A few days ago Tyler Cowen did a post discussing the 8.8% RGDP growth rate in Germany in the 2nd quarter. Because I had previously expressed skepticism about the robustness of the Germany recovery, let me congratulate Tyler for being correct. Nevertheless, in my never-ending struggle to turn sow’s ears into silk purses, I tried to make the best of it with this essay over at The Economist. Yes, I was wrong about the recovery (which I still think was less than robust until the second quarter) but the blowout number for German growth shows I was right about something far more important. I know what you are thinking, “How convenient, he can make up ad hoc theories for his past mistakes.” Bear with me; this is what I said in May:
“So stocks in the heart of the eurozone, the area with many banks that are highly exposed to Greek and Spanish debts, are actually down a bit less (on average) than the US. Perhaps the strong dollar is part of the reason. Perhaps monetary policy has become tighter in the US than Europe.”
Now I certainly did not expect 8.8% growth in Germany, but I did point out that the Greek crisis might have been hurting the US more than Germany. Recall that it sharply appreciated the US dollar against the euro, and that those gains were closely linked to news stories about the Greek crisis. So I think it is reasonable to infer that worries about the “PIIGS” led to an increased demand for dollars, which caused the dollar to appreciate. In principle, the Fed could have prevented this by increasing the supply of dollars, but they are reluctant to do unconventional QE.
I’d also like to mention a few ideas not in The Economist essay. Let’s start with the slowdown in US growth. David Beckworth has a post that shows May and June were the key months, when growth in US NGDP began to slow sharply. But can we really link this to tighter money? After all, doesn’t monetary policy work with long and variable lags?” Actually no.
Monetary policy affects the economy almost immediately. It is very hard to identify monetary shocks with postwar data, because policy is so endogenous. But in the interwar period there were some large monetary shocks that were easily identifiable, and in each case they led almost immediately to a sharply change in:
1. Stock prices
2. Commodity prices
3. The WPI
4. Industrial production
Those who want to argue long and variable lags have a problem. It isn’t just the empirical evidence I cite, on theoretical grounds the impact on stock and commodity prices must be immediate (unless there are a lot of $100 bills lying around on the ground.) But the movement in stocks and commodities is closely correlated with broader price indices and monthly industrial production. So whatever caused the prices of assets to change was also probably driving industrial production.
And of course we see the same thing in modern times. The great fall in industrial production in late 2008 occurred at the same time stock and commodity prices were collapsing. We know the Greek crisis sharply depressed US stock and commodity prices in May 2010. Now that we get the GDP report, we also know that it depressed NGDP, especially in May and June. In Germany, the effect was positive, as the weaker euro gave a big boost to the already robust German export machine, which is a big part of the German economy.
So what can we learn from all this? Here are some lessons:
1. Krugman was wrong in suggesting that the slowdown this spring was entirely predictable from the planned phase-out of stimulus. The slowdown was associated with a sharp drop in stock prices, which was obviously unforecastable.
2. Krugman was wrong for another reason; the slowdown in the US was not due to less spending, but rather less output growth, as the trade deficit worsened dramatically. And German output soared with strong exports.
3. There are no long and variable lags, the economy responds almost immediately to monetary shocks.
4. Monetary shocks (changes in the supply and demand for dollars) are often much more important than real shocks (banking problems.) The Greek crisis put the German and French banks under a great deal of stress. Yet the German economy grew fast, as the weaker euro was like an easing of monetary policy.
5. I do share one trait with Krugman. We both have an almost shameless ability to turn failed predictions into claims of “See, I was right all along!”
[Krugman fans: Just kidding, he actually does have a pretty good track record at forecasting. But he can be a bit hard to pin down at times.]
Next post: long and variable LEADS.