Living in a country with Hayek’s stable NGDP monetary rule

A recent post by Bill Woolsey showed that Japan’s NGDP has been amazingly stable since the early 1990s (with just a dip in late 2008.)  This article in the NYT describes what happened after Japan adopted a stable NGDP monetary policy:

OSAKA, Japan — Like many members of Japan’s middle class, Masato Y. enjoyed a level of affluence two decades ago that was the envy of the world. Masato, a small-business owner, bought a $500,000 condominium, vacationed in Hawaii and drove a late-model Mercedes.

But his living standards slowly crumbled along with Japan’s overall economy. First, he was forced to reduce trips abroad and then eliminate them. Then he traded the Mercedes for a cheaper domestic model. Last year, he sold his condo — for a third of what he paid for it, and for less than what he still owed on the mortgage he took out 17 years ago.

“Japan used to be so flashy and upbeat, but now everyone must live in a dark and subdued way,” said Masato, 49, who asked that his full name not be used because he still cannot repay the $110,000 that he owes on the mortgage.

Few nations in recent history have seen such a striking reversal of economic fortune as Japan.

.   .   .

The downsizing of Japan’s ambitions can be seen on the streets of Tokyo, where concrete “microhouses” have become popular among younger Japanese who cannot afford even the famously cramped housing of their parents, or lack the job security to take out a traditional multidecade loan.

These matchbox-size homes stand on plots of land barely large enough to park a sport utility vehicle, yet have three stories of closet-size bedrooms, suitcase-size closets and a tiny kitchen that properly belongs on a submarine.

“This is how to own a house even when you are uneasy about the future,” said Kimiyo Kondo, general manager at Zaus, a Tokyo-based company that builds microhouses.

.   .   .

The decline has been painful for the Japanese, with companies and individuals like Masatohaving lost the equivalent of trillions of dollars in the stock market, which is now just a quarter of its value in 1989, and in real estate, where the average price of a home is the same as it was in 1983. And the future looks even bleaker, as Japan faces the world’s largest government debt — around 200 percent of gross domestic product — a shrinking population and rising rates of poverty and suicide.

But perhaps the most noticeable impact here has been Japan’s crisis of confidence. Just two decades ago, this was a vibrant nation filled with energy and ambition, proud to the point of arrogance and eager to create a new economic order in Asia based on the yen. Today, those high-flying ambitions have been shelved, replaced by weariness and fear of the future, and an almost stifling air of resignation. Japan seems to have pulled into a shell, content to accept its slow fade from the global stage.

.   .   .

The classic explanation of the evils of deflation is that it makes individuals and businesses less willing to use money, because the rational way to act when prices are falling is to hold onto cash, which gains in value. But in Japan, nearly a generation of deflation has had a much deeper effect, subconsciously coloring how the Japanese view the world. It has bred a deep pessimism about the future and a fear of taking risks that make people instinctively reluctant to spend or invest, driving down demand — and prices — even further.

.   .   . 

A Deflated City

While the effects are felt across Japan’s economy, they are more apparent in regions like Osaka, the third-largest city, than in relatively prosperous Tokyo. In this proudly commercial city, merchants have gone to extremes to coax shell-shocked shoppers into spending again. But this often takes the shape of price wars that end up only feeding Japan’s deflationary spiral.

There are vending machines that sell canned drinks for 10 yen, or 12 cents; restaurants with 50-yen beer; apartments with the first month’s rent of just 100 yen, about $1.22. Even marriage ceremonies are on sale, with discount wedding halls offering weddings for $600 — less than a tenth of what ceremonies typically cost here just a decade ago.

.   .   .

“It’s like Japanese have even lost the desire to look good,” said Akiko Oka, 63, who works part time in a small apparel shop, a job she has held since her own clothing store went bankrupt in 2002.

This loss of vigor is sometimes felt in unusual places. Kitashinchi is Osaka’s premier entertainment district, a three-centuries-old playground where the night is filled with neon signs and hostesses in tight dresses, where just taking a seat at a top club can cost $500.

But in the past 15 years, the number of fashionable clubs and lounges has shrunk to 480 from 1,200, replaced by discount bars and chain restaurants. Bartenders say the clientele these days is too cost-conscious to show the studied disregard for money that was long considered the height of refinement.

“A special culture might be vanishing,” said Takao Oda, who mixes perfectly crafted cocktails behind the glittering gold countertop at his Bar Oda.

After years of complacency, Japan appears to be waking up to its problems, as seen last year when disgruntled voters ended the virtual postwar monopoly on power of the Liberal Democratic Party. However, for many Japanese, it may be too late. Japan has already created an entire generation of young people who say they have given up on believing that they can ever enjoy the job stability or rising living standards that were once considered a birthright here.

Yukari Higaki, 24, said the only economic conditions she had ever known were ones in which prices and salaries seemed to be in permanent decline. She saves as much money as she can by buying her clothes at discount stores, making her own lunches and forgoing travel abroad. She said that while her generation still lived comfortably, she and her peers were always in a defensive crouch, ready for the worst.

“We are the survival generation,” said Ms. Higaki, who works part time at a furniture store.

Hisakazu Matsuda, president of Japan Consumer Marketing Research Institute, who has written several books on Japanese consumers, has a different name for Japanese in their 20s; he calls them the consumption-haters. He estimates that by the time this generation hits their 60s, their habits of frugality will have cost the Japanese economy $420 billion in lost consumption.

“There is no other generation like this in the world,” Mr. Matsuda said. “These guys think it’s stupid to spend.”

Deflation has also affected businesspeople by forcing them to invent new ways to survive in an economy where prices and profits only go down, not up.

Yoshinori Kaiami was a real estate agent in Osaka, where, like the rest of Japan, land prices have been falling for most of the past 19 years. Mr. Kaiami said business was tough. There were few buyers in a market that was virtually guaranteed to produce losses, and few sellers, because most homeowners were saddled with loans that were worth more than their homes.

Some years ago, he came up with an idea to break the gridlock. He created a company that guides homeowners through an elaborate legal subterfuge in which they erase the original loan by declaring personal bankruptcy, but continue to live in their home by “selling” it to a relative, who takes out a smaller loan to pay its greatly reduced price.

“If we only had inflation again, this sort of business would not be necessary,” said Mr. Kaiami, referring to the rising prices that are the opposite of deflation. “I feel like I’ve been waiting for 20 years for inflation to come back.”

One of his customers was Masato, the small-business owner, who sold his four-bedroom condo to a relative for about $185,000, 15 years after buying it for a bit more than $500,000. He said he was still deliberating about whether to expunge the $110,000 he still owed his bank by declaring personal bankruptcy.

Economists said one reason deflation became self-perpetuating was that it pushed companies and people like Masato to survive by cutting costs and selling what they already owned, instead of buying new goods or investing.

“Deflation destroys the risk-taking that capitalist economies need in order to grow,” said Shumpei Takemori, an economist at Keio University in Tokyo. “Creative destruction is replaced with what is just destructive destruction.”

Before commenters like Greg jump all over me, re-read the intro.  I never claimed the adoption of the 0% NGDP growth policy had anything to do with the dreary story described by the NYT.  And I’m not sure it does.  There’s nothing wrong with touting a country as a smashing success in one area, even if you disagree with its policies elsewhere.  I’m always praising Singapore’s fiscal policy, yet I detest many policies of the Singapore government.  It could well be that the bad performance of Japan’s economy was caused by supply-side factors unrelated to monetary policy.  Some bloggers even claim the Japanese haven’t done all that bad.

And yet . . . let’s be honest.  This is a big problem for the 0% NGDP growth fans.  Japan’s slide into stagnation co-incided almost exactly with the (de facto) adoption of a stable NGDP rule.  And it’s the only country I know that has adopted this policy.  And before the policy was adopted most mainstream economists thought deflation was a really bad idea.  Put that all together and I think “zero percenters” have got a massive PR problem.

Yes, the US grew rapidly in the late 1800s under deflation, but we had strong NGDP growth.  Japan doesn’t.  Are there any examples of countries doing well with stable NGDP?  I don’t know of any.  Unless someone can find plausible counterexamples, that makes Hayek’s argument a really hard sell.

Why is this important?  Because Hayek’s argument underlies the Austrian view that monetary policy was too “inflationary” during the 1920s, despite no rise in the price level.  He argued NGDP should have been kept stable, so prices could fall with productivity gains.  This argument also underlies some of the critique of Fed policy in the 2000s, as price inflation wasn’t all that high.  In fairness, some point to the rapid NGDP growth after 2003 as a problem, and I partly agree.  So the critique of the Fed in this case seems stronger from a NGDP targeting perspective.  But still nowhere near as strong as the critique of their policy of allowing NGDP growth to plummet in the midst of a financial crisis.


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75 Responses to “Living in a country with Hayek’s stable NGDP monetary rule”

  1. Gravatar of Bill Woolsey Bill Woolsey
    17. October 2010 at 12:57

    Just a dip in late 2008?

    It was a disasterous collapse. Much worse than the U.S.

    Perhaps I made an error, but first quarter of 2009 looks like -18%!

    I favor 3% growth in money expenditures, but I find it hard to believe that the .12 percent trend I found could be responsible for the awful consequences described in the newspaper story.

  2. Gravatar of Bill Woolsey Bill Woolsey
    17. October 2010 at 13:00

    http://www.esri.cao.go.jp/jp/sna/qe102-2/jikei_1.pdf

  3. Gravatar of Chaitanya Chaitanya
    17. October 2010 at 13:03

    Excellent post.

    The link with even the hypothesized ‘long-run’ neutrality of money is here obvious.

    If money is in the long-run neutral, then 0% NGDP growth would be ideal. There would be no uncertainty over nominal values and all the utility-and-profit-maximizing-agents should shuffle into the most efficient positions in society, and the resultant would be the capitalist liberatarian utopia.

    As to why this isn’t the case, really, is anyone’s guess now. I haven’t heard a coherent explanation of why 0% NGDP growth is harmful.

  4. Gravatar of Doc Merlin Doc Merlin
    17. October 2010 at 13:03

    I think it more has to do with a falling population and massive fiscal misspending, and extremely high corporate tax rate (highest in the world) rather than 0% growth path for NGDP.

    Quick Question:
    In a country with a positive expected, long term growth path, shouldn’t marginal propensity to consume be larger than 1? If this is true then shouldn’t by Keynesian theory, the multiplier for G larger than 1 and negative?

  5. Gravatar of Will Ambrosini Will Ambrosini
    17. October 2010 at 13:05

    Stagnation? GDP per capita is on par with Western European countries and has been for a decade (at about 70% the US’s income). Japan’s per capita consumption grew almost as much as the US’s in the last decade when the price indices are calculated correctly. Unemployment in Japan is the envy of the rest of the industrialized world.

    The Japanese car industry outproduces the American one and they overtook us only recently. The film industry is more productive than France’s and the trend is up. Tourism has more than doubled in the last decade in terms of arrivals and almost tripled in terms of receipts.

    But, of course, there was that one guy in that one city that had a bad time. So that’s data too. :-)

  6. Gravatar of Lee Kelly Lee Kelly
    17. October 2010 at 13:12

    I actually prefer Woolsey’s 3% growth target to Hayek’s 0% stabilisation target.

    At least one of the reasons I prefer Woolsey’s suggestion is that prices are “stickier” downward than upward. Am I wrong to assume that prices, particularly wages, were more flexible downward in the 1920s? In any case, I do not know about Japan.

    I suspect Hayek would endorse Woolsey’s view if he were alive today, but that is probably just my bias.

  7. Gravatar of Doc Merlin Doc Merlin
    17. October 2010 at 13:40

    @Will
    Good point, while the stats may not show it. The japanese seem to be winning at the game. Could it be that excessive NGDP growth inflates the stats?

  8. Gravatar of Mark A. Sadowski Mark A. Sadowski
    17. October 2010 at 13:50

    Scott wrote:
    “Yes, the US grew rapidly in the late 1800s under deflation, but we had strong NGDP growth.”

    Did it really? I know this claim is repeated ad nauseum by deflation fanatics, but the facts seem to show otherwise. Population growth was of course extremely rapid in the late 19th century which was a large part of the rapid NGDP growth in the US. But there were long periods of below average real per capita GDP growth that coincided with the periods of sharp deflation (the periods immediately following the Civil War and the Panics of 1873 and 1893 for example).

    Repeating a lie often enough a la Goebbels (this is a criticism of those making this claim, not necessarily you Scott) will still never make it the truth.

    Remember, as portrayed in the Wizard of Oz, late 19th century Kansas was a grey colorless place (and a very hard life). The contemporaneous Japanese might even have it good by comparison.

  9. Gravatar of Doc Merlin Doc Merlin
    17. October 2010 at 14:05

    @Mark A. Sadowski:
    The average however was deflationary and quite positive.
    I think that the basis of the argument is this:

    Supply side deflation is good.
    Demand side deflation is bad.

    Anyway, imo a transition to a 0% per capita NGDP growth path is not a bad idea, but the move towards that would be very painful for consumers due to the way debt and contracts are set up.

  10. Gravatar of Mark A. Sadowski Mark A. Sadowski
    17. October 2010 at 14:17

    Doc Merlin,
    On average, yes, the period was good. But to make it an average you must include the periods in which there wasn’t rapid deflation. And if you’re doing that, to improve the record of a period, doesn’t that call into question the claim that deflation was not harmful for growth?

    Of course supply side shocks can generate good deflation in theory. But I strongly disagree that there has ever been a really good historical example of this.

    The empirical evidence suggests that there is a threshold of inflation below which there are real consequences for growth. This is because of downward stickiness in prices and wages that interferes with the process of factor reallocation. When inflation fanatics can point to one verifiable example of a good delation I will congratulate them wholeheartedly.

  11. Gravatar of Doc Merlin Doc Merlin
    17. October 2010 at 14:25

    ‘Of course supply side shocks can generate good deflation in theory. But I strongly disagree that there has ever been a really good historical example of this.’

    This isn’t an example of good deflation, but it is one of good disinflation… the 1990′s.

    For periods of good deflation I have to turn to the industrial revolution.

    Anyway, I suspect that the reason good deflations are so rare in the era of fiat currencies is that the currency authority would tend to use a positive supply shock to increase its currency printing, thus keeping the supply shock from bringing deflation.

  12. Gravatar of Mark A. Sadowski Mark A. Sadowski
    17. October 2010 at 14:37

    Doc Merlin,
    I don’t disagree that there were periods of good disinflation. To the 1990s you might add the 1980s. Despite the sharp reduction in inflation the record of the 1980s is actually fairly respectable.

    But I still disagree that even in periods before fiat currencies (i.e. the Industrial Revolution) there were periods of good deflation. Labor markets were probably more flexible then. But I still don’t see the evidence.

  13. Gravatar of Bill Woolsey Bill Woolsey
    17. October 2010 at 14:46

    The productivity norm advocates believe that deflation due to fallign money expenditures have undesirable consequences, but deflation due to improved productivity in the face of constant money expenditures causes no problems and is the better than the alternative–creating an excess demand for money to cause money expenditures to rise with productivity.

    Looking at the late 19th century, there are several periods of falling money expenditures. Those were bad. The problem was the falling money expenditures. While the price deflation actually dampened the adverse impact on output and employment, avoiding the decreases in money expenditures would have been better.

    However, there were also some episodes of growing real output and deflation. These supposedly show that improved productivity can result in rising output in the face of constant money expenditures or at least slow growth of money expenditures with price deflation.

    One slight complication is that Selgin, at least, argumes that money expenditures should grow with factor supply, which would mean rising money expenditures with population (or labor force) and I guess capital accumulation would be the same. The deflation should just reflect output per unit of input–that is, total factor productivity.

    I think, rought, that means 2 percent trend money expenditure growith for selgin and generally, a 1% secular deflation rate. While I favor 3% money expenditure growth, and stable prices. Sumner is open to both of these, but insits that these sorts of reforms probably should not take place right after we had banks load up on real estate loans secured by property that dropped in value. And so, he favors going back to the 5% growth path.

  14. Gravatar of Bill Woolsey Bill Woolsey
    17. October 2010 at 14:53

    yikes. Typos like usual. Also, the supposed alternative to allowing deflation is to create an excess supply of money to offset the deflation.

    I fully agree with this argument if we are discussing positive productivity shocks. Getting the price level back up is a mistake. This is also an implication of memoryless inflation targeting. But, of course, those favoring a target for the growth path of money expenditures do reverse any inflation or deflation causes by changes in money expenditures. But the price level is allowed to drift with changes in productivity.

    I realize it can be difficult to keep track of all the views without a scorecard, and perhaps there are some that argue that the periodic decreases in money expenditures caused no problem in the 19th century because the price level fell enough to keep real expenditures equal to the productivity capacity of the economy, but I don’t think that was Hayek’s view.

  15. Gravatar of Mark A. Sadowski Mark A. Sadowski
    17. October 2010 at 15:01

    In my opinion the nominal expenditures target should take into account the actual (not theoretical) degree of flexibility in the labor markets. A NGDP growth target that assumes stable prices is probably too low based on the empirical evidence. The empirical evidence points to a 1.5%-2.0% inflation rate as optimal. If that is true than Scott’s 5% NGDP target is not only optimal because it was the pattern for about 15 years prior to the Great Recession but it is optimal because it is consistent with the empirical evidence.

  16. Gravatar of Doc Merlin Doc Merlin
    17. October 2010 at 15:57

    Mark, the arguments based on wage stickiness have no bearing here. With NGDP targeting for small percentages near 0%, the targeting itself takes care of wage stickiness, so long as the path is kept. The main difference is difficulties shortly after implementation
    Scott argues that 5% growth path is optimal because the economy already factors in a 5% NGDP growth. I think this too high because it encourages store of value in things that are less liquid than money, and should eventually be reduced to a selgin-esk 0% per capita target, or dropped all together in favor of free banking. Anyway, this is a very academic point as we all seem to agree that NGDP targeting is better than inflation targeting, lets work for the better system, then we can argue about what % to do level targeting at.

  17. Gravatar of e e
    17. October 2010 at 16:04

    “Yes, the US grew rapidly in the late 1800s under deflation, but we had strong NGDP growth.”

    This sounds pretty circular, how is that different from saying:

    “Sure the economy did well in this period of deflation, but thats b/c the economy was doing well!”

    Doc said
    “Supply side deflation is good.
    Demand side deflation is bad.”

    I’m not an economist but this is kind of hard for me to swallow, if sticky wages and deflation are enough to turn a brief recession into a decade long depression, then they should be pretty destructive wherever they coincide. If that combination is as powerful as most economists claim than the “supply side deflation is good” argument sounds like a rug under which to sweep hard to explain data.

  18. Gravatar of Doc Merlin Doc Merlin
    17. October 2010 at 16:14

    @e
    Think of it this way, e. Prices on products can drop because the technology gets better and produces them less costly. This happened with oil in the late 1800′s and with computers in the 90′s. This doesn’t change total money expenditures, but does boost the economy, as people are getting more bang for their buck.

    Demand side deflation means people are buying less stuff because they can’t afford it, or don’t want it. In the first case, it means that something bad has happened to the economy, and in the second case it means that producers have to find and create different products that people do want, which is costly.

  19. Gravatar of Mark A. Sadowski Mark A. Sadowski
    17. October 2010 at 16:34

    Doc Merlin,
    Actually wage/price stickiness have enormous bearing here. It is precisely the downward stickiness of prices that makes the inflation version of the AD curve (Cowen/Taborrok) flatter at the 0% boundary. That’s the whole reason why countries that fall below a 1.5-2% inflation rate suffer so much real output loss.

    If memory serves me correctly Scott acknowledges the research concerning optimal inflation rates but is diffident concerning his own stance on a specific optimal NGDP target rate.

  20. Gravatar of e e
    17. October 2010 at 16:40

    Scott,

    I think I was unclear before, I get that you think that if RGDP is increasing fast enough then deflation isn’t a disaster, but over a long period of time there have to be some demand shocks right? Last time you said there was more labor market flexibility fwiw.

    Doc,
    I understand the distinction, the argument that Mark and Scott gave me before is that with deflation and sticky wages or prices the economy is especially susceptible to AD shortfalls. As I understand it if wages are sticky at 0 growth then a shortfall in AD will be met with unemployment not reduced real wages in a deflationary regime. Given that our economy was mostly agrarian at the time its hard to imagine there were long periods without shortfalls in AD just due to bad weather. I am sure I’m missing something but please explain it to me.

  21. Gravatar of Morgan Warstler Morgan Warstler
    17. October 2010 at 16:46

    And then a monetarist chimes in:

    http://online.wsj.com/article/SB10001424052748704361504575552481963474898.html

    “So you think a fixed exchange-rate system is more conducive to global free trade and global economic recovery than floating rates?” I ask.

    Mr. Mundell registers surprise that I would even inquire. “The whole idea of having a free trade area when you have gyrating exchange rates doesn’t make sense at all. It just spoils the effect of any kind of free trade agreement.”

    Coming from the man who helped design Europe’s single currency, it makes perfect sense. Since its introduction in 1999, the euro has eliminated exchange-rate fluctuations among the 16 trade partners who have adopted it. In just over a decade, the euro has become the world’s second largest reserve currency after the dollar, and the second most-traded currency in foreign-exchange markets.

    Which brings to mind another question. “What do you think about the rise in currency trading by banks, with some $4 trillion now turning over daily in global currency markets?”

    Mr. Mundell thrusts out his arms. “It’s part of the sickness of the system! These currencies should be fixed, as they were under Bretton Woods or the gold standard. All this unnecessary noise, unnecessary uncertainty; it just confuses the ability to evaluate market prices.”

    But Doctor Mundell! What of targeting inflation?

    “The Fed is making a big mistake by ignoring movements in the price of the dollar, movements in the price of gold, in favor of inflation-targeting, which is a bad idea. The Fed has always had the wrong view about the dollar exchange rate; they think the exchange rate doesn’t matter. They don’t say that publicly, but that is their view.”

    Somehow, I just trust this guy so much more.

  22. Gravatar of Mark A. Sadowski Mark A. Sadowski
    17. October 2010 at 16:58

    Morgan,
    What does Mundell think of the recent performance of the Baltic States (pegged to the Euro) and Ireland (on the Euro). Not to mention the fiscal position of Greece and Spain.

  23. Gravatar of scott sumner scott sumner
    17. October 2010 at 17:44

    Bill, I was worried people were going to misread my story. I wasn’t trying to pin the blame for Japan’s malaise on NGDP, I was trying to show that if you favor the Hayek NGDP rule, you should be holding up Japan as a example of how it works in the real world. In my whole life I don’t recall one Austrian saying “look at Japan, other countries need to adopt their monetary policy.” The question is why not? Why don’t they view that as a showcase?

    Chaitanya, The two most common objections to 0% NGDP growth are:

    1. Makes monetary policy hard to operate (zero lower bound), and hence countercyclical policies are harder to do in a recession.

    2. There may be downward nominal wage rigidity due to money illusion.

    I’m not completely convinced on either point, but to play it safe I’d aim for at least 3% NGDP growth, and if we continue with our dysfuntional Fed, at least 5%.

    Doc Merlin, See my response to Bill.

    I don’t follow your MPC argument.

    Will, I’m not sold on your argument:

    1. In my view auto production in higher in the US than Japan, but I suppose it is a question of definition, as we produce lots of pickups and vans. China produces more cars than either country, but less valuable cars.

    2. Japan’s per capita income was catching up to America’s until about 1990, and since then has slightly regressed. That’s not very impressive in my book, for a country with higher educational levels and a much more disciplined workforce than ours. Don’t Japanese living in America make something like 50% above our national average? Yes, their GDP per capita is about 70% or ours, or slightly above Spain, but I’m old enough to recall 1990 when lots of people assumed they’d soon surpass us–it was conventional wisdom.

    3. I don’t think the NYT was cherry-picking interviews. I’ve read many similar articles, and indeed entire travel books by people who hitchhiked across Japan. Every single one has the same perception, the economy’s been awful since 1990. Do you really think that’s all just an illusion?

    4. The unemployment data may not be comparable to the US, for various reasons. In Japan, unemployment is much more shameful than in America. I’ve read that people will go to great lengths to look employed. A popular movie in Japan showed the man hiding his unemployment from the rest of his family.

    5. Incomes haven’t just stagnated in yen terms, they’ve stagnated in dollar terms. That’s important because cost of living comparisons are tricky. The only thing we know for sure is that when Americans and Japanese travel to a given area outside japan (say Hawaii, Paris or Switzerland), the fact that American dollar incomes have risen much faster than Japanese dollar incomes suddenly becomes an OBJECTIVE FACT, It means that growth in the Japanese ability to travel abroad has been much slower than for Americans.

    6. Poor countries often attract a lot of tourists, as costs are lower. Notice the article mentioned lots of cheap goods and services in Japan–the same is true of Mexico. So I’m not surprised they are getting more tourists.

    You said;

    “when the price indices are calculated correctly.”

    There is no correct way to calculate price indices–all methods are very arbitrary. Economists get mesmerized by models that suggest there is a right way, but reality doesn’t correspond to our models. Tell me the quality change in my current PC from my Intel 486 machine from 15 years back. Whatever answer you give, I can tear it apart in five minutes.

    And finally, you are attacking a side issue. I wasn’t trying to claim Japan has done horribly, I am asking why Austrians don’t tout Japan as a shining success of Hayekian monetary policy. Except for the drop in late 2008, it looks pretty good from a Hayekian perspective. Of course if things are doing fine there, that does beg the question of why the Japanese government went deeply into debt and paved over much of their beautiful countryside in a futile attempt to stimulate the economy.

    Lee Kelly, I agree with everything you said.

    Doc Merlin, The only “game” I see the Japanese winning is the game of going extinct. Seriously, I actually like Japanese culture, and would love to visit the country someday. Indeed, I’d say Japanese culture is now my favorite.

    Mark, You said;

    “Remember, as portrayed in the Wizard of Oz, late 19th century Kansas was a grey colorless place (and a very hard life). The contemporaneous Japanese might even have it good by comparison.”

    If Will gave me a hard time over my argument, I can’t imagine what he’d think of this one. I’m assuming you are kidding. In the late 1800s America had close to the highest living standards in the world. But everyone back then was poor by current standards, even rich people had much lower living standards than average Americans today.

    I’ve read a lot of studies of the period from 1865 to 1896, and RGDP increased very sharply, despite rapid deflation. There were depressions after 1873 and 1893, but there are lots of depression in US history. They were nothing like the Great Depression.

    I apologize for continuing to spread the “big lie”. I guess it’s OK for me, as I am not advocating that awful policy.

    Doc Merlin, You think it will work better for us than Japan? You realize we have faster population growth don’t you, so American wages will have to fall even faster than Japanese wages.

    Mark, I agree about the “on average” part. And again, I think people miss the point–the late 1800s did see deflation, but it did not see (on average) falling, or even steady, NGDP. So it’s not a good example to use in favor of stable NGDP. At best, stable per capita NGDP.

    Bill, Yes, that’s why I mentioned Hayek and not Selgin. Selgin does not favor constant NGDP.

    e, You misunderstood my argument. It was not about deflation, it was about NGDP. I was anticipating someone saying “well it didn’t work for Japan, but it worked in 19th century America.” My point (to head off that argument) was that 19th century America never tried the monetary policy Japan has adopted. I was not trying to defend deflation.

    Mark, The reason I am a bit cagey on this issue is that the optimal NGDP growth rate depends on all sorts of conditions:

    1. If you eliminate taxes on capital the optimal NGDP growth rate rises sharply. Taxes on capital are by far the main cost of “inflation.”

    2. If labor markets become more flexible the optimal rate falls slightly.

    3. If monetary policy switches from interest rate targeting to NGDP futures targeting, then the optimal rate falls.

    4. In the short run, you should aim for the average rate of recent decades. (And engage in level targeting.)

    So those are all important conditions. There is no single “right answer” as to what the optimal rate of NGDP growth is. It also depends on population growth. Basically any model that claims to give us the optimal NGDP growth rate is dubious, as it would invariably leave out lots of important factors.

  24. Gravatar of Morgan Warstler Morgan Warstler
    17. October 2010 at 17:44

    Dude, he thinks it is GREAT. It is a miracle! 150 years – nothing fixed Greece, but here’s Mundell… and:

    Greece is eating it, being forced to become a better country to survive…. they can always quit, they won’t – they will bend.

    And if you don’t understand the massively positive future impacts on whole generations of Greeks – who were not born on the lucky side, and the entrepreneurs who will not have to play politics and rent seek… and the criminals who will be CRUSHED.

    That’s the point… in a world of a single currency – the myth of MACRO disappears, and with it ALL BAD FISCAL POLICY is exposed and governments are forced to compete with one another finding greater and greater ways to attract brains and capital.

    History goes this way —–>

    Don’t fight it… most of it will happen in your lifetime Mark.

  25. Gravatar of scott sumner scott sumner
    17. October 2010 at 17:47

    Morgan, If you have a fixed rate, which country gets to determine the rate of inflation, and which country just follows along? Who gets to be the leader. I vote for Australia, as they seem to be the only country that understands how to avoid falling NGDP.

    Mark, Good questions.

  26. Gravatar of Morgan Warstler Morgan Warstler
    17. October 2010 at 17:50

    Scott, Austrians want a single world currency. And are mostly concerned with getting Free Markets. They view Macro as a near facade, why do you think they’d point to Japan – master of the planned economy via Government Run Bank and focus on their great Monetary Policy?

  27. Gravatar of e e
    17. October 2010 at 17:51

    Scott,

    Oh, I reread it, that makes sense.

  28. Gravatar of Morgan Warstler Morgan Warstler
    17. October 2010 at 17:54

    Scott, I think as long as they keep it under 2% inflation no matter what it doesn’t matter.

    Though, with the Euroblock living on Austerity, it seems like the US just needs to peg them at 40% and the others will follow along, no?

    Perhaps you should spend some more time thinking through the effects of such an approach, before you one sentence snark it.

  29. Gravatar of Will Ambrosini Will Ambrosini
    17. October 2010 at 19:52

    I don’t know why Austrians don’t point to Japan as a success story. I’m not sure how you’re making this point when you suggest incomes are stagnant there.

    One interpretation of the data is that the 80s was a bubble both economically and in punditry about Japan. The first is supported by the relative GDP numbers, the 80s look like an outlier. The second is supported by all the “Japan Inc” books being replaced by “China roolz” books from the 80s to now. Japan is not stagnating just because it didn’t live up to the astronomical expectations of unaccountable pundits.

    I agree with your points about price indexes. I meant that Japan’s official statistics don’t make any adjustments for substitution effects. Its easy to make this correction and when you do you get much better looking real consumption growth for Japan.

    I don’t believe social ennui or the zeitgeist can be easily measured. You might collect lots of interviews suggesting people think times suck but that doesn’t tell us how things have changed. One data point: suicides in Japan are not more prevalent today than they were in the 1980s.

    But incomes can be measured. Where are you getting data that shows you “incomes are stagnating”? They’re not. All the measures I can find of real incomes show at least 10% growth in per capita gdp since the peak in 1991. This statistical worse case still has incomes rising 0.6% a year. In any case, Japanese tourism to the US and Western Europe was more or less flat for the five years before 2008 and it was up more than 30% to China and Taiwan (people not dollars).

    Maybe I should stop defending Japan. My Japanese wife is telling me that if I convince people that Japan is doing fine, people there “won’t work hard”. That’s another take on the “data” in the NYT article.

  30. Gravatar of Greg Ransom Greg Ransom
    17. October 2010 at 22:03

    Hayek acknowledged problems created by “sticky wages” (Marshall’s old idea) and other contractual matters — so at least one would deny that a productivity norm would produce “no problems”.

    Bill wrote:

    “The productivity norm advocates believe that deflation due to fallign money expenditures have undesirable consequences, but deflation due to improved productivity in the face of constant money expenditures causes no problems.”

  31. Gravatar of Greg Ransom Greg Ransom
    17. October 2010 at 22:04

    What Doc said.

  32. Gravatar of Greg Ransom Greg Ransom
    17. October 2010 at 22:16

    Two things to keep in mind.

    Hayek always looked at things from an open economy, international monetary system perspective. Prices within a nation depend in part on fluctuating and lag allowing changes in demand for its goods and currency outside of the nation, (etc.) — all of the trade cycle / money arguments found in Hayek’s _Monetary Nationalism and International Stability_.

    The other side of this is that Hayek admitted later that he didn’t know what was happening empirically with money and gold supplies both domestically and internationally in this period of the late 1920s and early 1930s. At the time, he didn’t know the actual facts.

    Facts were are still getting a better handle on still today.

    When Hayek’s knowledge of the facts changed, so did his analysis of what was going on. This holds as true for the late 1920s and early 1930s in America, as for any other historical period.

    The economics Hayek brought to the table didn’t much change, but the analysis of any historical episode did change, when his knowledge of the facts changed.

    And Hayek’s analysis of the Depression in America did change, due to changes in Hayek’s knowledge of the facts.

    We know the fact even better today. And Hayek’s analysis would have to be updated to those updated facts.
    Scott wrote,

    “Why is this important? Because Hayek’s argument underlies the Austrian view that monetary policy was too “inflationary” during the 1920s, despite no rise in the price level. He argued NGDP should have been kept stable, so prices could fall with productivity gains. This argument also underlies some of the critique of Fed policy in the 2000s, as price inflation wasn’t all that high. In fairness, some point to the rapid NGDP growth after 2003 as a problem, and I partly agree.”

  33. Gravatar of Greg Ransom Greg Ransom
    17. October 2010 at 22:22

    Isn’t Japan another example of a Keynesian train wreck?

    Keynesian economics has become like a bad parody of a classic unfalsifiable Popperian pseudo-science.

    I mean, at this point, is it any less unfalsifiable than Freudian psychology?

  34. Gravatar of Greg Ransom Greg Ransom
    17. October 2010 at 22:35

    So non-Hayekian Japanese policies caused a massive artificial malinvestment boom in the 1980s and an inevitable bust in the 1990s — and you blame Hayekian policies for the mess?

    It was bad policies in the 1980s that set up the inevitable bust — and horrible Keynesian policies which made it all worse in the 1990s.

    And the non-Hayekian retail, trade, banking, farm, construction, “stimulus”, and anti-competitive policies of the Japanese is world famous.

    Again, what’s up with blaming Hayekian policies for this mess?

  35. Gravatar of Liberal Roman Liberal Roman
    17. October 2010 at 23:01

    Greg,

    You are running the same line of arguments as all people whose policies have been tried and failed:

    “Well, my policies weren’t tried enough”

    The anti-competitive, malinvestment, government intervention, Keynesian policies that you talk about have been in place in many other countries and all have done better than Japan. The difference being that those countries didn’t have 0% NGDP growth that Scott talks about.

    Economics isn’t a perfect science where all variables can be controlled for, but all in all, the argument is clear. 0% NGDP growth = deflationary stagnation. End of story. The burden is on you to find a case where 0% NGDP growth was matched with prosperity.

  36. Gravatar of Doc Merlin Doc Merlin
    17. October 2010 at 23:07

    @ Liberal roman:
    ‘You are running the same line of arguments as all people whose policies have been tried and failed:

    “Well, my policies weren’t tried enough”’

    Actually, no he is arguing that his competitor’s policies destroyed the country. And while 0% NGDP growth has never been shown to work well, supply side deflation has. Many periods in the 19th century US attest to this.

  37. Gravatar of Mabuse Mabuse
    18. October 2010 at 00:29

    Umm… forgive my ignorance on this but I was under the impression that Hayek’s monetary rule was that NGDP growth should be kept in line with RGDP growth; not that NGDP shouldn’t grow. If that’s not the case then ignore me and continue on but if it is true then Japan isn’t a good example of Hayekian monetary policy at all.

  38. Gravatar of Jaap Jaap
    18. October 2010 at 02:23

    the words I haven’t seen here are: changed expectations. in the boom-time everybody thought Japan was going to grow and grow and grow, and that landprices and property-prices would have to rise in the future, so the price is already paid ‘today’. when it turned out the economy wouldn’t grow 5-10% a year, but only 0.6%, the forward looking prices collapsed. (like a stockprice is basically compounded future earnings)

  39. Gravatar of 123 123
    18. October 2010 at 03:03

    Hayek’s stable NGDP rule has nothing to do with problems in Japan.

    1. The first issue is the transition to stable NGDP. The transition has low costs if people are expecting variable NGDP, or if NGDP expectations are too low, or if NGDP expectations are unsustainably high. In Japan expectations of high and stable NGDP growth were embedded in long term financial contracts, and the debt/GDP ratio was very high before the crisis. My inner Hayek tells me that a very long and smooth transition period to stable NGDP growth was needed in Japan.

    2. Of course Japan does not target stable NGDP. 2000 crisis and 2008 crisis was caused by excess volatility of NGDP expectations.

  40. Gravatar of JTapp JTapp
    18. October 2010 at 03:37

    @ssumner I am quoting an Austrian economist re: Japan.
    “Stabilizing nominal spending might make sense if the problem in recession is not enough demand for too much production. The problem, however, is not that too many goods were produced, but that the wrong goods were produced. Capital must be reallocated toward its most productive uses. This problem is not solved by stabilizing spending.

    It is a good thing if Japan is not fully committed to higher inflation. Mass inflationary expectations is the first step to hyper-inflation. ”

    To them it’s all about MALinvestment, the quality of the projects being undertaken.

    And I respond with Hayek (1975):
    “Today I believe that deflation has no recognizable function whatever, and that there is no justification for supporting or permitting a process of deflation.”

  41. Gravatar of JTapp JTapp
    18. October 2010 at 05:05

    And I would think that Austrians (and non-Austrian supply-siders) would also want to point to Estonia as an example. Estonia’s reformers modeled its post-Communist reforms using Milton Friedman’s Capitalism & Freedom as the manual (true story). They’ve had incredible RGDP growth and become a technology hub in the last 20 years. And you have total absence of expansionary monetary policy & fiscal deficits (Estonia has a currency board).

    But the problem is that they STILL had a housing boom/bust and nasty recession with unemployment hitting 18%. In the crisis, they’ve refused to inflate, refused to devalue their currency. The process of price/wage adjustment to get back to full employment has been painfully slow– much slower than I think Austrians contend prices move. Now, they’re apparently proud of their sacrifices and feel that in the long-run they’re better off, but the pain and unemployment have been enormous. And more importantly–politically–the populism arising from the pain is threatening to ditch the neoliberal reforms altogether.

    Someone correct me if I’m wrong in my assessment there.

  42. Gravatar of scott sumner scott sumner
    18. October 2010 at 05:18

    Morgan, Austrians favor world government?

    Will, You said;

    “I don’t know why Austrians don’t point to Japan as a success story. I’m not sure how you’re making this point when you suggest incomes are stagnant there.”

    Why not? The incomes probably stabilized for reasons having nothing to do with NGDP targeting. The point is that NGDP has been fairly stable, unchanged over several decades. Why isn’t that a story to be trumpeted if you favor stable NGDP? The RGDP slowdown may have been due to supply side factors.

    I think it is very strange to constantly tout a utopian policy, and then never mention that the THIRD LARGEST ECONOMY IN THE WORLD HAS BEEN RUNNING THAT POLICY FOR DECADES.

    You said;;

    “One interpretation of the data is that the 80s was a bubble both economically and in punditry about Japan. The first is supported by the relative GDP numbers, the 80s look like an outlier.”

    You are right that punditry should not be relied upon. But Japan grew even faster in 1950-80, than in the 1980s, so I’m not quite sure why the 1980s is viewed as a bubble (except in the obvious sense that asset prices there got overinflated.)

    Again, I’m not denying incomes have risen since 1990, I was referring to the fact that prior to 1990 they were rapidly gaining on the US, and since then they slightly regressed vis-a-vis the US (in PPP terms). There also seems to be a sense that the younger generation is somehow blocked in terms of jobs and housing–but that may be anecdotal and it would be interesting to get data on how common it is for younger workers to be stuck, as compared to previous generations.

    I also find it “interesting” that what everyone admits was at least a sharp slowdown in the rate of growth, occurred almost precisely at the point where the BOJ began an ultra tight monetary policy which dramatically increased defaults on nominal loans and devastated the banking system. Was that timing all just coincidence.

    Since I am relying on anecdotal evidence, I guess I should defer to your Japanese wife on that score. Does she think the Japanese economy (outside of Tokyo) has done poorly since 1990? I have a more open mind on this issue than you might think–as you know I gravitate toward views that go against the conventional wisdom–which is one reason I like your blog.

    BTW, will you defer to my Chinese wife on questions about whether China roolz? :)

    greg, Read my post again. I never blamed Hayekian policies for the problems in Japan. I wasn’t even talking about Hayek, I was talking about modern Austrians who argue that if only NGDP were stable, things would be better. I certainly agree that Japan is a poster child for Keynesian fiscal stimulus ineffectiveness. And that there are all sorts of supply-side problems.

    What this essay is about is that Japan is a big PR problem for the stable NGDP idea. As long as the NYT keeps printing those sorts of stories, it will be a tough sell–fairly or unfairly (and I’m genuinely agnostic about how much of the problem is tight money.) My only semi-firm opinion is that the initial shock in the 1990s was due to deflationary policies, and again in late 2008.

    Mabuse, Actually, it was constant NGDP he favored.

    japp, I can agree with that.

    123, You seem to refute your own argument. You say NGDP had nothing to do with the problem, and then present evidence suggesting it did. The went very suddenly from high NGDP growth to zero–that’s harmful according to your model.

    Yes, they don’t explicitly target constant NGDP, but it is the de facto policy, and will continue for the foreseeable future.

    I agree about 2008, the 2000 shock was far milder.

    JTapp, Yes, but that doesn’t contradict my argument. I said there were many modern Austrians advocating stable NGDP, and citing Hayek’s interwar argument. This isn’t about “blaming” Hayek, (contrary to Greg’s assumption) it is about describing the views of some modern Austrians who cite Hayek’s earlier view that NGDP grew too fast in the 1920s. That view is quite common today, regardless of what some individual Austrians might say.

  43. Gravatar of 123 123
    18. October 2010 at 06:22

    Scott, all the problems in Japan were caused by deviations from Hayek’s teachings. NGDP grew too fast in 1920s because dollar was on the gold standard, but in 1980s Japan was on the 5% NGDP standard. Then BoJ created an unexpected shock that caused secondary depression that is equivalent to switching to a minus 5% NGDP path under the gold standard. 2000 and 2008 recessions were caused because BoJ permitted temporary deviations from the stable NGDP path, Hayek said such deviations are harmful. 2000 shock was mild according to the measured NGDP, but it was not mild according to NGDP expectations.

  44. Gravatar of Greg Ransom Greg Ransom
    18. October 2010 at 07:30

    Right. Phenomena straight out of book 4 of Hayek’s _Monetary Theory and the Trade Cycle_:

    “the words I haven’t seen here are: changed expectations. in the boom-time everybody thought Japan was going to grow and grow and grow, and that landprices and property-prices would have to rise in the future, so the price is already paid ‘today’. when it turned out the economy wouldn’t grow 5-10% a year, but only 0.6%, the forward looking prices collapsed.”

  45. Gravatar of Lee Kelly Lee Kelly
    18. October 2010 at 07:35

    I sometimes wonder if, for political reason, the income of individual earners should be stabilised (or its growth should be stabilised). That is, nominal income divided by the number of individuals gives the average. It is possible that this average may decline even with NGDP growth targeting. Since this would force nominal wages to decline and perhaps create political unrest (like government wage controls or employment regulations), it would be wiser to ensure that the average nominal income of individuals is always either stable or rising. Maybe. I am far from sold on the notion myself; it’s just something to ponder.

  46. Gravatar of Greg Ransom Greg Ransom
    18. October 2010 at 07:41

    Scott, thanks for clarifying. And fair enough.

    Recently the NY Times had a piece where they said that Hayek invented the notion of “the rule of law” and suggested that is was this was an obscure, archaic and fringe idea from a dead guy no one has ever hear of.

    As a citizen of the West Coast in the internet age, I don’t obsess much about the incompetence the NY Times, and its editor, reporters and columnists.

    Scott writes,

    “As long as the NYT keeps printing those sorts of stories”

  47. Gravatar of Benjamin Cole Benjamin Cole
    18. October 2010 at 07:55

    More superb commentary from Scott Sumner. This should be required reading.

  48. Gravatar of Lee Kelly Lee Kelly
    18. October 2010 at 09:04

    I have encountered very few Austrians, amateurs or professionals, who advocate Hayek’s stable nominal income policy norm. Some come close, like Selgin, White, and perhaps Horwitz, but are there any others?

    Most Austrians I have encountered (and I admit to have met few offline) are more precisely described as Rothbardians. Few of them are even aware that Hayek ever suggested a stable nominal income policy norm, and those that are usually reject it outright. It seems to me that most Austrians welcome deflation in the aftermath of an ‘artificial boom’ to ‘purge the rottenness [i.e. malinvestment]‘ from the economy.

    Austrians usually reject expansionary monetary policy as an attempt to prevent necessary relative price adjustments; they claim this will prolong the boom, but only at the expense of making the inevitable correction more painful. In this view, monetary stimulus merely ‘kicks the can down the road’; it is advocated by the mainstream out of a perverse neglect for the long run — after all, ‘in the long run, we’re all dead’.

  49. Gravatar of JTapp JTapp
    18. October 2010 at 10:37

    Lee Kelly,
    Those are the only Austrians I’ve run across as well. “Hayek was wrong just as Friedman was wrong” is the answer I’ve gotten.

    Bryan Caplan’s essay on “Why I’m not an Austrian” is a pretty good read.

  50. Gravatar of Jeff Jeff
    18. October 2010 at 11:14

    I am aware of only one decent argument for deflation, and that’s the one Milton Friedman made in The Optimum Quantity of Money. The societal cost of producing money is effectively zero (all you need is a printing press, paper and ink), while an individual’s opportunity cost of holding money is the nominal interest rate. If this is true, then there’s no good reason why individuals opportunity costs shouldn’t be zero, i.e., the nominal interest rate should be zero. Couple that with the idea that the real interest rate tends to converge to the growth rate of productivity and you get an argument that prices should fall at the rate of productivity growth.
    The trouble with this argument, according to Paal and Smith, is that at very low nominal interest rates, bank reserves become a very good asset, so banks have little incentive to lend, and with few banks loans to the private sector you get low rates of capital investments and growth.
    Scott will, of course, immediately recognize that if Paal and Smith are correct, then their paper is also an argument against paying interest on reserves, since that also reduces bank incentives to lend to the private sector.

  51. Gravatar of John Papola John Papola
    18. October 2010 at 11:14

    Scott,

    I think you misunderstand Hayek here. Evaluating a Hayekian monetary policy in terms of economic growth AFTER an Austrian bubble bursts and a massive round of Keynesian stimulus burdens the economy with massive debt is inherently problematic. Yes, Japan’s growth has been a problem since they paved the island in concrete on borrowed Yen.

    The fact that post NGDP stabilization, Japan hasn’t suffered any new financial crises and credit bubbles (or have they?) actually supports the Hayekian view.

    Remember, the KEY contribution of Hayek/Mises is the identification of what causes the “upper turning point”. Rising NGDP causes excess credit expansion which flows into more interest-elastic producer’s goods industries, driving up input prices, squeezing profits and leading to new credit demand. The boom turns to bust because of this latter process where capital goods inflation outruns on final prices. Copper. Concrete. Oil. Construction labor. If the central bank accommodates the increased credit demand that production overruns produce, we just get even more inflation and malinvestment.

    None of this helps too much in understanding the state of the economy AFTER the boom turns to bust. NGDP stabilization in the face of the bust will prevent the kind of secondary deflation which seems to be the sole focus of your post here about deflation. The reason why that deflation occurred in the first place is what I believe you are Hayek critics miss. And, if a national government goes about addressing the bust with a Keynesian fiscal hair of the dog and a bailed out zombie banking, that can just compound the damage even if the policy moving forward is sound.

    Consider this analogy:

    A man who packs on the pounds with sweets and gets diabetes will have his health impaired from that point forward. If, shocked into action by his disease, he eats very healthy moving forward, he still has to content with the lasting effects of his diabetes. That he continues to be sick is not an indictment of healthy eating.

  52. Gravatar of Luis H Arroyo Luis H Arroyo
    18. October 2010 at 11:36

    Morgan, you are fortunate: you have a Faith; you are a believer. I´m not.
    I´m spanish, and since the euro was launched, I have not see any significant increase in the commerce into the area. Spain exported 70% of its export to the UE before and after the euro.
    But is more serious the terrible effect of the euro in the debt market, erasing the risk premia of capital losses, and the equalizing the interest rate of all sovereign debts. That was the main cause of the huge external deficit in Spain (10% GDP) & co., financed by a misallocation of world saving. Now, thanks to the euro, It is impossible for Spain and other countries adjust its competitiviness deflating internaly. In fact, we have see aan increase of wages this year over 2%. So we have a 20% UR. Bravo, euro! Monetary illusion exist, and the fall of Spain an Co. is the evidence.
    If MI doesn´t exist, Hayek (and Mundell) would be right. But MI is a fact.

  53. Gravatar of Luis H Arroyo Luis H Arroyo
    18. October 2010 at 11:42

    BTW, why the Austrian hate the exchange market, A MARKET?
    When I was near an austrian, I was confident in all the markets, I never understand why austrian would force to close the most important market for a Country. The history of gold is not so brilliant.

  54. Gravatar of StatsGuy StatsGuy
    18. October 2010 at 11:59

    Bill W.:

    “I favor 3% growth in money expenditures, but I find it hard to believe that the .12 percent trend I found could be responsible for the awful consequences described in the newspaper story.”

    We really need to differentiate between a long run ~0% inflation rate, and a CHANGE in trend from 3% to 0%. That change in trend causes drastic reallocations of wealth, accompanied by bankruptcy and liquidity crises.

    It also causes changes in consumption patterns across all sorts of strata, including by age group. It’s difficult to track down wealth by age strata (links, anyone?), but it’s quite clear that unemployment is highest among the youngest workers, and deflation tends to favor fixed income consumers.

  55. Gravatar of Morgan Warstler Morgan Warstler
    18. October 2010 at 12:03

    Luis, the best part is that your government cannot deficit spend (which is printing money), so it forces it into more free market positions to compete with other Euro countries.

    All of Europe becomes more like Germany. What’s not to love?

  56. Gravatar of Morgan Warstler Morgan Warstler
    18. October 2010 at 12:08

    Scott. yes Austrians favor a single world currency… or more favorably multiple currencies being able to be used wherever you shop… that also ends MACRO.

    The moment the guy with the printing press is terrified of printing – Austrians are winning.

  57. Gravatar of Luis H Arroyo Luis H Arroyo
    18. October 2010 at 12:24

    Because is False. Spain is not marching towards Germany. It is ridiculous. Have I not said that wages have increase over a 2%? We have a socialist government, and spanish people is happy. Only now, people is discovering whay that means. But don´t be sure that the right party will win in 2012!
    I repeat, you are forutnate, you are believer, and as believer, you don´t like learn from history, as Scott is propposing here.

  58. Gravatar of Doc Merlin Doc Merlin
    18. October 2010 at 13:18

    @Luis H Arroyo

    Austrians aren’t against currency markets, they are against state currencies. This is a very important distinction. The Rothbardians believe in a commodity standard and the free bankers believe in private currencies.

  59. Gravatar of Greg Ransom Greg Ransom
    18. October 2010 at 21:17

    Note well, Caplan’s article has almost nothing to do with the work of Hayek, which Caplan hasn’t shown he really knows.

    “Bryan Caplan’s essay on “Why I’m not an Austrian” is a pretty good read.”

  60. Gravatar of brit brit
    19. October 2010 at 01:12

    What confuses me is, isn’t there some natural rate argument that says that Japan should have got used to 0% NGDP growth by now? That a constant monetary policy cannot have long term real effects. Is 10 years long enough for this to be considered long term?

  61. Gravatar of Luis H Arroyo Luis H Arroyo
    19. October 2010 at 01:16

    Don´t talk me about Rothbard and his followers, The Very very Utopians of today. No thanks.

  62. Gravatar of scott sumner scott sumner
    19. October 2010 at 06:09

    123, I don’t think that was Hayek’s teachings in the interwar period. When NGDP started falling after 1929 he didn’t say “keep it rising at the normal 3%”, he had thought that was too much. He just didn’t want a drop. Maybe you are describing his teachings from the 1970s. In any case, I am more interested in modern Austrian views of the situation, rather than Hayek’s view per se.

    Lee Kelly, Yes, that would be better, for several reasons. it’s a slightly higher rate for most countries, and it is closer to nominal wages, which is the best target.

    Greg, Yes, the NYT lives in its own little bubble.

    Thanks Benjamin.

    Lee, Maybe I am reacting too much to commenters who come on here and say money was easy in the 1920s because the Fed let NGDP grow. Is the Austrian view now that money wasn’t easy in the 1920s?

    Jeff, Good observation.

    John Papola, I thought the massive fiscal stimulus in Japan came AFTER the bubble burst.

    Morgan, Who runs the printing press for the world?

    brit, Yes, here are such natural rate models. But there are also models by people like Akerlof that say a low average inflation rate raises unemployment, when inflation is so low that downward nominal wage cuts are frequently needed.

  63. Gravatar of Lee Kelly Lee Kelly
    19. October 2010 at 12:27

    Scott,

    The consensus among Austrians does seem to be that monetary policy was too easy during the “roaring twenties”. Though I still agree with that view, I am increasingly sceptical of it. In any case, whatever views Austrians have of monetary policy during the ’20s, most of them do not advocate stabilising nominal income (or NGDP). I suspect this is very confusing to you, because it seems like Austrians are against one form of monetary disequilibrium and then for another. Well, it’s “confusing” to me as well, and it’s why I only would only describe myself as “Austrian” with some hesitation (besides being English!).

  64. Gravatar of George Selgin George Selgin
    19. October 2010 at 14:28

    e writes: “I’m not an economist but this is kind of hard for me to swallow, if sticky wages and deflation are enough to turn a brief recession into a decade long depression, then they should be pretty destructive wherever they coincide. If that combination is as powerful as most economists claim than the “supply side deflation is good” argument sounds like a rug under which to sweep hard to explain data.”

    But is deflation comes from the supply side, its only nominal output prices that have to decline, not nominal wages. So wage stickiness needen’t entail increased unemployment in this case. There’s nothing being “slipped under the rug” here.

    I appreciate Bill Woolsey’s attempts to dispel the suggestion that the productivity norm implies constant NGDP. That is generally not the case. But it also bears saying that in advocating such a norm I’ve never suggested that it makes no difference whether you are starting with an economy used to low NGDP growth or not. Of course, expectations matter; and as Scott has always insisted, a relative to a long-standing 5% growth trend a _sudden_ switch to 0% will be harmful. By the same token, though, were an economy accustomed to 10% NGDP growth, a sudden switch to 5% would hurt. Had we such a case study, Scott, would you agree that it would be unfair to point to it and declare, “See what’s (generally) wrong with 5%”?

    Concerning the U.S. case in the 19th century, I’m sure that the trend NGDP growth rate was more than 0%. But I’m equally certain that it was less than 5%. A good guess is that it was closest to the productivity norm “happy medium”!

  65. Gravatar of Mark A. Sadowski Mark A. Sadowski
    19. October 2010 at 17:36

    Scott,
    You wrote:
    “If Will gave me a hard time over my argument, I can’t imagine what he’d think of this one. I’m assuming you are kidding. In the late 1800s America had close to the highest living standards in the world. But everyone back then was poor by current standards, even rich people had much lower living standards than average Americans today.

    I’ve read a lot of studies of the period from 1865 to 1896, and RGDP increased very sharply, despite rapid deflation. There were depressions after 1873 and 1893, but there are lots of depression in US history. They were nothing like the Great Depression.

    I apologize for continuing to spread the “big lie”. I guess it’s OK for me, as I am not advocating that awful policy.”

    It’s less worse for you because at least you’re advocating an increase in AD. But you’re very guilty of giving in an inch to the historical revisionists when there’s no need to.

    The perceived greyness of Kansas according to the contemporaneous “Wizard of Oz” had little to do with its poverty relative with our own times (how could it?) but everything to do with its failure to preform in line with the expectations of present and future growth in its own times. This was clearly a product of the persistant and long running decline in price levels.

    Real GDP per capita growth averaged only 1.6% from 1865 through 1895, a period of nearly continuous deflation. Real GDP per capita growth averaged 2.1% during the period from 1949 to 2010, a period which has experienced continuous GDP deflator increases on an annual basis.

    Anyone who tries to insist to me that the “Long Depression” was the best of times will certainly have some arguing to do.

  66. Gravatar of Mark A. Sadowski Mark A. Sadowski
    19. October 2010 at 18:51

    From the “Wizard of of Oz” (1900) by Frank Baum:

    “Dorothy lived in the midst of the great Kansas prairies, with Uncle Henry, who was a farmer, and Aunt Em, who was the farmer’s wife. Their house was small, for the lumber to build it had to be carried by wagon many miles. There was four walls, a floor and a roof, which made one room; and this room contained a rusty-looking cooking stove, a cupboard for the dishes, a table, three or four chairs, and the beds.

    When Dorothy stood in the doorway and looked around, she could see nothing but the great gray prairie on every side. Not a tree nor a house broke the broad sweep of flat country that reached to the edge of the sky in all directions. The sun had baked the plowed land into a gray mass, with little cracks running through it. Even the grass was not green, for the sun had burned the tops of the long blades until they were the same gray color to be seen everywhere. Once the house had been painted, but the sun blistered the paint and the rains washed it away, and now the house was as dull and gray as everything else.

    When Aunt Em came there to live she was a young pretty wife. The sun and wind had changed her too. They had taken the sparkle from her eyes and left them a sober gray; they had taken the red from her cheeks and lips, and they were gray also. She was thin and gaunt, and never smiled now. When Dorothy, who was an orphan, first came to her, Aunt Em had been so startled by the child’s laughter that she would scream and press her hand upon her heart whenever Dorothy’s merry voice reached her ears; and she still looked at the little girl with wonder that she could find anything to laugh at.

    Uncle Henry never laughed. He worked hard from morning till night and did not know what joy was. He was gray also, from his long beard to his rough boots, and he looked stern and solemn, and rarely spoke.

    It was Toto that made Dorothy laugh, and saved her from growing as gray as her other surroundings. Toto was not gray; he was a little black dog, with long silky hair and small black eyes that twinkled merrily on either side of his funny, wee nose. Toto played all day long, and Dorothy played with him, and loved him dearly.”

    Read the original book. There’s nothing in there about our own times. Nothing, of course, unless it is about a repeat of an earlier deflationary episode.

  67. Gravatar of George Selgin George Selgin
    20. October 2010 at 03:01

    Sadawski: “Anyone who tries to insist to me that the “Long Depression” was the best of times will certainly have some arguing to do.

    Well, I won’t insist that iot was the best of times; but I will insist that the so-called “long depression” is a historical myth. The assumption that a “depression” is happening whenever prices are falling is simply not sustainable. Jospeh Davis has the 1873 contraction actually lasting just two years–that’s a lot less than 23!

    And 1.6% annual per capita average growth is damn good for a country thats admitting huge numbers of poor immigrants! Do you suppose the post WWII number would have been that good had 19th-century immigration policies remained in effect then?

  68. Gravatar of 123 123
    20. October 2010 at 05:40

    Scott, you said:
    “I don’t think that was Hayek’s teachings in the interwar period. When NGDP started falling after 1929 he didn’t say “keep it rising at the normal 3%”, he had thought that was too much. He just didn’t want a drop. Maybe you are describing his teachings from the 1970s.”
    I’ve got quite many questions. Hayek thought that zero NGDP trend is the most appropriate under the gold standard. Was he referring to global NGDP, or NGDP in a specific country? Did he think that there is no natural gold/NGDP ratio, and no matter what NGDP level you have achieved, you could target a flat NGDP path from that point? Or did he think that NGDP/gold ratio was still within a reasonable bounds in 1929?

    You said:
    “In any case, I am more interested in modern Austrian views of the situation, rather than Hayek’s view per se.”

    All those modern Austrians should return to classics. They should read Rothbard’s “The mystery of banking”, chapter “Inflationary or deflationary expectations” (1983):

    “We come now to the most important single influence on the demand for money: This is the public’s expectation of what will happen to prices in the near, or foreseeable, future.”

    I was debating one Austrian and he said: “I have read this book some time ago and this is a good book, i.e. there is nothing like that in all other chapters.”

  69. Gravatar of John Papola John Papola
    20. October 2010 at 18:17

    Scott,

    John Papola, I thought the massive fiscal stimulus in Japan came AFTER the bubble burst.

    Yep. I don’t understand this restatement as a question though. My point was that the debt monster which that stimulus unleashed very likely plays a role in whatever sub-potential growth Japan may have experienced, making stable NGDP at least potentially innocent/irrelevant.

  70. Gravatar of scott sumner scott sumner
    21. October 2010 at 05:23

    Lee, Yes, there are many types of Austrians,

    George, I agree with your comments. I don’t regard the Japanese case a a true test of stable NGDP. The initial problems in the 1990s could reflect the sharp slowdown in NGDP, and the most recent post-2008 problems are associated with falling NGDP. My point was that the experiment has been going on for a long time now, and despite not being a perfect test of stable NGDP, It comes awfully close if you look at Woolsey’s data. I think it does show that stable NGDP is not a cure-all. If it works at all, it has to be done gradually, and special care must be taken to avoid falling NGDP. By “special care” I mean level targeting.

    I didn’t mention your name on the post because I thought it unfair to associate your productivity norm with the Japanese case.

    Mark, I think it has more to do with the relative decline in food prices, which is not the fault of the gold standard. We needed to move half the population from the farms to the city, and we needed to uses the stick of falling farm incomes to do it. It had to be done, but it is not a pretty sight to watch creative destruction in action.

    And I say all this as someone who favored bi-metallism over gold.

    Mark#2, I read the book just last year (to my daughter.)

    123, I don’t know enough about Hayek to answer your question, but clearly global forces were important under the gold standard. The growth rate of gold supplies kept prices fairly stable in the long run, with perhaps a tiny deflationary trend. Actual deflationary periods like the 1870s reflected special factors like lots of countries adopting gold, or the relapse after war.

    John, OK, then what caused the deflation and recession in the first place, if not bad Japanese government policies?

  71. Gravatar of John Papola John Papola
    22. October 2010 at 11:24

    Hey Scott,

    I don’t know the facts about Japan sufficient to have a solidly useful comment on the cause. What I can say, in the abstract, with the caveat that the facts must support it, is that the double-bubble of housing/stock market suggests a credit-expansion driven boom much like ours and that such a scenario, in theory, would have caused a slew of malinvestments which became unprofitable as input prices and interest rates rose due to increased credit demand/central bank tightening money to curb inflation.

    So a bunch of firms become unprofitable. A bunch of banks holding outstanding loans with said firms face default and insolvency, and everything that comes next simply compounds those problems through increased public debt via keynesianism, a broken banking system due to zombies, etc.

    But that’s stylized, pop-Austrian stuff. Absent the real data, it’s just an assertion of the theory clinging on to my thin knowledge of the Japanese/East Asian crisis.

    But I think the causality you imply above is similar to the correlation/causality of “low interest rates are associated with tight money”. Yes, during a bust, deflation, reduced credit demand and a central bank behind the curve can lead to lower interest rates AND tight money. But during normal times, when financial intermediation is functioning and solvent, low rates can signal new money being injected beyond the current supply of real savings. Or am I missing something?

  72. Gravatar of Scott Sumner Scott Sumner
    23. October 2010 at 05:46

    John, I don’t think interest rates are a good indicator of money tightness, at any time. I look at NGDP growth. When I look at Japan I see a huge slowdown in NGDP growth in the 1990s–which seems to me (and Milton Friedman) to be the main problem.

    That’s not to deny there were lots of malinvestments, but I don’t see that as the key problem.

  73. Gravatar of John Papola John Papola
    24. October 2010 at 10:59

    Scott,

    I’m talking about the boom which preceded (and triggered) the 90s slowdown. The question is WHY did NGDP slow down in the 1990s? The austrian answer is that the artificial credit expansion which made the 1980s bubbly and caused the malinvestments. Coordination between producers, consumers and savers was broken. So when it because clear that investments weren’t as profitable as expected and the projected demand for certain goods (like real estate) it became necessary for the structure of production to be, well restructured. That the effort to restructure was arrested by Keynesianism and zombification only made things worse.

    The 90s NGDP decline may have been a “secondary deflation”, but that says little about the cause at the turning point. Ignoring that cause seems to me to be a serious problem for everyone but the austrians. Given, I could be wrong, obviously. But I don’t understand why there is such a strong bias to ignore that upper turning point even in your responses. But, then, so did Milton.

  74. Gravatar of vjk vjk
    25. October 2010 at 06:51

    John:

    I am not sure how Austrian free bankers, such as Selgin, substantiate, numerically, a limit to credit expansion. I read Selgin’s book, but on the face of it, it seems that the constant stock of “base money” is not sufficient per se to prevent credit bubble from happening.

  75. Gravatar of ssumner ssumner
    25. October 2010 at 07:06

    John, The problem is that we can’t fix problems until we correctly diagnose them. No one denies that “malinvestment” can cause some problems for an economy, what we do deny is that major business cycles can be caused by malinvetment. If Australia had suffered a recession, I don’t doubt that Austrians in Australia would be now attributing it to “malinvestments” over the previous decade. But the BOA didn’t allow NGDP to fall, and hence they had no recession. So I think monetary policy is far more important than malinvestments. But I do agree that malinvestment in housing did contribute to the slight rise in unemployment between June 2006 and June 2008.

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