Long and Variable LEADS

In the previous post I explained why the commonly held notion of long and variable lags is a myth.  I didn’t mention the reason for this myth.  It results from economists trying to cover up the fact that the monetary policy indicators they have fallen in love with (interest rates, the money supply, etc) don’t actually identify changes in the stance of monetary policy.  Recent work by Woodford and others shows that it is changes in future expected monetary policy that drive current AD.  Krugman also did important work in this area, and used this basic idea a few weeks back when he argued hawkish statements by Fed officials were already slowing the economy.

And in fairness to Mr. Bernanke, discord among senior officials also makes it difficult for policy to change expectations: it would be hard to credibly commit to higher inflation if this commitment were constantly being undercut by speeches out of the Richmond or Dallas Feds. In fact, I’d argue that loose talk by some Fed officials is already having a negative economic impact.

Suppose Fisher, Plosser, and Hoenig make a bunch of scary sounding statements about exit strategies, and that causes people to expect tighter money next year.  Why would that cause the economy to slow right now?  There are many reasons, but the easiest explanation involves a simple example using a perfectly competitive industry.  Suppose tighter money is expected next year.  Economic theory predicts this will reduce AD next year, and also depress commodity prices.  But if future expected commodity prices decline, then inter-temporal arbitrage also causes current prices to fall.  If wages are sticky, then lower current commodity prices will cause lower output of commodities like zinc. 

Those more comfortable with Keynesian explanations might look at the process through interest rates.  Tighter expected money next year will raise expected future real short term interest rates.  This will raise current real long term interest rates.  And this might slow housing.  I personally don’t like using this mechanism, because if tight money leads to slower expected growth, it might actually depress longer term rates.  Even so, it would contract current output by lowering the current price of houses.

Here’s what I find interesting about these expectations stories.  Suppose you think of monetary policy in the way most people do—as open market operations that change the money supply.  In that case, there may actually be LEADS in monetary policy, i.e. the effect may occur before the cause.  A future money supply change may cause a current change in demand and output. 

Those who are philosophically inclined may be a bit uncomfortable with the thought of effects occurring before causes.  “Wait” (I can just hear you saying) “it isn’t the future money supply change that causes a current change in spending, it is the CURRENT EXPECTATION of a change in future monetary policy, and future AD.”  OK, I’m willing to go along with that.  We should not describe changes in monetary policy in terms of current changes in the money supply, but rather expected future changes in the money supply.  And of course we also know that it isn’t just the money supply that matters, velocity is equally important.  So what really matters is changes in the expected future level of M*V, or NGDP.  It is changes in expected future NGDP that best characterizes changes in monetary policy, at least if we don’t want effects to occur before causes.  Of course that’s exactly what I have been arguing in my blog for 18 months. 

And by the way, if we define monetary policy changes in terms of changes in expected future M*V (as we should), and if the fiscal multiplier is estimated under the assumption that monetary policy is held constant, then it is a truism that the expected fiscal multiplier is always precisely zero.  

Don’t like that result?  Then give me your definition of “monetary policy changes” where:

1.   Cause doesn’t follow effect

2.  The definition does not imply money was “easy” in the Great Depression (when rates were low and the monetary base soared.)

Having trouble?


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50 Responses to “Long and Variable LEADS”

  1. Gravatar of Morgan Warstler Morgan Warstler
    30. August 2010 at 16:13

    “Suppose tighter money is expected next year.”

    But according to you tight money = low interest rates.

    If interest rates are at ZERO, how exactly is money going to get tighter? Please be specific on the other things that could make money tighter, when interest rates are at zero.

    Also, you told me last week V doesn’t matter, or is uninteresting, or something. Why the sudden interest in them? To talk about IOR?

    —–

    Ok on this future expectations game… how can you be so dense about future expectations on tax policy? future expectations on regulations?

  2. Gravatar of William Bruce William Bruce
    30. August 2010 at 17:02

    Was not this thesis the basis for Milton Friedman’s declamations about monetary regime uncertainty back in the 70s and 80s? I seem to recall him even telling off (in his polite way) former Chairman “Bill” McChesney Martin, by consideration of said policy implications. Actually, I think that was in his Free to Choose episode on inflation, of all things — not scholarly material by any means, but it is what it is.

  3. Gravatar of Steve Steve
    30. August 2010 at 17:11

    Ha ha ha Morgan, get off the short bus.

    Scott said low interest rates are a symptom of tight money, not an equality with tight money.

    As for future expectations on (bad) tax policy and (bad) regulations — these should lower RGDP potential, but shouldn’t lower inflation expectations if monetary policy is adequate.

    PS. I am tired of your shilling for the liquidationists. You will never get the chance to buy a 400K house for 40K with 20% down. Plenty of other people will pay 100-200K all cash, and you will be their tenant.

  4. Gravatar of Morgan Warstler Morgan Warstler
    30. August 2010 at 17:50

    Steve, you’re seriously mistaken. I’d expect the guys to pay $100K all cash. I’d require 40% down, but I’d weight towards cash.

    I actually think that once it starts moving, the price will head upwards.

    Scott’s coming around. There’s very little he disagrees with me on!

  5. Gravatar of Robert Robert
    30. August 2010 at 22:16

    “Even so, it would contract current output by lowering the current price of houses.”

    Please say “by reducing current demand for houses” (assuming that’s what you mean). I might have to link to your own blog post “Never reason from a price change”!

  6. Gravatar of Nick Rowe Nick Rowe
    31. August 2010 at 04:45

    Scott: To me, there seem to be 4 “times”:

    1. The time the Fed makes the announcement it will do something.

    2. The time it will do something.

    3. The time asset markets react.

    4. The time other markets react (P, GDP, employment, etc., or just simplify to NGDP, if you like).

    I would say that 1=3, and 4 is bigger than 1 and 3. 4 could be either greater than or less than 2, (lead or lag) it will depend on the circumstances, especially the gap between 1 and 2.

  7. Gravatar of OGT OGT
    31. August 2010 at 05:06

    The Fed controls ‘M’ they have limited influence on ‘V.’

    It seems your hypothesis only works if one makes some heroic assumptions about both the ability of the Fed to control expectations and the ability of market actors to process and act on the possible implications of future Fed policy.

    I think that market participants should and do have a very high discount rate for future monetary actions. Put it this way, what is worth more a cut in the real interest now (or think of it as monetary easing now) or real interest rate cuts/monetary easing in ten years?

    The answer should be obvious, yes?

    Of course, you are not arguing for a ten year lead, but it is important to establish that there is a discount rate for expected Fed actions. Further, I would argue that discount rate is much higher in periods of financial distress and greater liquidity constraints on market participants, such as now when consumer balance sheets are strained, banks are rebuilding capital and often still shaky and businesses face weak demand.

    All that said, my preferred solutions may not be that different from yours. For example, the discount rate on Fed policy is probably sky high now because of the inconsistent way they have interpretted the dual mandate, so a more concrete mandate needs to be set, either NGDP or an explicit Taylor rule where the Fed is required to submit an estimate of price level and non-inflationary employment level with explanations as to why they’ve missed their targets required semi-annually.

    I’d ideally like to see a money financed payroll tax cut whose duration and depth is tied to the Fed’s targets, as well as state aid with budget and pension reform measures tied to it.

  8. Gravatar of DanC DanC
    31. August 2010 at 06:05

    The weak link is, I think, the assumption that everyone agrees on what a given policy will achieve once implemented.

    The Fed can have an impact on price stability but less on employment.
    The following from Mishkin

    “Indeed, the level of maximum sustainable employment is primarily driven by the fundamental structure of the economy, including factors such as demographics, people’s preferences, the efficiency of labor markets, the characteristics of the tax code, and so forth. And many policies outside the control of the Fed can have a significant effect on the efficiency of the economy and hence on the maximum sustainable level of employment.”

    http://www.federalreserve.gov/newsevents/speech/mishkin20070410a.htm

    Given how poor fiscal policy has become, and how it has increased uncertainty about the future, I think Scott is expecting too much from monetary policy.

    Scott may be certain that QE and targeting NGDP will lead to positive result but it also appears that many agree with the Mishkin view that sustainable growth is built on sound and predictable monetary and fiscal policy. Cut off one of the legs and the economy has a hard time moving forward.

    That doesn’t mean that what Scott wants to do is a better path then most, just that I think he expects too much of a result. And by his own expectations argument, unless others are convinced that his is the correct path, prior to trip, it will have less impact.

  9. Gravatar of DanC DanC
    31. August 2010 at 06:08

    Correction

    That doesn’t mean that what Scott wants to do is NOT a better path then most, just that I think he expects too much of a result. And by his own expectations argument, unless others are convinced that his is the correct path, prior to trip, it will have less impact.

  10. Gravatar of Morgan Warstler Morgan Warstler
    31. August 2010 at 07:15

    DanC,

    That’s of course right. What bothers me is that Scott refuses to spend real time responding to the core structural arguments.

    He says all these things:

    1. less unions.
    2. less housing support on prices.
    3. no minimum wage / health care requirements
    4. better tax policy.

    But then REFUSES to acknowledge that even if he is right about targeting NGDP, the activity he is prescribing (your $100 is worth $81) in 5 years….

    The effect is far less immediate chance to do 1-4. If Obama isn’t on the ropes, 1-4 WILL NOT HAPPEN.

    It isn’t about the mechanics, it is about the political economy.

    We can ALWAYS target NGDP, why not wait until after 1-4 start to move the right way, and we see they don’t work?

    Micro trumps macro categorically, if macro policy promises to run afoul of micro, we shouldn’t even be considering it.

  11. Gravatar of William Bruce William Bruce
    31. August 2010 at 07:57

    Morgan Warstler, 31. August 2010 at 07:15:

    “We can ALWAYS target NGDP, why not wait until after 1-4 start to move the right way, and we see they don’t work?”

    Perhaps because “we” will doubtless see no such thing, provided that “we” includes Middle America. They — er, I mean, “we” — tend to see everything through post-hoc-ergo-propter-hoc-coloured glasses.

    (My apologies for the curt Mencken-mongering, but it had to be said.)

    Otherwise, it would indeed be pleasant to discuss the effects of unions, minimum wages, mandated benefits, price supports, etc. on both technical and non-technical price stickiness (including, naturally, a “culture” of wage stickiness). I, for one, would gladly read anyone’s musings on the matter.

  12. Gravatar of Benjamin Cole Benjamin Cole
    31. August 2010 at 08:47

    Scott:
    I like this post, but what we need now is a concrete set of proposals of where to go from here, monetarily speaking. Enough philosophizing. Do we engage in QE to the tune of $40 billion a month? $50 billion? Do we ramp up, ie, start at $10 billion and keep ramping until we see results? Or start at $100 and slowly ramp down?
    At what inflation rate do we start to pull in the reins?
    Stop paying interest on reserves? Start charging–again by a rate that ramps up gradually?
    Don’t get sidetracked into catfights–yes, it would be wonderful to eliminate agricultural subsidies, the minimum wage, the military or the home mortgage interest tax deduction, but you will get waylaid on side roads and unecessarily alienate people with such observations.
    The Big Thing now is monetary policy–what shape should it take. Remember, most people out there are not economists, let alone monetarists. They need to see a plan and the potential results of that plan laid out.

  13. Gravatar of Morgan Warstler Morgan Warstler
    31. August 2010 at 08:49

    By we I meant Scott’s chattering class of economists.

    Sumner binds himself up tight with DeKrugman on ultimate policy, even while he shoots pee-shooters at their stimulus, or causality, or whatever.

    My continuing point is: As Scott sides with the free market crowd, it makes no sense to champion QE when we’re finally getting 1-4 headed the right way… we want to wait to do QE, until we’ve gotten the very largest concessions on 1-4.

    To DeKrugman, targeting NGDP is a consolation prize when they can’t get any more stimulus. In that regard, Scott’s arguments are best understood as a way to head off appeals for more fiscal stimulus – when the liberals actually have the steering wheel, or after we go the austerity route, kill the insolvent bankers, and get the hard assets into the right hands.

    Is you point that you do not believe the middle class is now more open to 1-4?

    And man o’man do I need your proof-reading services.

  14. Gravatar of William Bruce William Bruce
    31. August 2010 at 10:50

    Morgan,

    To answer your question, I would say that the middle class is fickle, and maybe even for good reason. Thus, what they believe now is rather irrelevant. After all, they need only correlate one good policy with one bad event, and, lo and behold!, that policy is guilty by association. As is so often the case, Milton Friedman was right: We do not (mostly) have wage and price controls because they were so pernicious *and* people remember them. That association has been difficult to expunge, thankfully.

    In the interest of accuracy, it is the median or mean voter at issue, not the middle class per se. However, the linguistic flogging of “Middle America” draws no objection from me.

    As regards Professor Sumner’s “chattering class” — your words, not mine — the argument calls for a method of identifying both their actual and ideal influence in matters of political economy. Otherwise, invoking issues of political economy quickly becomes tendentious. I may have misinterpreted the underpinnings of your argument, but I did so charitably. Surely you are not suggesting that Professor Sumner engage in some kind of holistic policy-prescription-preaching? Or, that our economist “chattering class” friends do in fact — or should — rule over us like so many philosopher kings?

    I can see no way around this pitfall: Matters of political economy are matters of political influence and political POWER. Once we invoke them, we confront a “science” where our tools and apparatus are not sufficient (or even proper) for the task. In that position, and despite the contributions of public-choice-like economics, the comparative advantage of our “chattering class” simply melts into air. In that way, they are more similar than dissimilar to our dear Middle American.

    Perhaps, just perhaps, that motivates Professor Sumner’s discriminating approach. But that is for *him* and his intellectual conscience.

    As to your policy prescriptions and considerations generally, they all sound like a very dangerous game, with the aforementioned matters pertinent. I can find no more charitable interpretation there.

    And as regards proofreading, I help where there is obvious neglect, and help when anyone asks.

  15. Gravatar of Steve Steve
    31. August 2010 at 11:31

    A central bank that plays politics by refusing to pursue its legal mandates because it doesn’t like structural policy is playing a dangerous game. Likewise a bank that monetizes profligate spending (as measured by excessive inflation) is also playing a dangerous game. Today’s philosopher-king political ally can easily become tomorrow’s enemy.

    In June, Kevin Warsh made the statement, “Excessive growth in government spending is not the economy’s salvation, but a principal foe.” One can debate whether this was an inappropriate statement for an FOMC member to make, and whether the Fed is trying to play conservative politics.

    However, we should also remember that the overly tight monetary policy in 2008, led by hawkish dissenter Richard Fisher, is one of the leading reasons that Obama got elected. One could also point to the liquidationists of the 1930s as a reason why we ended up with social security. Beware of unintended consequences if you want the Fed to play politics.

    Either way, as Scott said, it is better to strive for good monetary policy and then let the democratic process sort out policy.

  16. Gravatar of marcus nunes marcus nunes
    31. August 2010 at 11:34

    Got this wonderful quote from a presentation by C Romer at Brookings in March 09!
    This similarity of causes between the Depression and today’s recession means that President Obama begins his presidency and his drive for recovery with many of the same challenges that Franklin Roosevelt faced in 1933.
    Why didn´t they “follow through”?

  17. Gravatar of marcus nunes marcus nunes
    31. August 2010 at 11:36

    Sorry: Maybe they think they did

  18. Gravatar of Jeff Jeff
    31. August 2010 at 11:54

    Morgan,

    The Fed wears two hats. As the monetary authority, it affects aggregate demand. As a financial regulator, it can also affect aggregate supply. To the extent that Fed regulation (or lack thereof) affects the financial system’s ability to channel savings and investment, or affects labor mobility (by slowing the necessary adjustments in house prices), it is affecting supply. I see most of your comments as complaints that the powers that be are pursuing policies that adversely affect the supply side.

    But what Scott has been saying for 18 months now is that, when you see underemployment of all kinds of resources across the board, the problem is a shortfall in aggregate demand, not a shortage of aggregate supply. While many of us agree that policies that reduce efficiency are not a good thing, the focus of this blog is monetary policy and how it affects aggregate demand.

  19. Gravatar of William Bruce William Bruce
    31. August 2010 at 12:25

    Steve,

    An excellent elaboration of my obtusely articulated point!

    31. August 2010 at 11:31:
    “Either way, as Scott said, it is better to strive for good monetary policy and then let the democratic process sort out policy.”

    Armchair idealizing is indeed worthwhile, but the words “political economy” belong nowhere near that activity. Plato’s Republic is a magnificent thing sitting on my chair’s arm. Unfortunately, someone gave Congress a copy, and they actually read *it*!

  20. Gravatar of Morgan Warstler Morgan Warstler
    31. August 2010 at 12:26

    “Surely you are not suggesting that Professor Sumner engage in some kind of holistic policy-prescription-preaching? Or, that our economist “chattering class” friends do in fact — or should — rule over us like so many philosopher kings?”

    Um, no in fact just the opposite. I want him to respect the Middle American forces of the past 40 years.

    What’s more I’d red flag this, “that the middle class is fickle, and maybe even for good reason. Thus, what they believe now is rather irrelevant. After all, they need only correlate one good policy with one bad event, and, lo and behold!, that policy is guilty by association.”

    Has a fine internal contradiction (covering you bases?) – either they have good reason, or they do not. And it odes not follow, that they are not irrelevant.

    I suggest they most assuredly have good reason to be fickle…. PRECISELY BECAUSE what they want is so clear and unchanging, and they are confronted by a steady stream of pols / bankers / elites who refuse to humbly deliver it – for whatever stupid reason they have.

    I didn’t lament Obama’s presidency because I knew he’d run smack into the buzz saw of what Middle America wants, just like Clinton did (see ending welfare). It ends up being a center-right country, with the goodies pretty much already divided up – seniors are our favored group, public employees not so much.

    The public’s logic, their message then is brutally clear: Do not even think about cutting SS and Medicare until you have gutted public employees and made sure unemployment hasn’t become welfare.

    Do not cut services, cut staff. Do more with less. Do not raises taxes, and if eventually after cutting staff, you do finally have to raise taxes – hit the very rich. And if hitting them starts to hurt growth, and all these other changes have been made – we’ll talk about raising the age of retirement – slowly.

    Obama’s task, with a more conservative Congress is basically the same as Clinton – to deliver on cutting Democrat programs like only a Democrat can: 1) End this new 99 week unemployment insurance as we know it – which practically begs for a market based re-training solution. 2) End Public Unions as we know them – see Chris Christie. 3) He’ll hate it, but we’re going to go through the dismembering of Obamacare. They’ll toss the requirement to purchase which will ruin funding, and then something new will need done. I favor a low budget universal single payer system (hows that for being libertarian) based on this phrase, “beggars can’t be choosers,” sold more directly on the idea that for any given good/service you gain the first 80% of possible functionality for 20% of the potential cost (a cheap cell phone is $100, and expensive one is $500) – this works for healthcare too.

    ——

    As to my dangerous policy ideas – mine seem to be the ones being followed. Every Friday we see more of the 800 insolvent banks taken out back and shot, and slowly we see homes prices falling. I just want to rip off the band-aid – because the band-aid is there for the bankers, it isn’t there for us.

    Finally, I think this NYT article refutes your underlying plea – that somehow Sumner is practicing a science:

    http://economix.blogs.nytimes.com/2010/08/27/when-value-judgments-masquerade-as-science/

  21. Gravatar of Benjamin Cole Benjamin Cole
    31. August 2010 at 12:30

    Jeff-
    Right, right. We could talk at length about the enormous federal subsidy lardbucket that is rural America. Highways, water systems, power systems, crops, telephones, airports–all federally subsidized. Without federal subsidy, rural America would just about blow away. Many zip codes are emptying out anyway–but now rich second-homers are moving in, but demanding the subsidized services stay in place.
    If anyone doubt this, check out the ultra-conservative Tax Foundation’s website, and track federal spending and revenues by state. The Red States should be renamed “The Red-Ink States.”
    Morgan–should we first dismantle the ossified federal rural lard system, and then tackle monetary policy? Or, can we avoid silly side arguments, and get down to business: What monetary policy actions need to happen now, and over the next year?

  22. Gravatar of david david
    31. August 2010 at 12:39

    I should remind the audience that, judging from his history of comments over the past few months, Warstler is still groping his way toward supply-side logic (of the Wanniski variety, it seems). He disputes any notion of powerful monetary policy, and opposes even stable inflation targeting as devaluing savings.

    “Practical men, who believe themselves to be quite exempt from any intellectual influence, are usually the slaves of some defunct economist.” Indeed.

  23. Gravatar of StatsGuy StatsGuy
    31. August 2010 at 13:33

    DanC:

    “Given how poor fiscal policy has become, and how it has increased uncertainty about the future, I think Scott is expecting too much from monetary policy.”

    No offense, but this has become a wall street marketing slogan. Echoed, now, by Mr. Loeb all over the web-o-sphere. It is quite false, but quite useful.

    Fiscal/tax policy right now is certainly no worse than it was in the 1950s or 1960s. Fiscal expenditure as a % of the economy (if it were on a _nominally_ stable trajectory) would be far lower.

    The problem is demand and money, and a structural ownership over resources that has suddenly and massively advantaged creditors over debtors. Is it any coincidence that the bankruptcy “reform” law passed at the peak of the bubble? That returns on bonds have skyrocketed as net wealth has plummeted?

    The only fiscally structural issues that are much worse than they were 30 to 50 years ago are social security, medicare, and medicaid – transfers, not direct government expenditures. If there is any fiscal cloud, this is it.

  24. Gravatar of William Bruce William Bruce
    31. August 2010 at 13:45

    Morgan,

    You have read far too much into my claims about the reasoning of the middle class. Those claims may indeed *allow* for a contradiction, but they do not contain one. The middle class has reasons for being fickle both extraneous and exogenous to the affairs of which we speak. In that regard, you are welcome to pick your poison: rational ignorance, political “pollution,” public choice, etc. However, I am not one who is so sold on the idea of dismissing civic virtue because of those considerations, hence my careful qualification of “maybe even.”

    Moreover, the ideas held now by the middle class *are* irrelevant to your bent of inquiry if they are so prone to alteration. I would never claim that they were altogether irrelevant, or irrelevant for policy considerations generally. The irrelevance pertains particularly to your question, as stated. That was my answer, and the reason I provided neither “yes” nor “no.”

    In short, what the middle class thinks is a mess, because they are doing a kind of tacit economics in some experientially confused way. For them (and for many of us, honestly), correlation implies causation. That can serve as a bulwark against technocratic folly when causation entails pernicious and perceived correlation, and when the event is remembered. Such was the case with wage and price controls.

    Honestly, I thought that you would at least jump on the far more plausible “contradiction” in my comment, namely, that they *do* remember wage and price controls, associating them with their pernicious effects. But I think it is obvious how that follows from my earlier assertions.

    31. August 2010 at 12:26:
    “I suggest they most assuredly have good reason to be fickle…. PRECISELY BECAUSE what they want is so clear and unchanging, and they are confronted by a steady stream of pols / bankers / elites who refuse to humbly deliver it – for whatever stupid reason they have.”

    We have a failure to communicate here because we have a confusion of reference. It is not merely their preference for party that is fickle, but policy. Their fickleness is pervasive. When confronted with supposedly changing facts, one is supposed to change one’s mind. When correlation implies causation, the “facts” change all of the time.

    “Um, no in fact just the opposite. I want him to respect the Middle American forces of the past 40 years.”

    Professor Sumner, as a professor, is not intellectually obliged to Middle America. Politicians, as practitioners of political economy, are.

    “Finally, I think this NYT article refutes your underlying plea – that somehow Sumner is practicing a science…”

    It is rather ironic that, after I dropped those devilish scare quotes, you came back with such a claim — but this is hardly the proper forum for that prickly and controversial issue. I am always amenable to email correspondence, and there is little need to populate the comments section of a blog with discussions that are vaguely on-topic at best. I, for one, have already indulged that proclivity here.

  25. Gravatar of DanC DanC
    31. August 2010 at 15:06

    to Statsguy

    The tax code has become much more complex and more distorting.

    Next, unfunded mandates and regulations play a much bigger role in the economy.

    These are just a bit of the reason why the simple comparison you make understates the growth of government.

    The path that the country is on under Obama is a large shift to the left. If Democrats were to maintain control we would see destructive energy policies etc. Obama is not pro-growth, he is pro-redistribution: either through taxes or regulation,

  26. Gravatar of Morgan Warstler Morgan Warstler
    31. August 2010 at 15:53

    Agreed, I’ll sens ya email – though I find this dialog revealing.

  27. Gravatar of StatsGuy StatsGuy
    31. August 2010 at 17:36

    DanC:

    The numbers of federal govt. size (# of full time employees vs. population size, dollar expenditures as % of GDP) are very clear, and have downtrended for several decades now.

    On the other side, you argue that “The tax code has become much more complex and more distorting. Next, unfunded mandates and regulations play a much bigger role in the economy.”

    What data backs this up? Are there any objective measures? Do we think that regulations in 2006 were more onerous than regulations in the 70s?? Which specific set of regulations are too onerous? I hear this argument often, presented with little hard evidence. It may or may not be true, but I would like someone to point to (or even describe) the objective measures they rely upon.

    Without that, I find Wall Street’s efforts to blame the failed recovering on federal fiscal intervention rather stretched and self-serving.

    “Coroporations now pay vastly lower taxes than in the 50′s… but it’s obvious that the reason we’re not recovering is because corporate tax rates are too high!”

    Really?

    http://www.cbpp.org/cms/index.cfm?fa=view&id=1311

    “■Although taxes paid by corporations, measured as a share of the economy, rose modestly during the boom years of the 1990s, they remained sharply lower even in the boom years than in previous decades. According to OMB historical data, corporate taxes averaged 2 percent of GDP in the 1990s. That represented only about two-fifths of their share of GDP in the 1950s, half of their share in the 1960s, and three-quarters of their share in the 1970s.
    ■The share that corporate tax revenues comprise of total federal tax revenues also has collapsed, falling from an average of 28 percent of federal revenues in the 1950s and 21 percent in the 1960s to an average of about 10 percent since the 1980s.”

    Also:

    http://www.bradreese.com/images/rbc-enterprise-12.jpg

  28. Gravatar of OGT OGT
    31. August 2010 at 17:44

    Sumner: Interesting e-mail comment from Jim Bullard to Tim Duy in response to his piece this morning:

    http://economistsview.typepad.com/economistsview/2010/08/jim-bullard-president-of-the-st-louis-fed-responds-to-tim-duy-hi-tim-i-read-your-fed-watch-column-th.html

  29. Gravatar of scott sumner scott sumner
    31. August 2010 at 18:27

    Morgan, I’m not sure how I can be so dense. You tell me.

    V is generally uninteresting, but can occasionally be used to make a point.

    William, Friedman worried about long and variable LAGS, not leads.

    Morgan#2; You said;

    “Scott’s coming around. There’s very little he disagrees with me on!”

    But that statement is one of them. :)

    Robert. I also said it is a mistake I often make myself. I was just demonstrating that here. Seriously, you’re right, I should have said reduced the demand for houses.

    Nick, That’s right. BTW, in 1933 the rise in P and Y occurred well before the rise in M.

    OGT, You make some good points, but I’d argue that some of those periods of distress are themselves created by the Fed’s unwillingness to commit to future policy. If they said they’d shoot for 5% NGDP growth, level targeting, in October 2008, the crisis would have been much less severe.

    DanC, You said;

    “Given how poor fiscal policy has become, and how it has increased uncertainty about the future, I think Scott is expecting too much from monetary policy.’

    Not at all, I agree 100% with Mishkin. If the natural rate of unemployment is 6%, monetary policy should not try to push it lower. You misunderstood me if you think I disagree with Mishkin on that point.

    Benjamin, Be patient, it will come soon.

    Steve, That’s right, in 2009 I often argued that tight money is the socialist’s best friend. It makes capitalism look bad. I don’t make that argument as much, because it is now hurting Obama. But it was true in 2008, and partly led to this huge expansion of government.

    Marcus, Good quote, and notice the main difference was monetary policy.

    OGT, Yes, I saw that, and it was interesting.

    Everyone—short responses today because of lack of time. I still plan to do Benjamin’s proposal this week. I will get to the earlier comments in earlier posts tomorrow.

  30. Gravatar of marcus nunes marcus nunes
    31. August 2010 at 18:48

    At least Bullard knows how MP works:
    The quote from Vince Reinhart, who is a great guy, gives the “shock and awe” view of QE. I do not think this is remotely correct. We know how monetary policy works: through the expected future path of policy, not through the actual move on a particular day.
    How about the other 12 (or 17)?

  31. Gravatar of Benjamin Cole Benjamin Cole
    31. August 2010 at 19:31

    I think this is the way to go, provide a road map for the rest of us. A platform a plank, something to propose and defend, and move the discussion into the practical realm. I see upsides, and no downsides. After all, right now the public must have a rather blurry idea of what is QE.

    Suppose we budge the needle even a little. What if other economists and pundits start to say, “Yeah–What would be wrong with buying $40 billion in bonds a month. What could it hurt–does anyone think hyperinflation lurks out there from this action, which could be halted at any time. or even reversed?”

    We need to constantly pound home the point that a subpar recovery and deflation is not a worthy goal, though it could be the result of current policy.

    Also, we must savage the idea that what we are proposing is reckless, liberal, weak, wildly inflationary etc.–indeed we need to somehow drap naysayers in a mantle of feebleness. They are the Neville Chamberlains of monetary policy.

    Okay, maybe Neville Chamberlain doesn’t work, Well, it had a ring.

  32. Gravatar of Morgan Warstler Morgan Warstler
    31. August 2010 at 20:35

    http://thespellmanreport.com/2010/07/15/spellman-interviews-hunt/

    Lacy Hunt of Hoisington is just brutal on you Scott.

    1. his bond fund has had big bets on deflation for some time…. says we’re facing it for 10+ years.
    2. Champions the elder Barro.
    3. Says Fisher over Friedman, big issue on V is that it is still above mean, but can go down, likely will, and thats going to hit us hard. Financial “innovation” = increase in V, less leverage etc. = less V.
    4. Says QE is basically impotent, monetary base doesn’t actually become money.
    5. Fisher over Friedman, problem isn’t money supply growth, it is indebtedness.
    6. Really hammers away on taxes. Make a killer assertion: $1 in cutting deficit + $1 in taxes is still an overall negative, as new tax even outweighs benefits of deficit cuts. He’s saying, no way we raise taxes, we simply have to have aggressive cuts.

    And then…

    “The secret that has completely eluded Bernanke is that aggregate demand is the sum of GDP plus the change in debt. So when debt is rising demand exceeds what it could be on the basis of earned incomes alone, and when debt is falling the opposite happens.

    I’ve been banging the drum on this for years now, but it’s a hard idea to communicate because it’s so alien to the way most economists (and many people) think.

    For a start, it involves a redefinition of aggregate demand. Most economists are conditioned to think of commodity markets and asset markets as two separate spheres, but my definition lumps them together: aggregate demand is the sum of expenditure on goods and services, plus the net amount of money spent buying assets (shares and property) on the secondary markets. This expenditure is financed by the sum of what we earn from productive activities (largely wages and profits) plus the change in our debt levels. So total demand in the economy is the sum of GDP plus the change in debt.”

    http://www.businessspectator.com.au/bs.nsf/Article/Bernankes-blind-spot-pd20100830-8T8HE?OpenDocument&src=sph

    Nice modelling there Scott, you should give is a looksee

    So far I have things I’ll call facts:

    1. All growth comes from productivity gains.
    2. Legitimate lending only comes from capital formation.

    But I’m thinking #3 might be: AD is GDP + change in debt. It feels right.

  33. Gravatar of Doc Merlin Doc Merlin
    31. August 2010 at 23:16

    @Steve:

    “A central bank that plays politics by refusing to pursue its legal mandates because it doesn’t like structural policy is playing a dangerous game. ”

    I don’t think its that at all. I think that fiscal stimulus effects are so much smaller than Keynesians say they are that when the fed adjusts its behavior to take into account the Keynesian stimulus effect, it causes a monetary contraction.

    On the flip side, this also means we have excessive monetary expansion when the government cuts its budget.

  34. Gravatar of DanC DanC
    1. September 2010 at 02:35

    Scott what is the natural rate of unemployment when the economy is facing increasing structural barriers? Is it moving up, down, or stagnant?

    Statsguy

    I really doubt your honesty on this issue. You don’t think tax regulations have become more complex since the 1950′s? You don’t think unfunded mandates have grown? You don’t think the tax code has increasingly been used for social engineering?

    “Regulations come in many different flavors. But it is fair to say that many of them serve as substitutes for taxes in that they change behavior to achieve some government prescribed outcome. If regulations are indeed substitutes for taxes, it is no surprise that the political tendency to avoid the latter leads to more of the former.”

    Also did you adjust your numbers for non-defense expenditures?

  35. Gravatar of StatsGuy StatsGuy
    1. September 2010 at 06:34

    DanC:

    I am being brutally honest – I have no idea. I very often hear assertions of common belief that are entirely off base (e.g. the federal government has grown vs. 40 years ago… taxes have gone up… corporate taxes are crushing corporations – all of which are absolutely refuted by data).

    The new argument is that regulations & tax code complexity have increased in the last 40 years and are burying companies in political uncertainty, detering investment – and THAT’s why we’re not recovering fast. Among ALL OF THE OTHER REASONS, this strikes me as hokey and self serving.

    So, where is the data? I’m not even asking for a causal link (aka, prove it’s the cause of the poor recovery). I’m just asking for a modicum of evidence that regulations have gotten worse.

    Do I disagree? I didn’t even say that. I have no idea, but I’m skeptical of any assertion without some data, particularly when it’s presented as a fact that must be accepted at face value.

    So where’s the data? I don’t even need a link, just a description of the dataset.

    What I do know is that Stigler wrote his seminal antiregulation article ~40 years ago, and that many industries are substantially less regulated than 40 years ago (trucking, telecom). I know the tax code has become a creature of subsidies and penalties (as you say). But has it really gotten worse than 40 years ago? Don’t know.

    The majority of Americans still believe that taxes for upper income americans were lower in the 1950s, that federal govt. was smaller in the 1950s… And corporations always seem to believe they’re paying more than their fair share of taxes.

  36. Gravatar of Morgan Warstler Morgan Warstler
    1. September 2010 at 08:11

    @Statsguy,

    dude watch Lacy Hunt interview – he references a bunch of work showing the fiscal adds close to zero to gdp. look at his data.

    His take is also clear: indebtness is the sole issue, we actually have to pay down debt, and it has to happen without raising taxes.

    Look at his data. He’s pretty wonky.

    At a personal level, all I can tell you is this: it isn’t just the regulations, its the the inflated hard assets banks are holding onto.

    In both commercial and residential, smart money SMELLS deals right around corner. The expectation is that there is going to be a deep deep valley in real estate prices, and everyone wants to wait until that moment happens.

    Its frankly kind of disturbing that so many people clamoring for more GDP (more velocity), for more growth, don’t see some value in suddenly having 6M+ houses and who knows how much commercial stuff CHANGE HANDS.

    Sure we’ll lose 800+ banks, but who cares? We all know they are dead anyway. The hard assets remain.

    And suddenly for the remaining banks, they have 6M+ loans coming in on super deals – assets deeply under-priced, 40% down.

    Raise rates, do business. Why does anyone believe this is bad? The Fed HAS TO HATE IT – they work for the banks. But why do neo-liberal economists hate it?

  37. Gravatar of scott sumner scott sumner
    1. September 2010 at 11:46

    Marcus, Yes, that Bullard quote impressed me too.

    Benjamin, Those are good ideas–I’m working on it. Lots of computer problems today–so things are slow.

    Morgan.

    1. I am also bearish on the price level.
    2. I also like the elder Barro,
    3. I also like Fisher. My proposal is completely Fisherian.
    4. I also think QE is relatively ineffective due to IOR
    5. I also favor tax cuts

    Funny, I don’t feel savaged yet.

    DanC, It’s probably gone up a bit, but it is almost impossible to measure, which is why I oppose targeting unemployment.

  38. Gravatar of DanC DanC
    1. September 2010 at 12:47

    I am bad at dancing, but my point is not that I disagree with Scott’s path, I just doubt it will work as well as he thinks it will.

    I think the natural rate of unemployment has gone up because of bad fiscal policy. I worry that the fiscal policy is so bad that the steps that Scott wants to take may just lead to stagflation. Higher price levels without a big bump in employment.

    to stats guy

    I could not quickly find a study. However we have the creation of ObamaCare that increases government control of health care, we had the Federal government take over a car company, we hear of a desire to control energy policy from Washington, we had the student loan business taken over, we have an aggressive and growing EPA, we have a Supreme Court that is, I think, giving government great powers under administrative law, etc

    Did we see some movement away from government regulation. Sure the government broke up some of the monopoles that they helped create.

    But read the writings of some of the behavioral economist that advice Obama. They don’t want to shrink the redistributive role of government, they just want the methods to be less obvious – harder to measure. On the plus size they claim you have less dead weight loss from people reacting to incentives, on the plus plus side for Obama some will even claim it isn’t even happening.

  39. Gravatar of marcus nunes marcus nunes
    1. September 2010 at 13:39

    C Romer still doesn´t “get it”:
    “Romer will answer her critics. She will say the financial shocks the U.S. faced were so rare “there were no reliable estimates of the likely impact. To this day, economists don’t fully understand why firms cut production as much as they did, and why they cut labor so much more than they normally would, given the decline in output.”

    Romer will say while real gross domestic product is growing, it isn’t doing so fast enough create the hundreds of thousands of jobs each month needed to return employment to its pre-crisis level”.
    Full Link:http://blogs.wsj.com/economics/2010/09/01/romer-calls-for-more-stimulus-in-final-speech/

  40. Gravatar of Morgan Warstler Morgan Warstler
    1. September 2010 at 15:33

    “Funny, I don’t feel savaged yet.”

    Not even a little tickle? Not even some kind of phantom molestation?

    Dude, Lacy says Fisher disagrees with Friedman that there’s no spending our way out, there’s no inflating our way out – that what it is going to take is spending less, paying down debts while sitting for a LONG period at dis-inflation.

    See to me, I hear “we must spend less” – and I get excited, that means we take all the entrepreneurs and when send them out to the front lines, and they get to topple more sacred cows than they normally can. Regulatory capture is out. Public Employees are gutted. Whole new more productive systems are required.

    It sounds GLORIOUS. Because I’m willing to go all in, that we are now a better people, we are far less likely to roll over and trust our government to solve our problems.

    Either way, it sure doesn’t sound like Fisher thought we should print money. And it doesn’t sound like Lacy thinks it. And he’s betting big that we’re going to be in this place for quite some time, so we better get busy.

  41. Gravatar of StatsGuy StatsGuy
    1. September 2010 at 16:55

    Morgan:

    “dude watch Lacy Hunt interview – he references a bunch of work showing the fiscal adds close to zero to gdp. look at his data.”

    Please, how is that relevant to the question of whether governmental regulation is more burdensome now than it was in the 1960s or 1970s?? If I’m not mistaken, he’s making an anti-keynesian argument.

    The Keynesian argument is one about demand (AD) management via fiscal policy and fiscal multiplier. The “overburdensome regulation” argument is one about regulation restricting supply and suppressing investment.

    I’m well aware of the libertarian/conservative leanings of this blog, but if you accept every self-serving pro-business argument made by hedge fund managers without any due diligence, then this place becomes an echo chamber.

    There are deep questions about how much of the malaise is structural, and how much is AD – or even WHAT is structural or demand (is debt load a structural problem, or a demand problem)? But to Scott’s point (made many times), we don’t even know how much is structural until we fix the demand problem – but we KNOW there is a demand problem of some sort.

    Moreover, the demand problem is rapidly transforming into a structural problem as unemployed workers lose skills, bad debts accumulate, and the fiscal deficit explodes (70-80% due to NOMINAL tax revenue losses, stimulus, and automatic stabilizers).

  42. Gravatar of Morgan Warstler Morgan Warstler
    1. September 2010 at 17:25

    Moreover, the demand problem is rapidly transforming into a structural problem as

    1. unemployed workers lose skills,

    (the jobs they had, are gone for good, it is structural -which is why we need a unemployment policy tied directly to retraining as I have outlined)

    2.bad debts accumulate,

    (this is not true, we are paying down debt – see the point we should be counting GDP + debt paid, we are liquidating debt holders – we should be doing it faster)

    3. and the fiscal deficit explodes (70-80% due to NOMINAL tax revenue losses, stimulus, and automatic stabilizers).

    (which is WHY my demand for 25% gains in public employee productivity saving $400B+ per year must happen, BTW, apart from stimulus – it that $400B that had caused our debt to explode. it is IRRESPONSIBLE to analyze our debt situation as taxes vs. services – the issue is to date is almost entirely government productivity. If you want to REALLY dig into stats guy – let’s do it).

  43. Gravatar of Are You Smarter Than A Professional Forecaster? : Invest My Money Are You Smarter Than A Professional Forecaster? : Invest My Money
    1. September 2010 at 23:25

    [...] that the Fed is allowing expectations of future aggregate demand (AD)  to fall.  Since future spending affects current spending, current Fed policy is also effectively slowing down current AD.  Given this running [...]

  44. Gravatar of scott sumner scott sumner
    2. September 2010 at 10:28

    DanC, You said;

    “I think the natural rate of unemployment has gone up because of bad fiscal policy.”

    I agree, but the best way to fix that is with monetary stimulus. In the textbooks monetary stimulus can’t lower the natural rate on unemployment, but in the real world it can.

    The biggest factor raising the natural rate in UI extensions to 99 weeks, and higher minimum wages are second.

    Monetary stimulus will lead Congress to remove the 99 week extension more quickly that if we have a very slow recovery. And it will slightly reduce the real minimum wage.
    Both factors will reduce the natural rate of unemployment.

    marcus, And the bizarre thing is that the same thing happened in 1929-30, and 1937-38, periods she studied intensively.

    Morgan, I assumed you meant Irving Fisher. Is that right? he favored inflation as the way out of the Depression.

    You said;

    “Moreover, the demand problem is rapidly transforming into a structural problem as

    1. unemployed workers lose skills,”

    Which is why we need more demand.

    “2.bad debts accumulate,”

    which is why we need more demand

    “3. and the fiscal deficit explodes (70-80% due to NOMINAL tax revenue losses, stimulus, and automatic stabilizers).”

    which is why we need more demand

    Did I remember to tell you we need more demand?

  45. Gravatar of Morgan Warstler Morgan Warstler
    2. September 2010 at 15:30

    Scott, let’s say there’s no more demand coming. Fiat it. Build it into your assumptions…

    Now, IF thats the case – THEN you do choose to rip of the band-aid, liquidate the insolvent banks, sell off their assets IMMEDIATELY right?

    On Lacy Hunt (watch the video please):

    25:45 – we have to cut spending and cut taxes.

    33:28 – Fisher says this is gonna last.

    35:25 – Fisher says the cause of Depression was NOT insufficient monetary growth (it was just a symptom) the cause was over-indebtedness.

  46. Gravatar of Morgan Warstler Morgan Warstler
    2. September 2010 at 15:38

    39:55 – Fisher says Fed cannot inflate way out of this BECAUSE Velocity is going to keep going down. In debt deflation, Velocity goes down.

  47. Gravatar of scott sumner scott sumner
    3. September 2010 at 06:17

    Morgan, I’ve always favored ending bank bailouts. If V goes down, raise M eve faster. BTW, V is falling precisely because of the tight money policies.

    Which Fisher?

  48. Gravatar of azmyth azmyth
    3. September 2010 at 11:10

    To me, this is one of your most convincing arguments. When I took monetary theory (grad level) I was continually struck with the difficulty of the identification problem. Authors would use FedFunds or M2, but they never really seems to get the kind of VAR responses I thought they would. It was hard for me to even find a relationship between monetary aggregates and the price level.

    Secondly, what do you think of the argument that sticky debt prices are as important as sticky wages to the business cycle? Many contracts are not indexed to the price level, not just wages.

  49. Gravatar of ssumner ssumner
    4. September 2010 at 05:28

    azmyth, I once wrote a paper on the topic of sticky debt prices (with Ross Newman and David Gulley) and we found that it did contribute to the liquidity effect–indeed created a longer term liquidity effect.

    But I still don’t think it has much effect on the business cycle, as it is a zero sum game, and changes in real debt values don’t affect the marginal cost of output, in the way that changes in the real wage rate do affect the real MC of output. Still, I’ll keep an open mind on the issue, there may be some effect. Of course it is difficult to disentangle. Maybe there’s a country that indexes debt but not wages.

  50. Gravatar of Bernanke invites Scott Sumner for lunch « The Market Monetarist Bernanke invites Scott Sumner for lunch « The Market Monetarist
    31. October 2011 at 13:08

    [...] illustrates a point that Scott himself has made over and over again: Monetary policy works with long and variable leads. If Bernanke indeed had invited Scott for lunch and it was made public then it is pretty certain [...]

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