find the wording to be a bit confusing, Hamilton’s conclusion makes sense if he is (at least implicitly) assuming that predictable changes in sticky prices (the CPI) are not economically meaningful for investors, and should not be incorporated into estimates of real interest rates.  Rather, what matters is the expected change in the equilibrium price level (as proxied by commodity prices.)

Temin’s (1976) view of real interest rates was consistent with the earlier Keynesian tradition, which viewed monetary policy as being less important than expenditure instability.  The more recent (new Keynesian) view is that monetary policy is generally quite potent, and that real interest rates are the appropriate policy indicator.  Papers in the new Keynesian tradition by Romer (1992) and Eggertsson (2005) have argued that ex ante real interest rates were quite high during the early 1930s, in the 10% to 20% range.  I have already raised one objection to this view, and Bernanke and James (1991, p. 49) provide an even more persuasive reason to doubt that real interest rates were high during the early 1930s.  They pointed out that those countries that left the gold standard early (such as Britain) were able to arrest the decline in prices, but continued to offer the same sort of low nominal yields on safe assets as did countries remaining on the gold standard, such as the U.S. and France.

Given that the gold market approach to the Great Contraction is essentially monetary (broadly defined) the reader may wonder why I have not embraced the high real interest rate hypothesis, which provides a perfectly suitable transmission mechanism between gold hoarding and declining expenditure.  In fact, I don’t have any problem with either view of real interest rates during the Depression, as nothing in my gold market analysis hinges on this issue.  This is one of those rare cases in economics where either of the opposing views can provide quite plausible monetary transmission mechanisms.  If the deflation was anticipated, then high real interest rates depressed investment.  If the deflation was unanticipated, then the sticky wage transmission channel provides a plausible link between gold, deflation, and falling output.  Rather, I would emphasize that gold hoarding will depress nominal spending, and prices, regardless of what happens to real interest rates.  There is no gain from adding interest rates to the story.


[1] Output is industrial production, the Dow represents mid-month closing prices, and gold is the world monetary gold stock in millions of U.S. dollars.  The U.S. monetary base and M1 are taken from Friedman and Schwartz (1963) and are also measured in millions of U.S. dollars.

[2] The almost universal perception that the spring 1932 OMPs had been a failure did not imply that all forms of monetary policy were viewed as being ineffective in a depression.  Few doubted that unorthodox monetary solutions involving fiat money were capable of generating high rates of inflation, but there was little support for this type of experimentation.  Eichengreen (p. 315) suggests that the 1932 OMPs led conservative American policymakers to view expansionary monetary policy as “conducive not to economic recovery but to inflation.”  But this his based on his (mistaken) view that prices rose during the spring of 1932.  In fact, prices fell, and conservatives looked at the liquidity trap issue pretty much the same way as Keynes did—i.e. as a problem of “pushing on a string.”

[3] Fisher favored switching to a pure fiat money regime.  Keynes was unwilling to support such a radical step.

[4] Laidler (1999, p. 259n) calls the perceived policy failure “one of the key ‘stylized facts’ underlying the evolution of monetary economics in the 1930s and 1940s.”

[5] Currie (1934 [1935]) was one of the few interwar commentators who understood this.

[6] Technically this assertion only holds for the price of money.  But it is exceedingly unlikely that a central bank could buy up all of the world’s stock of eligible financial assets, without first triggering inflation, if not hyperinflation.

[7] Meltzer (p. 276) points out that the Bank of England “had suspended the gold reserve requirement and relaxed restrictions on eligible paper for discount” during panics.

[8] The US situation after October 2008 was complicated by the Fed’s decision to pay interest on reserves at a rate above T-bill yields, which may have inflated commercial bank demand for reserves.

[9] Hanes (2006) showed that even when U.S. short-term interest rates had fallen close to zero during the mid-1930s, changes in reserve supply continued to impact longer-term interest rates.

[10] See Sumner (1993b), Krugman (1998) and Eggertsson and Woodford (2003).

[11] As noted in section 6.d, one type of emergency currency injection during 1932 was explicitly ruled by the Attorney General to have a three year limit.

[12] Hsieh and Romer also fail to find much evidence for devaluation fears in long term bond yield differentials.  But given the uncertain political situation in Europe, one must be careful in making any assumptions about the relative risk of these assets.  The U.S. did devalue before France, but the French monetary situation eventually became even more unstable.

[13] Gold reserves were used to back the monetary base.  Because M1 is several times larger than the base, policy counterfactuals that assume M1 is backed by gold would imply an implausibly large need for gold reserves.  Bordo (1994) first raised this issue.

[14] Meltzer (2003) noted that gold standard rules allowed gold reserve regulations to be adjusted in an emergency.  And 1929-32 would certainly seem to qualify as an emergency.

[15] See appendix 6a.


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62 Responses to “The first liquidity “trap” (1932, pt. 4 of 5)”

  1. Gravatar of Jon Jon
    27. March 2010 at 06:09

    “The Republicans allow both pro-life and pro-choice speakers at their conventions, the Dems only tolerate one point of view.”

    Nonsense, Scott. You can’t possibly believe that the Republican party is more inclusive of differing opinions on abortion.

  2. Gravatar of Philo Philo
    27. March 2010 at 07:14

    “They seem more outraged about a white firefighter who was passed over for a promotion then they do for all of the tragic history of African Americans (and Native Americans.)” I presume that a pragmatist will grant that an emotion such as *outrage* ought to have practical value, as a spur to action. Outrage at history is futile–the past cannot now be changed–but outrage at ongoing activities that are poised to continue into the future has practical value, if these activities are, indeed, bad. Nothing can be done about the Indian Wars and slavery, but the decision not to promote that white firefighter can still be reversed.

  3. Gravatar of ssumner ssumner
    27. March 2010 at 08:12

    Jon, Your response mischaracterizes what I wrote. As I’m sure you know the Republicans allow many pro-choice speakers at their convention (Guliani, Schwartzenegger, etc) and the Dems blacklisted Pennsylvania Governor Casey in 1992 soley because he was pro-life. These facts are very widely known. You can choose to ignore them if you like, but please don’t put words into my mouth and claim I said something that I didn’t say.

    Here’s ABC News:

    “Casey’s father, the late Pennsylvania Gov. Robert Casey D-Pa., was denied a speaking spot at the 1992 convention. The Casey family has long viewed the ’92 denial as stemming from his opposition to abortion rights.

    Over the years, the perceived 1992 snub has become a symbol for Democratic critics who want to alter the party’s staunch support for abortion rights.

    In 2004, Republicans contrasted the Casey snub with California Gov. Arnold Schwarzenegger, R-Calif., and former New York Mayor Rudy Giuliani, R-NY., two Republicans who support abortion rights, speaking to their convention.”

    http://blogs.abcnews.com/politicalradar/2008/08/casey-tapped-fo.html

    It does add that the Dems were so embarrassed by this history that Casey’s son was allowed to speak at the 2008 convention, but surely there is far more diversity of opinion on abortion among leading Republicans than leading Democrats. Both parties just have one view at the presidential level, but I’d guess that there are far more pro-choice Republicans in big populous states than their are pro-life Democrats.

    Philo, That may be the case but I could provide a 100 similar examples from current events. There is far more outrage expressed by conservatives when a white firefighter is passed over because of affirmative action, than when there is some sort of unfairness shown to black Americans. I really don’t see how anyone could dispute this. The rhetoric of both progressives and conservatives is very revealing, and tells me that both groups still have major blind spots. Where is the conservative outrage over 100,000s of black Americans who are in prison for drug law violations, whereas conservatives like Rush Limbaugh go to places like the Betty Ford clinic, not jail.

  4. Gravatar of Mark A. Sadowski Mark A. Sadowski
    27. March 2010 at 08:39

    The Republican Party has changed a lot in just the last few years Scott. With Bartlett, and now Frum, fired it’s increasingly clear that diversity of opinion is not going to be tolerated. And the irony with Frum is that Obamacare is really just Romneycare more or less, but you’ll find very few Republicans supporting it.

    With respect to diversity of opinion on monetary policy on the “right” I’m somewhat perplexed by that statement. You’re one of the very few self-described “right-wing” economists (a libertarian of course) who’s calling for more monetary stimulus. That’s one reason why I find your views so refreshing. On the other hand I can think of several left-wing economists who are in favor more monetary stimulus, although they think it’s impossible given the current FOMC.

    I’m not sure I like the analogy drawn between a blacklisted screenwrite and a fireman passed over for promotion. One is in effect denied both his freedom of speech and the opportunity to exercise a very specialized skill. The other is merely denied somewhat more responsibility and pay. It’s not a very good analogy.

    My father was extremely anti-communist. Being Polish he elected not to return to his home country after WW II for that reason. (He served as a Special Forces paratrooper under British command during the war.) But, perhaps ironicly, he was very anti-anti-Communist at the same time. When he arrived in New York harbor off the Queen Elizabeth in 1959 he was asked by the authorities if he had any communist literature in his luggage. My father responded “of course.” My father read widely, and was incredulous that they would ask such a question. (Personally I’m glad I didn’t experience those days.) I think it’s very possible to be both anti-communist and anti-anti-communist as you put it.

    And I think supply side thought is respected in the Democratic party much more than you acknowledge. Wasn’t the Tax reform Act of 1986 bipartisan? And what about the USA Tax proposal back in the 1990s? The USA Tax provided an unlimited savings allowance (USA). And what about the Bipartisan Tax Fairness and Simplification Act of 2010 (cosponsored by Senator Wyden)? That proposal replaces the corporate tax with a low flat simple flat tax and it greatly expands savings deductions and simplifies and lowers the marginal rates in the personal income tax. The Act has been endorsed by the Center for American Progress (CAP). By my count that’s three decades of supply side legislation and/or proposals by Democrats. I’m still waiting for the equivalent from the Republicans (but I’m not holding my breath).

  5. Gravatar of Mark A. Sadowski Mark A. Sadowski
    27. March 2010 at 08:56

    With respect to your manuscript I have nothing really to add (I’ve been keeping up but feel no need to comment). I’ve always bought the “Golden Fetters” hypothesis of Eichengreen and your book merely seems to provide much more detail in support of it. (Your book would make a good refereance if it ever gets printed) I’m still waiting for the part that you predict that I (a “left winger”) will disagree with.

  6. Gravatar of Philo Philo
    27. March 2010 at 09:23

    Instead of writing: “. . . whereas conservatives like Rush Limbaugh go to places like the Betty Ford clinic, not jail,” shouldn’t you have written: “. . . whereas *whites* like Rush Limbaugh . . ., etc.”? I don’t think anybody believes Rush Limbaugh’s *conservatism* got him lenient treatment; some will suspect that his race helped. (His wealth? His celebrity?)

    Most Republicans are probably more inclined to be outraged at Limbaugh’s escaping jail than at the black (and other) drug users’ being confined. But they don’t *express* outrage, because “He’s *our* son-of-a-bitch” (to borrow FDR’s characterization of Somoza).

  7. Gravatar of William William
    27. March 2010 at 09:58

    I don’t quite grasp why parties want to argue about which one is more “diverse” in its opinions. The whole point of establishing a brand like Republican or Democrat is so that people will know what they’re getting without having to invest too much time and effort.

    I’d be surprised to see a commercial for Oreo cookies that said, “Buy our cookies! Some of them are really good, but some are terrible! Maybe you’ll get lucky!”

    You want your brand to represent uniform quality. Similarly, in politics, once you’ve figured out what the median voter wants, it seems you’d want to kick out anyone in your party who doesn’t represent that view. That’s how you win.

  8. Gravatar of ssumner ssumner
    27. March 2010 at 10:08

    Mark, You said;

    “I’m not sure I like the analogy drawn between a blacklisted screenwrite and a fireman passed over for promotion. One is in effect denied both his freedom of speech and the opportunity to exercise a very specialized skill. The other is merely denied somewhat more responsibility and pay. It’s not a very good analogy.”

    You missed the point of my analogy. The point was that the harm done to the screenwriter was trivial compared to the harm done to the victims of communism. If one example is 1,000,000 to 1 and the other is 1,000,000 to 3, it doesn’t really make any difference. There have been a number of Hollywood films depicting the plight of screenwriters. There have been many, many, films depicting the victims of fascists. I only recall one film depicting the victims of communism, although I imagine there are a few I missed. But it’s a real blind spot on the left. There have even been Hollywood movies praising Stalin, and suggesting that he didn’t really purge is opponents, that the show trials were fair. I recall Ted Turner showing one once, and it was claimed as his attempt to improve US/Soviet relations! And how about the Che and Castro posters you see on faculty offices of progressives. Maybe all this is not obvious to someone who is themself progressive, but if you are a right-winger it all stands out like a sore thumb.

    BTW, not to excuse the disgraceful treatment of screenwriters, but I recall reading one saying that he was viewed as a hero everywhere he went, and got writing jobs (uncredited) on the side. So the differences with the fireman don’t all work in one direction.

    I’ll ask you this question: How many times have you heard a progressive describe someone as an anti-communist, and mean it as a compliment? Now repeat the question for anti-fascist. Progressives claim to be opposed to both fascism and communism, and in a sense they are. Conservatives claim to be opposed to racism, and in a sense they are. But look where all the passion is.

    You said;

    “I think it’s very possible to be both anti-communist and anti-anti-communist as you put it.”

    Bingo! But then why don’t progressives realize that it is possible to be both anti-racist and anti-anti-racist?

    Mark, I agree there was some respect for supply-side economics back in 1986, but how many Democrats today would vote for that bill? I’d predict zero. The top rate was set at 28%. In any case, I was talking about the more hard-core supply side economists. If you are talking about less controversal ideas like tax reform, then I agree that some Dems are on board. But I’m not sure how much influence Wyden has. His health care plan was far better than Obama’s but the Dems never gave it any consideration. Wyden’s the kind of guy that would be in my idea centrist party, if we had a parliamentary system.

    Mark#2, You said;

    “With respect to your manuscript I have nothing really to add (I’ve been keeping up but feel no need to comment). I’ve always bought the “Golden Fetters” hypothesis of Eichengreen and your book merely seems to provide much more detail in support of it. (Your book would make a good refereance if it ever gets printed) I’m still waiting for the part that you predict that I (a “left winger”) will disagree with.”

    Ouch! I have a completely different explanation of the Great Depression than Eichengreen. I need to do a better job explaining it. My focus is private and central bank gold hoarding, and using changes in the price of gold as a tool for expanding AD. Eichengreen argued that FDR’s gold buying program was ineffectual, and he had no explanation for why the Depression began when it did (as he never collected data on the world gold reserve ratio.) I also don’t recall him looking at private gold hoarding. He viewed the gold standard as something that constrained policymakers. It was a Keynesian model. I viewed the gold market as an independent source of shocks. And of course Eichengreen never explained why the recovery was so slow.

    Philo, Maybe I didn’t use the best example, but my point still stands. The drug laws are absurdly tilted against inner city blacks, and everyone knows it. (Think of the powder/crack cocaine sentencing disparities.) And unless I missed something I don’t see much conservative outrage. It’s not (usually) their friends and relatives going to prison. Libertarians are obviously better on this issue, but they (we) have our own blind spots.

  9. Gravatar of Mark A. Sadowski Mark A. Sadowski
    27. March 2010 at 10:48

    Scott,
    You wrote:
    “But I’m not sure how much influence Wyden has. His health care plan was far better than Obama’s but the Dems never gave it any consideration. Wyden’s the kind of guy that would be in my idea centrist party, if we had a parliamentary system.”

    Granted, Ron Wyden may not have a great deal of influence in the Democratic Party but he’s still pretty well respected in the lefty/MSNBC universe. And as I recall Wyden-Bennett got totally ignored by the Republicans as well.

    And it looks like Wyden-Bennett is playing a major role in the fact that Bob Bennett apparently failed to win Utah’s Caucus on March 23. After serving his state for three terms he’s going to face a June primary fight. It could be that another centrist Republican will be ousted in favor of the new Party line.

    If Wyden’s your conception of an idea centrist party, sign me up.

    You also wrote:
    “Ouch! I have a completely different explanation of the Great Depression than Eichengreen. I need to do a better job explaining it.”

    Perhaps I need to do a better job reading it. But, on the other hand, perhaps you could emphasize your differences with Eichengreen more for those of us who are a little dense.

  10. Gravatar of Jim Glass Jim Glass
    27. March 2010 at 12:26

    If we are old (like me) we were anti-communist before it was cool to be anti-communist.

    Has it ever become cool to be anti-communist?

    Here in NYC there is a KGB Bar, and if you follow the link you will see it is a hot spot of the literary set.

    There is no Gestapo Bar.

    This in spite of the fact that the Communists killed many millions more people than the Nazis did — multiples of how many the Nazis killed — as the Black Book of Communism tells us.

    For that matter, as even a good liberal like Brad DeLong tells us.

  11. Gravatar of Kevin Donoghue Kevin Donoghue
    27. March 2010 at 12:29

    Scott,

    You turn out some interesting posts, but an awful lot of what you say doesn’t really stand up. (Come to think of it, that probably means you have a great future in blogging.) Take this for instance: “On issues like monetary policy there is far more diversity among right wing intellectuals than among the left (who tend to be broadly Keynesian.)” I could write a long essay about all the reasons why that statement just won’t do. But it’s Saturday night so I’ll content myself with a shortish comment before I repair to the pub.

    Firstly, “broadly Keynesian” covers a huge spectrum. (One of these days I’ll try to clean up the Wikipedia page on Keynesian Economics; it’s just dreadful.) Pretty well any model in which unemployment is possible will be called “Keynesian” by somebody or other, even if it has nothing whatever to do with Keynes’s own theory. If the term “broadly Keynesian” includes Neo-Keynesian, Post-Keynesian and New Keynesian then it’s hardly anything more than an antonym for “broadly Classical”, a.k.a. freshwater, economics. Even Milton Friedman’s work was broadly Keynesian.

    The left, as you typically use the term, includes Keynes, Joan Robinson, Minsky, Tobin, Solow, Krugman, Stiglitz, Galbraith (father and son), Blinder and many, many more. In the blogosphere, Dean Baker, John Quiggin and Daniel Davies are all leftists relative to you. I really can’t imagine any view on monetary policy which is (a) remotely defensible and (b) rejected by them all. How much diversity do you want? I grant you there are limits which may not apply in right-wing circles; Galbraith Sr once flunked a student whose entire theory of money was that it is the root of all evil (he cited the Bible as his authority). But even then he did subsequently admit that the student had a point.

  12. Gravatar of Trent Trent
    27. March 2010 at 14:16

    I was interested to see you discussing how many on the Left perceive the Right as being more unified of opinion than them. Me and my Mom have argued over this, with she of the opinion that the Right is more unified than the Left. Along with you, I’m inclined to be skeptical. My favorite I.R. theorist, Robert Jervis, made the point in his book “Perceptions and Misperceptions in International Politics”, that a particularly common misperception is to see the behavior of other groups as more “centralized, planned, and coordinated than it is”, drawing on psychology research from the 50s and 60s, which I find convincing. Maybe there’s a decent argument to be made in there somewhere about overall patterns within the factions, but the slipperyness of factional identification and categories makes it all but impossible in my mind. There’s better, more concrete, more DEBATABLE topics to debate.

  13. Gravatar of Mark A. Sadowski Mark A. Sadowski
    27. March 2010 at 14:35

    Trent,
    I found your comment to be thought provoking. However, I refer you to the famous Will Rogers quote: “I am not a member of any organized political party. I am a Democrat.” I can’t imagine anyone saying anything equivalent about the Republican party.

    Most pundits consider the Republican party to be the more “disciplined” of the two parties. I suppose that it could be quantified by such things as frequency of voting as a block or similarity of voting patters etc. But it’s not worth my time to statistically analyze and I gather it’s not worth your’s either.

  14. Gravatar of 123 – TheMoneyDemand 123 - TheMoneyDemand
    27. March 2010 at 14:55

    “The US situation after October 2008 was complicated by the Fed’s decision to pay interest on reserves at a rate above T-bill yields, which may have inflated commercial bank demand for reserves.”
    I still don’t get your continued emphasis on IORs. Fed started IORs in order to implement QE/credit easing. IORs give Fed the ability to start start QE/CE stimulus before the ZIRP and allow Fed to keep QE/CE longer even after the end of ZIRP.
    It is the hawks who want to abolish IORs and are calling for the reduction of the size of the Fed’s balance sheet.

  15. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    27. March 2010 at 15:23

    ‘I’m not sure I like the analogy drawn between a blacklisted screenwrite and a fireman passed over for promotion. One is in effect denied both his freedom of speech and the opportunity to exercise a very specialized skill.’

    Baloney, no one is entitled to a high paying screen writing job. The studios–who created the blacklist–were justified in their anger. Especially Jack Warner over ‘Mission to Moscow’, which is undoubtedly the movie Scott remembers glorifying the Moscow Show Trials. Especially during the Korean War, they didn’t want communist propaganda in their films.

    The Hollywood Ten were guilty as hell, as one of them, Edward Dmytryk later admitted, of inserting pro-Moscow messages in the scripts. Those writers got around the blacklist anyway. Dalton Trumbo won an Oscar for ‘The Brave One’, written under the pen name Richard Rich.

  16. Gravatar of Mark A. Sadowski Mark A. Sadowski
    27. March 2010 at 16:00

    Patrick R. Sullivan,
    I was merely expressing myself. I think that I prove Scott’s larger point that those on side of the spectrum are outraged by different forms of injustices.

    Surely you don’t think all blacklisted directors, screenwriters, actors, composers, lyricists, musicians, singers, poets, writers, journalists, radio personalities etc. contributed as negatively as Harry Warner (Jack’s brother), who may or may not have been a communist.

    I am still sympathetic to Dalton Trumbo despite the fact he thought the United States should not get involved in the war on the side of Great Britain, since the Molotov-Ribbentrop Pact of nonaggression meant that the Soviet Union was at peace with Germany. (Keep in mind the M-R Pact was the pact that amounted to a modern partitioning of the Second Polish Republic, my father’s country.) But I fail to see how much of a negative impact those views could have had. And I wonder how any of us would feel, no matter how well we’re paid, working under a pseudonym.

  17. Gravatar of Mark A. Sadowski Mark A. Sadowski
    27. March 2010 at 16:31

    “….Scott’s larger point that those on side of the spectrum…”

    should read

    “….Scott’s larger point that those on opposite sides of the spectrum….”

    A good book about Mission to Moscow is “Mission to Moscow”, by Davis H. Culbert (1980). Mostly it sounds like studio bosses running amuck making WW II propaganda fims.

  18. Gravatar of ssumner ssumner
    27. March 2010 at 19:21

    William, No, you need a big tent in a two party system, otherwise people might feel they don’t have a home in your party. The Republicans need at least a few pro-choice moderates in the Northeast, otherwise many of those independents who like the Republicans on economic issues might be so turned off by the social conservatism that they vote Democratic. Diversity of opinion helps for a big tent. You also need internal critics within your party (like Frum) to know when you have drifted off course. The median voter model makes politics seem like more of a science than it really is.

    Mark, I agree about the Republicans, and have criticized them pretty sharply in some recent posts. Don’t blame yourself on the Eichengreen differences–I do need to do a better job. Plus you didn’t get to read chapter one, where I spell out exactly what my approach can explain that his can’t. That is a weakness in jumping right in to chapters 4-6.

    Jim Glass, Yes, and there are so many other examples like that. I just don’t understand how people on the left don’t see how embarrassing that stuff is. Of course the moderate left–which includes people who read this blog, don’t romanticize Che or think Mao and the KGB are sort of cute. But among the further left,there is still a sort of communist chic. And you are right, it still isn’t really cool to be anti-communist. But at least it’s acceptable, as long as you don’t call people commies who aren’t commies. I should read the Black Book someday. I seem to vaguely recall a book that summarizes all the really embarrassing things said about communism by progressives in the 1930-70s period. Does anyone know the name of that book?

    Kevin, “Intesting, but doesn’t hold up” Since you and I have different views I’ll take that as a compliment. :)

    OK, I’ll accept your claim that the left has diverse views on monetary policy. I was thinking on the right of categorical differences (Austrian, monetarist, fiscal theory, new classical, RBC, gold bugs etc) But I can accept the diversity within the keynesian umbrella is extremely large. So I’ll accept that point. I presume you agree there is a lot of diversity on the right.

    Going back to Mark’s comment, I did a piece for the AEI that definitely went against their ideology. I think Frum’s problem was to speak out on a very high profile issue when the right was feeling depressed by a big loss. But I still think the AEI made a big mistake.

    One final point. All I was really trying to do was respond to Yglesias claim that there is no diversity on the right. I wasn’t trying to show there is no diversity on the left. I probably left the wrong impression. Yglesias is right that the right has big flaws right now, but it isn’t precisely a lack of intellectual diversity, it’s more a matter of turning intellectual issues into partisan issues. (Three “rights” in one sentence!) The think tanks should be doing ideas–leave politics to the politicians.

    Trent, I think that’s a good point. I might add that I see the moderate left as broadly utilitarian, or at least consequentialist. The right includes classical liberals (libertarians) who actually have similar values as liberals, but just a different view of economics, plus conservatives with different values (according to Jonathan Haidt.) I guess I’ve always thought of the libertarian/conservative split as introducing an extra bit of diversity on the right. If I was a left leaning liberal I’d prefer the Dems to the GOP on 98% of issues. As it is I prefer the GOP on perhaps 60% of issues. Whereas conservatives often prefer the GOP on 98% of issues. I just don’t see any groups on the left who only favor the Dem position over the GOP by 60-40. I don’t know if that makes sense, but it gives you a sense of how libertarians have a different perspective on the left/right split.

    123, I agree that if you think in terms of monetary policy solety in terms of interest rates, it doesn’t seem to have been a big deal. Rather the mistake was not reducing rates more quickly in the late summer and fall of 2008. But many non-keynesians think that money works through channels other than the short term rate, and that this policy might have impacted expectations, reduced the expectation that the big monetary injections would raise future prices, and this feeds back to reduce current prices. I’ve never claimed it was a slam dunk that an interest penalty on reserves would have prevented NGDP from falling–rather I argued that the positive interest rate neutralized the impact of the QE. So all we had was the short term rate, which the Japanese already showed may be a weak tool in a deflationary environment.

    Patrick, It sounds like you know a lot more than me. It was Mission to Moscow, I had forgotten that title. I’m not going to comment further because I have had time to study the issue. As a libertarian I oppose governemtn censorship, but think artists who glorified communism were behaving dispicably. Here’s another anecdote. Film buffs know of a famous Ukrainian silent film called “Earth.” Every review gives it 4 stars as an inspiring film. I’ve never seen a reviewer criticize its politcs. But is was made in 1933, just as millions of Kulaks were being slaughtered. In the film Kulaks are depicted roughly as Jews are portrayed in Nazi films. Most film critics are progressives, and they are totally clueless about the politics of the film, because unless you know the history, you’d think these guys really are villains.

    Mark, I understand some of the pro-Russia films were made during the war, but what was Ted Turner doing showing the film in the 1980s, in an attempt to present the Russians in a more favorable light?

    And just to reiterate on the screenwriters, I’m not saying they were exactly comparable to firefighters–but I think any open-minded observer would notice that on the left there is much more passion about their suffering that the astronomically greater suffering inflicted by the communists. I firmly believe that even today many progressives fail to recognize how much of that suffering was caused not by fascist-style concentration camps, but by a “to each according to their needs” economic policy which took away all incentive for farmers to be productive, and led to mass famine.

  19. Gravatar of 123 – TheMoneyDemand 123 - TheMoneyDemand
    28. March 2010 at 03:31

    “123, I agree that if you think in terms of monetary policy solety in terms of interest rates, it doesn’t seem to have been a big deal. Rather the mistake was not reducing rates more quickly in the late summer and fall of 2008. But many non-keynesians think that money works through channels other than the short term rate, and that this policy might have impacted expectations, reduced the expectation that the big monetary injections would raise future prices, and this feeds back to reduce current prices. I’ve never claimed it was a slam dunk that an interest penalty on reserves would have prevented NGDP from falling–rather I argued that the positive interest rate neutralized the impact of the QE. So all we had was the short term rate, which the Japanese already showed may be a weak tool in a deflationary environment.”

    I certainly agree that expectations are very important for IORs and QE/CE. But I think that IORs are very helpful here – they create expectations that central banks will start QE very early, when there is still disagreement whether risk of zero rate bound exists. They also help with the exit expectations – IRs make the exit from QE/CE a slow gradual process that will not accidentally throw economy back to the zero interest rate bound.

  20. Gravatar of Daniel Kuehn Daniel Kuehn
    28. March 2010 at 03:56

    I’m curious where this impression of yours comes from:

    “One thing I have noticed about progressives is that while they pay lip service to having rejected communism, their real passion is for anti-anti-communism. They seem more outraged that a few Hollywood screenwriters lost their jobs in anti-communist witch hunts decades ago, than they do that policies advocated by those screenwriters, such as “to each according to their needs,” led to the starvation of tens of millions of people.”

    I really see no context or reason to think this. Modern liberalism has deep roots on what was The New Left, which emerged out of an explicit rejection by the left of those policies that “led to the starvation of tens of millions of people”. How in the world can this movement be conceived of as ignoring the problems. It’s whole purpose was to reject state socialism. There was some flirtation with Latin American communists at this point as an alternative – but I’d chalk that up to naivete rather than real conviction. The New Left’s visceral negative response to Soviet oppression pretty clearly demonstrates their deep concern with these problems. And outside the New Left, more traditional liberals like Truman, JFK and LBJ were certainly genuinely anticommunist. I can’t help the impression that you’ve remembered things in a way that’s convenient for you. Do you have any reason for thinking what you wrote, or is that just a vague impression?

  21. Gravatar of Mark A. Sadowski Mark A. Sadowski
    28. March 2010 at 06:16

    Scott wrote,
    “Mark, I understand some of the pro-Russia films were made during the war, but what was Ted Turner doing showing the film in the 1980s, in an attempt to present the Russians in a more favorable light?”

    I know you’d rather not devote too much time to discussing Mission to Moscow but you did bring it up. I’ll keep this as brief as I can. Here’s what I know, mostly based on David H. Culbert’s book on the subject.

    Mission to Moscow was a well-intentioned, if overzealous and unsuccessful, attempt by FDR, Davies, Warner Bros. Studios, and the official United States wartime propaganda agency, the Office of War Information (OWI), to counter Americans’ distrust of their socialist and allegedly totalitarian Soviet ally. Harry Warner came up with the idea, primarily because he saw an opportunity to turn former U.S. Ambassador to the Soviet Union Joseph E. Davies’s critically and commercially acclaimed book into a successful motion picture.

    The movie bombed both critically and commercially. It met a mixed reaction on both the left and the right. Believing that it would facilitate a military victory by solidifying the Grand Alliance, such conservative nationalist groups as local American Legion councils offered their endorsements. Although pleased with the picture’s criticism of conservative isolationists and its portrayal of the Soviet Union’s staunch fight against Nazism, the Nation’s James Agee claimed Mission to Moscow was:

    “A mishmash: of Stalinism with journalism with opportunism with shaky experimentalism with mesmerism with onanism, all mosaicked into a remarkable portrait of what the makers of the film think that the American public should think the Soviet Union is like-a great glad two-million-dollar bowl of canned borscht, eminently approvable by the Institute of Good Housekeeping.”

    The House Committee on Un-American Activities (HUAC) would later cite Mission to Moscow as one of the three noted examples of pro-Soviet films made by Hollywood, the other two being The North Star and Song of Russia. All of these films were unabashed studio propaganda pieces that sought to horn in on the missperceived market for such pictures in wartime.

    The film made its TV debut on PBS in the 1970s. It was most recently shown as part of Shadows of Russia film series this year on Turner Classic Movies (TCM). That’s where I saw it. TCM presented the film in its proper context.

    I don’t know anything about the 1980s showing of the film by Turner but given how little respect the film received from the left in 1943 it’s hard for me to believe Turner thought it would actually be very persuasive in presenting the Soviet Union in a more favorable light in the 1980s.

    P.S. Mission to Moscow was directed by Michael Curtiz. Michael Curtiz is of course famous for having directed such films as Yankee Doodle Dandy, Casablanca and White Christmas. Needless to say he wished he never had anything to do with Mission to Moscow (both from a critical and a political point of view).

  22. Gravatar of ssumner ssumner
    28. March 2010 at 07:06

    123. I don’t follow. How is it good to have expectations that QE will start very soon, if the same policy also produces expectations that the QE will be completely neutralized by the IOR?

    Daniel, I’m not trying to suggest that progressives support communism, I’m trying to draw a parallel between anti-anti-communism and anti-anti-racism. Everything you said applies equally well to modern conservatism on the subject of race. Find me a single modern conservative intellectual who supports Jim Crow laws. Or who explicit exposes any sort of racism. But that doesn’t stop people like Yglesias and Krugman from throwing the term racism at lots of conservatives.

    I’m trying to make a subtle point here. I work in academia, and I interact with progressives all the time. I know what there passions are. I know the blind spots in their knowledge of history. Sure they don’t favor totalitarianism, but they often are under the delusion that the worst excess occurred because Marxism wasn’t given a fair chance. In fact, the worst excess–the Great Leap Forward–occurred when Marxism was given a chance. A policy of to each according to his needs was implemented. Because of the mass starvation, all communist countries had to back off and add a bit of capitalism. I actually have heard progressives say that the worst excesses of Mao and Stalin weren’t communism, they were fascism. No, the worst excesses were communism, and many progressives still don’t get that.

    Read my other replies. There is a very revealing double standard among progressive artists toward crimes of the left and the right.

    Here’s another example. In Europe the progressives were trying to hawl Pinochet in to court for a crimes against humanity trial, at the very same time that the same progessive governments were hosting Castro at state dinners.

    You say that the new left opposed Soviet totalitarianism. but the new left often had good things to say about Ho Chi Minh, Mao, Castro, Che, etc.

    Unfortunately I’d need a whole book to make all the points I am trying to make, so let me just summarize it this way. I don’t think progressives today favor communism. But I think that they have many of the same biases and blind spots toward communism that conservatives have toward the problem of racism. And I also don’t think modern conservatives favor racism. The question is whether progressives fully understand just how evil Marxism is, and whether conservatives realize just how evil racism is. That’s still and open question.

    Mark, It’s easy to forget how deluded that Ted Turner was in the 1980s. But I rather not focus on one film. Here’s another example. Think about how progressives in the 1980s characterized different regimes. When there were evil right wing regimes they fell all over themselves using any pejorative adjective they could think of. But when it came to the Soviet Union, China, Cuba, North Vietnam, they’d get all upset when a rightwinger called the regime evil. You could almost see them role their eyes. I remember all of this quite vividly.

    This may be hard to believe, but I recall that in the 1960s the average Western left wing intellectual had a more positive image of the Chinese regime than they do today. And of course the regime back then was 10 times more totalitarian than today. What does that tell you?

  23. Gravatar of Mark A. Sadowski Mark A. Sadowski
    28. March 2010 at 07:43

    Scott,
    What I remember about the 1980s actually supports what you are saying. (But I watched very little TV then.) I was a left leaning libertarian at Chicago from 1982-1985 (and remained on campus through 1986). My friends (all left wingers) were generally supportive of the Sandinistas (I had one friend in particular who frequently wore a Che Guevara t-shirt). I was rabidly anti-Republican (not much has changed) but I was also very ambivilent about supporting the Sandinistas, as I obviously did not support their methods.

    P.S. I was also deeply interested in the history of the New Left at the time and made it a point to find the remains of the old SDS national headquarters on the Southern border (63rd Street?) of Hyde Park above a Harold’s Chicken Shack. I lived on Harold’s in those days: dark halfs with lots of hot sauce.

  24. Gravatar of 123 – TheMoneyDemand 123 - TheMoneyDemand
    28. March 2010 at 12:31

    “123. I don’t follow. How is it good to have expectations that QE will start very soon, if the same policy also produces expectations that the QE will be completely neutralized by the IOR?”
    If fed funds rate is held constant, AD is (much) larger when QE and IOR is operating.

  25. Gravatar of Lorenzo from Oz Lorenzo from Oz
    28. March 2010 at 14:02

    As a general rule “the Left” is more unified than “the” Right, simply because the Left has the unifying value of equality. One might argue that it is more of a fetish than a genuine value (there is not a lot of equality involved in democratic centralism, for example) but it is a genuine binding factor.

    By contrast, there is no binding value across “the” Right, which is why it is dubious to even talk of “the” Right as other than “the politically committed who are not Left”. Liberty, authority, tradition are all notable “Right” values but there is huge variance in commitment to them.

  26. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    28. March 2010 at 14:40

    ‘As a libertarian I oppose governemtn censorship, but think artists who glorified communism were behaving dispicably.’

    The blacklist was not government censorship, it was the studios’ idea. The screenwriters were working for Moscow at the behest of Otto Katz. Himself an agent of Willi Muenzenberg (aka The Red Millionaire), the man from whom Joseph Goebbels learned so much. That’s the reason HUAC was so interested in the Hollywood Ten; the covert relationship with Stalin.

    No need to reply, Scott. I feel guilty enough already for distracting you from your book.

  27. Gravatar of Mark A. Sadowski Mark A. Sadowski
    28. March 2010 at 14:58

    Patrick R. Sullivan,
    Of course it was government censorship. It was the studios idea to make such big multimillion dollar propaganda productions like Mission to Moscow (Warner Bros.), The North Star (RKO), and Song of Russia (MGM). When they got called out on it after the war by HUAC they simply stood out of the way and threw their directors and screenwriters and actors under the bus in a massive act of CYA.

  28. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    28. March 2010 at 15:06

    Mark, you are the victim of communist propaganda yourself. The Roosevelt administration essentially commissioned ‘Mission to Moscow’ and had the OWI supervise its production. OWI was one of the most thoroughly penetrated of the temporary wartime agencies.

    The studios would never have made such ridiculous tripe on their own volition. To her everlasting credit, Ginger Rogers refused to utter the line, ‘Share and share alike, that’s democracy’ in ‘Tender Comrade’. A line written by Dalton Trumbo.

  29. Gravatar of Mark A. Sadowski Mark A. Sadowski
    28. March 2010 at 15:22

    PatrickR. Sullivan,
    Harry Warner came up with the idea of turning Davies’ bestseller into a commercial movie. (Before proceeding, however, Davies did solicit and obtain Roosevelt’s approval however.) The book had sold 700,000 copies (a phenomenal amount for those days) and the thinking was that it would be a hugely successful film. Nobody twisted the arms of the Warner brothers into spending $2 million dollars to make Mission to Moscow.

  30. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    28. March 2010 at 15:43

    ‘Harry Warner came up with the idea of turning Davies’ bestseller into a commercial movie.’

    That’s in dispute. Jack Warner first said he was contacted by the Roosevelt Admin. Later that story was changed to Harry read the book and liked it. Whatever, the movie was supervised by the thoroughly communist penetrated OWI. Jack Warner would never have allowed a piece of crap like MTM to have been made with out pressure from Roosevelt.

  31. Gravatar of Mark A. Sadowski Mark A. Sadowski
    28. March 2010 at 15:57

    Patrick R.Sullivan,
    It’s no secret that FDR was very enthusiastic about the picture and met with Davies repeatedly in 1942 to get updates on its progress. And of course the communist penetrated OWI supervised its production. But Harry and Jack had a major falling out in 1947 in large part because Jack blamed Harry for the whole HUAC harrassment over MTM. It was Harry’s idea.

  32. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    28. March 2010 at 16:55

    You’re sure about that? Here’s an alternative explanation for Harry’s claim to infamy:

    http://ics.leeds.ac.uk/papers/vp01.cfm?outfit=pmt&requesttimeout=500&folder=933&paper=1230

    ———–quote———-
    Known as the “Roosevelt studio” and led by friends of the president and committed reformers, Warner Bros. had championed on screen both FDR’s New Deal and his increasingly pro-Allied and interventionist foreign policies before Pearl Harbor. In part, genuine patriotism, as Jack Warner claimed, motivated the executives. But because, like other industrialists, he and his brother were in the movie business to make money and not to educate, they needed financial inducements to make diplomatically charged films. A large portion of that incentive arrived just before American intervention when the White House, at the Warners’ urging, protected the industry from domestic antitrust litigation, insuring Hollywood’s domestic profitability and making executives more amenable to the administration’s publicity needs. In July 1939, at the request of small producers and independent theater owners, the Justice Department had charged the major studios -which dominated production, distribution, and exhibition-with violating the Sherman Antitrust Act. The Justice Department’s suit portended financial ruin by threatening to force the studios to divest themselves of their distribution and exhibition arms. The Warners, along with Will H. Hays, president of Hollywood’s trade association, the Motion Picture Producers and Distributors Association (MPPDA), beseeched the president and his confidant, Secretary of Commerce Harry L. Hopkins, for relief. By mid1940 Hopkins intervened and persuaded the Justice Department to issue a consent decree permitting the industry to remain intact while discontinuing some of its unfair trading practices. In exchange for the White House’s help, the trade periodical Variety reported, Hollywood pledged to lend cinematic support to the administration’s domestic and foreign policies. Soon afterward, Lowell Mellett, the head of an official information agency created by Roosevelt in 1939 (the Office of Government Reports) and the administration’s main contact with Hollywood, lent greater credence to such assumptions when he informed the president that an “effective plan” for securing filmmakers’ cooperation was “being developed.” Roosevelt sent a note, which was read during the 1941 Academy Awards ceremony, thanking the industry for its help. TO FDR, Mellett privately added, “the motion picture industry is pretty well living up to its offers of cooperation. Practically everything being shown on the screen . . . that touches on our national purpose is of the right sort.” Just one month after acquiring the rights to Mission to Moscow, a film designed to satisfy their internationalist patron in the White House, the Warners offered their “services and experience in the motion picture field” to the administration.
    ————-endquote———–

  33. Gravatar of Mark A. Sadowski Mark A. Sadowski
    28. March 2010 at 17:08

    Patrick R. Sullivan,
    What part of that paper contradicts my claims? I never said that the Warner brothers didn’t understand the role of good bargaining. I refer you to paragreaph 9:

    “Either Davies or Jack and Harry Warner, co-presidents of Warner Bros. Studios, came up with the idea of turning the bestseller into a commercial movie.”

    Since you admire Jack so much that only leaves Harry.

  34. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    28. March 2010 at 19:28

    Your claim is that Warner Bros. saw a profit opportunity in turning a best seller into a commercial movie. What I’ve quoted shows that Warner was committed to a political bargain much earlier. And, note: ‘Mission to Moscow, a film designed to satisfy their internationalist patron in the White House’.

  35. Gravatar of Mark A. Sadowski Mark A. Sadowski
    28. March 2010 at 19:39

    Within the constraints of the time of course he perceived it as a profit making opporunity. I never claimed he never struck a political bargain (it was clear he was very eager to). The point is that Harry Warner was the legitimate originator of the idea of making MTM into a picture (unless you want to count Davies who obviously always thought of making it into a picture).

  36. Gravatar of Mark A. Sadowski Mark A. Sadowski
    28. March 2010 at 20:07

    Let me be as clear as I can possibly be. You have failed to prove anyone other than Harry Warner (or Davies) originated the idea of making MTM into a film. Could I be any clearer?

  37. Gravatar of Jason Jason
    28. March 2010 at 20:41

    I enjoyed your counter-argument to Yglesias, however I think both concepts (racism, or more generically tribalism and Marxism, or more generally socialism) exist as a continuum in a single moral dimension.

    Divesting Americans of some of their money to aid other Americans (state socialism) is more defensible in political discourse than, say, to aid Nicaraguans (world socialism), which constitutes a form of racism … assuming you have a maxim you are defending it does not make sense for it to stop at national borders.

    Extreme anti-tribalism is essentially world scale socialism, whereas extreme anti-socialism is individual scale tribalism.

    There may or may not be an optimum along this scale, but I doubt if there is one it is at either end. A mixed economy (some socialism, welfare state mixed with capitalism) at large super-state scale (US/EU, to a lesser extent China/India) seems to be what has worked best so far. The EU tends to aim for a little lower Gini index, the US a little higher. The US has come to much better terms with its demographics than the EU.

  38. Gravatar of David Reich David Reich
    29. March 2010 at 07:35

    Because of the excesses of its most visible practitioners, “antiracism,” as conventionally understood, has taken on unfortunate associations.

    As pointed out in my novel The Antiracism Trainings, “the ideas advanced by [antiracism] trainers had come to seem not merely wrong but dangerous, divisive, reactionary. They dissipated energy, set people of goodwill against one another.”

    See:

    http://www.amazon.com/Antiracism-Trainings-David-Reich/dp/193540279X/ref=sr_1_1?ie=UTF8&s=books&qid=1264799779&sr=8-1

  39. Gravatar of scott sumner scott sumner
    29. March 2010 at 11:19

    Mark, Yes, I remember Harolds. In the 1970s there was lots of crime, and you’d slip the money under bullet-proof glass to the cashier. Did they still have that campus bar, I think it was Jimmy’s?

    123, But the IOR has been above the market funds rate; I see that as encouraging more hoarding than if the IOR was below the funds rate, or even equal. Again, it may not be that important, but it’s a concern, and something they should have handled differently.

    Lorenzo, I agree, and just made a similar point on the “vile” post comment section. The right is a grab bag of social, foreign policy, and economic conservatives, who often can’t stand each other.

    Patrick, That’s a good point–Reason had an article making a similar point about 3 or 4 months ago. If you can find it you might enjoy it.

    Jason, I think it is a 4 quandrant diagram, not a line. You have very tribal societies that are very communist, such as N. Korea. And you have capitalist places that are pretty cosmopolitan (at least compared to regional neighbors.) These includes cities like New York, London, Toronto, Singapore, Dubai. So I think it is more complicated that socialism vs tribalism. Cosmopolitan capitalism is also an option.

    David, That’s a good point. I see the extreme training seminars as analogous to McCarthyism (or the cultural revolution in China, for that matter.) The stakes may not be as high (obviously compared to China) but it can get fanatical. Communism and racism are evil, but anti-communism and anti-racism can easily go too far, and become problems. Not as bad as the problems they are fighting against, but very unfair and counter-productive nonetheless.

    Patrick and Mark–Interesting debate, but I’m not knowledgeable enough to comment.

  40. Gravatar of Mark A. Sadowski Mark A. Sadowski
    29. March 2010 at 11:31

    Scott,
    With respect to Harold’s Chicken, don’t forget the deep fried oil smoked filled waiting areas in front of the glass and the amateurish menus on the wall. If you sat down you’d leave with oil stains on your jeans. You’d meet some interesting people there. And Jimmy’s was the only bar in Hyde Park when I was there. It was a good place to hear live music.

  41. Gravatar of 123 – TheMoneyDemand 123 - TheMoneyDemand
    30. March 2010 at 02:51

    “123, But the IOR has been above the market funds rate; I see that as encouraging more hoarding than if the IOR was below the funds rate, or even equal. Again, it may not be that important, but it’s a concern, and something they should have handled differently.”

    Difference between IOR and fed funds rate is important, but in the opposite direction. If we hold fed funds rate constant, AD is larger when IOR is above fed funds rate. IOR neutralizes the effect of QE on fed funds rate, not on the aggregate demand.

  42. Gravatar of scott sumner scott sumner
    30. March 2010 at 05:38

    Mark, I had a lot of meals of beer and cheeseburgers at Jimmy’s. Beers were 35 cents, and cheeseburgers were also cheap.

    123, I don’t follow. A higher IOR encourages more hoarding. How does that raise AD?

  43. Gravatar of 123 – TheMoneyDemand 123 - TheMoneyDemand
    30. March 2010 at 07:13

    IOR higher than fed funds rate is a sign that QE has raised AD.

  44. Gravatar of jean_ jean_
    30. March 2010 at 09:25

    Sorry if my questions are naive but I don’t fully understand your refutation of the Fisher effect. If I understand well, if Fisher effect had been present, there should have been self-correlation in commodity prices.
    Could you give us a theoretical reference why?
    Besides, you mention that real interest rates were similar in countries which had already devaluated. So this rules out real interest rates as an explanatory variable but not balance sheets effects: businesses had also benefited of debt lightening which had improved their solvency and borrowing capacity (of course they also benefited of lower real wages).

  45. Gravatar of scott sumner scott sumner
    31. March 2010 at 05:48

    123, I don’t follow at all. Under QE the fed funds rate goes to the free market level. IOR is administered. More AD raises free market rates. I must be missing something. IOR above free market rates encourages hoarding–that’s never good for AD.

    jean, Finally a question on the chapter! It’s not that I disagree with the Fisher effect, it’s that I think it applies to ex ante inflation, not ex post inflation. I don’t think price changes were very forecastable back then—almost a random walk. So I don’t think we have much evidence on what happened to real rates. Ex ante real rates may not have risen, despite rapid deflation. A bit of deflation may have been expected, but I think we got more than expected. It is the unexpected deflation that causes high unemployment. I see rising real wages as a bigger problem than rising real interest rates, although I understand why not everyone agrees with me.

    Fell free to reply if this doesn’t answer your question.

  46. Gravatar of 123 – TheMoneyDemand 123 - TheMoneyDemand
    31. March 2010 at 08:21

    “Under QE the fed funds rate goes to the free market level.”
    No. Under QE/CE as implemented by Bernanke fed funds rate is still set by FOMC, but in addition to regular open market operations, Fed has additional tool to control fed funds rate – IOR.
    “More AD raises free market rates.”
    More AD sometimes raises free market rates, but sometimes lowers them closer to the natural rate.
    “IOR above free market rates encourages hoarding–that’s never good for AD.”
    In 2009 a tiny bit of hoarding created by 25 bps IOR maybe has raised fed funds rate by 10bps above free market equilibrium – this is almost unnoticeable.

    I don’t know why you think that IOR completely offsets the QE stimulus. To me this is equivalent to saying that fiscal stimulus financed by 25bps yielding overnight treasury bills would not increase AD in 2009.

  47. Gravatar of ssumner ssumner
    1. April 2010 at 05:18

    123, I disagree. The fed funds target is set by the Fed. But the fed funds rate (which after September 2008 often differed from the target) is set by the market.

    I’ve never seen more AD lower market rates.

    I think IOR is a problem because banks are hoarding ERs. You don’t want banks to hoard ERs. If necessary, the IOR should be negative. I think in terms of supply and demand for money as causal factors. Interest rates are endogenous, once monetary policy is determined. They are one of the effects of policy, not the policy itself.

  48. Gravatar of jean_ jean_
    1. April 2010 at 09:10

    @ssumner:
    I now understand your point on ex ante real interest rates (and the link with unforecastability of commodity markets).

    But I was also thinking about the effect of deflation on balance sheets, which is due to ex post inflation (just as for the wages). Of course, if Modigliani-Miller theorem was true or Pigou effect strong enough, that would not be a problem. But since there are coordination failures, this disturbs financial intermediation since banks won’t lend to people or businesses with too much debt. Do you have elements against this point of view?

  49. Gravatar of 123 – TheMoneyDemand 123 - TheMoneyDemand
    1. April 2010 at 12:50

    “I’ve never seen more AD lower market rates.”
    September 2008 is a good example. Fed & fiscal actions that increased AD (AIG bailout, money market fund support, conversion of investment banks to bank holding companies, TARP, etc.) have caused the effective fed funds rate to drop below the intended fed funds rate of 2 percent. A good proxy for AD in September 2008 is S&P 500.

    “I think IOR is a problem because banks are hoarding ERs. You don’t want banks to hoard ERs. If necessary, the IOR should be negative. I think in terms of supply and demand for money as causal factors. Interest rates are endogenous, once monetary policy is determined. They are one of the effects of policy, not the policy itself.”
    The main reason banks are hoarding ERs is low AD, and 25bps IOR has no practical significance. QE/CE is a much better tool than negative IOR.

  50. Gravatar of scott sumner scott sumner
    2. April 2010 at 08:17

    jean, Deflation may affect balance sheets, but that’s not a real interest rate argument. I don’t think that was the key problem, but it may have made things a bit worse.

    123, Monetary policy was very tight in September 2009 and AD fell sharply. So rising AD certainly doesn’t explain the low rates at that time.

    I disagree that low AD causes hoarding. In the early 1980s AD was very low, but banks could earn high rates on T-bills. So they didn’t hoard ERs. Hoarding occurs when the IOR is above the rate on T-bills.

  51. Gravatar of 123 – TheMoneyDemand 123 - TheMoneyDemand
    2. April 2010 at 10:04

    “Monetary policy was very tight in September 2009 and AD fell sharply. So rising AD certainly doesn’t explain the low rates at that time.”
    AD was much lower on September 15 2008 and on September 30 2008 than it was on September 22 2008. Effective fed funds rate fell way below 2 percent on those days when AD was relatively high.

    “I disagree that low AD causes hoarding. In the early 1980s AD was very low, but banks could earn high rates on T-bills. So they didn’t hoard ERs. Hoarding occurs when the IOR is above the rate on T-bills.”
    There is nothing so special about 3 months treasuries. Why don’t you compare IOR with 12 month treasuries that trade at higher yield than IOR? Banks are earning higher rates on 12 month treasuries than they are earning on “hoarded” reserves.

  52. Gravatar of ssumner ssumner
    3. April 2010 at 07:57

    123, 3 months is a better comparison. The expected rate of return on a 12 month Treasury is much lower over the next three months, than over the life of the bond. Reserves are a very liquid asset with a very short maturity. You should compare equals with equals. In the future it is expected that rates will rise–that’s why 12 month rates are higher than 3 month rates.

    I don’t understand your AD argument. We probably define the term differently.

  53. Gravatar of 123 – TheMoneyDemand 123 - TheMoneyDemand
    3. April 2010 at 13:59

    12month treasuries are a good substitute of reserves for banks in terms of liquidity, they have equal credit risk and they have an advantage of a small interest rate risk premium. So I’d say banks are hoarding reserves and 12month treasuries to an equal extent.

    I think we use the same definition of AD. The key driver of AD in September 2008 was a financial panic. On September 15 and on September 30 there was a very strong run on a financial system, but on September 20 the run was weaker because of AIG bailout, hopes of TARP, and money market fund insurance program. Many financial indicators support this description of events.

  54. Gravatar of ssumner ssumner
    4. April 2010 at 17:30

    123, I still say you can’t compare an overnight rate with a one year yield. It is quite possible that the expected average IOR over the next twelve months exceeds the current 12 month T-bill yield. That’s simply an application of the expectations hypothesis.

  55. Gravatar of 123 – TheMoneyDemand 123 - TheMoneyDemand
    5. April 2010 at 13:14

    There are many studies that show the existence of interest rate risk premium in the front end of treasury yield curve. There are many safe and liquid assets “hoarded” by banks, why do you focus on alleged 25bps pricing error on just one of them?

    Here is an article from April 2008 saying Fed wants to pay interest on reserves in order to add additional liquidity in the riskier parts of the spectrum without disturbing short term interest rates. At least in the Wicksellian framework such downward pressure on long term interest rates while keeping short term fixed should be inflationary. http://blogs.wsj.com/economics/2008/04/29/fed-paying-interest-on-reserves-an-old-idea-with-a-new-urgency/tab/article/

    The article also mentions that Friedman supported IOR. Many other central banks have paid interest on reserves for many years without any problems.

    In any case, the central bank reaction function and market expectations of future policy are more important than current IOR. And I strongly believe that reaction function that includes balance sheet expansion before zero nominal interest rate bound is hit is better in the sense that it should provide better macroeconomic stability compared to other alternatives.

    Imagine an alternative scenario. Lets say that Fed did not expand its balance sheet but started paying minus one percent IOR on September 2008. During a financial panic such policy would do no good as bad banks have a very different desired composition of their balance sheets. They want to dramatically increase the proportion of safe and liquid assets (including treasuries of various maturities) and a shift from fed funds rate of plus two to IOR of minus one would do little to discourage their desire to hoard.

  56. Gravatar of ssumner ssumner
    6. April 2010 at 07:13

    123, The reason I focus on IOR is that reserves are the medium of account, other assets are not.

    I understand why the Fed wanted to pay interest on reserves. They’ve already said it was so that they could increase the MB without the increase being expansionary. There is no debate about their motivation, they’ve admitted that the motivation was contractionary (to prevent short rates from falling.)

    Regarding Friedman, I have nothing against IOR, I just oppose paying a rate higher than what is earned on T-bill yields. I’m pretty sure he would have agreed.

    I agree that expectations of future policy are more important. But the Fed was sending out the wrong signals about future policy. So in that case the IOR was destructive.

    I agree that the alternative scenario would not be wise. I did not advocate that scenario. I suggested a negative IOR and an increased balance sheet.

  57. Gravatar of 123 – TheMoneyDemand 123 - TheMoneyDemand
    6. April 2010 at 16:28

    “The reason I focus on IOR is that reserves are the medium of account, other assets are not.”
    There are other assets (short term treasuries) that are almost identical to medium of account and have almost identical macroeconomic effects.

    “I understand why the Fed wanted to pay interest on reserves. They’ve already said it was so that they could increase the MB without the increase being expansionary. There is no debate about their motivation, they’ve admitted that the motivation was contractionary (to prevent short rates from falling.)”
    They wanted to increase MB in order to increase AD, but wanted to do it in a way that changes only long term interest rates. How can increased Ad be contractionary?

    “Regarding Friedman, I have nothing against IOR, I just oppose paying a rate higher than what is earned on T-bill yields. I’m pretty sure he would have agreed.”
    The only reason T-bills trade at lower yields than IOR is that Fed doesn’t pay interest on funds held at Fed by GSEs and foreign institutions. I agree that GSEs should be abolished, but I see nothing wrong with fed paying zero to foreign institutions.
    More here: http://www.econbrowser.com/archives/2008/11/the_anomalous_f.html

    I agree that expectations of future policy are more important. But the Fed was sending out the wrong signals about future policy. So in that case the IOR was destructive.”
    Talk of IOR in March 2008 was very useful in postponing the crisis. It has raised hopes that Fed will be able to emulate ECB’s policy of unlimited liquidity auctions that was started in 2007. ECB’s IOR policy was very constructive during the crisis.

    “I agree that the alternative scenario would not be wise. I did not advocate that scenario. I suggested a negative IOR and an increased balance sheet.”
    During a financial panic a negative IOR doesn’t help much. The most important mistake was not having level targeting. The second most important mistake was underestimating the size of balance sheet expansion that was needed. If you get these two things right, you get credibility and a wide range of interest rates of reserves is compatible with stable economy.

  58. Gravatar of ssumner ssumner
    7. April 2010 at 05:21

    123, You said;

    “There are other assets (short term treasuries) that are almost identical to medium of account and have almost identical macroeconomic effects.”

    I don’t agree. When I go shopping I may stuff some cash in my wallet. If I didn’t have any cash, I wouldn’t stuff some T-bills in my wallet, as I don’t view T-bills as close substitutes. Banks may regard them as close substitutes, but as I’ve already said if they do they we should charge a significant negative rates on reserves, which would make them no longer close substitutes.

    You asked:

    “They wanted to increase MB in order to increase AD, but wanted to do it in a way that changes only long term interest rates. How can increased Ad be contractionary?”

    You are confusing two issues, the increase in the MB and the IOR. I agree that the increase in the MB is expansionary, considered in isolation. But the IOR program was contractionary, for any given increase in the base. You act as if they couldn’t have increased the base w/o the IOR program. That makes no sense. Not only could they have, but it probably would have led to hyperinflation. That’s why they did the IOR, its effect was to prevent high inflation (according to James Hamilton), i.e. its effect was contractionary (according to Robert Hall.)

    In my view the ECB did an even worse job than the Fed, as NGDP feel even more sharply in Europe. So I don’t see how you can point to ECB policy as a success.

    I agree the failure to do level targeting was the biggest mistake. I also believe that if they had done level targeting (for NGDP) no large balance sheet expnasion would have been required. The huge increase in demand for reserves reflected expectations of falling NGDP.

  59. Gravatar of 123 – TheMoneyDemand 123 - TheMoneyDemand
    7. April 2010 at 16:00

    “I don’t agree. When I go shopping I may stuff some cash in my wallet. If I didn’t have any cash, I wouldn’t stuff some T-bills in my wallet, as I don’t view T-bills as close substitutes. Banks may regard them as close substitutes, but as I’ve already said if they do they we should charge a significant negative rates on reserves, which would make them no longer close substitutes.”
    From the perspective of large scale users of money, the main difference between T-bills and reserves is the name. Significant negative rate on reserves will significantly drag down T-bill rates too.

    “You are confusing two issues, the increase in the MB and the IOR. I agree that the increase in the MB is expansionary, considered in isolation. But the IOR program was contractionary, for any given increase in the base. You act as if they couldn’t have increased the base w/o the IOR program. That makes no sense. Not only could they have, but it probably would have led to hyperinflation. That’s why they did the IOR, its effect was to prevent high inflation (according to James Hamilton), i.e. its effect was contractionary (according to Robert Hall.)”
    First, for any level of intended fed funds rate the IOR program is expansionary. Your argument makes sense only if you say that Fed should abolish fed funds rate and move to the targeting of the quantity of monetary base. Second, increased monetary base without IOR has not created hyperinflation in Japan.

    “In my view the ECB did an even worse job than the Fed, as NGDP feel even more sharply in Europe. So I don’t see how you can point to ECB policy as a success.”
    In 2007-2008 ECB did a much better job when measured by volatility of 5 year inflation expectations. ECB liquidity auctions were so successful that they even raised interest rates in the summer of 2008. ECB targets inflation, not NGDP, and so far the eurozone price level is only 1.5% below the long term trendline.

    “I agree the failure to do level targeting was the biggest mistake. I also believe that if they had done level targeting (for NGDP) no large balance sheet expnasion would have been required. The huge increase in demand for reserves reflected expectations of falling NGDP.”
    The financial panic has increased the demand not only for reserves but also for all other safe assets. QE/CE was necessary to correct the expectations of falling NGDP as short term interest rate policy is not very effective during the financial panic.

  60. Gravatar of 123 – TheMoneyDemand 123 - TheMoneyDemand
    7. April 2010 at 16:07

    And ECB is expecting to hit the long term price level trend at the end of 2010, as Trichet has recently stated:
    “The average annual rate of inflation for the first 12 years of the euro up to the end of 2010 is expected to be about 1.95%. This is exactly in line with our quantitative objective for price stability, which aims for medium-term growth in the Harmonised Index of Consumer Prices for the euro area to be close to, but below, 2%. “

  61. Gravatar of ssumner ssumner
    8. April 2010 at 04:42

    123, You said;

    “From the perspective of large scale users of money, the main difference between T-bills and reserves is the name. Significant negative rate on reserves will significantly drag down T-bill rates too.”

    Until 2008 more than 90% of money was held as cash by the public. The large scale users were drug dealers, and they didn’t consider cash and T-bills to be close substitutes. The recent rise in the importance of ERs was of course a deliberate policy choice of the Fed. It’s why they started paying interest on ERs.

    You said,

    “First, for any level of intended fed funds rate the IOR program is expansionary.”

    No, for any given level of fed funds rate, the higher the IOR the more contractionary the policy–as it increases demand for ERs.

    You said;

    “Second, increased monetary base without IOR has not created hyperinflation in Japan.”

    Two responses:

    1. The monetary base in Japan did not double in a few weeks.
    2. It’s posisble that it would not have been inflationary, but the Fed clearly saw that as a risk, as did economists like Hamilton.

    The ECB may think they are doing a good job, but I don’t. Their policy is threatening to cause a major debt crisis in the Eurozone. Because measured prices are sticky, a 1.5% shortfall in inflation can be associated with a big drop in RGDP.

    QE is much less effective at supporting AD than simply setting a NGDP target. If they had done so, and if NGDP was expected to grow at 5%, there probably would have been only a small increase in the demand for ERs. And the financial crisis would have been an order of magnitude smaller, something like early 2008, when there was little hoarding of reserves.

    Trichet is making an silly argument. Prices at the end of 1940 were similar to prices at the end of 1930. But what happened in between? If he thinks there is no AD shortfall in Europe, then what explains the high unemployment?

  62. Gravatar of 123 – TheMoneyDemand 123 - TheMoneyDemand
    8. April 2010 at 15:59

    “Until 2008 more than 90% of money was held as cash by the public. The large scale users were drug dealers, and they didn’t consider cash and T-bills to be close substitutes. The recent rise in the importance of ERs was of course a deliberate policy choice of the Fed. It’s why they started paying interest on ERs.”
    This narrow definition of money might have been useful in the nineteenth century, but now when we have repo transactions and credit cards, cash and ERs are less important.

    “No, for any given level of fed funds rate, the higher the IOR the more contractionary the policy–as it increases demand for ERs.”
    If higher IOR increases demand for ERs, it should also increase fed funds rate. But we are holding fed funds rate constant…

    “1. The monetary base in Japan did not double in a few weeks.”
    I remember the quantity of reserves was five or six times the legal minimum.

    “The ECB may think they are doing a good job, but I don’t. Their policy is threatening to cause a major debt crisis in the Eurozone. Because measured prices are sticky, a 1.5% shortfall in inflation can be associated with a big drop in RGDP.”
    They are hoping to close the gap of 1.5% in the price level relative to trend by the end of this year. ECB is causing the debt crisis in Greece in a way Greenspan has caused the debt crisis in Argentina.

    “QE is much less effective at supporting AD than simply setting a NGDP target. If they had done so, and if NGDP was expected to grow at 5%, there probably would have been only a small increase in the demand for ERs. And the financial crisis would have been an order of magnitude smaller, something like early 2008, when there was little hoarding of reserves.”
    NGDP level targeting should be the first step. But during the financial panic QE is much more effective in keeping NGDP expectations stable than interest rate policy.
    In early 2008 financial panic was stopped by the bailout of Lehman.

    I think it is important to say that hoarding started on September 17 2008 when T-Bill rates briefly became negative. This happened when there was no IOR policy.

    “Trichet is making an silly argument. Prices at the end of 1940 were similar to prices at the end of 1930. But what happened in between? If he thinks there is no AD shortfall in Europe, then what explains the high unemployment?”
    Prices were a little bit above trend in 2008 because of high commodity bubble, and now they are a little bit below trend because of reduced export demand. What is encouraging is Trichet’s de facto talk about price level trend.

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