A little more inflation or a little more socialism?

In the 1930s the right had to choose between a modest amount of inflation (returning prices to the pre-Depression levels) or more socialism.  They weren’t thrilled with big government, but their strongest opposition was reserved toward policies of inflation.  So we ended up with deflationary policies between 1929 and 1933.  Of course the voters wouldn’t accept 25% unemployment, so we got big government instead of the inflation.

As this video shows, we are essentially facing the same choice today.  We could pump up the economy through monetary policy, or we can have Fannie and Freddie continue to throw $100s of billions down the drain, socialize the auto industry, extend unemployment benefits to 99 weeks, etc.  And if that isn’t enough there are also calls to move away from free trade policies.  And then there’s the higher taxes we’ll pay in the future to cover the costs of debts run up in a futile attempt to stimulate the economy.

Just as in the 1930s, the right seems to have decided that a little bit of socialism is better than a little bit of inflation.  What do I mean by a little bit of inflation?  I mean enough so that the post-September 2008 trend rate of inflation is the same as the pre-September 2008 trend rate of inflation.  Apparently even that little bit of inflation is more distasteful than massive government intervention in the economy. 

And the irony is that many of the policies I describe, such are Fannie and Freddie propping up the housing market, unemployment insurance extensions, and trade barriers, are themselves slightly inflationary.  But they don’t just raise the price level, they also cause all sorts of distortions—they move prices away from their free market equilibrium.   (I’m looking at you Morgan.)

The even greater irony is that this isn’t even one of those pick your poison cases.  The inflation I am calling for would be nothing more than a continuation of the inflation that occurred in the previous two decades.  We’d want it even if we hadn’t had a housing crisis and recession.  I don’t recall conservatives complaining loudly that 2% inflation was a disaster when Clinton was president.  So why the sudden and hysterical opposition to 2% inflation?  Is that really a fate worse than socialism?

The still greater irony is that the more the conservatives win today, the more inflation we’ll get in the long run.  The conservatives got their way in the early 1930s, but it so discredited their ideology that it opened the door to much higher inflation over the next 40 years.

Part 2.  A few more “whiffs” of racism directed against Fannie and Freddie.

As you know, some fearless bloggers have exposed the “whiff” of racism in attempts by conservative economists like Raghu Rajan to blame the government for the mortgage fiasco.  Here for example, is Edmund Andrews:

Of all the canards that have been offered about the financial crisis, few are more repellant than the claim that the “real cause’’ of the mortgage meltdown was blacks and Hispanics.

Oh, excuse me — did I just accuse someone of racism?   Sorry.  Proponents of the above actually blame the crisis on “government policy’’ to boost home-ownership among low-income families, who just happened to be disproportionately non-white and immigrant.  Specifically, the Community Reinvestment Act “forced’’ banks to make bad loans to irresponsible borrowers,  while Fannie Mae and Freddie Mac provided the financial torque by purchasing billions worth of subprime paper.   

The argument has been discredited time and again, shriveling up almost as soon as it’s exposed to sunlight.  But it keeps coming back, mainly because the anti-government narrative gives Republicans a way to deflect allegations that de-regulation allowed Wall Street to run wild.   It’s the financial version of Sarah Palin’s new line that “extreme environmentalists”  caused the BP oil spill. 

Paul Krugman caught a whiff of it in a recent commentary by Raghuram Rajan in the FT, and quickly denounced it. 

Now Bloomberg.com seems to be making those sorts of racist accusations:

June 14 (Bloomberg) — The cost of fixing Fannie Mae and Freddie Mac, the mortgage companies that last year bought or guaranteed three-quarters of all U.S. home loans, will be at least $160 billion and could grow to as much as $1 trillion after the biggest bailout in American history.

.   .   .

The companies’ liabilities stem in large part from loans and mortgage-backed securities issued between 2005 and 2007. Directed by Congress to encourage lending to minorities and low- income borrowers at the same time private companies were gaining market share by pushing into subprime loans, Fannie and Freddie lowered their standards to take on high-risk mortgages.

Many of those went to borrowers with poor credit or little equity in their homes, according to company filings. By early 2008, more than $500 billion of loans guaranteed or held by Fannie and Freddie, about 10 percent of the total, were in subprime mortgages, according to Fed reports.

It seems even the Fed is peddling those vicious racist lies.

Even worse, they assert that Fannie and Freddie’s heavy involvement in sub-prime lending continued even during the height of the housing bubble:

The composition of the $5.5 trillion of loans guaranteed by Fannie and Freddie suggests that the surge in delinquencies may continue. About $1.98 trillion of the loans were made in states with the nation’s highest foreclosure rates — California, Florida, Nevada and Arizona — and $1.13 trillion were issued in 2006 and 2007, when real estate values peaked. Mortgages on which borrowers owe more than 90 percent of a property’s value total $402 billion.

That doesn’t seem to mesh with what I’ve been reading in Krugman’s blog:

He [Schwarzenegger] asserted, as a simple matter of fact, that “government created the housing bubble”, because Fannie and Freddie made all these loans to people who couldn’t afford to pay them.

This is utterly false. Fannie/Freddie did some bad things, and did, it turns out, get to some extent into subprime. But thanks to the accounting scandals, they were actually withdrawing from the market during the height of the housing bubble — the vast majority of the loans now going bad came from the private sector.

Yet it’s now clear that the phony account of the crisis — that it’s all due to Fannie, Freddie, and nasty liberals forcing poor Angelo Mozilo to make loans to Those People — is setting in as Republican orthodoxy

If you are wondering what the phrase “it turns out” refers to, perhaps it is this earlier post by Krugman:

But here’s the thing: Fannie and Freddie had nothing to do with the explosion of high-risk lending a few years ago, an explosion that dwarfed the S.& L. fiasco. In fact, Fannie and Freddie, after growing rapidly in the 1990s, largely faded from the scene during the height of the housing bubble.

Partly that’s because regulators, responding to accounting scandals at the companies, placed temporary restraints on both Fannie and Freddie that curtailed their lending just as housing prices were really taking off. Also, they didn’t do any subprime lending, because they can’t: the definition of a subprime loan is precisely a loan that doesn’t meet the requirement, imposed by law, that Fannie and Freddie buy only mortgages issued to borrowers who made substantial down payments and carefully documented their income.

So whatever bad incentives the implicit federal guarantee creates have been offset by the fact that Fannie and Freddie were and are tightly regulated with regard to the risks they can take. You could say that the Fannie-Freddie experience shows that regulation works.

Just to get serious for a moment; when I get upset at “Those People,” I am thinking about the Congressmen who created Fannie, Freddie and the CRA.  And yes, I know that the CRA was only a minor factor in the crisis, but everyday it becomes clearer that Washington’s attempts to enlist Fannie and Freddie into their crusade to make every American a homeowner lies at the center of this crisis.  Indeed the misdeeds of the “too-big-to-fail” banks (and their associated bailout with TARP funds), now comes in a distance third (or fourth if you include the Fed), far less costly to taxpayers than even the misbehavior of smaller banks that exploited the incompetence of the FDIC.

The experts say we can’t eliminate F&F right now, and I suppose they are right.  But only because we don”t have a monetary policy that stabilizes NGDP growth expectations.


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83 Responses to “A little more inflation or a little more socialism?”

  1. Gravatar of Morgan Warstler Morgan Warstler
    14. June 2010 at 18:49

    Just as people who grew up during the Depression lived their lives being terrified and rolling over and accepting nanny state government in every aspect of their lives, so to it appears does studying the Depression at length effect one’s view of the world.

    Let me give you my alternative theory of the 20th century.

    Everything was great, apart from some historical nastiness that came from humans being born as cavemen.

    Then in 1913, suddenly wealth could not escape taxation, and Dem’s began a century long strategy of “1) vote for me 2) get somebody else’s stuff for free.”

    And we begin an experiment known as Democracy. Jury is still out.

    Conservatives for a long time tried a losing strategy of fight to keep the budget balanced. We misplayed the GD. It was a war of attrition. We were losing.

    Then Reagan (who took some notes from Nixon) came in and said funnily enough, “I didn’t come here to balance the budget.”

    Clinton was the first Democrat to fail on the 2nd part of the deal.

    GWB doubled down on Reagan’s strategy. I swear I think $700B was the exact number they thought the bond market would still allow to be spent.

    And Obama knows this is all the deal, and is RUNNING every which way to see if he can play out of the hole.

    I say, he can’t. That the credit for the coming improvement will be granted to austerity and respect for ownership.

    I think we’ll end up dumping Medicare and his plan into something that smells more like HSAs – with means tested aid. And with that, there will be two presidents who delivered nothing on #2.

    The question of Democracy is still wide open. And its success hinges on it finding its limits – public unions eating it, and acceptance that disparity is not in and of itself a bad thing – and realizing Monetarists are idiots.

    We live in a 100% networked economy. In another 20 years, a huge percentage of people will not go into work.

    We will be able to track every dollar spent, taxed, where it goes, who received it. And much of the mystery of monetary policy will vanish. You’ll be able drill down with specificity and know much more clearly what is going on, what policies work and don’t and why. And that’s when we’ll see that mainly spastic government is what freaks out investors.

    Inflation or socialism sounds like the flag of defeat. And frankly, you might not like this answer, but since 1980, we’ve been winning – we just need another generation or so of voters to realize there is no free lunch.

    We’ll all be just fine as soon as we have a Balance Budget Amendment OR Wealth can easily flee.

    We just need a greater percentage of our citizens to get out and push. Whatever gets us there quicker, is fine with me. My ideas are based on that. Are yours? How does NGDP cause that to happen?

  2. Gravatar of Ricardo Ricardo
    14. June 2010 at 19:04

    Scott, I think many people want more inflation now, they just don’t think that’s possible in a liquidity trap (i.e. at the zero bound). They think all the quantitative easing underway is useless now, but will create out-of-control inflation once the liquidity trap finally and spontaneously goes away .

    I think you should use some of your considerable prestige to make the case of *how* inflation can be increased at the zero bound. Commit to higher inflation! Meh. Target NGDP! How do you do that? What are the tools the Fed has to control NGDP at the zero bound? I’m a regular reader of yours and still don’t get it. Depreciate the dollar! How? What’s the historical evidence on that front? Mail everyone $1,000 cash! That sounds effective. Is that your suggestion? More posts on the *how* of inflation at the zero bound, please.

  3. Gravatar of david david
    14. June 2010 at 19:50

    Balanced Budget Amendment amidst a recession. Where do these people even come from!

  4. Gravatar of Michael Meyers Michael Meyers
    14. June 2010 at 19:59

    I don’t understand saying the “right” choose socialism over inflation during the 30′s and now. Was not the “left”, i.e. Democrats, in control in both cases????

  5. Gravatar of Bob Murphy Bob Murphy
    14. June 2010 at 20:04

    Scott, you are taking it for granted that you can get the (price) inflation target you desire. It’s not really true that “right wingers” are literally choosing < 2% price inflation over "a non-socialist economy."

    And I could just as well flip your argument on you: If we pursue the "noninterventionist" inflationary path recommended by the likes of Scott Sumner, we will get stagflation, which will then lead Obama to impose price controls, which will then cause further disruptions and lead to a huge increase in gov't…just like happened in the 1970s. So by narrowly focusing on avoiding budget deficits and new regulations, at the expense of throwing monetary caution to the winds, Sumner will get more socialism than he thought possible.

  6. Gravatar of jsalvatier jsalvatier
    14. June 2010 at 20:29

    @ everyone

    Many people on “Right” continue to agitate for more contractionary monetary policy even though inflation has actually been substantially below target for quite a while now. Obviously The Right is not in charge of the government right now, but there is no reason to actively agitate for a worse policy.

  7. Gravatar of David Pearson David Pearson
    14. June 2010 at 21:00

    Scott,

    I’m no fan of the GSE’s. In fact they were amongst my best shorts. However, I think you are missing the obvious fact that subprime securities offered a higher net interest spread than plain-vanilla RMBS: 2-3x higher. That is why Merrill, Bear, Lehman, scores of hedge funds, AIG — none of whom operated with a low-income housing mandate — ended up with large subprime loan portfolios. Ocam’s razor applies here.

    BTW, I think you tend to confuse “low income housing” with “low fico lending”. The median subprime loan in California in 2005 was for $350k, implying an income of $78k at a then-standard subprime debt-to-income ratio of 42%. $78k just also happened to be the median income for households in CA at that time. Subprime, at least in California, was hardly low-income lending. And California is where the bulk of subprime delinquencies originated.

    Also, you may want to know that the bulk of Fannie Mae’s non-Agency exposure was in Alta-A (so called “Liar Loans”). Alt-A was not a low-income product by any stretch. Neither was it a low-fico one.

    There is plenty of blame that one can lay on the GSE’s for the housing crisis. And there is plenty of blame one can lay on Congress for favoring housing and allowing the GSE’s to have ridiculous leverage. But blaming low-income Congressional mandates for the failure of Fannie and Freddie is an unnecessary stretch. There are simply more obvious reasons for why the GSE’s bought non-Agency securities for their portfolios, and they all have to do with maintaining earnings growth after the Fed-induced mortgage refi boom of 2003.

  8. Gravatar of Greg Ransom Greg Ransom
    14. June 2010 at 21:12

    Scott, your history is bogus.

    “Conservative” Hoover believed in reviving the economy by stimulating aggregate demand via a high wage policy — he was Foster & Catchings guy, i.e. a vulgar Keynesian before Keynes. Hoover also expanded government loan programs and government spending.

    The tight money guys in America were Real Bills guys, they didn’t have anything to do with the leading market theorists of the time.

    Here’s some help on the history from Lawrence White, who rebuts De Long’s embarrassingly dishonest work on this topic

    http://economics.sbs.ohio-state.edu/jmcb/jmcb/07056/07056.pdf

  9. Gravatar of cassander cassander
    14. June 2010 at 21:36

    Hoover wasn’t a conservative. Hoover was a progressive republican, at a time when the republicans were the more liberal party. At the time, he was arguably the most left wing president in american history. The platform FDR ran on, ironically, called for slashing federal government spending by 25%, hardline adherence to the gold standard, and unemployment insurance only under state law.

  10. Gravatar of Jimmy Jimmy
    14. June 2010 at 23:45

    Scott, you didn’t present a single piece of evidence to support the “GSEs caused the crisis” hypothesis. If it were really there, I think you would have shown it to us.

    Greg, Hoover tried to balance the budget in 1932. Hence recession turns into depression.

  11. Gravatar of Dave Samples Dave Samples
    15. June 2010 at 01:52

    Why even bother with the Whistlers and Ransoms of the world?

    If you wanna read “true” right wing conservative pieces. Read Julius Evola’s revolt against the modern world or Yockey’s emperium.

    Free market totalitarianism is a dangerous concept Whistler and Ransom are spouting. They will destroy America send us to slavery making goods for the monied elite, upsetting the balance of nature.

  12. Gravatar of jnp jnp
    15. June 2010 at 03:43

    “We could pump up the economy through monetary policy, or we” can implement socialist policies

    Scott, why do you think this is an ‘either/or’ choice?

    Thanks.

  13. Gravatar of q q
    15. June 2010 at 03:58

    how do you get to $1T in credit losses from the GSEs?

    back of the envelope calculation: right now they owe the govt $140B but have about $80B in cash reserves, so pending losses on the current portfolio would have to be $940B on a roughly $5000B portfolio. that’s a loss severity of 19%.

    the current loan to value of the portfolio is (i think) around 75% — this is very high, but it gives you an idea of what they could expect to recover given a default. let’s be pessimistic and say that defaults only recover 50% of the loan — that would imply at least a 20% drop in housing prices from here. that means a default rate of 38% — 38% of mortgages would have to default.

    seems very unlikely given that their current rate of non-paying loans is under 5%.

    i don’t think that’s likely — that’s a far worse than great depression scenario.

    (of course a boost in NGDP and/or drop in unemployment would help their situation greatly.)

  14. Gravatar of mlb mlb
    15. June 2010 at 05:04

    Prices have already returned to their pre-crisis level. Further, market expectations are for them to keep rising. Further, wages are flat at best. There is clearly more at work here than sticky wages.

  15. Gravatar of StatsGuy StatsGuy
    15. June 2010 at 05:10

    @ Michael Meyers

    “I don’t understand saying the “right” choose socialism over inflation during the 30’s and now. Was not the “left”, i.e. Democrats, in control in both cases????”

    Actually, in both cases, the Right began the downturns in power. One can arguably blame the Right, but that’s irrelevant. The issue is the response.

    Ssumner is arguing that precisely because the Right failed terribly in its monetary response to 1929, it lost the elections in 1932 and gave Roosevelt the opportunity to usher in Socialism. Regardless of what you think about Roosevelt’s policies, his argument is if the Right had not kowtowed to hard-money-fanatics and swallowed a bit more inflation in 1930, then the Left would not have won handily in 1932, and Roosevelt would never have launched the New Deal.

    The parallel in 2008 is obvious, except that Obama came into power quickly after 2007 (when the downturn really started) – AND that Obama is very much a creature of the status quo. In many ways – particularly financial regulation and even areas like health and energy – he has advocated “soft” reforms that push for very gradual change, leaving the current system mostly intact and merely patching the most broken areas. Indeed, he has very often softened Congressional proposals – on health, finance, and other areas.

    Had the Fed avoided any QE and asset puchases in 2009, we can be almost certain that the Fiscal authority would have responded even more aggressively to placate the electorate. Democracy and 25% unemployment are not consistent, and if pure “capitalism” requires 25% unemployment then most electorates would rather not have it.

    With regard to the relative mobility of capital vs. labor (the frieden/rogowski arguments) and the exit option, this is assuredly one of the factors in the recent instability. I suspect that in the absence of global regulation on capital/asset ratios and leverage, and without globally coordinated monetary policy, that international asset arbitrage (also known as capital flight) has heavily curtailed the lattitude of monetary responses. Interestingly, however, bond vigilantes have run of of places to hide.

  16. Gravatar of Secondary Sources: Rescuing Europe, Double Dip, Inflation vs. Socialism – Real Time Economics – WSJ Secondary Sources: Rescuing Europe, Double Dip, Inflation vs. Socialism - Real Time Economics - WSJ
    15. June 2010 at 05:18

    [...] [...]

  17. Gravatar of scott sumner scott sumner
    15. June 2010 at 05:27

    Morgan, I hope you are right about Medicare being replaced by HSAs. I agree that long run trends are positive, but the short run . . .

    Ricardo, You said;

    “I think many people want more inflation now, they just don’t think that’s possible in a liquidity trap”

    I don’t think there are many distinguished economists who believe that nonsense. Even Krugman admits the Fed could inflate if it wanted to. My suggestion is set a higher NGDP target. Create a NGDP futures market, and peg the price of NGDP futures contracts at the target level. That means the monetary base automatically adjusts to create on-target NGDP growth.

    Believe me, the Fed can create inflation. When asked why they don’t, they don’t say “we can’t. They say it would be a bad idea.

    You said;

    “Depreciate the dollar! How? What’s the historical evidence on that front?”

    A 20% rise in the WPI during a period of 25% unemployment. (1933) How’s that for stimulus?

    david, Who’s idea is that?

    Michael, In both cases the right was in control of monetary policy, and because they wouldn’t allow even normal inflation rates, we had a severe recession and then political system reacted with bad policies. In the 1930s those bad policies were done under both Republican and Democratic presidents. We didn’t get these awful policies under Bill Clinton, because the macroeconomy was in good shape.

    Bob, I think our problems are too little demand, not too little supply, so I wouldn’t expect a repeat of the 1970s.

    And I think they do have the tools to create a little more inflation w/o overshooting. It’s called level targeting (rather than inflation rate targeting.) You choose a target path and commit to make up for shortfalls or overshoots.

    jsalvatier, Yes, and they do control monetary policy. But you are right, the outside agitation makes the Fed more afraid to ease.

    David;

    “I’m no fan of the GSE’s. In fact they were amongst my best shorts. However, I think you are missing the obvious fact that subprime securities offered a higher net interest spread than plain-vanilla RMBS: 2-3x higher. That is why Merrill, Bear, Lehman, scores of hedge funds, AIG — none of whom operated with a low-income housing mandate — ended up with large subprime loan portfolios. Ocam’s razor applies here.

    BTW, I think you tend to confuse “low income housing” with “low fico lending”. The median subprime loan in California in 2005 was for $350k, implying an income of $78k at a then-standard subprime debt-to-income ratio of 42%. $78k just also happened to be the median income for households in CA at that time. Subprime, at least in California, was hardly low-income lending. And California is where the bulk of subprime delinquencies originated.”

    I do understand all that. The big banks who made mistakes are repaying their TARP loans. Meanwhile F&F continue to suck in almost unlimited taxpayer bailouts. I never said the big banks didn’t make mistakes, but rather they are a much smaller public policy fiasco that F&F. If the big banks lose their own shareholders money, that’s their problem.

    And your point about expensive sub-prime loans doesn’t conflict at all with what I said. Congress wasn’t just trying to get all poor people into homes, they were equally committed to helping (much more numerous) middle class people get homes. I’ve never argued that this is about poverty.

    Greg, You said;

    “Scott, your history is bogus.

    “Conservative” Hoover believed in reviving the economy by stimulating aggregate demand via a high wage policy — he was Foster & Catchings guy, i.e. a vulgar Keynesian before Keynes. Hoover also expanded government loan programs and government spending.
    The tight money guys in America were Real Bills guys, they didn’t have anything to do with the leading market theorists of the time.”

    I agree about Hoover, but that wasn’t my point. Hoover was very conservative on monetary policy. This led to the Depression, which opened to the door to Hoover and FDR’s left wing ideas on other government policies.

    The leading monetary theorists saw the problem, but in those days were regarded as left of center (Keynes, Fisher, etc) The conservatives who ran the economy most definitely did favor the tight money of 1929-33. There is a reason it happened, it reflected the prevailing conservative ideology of the time. Milton Friedman would have been viewed as a leftist in 1931.

    cassander, See my responses above. Hoover was a conservative on monetary policy. That was my point. I agree he was liberal on other issues. His wage fixing policies would never have played a role if not for the depression created by his right wing monetary ideas.

    Jimmy, First of all, I consider the crisis” to be the government bailout. That is the public policy problem that interests me. The recession was caused by the Fed. The F&F bailout costs are $165 billion and rising fast. The TARP bailout of big banks plus AIG is $29 billion and falling. Which is the bigger public policy problem?

    Dave, I’m not sure I want to read “true” right wing stuff. But I’ll keep that in mind.

    jnp, If we hadn’t had tight money then there would be much less of the statist policies that I mentioned. When things are going well (Clinton) even Democratic presidents don’t want to rock the boat.

    q, I agree, and notice that I never cited the $1 trillion dollar figure. It is an implausible worst case. But the losses are still huge.

  18. Gravatar of scott sumner scott sumner
    15. June 2010 at 05:33

    mlb, I disagree. First of all, prices are well below a 2% growth track from September 2008. More importantly, you need to look at NGDP, not prices. When NGDP suddenly and permanently shifts to a 8% lower growth track, all wages must also downshift by 8% relative to the old trend line. Thus workers who normally get a 4% raise would need 4% pay cuts. We haven’t even come close to that happening, so we’ll have a long period of high unemployment.

    Statsguy, I agree, and as I said above even those left wing parts of the Hoover agenda were themselves a reaction to a depression created by his conservative views on money.

  19. Gravatar of David Pearson David Pearson
    15. June 2010 at 06:56

    Scott,

    I agree on middle-class inducements to buy homes.

    BTW, the reason F&F are so costly is because they had much higher leverage than even the investment banks. Fannie Mae had assets of $0.8tr and guarantees (contingent liabilities) of around $1.6tr. For that $2.4tr in credit exposure, Fannie had equity of around $0.04tr. They were levered 40x! Leverage matters, and fortunately, even with their off-balance sheet obligations, bank holding companies never reached those kinds of leverage multiples.

    The reason Fannie and Freddie carried out-sized leverage is because everyone — analysts, investors, regulators, management, economists — underestimated tail risk. This is one reason I think that ignoring or downplaying the tail risk of policy actions is quite dangerous.

  20. Gravatar of David Pearson David Pearson
    15. June 2010 at 06:57

    Sorry, that leverage calculation was 60x, not 40x.

  21. Gravatar of Morgan Warstler Morgan Warstler
    15. June 2010 at 07:20

    Scott and statsguy,

    Do you at least agree that in a tight money world, without any other inputs changing when credit is overextended… prices fall? Too many goods chasing too few dollars?

    Ok than, regardless of the other things, without any further F&F machinations, and before we see rates ratchet up, where do you think housing prices are going to go over the next year?

    And as rates go up, do you expect to see housing prices continue to fall?

    I want some hard guesstimates. Let’s use an average US house in a sun state, say FL, worth $250K…

    I’m trying to get a street level view of what you, Scott and statsguy, think is worst case scenario.

    I think when that house is worth $150K-175K, including the extra ARM-A and prime inventory that comes on the market when values continue to fall… that’s when the cash guys swoop in and start buying. And prices start to rise again towards $200K+. Quickly. Because the cash guys finally sense they are at the bottom trough.

    Do you think this doesn’t happen? Do you think the value of homes just plummets forever? Suddenly houses are all $50K?

  22. Gravatar of Catching Up, Arnold Kling | EconLog | Library of Economics and Liberty Catching Up, Arnold Kling | EconLog | Library of Economics and Liberty
    15. June 2010 at 07:25

    [...] Scott Sumner writes, We could pump up the economy through monetary policy, or we can have Fannie and Freddie continue [...]

  23. Gravatar of Greg Ransom Greg Ransom
    15. June 2010 at 07:31

    Scott, this is the problem with your blanked labeling system — rather than being informative, your use of the words “right wing” and “conservative” MISLEADS the reader, lumping together folks with OPPOSED theoretical systems and OPPOSED views of the political economy.

    Sometimes it seems this is your purpose in using the misleading labeling system. You want to discredit Hayek using the “Real Bills” guys, similar to De Long’s dishonest and historically laughable gambit of tying Hayek to Hoover.

    Scott wrote,

    “The leading monetary theorists saw the problem, but in those days were regarded as left of center (Keynes, Fisher, etc) The conservatives who ran the economy most definitely did favor the tight money of 1929-33.”

  24. Gravatar of Greg Ransom Greg Ransom
    15. June 2010 at 07:38

    The labeling system of the 1920s and 1930s was rather different from today’s — another reason use of these labels serves the purpose of misleading people, rather than bringing light to the subject.

    The modern political label “conservative” wasn’t constructed until the 1950s.

    The label “liberal” had ambiguous and had multiple and overlapping meanings covered people who opposed each other across the American spectrum in the 1920s.

    “Leftist” as we use the term today wasn’t common, and didn’t refer really to the sorts of leftist we find all over the place today. Etc.

    Scott wrote,

    “The leading monetary theorists saw the problem, but in those days were regarded as left of center (Keynes, Fisher, etc) The conservatives who ran the economy most definitely did favor the tight money of 1929-33. There is a reason it happened, it reflected the prevailing conservative ideology of the time. Milton Friedman would have been viewed as a leftist in 1931.”

  25. Gravatar of Greg Ransom Greg Ransom
    15. June 2010 at 07:44

    As far as I can tell, this is no more informative than any tautology — “conservative” = tight money, and there is no more information to the claim than that.

    But your syllogism using “conservative” demands that the word carries deeper implication, unfortunately the demanded implication is false.

    In a post bust deflation Hayek believed in easy money — which makes him a liberal, or “leftist” as you describe Friedman.

    Scott,

    “The conservatives who ran the economy most definitely did favor the tight money of 1929-33.”

  26. Gravatar of Morgan Warstler Morgan Warstler
    15. June 2010 at 10:39

    Greg,

    “In a post bust deflation Hayek believed in easy money — which makes him a liberal, or “leftist” as you describe Friedman.”

    Do you mean simply as prices go down, as more money is chasing few deals, money is “easy.”

    Where did Hayek advocate “easy money.”

  27. Gravatar of Mari Mari
    15. June 2010 at 12:19

    Scott: lets say BB wakes up tomorrow and says that that darn SS is right, my brain is some how swapped. I am going to make it right and charge 5% interest on excess reserves. Can you walk through what happens so that non-monetary economics folks like me can get it? Thanks.

  28. Gravatar of D. Thomas D. Thomas
    15. June 2010 at 12:50

    I second Mari’s request for a “walk through”.

  29. Gravatar of StatsGuy StatsGuy
    15. June 2010 at 13:02

    “where do you think housing prices are going to go over the next year?

    And as rates go up, do you expect to see housing prices continue to fall?”

    1) It depends on what the Fed and other central banks do

    2) Do you mean if the natural rate goes up? Presumably, if the natural rate is going up, it’s because demand and real investment returns are going up… In which case housing prices probably lead the Fed rate increase (which would be a good thing). If you mean the Fed raises its rate prior to the natural rate going up, then house prices drop sharply (and unemployment probably spikes more).

    The point on which I disagree with ssumner (I think) is the relevance of the international currency markets. If the dollar is challenged by currency traders due to perceived sovereign debt crisis or a perceived unsustainable trade balance, and the Fed is forced to increase its rate to defend the currency – which is what I believe happened in summer 08 when an anti-dollar carry trade manifested as a commodity bubble that the Fed killed by raising rates – then that is very bad. If the Fed increases its rate to defend the currency (“defending a peg”), however, that’s really very short sighted. It is also the surest way to ensure that the Federal Government becomes nearly insolvent (due to high unemployment due to high real wages, and reduced national tax income, and transfer payouts).

    In other words, defending the dollar peg rather than accepting devaluation is the surest way to get deflation in the short term and hyperinflation down the road. Just look at Argentina (although at least we don’t have non-dollar denominated federal debt).

    Yet that’s where the “strong dollar is good for the US economy” folks want to take us.

    Aside: I also happen to think that the dollar is chronically overvalued due to its status as a reserve currency. That is, we have the privilege of continuously exporting dollars to other dollar-users, which helps fund imports. In the long term, I think this is structurally difficult because our dollar exporting position is not sustainable, and then we’ll need to pay for our imports with actual exports (but will have lost real infrastructure). ssumner may disagree with this too, but I don’t think the market does a good job at predicting hegemonic/paradigm change which happens once a century.

  30. Gravatar of Doc Merlin Doc Merlin
    15. June 2010 at 13:12

    @ Morgan Warstler

    Hayek advocated competitive (and private) money issuance, but when asked what he would prefer if competitive money was off the table, he replied with an idea very similar to NGDP targeting. (He didn’t call it that. Being Austrian, he didn’t believe in GDP. But the description he gave was about the same.) In an austrian cycle, NGDP targeting automatically would tighten during the boom and loosen during the bust. I think this is what was meant by “post bust deflation Hayek believed in easy money.”

  31. Gravatar of david david
    15. June 2010 at 14:55

    david, Who’s idea is that?

    Morgan Warstler’s, above :P

  32. Gravatar of Greg Ransom Greg Ransom
    15. June 2010 at 15:45

    Hayek advocating “easy money” in the 1930s:

    “I agree with Milton Friedman that once the Crash had occurred, the Federal Reserve System pursued a silly deflationary policy. I am not only against inflation but I am also against deflation. So, once again, a badly programmed monetary policy prolonged the depression.”

    – F. A. Hayek, quoted from _Conversations with Great Economists: Friedrich A. Hayek, John Hicks, Nicholas Kaldor, Leonid V. Kantorovich, Joan Robinson, Paul A.Samuelson, Jan Tinbergen_ by Diego Pizano.

    Originally published in Spanish as Dialogos Con Economistas Eminenes, (Mexico) Fondo de Cultura Economica, 1980.

  33. Gravatar of Greg Ransom Greg Ransom
    15. June 2010 at 15:49

    Here’s Hayek in 1975 answering a question from his friend Gottfried Haberler about the American Great Depression and the post bust secondary deflation:

    “The moment there is any sign that the total income stream may actually shrink, I should certainly not only try everything in my power to prevent it from dwindling, but I should announce beforehand that I would do so in the event the problem arose.”

  34. Gravatar of Greg Ransom Greg Ransom
    15. June 2010 at 15:52

    Here’s David Glasner, explaining how Friedman got Hayek WRONG:

    “[Hayek's] opposition to monetary expansion and public spending earned him an _undeserved_ reputation, even among such kindred spirits as Milton Friedman and other Chicago School economists, as a “liquidationist” who was impervious to the horrors of the Great Depression.”

    http://hayekcenter.org/?p=335

  35. Gravatar of Greg Ransom Greg Ransom
    15. June 2010 at 15:57

    Here’s Hayekian macroeconomist Steve Horwitz on Hayek, deflation and the Great Depression:

    http://austrianeconomists.typepad.com/weblog/2009/10/hayek-on-deflation-and-the-great-depression.html

    “Greg Ransom has found a new book with an interview done with Hayek in 1979. In it, Hayek says the following:

    “I agree with Milton Friedman that once the Crash had occurred, the Federal Reserve System pursued a silly deflationary policy. I am not only against inflation but I am also against deflation. So, once again, a badly programmed monetary policy prolonged the depression.”

    Those Austrians who think deflation is always and everywhere a good phenomenon strongly overlap with those Austrians who wonder whether Hayek is really an Austrian (or a even a classical liberal) anyway, so I’m doubtful this will convince them of the claim that a concern with monetary deflation has been, and should be, a core part of Austrian monetary and macro theory. However, it does, in fact, bolster the case for a monetary equilibrium reading of Hayek.

    It is also useful to counter the claim that Hayek was a “liquidationist” in the sense often deployed by people like Brad DeLong, as well as the more general claim that Hayek thought we should do nothing during the depression. By implication, if you think deflation is bad, you believe that the Fed (given its existence) should have behaved differently between 1930 and 33. It could have done something to prevent the events that “prolonged the depression.”

    This also is some support for what I would call the Austrian-Monetarist-Interventionism explanation of why the Great Depression got started, got so deep so quickly, and lasted so long. Each “school” (think Rothbard, F&S, and Higgs if you want authors) lines up with each element of the explanation in the order given. Even Hayek agrees that traditional Austrian cycle theory alone can’t explain the whole thing, even buttressed by Higgs or Cole & Ohanian. If you want to explain why the Great Depression was both “great” and a “depression” not a recession, you need the Friedman and Schwartz story, and you’ll have Hayek on your side.

    Whether the same situation as we faced in 1930 was in place last fall remains a debatable question. However, if velocity was falling in the way some folks believed, doing nothing would have invited a potential repeat of the early 30s, and now we can say with even more certainty that Hayek, at least, would have recommended that the Fed act to avoid it. (Of course, nothing in this paragraph is an endorsement of the extreme to which the Fed went, nor the other really stupid things it did last fall and since.)”

    To give Brad De Long credit, he reposted these comments on his blog .. but then blocked any comments:

    http://delong.typepad.com/egregious_moderation/2009/10/steve-horwitz-hayek-on-deflation-and-the-great-depression.html

  36. Gravatar of david glasner david glasner
    15. June 2010 at 18:43

    Greg, Thanks for the plug. However, you didn’t include my next sentence which reads

    Hayek later admitted that he had erred in his early policy recommendations, and he greatly regretted that he had been understood to oppose taking countermeasures to stop the deflationary spiral that enveloped the world economy in the 1930s

    Hayek was not a liquidationist in the sense that Rothbard and perhaps Mises were liquidationists who believe that a secondary deflation performs a valuable social function in clearing away all the inefficient undertakings that had been allowed to survive by the monetary expansion that fueled the previous boom. Hayek understood that this is not a valuable social function but a destructive anti-social function. However, he favored deflation in the 1930s because he mistakenly believed that it would serve the valuable social function of undermining various forms of monopolistic restrictions and price fixing that were then preventing resources from being efficiently allocated. That was a political-economic misjudgment which he later regretted.

    I would also admit that in the piece that I wrote for Greg’s website in which I tried to defend Hayek from the unsavory embrace of Dick Armey, I tried hard to give Hayek the benefit of the doubt on charge of liquidationism, especially since he clearly did later regret taking a pro-deflation stance in the 1930s. However, I don’t think that it was unfair of Friedman to attribute Hayek’s pro-deflation stance to Misesian liquidationism.

  37. Gravatar of Morgan Warstler Morgan Warstler
    15. June 2010 at 19:18

    Greg / david,

    but there has to be a difference between:

    prices go up in a boom and down in a bust where monetary policy is aimed at zero inflation. that’s not real deflation is it? meaning, if housing prices are just headed back to where they should be, is it deflation?

    vs. we are experiencing some kind of deflationary spiral that CANNOT BE STOPPED unless we inflate!

    There is room for both ideas, right?

  38. Gravatar of Greg Ransom Greg Ransom
    15. June 2010 at 19:42

    David,

    I pointed this fact out in the comments to the post just before this one, and I’ve done somI’ve repeatedly on this blog, so I saw no point in resting it yet again.

    David wrote,

    “Hayek later admitted that he had erred in his early policy recommendations, and he greatly regretted that he had been understood to oppose taking countermeasures to stop the deflationary spiral that enveloped the world economy in the 1930s.”

  39. Gravatar of Greg Ransom Greg Ransom
    15. June 2010 at 19:48

    Morgan, see George Selgin’s _Less Than Zero_ for some distinctions:

    http://www.iea.org.uk/record.jsp?ID=98&type=book

  40. Gravatar of Greg Ransom Greg Ransom
    15. June 2010 at 20:02

    Hayek was thinking about the situation in Britain, wasn’t he. And Hayek understood that situation in the context of the British post 1925 deflation problem and high wage problem, didn’t he. And Hayek wasn’t focused on or very much informed about the Amercan situation was he.

    And Americans seem never to understand this, do they.

    Every interview with Hayek about Keynes makes it clear that his background problem situation when thinking about Keynes and the depression was the British problem dating to 1925.

    Writers on this topic aren’t going to get this right till they wrap their minds around this fact.

    David writes,

    I would also admit that in the piece that I wrote for Greg’s website in which I tried to defend Hayek from the unsavory embrace of Dick Armey, I tried hard to give Hayek the benefit of the doubt on charge of liquidationism, especially since he clearly did later regret taking a pro-deflation stance in the 1930s. However, I don’t think that it was unfair of Friedman to attribute Hayek’s pro-deflation stance to Misesian liquidationism.”

  41. Gravatar of Greg Ransom Greg Ransom
    15. June 2010 at 20:03

    Sorry, I was replying also to this from David:

    ” he favored deflation in the 1930s because he mistakenly believed that it would serve the valuable social function of undermining various forms of monopolistic restrictions and price fixing that were then preventing resources from being efficiently allocated. That was a political-economic misjudgment which he later regretted.”

  42. Gravatar of Greg Ransom Greg Ransom
    15. June 2010 at 20:13

    David, Hayek was talking about internationally uncompetive British union labor — in the post 1925 deflationary environment, right.

    Breaking extra-legal union power and non-equilibrium over priced labor is a life long theme in Hayek, and Britain is always his focus (although Vienna is no doubt in the back of his mind.

    I’ve seen no evidence that Hayek ever concerned himself seriously with the facts on the ground in America.

    David writes,

    ” he favored deflation in the 1930s because he mistakenly believed that it would serve the valuable social function of undermining various forms of monopolistic restrictions and price fixing that were then preventing resources from being efficiently allocated. That was a political-economic misjudgment which he later regretted.”

  43. Gravatar of Greg Ransom Greg Ransom
    15. June 2010 at 20:47

    David, do you have the text where Hayek says this? I can’t find it. Thanks.

    David wrote:

    “[Hayek} favored deflation in the 1930s because he mistakenly believed that it would serve the valuable social function of undermining various forms of monopolistic restrictions and price fixing that were then preventing resources from being efficiently allocated.”

  44. Gravatar of Inflation, Socialism, and Moral Indifference, Bryan Caplan | EconLog | Library of Economics and Liberty Inflation, Socialism, and Moral Indifference, Bryan Caplan | EconLog | Library of Economics and Liberty
    15. June 2010 at 21:05

    [...] the next election, but the idea trap's been awfully ugly this time around.Challenge inspired by Sumner's latest post: Put all the American policy disasters of the last three years on one side of your mental [...]

  45. Gravatar of Joe Calhoun Joe Calhoun
    16. June 2010 at 05:23

    Scott,

    Is it possible that monetary policy is actually easier than you think? The ECB is now engaged in QE (or at least I think they are) and markets are responding positively. Does it matter whether it is the Fed or the ECB doing the easing? Maybe the Fed and the ECB are coordinating policy?

  46. Gravatar of scott sumner scott sumner
    16. June 2010 at 05:30

    David Pearson, You said;

    “The reason Fannie and Freddie carried out-sized leverage is because everyone — analysts, investors, regulators, management, economists — underestimated tail risk. This is one reason I think that ignoring or downplaying the tail risk of policy actions is quite dangerous.”

    I agree that leverage was the key problem, which is why liberal economists are so disingenuous in pointing to the number of sub-prime mortgages that F&F were involved in. It doesn’t matter if private banks financed more than F&F, what matters is the losses borne by the public.

    As far as who’s to blame, it should be said that some economists (including me) were very strong opponents of F&F over the past two decades. It seems to me that most of those strong opponents were on the right. Without the government’s guarantee of their debt, they would not have been able to operate with such little capital.

    Morgan, I believe in the EMH, so I don’t think housing prices are forecastable. One of the reasons we got into this mess is that home buyers and regulators thought they were forecastable.

    Greg, I don’t even recall mentioning Hayek’s name in the post. I said conservatives support tight money. Who do you think favored the tight money? Liberals?

    Greg#2, #3, I read every NYT from the 1930s, and lots of other papers as well. I know exactly where the push for hard money was coming from. Conservatives. And the same is true today.

    Mari and D. Thomas, Because banks can earn 0% on T-bills, they won’t want to hold ERs paying negative 5%. They will try to get rid of those excess cash balances. Economics 101 says inflation is caused by excess money. As people try to get rid of money the process drives up prices. I have a post entitled a short course in monetary economics (google it with money illusion) which discusses this

    What BB really needs to do is set a higher price level of NGDP target.

    Statsguy, God I hope the Fed isn’t still obsessed about “defending the dollar.”

    Greg#4, #5, #6, #7, I can accept much of what you write. But it doesn’t do much good to realize that we needed easy money in the 1930s, if it is already the 1970s!

    David Glasner. That sounds right to me.

    Morgan#2, The Fed shouldn’t be targeting housing prices at all, it’s none of their business. Housing prices don’t “need” to go anywhere. People are free to pay what they want for houses. It’s the Fed’s job to control the value of money, not houses.

    Greg, I think you focus too much on Hayek. If you read the papers form the 1920s and 1930s, much of what you read sounds almost exactly like what self-styled Austrians are saying about the current crisis. There is an intellectual link. I am much more interested in broad philosophical tendencies, which is precisely why I didn’t even mention Hayek’s name in this post (or Selgin’s).

  47. Gravatar of scott sumner scott sumner
    16. June 2010 at 05:35

    Joe, I judge monetary policy in terms of expected NGDP growth. We have pretty good data on expected inflation, but real growth forecasts are more difficult. My sense is that the consensus forecast is for 4% to 5% NGDP growth and 1% inflation over the next year. I consider that monetary policy to be too tight, given the depressed nature of the economy. If we hadn’t recently had a sharp recession, those rates would be fine.

  48. Gravatar of scott sumner scott sumner
    16. June 2010 at 05:38

    Joe, One other thing. I don’t believe in guesswork. Monetary policy should target expected NGDP growth not actual. Thus even if actual growth was strong, I would consider money too tight if expected growth had been below target. One problem with low expected NGDP growth is that it causes us to waste lots of money of fiscal stimulus, bailouts, etc, that would not occur if we weren’t in recession.

  49. Gravatar of Greg Ransom Greg Ransom
    16. June 2010 at 06:04

    David and Scott,

    What we need to do is stay in the realm of facts.

    1. Hayek and Hayek’s work had NO influence on economic policy in any country in the world in the 1930s.

    2. Hayek didn’t do ANY work in the realm of either empirical study or policy recommendations in the 1930s.

    3. Hayek’s economics — give the ACTUAL FACTS of the time — imply counter-deflationary monetary actions.

    4. The measures David claims Hayek recommended in the early 1930s (please provide the passages) are NOT implied by his monetary / trade cycle work — they are POLITICAL measure to address a political problem.

    Here’s why this matters. Economists such as De Long and Krugman want pass off a FALSE account of these facts order to smear and discredit Hayek’s THEORETICAL work on grounds that have NOTHING to do with his work, and that is EXACTLY what Krugman does in his blog post, and that is what Scott has repeatedly also does with his references to Friedman’s attacks on “Austrian” economics in his _Monetary History_.

    If we care about actual getting the science right we need to chop away all of the unhelpful bogus history that provides a brick wall blocking actual thinking.

  50. Gravatar of Greg Ransom Greg Ransom
    16. June 2010 at 06:07

    Scott, again, you haven’t shown you are going beyond a simple tautology here

    conservative = “tight money”

    But your syllogism depends on going beyond that tautology.

    And you don’t address the fact that the words “conservative” and “liberal” are used completely differently 90 years ago.

    Scott writes,

    “I read every NYT from the 1930s, and lots of other papers as well. I know exactly where the push for hard money was coming from. Conservatives. And the same is true today.”

  51. Gravatar of Greg Ransom Greg Ransom
    16. June 2010 at 06:11

    Let me say it different. A bogus history is being used as an excuse for not thinking — and for mutilating scientific theory.

  52. Gravatar of Morgan Warstler Morgan Warstler
    16. June 2010 at 06:12

    Scott, but you DO care about price! Stop saying you don’t. I’m the one who doesn’t care about price…. I don’t care what it is, as long as it is honest.

    Right now we both know, and you will admit, housing prices have been driven artificially high, and you want to target NDGP specifically because you don’t want to see price deflation.

    statsguy is at least honest and says government can’t won’t allow what he calls “liquidation” and what I call selling off excess inventory – because right now banks which own the homes are not having to sell off their inventory because they have profits from reserves rolling in.

    this is exactly the case. the banks own a bunch of homes, the upside down borrowers do not them.

    Now please admit that I want to find out what the price really is – and YOU ARE TERRIFIED of finding out the real price.

    No one is saying the Fed should set housing prices, you are saying the Fed should not let us find out what housing prices are really worth, because built into your model is purposeful inflation.

  53. Gravatar of Greg Ransom Greg Ransom
    16. June 2010 at 06:16

    Scott, look, the leading “conservative” economists and most significant rival to Keynes of the last 75 years is Hayek — and you’s constantly explicitly used Hayek as a totem in your references to Friedman on the mistakes of the Austrians in his monetary theory.

    And in the post just before this one, Hayek was explicitly one of the “conservatives” you were talking about — also one of Krugman’s subject.

    If you don’t want to constantly mislead people, you need to come up with better descriptors.

  54. Gravatar of david glasner david glasner
    16. June 2010 at 06:55

    Greg, I understand your exasperation with much of the mistreatment that Hayek gets. However, your fire should be aimed at people like the Pauls, Tom Woods and Robert Murphy who brazenly invoke Hayek’s authority for the nonsensical deflationary policies that they advocate, not innocents like Scott who is just trying to save Western Civilization.

    I’m sorry that I don’t have a quote for Hayek handy about why he thought that deflation might be justified in the 1930s. The first place I would look would be in his talk (which you quoted from) at AEI in which his old (apostate) Austrian buddy Gottfried Haberler engaged him on his support for deflation in the 1930s. Another place to look would be in the interviews that various UCLA economists conducted with him in the 1970s. I think you have a link to them on your website, don’t you?

    I agree that Hayek’s own theory (which amounted to stabilizing MV and is thus a precursor to Scott’s NGDP rule) implies inflation, not deflation in a crisis, but he never drew that obvious inference from his theory. I think that Larry White expounded on that paradox in his recent paper on Hayek in JMCB.

  55. Gravatar of Greg Ransom Greg Ransom
    16. June 2010 at 07:31

    I’m pretty sure it’s not there.

    Hayek’s talk was on another topic, and in his reply to Haberler’s off topic question Hayek reiterated his counter-deflationary and pro-public works position.

    David writes,

    “The first place I would look would be in his talk (which you quoted from) at AEI in which his old (apostate) Austrian buddy Gottfried Haberler engaged him on his support for deflation in the 1930s.”

  56. Gravatar of mlb mlb
    16. June 2010 at 07:33

    “mlb, I disagree. First of all, prices are well below a 2% growth track from September 2008. More importantly, you need to look at NGDP, not prices. When NGDP suddenly and permanently shifts to a 8% lower growth track, all wages must also downshift by 8% relative to the old trend line. Thus workers who normally get a 4% raise would need 4% pay cuts. We haven’t even come close to that happening, so we’ll have a long period of high unemployment.”

    Hmmm, maybe my numbers are wrong put i have 1Q 2010 NGDP at $14.6T, up 0.3% vs the prior peak in 3Q 2008. I have 1Q 2010 average hourly compensation down 0.2% from its peak in 2Q 2009. Further since 2003 (let’s assume that was the start of this cycle) NGDP is up 31% and average hourly compensation is up 22%.

    I’m not seeing how workers have priced themselves out of the economy.

  57. Gravatar of Greg Ransom Greg Ransom
    16. June 2010 at 07:34

    It’s not there either. What we want is something from the early 1930s, right? What we have from the early 1930s is Hayek endorsing Keynes’ innovative ideas for counter-deflationary/ recessionary policy.

    David writes,

    “Another place to look would be in the interviews that various UCLA economists conducted with him in the 1970s.”

  58. Gravatar of Greg Ransom Greg Ransom
    16. June 2010 at 08:30

    Yes, Hayek did in fact state the obvious implication of his work. And I supplied the quote where he does that in the comments section of Scott’s last post.

    Hayekian macroeconomist Steve Horwitz has laid out the Hayekian position in greater detail in a book published in the 1990s.

    David writes,

    “I agree that Hayek’s own theory (which amounted to stabilizing MV and is thus a precursor to Scott’s NGDP rule) implies inflation, not deflation in a crisis, but he never drew that obvious inference from his theory. “

  59. Gravatar of Greg Ransom Greg Ransom
    16. June 2010 at 08:38

    “your fire should be aimed at people like the Pauls, Tom Woods and Robert Murphy”

    Steve Horwitz has engaged these guys on this matter, better than I could.

    Paul Krugman writes in the New York Times, Woods and Murphy write on an obscure economics blog. And Scott is writing a major scholarly work on the Great Depression, unlike these others. Krugman and Sumner are read by the leading economist in the world, Murphy, Woods and the Pauls are not.

    I don’t see Murphy invoking Hayek, is seem him (controversially) invoking Mises. And I don’t recall coming across this stuff from the Pauls or Woods invoking Hayek on the topic of a post-bust deflation. My interest is principally in the discussion of economic theorists, and I don’t go out of my way to read the popular libertarian stuff from politicians and pop history authors. I just don’t. I haven’t read Paul, and I don’t own Woods book.

    Finally, I have engaged on this issue, e.g. by advertising the quotes that Horwitz has used in his debates with Murphy, et al and by publishing your own piece on this topic, etc.

  60. Gravatar of Greg Ransom Greg Ransom
    16. June 2010 at 08:39

    Scott, leftist use “conservative” to mean businessmen who use government to line their own pockets and to mean economist who oppose businessmen using government to do this.

    I don’t think this is any accident.

    Is it an accident in your case?

  61. Gravatar of Greg Ransom Greg Ransom
    16. June 2010 at 09:34

    Scott, why don’t you call Fisher a “conservative”?

    He was a prohibitionist — you can’t get any more conservative that that.

    And he was pro-market guy. Very conservative.

    So why isn’t Fisher one of your “conservatives”.

    Maybe because he doesn’t fit your cognitively closed tautology?

  62. Gravatar of Mari Mari
    16. June 2010 at 12:46

    Thanks Scott…I read through your short course…very helpful.

    In the course you say “first everyone has more cash than they prefer to carry in their wallets. So they bring it to their bank. But even in a recession when no one is borrowing, banks would prefer to hold T-bills earning 3% rather than reserves earning zero percent. So they shovel the cash out just as fast as they receive it (buy buying interest-bearing assets.) This game of “hot potato” continues to accelerate velocity as people desperately try to exchange the excess cash balances for goods, services or assets. AD rises.”

    What happens if people start stuffing it in the mattress instead of taking it to the bank, as banks will charge same or higher negative interest the fed is charging them? Is this not a possibility? which will reduce the “V” further?

    In light of this possibility, isn’t there an argument that even “bridge to nowhere” fiscal spending will increase the “V”?

  63. Gravatar of azmyth azmyth
    16. June 2010 at 12:50

    I think what a lot of the commentors are missing is the mechanism by which stable prices (and/or NGDP) lead to fewer socialist policies.
    1) Inflation + Government backing of banks = leverage fueled boom
    2) Boom collapses due to micro/RBC/ABCT factors.
    3) Fed amplifies debt deflation deleveraging cycle with contractionary policies (What Scott is opposed to!)
    4) Unemployment + RGDP collapse = desperate politicians
    5) Desperate politicians create crazy socialist policies to combat the effects of a pro-cyclical monetary policy.
    6) Crazy policies cause supply side problems and terrify populace into buying gold, guns and freeze dried food.

    Without the deflationary policy, politicians wouldn’t have any reason to go nuts. There would be no talk of a trade war or “saving jobs” if unemployment were at 5%. I see this as a monetary extension of the argument in Road to Serfdom. Bad policies create unintended consequences, leading to more centralization of power which lead to more bad policies. Repeat ad absurdam (until you get a reasonable person to stop the insanity). If we had sound money or free banking or denationalized money, this would probably not be a problem. Unfortunately, we’ve got central bank issued fiat currency, and until that changes, we’ve got to make the best of what we’ve got.

  64. Gravatar of Silas Barta Silas Barta
    16. June 2010 at 12:56

    Cross-posted from Bryan Caplan’s blog, since they’re not responding there anymore.
    ***
    I don’t consider this an insightful question, because it leaves the important issues underspecified.

    1) It’s not inflation per se that bothers me, but the fact that interest rates don’t make up for the loss of purchasing power. If there were a way to protect my savings from that loss, I would gladly take inflation. (No, TIPS doesn’t count because the bond prices would be bid up to the point where the return would be less than inflation.)

    2) Are we talking about *true* inflation, or *government-reported* inflation? The official stats are very disconnected from the prices consumer face, in part because they never seem to adjust *up* for *decreases* in product quality, only the opposite. And they don’t have the facilities that would detect product degradation in the first place.

    A *true* 2% inflation rate would be much better than these policy disasters, but the government’s 2% would mean more like 10%. To answer the question, I would say that a government-reported 8% inflation rate would be the highest rate that would be preferable to the policy disasters.

    Of course, I reject Sumner’s reasoning entirely. Injecting free money into the vaults of politically powerful banks would *not* cause a genuine recovery; it would just wiggle phony stats into the right place.

  65. Gravatar of Morgan Warstler Morgan Warstler
    16. June 2010 at 15:52

    “If we had sound money or free banking or denationalized money, this would probably not be a problem.”

    Hear, hear. And someday we will. But since we don’t…. let us raise ourselves up – we are doing it as we speak – 60%+ hate Obamacare. Public Unions are going to be drown in the bathtub of web based productivity. Even in this “crisis” America is so soon ready to throw out the socialists. The Tea Party, NOT FDR, is winning. We are a better people, than our ignorant grandparents.

    Stable prices aren’t “procyclical” – the price of oil goes through the roof whenever the economy grows a tad (see Peak Oil). Congress wants home ownership to be a human right, driving up home prices. The market basket of things we spend money on becomes less staple oriented, and more virtual. Network effects cause things to get cheaper as more people have them.

    Why give up and try a short term fix? Targeting NGDP soon becomes the new normal wile furthering the idea that monetarists are actually smart. But even with NGDP in a moment of crisis, we still need some extra spending. We still need rates really low, and we’re even more panicked because we’ve tried to structure against “boom” and “bust”!

    Let’s instead preach, a strong stomach is procyclical – and if government isn’t built for highs and lows, then we need to change government.

    I call it GOV2.0.

    Today I even spoke of Scott: http://bit.ly/bNKsu4

  66. Gravatar of Bonnie Bonnie
    16. June 2010 at 16:38

    What could be missed here is the context in which the “conservative” label *might* be utilized. One can be conservative with money choices but be socially liberal, like the Blue Dogs for example.

    Here’s how I look at the situation in case there isn’t just a misunderstanding regarding context:

    Democrats are in power now, both houses and the pres. They have the ability to score on the Fed and get it to do what needs to be done, all other issues aside. They have yet to do so for whatever reason and have the most to lose with the delay. One would think the Democrats would be held responsible for delivering tangible economic improvement as they promised, but have yet to deliver and they look pretty idiotic at the moment.

    What I’m seeing instead is an argument that sounds like you can’t blame a socialist for being socialist and ramming their utopian ideals through the legislative process regardless of what average Americans feel our national priorities should be, blame conservatives instead. Sorry, but I must have missed some so called conservative bringing socialist utopia legislation to the floor. Are socialists completely incapable of intellectualizing real solutions to real problems, feeling the same sense of urgency regarding our recovery as most Americans feel, or deal with the Fed? I think they can do it, and do have some right to some of what they want because of where they are.

    We get socialism because people voted for socialists, and they act like socialists when they get to D.C. What a shocker. People who don’t want that shouldn’t vote for it. I didn’t and I don’t recall Obama et al being deceitful about their intent.

    In all reality, I don’t believe what’s going on in D.C. right now regarding the economy has as much to do with ideology as it does just sheer incompetence on both sides of the isle and at the Fed. If I could vote no confidence in all of them and get new players right here and right now I would.

  67. Gravatar of scott sumner scott sumner
    17. June 2010 at 05:57

    Greg, You said;

    “David and Scott,

    What we need to do is stay in the realm of facts.

    1. Hayek and Hayek’s work had NO influence on economic policy in any country in the world in the 1930s.

    2. Hayek didn’t do ANY work in the realm of either empirical study or policy recommendations in the 1930s.”

    I have several reactions. First, I never claimed the opposite. Second, with friends like you Hayek doesn’t need enemies. Any macroeconomist who ignores empirical issues is almost certainly going to produce bad theory. Macro is inextricably tied to current policy issues.

    Regarding my Friedman post, I stand behind Friedman’s claim that the Austrians thought money was too easy in the late 1920s. I think they did believe that, and I think they were wrong.

    Yes, the definition of conservative has changed, but not their preference for hard money. That view seems hard-wired into the conservative brain.

    Morgan, You said;

    “Scott, but you DO care about price! Stop saying you don’t. I’m the one who doesn’t care about price…. I don’t care what it is, as long as it is honest.

    Right now we both know, and you will admit, housing prices have been driven artificially high, and you want to target NDGP specifically because you don’t want to see price deflation.”

    I don’t care about relative prices at all. I care a bit about absolute prices, but prefer NGDP. I certainly don’t care about housing prices, nor do I concede they are currently too high.

    You said;

    “Now please admit that I want to find out what the price really is – and YOU ARE TERRIFIED of finding out the real price.”

    That’s completely false. I am one of the few economists who wants housing prices to find their true level. I am one of the few who opposes attempts to use Fannie and Freddie to prop up housing prices. You have completely misunderstood my views on monetary policy. I oppose attempts to prop up housing prices with monetary policy. If anything, monetary policy should be concerned with the absolute price level, and let the relative price of each product find its natural level.

    Greg, If you are right that Hayek never talked about policy issues, then I am obviously not referring to Hayek when I discuss conservatives who were encouraging tight money in the early 1930s.

    The bizarre thing about this is that you and I seem to complete agree. We both agree that Hayek opposed easy money in the beginning of the Depression, and we both agree he changed his mind later and in the 1970s said that in fact easy money was called for, and he regretted his earlier views. So what’s the debate? I am talking about those conservatives who did get their hands dirty and did get involved in policy issues during the 1920s and 1930s.

    mlb, If you run a trend line over the past 20 years, NGDP grew at just over 5% per year. Thus over a 2 year period it should be up a bit more than 10%. I date the key turning point as July 2008. A year later NGDP was down about 3%, instead of rising 5% (unfortunately this involves a bit of guesswork as we for some bizarre reason lack monthly NGDP data.) That’s 8% below trend. Since then we’ve grown at about trend.

    I don’t have the wage series in front of me, but I’m quite sure that hourly wages haven’t fallen 8% relative to trend.

    BTW, I’m not claiming workers priced themselves out of the market, I’m claiming the Fed priced workers out of the market. (Plus a 40% rise in the minimum wage rate.)

    Greg, Fisher was conservative on many issues, but not monetary policy. He was clearly an outlier in the 1930s, there were very few people with his set of views. George Warren had identical views on monetary policy and advised FDR. He was viewed as one of the more left wing people in the Roosevelt administration.

    My memory is failing me, but can someone dig up that recent article on Hayek and Robbins views on monetary policy during the Depression? (JMCB?) It was written by well-respected Austrians, and has the same views as I have. Indeed that’s where I got my views from.

    Mari, Yes, that is possible, but there are several responses:

    1. Then print more money, until the public’s demand for cash is satiated.

    2. A better solution is inflation or NGDP targeting. Liquidity traps don’t last forever, so if you promise higher inflation after exiting the liquidity trap, that will lower real rates right now. People are less likely to want to hoard cash if they expect higher inflation.

    3. Devalue your currency to create inflation via higher import prices. There is no zero lower bound on exchange rates.

    4. Create and target the price of CPI futures contracts.

    So there are many ways out of this hypothetical trap. It is important to note that no country that wanted to inflate has ever failed. It simply has never happened. So it’s not a problem we need worry about. The problem is that the Fed says it doesn’t want to inflate. In that case we won’t get inflation. That’s where we need to focus.

    azmyth, Very well put.

    Silas, I also dislike the phony government inflation numbers, which is why I prefer to target NGDP. I only talk about inflation because that’s what everyone else focuses on.

    An easier money policy would promote rapid recovery, which would lead to higher real interest rates for savers. The reason real returns are so low right now is that the economy is severely depressed.

    Injecting “free money” is much less friendly to banks than the current policy, which actually pays banks to hold reserves. I oppose that subsidy. My policy would actually result in a much lower monetary base, and much higher long term interest rates.

    Morgan, Thanks for the mention.

    Bonnie, There are two groups on the left. People like Krugman, Yglesias and DeLong, who favor easier money, and the much larger group who are so clueless that they don’t even know that easier money is possible. I should have mentioned that larger group (which I frequently criticize in other posts) as they are also part of the problem. That clueless group includes the Obama administration

  68. Gravatar of mlb mlb
    17. June 2010 at 06:46

    Scott, I don’t see why deviation from trend matters. The fact is NGDP is at a new high and wages are not. Relative to the last period when we had near-full employment, it should currently be more advantageous to hire workers.

    The trend sinc the 1970s has been for NGDP growth to outpace wage growth. To me this is just another way of saying that productivy gains accrue to the owners of capital, not labor. I suppose that can exist for a while if labor is able to expand their spending power by taking on debt. But at some point that game has to end and benefits of productivity have to be split more evenly.

    Further, when demand drops why should wages take the adjustment? Corporations could just as easily drop price, shrink margins, and create enough demand to regain full employment. Given record high profit margins I would think this would be an easier solution than engineering a real wage cut. It seems that time and again labor gets the short end of the stick – I can understand why confidence in the economic system is at record lows.

  69. Gravatar of Philo Philo
    17. June 2010 at 07:53

    Dan Klein posted a petition from 150 economists, led by Harry Gunnison Brown, dated March 3, 1933, that called upon FDR to produce . . . inflation. Though most of the names are rather obscure, this petition shows that Irving Fisher and George Warren had company.

    http://econfaculty.gmu.edu/klein/Assets/1933Price-level_petition.pdf

  70. Gravatar of marcus nunes marcus nunes
    17. June 2010 at 09:51

    Scott: Others are paying attention…
    “Make no mistake, this is a failure of monetary policy to boost expectations of future NGDP. Getting mad a Congress is an exercise in futility”.
    http://modeledbehavior.com/2010/06/17/missed-your-growth-spurt/

  71. Gravatar of Michael Meyers Michael Meyers
    17. June 2010 at 13:18

    Scott,

    Thanks for the answer to my question… although I just don’t buy into your logic… i.e. if A makes a mistake, and then B capitalizes on that mistake to do something bad, then it’s A’s fault since A started the chain of events….. In my moral world, it’s really B’s fault for the bad that was done.

    Regards,
    Michael

  72. Gravatar of Morgan Warstler Morgan Warstler
    17. June 2010 at 16:16

    “That’s completely false. I am one of the few economists who wants housing prices to find their true level. I am one of the few who opposes attempts to use Fannie and Freddie to prop up housing prices. You have completely misunderstood my views on monetary policy. I oppose attempts to prop up housing prices with monetary policy. If anything, monetary policy should be concerned with the absolute price level, and let the relative price of each product find its natural level.”

    Scott, the title of this post is “A little more inflation” – you want prices to go up over time.

    Meanwhile, an honest snap shot says right now asset prices should be far lower. And lower prices can give us two very good things:

    1. less tax base – so we have to automate government to have less public employees.

    2. making sure the banks have their dirty fingers pried off ill gotten gains – a giant lesson they need to learn before we can move forward. Prices have been artificially inflated. Forget Fannie and Freddie demand inflation, I’m not talking about that – I know you want to end that.

    The banks own a giant pile of distressed real estate assets, and BEFORE the the economy recovers, I want them to deal with it: so we need to force them into mark to market (I don’t know your position here) and no interest on reserves (which you support).

    We’ll have oversupply drive down the price… which you hate, because you are so worried about deflation (prices).

    I don’t know about you, but the two biggest structural issues facing us are:

    1. Public Employee Unions
    2. Banksters

    And BOTH of those will be forced to eat it if we wait on your NGDP plan, and focus on removing the structural support for prices.

    Who knows with both of those problems solved, we might be able to get by without NGDP. I liken your policy to our nation taking Prozac

  73. Gravatar of david david
    17. June 2010 at 21:32

    Morgan Warstler, I think there’s a difference between real estate prices and the general price level!

  74. Gravatar of Morgan Warstler Morgan Warstler
    18. June 2010 at 10:50

    david, please elaborate on that one.

  75. Gravatar of scott sumner scott sumner
    18. June 2010 at 11:39

    mlb, I don’t know where you are getting your data. This government report says wages have risen 3.8% over the past two years.

    http://data.bls.gov/PDQ/servlet/SurveyOutputServlet?data_tool=latest_numbers&series_id=CIU1010000000000A

    There has been some shift toward capital, but I don’t think it is all that big. You should compare wages to NGDP/worker, not overall NGDP.

    Philo, Yes, by 1933 many economists favored reflation. But even then some opposed devaluing the dollar. It was a pretty radical step.

    Michael, I don’t disagree with you. I wasn’t trying to assign moral blame, just getting people to think about the consequences of their actions. If we have sub-normal inflation, bad things will happen.

    Here’s an analogy. If someone yells “fire ” in the theatre, the moral thing for everyone to do is walk out in a single file. Perhaps no one will die. But in fact everyone will rush for the doors, and most people will die if the door clogs. In that case both the one who yelled and the patrons are to blame.

    Thanks Marcus, He’s also a commenter here.

    Morgan, Falling NGDP helps public employee unions. They are one of the few groups that are probably better off on average during this recession (even given the fact that some have been laid off.) My proposal to boost NGDP would move resources from the public sector to the private sector. Do you object to that?

    I don’t want the government “forcing” asset prices anywhere. Let the market determine asset prices. (Except cash, I want the government to determine the value of a dollar bill.)

    David, Yes, Morgan keeps missing that.

  76. Gravatar of Doc Merlin Doc Merlin
    18. June 2010 at 21:38

    “But in fact everyone will rush for the doors, and most people will die if the door clogs. In that case both the one who yelled and the patrons are to blame.”

    YEs, but only if there isn’t actually a fire.

  77. Gravatar of Even Eric Cantor’s Portfolio Says… «  Modeled Behavior Even Eric Cantor’s Portfolio Says… «  Modeled Behavior
    18. June 2010 at 22:03

    [...] vs trend NGDP from the Great Moderation), and get the real economy moving again…lest we want more socialism (or more fiscal [...]

  78. Gravatar of Greg Ransom Greg Ransom
    19. June 2010 at 09:36

    Scott, the whole point is that changes in the money supply and the credit supply and in the leverage supply directly changes the market determination of asset prices — it changes the structure of relative prices and the time stream of alternative production processes. This is the heart the market process — and by conceptual fiat you model declares it’s non existence. You are not addressing the central issue.

    “I don’t want the government “forcing” asset prices anywhere. Let the market determine asset prices. (Except cash, I want the government to determine the value of a dollar bill.)”

  79. Gravatar of Morgan Warstler Morgan Warstler
    19. June 2010 at 16:36

    Scott, so I’ll take it you admit you are concerned with price. I’d prefer if you are VERY specific here.

    Maybe you didn’t get my tongue in cheek with david, PLEASE elaborate on the obvious and clear difference between current real estate prices and the general price level!

    And please no squirreling here, make a clear distinction – and do so while admitting that currently real estate prices are too high / artificially inflated.

    It has become apparent to me that your real issue is that you are unimpressed with American likely voters (the only folks who matter) particularly in your unwillingness to TRUST they will GUT public employees, and their satisfaction at banks becoming unprofitable because of mark-to-market.

    I say this because it is almost impossible to get you to work outside your own comfort zone.

    I’m trying to get you to STOP trying to solve this with the FED, and focus on us solving it as political republic made up of many small communities led by free market small business men. That’s what this country is really.

    I keep challenging you to FOCUS on gutting public employee unions. We need a economist to scream: stop paying interest on reserves and mark to market.

    You are such an economist.

    You refuse to even consider the ramifications of a budget brought near balance simply through GOV2.0. This is the problem, you want to paper over a political issue with economic policy.

    You have no faith that likely voters will force government to become smaller, as such you refuse to work from hypotheticals where it is smaller.

  80. Gravatar of Scott Sumner Scott Sumner
    20. June 2010 at 05:10

    Greg, Actually I do allow for relative price changes. During monetary expansion the prices of goods rises relative to labor. And the price of flexible price assets rises relative to consumer goods and services.

    Morgan, You asked,

    “Maybe you didn’t get my tongue in cheek with david, PLEASE elaborate on the obvious and clear difference between current real estate prices and the general price level!”

    Housing prices are a relative price, and hence explainable by microeconomics. The overall price level is the value of money, and hence explainable by macroeconomics. They are completely unrelated issues.

    You said;

    “I keep challenging you to FOCUS on gutting public employee unions. We need a economist to scream: stop paying interest on reserves”

    You are wasting you time on public employees. I’d like to greatly reduce their numbers, but this is a blog that focuses on monetary economy. Your second point is a bit off target, given that I have probably written more in opposition to interest on reserves than all other bloggers combined.

  81. Gravatar of Summer Weekend Reading | Invest It Wisely Summer Weekend Reading | Invest It Wisely
    20. June 2010 at 06:12

    [...] TheMoneyIllusion: A little more inflation or a little more socialism? [...]

  82. Gravatar of Greg Ransom Greg Ransom
    20. June 2010 at 14:21

    These aren’t the relative prices changes that matter if the claim is you are engaging Hayek’s empirical claims about America in the late 20s.

    Your position is like a creationist laughing at Darwin when the creationist excludes the possibility of relative adaptive difference between individuals by conceptual fiat, e.g. The creationist assumption the populations of species are made up of individuals exemplifying a Platonic natural kind.

    Scott wrote,

    “Greg, Actually I do allow for relative price changes. During monetary expansion the prices of goods rises relative to labor. And the price of flexible price assets rises relative to consumer goods and services.”

  83. Gravatar of ssumner ssumner
    21. June 2010 at 09:11

    Greg, I am disagreeing with Hayek’s empirical claim about America in the 1920s. I thought disagreement was engagement. I don’t see evidence that there was important misallocation in the 1920s.

    People often point to the 1926 Florida housing bubble. But I don’t recall any Great Depressions in 1927.

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