Conservatives for monetary stimulus

This article in the National Review is a very fair and balanced look at the pro- and anti-monetary stimulus camps.   Ramesh Ponnuru points out that a number of economists generally regarded as right of center have favored monetary stimulus and/or a higher inflation target.  He mentions John Makin, Greg Mankiw, David Beckworth and yours truly.  There are others as well, many of whom have blogs (Bill Woolsey, etc—I won’t try to mention all the names because I’m never sure who likes being called conservative.  I prefer the term ‘right-wing liberal.’)  The article also mentions George Selgin’s productivity norm.  BTW, people have asked me about his co-authored piece on the Fed (which is excellent) and I plan a post soon.

The article points out that the left is also split, although among professional economists I think liberals are significantly more in favor of stimulus.  Brad DeLong has a new post that shows the famous graph of NGDP growth falling far short of trend, and then makes this point:

The problem with our economy is not that something bad happened to our productive capacity while the flow of nominal spending continued to blip along, it is that something bad happened to the flow of nominal spending and that carried real production and employment down with it. At the moment our flow of nominal spending at $14.7 trillion per year is some 12% below its pre-2008 trend. And in the absence of any 12% decline in prices and wages, that shortfall in spending has to produce our current macroeconomic distress: there is not enough “money” to support enough of a flow of spending to chase all the goods we could produce. We don’t have a deficiency of real supply (for whatever reason). We have a deficiency of nominal demand.

That’s what John Walter Bagehot would say. That’s what Irving Fisher would say. That’s what Jacob Viner would say. That’s what Milton Friedman would say.

And they would say that it is a central bank’s business to intervene in asset markets to boost the flow of nominal spending back to what everybody expected it to be and counted on it being

Excellent points.  But before DeLong does too much conservative bashing, he might want to ask which two blogs were best known for presenting quite similar arguments for monetary stimulus in February 2009, and what was the political orientation of those two bloggers.  And by late 2009 you could have added Bill Woolsey.

HT:  JimP, for both links.


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41 Responses to “Conservatives for monetary stimulus”

  1. Gravatar of Liberal Roman Liberal Roman
    15. November 2010 at 17:52

    Umm…but now we also have this

    http://economics21.org/commentary/e21s-open-letter-ben-bernanke

    I wonder if the recent stock decline has been in expectations that Bernanke will fold to all of the criticism.

  2. Gravatar of Doc Merlin Doc Merlin
    15. November 2010 at 18:13

    I’m more on the right (as a libertarian) and I strongly oppose QE2, mostly because I think it will further inflate the gold/food/commodities bubble we are experiencing. I think a better option would have been a drop in the interest rates (no interest on reserves) combined with allowing the banks to fail, then the Fed bailing out FDIC if it needed to (it looks like it wouldn’t have had to from the data I am looking at now.)

    Ultimately however, the fed needs to be replaced with a something that isn’t an arbitrary centrally planned power. Your plan, Bill’s plan, George Selgin & Larry White’s Plan, Hayek’s plan in The Denationalization of Money, Friedman’s plan to replace it with a computer, would all be improvements on what we have now.

  3. Gravatar of JTapp JTapp
    15. November 2010 at 18:17

    I can’t believe the WSJ publishes this stuff. But it’s all over everywhere. Economics21 backs their boss’s play. The Weekly Standard joins the fight. Art Laffer disciple Scott Grannis announced the return of the bond market vigilantes a few days ago. The people who signed the letter are apparently trying to influence the House to neuter the Fed.
    You’re not a conservative in their eyes, Scott. Anyone with any reasoning that includes the words “aggregate demand” is a “Keynesian.”

  4. Gravatar of Morgan Warstler Morgan Warstler
    15. November 2010 at 18:28

    “And in the absence of any 12% decline in prices and wages, that shortfall in spending has to produce our current macroeconomic distress: there is not enough “money” to support enough of a flow of spending to chase all the goods we could produce.”

    I take this as a full on support from DeLong to a 25% cut to Public Employee Compensation in the aggregate… and another 10% fall in housing prices, which will get us MUCH CLOSER to where we need to be.

    Meanwhile Scott… please notice the important thing gets the National Reviews attention:

    “This policy would, in the short run, increase inflation, but to a low rate; we have averaged higher than 2 percent inflation for each of the last five decades. Eventually it would yield a gentle, long-term deflation: Prices would fall during periods of productivity growth. (George Selgin, an economist at the University of Georgia, has made an elegant case that productivity-driven deflation is not dangerous.) Beckworth cites evidence that both Milton Friedman and Friedrich Hayek favored something like this approach of stabilizing nominal spending.”

    How many times have I said this?

    The beauty of you is not the little bit more inflation we get right now, it is pissing on booms that we get long term.

    The promise that we don’t risk overheating again is the best part, and you NEVER really harp on that. Why?

  5. Gravatar of Richard W Richard W
    15. November 2010 at 19:05

    Quite bizarre to listen to monetarists arguing against monetarism. Conservatives opposing the monetary authority actually conducting monetary policy. I am sure somewhere in their head it all makes sense but alas they have not let the rest of us into the secret. I am sure the most dogmatic members of the ECB would heartily endorse the WSJ letter signers. However, since the current state of the eurozone periphery is their handiwork. Maybe it is not such a good endorsement.

    A good contrast is a right-wing monetarist like Tim Congdon. Although he concedes there is not much of a case for the BoE to conduct more QE at this time. He still believes the Bank should do it anyway as a ‘ pre-emptive strike ‘. The only hope of having a sustainable fiscal budget is to have above-trend growth.

    ‘ However, somewhat above-trend growth would now be desirable – and not only for its own sake. Early above-trend growth would also lead to a speedier return to a balanced budget and hence a lower long-run debt interest burden. ‘

    http://www.timcongdon4ukip.com/docs/imrltdnotes.pdf

  6. Gravatar of George Selgin George Selgin
    15. November 2010 at 19:12

    I’d like to know precisely where it is that Bagehot argues that central banks should inervene to stabilize nominal spending. (Lending freely to solvent banks during an external drain is another matter.)

  7. Gravatar of Doc Merlin Doc Merlin
    15. November 2010 at 19:12

    @Richard W.

    Um, thats what monetarists did. Their belief, was that monetary policy was too dangerous to leave to an arbitrary authority like the fed. This is why Friedman suggested replacing the fed with a computer, and why Taylor suggested replacing it with his rule.

  8. Gravatar of Doc Merlin Doc Merlin
    15. November 2010 at 19:18

    Oh, I should add, also why Scott suggested using an NGDP futures market to adjust money supply.

  9. Gravatar of scott sumner scott sumner
    15. November 2010 at 19:35

    Liberal Roman, Yes, that was the subject of the DeLong post I linked to.

    Doc Merlin, I regard the word ‘bubble’ as one of the most meaningless concepts in the English language, but I must admit this is the first time I had heard of a food bubble. I take it people are hoarding jars of peanut butter in anticipation of future price rises in peanut butter?

    Just out of curiosity, what is the difference between a food “bubble” and a rise in food prices? And if the answer relates to whether the price rise is “justified,” which omniscient God will inform us when price rises are justified?

    At least we agree about the Fed.

    JTapp, Then Milton Friedman is not a conservative.

    Morgan, This recession wasn’t caused by previous overheating, the housing problem were caused by inept federal housing policies and some stupid decisions by private bankers. Monetary policy can’t fix that. At best, easy money explains 20% of the housing boom. In earlier years we often had much easier money w/o any housing boom at all.

    Richard, Yes, Tim Congdon is also someone I could have mentioned.

    George, You may be right. DeLong is more of an economic historian than me (of the 19th century, not the 20th) so I assumed he had some passage in mind. But then I recall he is often sloppy and shoots from the hip, so it wouldn’t surprise me if he slipped up on that one.

    Doc Merlin, But he also said the Fed should offset obvious changes in velocity, which they are not doing. And he certainly wouldn’t have favored adopting an IOR policy in the midst of a panic. (Note, even if 123 is right about IOR, I know Friedman’s views pretty well, and he would have opposed IOR because he would have looked at it from a supply and demand for money perspective, not an interest rate perspective.

  10. Gravatar of Richard W Richard W
    15. November 2010 at 19:39

    @ Doc Merlin

    Maybe if they were an arbitrary authority they would get on better. It seems to me everyone in the US wants to be chairman of the Fed.

  11. Gravatar of Morgan Warstler Morgan Warstler
    15. November 2010 at 20:14

    “Morgan, This recession wasn’t caused by previous overheating, the housing problem were caused by inept federal housing policies and some stupid decisions by private bankers. Monetary policy can’t fix that. At best, easy money explains 20% of the housing boom. In earlier years we often had much easier money w/o any housing boom at all.”

    Scott, you’ve never clearly responded to the counter your piffle:

    Fraud. Outright criminal fraud. It wasn’t just “easy money” it was the culture the Fed acted like was normal, and was criminal.

    I knew countless people who were taking out mortgages in SoCal – so they could take cash out at close and live on it. They had no other income. Mortgage guys were trolling Craigslist looking for people with 700 credit scores and no job. Whole histories were being forged.

    And Greenspan owns ALL OF THAT.

    And frankly, is you listen to Greenspan when he’s on Sunday morning TV – Meet the Press yesterday – he totally lifts the fed skirt and explains what is going on.

    He say the long term assets (read mortgages) are illiquid, and that right now we are at the cusp of the 8 MILLION (he has the stats down cold) standard conforming loans (20% down) toppling into upside down…. this is the moment when the home owner has LOST their entire deposit even after making payments for the past 5 years…. and the ONLY thing Greenspan is focused on like a laser is keeping those prices from falling.

    The whole of fed targeting is housing prices – it is not CPI.

    And the stock market is check Ben uses to see if he can keep trying to keep housing from going down… I thought you were right until Sunday, but he isn’t dating the Stock Market, he’s married to housing prices.

  12. Gravatar of Greg Ransom Greg Ransom
    15. November 2010 at 20:29

    Scott, you may find this paper of some interest:

    http://reason.org/files/federal_reserve_monetary_policy_hayek_rule.pdf

    “The Hayek Rule: A New Monetary Policy Framework for the 21st Century”, (pdf) by Marius Gustavson and Anthony Randazzo Nov. 9, 2010. Quotable:

    “We propose a new policy framework for monetary policy, one that looks at monetary aggregates and factors in the connections between monetary policy and asset prices. Our proposed “Hayek rule” is a symmetrical approach that seeks to stabilize nominal income, in both good and bad times,
    through a system in which the annual flow of money—what we will refer to as the “circulatingmedium of exchange,” which is equal to nominal spending (MV)—remains at a constant level.”

  13. Gravatar of Greg Ransom Greg Ransom
    15. November 2010 at 20:33

    Scott, using your own dictionary, by definition these guys CAN’T be “conservatives”.

    You’ve repeatedly defined “liberal” as someone who advocates stimulus, and you’ve defined “conservative” or “right wing” as someone who opposes it — and this taxonomy over-rides any other consideration, as you’ve used these labels.

    So there is no such thing as a “conservative” who favors “stimulus”.

    It’s a conceptually impossible category — as YOU have taught us to use the language.

  14. Gravatar of Full Employment Hawk Full Employment Hawk
    15. November 2010 at 20:37

    “Friedman’s plan to replace it with a computer, would all be improvements on what we have now.”

    Friedman’s computer would have held the rate of growth of M2 constant when the velocity of M2 fell sharply, which would have caused a major recession or depression.

    When a plane is flying through an uncharted mountain range, the last thing you want to do is put it on autopilot.

  15. Gravatar of Full Employment Hawk Full Employment Hawk
    15. November 2010 at 20:42

    “why Taylor suggested replacing it with his rule.”

    Taylor’s rule now calls for a negative federal funds rate target.

    Lots of luck with that rule.

  16. Gravatar of Doc Merlin Doc Merlin
    15. November 2010 at 20:49

    @Scott Sumner:
    ‘Doc Merlin, I regard the word ‘bubble’ as one of the most meaningless concepts in the English language, but I must admit this is the first time I had heard of a food bubble. I take it people are hoarding jars of peanut butter in anticipation of future price rises in peanut butter?’

    “I take it people are hoarding jars of peanut butter in anticipation of future price rises in peanut butter?’”

    Funny Scott, but no, they are hoarding food commodity futures and since only a tiny percent of futures are actually taken delivery of, its no different than a stock bubble, except it controls the price of the underlying commodity.

    There are even agricultural commodity ETFs which purchase commodity futures and traded on the stock exchanges.

    From seeking alpha:
    “Agricultural commodities include cocoa (NIB), coffee (JO), cotton (BAL) and sugar (SGG) — all ETNs. Agriculatural commodity baskets cover livestock (UBC, COW), grains (JJG, GRU), softs — ie. coffee, cotton and sugar — (JJS), biofuels (FUE) and food (FUD). Broader agricultural indexes are also available via ETF (DBA) or ETN (UAG, JJA, RJA).”

    Note these financial products are not ETFs that invest in agri/food companies, but speculate in the food futures themselves.

  17. Gravatar of Doc Merlin Doc Merlin
    15. November 2010 at 20:55

    @Full inflation hawk.

    “Friedman’s computer would have held the rate of growth of M2 constant when the velocity of M2 fell sharply, which would have caused a major recession or depression.”

    Wouldn’t have happened if we hadn’t of been paying IOR.

    “When a plane is flying through an uncharted mountain range, the last thing you want to do is put it on autopilot.”

    Hardly unprecedented, this recession started very similarly to the 1920 panic.

    ‘“why Taylor suggested replacing it with his rule.”

    Taylor’s rule now calls for a negative federal funds rate target.

    Lots of luck with that rule.’

    Taylor says his original rule doesn’t, but a taylor rule that others have used does. Also, removing the IOR would probably be enough to fix any such problems.

  18. Gravatar of Cameron Cameron
    15. November 2010 at 21:30

    Tonight for the second week in a row I found myself arguing with a table full of “conservative” economists over whether monetary policy is too tight.

    Last week it was a table full of GMU Austrian undergrads. I found them surprisingly accepting of the idea that QE2 is a good thing. One student said she was “shattered” by my (your) arguments. Everyone at least admitted they made sense.

    Tonight it was Jeffery Miron(who is not an Austrian) and a handful of other Austrian leaning guys. Again they seemed surprisingly receptive. Miron was worried about inflation and thought markets were predicting potentially high inflation, but he seemed fairly convinced when I told him higher 30 year yields probably reflect higher real growth expectations, gold is wishy washy and TIPS spreads were probably the best predictor. They all still agreed the Fed should be abolished, but I think I pushed them toward QE2 if we do have a Fed (mostly by evoking EMH and Friedman).

    It wouldn’t surprise me if conservative economists(although not laymen) were actually easier to convince than liberal ones. They are especially receptive to the idea of setting monetary policy with markets rather than with a panel of experts.

    Oh and although I’d like to think it’s all me, I’m just basically repeating your arguments. At the end of our conversation Miron appropriately said “Sumner’s ideas certainly are interesting.”(in a good way)

  19. Gravatar of Richard W Richard W
    15. November 2010 at 22:51

    Pretty strong to say that buying long futures ‘ controls the price of the underlying commodity ‘, Doc Merlin. Are you saying without taking actual delivery of the asset that one can with trading paper futures set the price of the underlying regardless of the supply and demand for the asset? In a liquid market short and long futures should reach an unbiased expectation of the future price. However, the underlying is still determined by supply and demand.

  20. Gravatar of David Pearson David Pearson
    15. November 2010 at 23:03

    Most conservatives prefer to limit technocratic discretion of any stripe. Rules-based policy is therefore a logical choice. The problem is monetary policy cannot be rules-based if it is inherently asymmetric in the presence of a large output gap. Discretion is what results when inflation expectations overshoot and unemployment remains stuck above 8%.

    The response, “that will never happen,” is a prediction, not a discretion-limiting contingency plan. Unfortunately, such a degree of certainty was last assigned by technocrats to the probability of falling house prices.

  21. Gravatar of Greg Ransom Greg Ransom
    15. November 2010 at 23:04

    Here’s a color version of the Sumner QE2 dialogue:

    http://www.xtranormal.com/watch/7687255

  22. Gravatar of Full Employment Hawk Full Employment Hawk
    15. November 2010 at 23:35

    ““Friedman’s computer would have held the rate of growth of M2 constant when the velocity of M2 fell sharply, which would have caused a major recession or depression.”

    “Wouldn’t have happened if we hadn’t of been paying IOR.”

    The Fed only recently started paying interest on reserves. This happened years ago at the time the Fed was abandoning money supply targeting. I don’t remember the exact year offhand.

  23. Gravatar of Morgan Warstler Morgan Warstler
    16. November 2010 at 02:38

    “Friedman’s computer would have held the rate of growth of M2 constant when the velocity of M2 fell sharply, which would have caused a major recession or depression.”

    I thought Friedman would increase M when V fell?

  24. Gravatar of Lorenzo from Oz Lorenzo from Oz
    16. November 2010 at 02:41

    In an online world, we have animated satire of Fed Policy. It is even funny. (This is not an endorsement of its economic analysis.)

  25. Gravatar of Lorenzo from Oz Lorenzo from Oz
    16. November 2010 at 02:50

    Now I feel silly, you linked to that video in your previous post. It is a problem, keeping up with the speed of online world :)

  26. Gravatar of Steve Steve
    16. November 2010 at 03:44

    Well, if it’s fair game to post links to animated satire, I figure the below link fits the bill. I’m just not sure if its a satire of monetary policy, politics, or simply journalism.

    “If the Fed starts printing money out of thin air…we talked a little about chocolates and what’s happening there…and the unpredictable volatility of the world there could be an activity that takes place that really drives inflation.”

    http://www.youtube.com/watch?v=vjWbDzmfMtw

  27. Gravatar of JTapp JTapp
    16. November 2010 at 06:10

    Scott, do you think if the FOMC had announced they were pursuing level targeting, explicitly named a target, that John Taylor & co. would still be opposed? My guess from reading his blog is that he wouldn’t be. He wants them to follow coherent policy rules.

  28. Gravatar of scott sumner scott sumner
    16. November 2010 at 06:41

    Morgan, The big banks thought these MBSs were great investments–even in 2007 they were buying ones they had previously sold. You can’t expect government bureaucrats to know something the big banks themselves didn’t know.

    Greg, I’ve never once defined liberal as someone who favors stimulus. I define liberal as roughly utilitarian, and right wing liberals as utilitarians who think the market is very effective at meeting their goals, and left liberals as those more skeptical of the market.

    Thanks for the link.

    Full Employment Hawk, I favor a NGDP rule, implemented by the market (use of NGDP futures contracts). I agree with you about the rigidity of the Friedman and Taylor Rules. My rule is sort of like replacing the FOMC with the entire market, and letting the market use discretion to avoid crashing into mountains.

    Doc Merlin, As I recall people have been trading commodity futures for decades, so you didn’t answer my question as to how you distinguish between food price increases and food price bubbles. Something tells me I won’t find your answer persuasive, but I’ll keep an open mind until I hear it.

    Cameron, You said;

    “Last week it was a table full of GMU Austrian undergrads. I found them surprisingly accepting of the idea that QE2 is a good thing. One student said she was “shattered” by my (your) arguments. Everyone at least admitted they made sense.”

    That made my day. BTW, I have disagreed with Miron on money, but I love his stuff on drug legalization.

    Richard, I agree.

    David Pearson, Yes, but we have discretion right now, and the Fed must do SOMETHING. So conservatives ought to be recommending the Fed does a good thing, not a bad thing. They are always doing something, even if the money supply is unchanged.

    Greg, Thanks, but I prefer uncolorized versions of classic films. :)

    Morgan, Friedman mostly favored stable growth in M, but late in his career became more flexible, praising the targeting of TIPS spreads, and also policies that offset major moves in velocity. I focus on late in his career.

    Lorenzo, Yes, and there already is a rebuttal video from me (created by a commenter in the previous comment thread), and colorized by Greg in this thread.

    Thanks Steve.

  29. Gravatar of scott sumner scott sumner
    16. November 2010 at 06:47

    Steve, I watched part of it. I’ll say this, people used to say Reagan was a movie star, but Palin really does come off like someone from the entertainment industry. She looks great and oozes charisma. Which sort of scares me. On content, it’s no better or worse than the standard conservative argument against QE.

    JTapp, That’s a really good point, and I’d say the same about lower IOR. QE really does sound like banana republic stuff to the average person.

  30. Gravatar of Morgan Warstler Morgan Warstler
    16. November 2010 at 07:23

    Morgan, The big banks thought these MBSs were great investments–even in 2007 they were buying ones they had previously sold. You can’t expect government bureaucrats to know something the big banks themselves didn’t know.

    Um, I CAN EXPECT Government Bureaucrats to let the guys who saw it coming, got out, and are cash heavy to own all the hard assets.

    Scott, I mean no disrespect but Greenspan is a very smart guy… and nothing you write about focuses on how’d you piss on booms, the way Greenspan should have – and of course, thats the good reason the National Review gives to even pay attention to you.

    Sumner: pisses on booms.

    But you don’t seem to get that whats interesting. So, I’m going to pay Greenspan a little more attention – and of course, I notice that you don’t…

    He’s obviously a better Fed Chair than Ben, and the man doesn’t speak without mentioning housing prices. He seems to sleep with new start construction data under his pillow, he rattles off the status of conforming loans. He views the entire banking sector, and this the country, as dependent on home prices not falling. Why?

    Maybe you could do a post that starts:

    What if the price of everything is going up, and only house prices are falling….

    And doesn’t argue the premise, but explains how great targeting NDGP work in such a model.

  31. Gravatar of OGT OGT
    16. November 2010 at 08:13

    I appreciate what you’re trying to do here. But it looks like monetary policy is being politically polarized outside of elite circles. And so far the incentive dynamic is pushing those conservative elites that agree with the political operators to the fore.

    I’d like to spin this as a good thing, since I think that a stable reform of monetary policy would involve a change off of the dual mandate. And that would necessitate political involvement, however, it’s difficult for me to see a plausible political path to sensible reform. I can almost see the Romney ads as the ‘Sound Money’ candidate running now.

  32. Gravatar of TheMoneyIllusion » An open letter to conservatives TheMoneyIllusion » An open letter to conservatives
    16. November 2010 at 08:30

    [...] has recently been a lot of pushback against QE from conservatives.  In this post I pointed out that plenty of conservatives support monetary stimulus.  Here I’d like to [...]

  33. Gravatar of rob rob
    16. November 2010 at 08:37

    I realize you are talking about economists and not the electorate, but conservatives in general are perhaps against monetary stimulus for the sheer reason every time you turn on an AM radio station or CNBC or Fox News somebody is saying “Central banks continue to print money like never before in history. Buy gold!”

    I think that has some effect on public opinion. Not that public opinion matters here, unless of course the public elects enough politicians who want to do away with the Fed or its quasi-independence altogether.

    Meanwhile, Soros now calls gold “the ultimate asset bubble”. We’ll see if his record of predicting bubbles holds this time.

  34. Gravatar of Jeff Jeff
    16. November 2010 at 13:07

    Like most people who are not monetary economists, most conservatives really don’t know much about monetary economics. So they take their cues from people who they think are both knowledgeable and on their ideological wavelength. Prior to the financial crisis, Ben Bernanke, appointed to high-level jobs by a Republican president, seemed to be OK.

    I think conservatives were shocked and disappointed by what Bernanke did during the crisis: bailing out AIG and scaring the Congress into passing TARP so the big banks could also get bailed out. The anger over that has not and will not subside. Nothing he does will ever be viewed without great suspicion by conservatives.

    And it’s not just Bernanke. Fox News has been doing little segments they call “12 for 2012″ about possible contenders for the Republican presidential nomination. A few days ago the subject was South Dakota senator John Thune, who shot to fame by defeating then-Senate Minority Leader Tom Daschle in 2004. Thune is an attractive candidate: smart, articulate, and fairly conservative.

    Except for one thing: he voted for TARP. For that reason alone, he will never get the nomination of a conservative party.

  35. Gravatar of ssumner ssumner
    17. November 2010 at 09:43

    Morgan, NGDP targeting restrains booms better than inflation targeting. You should be on my side.

    OGT, The same thing happened in the Great Depression, with conservative sound money groups forming. And you have BOJ officials recently saying they are worried about inflation. Things never change.

    rob, I don’t predict asset prices, but (as OJ said) “if I did” I’d predict gold won’t be a good long term investment, because I don’t see the inflation coming. The reason I don’t sell it short is because I believe in the EMH, and because the nagging fear that real factors, not inflation, are driving up gold.

    Jeff, That’s too bad about Thune, I have mixed feeling about TARP, but it was an issue that honest people could disagree about–it should not be a litmus test. They should look at who voted for the rest of Bush’s big government agenda.

  36. Gravatar of Doc Merlin Doc Merlin
    17. November 2010 at 11:57

    ‘Doc Merlin, As I recall people have been trading commodity futures for decades, so you didn’t answer my question as to how you distinguish between food price increases and food price bubbles. Something tells me I won’t find your answer persuasive, but I’ll keep an open mind until I hear it.’

    I’ll break this up.

    ‘how you distinguish between food price increases and food price bubbles.’

    1. Bubbles have damped oscillatory behavior combined with super-exponential growth. Its called a Log Periodic Power Law model. This can actually be derived directly from EMH (but it doesn’t require EMH, just without EMH the derivation is longer and more complex). Didier Sornette, Ryan Woodard, and others have explored this phenomena thoroughly. Their research has been very thorough and their predictions very good.

    This wouldn’t work for regulators however, as trying to use knowledge about bubbles to pop them has been shown in experiments to be almost impossible even when everyone knows it is a bubble, because by the time it is identified, each person has too much to lose and is trying to minimize their losses. Think of it as a massive game theory game with bad results for almost everyone.

    2. We have learned from experimental economics, that often in a bubble, even if everyone knows that a bubble is forming and knows what moment it will crash, it still doesn’t really change their behavior. It ends up being a weird financial analog to the prisoner’s dilemma. Where everyone is trying to one-up everyone else, and almost all of them get harmed.
    Vernon Smith (yes that Vernon Smith) has done some really good experiments on bubbles. (here is his first.)

    http://www.jstor.org/pss/1911361

    Here is Alex Tabbarok talking about some of the experiments with bubbles and what we have learned.

    http://www.marginalrevolution.com/marginalrevolution/2009/07/identifying-and-popping-bubbles.html

    And here is an experiment saying that excess cash floating around in a system increases bubble formation.
    http://www.pnas.org/content/95/2/756.abstract
    (Hey Austrians, doesn’t it feel weird for someone to be basically claiming experimental validation of ABCT?)

  37. Gravatar of ssumner ssumner
    19. November 2010 at 14:56

    Doc Merlin, I don’t agree that it is easy to predict asset prices, and I don’t agree that experimental economics can explain how real world financial markets work. When real money is at stake, people can’t afford to be as foolish. There are also studies that show experimental results don’t always carry over into the real world.

  38. Gravatar of Doc Merlin Doc Merlin
    20. November 2010 at 10:34

    “Doc Merlin, I don’t agree that it is easy to predict asset prices, and I don’t agree that experimental economics can explain how real world financial markets work. When real money is at stake, people can’t afford to be as foolish. There are also studies that show experimental results don’t always carry over into the real world.”

    Let me separate this.

    “Doc Merlin, I don’t agree that it is easy to predict asset prices”

    I am not the one making that claim, I am making the claim that its not hard to see when assets are in a bubble, but its almost impossible to actually stop it once it is noticeable. Even George W. Bush knew housing was in a bubble, and his folks were trying to get congress to reign in Fanny and Freddy though much of his administration.

    ” I don’t agree that experimental economics can explain how real world financial markets work. When real money is at stake, people can’t afford to be as foolish.”

    In these experiments real money is at stake. Also, Didier Sornette’s work is directly in the markets and not in controlled experiments. Him and other LPPL theorists have put their reputations on the line and made rather big, public calls for when a bubble will crash, multiple times, including prediction of dates and such. I don’t think that the participants are being foolish, I think its built in to how the markets actually work:

    1. The costs for example to short, are much higher than to go long.
    2. Shorting still requires you to buy the underlying asset within 3 days, so it causes upwards spikes in price about 3 days after a large market move towards a short position.
    3. Also, in some markets having a short position is illegal.
    4. If you want to see the derivation of LPPL from EMH I can dig it up.
    5. It isn’t as if this is new, its basically what austrians have been saying all along. Prices are signals, when interest rates are messed up due to central banker involvement, the price signals don’t convey the information that they need for proper equilibration across time, and we get “bubbles”.

  39. Gravatar of Philo Philo
    23. November 2010 at 09:41

    Everyone knows that unexpected inflation is (in the short run, at least) good for borrowers and unexpected disinflation is bad for them. Since September, 2008, we have had unexpected disinflation, and borrowers, especially mortgage borrowers, have had correspondingly unexpected difficulty in paying off their loans. If they had all paid, the development would have been good for the lenders. Since so many are defaulting, the result is bad for many of the lenders (especially those who, being highly leveraged, are squeezed between defaulting borrowers and demanding creditors), as well as for those who relied on their soundness, such as the governments that guaranteed their liabilities. The result has been a financial crisis, due in large part to the unexpected disinflation, which (obviously) could have been prevented by the monetary authorities. Incompetent monetary authorities are very nearly the villains of the piece–not quite real villains because their *intentions* were not bad.

    This narrative of the financial crisis is easy to understand, and fits with the common, widespread view about the effects of unexpected inflation/disinflation. Why is it not the predominant narrative of the crisis in the public mind? Perhaps the common view about the consequences of unexpected (dis-)inflation, though *present* in the public mind, is not really *salient*: it does not rise spontaneously into consciousness as a possible cause of the financial crisis. But I suspect the main factor is that people like to conjure up real villainy as the cause of a catastrophe, rather than mere incompetence.

  40. Gravatar of ssumner ssumner
    23. November 2010 at 13:19

    Doc, I was just at an economics conference and people there were presenting papers talking about how experimental evidence doesn’t hold up when you translate the results to the real world. By “real money” I meant a lot of money. I know that experiments use money.

    I’ve done many posts explaining why I view the anomaly studies as useless.

    I don’t agree with the Austrian view that low rates mean easy money.

    Did Sornette’s model correctly predict the Australian housing crash? (That’s a trick question.)

    Philo, I agree with you except your comment that this is widely known. Many people think disinflation is good for savers. But as you point out it’s not a zero sum game. If borrowers can’t repay their debts, we all lose.

  41. Gravatar of 保守派への公開書簡 BY SCOTT SUMNER – 道草 保守派への公開書簡 BY SCOTT SUMNER – 道草
    6. December 2010 at 00:41

    [...] 最近、保守派からのQEに対する反動が沢山湧き起こっている。この記事で私は保守派でも多くの人が金融緩和による景気刺激策を支持していることを指摘した。ここで私は、右翼の同胞たちに、七つの反対論を述べたい: [...]

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