Any fiscal stimulus advocates left?

Throughout this crisis there have been a few paleo-Keynesians arguing that monetary policy is out of ammunition at the zero bound, and hence we must rely on fiscal stimulus.  Then there is a more enlightened group of Keynesians (Krugman, DeLong, Duy, Yglesias) that favor monetary stimulus, but also think fiscal stimulus can help.  They use what in philosophy is called a “God of the gaps” argument.  If the Fed wants 5% NGDP growth, and the Fed currently expects only 3% NGDP growth, then fiscal stimulus may be able to boost growth by 2%, before being neutralized by offsetting Fed tightening. 

I have mixed feeling about this argument (mostly skeptical), but whatever relevance it might or might not have had for 2009-10, it certainly doesn’t seem to fit the current policy environment.  Here’s Ryan Avent:

But to move toward the point, the latest employment report has some economists wondering whether the Fed will keep to its planned QE2 purchases. The message of that report was far from clear, but the changes in the household survey, including the near 600,000 job rise in employment and the drop in the unemployment rate to 9.0%, seem meaningful. This has Macroeconomic Advisers increasing its inflation forecasts and reiterating its warning that Fed tightening may come sooner rather than later. And Tim Duy has the Fed shifting its bias from more easing to tightening. Are they right?

I wish they weren’t, but I suspect that they are. If we go back to January of last year, when economic figures were improving, and the Fed was mostly talking about its exit strategy preparations, we see a Fed forecast for 2011 unemployment of between 8.2% and 8.5%—almost identical to the forecast in November of 2009. I think we have to conclude that the Fed was basically happy with the trajectory of falling unemployment that it saw at that time. I think it was wrong of the Fed to be happy with this level of unemployment, but that’s beside the point.

It’s my feeling that the Fed will quickly grow concerned about inflation if the unemployment rate drops to 8.5% during the first half of the year. Ben Bernanke isn’t going to draw any conclusions about policy from the mixed January report, but I agree with Mr Duy that his biases may have shifted, and February and March data will quickly indicate whether the January trend is real. Again, I think the Fed should still be biased toward expansion, and that it should tolerate a period of catch-up inflation, but that’s beside the point.

That doesn’t sound much like the paleo-Keynesian vision of the Fed, a group taking a nap on the beach until the “liquidity trap” is over, planning on waking up when rates rise above zero and they can “start doing monetary policy” again.  And it doesn’t even seem much like the enlightened Keynesian vision; a Fed active, but for whatever reason not willing or able to produce desired nominal growth.  Here’s Richmond Fed President Jeffrey Lacker:

The Federal Reserve should seriously reconsider its bond purchases now that the U.S. economy looks stronger, a top Fed official said Tuesday.

Richmond Federal Reserve President Jeffrey Lacker said he expects the economy to expand close to 4.0% this year, lifted by robust consumer spending.

Can we please stop talking about fiscal stimulus?  Does anyone seriously believe that a fiscal initiative aimed at boosting NGDP growth would not be offset by a quicker exit strategy at the Fed?

BTW, The same Ryan Avent post contains a Paul Krugman quotation that discusses the ‘God of the gaps’ approach much more eloquently than I can:

…if you want a simple model for predicting the unemployment rate in the United States over the next few years, here it is: It will be what Greenspan wants it to be, plus or minus a random error reflecting the fact that he is not quite God.

HT:  Marcus Nunes

PS.  BTW, last year Marcus Nunes was just a commenter at blogs like this one.  Now he’s in the big time, getting quoted by Fortune magazine.  David Beckworth is also quoted.


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107 Responses to “Any fiscal stimulus advocates left?”

  1. Gravatar of johnleemk johnleemk
    8. February 2011 at 09:45

    Scott, that Krugman quotation (which I first read in an anthology of Krugman’s essays from the 90s — the book which inspired me to study economics to begin with) really shows just how crazy the profession has become in recent years. In the 90s when things were humming along, everyone knew monetary policy was effective. But when things fall apart, it somehow instantly becomes ineffective.

    My hypothesis is that most of the “zero-bound” believers as well as “the Fed can never do right / less wrong” ideologues never truly believed in the efficacy of monetary policy, but just had no reason to complain in the 90s. But the overall effect is such that it seems the profession has totally forgotten anything it learnt from Milton Friedman.

    Another germane quote, this time from Friedman: “I’m inclined to think that there’s no field so rife with cranks as currency and money.”

  2. Gravatar of Mark A. Sadowski Mark A. Sadowski
    8. February 2011 at 10:05

    So 4.0% real growth and 8.5% unemployment is good enough given the massive size of the output gap? (Well over a trillion dollars a year.) Inconceivable!

    http://www.youtube.com/watch?v=D58LpHBnvsI&feature=player_embedded

    This underscores the fact that the biggest problem is not at all people like Krugman, DeLong, Duy or Yglesias but people like Jeffrey Lacker (and Charles Plosser, but don’t even get me started).

  3. Gravatar of ssumner ssumner
    8. February 2011 at 10:11

    johnleemk, Good points.

    Mark, Some are saying the Fed will raise rates in early 2012. If unemployment is around 8% and core inflation is around 1%, what justification would they have? They could talk about higher inflation expectations, but that would beg the question of why they ignored the low TIPS spreads in late 2008 and 2009.

  4. Gravatar of marcus nunes marcus nunes
    8. February 2011 at 10:31

    By Invitation deals with “The risk of rising inflation”!
    I made a short comment:
    http://thefaintofheart.wordpress.com/2011/02/08/it%c2%b4s-baaaaack/

  5. Gravatar of W. Peden W. Peden
    8. February 2011 at 11:01

    The idea that the Fed should tighten the moment the US economy gets going stinks.

    There’s only one argument left for fiscal stimulus that I can take seriously anymore: a situation of tight money can be an opportunity to expand the state sector relative to the private sector. I don’t agree with this arguments underlying values, but it seems to be factually correct to me: one can “starve the beast” of industry and expand the welfare state etc. using a crisis.

    However, as Prof. Sumner pointed out lately, as long as the idea that fiscal policy affects real indicators and monetary policy affects nominal indicators, we’re still going to see what we’ve seen in these past few years. The result will be unnecessarily slow, painful recoveries and totally unnecessary national debt, with no pay-off whatsoever.

  6. Gravatar of Captain Chalmers Captain Chalmers
    8. February 2011 at 11:43

    This is completely, utterly, entirely off topic, so please forgive me. I follow your blog daily. :)

    I’ve been reading a whole lot of the RBC literature lately (from the historical Prescott stuff on through the more recent papers by folks like Ohanian) and was curious how popular this approach still is in modern macroeconomics? If you had to toss out a very rough estimate of the makeup of academic economists, what would it look like? (Ex. 50% some kind of New Keynesian, 20% RBC/New Classical, 30% other etc. etc.)

    Thank you!

  7. Gravatar of W. Peden W. Peden
    8. February 2011 at 12:56

    Prof. Sumner,

    “Any fiscal stimulus advocates left?”

    Actually, a surprising number are on the right, however they put things in supply-side arguments rather than demand management arguments: cutting taxes will reduce the deficit and increase growth.

    I do remember reading a blog where someone argued that, in a 0% interest-rate environment, one could get out of the “liquidity trap” without either monetary stimulus or deficit financing by tax redistribution e.g. raising taxes on idle wealth and cutting taxes on investment and consumption.

  8. Gravatar of Brendan Brendan
    8. February 2011 at 13:12

    Please feel free to completely ignore this, I won’t be offended. This is something I’ve been curious about, but is unrelated to the post.

    Financial economist (and QE2 skeptic) John Hussman frets that given 1) the historical relationship between liquidity preference and short-term rates and 2) the massive stock of idle base money, that the impact on liquidity preference/velocity of a small increase in short-term rates could trigger a very large burst of inflation.

    I’m trying to guess the fundamental difference you have with him on this particular point (I know your counterargument to his other claims). But on this point, is it that you see the current SRAS as super-flat and think that a burst in monetary velocity would trigger very rapid REAL growth?

    Here’s a link to his post.

    http://www.hussmanfunds.com/wmc/wmc110124.htm

  9. Gravatar of Lorenzo from Oz Lorenzo from Oz
    8. February 2011 at 13:32

    Brendan: my eye was immediately caught by Hussman’s Liquidity preference is simply the amount of monetary base that people are willing to hold, per dollar of nominal GDP. We’ve seen that this demand for base money is essentially a function of short-term interest rates. When interest rates are low, people are willing to hold higher cash balances. When interest rates are high, people tend to economize on cash balances. Why assume causation goes in the direction he is assuming? If one takes people to have expectations across time about the future value of money, would not causation go the other way? He seems to be breaking a basic rule of Sumnerian analysis — never reason from a price change. But I am not really an economist (all I have is a Grad.Dip.Ec. from ANU), so I could be completely wrong about this.

  10. Gravatar of What if we called it "opportunistic spending"? – Economics - What if we called it "opportunistic spending"? - Economics -
    8. February 2011 at 14:42

    [...] SEE that Scott Sumner is taking a victory lap of sorts—not unearned—over the fact that views of monetary policy have come full circle since [...]

  11. Gravatar of Full Employment Hawk Full Employment Hawk
    8. February 2011 at 14:58

    ” but people like Jeffrey Lacker (and Charles Plosser,”

    This once again raises the question of why people largely chosen by bankers are allowed to have such a disproportionate role in determining monetary policy.

    An independent central bank is only consistent with the values of a representative democracy if the people running it are chosen by and ultimately responsible to the elected representatives of the people.

    As long as the Presidents of the individual Federal Reserve Banks are largely chosen by the bankers, they should not have a vote on the FOMC. Since the individual Federal Reserve Banks play an important role in the implementation of monetary policy, a better option would be to have the Presidents of the Federal Reserve Banks appointed by the Board of Governors.

  12. Gravatar of Full Employment Hawk Full Employment Hawk
    8. February 2011 at 15:00

    The fact that Plosser, who is one of the originators of a patently false theory of business cycles, real business cycle theory, has a vote on the FOMC this year is especially dangerous.

  13. Gravatar of Full Employment Hawk Full Employment Hawk
    8. February 2011 at 15:03

    “So 4.0% real growth and 8.5% unemployment is good enough given the massive size of the output gap?”

    If the Fed abandons expansionary monetary policy and moves to contractionary policy, it will still be in violation of its mandate to achieve maximum employment.

  14. Gravatar of Full Employment Hawk Full Employment Hawk
    8. February 2011 at 15:35

    “This has Macroeconomic Advisers increasing its inflation forecasts and reiterating its warning that Fed tightening may come sooner rather than later.”

    In its Tuesday, January 29 posting, Macroeconomic Advisors, includes the following paragraph:

    “This higlights the importance of delaying any significant fiscal restraint until monetary policy is in a position to at least partially offset the added fiscal drag.”

    This implies that macroeconomic advisors believes in a liquidity trap, so that the Fed can offset the upward stimulus of an expansionary fiscal policy, but not the contractionary effect of a contractionary fiscal policy.

    While I do not think the Fed cannot offset such a contractionary effect, I tend to doubt that it will do so more than partially. This implies that expansionary fiscal policy under the current political environment consists of minimizing the spending cuts the Republicans succeed in imposing. And that appears to be precisely what the Obama administration is currently trying to achieve.

  15. Gravatar of What if we called it "opportunistic spending"? [The Economist] | DreamInn What if we called it "opportunistic spending"? [The Economist] | DreamInn
    8. February 2011 at 16:50

    [...] SEE that Scott Sumner is taking a victory lap of sorts—not unearned—over the fact that views of monetary policy have come full circle since [...]

  16. Gravatar of marcus nunes marcus nunes
    8. February 2011 at 18:09

    Scott
    I know you´ll have a field day (in the productive serious sense) with this reaction to your post by Thoma
    http://economistsview.typepad.com/economistsview/2011/02/can-econometrics-distinguish-between-the-effects-of-monetary-and-fiscal-policy-during-the-crisis.html?utm_source=feedburner&utm_medium=feed&utm_campaign=Feed%3A+typepad%2FKupd+%28Economist%27s+View+%28typepad%2FKupd%29%29
    via Ryan Avent:
    http://www.economist.com/blogs/freeexchange/2011/02/fiscal_policy

  17. Gravatar of marcus nunes marcus nunes
    8. February 2011 at 18:14

    Scott
    Got caught in “waiting for moderation”, so here´s another try.
    I know you´ll have a field day (in the productive serious sense) with this reaction to your post by Thoma:
    http://economistsview.typepad.com/economistsview/2011/02/can-econometrics-distinguish-between-the-effects-of-monetary-and-fiscal-policy-during-the-crisis.html
    via Ryan Avent:
    http://www.economist.com/blogs/freeexchange/2011/02/fiscal_policy

  18. Gravatar of W. Peden W. Peden
    8. February 2011 at 18:23

    Full Employment Hawk,

    A contractionary budget would be the PERFECT cover for eliminating IOR and QE3, as well as an acceleration of QE2.

    History tells us that monetary policy can counter any fiscal contraction very effectively. The UK in 1981 is the classic case, where an easing of monetary policy more than offset deep Conservative cuts in the middle of a deep recession and preceded a steady recovery in the midst of an international recession.

    Obviously though, as you say, the absence of a fiscal tightening would make the Fed’s job a lot easier. It’s even possible that the best case scenario WOULD be a boost in resources for the private sector, because there are a lot of inflation haws in the Fed who’d love the US to go onto a path of <1% inflation.

  19. Gravatar of Steve Reilly Steve Reilly
    8. February 2011 at 18:32

    For what it’s worth, Krugman has poked a bit of fun at himself for that quote above. In the pdf you can find here: http://bit.ly/eNR7F8 (at the top of that Google search) he places it under the heading “Famous Last Words”.

  20. Gravatar of Mark A. Sadowski Mark A. Sadowski
    8. February 2011 at 19:43

    Full Employment Hawk,
    quoted me as saying,

    ”…but people like Jeffrey Lacker (and Charles Plosser,…”

    And you wrote:
    “The fact that Plosser, who is one of the originators of a patently false theory of business cycles, real business cycle theory, has a vote on the FOMC this year is especially dangerous.”

    Run Charles Plosser’s speeches backwards and you’ll know why I mentioned him.

    He’s the Devil!!! (Or at the very least he’s Darth Vader!)

    We need to stop him while we can.

  21. Gravatar of Mark A. Sadowski Mark A. Sadowski
    8. February 2011 at 19:49

    And I don’t mean with force. For God’s sake people, I’m a Libertarian. Reason should do.

  22. Gravatar of Mark A. Sadowski Mark A. Sadowski
    8. February 2011 at 21:36

    Reload and discharge.

  23. Gravatar of Doc Merlin Doc Merlin
    9. February 2011 at 05:15

    Can’t we just stop pretending that the NY Fed isn’t a hedge fund and out only for the profits of its stockholders?

  24. Gravatar of OGT OGT
    9. February 2011 at 05:35

    I think the case for automatic fiscal stabilizers remains quite strong (See Britain).

    The quasi-monetarists should probably be working on their ‘Britain is special’ apologia now just in case the current stagflation lasts another quarter or two, which seems likely. This will be even more true if King blinks and tightens before RGDP picks up revealing monetary laxity and fiscal tightening to be both politically and economically unstable.

  25. Gravatar of W. Peden W. Peden
    9. February 2011 at 06:51

    OGT,

    If British monetary conditions hadn’t tightened since mid-2010 and NGDP slowed, you’d certainly have a very good point. However, unfortunately Britain is not a good case for non-quasi-monetarists, since there hasn’t been monetary easing to compensate for the monetary effects of fiscal tightening.

    We can imagine a counter-factual case where, say, the BoE engaged in small quantitative easing to substitute for the effects of the emergency budget. In such a case, the current slowdown in British NGDP would be very problematic for economists like Scott Sumner.

    The political problems of monetary laxity and fiscal tightening are largely due to the belief that fiscal policy affects RGDP and only RGDP, while monetary policy affects inflation and only inflation.

  26. Gravatar of William J McKibbin William J McKibbin
    9. February 2011 at 06:58

    Count me in as a advocate of monetary expansion — more at:

    http://wjmc.blogspot.com/2010/06/deflation-or-inflation.html

    Thank you for the opportunity to comment…

  27. Gravatar of W. Peden W. Peden
    9. February 2011 at 06:59

    See p4 to see why the UK needs more monetary easing to compensate for the effects of the emergency budget on the money supply and NGDP-

    http://www.statistics.gov.uk/pdfdir/oie1110.pdf

  28. Gravatar of Full Employment Hawk Full Employment Hawk
    9. February 2011 at 08:06

    “since there hasn’t been monetary easing to compensate for the monetary effects of fiscal tightening.”

    Scott’s argument of why fiscal policy is ineffective, if I understand it correctly, is not that fiscal policy does not affect aggregate demand (and NGDP growth) but, rather, that the central bank will offset the effect of the fiscal policy on AD with a monetary policy in the opposite direction. That is certainly the argument in the present posting.

    If, as appears to be the case, the Bank of England does not offset the contractionary fiscal policy in Great Britain with a more expansionary monetary policy, that does put the GENRALITY of the view that fiscal policy is ineffective because it will be offset by monetary policy into question. It will imply that whether that happens or not depends on the specific situation.

    However, in the present case of the United States, the proposition is very likely to hold. Obama’s failure to promptly fill the vacancies on the BOG with full employment hawks, and the presence of representatives of the bankers like Plosser on the FOMC, makes this outcome likely in this case.

  29. Gravatar of Full Employment Hawk Full Employment Hawk
    9. February 2011 at 08:07

    Whether monetary policy CAN offset the effects of fiscal policy on aggregate demand and whether monetary policy WILL be conducted to achieve this result are, of course, separate questions.

  30. Gravatar of W. Peden W. Peden
    9. February 2011 at 08:22

    Full Employment Hawk,

    A rock only goes down the hill if it’s pushed.

    Just as the Treasury View is sound insofar as monetary conditions are held constant, I think that fiscal policy becomes perfectly effective if accomodated for by monetary policy makers. Any worthwhile theory in the social sciences has to take into account the “human factor”.

    In the case of Britain, we have a central bank that is constrained from addressing a decline in NGDP caused by a contractionary budget by its mandate to control CPI inflation. What’s needed is joined-up thinking, as there was in Britain in 1981. In 1981, the government (which was also in charge of monetary policy) compensated for the effects of tightening money on GDP by releasing money from the government for use by the private sector. In 2011, we need the Bank of England to compensate for the effects of fiscal retrenchment on the private sector by loosening monetary conditions, but this can only be accomplished politically if the BoE is given a better target (a NGDP target of some sort ideally; even just adding a monetary aggregate target as an add-on to inflation targeting would provide a good excuse for a stimulus) in order to justify monetary easing with CPI inflation at 3.7%.

    I agree that there is a real danger of the Fed not compensating for the effects of any contractionary budgets from the US government, given how long its taken them to get their act together with QE2.

  31. Gravatar of Philo Philo
    9. February 2011 at 08:34

    (A note from a fan, not especially related to this post:)

    It’s time to revise the right-gutter material on your blog’s webpage. In particular, this clause from the “About” section must be removed: “You’ll quickly notice that I am not a natural blogger . . . .”

    It was on a tip from Tyler Cowen in Marginal Revolution that I learned, almost two years ago, about your blog. Tyler, I am eternally grateful to you!

  32. Gravatar of Scott Sumner Scott Sumner
    9. February 2011 at 14:32

    Marcus, Yes, more climatologists.

    W. Peden. I agree.

    Captain Chalmers, I don’t think there are any new classicals left, at least in the sense Robert Lucas was a new classical. I’d guess 70% of economists are old or new Keynesians, and perhaps 10% are RBC types. The rest are various schools of thought like Austrian and monetarist.

    W. Peden, What’s “idle wealth?” I consider supply-side arguments to be entirely different. Supply-side policies may still work, by changing the composition of NGDP, rather than the level of NGDP. But they can only do so much, they aren’t going to give you a quick recovery.

    Brendan, No, I don’t think the SRAS is superflat, I think that slightly higher rates wouldn’t cause a huge burst in AD. The Fed would neutralize it, perhaps through higher IOR, or else open market sales.

    Inflation never bursts higher unless the markets expect the price level to remain higher for years. Thus the Fed has more time to counter that sort of inflation surge than most people assume (if using simple monetarist models without expectations.)

    Full employment hawk, I agree. I don’t like having bankers on the FOMC.

    The issue of what the Fed can and would likely do in the face of fiscal restraint is complicated. I hope to do a post on that soon.

    Marcus, Thanks, I saw the Avent post, and plan a reply (I left a short reply in his comment section. I’ll look at the Thoma post after I answer about 100 comments.

    Steve, Yes, I imagine he’s backed off a bit on that one. He sounded more Sumnerian than I do!

    Doc Merlin, If it’s trying to help the bankers, it’s not doing a very good job.

    OGT, You said;

    “The quasi-monetarists should probably be working on their ‘Britain is special’ apologia now just in case the current stagflation lasts another quarter or two, which seems likely.”

    The Keynesians will also need one, as staflation is even more inconsistent with the Keynesian model than the monetarist model. Keynesians usually assume a flatter SRAS than monetarists. The Keynesian model says fiscal contraction should lead to lower inflation.

    FEH, I mostly agree with your comments about Britain. But I’d reiterate that OGT wasn’t making that argument. He was talking about stagflation, that is he was questioning my assumption that the SRAS is fairly flat. Actually I’ve never argued that the UK SRAS is fairly flat, and indeed don’t know enough to have an informed opinion. But if I had to guess I’d probably guess it was currently fairly flat, and that more NGDP would probably result in more extra RGDP than extra inflation.

    Philo, Thanks, should I say “you’ll quickly notice that I am a natural blogger?” No, probably best to avoid both boasting and false modesty, and keep my mouth shut. I should adjust my bio too, I’ve been at Bentley for 29 years.

    Tyler has done a lot for me behind the scenes. Almost every time I get an invitation, they say “you were recommended by Tyler Cowen.”

  33. Gravatar of Doc Merlin Doc Merlin
    9. February 2011 at 15:36

    “Doc Merlin, If it’s trying to help the bankers, it’s not doing a very good job.”

    How not? NY bank’s profits have been very very high, and they have had many of their competitors go out of business.

  34. Gravatar of OGT OGT
    9. February 2011 at 18:33

    Sumner you said: “The Keynesian model says fiscal contraction should lead to lower inflation.”

    Interesting. My hypothesis would be that large changes in either direction to baseline fiscal policy would flatten SRAS. Just as if one accepts that this recession (most?) have some structural elements, and NAIRU is temporarily perhaps 1% or 1.5% higher due to construction industry or FIRE industry changes, then laying off teachers or nurses or national railway personnel would flatten SRAS. I could also make slightly more indirect arguments about large changes in benefits or taxes. If social security benefits were cut in half tomorrow, I would argue that the PSST would change, certainly in FL and AZ.

    I wouldn’t go so far as to argue that this the primary cause of British stagflation, but it seems a plausible contributor. In any case, politically speaking, Britain is the poster child for fiscal austerity and accommodating monetary policy (though I realize you would argue not accommodating enough, but with stagflation that’s a harder argument to sell).

    W Peden @ 8:022- Your comment is a good argument against central bank independence, at least as it is practiced in the US, UK, Japan and Europe. In some sense the US is the worst given the elasticity of the dual mandate. If you were a administration official or congress person in 01/2009 you would have little way to tell whether fiscal policy changes would be accommodated or fought. Though I’d agree that Obama did not lever his appointment power well in this field.

  35. Gravatar of Morgan Warstler Morgan Warstler
    9. February 2011 at 18:52

    “Can’t we just stop pretending that the NY Fed isn’t a hedge fund and out only for the profits of its stockholders?”

    Pure genius.

    Scott, c’mon man, can’t you get out of the tree, and imagine for a second, that what this country needs is a Big Bank enema? (Scott, PEE)

  36. Gravatar of Full Employment Hawk Full Employment Hawk
    9. February 2011 at 19:00

    “Just as the Treasury View is sound insofar as monetary conditions are held constant,”

    That depends on what the meaning of “monetary conditions” is. If it means the rate of growth of the money supply is held constant, the Treasury View is not sound, because the velocity of money depends on the rate of interest. If it means the rate of growth of NGDP is held constant by the central bank, then the Treasuruy View holds. I think the kind of crowding out that results in this case should be called “monetary policy crowding out.”

  37. Gravatar of Rien Huizer Rien Huizer
    9. February 2011 at 19:33

    Kantoos works in parallel ways apparently:

    http://kantoos.wordpress.com/2011/02/09/what-is-the-best-way-to-stabilize-ngdp-a-reply-to-brad-delong/#comments

  38. Gravatar of Full Employment Hawk Full Employment Hawk
    9. February 2011 at 23:02

    “He’s the Devil!!! (Or at the very least he’s Darth Vader!)”

    No, rather he is Cardinal Bellarmine arguing against Galileo.

  39. Gravatar of Scott Sumner Scott Sumner
    10. February 2011 at 07:08

    Doc Merlin, The Fed’s tight money policy of late 2008 caused bank stock values to plummet.

    OGT, I think fiscal changes steepen the SRAS. But in any case I was reacting to your comment that stagflation is a big problem for quasi-monetarists. It’s a much bigger problem for Keynesians. The groups that would be strengthened would be the RBC people and the Austrians, who favor fiscal austerity.

    Morgan, Your metaphors are getting very one dimensional. I’m concerned.

    Rien, Thanks, I wish I had time to keep up with all these blogs.

  40. Gravatar of Morgan Warstler Morgan Warstler
    10. February 2011 at 07:42

    “Doc Merlin, The Fed’s tight money policy of late 2008 caused bank stock values to plummet.”

    Wrong. The Fed’s loose money policy of 200-2006 led to a housing crisis, which caused bank stocks to plummet in 2008.

    You can’t blame the second mistake Scott, the first one is what screwed up the banks.

  41. Gravatar of Liberal Roman Liberal Roman
    10. February 2011 at 11:42

    The argument that low interest rates cause asset bubbles is more and more odd the more I think about it.

    Imagine an ideal fiscally conservative, free market utopia with amazing technological progress, great institutions and a great tax system which heavily favors saving. One of the rewards of such an amazing conservative utopia would be naturally, low interest rates.

    But I guess, unfortunately for the poor utopia the low interest rates would cause automatic ruin and huge financial crashes according to….the very people who claim to be free market absolutists.

    So many contradictions my head is spinning…

    It’s the same as saying that because government is subsidizing bananas, it’s the government’s fault that people took those bananas and stored them all on their roof so that the roofs collapsed on them.

    You can make the argument that government subsidized cheap money at the expense of other things (just like agricultural subsidies create a cheap product at the expense of other products) but that’s not really what is being argued here. It’s the argument that cheap money itself is the problem. But as I said, money can be cheap artificially or naturally. Does that mean that in the utopia I outlined above, we should artificially make money more expensive to prevent asset bubbles???

  42. Gravatar of Mark A. Sadowski Mark A. Sadowski
    10. February 2011 at 12:03

    This just in, hot through the intertubes. Kevin Warsh will be leaving the Fed at the end of March. He submitted his resignation to the President earlier today:

    http://finance.yahoo.com/news/Warsh-says-he-will-leave-Fed-apf-2395573750.html?x=0

    I consider this to be very good news. Despite his record of often voting with Bernanke he’s actually quite hawkish (read his WSJ articles) and I personally thought he was the least competent member of the Board of Governors.

    Now, the questions are:
    1) Will Obama wait two years before nominating a successor?
    (As he’s done in the past.)
    2) When he does get around to filling this very important vacancy, will his nominee actually know anything about monetary policy? (His past nominees have been somewhat questionable.)
    3) Even if #2 is satisfied will the Senate Republicans reject his nominee anyway? (Just for the fun of it.)

  43. Gravatar of W. Peden W. Peden
    10. February 2011 at 12:15

    OGT,

    The American practice of central bank independence came to Britain precisely because the Labour party lacked the confidence of the markets. I agree that changing the previously successful system of regulation and monetary management to compensate for Labour’s record was a bad move. Any politician who cannot earn respect should not abandon responsibility to compensate for this deficiency.

    I’m largely unfamiliar with the US system, but the British monetary system really needs fiscal and monetary policy to be co-ordinated in order for it to survive crises. If there’s (1) an inflationary crisis, then we need to keep money in the private sector while tightening; tightening the money supply by reducing short-term government debt in the commercial banks is one of the best ways to accomplish this task.

    On the other hand, if there’s (2) a deflationary/disinflationary crisis, then we ideally should have monetary easing and no fiscal stimulus. Understandably, the government will want assurances from the central bank, so it doesn’t feel obligated (and, even better, it doesn’t have an excuse) to do a fiscal stimulus. In our current situation, Britain should ideally have monetary stimulus that is co-ordinated exactly with fiscal tightening.

    Britain’s government was able to do co-ordinate the two in 1981 and get out of Thatcher’s recession. Unless they are co-ordinated again, we’re in trouble. Still, one can’t read too much into one quarter, especially when January was a pretty good month according to the earlier indicators.

  44. Gravatar of Dustin Dustin
    10. February 2011 at 14:24

    Mark:

    1) no, just a year

    2) no

    3) yes

  45. Gravatar of Doc Merlin Doc Merlin
    10. February 2011 at 14:25

    “Over the past 30 years, major changes have been made to the calculation of the CPI due to “re-selection and reclassification of areas, items and outlets, [and] to the development of new systems for data collection and processing,” according to the Bureau of Labor Statistics. If you eliminate those adjustments and calculate CPI as it would have been calculated in 1980, it would be nearly 12 percent today…No wonder clients constantly tell me they distrust government inflation data.” (“Back to the 1970s?” Charles Schwab Investing Insights, June 19, 2008)”

    So… they are saying that while CPI isn’t that high, we have similar inflation to the 70′s. I know it feels that way to me… my food bill has gone up massively in the last year.

  46. Gravatar of John Papola John Papola
    10. February 2011 at 14:50

    Excuse that I haven’t read the comment thread. I will, just not now….

    Scott,

    Here’s my question: why is so-called “fiscal policy” even put in the same boat with monetary policy. The two things appear to be completely unrelated to me.

    I think of monetary policy is essentially a microeconomic mechanism that has macro effects. Money is a single commodity with supply and demand. The Fed controls the supply and the market produces the demand. This is oversimplified, of course, but I think it’s basically true.

    So-called “fiscal policy” on the other hand is not micro economics involving one good that can be demanded by real people and supplied to address that specific demand. It’s this bizarre idea that if you have some particular people unemployed and some particular non-human resources become under-utilized… governments can re-employ those people by spending money on OTHER PEOPLE and other resources in other sectors based on political allocation of borrowed money, which will need to be paid back.

    If demand withdraws from the housing market and people horde that money as cash, having government borrow it to spend on pushing up prices in supply-constrained healthcare and bloated education doesn’t seem to make one damn bit of sense. Sure, that may for a short time increase AD by virtue of the C+I+G tautology, but I don’t see how it is any more likely to produce sustainable patterns of specialization and trade that increase productivity and make the society richer.

    And if it can… if government has the knowledge and incentives to make wise investments during a bust when entrepreneurs have their hardest time doing so… why doesn’t socialism work? If the state can determine what grows an economy out of a bust, surely it should be even better at making those calculations when the economy is healthier.

    I just don’t get it. Monetary policy has micro. There are real supply and demand forces interacting drive by humans. Fiscal “policy” isn’t.

    …or am I confused?

  47. Gravatar of Full Employment Hawk Full Employment Hawk
    10. February 2011 at 14:55

    “When he does get around to filling this very important vacancy, will his nominee actually know anything about monetary policy? (His past nominees have been somewhat questionable.)”

    I hope Obama understands that his chances of being reelected depend crucially on what the unemployment rate is in Fall of 2012, and that he better try to choose as much of a full employment hawk as he can get past the Republicans in the Senate, and that he pick somebody P.D.Q.

  48. Gravatar of Nominelles BIP und optimale Währungsräume « Aus dem Hollerbusch Nominelles BIP und optimale Währungsräume « Aus dem Hollerbusch
    10. February 2011 at 14:57

    [...] In letzter Zeit setzt sich immer mehr die Erkenntnis durch, dass nicht nur die Regierungen, sondern auch die Notenbanken ein breites Arsenal in Krisenzeiten zur Verfügung haben, das über das Setzen von Zinssätzen weit hinausgeht, Stichwort Quanitative Easing. Das kommt nicht von ungefähr, schließlich haben etliche Regierungen ihr Pulver schon in guten Zeiten komplett verschossen haben. „Quasi-Monetarist“ Scott Sumner, der seit Monaten einer Ausweitung der Geldmenge das Wort redet, triumphiert nicht von ungefähr: „Any fiscal stimulus advocates left?“ [...]

  49. Gravatar of Full Employment Hawk Full Employment Hawk
    10. February 2011 at 15:04

    “why is so-called “fiscal policy” even put in the same boat with monetary policy.”

    Because both affect aggregate demand and NGDP growth.

    “Money is a single commodity with supply and demand.”

    But in a monetized economy where goods are exchanged for money and then money is exchanged for goods, the medium of exchange is not just another good but unique in that it enters the transactions for all goods. Therefore money is a macroeconomic mechanism because it affects all markets for all goods. (Barter transactions are, of course, an exception, but in a monetized economy, these are rare.)

  50. Gravatar of Full Employment Hawk Full Employment Hawk
    10. February 2011 at 15:16

    “It’s this bizarre idea that if you have some particular people unemployed and some particular non-human resources become under-utilized… governments can re-employ those people by spending money on OTHER PEOPLE and other resources in other sectors”

    The current problem is not that we have SOME people in SOME markets being unemployed, but that we have unemployment in the great majority of ALL the markets. The government by spending money, when there is unemployment is most markets, will directly increase employment in the markets in which it is spent. In addition, by increasing aggregate demand, it will also increase employment in those markets in which it is not spent. (All this assumes that the central bank does not offset the increase in government expenditures, of course.)

    “borrowed money, which will need to be paid back.”

    Unless the U.S. government intends to go out of business, the borrowed money never needs to be paid back. As one debt issue matures, it is simply paid off by a new debt issue. Of course, the government has to keep paying interest on it, but if the economy keeps growing the fraction of National Income going to this interest will decrease over time. The money the U.S. government borrowed to finance WWII has never been paid off.

  51. Gravatar of Full Employment Hawk Full Employment Hawk
    10. February 2011 at 15:42

    “having government borrow it to spend on pushing up prices in supply-constrained healthcare and bloated education doesn’t seem to make one damn bit of sense.”

    The objective of the health care reform is not, and was never intended, to act as an economic stimulus. As a matter of fact it is intended to REDUCE the deficit. (One can argue about whether it does or not, but that is the intention.) The objective, instead, is to make health care available to people who currently cannot afford it. (Once again, on can argue about whether it succeeds in doing so or not, but that is clearly its intention.)

    As far as bloated education is concerned, I do not believe that the layoffs of teachers in many states that is currently occurring is going to improve education, but we will have to agree to disagree on that. But when teachers are laid off, they reduce their expentitures and this reduces aggregate demand.

    “Sure, that may for a short time increase AD by virtue of the C+I+G tautology, but I don’t see how it is any more likely to produce sustainable patterns of specialization and trade that increase productivity and make the society richer.”

    The primary intention of the stimulus is to move the economy from being below potential output back to potential output, not to increase potential output. A society that is at potential output enjoys greater economic well being than one that is below potential output. That is done by increasing aggreagate demand. Expenditures that also increase potential output as a secondary effect are obviously preferrable to ones that do not, but increasing potential output is not the objective of fiscal stimulus.

  52. Gravatar of Full Employment Hawk Full Employment Hawk
    10. February 2011 at 15:50

    “If the state can determine what grows an economy out of a bust, surely it should be even better at making those calculations when the economy is healthier.”

    Getting the economy out of a recession and restoring output to potential output simply requires it to stimulate aggregate demand by monetary policy, fiscal policy, or both. That is RELATIVELY easy to do.

    The decisions needed to grow potential output require an enourmous number of different decisions in a multitude of markets about the efficient allocation of resources. This is something governments have shown themselves unable to do.

  53. Gravatar of John Papola John Papola
    10. February 2011 at 16:08

    Mr hawk,

    “but that we have unemployment in the great majority of ALL the markets.”

    This is false. We do not have unemployment in healthcare or education, where prices are continuing to rise and real scarcity and supply constraints are already in play. The “general glut” is a meaningless ex-post tautological device. Moreover the unemployment rates are wildly different based on the education, income and geography of the people.

    I do understand the assertions which paleo-Keynesian theory make about the connection between aggregate demand and employment… I simply reject that they are correct. They suffer from too much aggregation and thus mask the real structural sectoral things going on. This was Hayek’s critique and I believe it is correct.

    There is no way to know from the top down if a sector is illiquid or insolvent. There is no way for a Keynesian administrator to tell if “slack” in some sector is due to an increased demand for money which will return when confidence returns or if it is a preference shift that is essentially permanent.

    The result is that Keynesian stimulus is just as wasteful and destructive to the economy as any other government waste. There is no multiplier. Throwing money at New York public school teachers doesn’t re-employ nevada construction workers.

    I find it odd that you would call fiscal policy “easy” considering the track record of failure. Circular claims that “it would have been worse” or “it failed because the economy was worse than we thought…” don’t hold up to any reasonable scrutiny.

    As for the “free lunch” of government debt… I offer Europe as exhibit A and Japan as exhibit B.

    Now… All that said… If you could explain to me how keynesian stimulus restores “full employment” using some micro economic process, I would love it. Restating the textbook aggregate assertions is not convincing. I know them. They don’t make sense. They haven’t worked. So what else am I missing?

  54. Gravatar of Liberal Roman Liberal Roman
    10. February 2011 at 16:17

    “Getting the economy out of a recession and restoring output to potential output simply requires it to stimulate aggregate demand by monetary policy, fiscal policy, or both. That is RELATIVELY easy to do.

    The decisions needed to grow potential output require an enourmous number of different decisions in a multitude of markets about the efficient allocation of resources. This is something governments have shown themselves unable to do.”

    I have never seen the argument put in a more succinct manner than that. But I think the problem is that most people see the economic crisis as something REAL. Not just a nominal shock. It comes back to Scott’s FAQ section where he puts up this question:

    Isn’t the real problem ______ ?

    And this answer:

    NO!

    People can’t seem to grasp this concept. They feel like something REAL has to be wrong. Either you are a liberal and believe it’s those evil banks doing their evil things. Or you are a conservative and think it’s evil government it’s evil things. There must be a REAL reason behind this crash.

    No one wants to accept that it was just the central bank’s failure to print enough money.

  55. Gravatar of W. Peden W. Peden
    10. February 2011 at 16:47

    Doc Merlin,

    On the basis of that CPI inflation and NGDP, when was the last time the US wasn’t in a deep depression that makes the 1930s look mild? The 1990s? The 1980s?

  56. Gravatar of Morgan Warstler Morgan Warstler
    10. February 2011 at 16:51

    Roman, I’m willing to accept that we sometimes need to print or destroy money, raise or lower rates – as long as you, end the government practice of borrowing…

    No matter how great your cause, unless it is for a good old fashioned war, you give up Fiscal Spending past tax receipts, and I promise to use monetary policy whenever things get harry.

    That’s really your only choice. If you and the other liberal accept it, Sumner can win a fancy prize.

    If you accept it, then I’ll agree with you the CB has failed to print money.

  57. Gravatar of marcus nunes marcus nunes
    10. February 2011 at 17:00

    @ Liberal Roman
    It cannot be so “simple”. If it´s easy (relatively or otherwise) it CANNOT be true by definition. Because if it is why all those all night computer simulation runs to solve THE model?

  58. Gravatar of Full Employment Hawk Full Employment Hawk
    10. February 2011 at 17:11

    “which paleo-Keynesian theory”

    I could just as easily call Austrian economics “paleo-Austrian theory” but name calling is not a good way to resolve issues.

    I personally consider the present Austrians an ideologically bound cult. Scott may be right in arguing that Hayek had a much better understanding of macroeconomics than he is being given credit for, but this is not reflected in the current version of Austrian economics.

    There are a lot more Keynesian and New Keynesian economists than Austrian economists. While that does not prove that Keynesian economics is correct, it demonstrates that Keynesian economics cannot be dismissed out of hand the way you seek to do.

    “This is false. We do not have unemployment in healthcare or education, where prices are continuing to rise and real scarcity and supply constraints are already in play.”

    I said “most markets” not ALL markets. Healthcare is an exception. With all the teachers that are being laid off, where is your proof that we currently have scarcity there?

    But MOST labor markets are currently in excess supply. The fact that the amount of excess supply differs from market to market does not change that fact. A situation in which most markets are in excess supply can well be described as a “general glut,” but that is an archaic term. Deficient aggregate demand, or deficient NGDP growth, are more up to date terms. When there is excess supply in most markets, this is clearly not a structural problem but a deficient aggregate demand-based problem.

    “I do understand the assertions which paleo-Keynesian theory make about the connection between aggregate demand and employment… I simply reject that they are correct.”

    You are saying that you reject what you do not understand. That is the attitude of an ideologue, not a rational thinker. Before you reject something you should try to understand it because you may discover that you are wrong in rejecting it.

    “This was Hayek’s critique and I believe it is correct.”
    Faith-based economics.

    “As for the “free lunch” of government debt…”

    I never said government debt is a free lunch. While it does not have to be paid off, the government has to pay interest on it. Clearly a government can get so much debt that its ability to pay the interest comes into doubt. That happened to Greece, whose government was indisputably fiscally irresponsible. On the other hand, Spain was in fine shape with respect to its debt until the bottom dropped out of the Spanish economy. Obviously that reduces the revenue of the government and a debt that was not a problem when the economy was at potential output can become a problem when the economy is depressed.

    “I find it odd that you would call fiscal policy “easy” considering the track record of failure.”

    A detailed analysis of the effectiveness or lack thereof of fiscal policy requires many journal articles and cannot be discussed in a brief note. But note that the huge government expenditures during WWII finally restored the U.S. economy to full employment. In Germany the economy was back to full employment in 1936. A combination of public works spending (the Autobahns) and military rearmament, at least partially financed by printing money, was the cause of that.

    Incidentally, while I am more than 50% Keynesian, I support Scott’s position on monetary policy. Among other things, I agree that if the central bank offsets an expansionary fiscal policy with a contractionary monetary policy, fiscal policy will not be stimulative. This also makes me part Quasi-Monetarist.

  59. Gravatar of Doc Merlin Doc Merlin
    10. February 2011 at 17:32

    @Full Employment Hawk
    “Unless the U.S. government intends to go out of business, the borrowed money never needs to be paid back. As one debt issue matures, it is simply paid off by a new debt issue. Of course, the government has to keep paying interest on it, but if the economy keeps growing the fraction of National Income going to this interest will decrease over time. The money the U.S. government borrowed to finance WWII has never been paid off.”

    Its somewhat disingenuous to say that… as the cost of the principal has been paid many many times in interest payments by the borrower. And as long as we continue to accumulate debt at the rate we are, the interest payments will consume more and more of our GDP.

  60. Gravatar of Full Employment Hawk Full Employment Hawk
    10. February 2011 at 17:35

    ““I do understand the assertions which paleo-Keynesian theory make about the connection between aggregate demand and employment… I simply reject that they are correct.”

    Sorry, I misread your statement. Therefore my reply to that statement is incorrect and I take it back. Nevertheless your rejection is ideological. These real structural things only exist in Austrian ideology. The connections between aggregate demand and employment are very straightforward and are easily recognizable.

  61. Gravatar of Full Employment Hawk Full Employment Hawk
    10. February 2011 at 17:44

    “And as long as we continue to accumulate debt at the rate we are, the interest payments will consume more and more of our GDP.”

    I agree that in the long run, the deficits of the U.S. government are not sustainable and need to be eliminated. But as long as the economy is depressed, reductions in the deficit before the economy has recovered, unless fully offset by a more expansionary monetary policy, will slow the recovery and, if large enough, may cause a double dip recession. Since I consider it unlikely that any such offset from monetary policy, if it happens at all, will be more than very partial, reducing the deficit prematurely will slow and may stall the recovery. Therefore the correct order is full employment first, deficit reduction second.

    Incidentally, a more expansionary monetary policy is the easiest way to reduce the deficit in the short-run, and such deficit reduction will not slow the recovery and is a second benefit of a more expansionary monetary policy, in addition to the reduced unemployment.

  62. Gravatar of Full Employment Hawk Full Employment Hawk
    10. February 2011 at 17:50

    “Its somewhat disingenuous to say that… as the cost of the principal has been paid many many times in interest payments by the borrower.”

    According to the Ricardian equivalence proposition, the PRESENT VALUE of the interest payments is equal to the amount of the principal, so that paying it off and paying interest on it are equivalent. My point was merely that it does not have to be paid off, as the debt for WWII never was.

  63. Gravatar of Rien Huizer Rien Huizer
    10. February 2011 at 19:02

    Liberal Roman e a

    The problem is not that economists do not know that fiscal policy is, at best, very hard to design and execute, without los of “waste”. The problem is that politicians in countries with high levels of voter participation expect that their constituencies will bot allow them to “do nothing”. I guess that the US with its very low voter participation and presence (thanks to low brow media) of primitive economic libertarian/anarchic movements is one of the very few countries where gvts can get away with this unless they are Democratic.

    In many other countries, like NW Europe, Australia, the presence of (residuals of) class based politics, the “do nothing” option simply does not exist. Even if every senior technocrat is convinced -which they generally are as far as I know, regardless of their personal position re capitalism- that fiscal policy does not work (and there policies with supply side effects that can be funded under the guise of “stimulus”, like the German “Kurzarbeit”), there has to be an increase in gvt spending, preferably not in the direction of known import leaks.

    These countries tend to be much smaller, so the Nevada problem does usually not exist (the Nevada problem is in Spain though). Once the EU area (and if) takes the next step towards integration (the current Stability Pact has not worked well enough) and develops some form of fiscal policy coordination, this will become a very interesting area for political economists.

    Now, back again to the US, how would stimulus have looked in a hypothetical US with a much smaller Federal gvt and much bigger (also much more tax autonomy, for instance as a result of a State VAT with a mandatory minumum of 15% and a state gasoline tax with a minimum of USD 4.- per gallon, and commensurate reductions in Federal income and corporate taxes?) Would states have shown diversity in their “fiscal” policies. For instance stuck to balanced budgets, in the position of Nevade, gambled for survival?

  64. Gravatar of ssumner ssumner
    10. February 2011 at 19:11

    Morgan, Bank stocks respond immediately to news.

    Liberal Roman, You said;

    “The argument that low interest rates cause asset bubbles is more and more odd the more I think about it.”

    That’s an understatement. Japan’s had near zero rates since the mid-1990s, and housing prices have fallen for 18 years in a row.

    Mark, It’s weird how we think alike, I just finished a post entitled “good news”.

    Doc Merlin, You obviously didn’t experience the 1970s. Here’s what the 1970s were like. You go buy a car for $3000. Later you trade it in and the same car is $10,000. Just imagine today if a few years from now that $25,000 Camry was suddenly $75,000. That’s what the 1970s were like. The Schwab comment was utter nonsense.

    John Papola, You are partly right and partly confused. The advocates of fiscal stimulus claim it will boost velocity.

    Full Employment Hawk, I have a BOG suggestion that get breeze through the Senate, check out my new post.

    W. Peden. Yes, these high inflation claims imply a Great Depression for real GDP–it makes no sense.

  65. Gravatar of Rien Huizer Rien Huizer
    10. February 2011 at 19:28

    @ Aus dem Hollerbusch: from the Devil’s Tree???

  66. Gravatar of Andy Harless Andy Harless
    10. February 2011 at 22:35

    Damn, I’m so late to the party. You need to get on Twitter so I can get notifications of posts in my Twitter stream :)

    As to the matter in question, I still believe the “god of the gaps” argument. (In fact, I may be the only one who has made the argument explicitly. Krugman and others kind of dance around it but don’t quite come out and say it.) Moreover, I believe that we are seeing it in action, although it will never be possible to prove counterfactuals about what Fed would have done. But we saw the tax compromise last year, and we saw that forecasters revised their forecasts as a result and that subsequent economic reports were consistent with that increased optimism, and a lot of people thought that the Fed would cut QE2 short because of the improvement. But subsequent Fedspeak makes it clear that such a cutting short is highly unlikely. I’d say that we are in a gap and that Almighty Fiscal Policy is filling part of it.

    Concerning some of the earlier comments:

    The Keynesians will also need [an explanation of the UK experience], as staflation is even more inconsistent with the
    Keynesian model than the monetarist model. Keynesians usually assume a flatter SRAS than monetarists. The Keynesian model says fiscal contraction should lead to lower inflation.

    But as I argued in comments of a previous post, monetary policy in an open economy can shift the SRAS curve downward. I’m hardly the first person ever to suggest that.

    Also, when you say that “Keynesians usually assume a flatter SRAS curve than monetarists,” what Keynesians and what monetarists are you talking about? In recent decades, it has been fairly typical in Keynesian empirical work to assume a linear Phillips curve, which generally won’t come out very flat. Meanwhile, I’m not sure who the monetarists are. There are people like you who are quasi-monetarists, but as you said elsewhere in the comments, you believe that the SRAS curve is quite flat right now.

    LiberalRoman:

    The argument that low interest rates cause asset bubbles is more and more odd the more I think about it

    It is if you think of bubbles as irrationality, but I would argue that low interest rates just make it more difficult to estimate asset values, which means there can be things that look like bubbles and have the same impact as bubbles but are really just a matter of people making reasonable mistakes. When interest rates are low, small revisions in growth expectations can result in large changes in asset prices, which can be a big problem if those assets are important collateral.

    BTW I don’t blame monetary policy for low (real) interest rates. But I think there is a very good case to blame tight Chinese fiscal policy (as well as Norway and Saudi Arabia and Singapore and others, if you like) for the financial crisis.

  67. Gravatar of Scott Sumner Scott Sumner
    11. February 2011 at 13:48

    Rien, I have no ability to read German, so I always wonder what they are talking about.

    Andy, You’ve presented the strongest “gap” argument for fiscal stimulus. I plan a post on this soon, so I won’t have much to say here. My general view is not that fiscal stimulus never works, but that on average it has little or no effect. That requires (if you are right about this case) other cases where the effect is negative. I’ll try to make that argument in a few days.

    You said:

    “But as I argued in comments of a previous post, monetary policy in an open economy can shift the SRAS curve downward. I’m hardly the first person ever to suggest that.”

    I recall that. I happen to think that the adverse effect of fiscal stimulus is stronger than the adverse affect of monetary stimulus. But I see that as a separate issue, as I’ve neve rheard prominant Keynesiasn bloggers say more monetary stimulus reduces AS. By the way, I beleive that only a small part of the recent rise in commodity prices is due to QE2, but in fairness I’ve argued that a much more aggressive monetary stimulus would raise commodity prices substantially. So there is an effect.

    Regarding the question of whether Keynesians or monetarists are more pessimistic about SRAS, I’ll give you two reasons for my view:

    1. Back in the 1970s and 1980s the Keynesians definitely viewed the SRAS as being flatter. Monetarists constantly warned that more stimulus would lead mostly to inflation, whereas Keynesians warned that Volcker’s attempt to bring down inflation would lead to high unemployment for many years. That’s where my perception first formed.

    2. You are right that I argue the US SRAS is currently fairly flat (and BTW the Q4 number for the US strongly supports that view, especially for final sales). But I still probably think it’s a bit steeper than people like Krugman/DeLong/Thoma/Yglesias, etc. That’s because I do think structural problems like extended UI (99 weeks) mean that stimulus will produce a bit more inflation and a bit less real growth than otherwise. Most Keynesiasn seem to think extended UI has no impact on the supply side of the economy.

    I don’t have strong views about the UK, as I don’t know the supply-side of their economy as well as the US. My hunch is that the UK SRAS is somewhat flat, but not as flat as the US. I don’t expected the staflation of Q4 to continue, if it did it wouldn’t cause me to revise my monetarist ideas, it would cause me to revise my view that the UK problem is mostly demand-side.

    Regarding your answer to Liberal Roman, that’s a good point about low rates and asset price volatility. But then I won’t say the high saving countries caused the financial crisis, I’d say they caused the housing bubble. The housing bubble didn’t cause the fiancial crisis, if our banks were regulated like Canadian banks (minimum 20% down) we could have survived a housing bubble. Bad regulation was the real problem.

  68. Gravatar of Mark A. Sadowski Mark A. Sadowski
    11. February 2011 at 14:30

    Scott wrote:
    “Rien, I have no ability to read German, so I always wonder what they are talking about.”

    Was können Sie nicht Deutsch sprechen?

    (Correct me if my German is incorrect Rien.)

    It’s a very important language Scott, and it’s still not too late for you to pick some up. I say this as an American of half-Polish descent who’s a huge believer in the Euro project.

  69. Gravatar of John Papola John Papola
    11. February 2011 at 14:38

    Sumner,

    Could you elaborate on where and why I’m confused?

  70. Gravatar of John Papola John Papola
    11. February 2011 at 16:44

    Hawk,

    “paleo-Keynesian” wasn’t some kind of attack. It was merely a repetition of Scott’s phrase to distinguish between new/neo/post Keynesians and plain old “dig a ditch or fight a war as stimulus” old keynesians.

    Speaking of which, I am disappointed that you would wip out the war-as-prosperity fallacy in defense of keynesiansism, though it does seem to be the only “proof” that the theory allegedly works within reach for every keynesian I’ve debated.

    Sorry. It’s nonsense. Dangerous nonsense. Drafting the unemployed away isn’t sustainable macroeconomics with an eye on improving material wellbeing. There’s no unemployment of slaves either. Big deal. Consumption and standard of living shrank during the war because real resources are still scarce even in depressions. War isn’t stimulus. This fallacy is the worst thing of all time. People work to live better, not to work.

    The other problem, of course, is that there was broad consensus among Keynesians that the end of the war would bring back depression. It was THE consensus. Didn’t happen. Government spending imploded, millions of people returned home in need of work, and the economy absorbed them and was fine.

    I used “general glut” because it’s been used repeatedly by DeLong and others.

    The fact is that there could be slack in lots of sectors because people borrowed 15 to 20 years worth of income and spent it on unproductive consumption and durable goods in 10 years. Well, now we need to live with what we bought and pay down our debt. That’s gonna have a big impact on lots of firms who boomed with home-equity driven demand in the 2000.

    Now, if the creditors are sitting on the cash or other savers are hoarding cash, supply more cash to meet demand. Fine. I buy that (mostly, with some skepticism). But having government borrow and spend on different people from either the unemployed or the boarders solves nothing…. Unless you only think in ex-post aggregates where labor is “L”, capital is a blob of “K” and all people are doing the same thing by virtue of only seeing the sum of their actions.

    So please explain the mechanics of why I’m wrong beyond restating that “we” need more AD beyond the micro of moey supply and demand.

  71. Gravatar of Full Employment Hawk Full Employment Hawk
    11. February 2011 at 23:34

    “Speaking of which, I am disappointed that you would wip out the war-as-prosperity fallacy in defense of keynesiansism, though it does seem to be the only “proof” that the theory allegedly works within reach for every keynesian I’ve debated.”

    Germany in 1936 was not at war. But with the exception of that, there are few, if any, non-war episodes where expansionary fiscal policy has been strong enough to restore the economy to full employment, so you have to use the data you have, not the data you want.

    “Drafting the unemployed away isn’t sustainable macroeconomics with an eye on improving material wellbeing.”

    Obviously war is not a desirable way of restoring the economy to full employment and is not, and should not be, fought for that purpose. But the workers who had been unemployed before the war and found work in the war industries were made better off.

    In the case of Germany, by 1936 only a relatively small percentage of the labor force were in the military, so it was not the case of drafting the unemployed away.

    “The other problem, of course, is that there was broad consensus among Keynesians that the end of the war would bring back depression. It was THE consensus. Didn’t happen. Government spending imploded, millions of people returned home in need of work, and the economy absorbed them and was fine.”

    I agree with you that the concensus was wrong. The belief that the Keynesian consumption function, flatter than the 45 degree line, held in the long run, and not just in the short-run turned out to be incorrect, as additional empirical research showed. (Keynes, when he wrote the General Theory had virtually no empirical data to work with.) After the war, households had a large amount of deferred purchases to catch up for, such as, for example, automobiles, which had not been produced during the war, and with the war bonds they had patriotically purchased they had the means to pay for them. In addition, there was a lot of deferred construction of housing and commercial building to be invested in, so aggregate demand was strong in spite of the reduction in government purchases.

    “Unless you only think in ex-post aggregates where labor is “L”, capital is a blob of “K” and all people are doing the same thing by virtue of only seeing the sum of their actions.”

    I have emphasized that the problem is that most (but not all) labor markets are currently in excess supply. (The same is also true with many product markets.) How is that seeing labor and capital as a blob?” But the excess supplies in many different labor markets sums up to a high unemployment rate in the economy. When the government buys goods and services from many different firms, who hire labor in these many markets that are in excess supply, those firms sell more. Thereofore they produce more and hire more workers in those many markets that are in exess supply. This reduces, and may even eliminate, the excess supply. A reduction in the excess supply in these many markets adds up to a reduction in the unemployment rate. Whether or not the money is directly spent on the unemployed or hoarders is irrelevant to this process.

  72. Gravatar of Full Employment Hawk Full Employment Hawk
    11. February 2011 at 23:48

    John Papola:

    While I consider myself a more than 50% Keynesian, I am definitely not an orthodox Keynesian, I am a Full Employment Hawk and when an economy is depressed I judge policies on whether I think they will restore the economy to full employment or not, not whether or not they conform to some economic ideology or other. That is why I support Scott’s position on monetary policy, which also makes me part Quasi-Monetarist.

    For your run of the mill recession, monetary policy and the automatic stabilizers are the appropriate tools to do the job. Discretionary fiscal policy is much too clumsy for that purpose, although, if the Fed would not offset it, it would, if stong enough restore the economy to full employment. But when the economy is hit by a really serious shock from the financial system, such as in the 1930s and 2008, a COMBINATION of monetary and fiscal policy is optimal. That appear to be similar to the postion taken by Christina Romer. Monetary policy has not lost its ability to affect aggregate demand and there is no liquidity trap, but the conduct of monetary policy with a damaged financial system and the loss of federal funds pegging as the monetary instrument makes monetary policy much more difficult and uncertain, and whether it can, by itself, restore the economy to full employment is something on which I reserve judgement.

  73. Gravatar of Full Employment Hawk Full Employment Hawk
    12. February 2011 at 00:04

    “real resources are still scarce even in depressions.”

    Almost missed that.

    In a depression both labor and physical capital are in excess supply in most (but not all) markets. There is no scarcity in these markets and an increase in aggregate demand due to increased spending by households, firms, or governments would reduce and eventully eliminate this excess supply. In the case of an increase in government purchases, I have described the process in the posting above. For the case of increased spending by houselholds and firms the process is similar.

    With respect to the scarcities in WWII, this was an all-out war of national survival in which a huge amount of expenditures were diverted from civilian use to the war effort. This diversion to war spending far exceeded the excess capacity that the economy had going into the war, so capacity that had already been fully employed had to also be diverted to the war effort.

  74. Gravatar of Rien Huizer Rien Huizer
    12. February 2011 at 00:57

    Scott,

    I found it amusing that the German language (I have no idea who is behind the “Hollerbusch” blog) blogger who quotes your post on fiscal stimulus, is named after the “devil’s tree” That’s all. Of course the people over in Europe find monetary policy a bit more complicated and hence the reference also to optimal currency areas.

    Unfortunately A. d. Hollerbusch does not do English versions. Kantoos does..so, Hollerbusch, if you want a larger audience, switch on the translator…

  75. Gravatar of Tweets that mention TheMoneyIllusion » Any fiscal stimulus advocates left? — Topsy.com Tweets that mention TheMoneyIllusion » Any fiscal stimulus advocates left? -- Topsy.com
    12. February 2011 at 03:47

    [...] This post was mentioned on Twitter by 高橋昭二, 柏のさかなくん, カントリー・ゼントルマン通りもん, エイチワッショイ, erickqchan and others. erickqchan said: #defle 御大は、名目GDP成長は中央銀行の仕事で実質成長を助けるのは政府の仕事と完全に割り切れと。昨日のエントリでも強調してた→ http://ow.ly/3V98E [...]

  76. Gravatar of John Papola John Papola
    12. February 2011 at 07:45

    Hawk,

    I appreciate and share your goals of a “macro” policy that maximizes the ability of the unemployed to find work. We’re both in favor of the same ends. I’d like to try and convince you to be even more skeptical of so-called “fiscal stimulus”. (I’m generally pretty skeptical about all macro, but that’s another matter)

    It’s clear that, as you admit, all peacetime fiscal policy efforts to date have NOT worked in achieving their stated goals. So there remains no evidence that peacetime fiscal stimulus in the form of deficit spending can do what Keynesians claim. There are, on the contrary, plenty of counter-examples (Post WWII USA, Japan, 1970s stagflation, Current stagflation) which falsify the claims of keynesian doctrine.

    We can, of course, have both high inflation AND high unemployment. The aggregate view of the economy and “slack capacity in most markets” view makes this seem impossible. Yet there it is. Venezuela, Argentina, the UK. Inflation. Unemployment. Lots of slack.

    The hayekian critique, which I find very credible, is that the sectoral, microeconomic elements and the particular structure of capital matters and cannot be hand-waved away by focusing on the ex-post accounting entities and aggregates. Spending on “anything” to stimulate “everything” as so many prominent Keynesians have claimed is clearly false. Spending on state public sector employment has NOT lead to changes in other sectors. There doesn’t appear to be any mechanism for spill-over or systemic change. There’s also reason I can see to for believing that government stimulated-sectors are sustainable. Underneath this idea is a keep-the-top-spinning instability of the economy that always boils down to ex-post pop-psychology (ala Schiller).

    Scott mentions that the idea is to change velocity. But this too is not really about “velocity” but about psychology. At the heart of the fiscal deficit spending idea is that “confidence” will be restored and people will cease hoarding.

    Again, all of this is contingent on a set of institutional assumptions, the number one being “sticky” prices and wages. The assumption is that government action can move faster to re-inflation nominal prices and wages than they can adjust downward. Where’s the evidence for that? I understand the challenges of money illusion and the reasons to believe that stable NGDP (though not growing) is the ideal situation to avoid money-illusion induced deflationary depression. I just don’t see the means from the top down to determine which depressed sectors are facing temporary liquidity-preference reduced demand vs. the ones whose reduced demand isn’t coming back and represents a permanent preference shift.

    More importantly, WHICH WAGES? WHICH PRICES? WHICH PEOPLE ARE HOARDING? Sorry for the caps, but this really is the key. It’s the reason that stagflation can happen. You can have slack in some sectors and greater rising prices in others sufficient to produce a rise in the overall “price level”, a ex-post accounting I find of minimal information content or value personally. This can and does happen even if the unemployed in the slack sectors haven’t found work in the sectors with rising prices.

    For example. We don’t seem to need as many new houses today as yesterday. We overproduced yesterday thanks to the bubble. So now we have “slack” in housing which should go do something else. Prices should be allowed to drop like rocks in housing (and have… so much for “stickiness”). And yet, the government has done everything it can politically accomplish to re-inflate housing. Why? Every nickel spent on housing by the government makes us poorer as a society and prevents the needed corruption. Every single nickel.

    Perhaps the biggest problem of all for keynesianism is this kooky idea of the alleged “liquidity trap”. This is, after all, the whole linchpin for deficit spending vs monetary accommodation. But it’s bizarre. It may indeed be the case that central banks which base their policy on targeting short term interest rates can hit the zero bound. But that simply means they should change their target. The leap from narrow institutional quirk to “oh lets just have the government dig ditches instead” is, in my view, nonsense on stilts. The solution to this institutional problem is to have the central bank change its policy. Money hoarding is money hoarding. It’s not dishoarding of some “general good”. Money demand is a demand for a good. Noting that you must reduce your demand of other goods does not tell us anything of value at all.

    There is a much deeper error in Keynesianism, though, which is this circular flow as the root of prosperity and savings as an evil. That’s just dead wrong. Spending is not the root of economic growth or progress. Production of what people demand at cost-covering prices is. That’s the entrepreneurial process. Keynes did not refute Say’s law.

    This division between macro-stability and micro decisions is false. There are macroeconomic phenomina but only microeconomic causes and microeconomic solutions. Government spending is just as wasteful of real resources in a recession as it is during a boom… unless you can demonstrate the mechanisms through which keynesian planners can identify which spending will increase productivity or how it will find the money-hoarders and change their psychological profile to “increase velocity” before prices and wages adjust and make the whole thing irrelevant.

  77. Gravatar of TheMoneyIllusion » Don’t mind the gap TheMoneyIllusion » Don’t mind the gap
    12. February 2011 at 11:58

    [...] universe, the laws of nature, Morgan’s comments, etc) must be attributed to a deity.  In this recent post, I argued Keynesians were using a similar argument for fiscal [...]

  78. Gravatar of Scott Sumner Scott Sumner
    12. February 2011 at 13:38

    Mark, It’s too late. I tried to learn Chinese and it scrambled my brain so badly that my research career was set back 5 years.

    John, It seemed to me that you ignored the key Keynesian argument, that fiscal stimulus boosts velocity.

    FEH, I agree that the “success” of the military buildups was more than just the draft; output rose sharply. But John’s also right that consumption (and hence living standards) fell during the war. After the war NGDP stayed fairly high because monetary policy was much more expansionary that after WWI (due to the 1933 devalaution.)

    Rien, Thanks for the info.

  79. Gravatar of Full Employment Hawk Full Employment Hawk
    12. February 2011 at 13:40

    “I appreciate and share your goals of a “macro” policy that maximizes the ability of the unemployed to find work. We’re both in favor of the same ends.”

    When an economy goes into a recession, all Austrian Economics has to offer is for us to do nothing and wait for the situation to correct itself. I consider that learned helplessness and my response to any approach that advocates this is to shoot holes into it and try to discredit it. For this reason I have an even lower opinion of Real Business Cycle Theory than Austrian Economics. At least Austrian Economics recognizes that the cause of the recession comes from the financial system, not technology shocks.

    “It’s clear that, as you admit, all peacetime fiscal policy efforts to date have NOT worked in achieving their stated goals. So there remains no evidence that peacetime fiscal stimulus in the form of deficit spending can do what Keynesians claim.”

    I gave you the one example I could immediately think of without doing some search of the literature where it did restore the economy to full employment: Germany in 1936. And, yes, a good amount of it was financed by printing money, the most effective method of financing fiscal policy if one wants to use it to restore the economy to full employment. There is a good amount of empirical evidence of instances where expansionary fiscal policy has moved the economy TOWARD full employment during peace time. I do not have the time to dig through the literature to come up with a list. Paul Krugman is in a much better condition to do this. But the research by the Congressional Budget Office, IHS Global Insight, Macroeconomic Advisors, and Moody’s Economy have all shown that the current stimulus has made the recession less bad. No, I am not in a position to debate the validity of their methodology, I am only giving this as an example of the existing research that does show that expansionary fiscal policy can be effective in making output larger than it would otherwise be.

    As far as the current situation is concerned, I agree with Krugman, who has been arguing before the stimulus was made, when it was made, and since it was made, that it was too small to restore the economy to full employment. But note that when Obama took office, output was falling at a rate of 6% and by the Summer it was growing. While many other things happened at the same time, such as the actions of the Fed and TARP, what happened, in light of the inadequate size of the stimulus, cannot be used as an evidence of failure.

    “We can, of course, have both high inflation AND high unemployment. The aggregate view of the economy and “slack capacity in most markets” view makes this seem impossible.”

    Not so. If the sticky wages and prices are set on the expectation that wages and prices will be rising in the future, a slowdown in the rate of growth in AD (or NGDP growth) will cause unemployed resources while inflation continues. There will be excess capacity in most markets even when wages and prices are rising in most markets. This is due to the fact that they are rising at a rate higher than justified by the lower than expected rate of growth in AD.

  80. Gravatar of Full Employment Hawk Full Employment Hawk
    12. February 2011 at 13:43

    “by focusing on the ex-post accounting entities and aggregates.”

    Aggregate demand, which is the sum of demand in all markets for final goods and services is an ex-ante quantity and not an accounting identity. While it is true that REALIZED purchases and sales are identical, desired purchases and sales can differ, and if they do, the economy has to adjust until they are equal. With sticky wages and prices, much of the adjustment is in the form of output adjustment in the short run. And in an inflationary situation, the stickiness is with respect to the rate of change, not the level.

    “There doesn’t appear to be any mechanism for spill-over or systemic change.”

    When the government buys goods and services, these expenditures are made on may firms in many markets. The firms in those markets sell more, therefore produce more, and therefore hire more workers, reducing excess supply in those markets. The additionally employed workers now have income to spend in many different markets. As a result, firms, once again sell more, produce more, and hire additional workers who spend their additional income in additional markets, etc. If the government directly employs workers, they will spend the additional income in many markets also.

    “Scott mentions that the idea is to change velocity. But this too is not really about “velocity” but about psychology. At the heart of the fiscal deficit spending idea is that “confidence” will be restored and people will cease hoarding.”

    In the Keynesian model the cause of the recession is deficient aggregate demand because households try to save more than firms want to invest (physical investment). Therefore planned expenditures are too low to permit the full employment output to be sold and therefore less than the full employment output is produced. What government purchases do it to compensate the deficient planned expenditures of the private sector. But this only needs to be done until the economy is restored to full employment output. As aggregate demand increases firms will invest more and households, since their income has increased will buy more. Therefore increased private expenditures eliminate the need for the government expenditures.

    With a fixed increase in the rate of growth of the money supply, the increased income and expenditures can only happen if each dollar turns over more frequently. Because the velocity of money increases with the interest rate, the increase in velocity happens. If the velocity of money did not depend on the interest rate, the above process could not happen.

  81. Gravatar of Full Employment Hawk Full Employment Hawk
    12. February 2011 at 13:48

    “Again, all of this is contingent on a set of institutional assumptions, the number one being “sticky” prices and wages.”

    David Hume already understood that when the money supply changes, prices adjust only gradually and sequentially, and until the adjustment has been completed a change in the money supply will affect output.

    Sticky wages and prices do not require money illusion or hoarding. They result from the fact that wages and many prices do not continuously change but are set for significant periods of time. And when changes are made, they are not made all at once, but different wages and prices are changed at different times. And they incorporate the expected rate of inflation at the time they are set. That is why, in the short run a change in the rate of growth of AD (orNGDP) affect output.

    One of the most basic fallacies of Austrian Economics is the unjustified belief that in a recession there is excess supply in some markets matched by excess demand in other markets. During a recession, there is excess supply in most markets and excess demand in very few, if any, markets. That is why Austrian Economics is on the wrong track.

    “Perhaps the biggest problem of all for Keynesianism is this kooky idea of the alleged “liquidity trap”.

    I have argued with Keynesians, like Krugman, on their blogs that the economy is not in a liquidity trap.
    A liquidity trap is not needed for expansionary fiscal policy to increase output. All that is needed is that the velocity of money depends on the rate of interest (which it does) and that the central bank does not offset the expansionary fiscal policy with a contractionary monetary policy.

    “It may indeed be the case that central banks which base their policy on targeting short term interest rates can hit the zero bound. But that simply means they should change their target.”

    I totally agree and have been arguing that very thing.

    The case for the use of expansionary fiscal policy when the economy has been hit with a serious shock from the financial system is that this requires making monetary policy under a damaged financial system and by using unconventional techniques whose effects are uncertain. Also even though expansionary monetary policy remains effective, whether it is strong enough to restore the economy to full employment BY ITSELF UNDER SUCH CONDITIONS (only) is controversial. I reserve judgment on that. Under those conditions a good case can be made for helping expansionary monetary policy with expansionary fiscal policy.

    For the run-of-the mill recession, monetary policy plus the automatic stabilizers are sufficient. But that calls for Quasi-Monetarism, not Austrian Economics.

  82. Gravatar of Full Employment Hawk Full Employment Hawk
    12. February 2011 at 13:54

    ““There is a much deeper error in Keynesianism, though, which is this circular flow as the root of prosperity and savings as an evil.”

    That is the root of the conservative hostility to Keynesianism. It violates the Protestant Work Ethic, which forms the ideological basis of capitalism. It implies that in a recession, saving is bad, and being a spendtrift is good. But economics should be a science and not a system of morality. The reality is that in a recession, desired spending is inadequate because saving is too large, and cannot be absorbed by desired (physical) investment. The solution is to get people to save less and spend more. In principle, this can be done using either expansionary fiscal policy, or expansionary monetary policy.

    “This division between macro-stability and micro decisions is false. There are macroeconomic phenomena but only microeconomic causes and microeconomic solutions.”

    What happens at the macroeconomic level depends not only on what happens in individual markets, but on HOW THE MARKETS INTERACT WITH EACH OTHER. The need to understand this interaction is what makes macroeconomics different from microeconomics.

    “Keynes did not refute Say’s law.”

    There is a lot of disagreement in the literature about what Say really meant. But if you interpret it as asserting that you cannot have a general glut (that is, and excess supply in all product and labor markets simultaneously), Keynes did refute Say’s law.”

    I apologize for taking up all this space, but having an opportunity to try to refute the Austrian Economics position on the cause and remedies for recessions, I could not resist the temptation to do so.

    I consider Austrian Economics not only wrong, but dangerous. It is dangerous because it leaves policy makers helpless in restoring the economy to full employment.

  83. Gravatar of Full Employment Hawk Full Employment Hawk
    12. February 2011 at 13:58

    “After the war NGDP stayed fairly high because monetary policy was much more expansionary that after WWI”

    You are correct, my completely Keynesian explanation of why NGDP stayed high unfairly neglects the crucial role monetary policy played. But I think that the items I mentioned were also factors.

  84. Gravatar of Doc Merlin Doc Merlin
    12. February 2011 at 14:12

    “Doc Merlin, The Fed’s tight money policy of late 2008 caused bank stock values to plummet.”

    That was /mostly/ caused by the accounting rules change (not by the Fed) requiring them to change how they accounted capital, which caused the tight money (and the housing crash) in the first place.

    The Fed’s problem was not seeing the tightening caused by the change in the accounting rules, until banks were already legally insolvent.

  85. Gravatar of John Papola John Papola
    13. February 2011 at 06:55

    Hawk,

    “When an economy goes into a recession, all Austrian Economics has to offer is for us to do nothing and wait for the situation to correct itself. ”

    This is absolutely false. F.A. Hayek, Selgin, White, Horwitz and others all emphasize that monetary policy should maintain NGDP to prevent a “secondary deflation”. They all offer the central bank targeting NGDP stability as a second-best solution to free banking, but they (and I) are most certainly NOT saying we should “do nothing”. Rothbardians also favor ending the central bank, but emphasize a 100% reserves approach to banking which would in their view prevent the credit boom. In the bust, they do indeed welcome deflation in the view that it will restore profitability to strong firms because inputs and commodities fall faster than consumer prices (which is true). They assume that the real cash balance effect will satiate money demand and they point to period like the post 1920 deep recession as examples of their position being feasible. They have a point.

    More fundamentally, NOBODY wants “us” to do nothing. The question is always WHO DOES THE DOING? Do individuals, leveraging their local knowledge and incentives do the doing, or do central planners and corrupt politicos do the doing? I’d rather spend my own money than expect the designers of child-starving corn ethanol mandates to do anything right or just. Even if there are good intentions, they lack the information and incentives to do right.

    “But the research by the Congressional Budget Office, IHS Global Insight, Macroeconomic Advisors, and Moody’s Economy have all shown that the current stimulus has made the recession less bad.”

    This stuff is nonsense. “It would have been worse” is pure confirmation bias scientism. Blinder and Zandi started with the assumption that their models were correct (ensuring their answer from the outset), then input the real-world performance running in reverse. This isn’t science or economics. It’s computer games. We have what they claimed it would do. It failed miserably and unemployment rose well above the “without stimulus” level, where it currently remains. They have no credible response other than “this proves the economy was worse than we thought” which embeds the assumption that the policy MUST have been right, just too small. 100% unconvincing. And believe me, I’d love to be convinced, as it would give me more hope.

    There is nothing but confirmation-bias in claims that the stimulus should have been bigger. Nothing.

    Your theorizing about sticky wages and prices rising slower than NGDP is something I don’t understand. What mechanism is driving wages up in that environment? This sounds like some old-school cost-push inflation idea driven by collective bargaining. Again, WHICH WAGES AND PRICES? Too much aggregation. Of course wages and prices don’t change instantaneously. This is not some bug to be fixed. It’s the result of the fact that prices and wages emerge out of a human process of information gathering, bidding and deciding how to act. So what? One would think that housing would be the stickiest price of all, since people have so much at stake and are so reluctant to cut their price… and yet housing prices have dropped like rocks.

    The whole keynesian framework rests on the idea that government spending can re-inflate faster than prices can change. I don’t see any proof of that, even leaving aside all of the other problems with the framework in terms of waste, blindness-through-aggregation, etc.

    I really want to get a better understanding, Hawk. I do. But I feel like you keep asserting the same basic “just boost aggregate demand” as if PQ = MV = C+I+G isn’t just a tautology. Your discussion of velocity is in reverse. You assume that by boosting G, you boost Y and therefore V must go up if M won’t move. But the question REALLY is HOW does boosting G boost V? Because the equation of exchange says so??

    The biggest problem with all keynesian analysis is that it offers no accounting for TIME. If I borrow to pull consumption into the present, but it does not increase my productivity, I will have to spend less in the future to pay it off. You need to move toward a multi-period analysis to even start getting a handle on what’s going on. Some “short run” circular flow approach misses all of this, which is why Keynes was so hostile to ALL savings, even going so far as disparage the Jews for their cultural proclivity to save and celebrating the Egyptians for their love of pyramid building make work.

    “One of the most basic fallacies of Austrian Economics is the unjustified belief that in a recession there is excess supply in some markets matched by excess demand in other markets. During a recession, there is excess supply in most markets and excess demand in very few, if any, markets. That is why Austrian Economics is on the wrong track.”

    This is incorrect. There can of course be a decrease in aggregate spending as people hold larger cash balances. So some people buy fewer houses but don’t buy more of anything else (yet). This doesn’t say anything about Austrian economics. Mises and Hayek understood this perfectly well. Again, the austrian term “Secondary Deflation” is precisely aimed at addressing this problem via increasing the supply of money to meet demand.

    Finally… please don’t try to dismiss my position by putting words in my mouth about some morality play. This is, though you may not intend it, a lazy cop out. It’s ad hominem. Yuck. I approach all of these ideas purely based on what makes sense to me and what seems to be supported by the facts as I’m able to acquire them. Keynesianism asserts that there is some kind of special “depression economics” which kick in and upend everything that makes sense. Suddenly, production doesn’t come first, consumption and spending does. The insight of Say’s law is chucked without having even grasped it. Suddenly, if we are at less than “With employment less than full and Net National Product suboptimal, all the debunked mercantilist arguments turn out to be valid.” (Samuelson).

    Austrian economics isn’t dangerous, but the above Samuelson fallacy surely is. Austrianism offers essentially the same prescription Scott offers assuming we have a central bank: NGDP stabilization, with the tweak that it should be stable, not grow as the ideal. Your attempted refutation is, much like keynes attempt to overturn Say’s law, is built on a strawman.

    Lastly, Keynesianism is utterly ignorant of public choice. It identifies imperfections in the private economy and offers perfect government as the solution. But in reality, politicians are greedy too and they take every opportunity to expand the state. Keynesianism offer them cover, and so it’s naturally popular. Each downturn then becomes a reason to grow the government, until of course the cumulative effect of this ratcheting up leaves the nation insolvent and buried in debt (like Europe and Japan… and the USA). And all along the road to bankruptcy, Keynesians will cry that we “should have spent more”.

    We might never see eye to eye on this, Hawk. But I hope I’ve not misrepresented the claims Keynesianism makes in the same way that you’ve misrepresented Austrian economics. If I have, please correct me. I will accept the correction.

  86. Gravatar of John Papola John Papola
    13. February 2011 at 07:04

    Regarding Mr. Zandi. I have reason to question his approach to impartial economic analysis vs political agenda-driven analysis. Here he is in 2006:

    ——-
    Economist Mark Zandi said he sees two classes emerging in Boston and
    nationally: One earns above the region’s median family income, about
    $75,000 in the Boston area, and lives in comfort, with job security,
    stock holdings, and little debt. The other half earns below the median,
    has far less job security, and worries about credit card debt and
    student loans.

    ”This reinforces the view that the folks who are doing well are doing very well, and the folks who aren’t doing well aren’t doing very well at all,” said Zandi, chief economist for Moody’s Economy.com. ”The middle class is bifurcating. It’s becoming two classes.”
    ——— Boston Globe, Jan 1st, 2006

    Talk about tautology. We’re bifurcating into TWO CLASSES! One BELOW the median income and one ABOVE!!! How will we ever escape this?!?!?

    I’m going to guess that, well, around 50% is in this particular “lower class” while around 50% are in this particular “upper class”.

    I don’t mean to say that Mark Zandi is a corrupt man or ill-intentioned. But come on. This is what happens to “economics” when you leave your partisan glasses on while reading data.

  87. Gravatar of Scott Sumner Scott Sumner
    13. February 2011 at 08:16

    Full Employment Hawk: You said:
    “But the research by the Congressional Budget Office, IHS Global Insight, Macroeconomic Advisors, and Moody’s Economy have all shown that the current stimulus has made the recession less bad.”

    It would be more accurate to say they assumed the fiscal stimulus worked. Or more precisely they estimated its impact using models that assume it works.

    In recessions, the problem is NOT too much saving, it is too much demand for money.

    Otherwise I agree with all your comments about the importance of nominal shocks.

    Doc Merlin, I don’t agree. The main problem was increased loan defaults.

    John, What’s even worse about those Boston income data is that to a large extent it is young versus old, not rich vs poor. When I was 18 to 30 years old my “family income” was below average. (I was single) That doesn’t mean I was poor.

  88. Gravatar of John Papola John Papola
    13. February 2011 at 11:32

    Scott,

    Isn’t the blinder and Zandi paper based on an old 1950s keynesian model?

    I’m
    Not sure why I should take Alan Blinder seriously when he is currently claiming that a carbon tax will “create jobs”. If he’s right, I’ve got a few rocks I can throw through my neighbor’s windows that should help GDP. It’s “analysis” like Blinder and Zandi which it hard to take Keynesian economics seriously.

  89. Gravatar of John Papola John Papola
    13. February 2011 at 11:41

    Another thought or two on “sticky” wages.

    #1. I would think that we are currently in the US less “sticky” than at any other point in our history. Aren’t substantial numbers of the employed freelance, independent contractors, commission-based, bonus-eligible, and self-employed? The talk of “labor” and “wages” is really anachronistic given the current labor market. Is a freelance web designer a worker or a capitalist? Does he even have a wage? Day rates fluctuate radically in my business (entertainment).

    #2. Sticky never did or should me rigid. Prices and wages DO change. Lots of the keynesian analysis I see seems to imply that wages are absolutely rigid downward forever. That is clearly false. Hawk, some of your discussion of wage stickiness above has the tincture of this rigidity.

  90. Gravatar of Full Employment Hawk Full Employment Hawk
    13. February 2011 at 17:14

    John:

    I don’t have time to systematically respond to all the points you have raised above, but hope to respond a few of them.

    I think Hayek may well have had a much better understanding of macroeconomics than the current spokespersons for Austrian Economics have, and the same may be true for the other persons you mention. But since the opportunity cost of doing an extensive exploration of Austrian Economics is too high for me, I need to judge Austrian Economics by their more prominent current advocates. Does their main spokesman in Congress, Ron Paul really advocate maintaining NGDP growth? I don’t think so. And in the recent article “The Importance of Capital Theory”, issued by the Ludwig von Mieses Institute, it assets that “it becomes clear that the worst recommendation is for the Fed to cut interest rates and pump in ever more “liquidity.” Also, “Greenspan brought the federal funds target rate down to a ridiculous 1 percent … He did this in order to (apparently) obviate the need for a harsh recession in the “real economy” after the dot-com crash…. If Bernanke continues shoveling in hundreds of billions to needy bankers, five years from now Americans … may look back fondly on the present the way the 2001 downturn now seems like a minor inconvenience. According to the dominant thinking of the main spokesmen for Austrian Economics, doing nothing and waiting for things to self-correct is the policy they advocate. I’m glad to see that you do not agree with this. Looking at things from very different analytical frameworks, we can agree that the Fed should make NGDP grow fast enough to restore the economy to full employment.

    “I really want to get a better understanding, Hawk. I do. But I feel like you keep asserting the same basic “just boost aggregate demand” as if PQ = MV = C+I+G isn’t just a tautology. Your discussion of velocity is in reverse. You assume that by boosting G, you boost Y and therefore V must go up if M won’t move. But the question REALLY is HOW does boosting G boost V?

    The reason you are having such difficulty understanding the Keynesian approach is that you insist on trying to force it into the Austrian analytical framework, into which it does not fit. To understand it, you need to look at it from the standpoint of the Keynesian analytical framework. You may disagree with this framework and reject it as invalid, but if you really want to understand Keynesian economics and really understand what you are opposing and why, you have to understand this framework. Obviously I cannot adequately explain it in a short comment. If you really want to understand (traditional) Keynesian economics, I recommend that you read the parts of Mankiw’s Intermediate Macroeconomics text that deal with the short run.

    But here is a very brief sketch of one part of it:
    Y = C + I + G (for a closed economy), where Y is output and I is planned or desired investment is NOT a tautology, it is an EQUILIBRIUM CONDITION. (In order to match what you have stated, I am specifying the terms as nominal quantities, even though in the Keynesian model they are in real terms.) If they are not equal, Y has to adjust until they are. With sticky prices and with Y below potential output, most of the adjustment is in output, rather than the price level. (In the long run, with the economy at potential output, the adjustment will, of course, be in the price level.)
    An increase in G increases the sum of C + I + G. Therefore if the economy is below potential output, Y has to increase to restore the equality. This moves Y toward the full employment level of output.
    But MV = Y also has to hold. Even when M is fixed, Y can increase because V depends on the rate of interest. The way this works in the Keynesian analytical framework is that as Y increases, the demand for money increases. With M fixed, this creates an excess demand for money. The excess demand for money causes an excess supply of bonds as people try to increase their money holdings by selling bonds. This drives down the price of bonds and therefore increases their yield, i.e., the interest rate, which increases the velocity of money, so that MV increases to equal Y. So, the change in V is an effect and not a cause here. If the demand for money did not depend on the rate of interest MV could not increase, and in that case Y could not increase.

    “Finally… please don’t try to dismiss my position by putting words in my mouth about some morality play.” You are the one who introduced an ethical component when you said “There is a much deeper error in Keynesianism though … and saving as an evil. I am convinced that the fact that Keynes’ analysis implies that there are situations in which saving is an evil and being a spendthrift can be a good is morally offensive to many conservatives.

  91. Gravatar of John Papola John Papola
    13. February 2011 at 18:07

    Hawk,

    I stand by my own comments alone and have nothing really to say regarding the other people you’ve quoted, accept that for the most part, they are but a hair away from me on most of these issues. In the end, I stand with them in rejection of the end goal: ending central banking and allowing a free market in money.

    I also don’t quite agree with your statement. I believe NGDP should be stable. It should NOT grow. It certainly shouldn’t be forced to grow in order to try and achieve some employment goal. MV should be stable. MV growth should be ZERO. Productivity should produce supply-side deflation equal to the rate of productivity growth. Supply-side shocks should lead to an increased price level. Collapses in V should be offset by increases in M.

    As for your walkthrough of intro-macro. I know it. I’ve gone through it. I don’t buy it. I’ve also studied Roger Garrison’s comparative frameworks between Austrianism and Keynesianism.

    Y = C + I + G is NOT an equilibrium condition. It is an ex-post accounting identity. The statement of this identity does not in any way illuminate the relationship between the C, I and G.

    More importantly for this discussion, though, there is NOTHING in that identity which offers any information or framework for understanding the level of employment. There is no model of the the labor market(s) and supply and demand for labor or the wage rate(s) in the accounting identity. Not in and of itself. So you are showing me C+I+G and then simply asserting out of thin air the relationship between Y and the level of employment. There’s no economics there. Dig into THAT connection and you may have a chance of teaching me something new. I want to learn something new.

    But what you’ve buried the lead. The REAL departure for keynesianism of the liquidity preference model for interest. Keynes rejected the loanable funds market model of interest rate determination and instead asserted that interest rates were a function of money demand.

    This is I believe mostly false. Interest rates emerge out of a bidding process between borrowers and lenders. That’s the market for credit/loanable funds. Changes in people’s demand to hold cash balances does indeed reduce the supply of loanable funds, thus leading to an increased rate of interest in the face of unchanged demand for credit. But people don’t hold cash because of interest rates. There’s no market process through which demand for cash generates an interest rate.

    I get a paycheck. Rather than putting half of it in the bank and spending the other half, I put half of it in my basement. Why? Because I’m scared that my bank might fail. That’s the process.

    Here’s the NUMBER ONE problem with the keynesian framework. C and I are presented as additive in the short run. Theoretically this is wrong. In order to have an increase of investment, there needs to be an increase in the supply of loanable funds, which means there needs to be a DECREASE in consumption.

    Now, empirically, C and I can and do co-move partly because the economy is usually growing and partly because of the effects of credit expansion/contraction by the central bank.

    There is no TIME in the Keynesian framework. It’s all just a static-world circular flow. That flow somehow dropped right out of the sky because there is no means by which anything gets built or the rate of saving in the economy increases since that’s a “leak” in the hydraulics. Again, we are debating crude keynesianism here. 101 keynesianism. We’re only doing so because that’s the presentation you’ve given me. I was hoping for more, but so far you’re just confirming my opinions that the Keynesian framework is mostly nonsense.

    Back to MV = Y for a minute. You’re asserting that increasing government spending will not only have no negative impact on consumption and invest, but also that the supply of “money” is fixed. Which supply of money? We do have a very elastic money supply thanks to the money multiplier. How can I really buy this scenario as anything but a hermetically sealed set of narrow pre-conditions which have no bearing to the real world? Again, there’s no model for the credit or money market in this exposition of yours.

    As Scott said, this is a framework built with the assumption that Keynesianism is true. It is not science or, in my opinion, economics. It’s a set of asserted relationships unsupported by any explanation of why or how these relationships manifest through actual human actions.

    As for the morality play, again, it really doesn’t matter what you assert “conservatives” to believe. I’m neither a conservative nor making a moral case. Again, heres’ the full quote from me above:

    “There is a much deeper error in Keynesianism, though, which is this circular flow as the root of prosperity and savings as an evil. That’s just dead wrong. Spending is not the root of economic growth or progress. Production of what people demand at cost-covering prices is. That’s the entrepreneurial process. Keynes did not refute Say’s law.”

    I was clearly saying that KEYNES viewed savings as evil and that I consider that wrong on economic grounds. Keynesians like Paul Krugman repeat this nonsense all the time, such as when he proclaimed that maintaining the current tax rates on the “rich” wouldn’t be “stimulative” because the “rich” will merely “save” the money… as if rich people don’t put their savings in a bank account or some other investment good.

    Savings is the source of investment funds which only translate into economic growth when they increase productivity. There’s no morality play here. It’s just plain old classical economics. Say’s law. Production comes first so that you can have the means to demand other goods. I must produce so that I can have an income and buy stuff. The first step is production. The second step is savings. Spending is the ends. It’s the outcome. Caruso economics. No emotion. No protestant values (I’m catholic, btw). Just economics as it was before Keynes hijacked it and took us on this detour into the dark ages of macro by selling the fallacies of William Spence and John Law to the ready and willing ears of politicians anxious to justify their boondoggles.

  92. Gravatar of John Papola John Papola
    13. February 2011 at 18:08

    Error:

    “I stand with them in rejection of the end goal: ending central banking and allowing a free market in money.”

    Correction:

    “I stand with them in SUPPORT of the end goal: ending central banking and allowing a free market in money.”

  93. Gravatar of John Papola John Papola
    13. February 2011 at 18:09

    Hawk,

    I really appreciate your replies and efforts, by the way. Very much so.

  94. Gravatar of John Papola John Papola
    13. February 2011 at 18:22

    One other thought…

    There seems to be a pretty consistent pattern to “stimulus” programs: GDP falls as they are withdrawn.

    http://www.bloomberg.com/news/2011-02-14/japan-s-economy-shrank-at-1-1-annual-pace-gdp-surpassed-by-china-in-2010.html

    So the question is, when does the keynesian moment ever end? The idea is to give the spinning top that is the keynesian economy another spin… but it slows down as soon as you take your hand off. That’s because it’s borrowing from the future. When the future comes, you’re poorer, unless keynesian central planners managed to do a whole heck of a lot more productive investment than digging ditches. But, again, if they can do that, socialism works.

  95. Gravatar of Full Employment Hawk Full Employment Hawk
    13. February 2011 at 22:02

    “There seems to be a pretty consistent pattern to “stimulus” programs: GDP falls as they are withdrawn.”

    GDP falls if they are withdrawn before the economy has been restored to full employment. If the stimulus is allowed to complete its work, as the economy moves to full capacity, physical investment increases and replaces the stimulus. Also as the income of households increases, consumption increases and takes the place of government purchases.

  96. Gravatar of Full Employment Hawk Full Employment Hawk
    13. February 2011 at 22:23

    “I believe NGDP should be stable. It should NOT grow. It certainly shouldn’t be forced to grow in order to try and achieve some employment goal.”

    I agree with the Quasi-Monetarists on this. In a growing economy NGDP should grow. And if the growth in NGDP has been too slow, there needs to be a period of faster growth as catch up.

    Following a policy of producing deflation when potential output grows tends to keep actual output depressed below potential output. The problem with the kind of deflation one gets as a result in actual economies was already pointed out Thomas Atwood in 1817:

    “If prices were to fall suddenly, and generally, and equally, in all things, and if it was well understood, that the amount of debts and obligations were to fall in the same proportion, at the same time, it is possible that such a fall might take place without arresting consumption and production, and in that case it would neither be injurious or beneficial to any degree, but when a fall of this kind takes place in an obscure and unknown way, first upon one article and then upon another, without any correspondent fall taking place upon debts and obligations, it has the effect of destroying all confidence in property, and all inducements to its production, or to the employment of laborers in any way.

    And keeping NGDP constant when the economy is depressed instead of making it grow fast enough to restore the economy to potential output really does amount to what I accused
    Austrian Economics of initially, standing by and doing nothing (at least nothing effective) to restore the economy to potential output and waiting for the situation to clear up by itself.

  97. Gravatar of Full Employment Hawk Full Employment Hawk
    13. February 2011 at 22:35

    “Y = C + I + G is NOT an equilibrium condition. It is an ex-post accounting identity.”

    A significant part of traditional Keynesian economics involves the analysis of what happens when Y is not equal to C + I + G, or equivalently, when saving is not equal to planned or intended investment. This is, for example, especially obvious in the simplest of all the Keynesian models, the Keynesian Cross. In this simple model if Y is to the right of the point where the C + I + G planned expenditure function crosses the 45 degree line, C + I + G < Y. As a result, firms cannot sell everything they are producing and therefore reduce output until the EQUILIBRIUM CONDITION C + I + G = Y holds. When initially C + I + G can DIFFER FROM Y, this cannot be an identity. And since the economy adjusts until they are equal and then stops adjusting, this has to be an equilibrium condition. Garrison clearly has this wrong.

  98. Gravatar of Full Employment Hawk Full Employment Hawk
    13. February 2011 at 22:46

    “Again, we are debating crude keynesianism here. 101 keynesianism. We’re only doing so because that’s the presentation you’ve given me.”

    The criticisms you raised about the Y = C + I + G equilibrium condition and the relationship to MV deal with the most elementary features of the model and therefore need to be answered with the most elementary models. For example, you asked me about how a change in G changes Y. You that can be answered at the intermediate undergraduate level and does not require a DSGE model.

    Models for labor market can be added to the model in a number of different ways.

  99. Gravatar of Full Employment Hawk Full Employment Hawk
    13. February 2011 at 22:51

    “Back to MV = Y for a minute. You’re asserting that increasing government spending will not only have no negative impact on consumption and invest, but also that the supply of “money” is fixed. Which supply of money? We do have a very elastic money supply thanks to the money multiplier.”

    I was demonstrating that an increase in G can increase Y even if M is fixed (which is what you were asking about) through the effect on V. If the money supply is allowed to increase, G can increase Y even if velocity does not depend on the interest rate.

  100. Gravatar of Full Employment Hawk Full Employment Hawk
    13. February 2011 at 23:03

    “Keynes rejected the loanable funds market model of interest rate determination and instead asserted that interest rates were a function of money demand. This is I believe mostly false. Interest rates emerge out of a bidding process between borrowers and lenders.”

    Don Patinkin in Money, Interest, and Prices demonstrated that liquidity preference and loanable funds are equivalent. They are two different ways of looking at the same thing. (Actually that is only strictly correct if no transactions can take place and be finalized when the market for goods and services does not clear.)

  101. Gravatar of Full Employment Hawk Full Employment Hawk
    13. February 2011 at 23:19

    “Spending is not the root of economic growth or progress. Production of what people demand at cost-covering prices is.”

    In the short run, if spending is inadequate, that is if
    C + I + G < Y the output that would be produced at potential output cannot be sold. Therefore firms reduce at a level of output below potential output. An increase in spending is needed to get the economy back to potential output. This can, of course, be brought about by expansionary monetary policy, which will increase I and C, not only by an increase in G.

    The rate of growth in potential output itself is not determined in this way, of course. That depends on the rate of growth in the economic resources and technology.

  102. Gravatar of John Papola John Papola
    14. February 2011 at 14:42

    Hawk,
    Your (and Tom Atwood’s) concerns about productivity-driven deflation are not justified. We had falling aggregate prices and rising output throughout the boom of the 1865-1900 period. Yes, there were panics due to horrible state regulations on banks that kept them small, weak and universe. Canada had no such trouble with their free banking system. But still, rising productivity pushed the “price level” down as output and employment went up.

    Here’s George Selgin from “The Price is Right”, a short summary of his work in “Less Than Zero:

    Myth #1: Deflation always means depression or recession. Actually, it depends on the cause. The deflation of the early 1930s was a genuine disaster, involving massive declines in production and employment. But what made that deflation so painful, besides its severity, was its underlying cause: a collapse of the money supply, which in turn led to a collapse in consumer spending. Deflation can also be a consequence of improvements in productivity, in which case it needn’t be harmful at all. Such “benign,” productivity-driven deflation was a common occurrence during the last part of the nineteenth century, when people routinely looked forward to goods’ getting cheaper. Today, with productivity growing at more than 2 per cent annually, prices ought to be falling concomitantly.

    Myth #2: Falling prices mean falling wages and earnings. Not if they’re based on improvements in productivity. When productivity rises, the cost of producing goods and services declines. Prices of goods and services can then be cut painlessly, without any absolute decline in business earnings or wages. Last year, for example, workers’ average weekly earnings rose by about 4 per cent, or more than twice the official rate of inflation. Had monetary policy allowed consumer prices to fall 2 per cent — roughly the rate of overall productivity growth — average money wages would have risen slightly above their 1996 level. But because of lower prices, average real wages would still have risen by more than 2 per cent, just as much as their recorded increase under mild inflation.

    Myth #3: Deflation harms debtors. Again, not necessarily. Suppose, for example, that over the course of one year productivity unexpectedly rises 2 per cent and prices therefore unexpectedly fall 2 per cent. Then, although loans would be repaid in dollars more valuable than before, the dollars the borrowers made with the loan would also be more valuable. On the other hand, a productivity-driven deflation is very kind to pensioners and others living on fixed incomes: When lowered costs of production are reflected in lowered prices, persons on fixed incomes share in overall gains that would otherwise be enjoyed only by persons with flexible incomes. Why —-shouldn’t the benefits of improved productivity be passed on to all consumers?
    —-end quote—-

    Productivity-driven deflation does not introduce money illusion that can lead firms to depress output because it is CAUSED BY FIRMS who are increasing productivity. Apple figures out how to make more iPads with less using better robots. They know that the iPad price is going down and their profits for a while will go up. iPad buyers see their purchasing power rise with no negative impact on their nominal incomes. If Apple laid off workers in the process, the increased purchasing power of iPad buyers can go toward output for something these laid off worker produce. That’s how we went from 40% farmers to 2% farmers. Productivity reduced food costs and opened up markets for other goods. Again, this is just Say’s law of markets at work.

    Regarding your restatement of the way keynesians use the C+I+G accounting identity, you still are not connecting with me here. I don’t care that the Keynesian framework predicts keynesian outcomes. I care about what is actually going on and whether the Keynesian framework is true. Y is ALWAYS equal to C + I +G (+ Nx) because that’s the definition of Y. Our concern is about Y shrinking, not being redefined. If they are shrinking, due to a drop in I as people hoard money, there is a good that can be produced to address that increased money demand without wasting real resources on political boondoggles like Ethanol: money.

    Macro is really just about the impacts of changes in the supply of and demand for money. The impacts on C, I and G are all an ex-post account.

    I’m not try to be annoying, here, but I think what’s happening is that you are assuming I don’t fully grock intro macro while I in fact do grock it, think it’s wrong, and want to get those intermediate macro answers you alluded to.

    Based solely on the intro frameworks you’ve discussed, there is nothing to support the idea of “potential output”, nothing to connect aggregate demand to the labor markets and nothing to demonstrate the market processes which give rise to relationships between C, I and G. So I don’t see any economics here in the classical sense. I just see ex-post accounting and assertions. Keynes and Hayek both recognized that MV = PQ is NOT some sealed, hydraulic relationship, which is precisely what you’re saying when you talk about the impact on V when Y moves and M is held constant. This, I believe, is the methodological error that comes from spending time looking at accounting entities instead of voluntary human-driven market processes, incentives and opportunity costs… and money prices. Economics without prices is… um…. I don’t know what it is. Macro I guess. Is that economics though? I’m unconvinced.

    Please hold my hand help me into the intermediate pool and convince me. Submit to the sunk-cost fallacy of blog comments on my behalf.

    So here are my questions, which cannot be answered with any of the tools above:
    #1. What are the market processes which transmit changes in AD to the labor markets?
    #2. What is the M is MV? Which aggregate?
    #2a. Isn’t Scott’s whole point that M is nonsense? There’s really no good way to separate M from V and thus synthetic efforts to imagine the impact of holding M constant are pointless.
    #3. How do you determine the “potential output” of an entire economy?
    #4. How do you determine if underutilized capital is “slack” because of money-demand declines or because people changed their minds and the equipment is now worthless?

    One example for #4.

    Say the government came to its senses and stopped subsidizing and mandating corn-based ethanol tomorrow. That industry would collapse. The equipment and company values would collapse. Let’s say that all the dollars that were going to go into buying ethanol instead went into cash hoards, thereby failing to immediate provide rising demand in another sector which ethanol workers could migrate.

    Does it make sense for the government to resume the mandates and subsidies on the grounds of maintaining aggregate demand and re-employing “slack” capacity? It would clearly be wasting resources to do so. No question about it in my mind. Yet the keynesian intro model above says it’s A okay. That’s a problem.

    One last thing.

    Having the Fed maintain NGDP is NOT “doing nothing” in the face of a crisis/panic like that of 2008. Not at ALL. So let’s not throw around econ ad hominems. I don’t want to “do nothing”. There’s plenty to do. The question is who does what for whom with what information!

  103. Gravatar of 「微修正マネタリスト・サムナーに対する異議申し立て」 by Brad DeLong – 道草 「微修正マネタリスト・サムナーに対する異議申し立て」 by Brad DeLong – 道草
    14. February 2011 at 16:12

    [...] 哲学の分野で「隙間の神」(“god of the gaps”)として知られる話がある。科学は大半の現象を説明することができるが、科学をもってしてもどうしても説明できないように見える出来事も中にはある(生命の起源や宇宙の起源、自然法則、モーガン(Morgan)のコメント、その他諸々)。そのような出来事は神のせいに違いない、というものである。先日のこのエントリーでも触れたように、ここ最近ケインジアンらはこの「隙間の神」と同様の議論を財政刺激策に対しても用いようとしているのではないか、と私の眼には映る。1990年代までであれば、大半のマクロ経済学者は名目支出の期待水準に変化が生じたとすればその原因を金融政策に求めたものである。そしてこのことは同時に、財政政策を経済安定化政策の枠内において4輪自動車の5番目のタイヤみたいなもの、つまりは余分なものとして位置付けることを意味してもいた。しかし、ここのところの経済危機をきっかけとして、「ゼロ金利制約に直面した金融政策は無効である」と主張すると同時に経済安定化政策としての財政刺激策の復権を試みるケインジアンがいくらか現れてきている。準マネタリスト(quasi-monetarists)のグループが非伝統的な金融政策の存在を指摘すると、ケインジアンらはこう反論する。「非伝統的な金融政策が効果を持つとすれば、それはその政策が人々から信頼あるものとして受け入れられる限りにおいてである。マーケットは中央銀行の「インフレーションを起こします」という約束を信じるようには思えない」、と。それに対して準マネタリストの面々がこう返す。「マーケットがQE2(第2弾の量的緩和)の噂(近々QE2が実施されるかもしれないとの噂)に対して見せた反応は、まさに政策が信頼あるものとして受け入れられたことを暗に示すかのような反応だったんだけど・・・」。こうして再び、ケインジアンの勧める財政刺激策が経済安定化に果たす役割は何もなくなったかのように見えるのであった。 [...]

  104. Gravatar of Scott Sumner Scott Sumner
    15. February 2011 at 19:16

    John, I agree it is silly to talk about carbon taxes creating jobs.

    Most people still learn wages, and nominal wages are still pretty sticky. My wage is quite sticky, although I’m not sure why.

    Full Employment hawk, You said;

    “GDP falls if they are withdrawn before the economy has been restored to full employment.”

    Krugman now says there was no net fiscal stimulus, despite the Federal government doing a $800 billion stimulus. So let’s say they did the $1.3 trillion he wanted. It’s clear that it might have helped a bit more, but if Krugman’s right that $800 billion did virtually nothing, it’s obvious we still would have had pretty high unemployment with $1.3 trillion. But then when that stimulus was withdrawn, unemployment would have gone right back up–not according to me, according to the Keynesians I read. In other words, it was hopeless from the beginning.

  105. Gravatar of TheMoneyIllusion » Jumping to conclusions TheMoneyIllusion » Jumping to conclusions
    17. February 2011 at 20:00

    [...] following Mark Thoma statement isn’t exactly a misquotation, but comes close: Or they are making the claim that those who said monetary policy is ineffective at the zero bound have been shown to be [...]

  106. Gravatar of TheMoneyIllusion » Connect the dots TheMoneyIllusion » Connect the dots
    26. March 2011 at 09:22

    [...] Avent published the following observation over at The Economist.com: I SEE that Scott Sumner is taking a victory lap of sorts—not unearned—over the fact that views of monetary policy have come full circle since [...]

  107. Gravatar of TheMoneyIllusion » Is there too much gloating by market monetarists? TheMoneyIllusion » Is there too much gloating by market monetarists?
    16. September 2012 at 13:19

    [...] the Fed could and should do more.  Here’s Ryan Avent in 2010: I SEE that Scott Sumner is taking a victory lap of sorts—not unearned—over the fact that views of monetary policy have come full circle since [...]

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