The lonely ones
I think we all form mental maps of our profession. In my field (monetary economics) I saw the new classical/RBC groups as being on the right, and the old Keynesians (or Post Keynesians) as being on the left. Both believed in “monetary ineffectiveness,” at least to some extent, but the right thought of the ineffectiveness in real terms and the left thought in nominal terms. In this mental map the new Keynesians were in the middle, and thoroughly dominated the upper echelon of the profession.
I tended to read quite a bit of stuff by Bernanke, Krugman, Svensson, and Woodford, who I believe were all at Princeton sometime around the early 2000s. To me, these economists seemed to be both at the ideological center of macro, and also at the cutting edge of research. And when Bernanke was picked to run the Fed, it pretty much confirmed my image of new Keynesianism being the standard model of macroeconomics.
I now believe my mental map of the profession was completely false. At least three of these guys are way out on the fringes, despite appearing to be in the center. Perhaps the real split is between theoreticians and pragmatists. Between those who take a common-sense approach, and those who understand the deeply counter-intuitive nature of monetary economics. A few brief comments on each:
1. Michael Woodford wrote what is generally regarded as the bible of new Keynesianism. So I always sort of assumed that he was a towering figure in the profession. But how often do you see his ideas discussed in the elite press? (I.e., the WSJ, NYT, FT, The Economist, etc.) He argues that when rates hit zero you shouldn’t be doing inflation targeting, you need price level targeting. Do you see those ideas being discussed? I don’t.
2. Lars Svensson is a member of the Swedish Riksbank. With no disrespect to the other 5 board members, I’d have to assume that his academic reputation towers over the others. Yet look how little influence he has:
Sept. 17 (Bloomberg) — The Swedish Riksbank’s most outspoken board member on the risks of deflation said central banks shouldn’t raise rates to curb asset-price growth when inflation is low — a path his own bank is pursuing.
“The policy rate is an ineffective instrument for influencing financial stability,” Riksbank Deputy Governor Lars E. O. Svensson said in a speech delivered in Tokyo and published on the bank’s website yesterday. “The use of the policy rate to prevent an unsustainable boom in house prices and credit growth poses major problems for the timely identification of such an unsustainable development.”
Sweden’s central bank on Sept. 2 raised its benchmark repo rate a second time in as many months in part, it said, to cool the housing market. Inflation, which has lagged behind the bank’s 2 percent target since December 2008, slipped 0.2 point to 0.9 percent last month. Policy makers in Sweden, which emerged from an eight-month bout of deflation at the end of last year, may be underestimating the risk that price declines can return, some economists say.
“The Riksbank’s Monetary Policy Committee, except for Svensson, is not taking deflation seriously,” said Par Magnusson, chief Nordic economist at Royal Bank of Scotland Group Plc’s Stockholm office. “But they should. Deflation is a far greater threat than inflation.”
According to New York University Professor Nouriel Roubini, deflation is becoming a broader threat, with the U.S. also at risk of experiencing price declines as it faces the prospect of a sluggish recovery. Magnusson says deflation is tougher to tackle for central banks than inflation, especially when rates are already low.
‘So Much Worse’
“The effects of deflation are so much worse than the effects of slightly too high inflation,” he said. The Riksbank “really should rather be safe than sorry in their policy and not hike until they are dead sure” there’s no deflation threat.
Svensson was the only Deputy Governor of the Riksbank’s six board members to vote against the Sept. 2 quarter-point rate increase. “The market is right and the Riksbank is wrong about the level of the repo-rate path,” Svensson said, according to the minutes of this month’s meeting, published Sept. 15.
The Riksbank has signaled it will raise the main rate by another 0.5 percentage point over its next two meetings in October and December, bringing it to 1.25 percent by the end of the year.
“The market is right and the Riksbank is wrong.” Replace ‘Riksbank’ with ‘Fed’ and you have described our own policy failures.
3. Paul Krugman is easily the most influential economic blogger in the world. The favorite columnist of many Democratic readers. And recall that well over 50% of the Washington DC and NYC intellectual establishments are Democrats. Three fourths of academic economists vote Democratic. So his ideas on the need for more monetary stimulus must be really popular, right? Then why does he consider himself (with Robin Wells) a voice crying in the wilderness?
In the winter of 2008-2009, the world economy was on the brink. Stock markets plunged, credit markets froze, and banks failed in a mass contagion that spread from the US to Europe and threatened to engulf the rest of the world. During the darkest days of crisis, the United States was losing 700,000 jobs a month, and world trade was shrinking faster than it did during the first year of the Great Depression.
By the summer of 2009, however, as the world economy stabilized, it became clear that there would not be a full replay of the Great Depression. Since around June 2009 many indicators have been pointing up: GDP has been rising in all major economies, world industrial production has been rising, and US corporate profits have recovered to pre-crisis levels.
Yet unemployment has hardly fallen in either the United States or Europe””which means that the plight of the unemployed, especially in America with its minimal safety net, has grown steadily worse as benefits run out and savings are exhausted. And little relief is in sight: unemployment is still rising in the hardest-hit European economies, US economic growth is clearly slowing, and many economic forecasters expect America’s unemployment rate to remain high or even to rise over the course of the next year.
Given this bleak prospect, shouldn’t we expect urgency on the part of policymakers and economists, a scramble to put forward plans for promoting growth and restoring jobs? Apparently not: a casual survey of recent books and articles shows nothing of the kind. Books on the Great Recession are still pouring off the presses””but for the most part they are backward-looking, asking how we got into this mess rather than telling us how to get out. To be fair, many recent books do offer prescriptions about how to avoid the next bubble; but they don’t offer much guidance on the most pressing problem at hand, which is how to deal with the continuing consequences of the last one.
Nor can this odd neglect be entirely explained by the mechanics of the book trade. It’s true that economics books appearing now for the most part went to press before the disappointing nature of our so-called recovery was fully apparent. Even a survey of recent articles, however, shows a notable unwillingness on the part of the dismal science to offer solutions to the problem of persistently high unemployment and a sluggish economy. There has been a furious debate about the effectiveness of the monetary and fiscal measures undertaken at the depths of the crisis; there have also been loud declarations about what we must not do””warnings about the alleged danger of budget deficits or expansionary monetary policy are legion. But proposals for positive action to dig us out of the hole we’re in are few and far between.
4. If Krugman sometimes seems a figure of almost Shakespearian complexity, then Bernanke seems enmeshed in Hamlet’s predicament. (Someone with more skill than me should rewrite the famous soliloquy as “To ease or not to ease . . .” I’ll spare you from my lack of literary talent.)
There are two ways to visualize Bernanke’s current position. Perhaps he still does represent the ideological center of American macroeconomics. In other words, maybe that center has shifted far to the right since the days when Bernanke was criticizing the Japanese for showing a lack of boldness, a lack of what he called “Rooseveltian resolve.” Or perhaps he finds himself surrounded by lots of people who fail to understand the need for stimulus, and lots of other people who do realize that we need more AD, but fail to understand the effectiveness of unconventional policy tools. I suppose we’ll find out when we read his memoirs. I’m guessing they will provide yet another example of the famous maxim; “It’s lonely at the top.”
Tags: New Keynesianism
18. September 2010 at 08:22
To ease or not to ease- that is the question:
Whether ’tis nobler in the Fed to suffer
The slings and arrows of outrageous inflation-phobia,
Or to take unconventional policy action
And, by doing so, inflate. To QE, end IOR
No more – and by changing expectations
To provide the economy a positive shock
That good NGDP gives – ’tis a policy
Popularly unknown. To QE, to target
Price levels, perchance to succeed. Ay, there’s the rub,
For in that price level targeting what criticism may come,
When we have shuffled off current monetary policy,
Gives me much pause. (Too much pause, if you ask me, Mr. Bernanke)
(With apologies to William Shakespeare. And anyone who might have read that.)
I’m not sure if any economist is influential at the moment. In fact, one could argue that economists have only been influential when their theories can provide good justification for politician’s pre-existing objectives: politicians paid homage to the Keynesianism of old when it meant fiscal stimulus and ignored Keynesianism when it meant deficit reduction or surpluses; Thatcher listened to the monetarists when monetarism meant cutting inflation and abandoned it when it menat tightening ahead of the 1987 UK general election; Rubinomics was popular in some Democratic circles in the 1990s, but is dead and buried now etc.
It may be that Obama has calculated (wrongly, I think) that monetary stimulus is not in his best political interests, so putting pressure on the Fed is not a priority. Quite why he thinks so, I don’t know, but it’s a definite possibility.
Contrariwise, the UK government has chosen a “private sector led” recovery plan, with fiscal tightening. This requires available credit, which is why the Bank of England has been allowed to effectively abandon its 2% CPI target (CPI is running at 3.1% here, without any concern from the BoE) and has made noises about being prepared for further QE in the event of a double-dip.
They’re not executing the strategy perfectly, e.g. they’re pressuring banks to recapitalise and lend at the same time, which seems absurd. Still, I would happily swap the BoE for the Fed: not because I want the Fed, but because the USA is the number 1 economy and the whole world needs it to have a decent central bank.
18. September 2010 at 08:35
W. Peden, How about:
To ease or not to ease;
Whether tis nobler to suffer
The slings and arrows of declining fortunes . . .
Oh well, now you see why I left it to others.
I’m no poet, and I know it.
I think you give Obama too much credit, I doubt he knows what monetary stimulus could have accomplished.
18. September 2010 at 09:00
Professor Sumner,
Perhaps I am overestimating Obama. That said, if the problem is his ignorance, then that’s not such a problem. It is easier to sell a new product to someone than a product they have already rejected and disparaged, even if the product would be equally beneficial in both cases.
I can only imagine how frustrating this is on the other side of the pond. I get frustrated by American politics, even though it only makes the news here on a slightly regular basis.
18. September 2010 at 11:32
Obama doesn’t even understand the economics of auto insurance.
But, don’t miss Rajan’s evisceration of Krugman (after dismissing the little woman);
http://blogs.chicagobooth.edu/n/blogs/blog.aspx?nav=main&webtag=faultlines&entry=24
‘I will say “Krugman” and “he” instead of “Krugman and Wells” and “they”’
18. September 2010 at 11:44
Another ace post by Scott Sumner.
Core inflation is under one percent, has been sinking steadily, and there is reason to think (Boskin Commission) that the CPI overstates inflation by 0.5 percent or more. We could be at deflation now.
But there are members of the Fed who still pettifog about inflation. It has become politicized, and it is an easy way to sound virtuous, far-sighted, and not the sort who weakly caves in to immediate needs.
Does anyone have an idea of how much QE would be needed to trigger inflation, or double-digit inflation? Would it not be straightforward to curb inflation, once it was re-ignited, if it should become too high?
So, is the Japan Wing just afraid of monetary ghosts at this point?
18. September 2010 at 15:02
Patrick R Sullivan: Rajan in wrong on housing. The reason Germany escaped a housing boom was due to the lack of regulatory barriers to housing supply, as I discuss here and here. Easy credit may encourage investment, but which assets are invested in (and to what effect) is determined by more specific factors. Krugman is correct to draw attention to the Zoned Zone and Flatland differences.
18. September 2010 at 15:26
Scott,
You wrote:
“I think we all form mental maps of our profession. In my field (monetary economics) I saw the new classical/RBC groups as being on the right, and the old Keynesians (or Post Keynesians) as being on the left. Both believed in “monetary ineffectiveness,” at least to some extent, but the right thought of the ineffectiveness in real terms and the left thought in nominal terms. In this mental map the new Keynesians were in the middle, and thoroughly dominated the upper echelon of the profession.”
My mental map was formed by what I was force fed in graduate school and by my own congenital prejudices. We were taught that the great division was between the “Neo-Keynesians” and the “Neo-Classicists”. This division was defined by beliefs concerning the degree of price stickiness. Thus Neo-Keynesians believed that policy actions had relatively greater real effects and Neo-Classicists believed they had relatively greater nominal effects.
But it was always implicit that the policy tool was monetary policy. Fiscal policy was taught, but only as an artifact, useless in a flexible exchange environment. In short Neo-Keynesians were implicitly Monetarists. The liquidity trap was discussed but only as a hypothetical case, unlikely to ever come to fruition, at least in the case of the US and Europe.
My what a difference a Great Recession makes.
Now a division has been exposed, not within the “Neo-Classicist” camp but within the “Neo-Keynesian” camp. This division is defined by beliefs concerning the monetary transmission mechanism. Those who believe in the credit/interest rate channel tend to believe that monetary policy has now become impotent and that fiscal policy is the cure. But in my opinion the cutting edge work is being done by those who are exploring alternative monetary policy and monetary policy instruments (such as yourself), especially in the context of the liquidity trap.
I have to admit that I was initially among those that believed that monetary policy was ineffective in the liquidity trap. But a little history (e.g. the Great Depression) and some empiricism (e.g. Japan) cured me of those beliefs. Consequently my views have become much more Sumnerian.
In short my mental map of our profession has become a triangle, with “RBC/Neo-Classicists” at one corner and “Keynesians” and “Monetarists” at the other two corners. Given this map, count me as a Monetarist.
18. September 2010 at 15:35
W. Peden,
I thought briefly about rewriting the soliloquy. However, I could not have done a better job. Bravo!
18. September 2010 at 17:46
Lorenzo, I don’t disagree with your ideas about the role restrictive land use policies played–Tpm Spwell also featured that aspect in his recent book–but. Rajan is responding to the specifics of the Krugmans’ piece in the NYRB, and that isn’t at issue there.
Rajan could have done even more. For instance, ‘they’ claim that the CRA didn’t apply to non-bank lenders like Countrywide Mortgage. That’s, at the very best, disingenuous.
In the early Clinton Admin, HUD went to the Mortgage Bankers Assn., whose then President was Angelo Mozilo, and told them they had two choices; sign onto the HUD’s ‘Best Practices Iniative’, or, they would go to congress and have them pass legislation extending the CRA to their members. It was the classic, ‘testicles…hearts…minds…follow’ gambit.
18. September 2010 at 21:00
W. Peden:
With apologies to William Shakespeare. And anyone who might have read that.
No need for the show of modesty. It was a great job.
The penultimate line could use a little work. How about ‘When we have shuffled off this o’ertight money’?
18. September 2010 at 21:15
W. Peden:
In fact, one could argue that economists have only been influential when their theories can provide good justification for politician’s pre-existing objectives . . . Thatcher listened to the monetarists when monetarism meant cutting inflation and abandoned it when it meant tightening ahead of the 1987 UK general election . . .
I confess my total ignorance of the British case, but I read somewhere that Hayek was Reagan’s favorite economist. Without such an influence I doubt Reagan would have had the confidence to ‘stay the course’, with the expectation that restraining inflation would eventually bring down unemployment.
18. September 2010 at 23:01
In the early Clinton Admin, HUD went to the Mortgage Bankers Assn. . . . and told them they had two choices . . .
Wow. This is a hugely important piece of the puzzle. I haven’t seen it mentioned before, and I’ve been reading lots about the crisis.
Do you have a source?
Krugman (and other liberals) are disingenuous about the CRA in another way. They emphasize the length of time between its passage and the beginning of the bubble. But the CRA isn’t a clear and rigid rule or set of rules. It’s a big grant of discretionary authority to regulators. It’s to be expected that the impact of the CRA would be a function of how the regulators applied it.
19. September 2010 at 03:25
David Tomlin,
Interesting. While I’m aware that Hayek was supposed to have had some broad influence on Ronald Reagan, I’d not really considered whether he might have had a policy influence.
19. September 2010 at 07:00
W. Peden, Later today I am going to do a post that is highly critical of the American left’s ignorance of monetary policy.
Patrick, Yeah, That was pretty devastating. It’s clear that Krugman doesn’t know much about the GSEs and just shoots from the hip. I’m no expert either, but I generally try to avoid claiming more knowledge than I actually have.
Benjamin, The reason you can’t put a specific number on the QE needed is that it depends what else the Fed does at the same time. If they don’t set a higher inflation target, then they need much more QE than if they do. It also depends on whether they suggest it is temporary.
Lorenzo, Good point, but on the broader regulatory issues he is much more right than Krugman.
Mark, Yes, I was actually thinking along the same lines, but ended up leaving out the monetarists. But that’s a good way of thinking about it.
Patrick, Yes, Bill Clinton knew how to be “persuasive.”
19. September 2010 at 10:01
‘Wow. This is a hugely important piece of the puzzle. I haven’t seen it mentioned before, and I’ve been reading lots about the crisis.
‘Do you have a source?’
Former Fannie executive Edward Pinto:
http://www.aei.org/docLib/Pinto-Government-Housing-Policies-Crisis.pdf
for instance:
“A group of lenders not subject to CRA–and more directly under HUD’s purview–are the
nation’s mortgage banks. In mid-September [1994], the Mortgage Bankers Association of
America-whose membership includes many bank-owned mortgage companies, signed a
three-year master best-practices agreement with HUD. The agreement consisted of two
parts: MBA’s agreement to work on fair-lending issues in consultation with HUD and a
model best-practices agreement that individual mortgage banks could use to devise their
own agreements with HUD. The first such agreement, signed by Countrywide Funding
Corp., the nation’s largest mortgage bank, is summarized on this page. Many have seen
the MBA agreement as a preemptive strike against congressional murmurings that
mortgage banks should be pulled under the umbrella of the CRA.”
Pinto footnotes to:
http://www.questia.com/googleScholar.qst?docId=5001707340
The Pinto paper is a 181 page pdf that badly needs an editor. You could eliminate 2/3 of what’s in it and still get the complete story, but it is chronological.
19. September 2010 at 10:50
Thanks Patrick, I’ll probably do a post on that tomorrow.
19. September 2010 at 15:42
@ Patrick R. Sullivan
Thanks.