A serious error by Robert Hall and the JEP

The Journal of Economic Perspectives is a widely read journal that provides economists with relatively accessible (i.e. non-mathematical) articles on important issues.  The new issue focuses on the current crisis, with articles by famous economists such as Hall, Woodford and Ohanian.  The lead-off article by Robert Hall begins as follows:

The worst financial crisis in the history of the United States and many other countries started in 1929. The Great Depression followed. The second-worst struck in the fall of 2008 and the Great Recession followed. Commentators have dwelt endlessly on the causes of these and other deep financial collapses.  Less conspicuous has been the macroeconomists’ concern about why output and employment collapse after a financial crisis and remain at low levels for several or many years after the crisis.

If you’ve followed my blog you know that I don’t think those assertions are correct.  Indeed I don’t think they are even defensible.  Let’s start with the first two sentences.  The US did not suffer any sort of financial crisis in 1929.  Rather, the Great Depression began in August 1929, and the first crisis occurred at the end of 1930 (and was itself quite mild.)  A severe banking crisis did occur after Britain left gold in September 1931, by which time the US was already deep in depression.  Note how Hall’s intro leads the reader to assume causation ran from financial crisis to economic depression, when in fact the causation ran in exactly the opposite direction.  It is doubtful the US would have experienced any financial crisis during the early 1930s, if we had not seen NGDP fall in half.

I re-read the passage several times, trying to imagine what Hall could have had in mind.  Perhaps he was thinking of the 1929 stock market crash.  But there are two problems with that view.  First, a stock market crash is not a financial crisis.  And second, the 1987 stock crash was almost identical to the 1929 crash, and yet did not cause even a tiny ripple in the economy.  So no one would start a paper arguing that big stock market crashes cause recessions.  And if stock market crashes really were ”crises,” then 1987 should be considered one of the great financial crises in US history, and I think almost everyone would regard that assertion as crazy.  So I’m completely perplexed by what Hall (and the JEP editors who approved his manuscript) were thinking.  And remember that Hall is right up there with McCallum as one of my favorite macroeconomists.

The second pair of sentences are hardly any better.  The Great Recession (also the name I use) started in December 2007, long before the severe crisis of late 2008.  In fairness, the recession was not at all severe during the early months.  But if you look at the monthly GDP series from Macroeconomics Advisers, you’ll notice that the severe plunge took place between June and December 2008. The financial crisis occurred half way through that severe plunge in GDP (real and nominal.)

Why am I being so picky?  After all, we all know that intros are just flowery window dressing before economists get to the meat and potatoes of the paper.  To see why, consider the title of the paper:

Why Does the Economy Fall to Pieces after a Financial Crisis?

Hall has written a paper to explain stylized facts ”we all know are true,” that in fact are completely false.  The paper should be entitled:

Why are Financial Crises Preceded by the Economy Falling to Pieces?

And the intro should read:

The worst depression in the history of the United States and many other countries started in 1929. The Great Banking Panics followed.  The worst recession since the 1930s struck in December 2007, and dramatically worsened in July 2008.  The Great Financial crisis of the fall of 2008 followed. Commentators have dwelt endlessly on the causes of these and other deep financial collapses.  Less conspicuous has been the macroeconomists’ concern about why output and employment collapse before a financial crisis and remain at low levels for several or many years after the crisis.

We know that severe declines in NGDP are likely to cause severe declines in RGDP.  The reasons are murky, although I believe sticky wages are an important transmission mechanism.  There is more controversy about what causes NGDP to plunge.  But given the recession began in December 2007, and given the severe plunge in NGDP occurred between June and December 2008, it seems a bit hard to believe that the financial crisis of the fall of 2008 was the cause.

I was also a bit disappointed by the final paragraph of Hall’s paper:

In the category of blue-sky thinking, a few macroeconomists, including this writer when he has nothing better to do, think about how to work around the zero lower bound on interest rates. The key policy move to eliminate the bound is for the Fed to drop its unlimited willingness to issue currency, given that currency is, in effect, a way that the federal government borrows from the public at above-market interest rates. If the Fed stopped accommodating the swelling demand for currency, the existing stock of currency would appreciate—a $20 bill would buy more than $20 worth of merchandise, just as a British pound buys more than a dollar today. We are still pondering how the public would react to this departure from a century and a half of government currency issuance.

I’d rather see brilliant economists like Hall focus on pragmatic solutions for our AD shortfall, such as my “cocktail” policy of NGDP targeting (level targeting), negative IOR, and QE.  People are used to using currency as a medium of account—indeed its great convenience comes from the fact that its nominal price is fixed, making it extremely easy to use in transactions.  Suppose we did increase its value by ceasing to issue new currency, and suppose it remained a medium of account; where would we be then?  (Hint: the answer starts with the letter “d”.)


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30 Responses to “A serious error by Robert Hall and the JEP”

  1. Gravatar of Mark A. Sadowski Mark A. Sadowski
    12. November 2010 at 18:24

    Robert Hall wrote:
    “We are still pondering how the public would react to this departure from a century and a half of government currency issuance.”

    I’m still pondering what on earth he is talking about.

  2. Gravatar of Doc Merlin Doc Merlin
    12. November 2010 at 19:13

    The Fed will never do negative IOR, Scott. Their stockholders wouldn’t allow it.

  3. Gravatar of Tom Grey Tom Grey
    12. November 2010 at 20:41

    The economy falls to pieces after massive mal-investment. It then needs great recalculation and reinvestment.
    But the real mal-investment shows up as loan defaults after the real economy has fallen.

    And the real economy falls when there are multiple sectors falling, and no sectors growing (or not enough).

    This is made worse when wages are too high; and made much worse when gov’t wages are higher.
    Excess gov’t wage stickiness downward is the key reason the US will have low growth for the next many years.

  4. Gravatar of Niklas Blanchard Niklas Blanchard
    12. November 2010 at 21:15

    Hall will get a mini-test of his currency appreciation theory in about 20 years when BitCoin ceases issuing new currency…

    …provided BitCoin is around at that time.

  5. Gravatar of Benjamin Cole Benjamin Cole
    12. November 2010 at 22:34

    Scott-

    I have (as an amateur econ buff) been pondering sticky wages too. No doubt they play a role in stubborn declines in real output.

    Then I think I realized something else: Real estate.

    Loans are made in nominal dollars. People borrow money, and develop or buy property, placing a bet on the future. When the real economy declines, one cannot just back out of the deal–indeed, a building may be under construction, in lease-up etc.

    So real estate starts going sour–and banks feel that. They are very exposed to real estate. Indeed, if you are a small business, you likely cannot borrow unless you post real estate as collateral. Your equipment, your employees–almost all worth nothing. But if you own a warehouse, you can borrow from SBA. When values are rising, banks will lend on almost anything.

    Once real estate starts going down, it quickly snowballs. Banks stop lending, which fuels to downward trend, which makes buyers skittish, which gets into the general economy, worsening the general downward trend.

    The whole picture was worsened by loose underwriting standards in housing (although I must say, the commercial sector, including big office buildings, took a nearly equal whack in value).

    I would look to real estate as a linchpin in starting and prolonging recessions.

    It all goes back to loans made in nominal dollars–which is why I think it is so important to reflate real estate now, by any means necessary.

    Banks will lose money on real estate loans, and thus lend out less–further driving down real estate values, resulting in more bad loans etc. Maybe this is why Japan’s property bust, played out now over 20 years, has been so hard to right. People say Japan’s banks should have written down bad loans quickly–perhaps they did, but there was always fresh waves of new bad loans. That’s what happens when property values fall by 75 percent over 20 years. Egads, I hope they are bottom at long last.

    I think we may do a Japan, unless we somehow get Scott Sumner locked in a room with Bernanke for a week. Or if we could force Rush Limbaugh (since he seems to control the R-Party) to channel Sumner.

    Anyway, food for thought–real estate.

  6. Gravatar of Bill Woolsey Bill Woolsey
    13. November 2010 at 04:59

    Scott:

    Hall is right about suspensions of redeemability of deposits into currency.

    You are too focused on currency. Perhaps it is that Chicago background.

    Deposits can serve as medium of account and have negative nominal interest rates. Reserves are a type of deposit and can also have negative nominal interest rates (as you recognize.)

    If the Fed quits issuing currency, or only in limited amounts, and currency trades at a premium, this doesn’t mean that money (deposits) no longer serve as medium of account. It is just that currency no longer plays that role.

    I think it would really help your understanding of macroeconomics if you could get your head around the concept.

    I don’t see any conflict at all between nominal income targeting and quantitative easing and suspension of hand-to-hand currency convertibility. Suspension and negative interest on reserves are complements! Suspension and quantitative easing are substitutes, and the benefit of suspension is that it reduces the interest rate risk (and perhaps credit risk) that the Fed takes by purchasing long term (and maybe risky) bonds in large amounts.

    _The_ fundamental problem with the zero bound is the redeemabiliy in zero nominal interest rate hand-to-hand currency.

    The solution is to privatize the issue of hand to hand currency. Then, if the zero nominal bound is approached, banks will just quit issuing currency. The monetary system, based on deposits, would continue to operate. A dollar deposit account would still define the dollar unit of account. Electronic payments and checks would still work just fine. It is just that no one could get currency because no one would issue it. And nothing would prevent short term (overnight) interest rates from being negative.

    If the Fed wanted to do quantitative easing to make money (funding a portfolio of longer term bonds with positive yields with negative rate reserves) then it could. Just like the private sector could.

    By the way, contrary to your “flat AS curve” arguments, my calculations suggest that a prompt return of money expenditures to its trend growth path would involve nearly 10 percent inflation. I imagine that even Krugman would accept that real interest rates would not need to be less than -10 percent. Presumably, nominal interest rates would need to rise quite a bit, including the short term ones, and so the zero nominal bound would be left behind.

    But this is only a _solution_ to the current situation. How can the solution to the problem be–let NGDP fall to 13 percent below trend, and then when we get it back up, this will result in enough inflation and real growth to raise nominal interest rates?

    The goal should be to avoid any drop. The interesting issue is what happens if we are on target, and short term interest rates hit zero. A permanent increase in base money will fix it? No. Keeping on the target means that any increase in base money is tentative. A permanent increase in base money that will eventually raise the price level permanently might rise nominal interest rates, but it is against the rule.

    You entire approach amounts to–it will never happen. Maybe it won’t. But the way to keep it from happening is to either allow the Fed to suspend currency payments or else to have it purchase long term or risky bonds–take the risk and effectively create a subsidy for those wanting to hold low risk financial assets.

    The “let’s ignore banks and deposits” and focus on currency is a serious error of economic analysis.

  7. Gravatar of 123 – TheMoneyDemand Blog 123 - TheMoneyDemand Blog
    13. November 2010 at 06:13

    Bill,
    good points.

    “Then, if the zero nominal bound is approached, banks will just quit issuing currency.”
    They will certainly continue to issue currency for a fee (if such fees are prohibited, only the “best” customers would get new cash which amounts to the same thing). The size of such fee can be determined according to expected future interest rates and their expected volatility. The free market solution is to allow such fees.

    As bank asset portfolios have different credit risk and liquidity risk characteristics, not every bank will hit the zero nominal bound at the same time.

  8. Gravatar of TheMoneyIllusion » More evidence the recession was not caused by the financial crisis TheMoneyIllusion » More evidence the recession was not caused by the financial crisis
    13. November 2010 at 07:00

    [...] night I criticized a new Robert Hall article in the JEP, which argued that the financial crises of 1929 and late 2008 caused the Great [...]

  9. Gravatar of Philo Philo
    13. November 2010 at 08:12

    A civics-lesson request (prompted by Bill Woolsey’s comment): Please tell me how the government–the Fed, I presume, issuing orders to the Mint (or is there a different chain of command?)–decides how much paper currency to issue and how many coins to produce. Besides replacing worn-out currency and coins that are presented to it (mainly by commercial banks, I presume), how does it get new currency and coins into circulation?

  10. Gravatar of scott sumner scott sumner
    13. November 2010 at 08:26

    Mark, Check out Bill’s comment.

    Doc Merlin, I think banks might benefit from negative IOR–if it created a robust recovery.

    Tom, I agree about wage stickiness, but malinvestment should not cause a big drop in production (and didn’t between mid-2006 and mid-2008, when the malinvestment problem was at its worst.)

    Niklas, I am afraid I don’t know much about that–why will they cease issuing Bitcoins in 20 years?

    Benjamin, I agree that real estate play a big role in the gradual slowdown between mid-2006 and mid-2008, but I don’t think that’s enough to explain the sharp plunge after mid-2008. I think you need to look at AD (NGDP.)

    Bill, You said;

    “Deposits can serve as medium of account and have negative nominal interest rates. Reserves are a type of deposit and can also have negative nominal interest rates (as you recognize.)
    If the Fed quits issuing currency, or only in limited amounts, and currency trades at a premium, this doesn’t mean that money (deposits) no longer serve as medium of account. It is just that currency no longer plays that role.”

    Yes, I understand that MIGHT happen, but I also suggested that we don’t know for sure, we’ve never tried that. Isn’t it possible that the rise in the value of currency would occur via deflation, and that currency would still serve as a medium of account? People think of a dollar bill as being worth a dollar. I’m not sure it’s going to be easy to convince the public that the dollar bill is worth 1.145 cents when they shop at WalMart. Convenience is the great advantage of currency. I agree that in the long run all currency will be replaced with electronic money, and then you, I, and Hall will all be on the same page–no more liquidity traps. But I think it is too soon.

    My other objection is that this policy is totally unnecessary. Bernanke insists the Fed has plenty of tools to boost AD, he just doesn’t think these tools are needed at this point; he thinks the recent QE will provide the optimal rise in AD. So there is no reason to examine policy which would cause massive inconvenience to the public. Remember, millions of people don’t even have bank accounts—what are they going to do?

    You said;

    “By the way, contrary to your “flat AS curve” arguments, my calculations suggest that a prompt return of money expenditures to its trend growth path would involve nearly 10 percent inflation.”

    That is not contrary to my flat SRAS assumption, because you are contemplating a much bigger rise in NGDP than I am. I am suggesting it is rather flat at current levels of AD. I discussed how 6% or 8% rises in NGDP would be mostly real–I agree that if we tried to quickly return to the pre-2008 NGDP trend there would be lots of inflation.

    123, See my answer to Bill. I don’t see what problem is being addressed here–it’s not like we don’t know how to boost AD.

  11. Gravatar of scott sumner scott sumner
    13. November 2010 at 08:29

    Philo, I am pretty sure they respond to bank requests, which in turn responds to public requests. Suppose the public chooses to hold more cash and less bank deposits. The public withdraws cash and bank vault cash levels decline. Banks ask the Fed for some cash to rebuild vault cash, and the Fed gives the banks cash and subtracts the amount from the bank’s reserves at the Fed. The base is unchanged. In practice the Fed might restore those reserves by boosting the monetary base via OMPs, to prevent deflation.

  12. Gravatar of 123 – TheMoneyDemand Blog 123 - TheMoneyDemand Blog
    13. November 2010 at 09:11

    Scott, negative interest rates are a cheap and credible way to boost AD. QE2 is less credible and potentially more expensive.

    “Isn’t it possible that the rise in the value of currency would occur via deflation, and that currency would still serve as a medium of account?”
    Currency will continue to serve as a medium of account in some unimportant cases (illegal drugs, etc.). It is important to pass a law whereby electronic money is a legal tender for sticky transactions (wages, mortgages, other long term financial contracts).

  13. Gravatar of Bill Woolsey Bill Woolsey
    13. November 2010 at 09:34

    Scott:

    Your theory that the price level would follow inconvertable currency and deposits would have a discount (or just disappear) is entirely unrealistic.

    The most likely scenario is people quit spending currency but continue to write checks and make electronic payments. Walmart continues to charge the _same_ prices (or continue with the existing trajectory of prices) and accept checks and electronic payments at par. People continue to get paychecks at par (or direct deposit.) They continue to have balances in their deposit accounts as before. They continue to write checks or make electronic payments to pay bills and buy goods.

    Poor people who operate on a currency basis, vending machines, sidewalk vendors, shops that don’t have pos terminals–they are all screwed. There will be a massive switch over.

    You tell me your process.

    Walmart responds to the drop in currency sales by lowering prices enough to increase currency sales to previous levels. Because deposits can no longer be redeemed for currency, but rather must be exchanged for currency on some kind of secondary market, Walmart begins to use that exchange rate to post a discount for checks and electronic payments. Employers begin to use that discount and increase the size of everyone’s paychecks so that the amount they can cash the checks for at the secondary market allows them to get the same amount of currency.

    Come on! The result is that prices and wages will all stay tied to deposit money, and there will be a shortage of currency at those prices. And Gresham’s law will result in no currency being spent.

    If currency is privatized, the chance that prices will follow private currency rather than deposit payments system is slim to none.

    Think about it.

  14. Gravatar of Bob OBrien Bob OBrien
    13. November 2010 at 09:45

    Scott said:

    “..Undoubtedly those crises worsened each slump by further depressing AD, but they weren’t the cause—tight money was…”

    What caused the “tight money”?

    I am assuming that when housing went bust people stopped using their homes as piggy banks and this is what caused tight money. If this is true then could it be that the house price decline caused the crises not tight money and tight money was a result of the crisis not the cause of the crisis.

  15. Gravatar of Jim Picerno Jim Picerno
    13. November 2010 at 11:01

    Of course, the really big question is why recessions occur at all? Economic contractions may or may not be accompanied by a financial crisis, or a stock market crash. But explaining why recessions occur in a convincing, economically logically way is elusive. Or perhaps I’m misinformed?

  16. Gravatar of Robert Simmons Robert Simmons
    13. November 2010 at 20:15

    Scott, your assertion is that GDP was already dropping when Lehman failed. But looking at the monthly numbers, I don’t see it. True, NGDP dropped 10% in August, but it rose 15% in June; August’s # was higher than April’s, and it seems likely to me that the drop in August from June/July was just a reaction to the unusual jump in May (when the first stimulus package occurred). Yes, the economy was weak before the s#*! went down, but if we take the July/August/September shrinkage as the post-stimulus effect, the big drops are in October (-9%), and in December (-22%), which I think we can interpret as reactions to Lehman.
    What am I missing?

  17. Gravatar of Two on the Drum! «  Modeled Behavior Two on the Drum! «  Modeled Behavior
    14. November 2010 at 03:04

    [...] the concepts into the framework of a financial crisis leading to disaster which they already hold. Reverse causality, and it is much easier to explain [...]

  18. Gravatar of Bill Woolsey Bill Woolsey
    14. November 2010 at 06:19

    By the way, if there is no hand to hand currency, poor people take their paychecks to thank bank and purchase pre-paid debit/credit cards. Unlike the current ones, they have to be dated (good for a month, say) and the fee for this (cashing a check with no checking account and purchasing a pre-paid credit/debit card) would be higher, the lower market interest rates.

  19. Gravatar of scott sumner scott sumner
    14. November 2010 at 09:19

    123, I agree about negative rates, but since they are apparently not politically feasible for the Fed, I’m also supporting QE as better than nothing. I actually think zero rates plus a NGDP target, level targeting, would be enough. But if we need negative IOR, let’s do it.

    Bill, I was assuming currency would also trade at par with deposits. I admit that I can’t be sure, but to me it seems a moot point, because even if it “worked” exactly as you said, it would be a disastrously inefficient policy on microeconomic grounds, Currency is very convenient, I see no benefits from getting rid of it.

    I was not assuming privatization of currency, I thought you simply meant no more currency issued.

    Bob, Here’s an answer I just gave on another thread:

    Even in the first half of 2008 the Fed did enough to prevent a severe recession. The cause of the recession was their passivity after June. Here’s an analogy. If Russians hoard lots of US currency after communism collapses, and if the Fed doesn’t accommodate that hoarding, and if real interest rates rise as a result, and if the economy goes into recession, EVERYONE will blame the Fed. NO ONE will blame the Russians. In fact foreigners often do hoard lots of currency, and the Fed accommodates those increases.

    If banking turmoil increases the demand for base money very modestly between April and November 2008, and the Fed doesn’t accommodate that modest increase, and if real interest rates rise sharply, and if we go into a severe recession as a result, who’s fault is that?

    Jim, Two questions: Why does NGDP have cycles? That’s easy to explain–monetary shocks. Why do NGDP cycles lead to RGDP cycles? The most common answer is wage/price stickiness.

    Robert, Those are very good arguments, but I am relying on more than the MA data.

    1. RGDP was significantly lower in August than April. Hall would probably look at RGDP.) RGDP fell at a sharp 4% rate in 2008:Q3. The reason NGDP was a bit higher was because of inflation (which was fairly high at the time.) But NGDP was falling significantly below trend growth.

    2. I agree that the worst declines occurred after Lehman, but I have two responses:

    a. I think the decline in expected future NGDP contributed to the economic crisis.
    b. More importantly, the stock market reaction to events tells me it was Fed passivity, not Lehman itself, which was the main problem. Stocks fell somewhat after Lehman, but not all that dramatically. The big crash was in early October and I believe that was due to disappointment that the Fed did not take aggressive action to stimulate the economy. I haven’t done a complete study, but I remember one day in October when the news discussed how stocks crashed on a disappointingly small rate cut from the ECB. We know from September and December 2007 Fed announcements that the stock market reacts very strongly to monetary policy surprises when there is the threat of recession. The Fed was ultra-passive in the first week of October, with their only action being contractionary–I think this caused the crash. There was no special banking news during the October crash. And when the banking system stabilized after November, but NGDP kept falling, the economy and stock market got worse. Then the Fed did QE1 in March 2009, and the economy and markets gradually improved–despite no change in the banking crisis.

    Having said all that, I agree that if the financial crisis hadn’t happened, the demand for base money would have been less, and the recession would have been much milder.

    I agree your observation does weaken my argument–it’s just that I am not able to do the full argument in each post–I must simplify.

    Bill, I know lots of people who deal only in cash. If the government wants to ban cash to smoke out the underground economy, that’s their right. But I don’t see that as monetary policy, that’s a fairly radical expansion of the government’s ability to know everything we do. 1984 is on the way with electronic cars (GPS), money, toll booths, retina scans, etc.

  20. Gravatar of Robert Simmons Robert Simmons
    14. November 2010 at 11:08

    Scott, fair enough about not being able to give the full argument each time. I actually don’t think we disagree a whole lot. Economy was weak but not terrible, with housing and banking the most vulnerable sectors, and when people began to get scared the Fed made some small positive moves and some significantly negative moves; normally that wouldn’t be all that bad, but the timing was awful. Since then the Fed has only partially moved back to where they should.

  21. Gravatar of Bob OBrien Bob OBrien
    14. November 2010 at 12:46

    Scott said:

    “..Even in the first half of 2008 the Fed did enough to prevent a severe recession. The cause of the recession was their passivity after June…”

    There are two people and a policeman in a room. One person pulls out a gun and shoots the other person. The policeman doesn’t prevent the shooting but does put the shooter in jail. Did the policeman cause the shooting?

    The fed did not prevent the crisis after June but is it fair to say they caused the crisis?

  22. Gravatar of Doc Merlin Doc Merlin
    14. November 2010 at 18:08

    @ Bill Woosley:

    Does that suggests that the higher monetary aggregates are mostly endogenous (but the Fed wiggles the levers a bit)? If so, how would NGDP targeting work? I’m unsure what endogenous money would mean.

  23. Gravatar of Norman Norman
    14. November 2010 at 21:02

    @ Bob OBrien

    No, the policeman didn’t cause the shooting, but if the policeman could have readily prevented the shooting and didn’t, it would be surprising if the policeman weren’t reprimanded or possibly sacked.

    I think this fits with Scott’s general position, which seem to be that the Fed didn’t precisely cause the financial crisis, but through negligence did cause the recession.

  24. Gravatar of scott sumner scott sumner
    15. November 2010 at 06:47

    Robert, I agree.

    Bob, Your analogy doesn’t work because it’s not the Fed’s job to be passive. If the Fed keeps interest rates fixed they are not “doing nothing” they are adopting an increasing tight monetary policy (in 2008). BTW, for what it’s worth there is not one economist in a 1000 who would agree with you as a matter of general principle. In the Russian currency hoarding analogy I gave you virtually all economists would agree with me. They don’t agree with me on 2008, but I still haven’t heard a good explanation of why.

    And yes, if a cop didn’t stop a mentally retarded person from shooting another person, EVEN IF HE COULD HAVE EASILY DONE SO, then I would blame the cop–no doubt about it. The market is not an individual, and hence is not morally culpable for its effects. (although individual bankers may be–but no individual banker caused the crisis.)

    Norman, Yes, we think alike.

  25. Gravatar of Bob OBrien Bob OBrien
    15. November 2010 at 08:56

    Scott,

    The policeman was not passive, he just did not know the guy was off his rocker and was not fast enough to stop him from shooting. Maybe the fed just did not figure out that the crisis was upon us in time to act in advance.

    I have read many economic blogs and yours is the only one that Ive found that predicted in advance that the fed needed to take action to avoid a crisis. It seems to me that this was caused by a financial system that was very unstable and just went up in smoke before the fed police could stop it.

  26. Gravatar of 123 – TheMoneyDemand Blog 123 - TheMoneyDemand Blog
    15. November 2010 at 16:13

    Scott, you said:
    “123, I agree about negative rates, but since they are apparently not politically feasible for the Fed, I’m also supporting QE as better than nothing. I actually think zero rates plus a NGDP target, level targeting, would be enough. But if we need negative IOR, let’s do it.”

    My preference is to have NGDP level target, combined with credit easing when zero bound applies. Bernanke described credit easing as one of the options in his 2002 deflation speech:
    “Unlike some central banks, and barring changes to current law, the Fed is relatively restricted in its ability to buy private securities directly. However, the Fed does have broad powers to lend to the private sector indirectly via banks, through the discount window. Therefore a second policy option, complementary to operating in the markets for Treasury and agency debt, would be for the Fed to offer fixed-term loans to banks at low or zero interest, with a wide range of private assets (including, among others, corporate bonds, commercial paper, bank loans, and mortgages) deemed eligible as collateral. For example, the Fed might make 90-day or 180-day zero-interest loans to banks, taking corporate commercial paper of the same maturity as collateral. Pursued aggressively, such a program could significantly reduce liquidity and term premiums on the assets used as collateral. Reductions in these premiums would lower the cost of capital both to banks and the nonbank private sector, over and above the beneficial effect already conferred by lower interest rates on government securities.”

    I think it was a huge mistake that credit easing was restricted only to a brief period before QE1.

  27. Gravatar of scott sumner scott sumner
    16. November 2010 at 05:46

    Bob, I am not asking the Fed to predict better than they can, just target the forecast. They should set policy at a point where even THEY think NGDP growth will be on target. They didn’t do that, they set policy at a level where even they expected to fail (in October), and said so. Then they asked Congress for fiscal stimulus–which was stupid to do, given monetary stimulus is much more effective, and also doesn’t balloon the deficit.

    Yes, in September the problem was they made a bad forecast, and should have paid more attention to market forecasts.

    123, I’m no expert on credit easing. My instincts tell me it’s not needed if they do the other things well. But of course they didn’t do the other things well—and I completely agree that credit easing is much better than severe recession.

  28. Gravatar of Scott Sumner Assumes a Can Opener Scott Sumner Assumes a Can Opener
    18. December 2010 at 17:47

    [...] sometimes, and ignores the economics of what he is saying. The most blatant example I’ve seen came in November when Scott (yes, I think we are on a first-name basis) was taking Robert Hall to [...]

  29. Gravatar of TheMoneyIllusion » A note on the financial crisis of 1929 TheMoneyIllusion » A note on the financial crisis of 1929
    23. March 2012 at 17:52

    [...] Robert Hall made a similar mistake in the opening sentences of an important JEP paper published in 2010: The worst financial crisis in [...]

  30. Gravatar of TheMoneyIllusion » Keep banks out of macro TheMoneyIllusion » Keep banks out of macro
    22. January 2013 at 11:27

    [...] fact, macroeconomists grossly overrate the importance of banking.  Robert Hall started off a recent survey article with the conventional wisdom: The worst financial crisis in the [...]

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