Don’t mind the gap

In philosophy the “god of the gaps” hypothesis suggests that while science can explain most phenomena, certain seemingly inexplicable events (the origin of life, the 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 stimulus.

By the 1990s, most macroeconomists attributed changes in the expected level of nominal spending to monetary policy, and this made fiscal stabilization policy redundant, a sort of 5th wheel.  During the recent crisis, some Keynesians have attempted to revive the arguments for fiscal stimulus, arguing that monetary policy was ineffective at the zero rate bound.  When a group of quasi-monetarists reminded them that there are all sorts of unconventional monetary policy tools, the Keynesians argued that these tools would only be effective if credible, and it was unlikely that markets would believe central bank promises to inflate.  Then the quasi-monetarists showed that markets did react to rumors of QE2 in a way that implied the policy was credible.  Once again, Keynesian fiscal stimulus would seem to have no role to play.

Keynesian were not going to give up easily.  The next argument was that while monetary stimulus can be effective, central banks were afraid to aggressively pursue this sort of policy.  In that case a “gap” would open up between the central bank’s forecast of NGDP, and their implicit target.  Fiscal policy can fill that gap.  In essence, they argue that fiscal policy is useful in direct proportion to the degree to which monetary policy is incompetent (in the Svenssonian sense of failing to equate the policy forecast and policy goal.)  And to give credit where credit it is due, monetary policy has been strikingly incompetent over the past 30 months.

[As an aside, this explains why back in 2009 both the right and left thought the other side was returning to the dark ages.  The right recalled that Keynesian fiscal stimulus had been expunged from graduate education for nearly 30 years, as the fiscal multiplier is zero under an inflation targeting regime.  The left couldn’t understand why the right denied that fiscal stimulus could be effective in a world where the central banks had obviously allowed inflation to fall below target.]

Before addressing some questions by Ryan Avent, I’d like to tell a brief story that might help explain why I think Keynesians are putting too much weight on the “gaps” argument.  Not that the argument is wrong, but rather that it is much less right than it seems at first glance.

Years ago I used to get into arguments with our dean, who insisted that the marginal cost of admitting an extra student to Bentley was essentially zero.  He relied on the common sense notion that most classes had at least a few empty seats, and hence one extra student could be squeezed in at virtually no additional cost.  Here’s why I think that argument is wrong.  Bentley caps classes at 35.  For simplicity, assume it costs $35,000 in salary and benefits for each professor-taught course.  (I.e. profs earn $140,000 in total comp., and teach 4 sections.)  For each student added by Bentley, there is a 1/35 chance that the admission will trigger the need for an extra section.  In that sense the dean was right.  It’s quite likely that the marginal cost would be zero.  On the other hand, if an extra class was needed the cost would be $35,000.  Since we have no idea when and where students will trigger an extra section being offered, the expected cost of an extra student is (1/35)*$35,000, which equals $1000.  And that’s also the average cost.  There’s no “expected gap” to be filled, even if there are occasionally some actual gaps that can be filled at no cost.

The Keynesian gap argument is not as weak, because we may be able to observes gaps in the aggregate economy more easily than in class size.  But I still think they are making an analogous mistake.  For instance, let’s go back to the argument (which I agree with) that the Fed has recently allowed the forecast NGDP growth rate to fall below their policy goal.  For simplicity, assume the Fed’s goal is 6% NGDP growth during the recovery, and the forecast is 4.5%.  So there is a 1.5% gap that might be filled by fiscal stimulus.  And furthermore (so the Keynesians argue) if fiscal stimulus does try to fill this gap, the Fed won’t take affirmative steps to neutralize the stimulus.

Now let’s ask why the Fed allows this 1.5% growth gap.  Perhaps it is fear that unconventional stimulus is a dangerous weapon, and that we might overshoot to high inflation.  (Recall the monetary base has more than doubled.)  The next question is; how should we interpret that caution?  Does that mean the Fed has a de facto 4.5% NGDP target?  When I talk to Keynesians, I get the feeling that they differentiate between situations where the Fed is “doing nothing” and where the Fed is “doing something.”  Thus the Fed would not do unconventional stimulus to push NGDP growth above 4.5%, but if fiscal stimulus pushes it above 4.5% (but below 6%) the Fed would not pull back to slow the economy.  They will allow faster growth, but they won’t try to cause faster growth.

This is where I begin to part company with the Keynesians.  I believe it’s better to think in terms of the Fed always “doing something.”  This is probably easier to explain with an example.  During the spring of 2010 NGDP growth slowed, perhaps due to dollar hoarding following the Greek/euro crisis.  Keynesians argued for more fiscal stimulus, and made the quite plausible assumption that the Fed would not try to offset the effects of fiscal stimulus.  One particularly sophisticated argument was that Bernanke didn’t have enough support (at that time) to push for more stimulus, but that the inflation hawks also lacked enough power to tighten policy after a fiscal boost.  Monetary policy was adrift in the gap.

How do things look today?  If the Keynesians had gotten their way in the spring and early summer of 2010, then Congress would have debated a new fiscal stimulus for a few months, and passed it during the second half of 2010.  Would this have boosted NGDP growth in 2011?  I’m skeptical, as it turns out that the monetary policy “gap” wasn’t that big.  The Fed did move aggressively in November, and indeed moved in September, if you recall that expectations of monetary stimulus are the same thing as actual monetary stimulus, even in the new Keynesian model.  If Congress had done another $400 billion stimulus, it seems unlikely that the Fed would have moved until they had a chance to see whether the fiscal boost would do the trick.  In that case the argument for a positive fiscal multiplier is essentially that fiscal stimulus is more powerful than monetary stimulus.  But in the famous cases where fiscal and monetary stimulus worked in opposite directions (1968-69 and 1981-82), monetary stimulus seemed much stronger.

Here’s my point.  In the spring of 2010 even I had trouble coming up with persuasive arguments against the Keynesian proposals for fiscal stimulus.  Even I had to admit that it was unlikely that the Fed would try to sabotage fiscal stimulus when the recovery was so weak.  But as things played out in reality, it seems unlikely that a fiscal boost would have helped all that much, not because it would have been intentionally sabotaged, but because it would have taken the Fed off the hook, allowing them to do nothing in the fall of 2010.

It’s a mistake to think the Fed is ever really in a situation of “doing nothing.”  We’ve seen them do several mid-course corrections (March 2009 and November 2010) when the recovery was unacceptably weak.  During early 2010 policy was de facto contractionary, as lots of Fed officials talked about “exit strategies.”  If, as seems plausible, these back and forth swings of monetary policy are reactions to expected NGDP growth, then it would be more accurate to say that there is no significant policy gap, but rather the Fed is (for whatever reason) targeting NGDP at a lower level than they would if they could rely on their tried and tested fed funds targeting approach.  They are like that 85 year old lady driving her Camry very slowing, with one foot on the brake, because she read scary news reports of “sudden acceleration” problems in Toyotas.  If Morgan Warstler gets right on her tail with his big SUV, and starts honking, she’ll get even more nervous and drive even slower.  (Sorry Morgan, I’m using you as a symbol of fiscal stimulus.)

In this comment section, Andy Harless presented one of the best arguments for fiscal stimulus:

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.

I’m not going to argue Andy is wrong, rather I’ll argue he is less right than he thinks.  First, Tyler Cowen often notes that the Fed is normally the “last mover” in the stabilization game.  Congress acts infrequently, whereas the Fed meets every 6 weeks.  In the case Andy discusses, Congress became the last mover for a variety of unusual reasons:

1.  QE2 occurred around election day.  This was partly because the recovery had stalled, and partly because Bernanke was waiting for more support (from the new Obama appointees) on the Board of Governors.

2.  The GOP made huge gains, necessitating a compromise to prevent a huge tax increase in 2011.  Obama was forced to give in on tax cuts for the rich, and in exchange was able to secure more fiscal stimulus via a payroll tax cut.

3.  Because the fiscal stimulus happened to occur right after QE2, and because the Fed likes to “wait and see” after a dramatic policy shift, we can be reasonably sure the Fed won’t immediately negate the tax cuts.

I would also agree that the fiscal stimulus has been somewhat effective.  But the reasons I’d give are a bit different from those of the Keynesians.  I believe cuts in MTRs boost the supply-side of the economy, which slightly raises the Walrasian equilibrium real interest rate.  This effectively makes monetary policy (even at the zero bound) slightly more expansionary.  I don’t believe spending increases have any supply-side boost, and I think their effect on the Walrasian real rate is smaller.  Hence part of the higher expected growth is a direct supply-side effect, part is the indirect effect on monetary policy, and perhaps another part is that if we exit the liquidity trap more quickly, the Fed will be more comfortable with slightly higher NGDP growth, as they can then use conventional tools.  No more 85 year-old lady driving the economy.

And if Keynesians insist on defining “monetary policy” as changes in interest rates, then the tax cuts probably did lead to tighter money.  Woodford argued the Fed should promise to hold rates at zero for an extended period.  But the fiscal boost seems to have moved the expected date of Fed rate increases closer to the present.  Unlike Woodford, I don’t necessarily see that as bad news, as it also indicates that markets think the economy will recover more quickly.  So I’m not going to argue against this particular fiscal stimulus.  All I’ll say is that there was a bit of luck (avoiding the usual last mover problem) and that it was effective partly for supply-side reasons.  (I won’t even attempt to defend that argument here, as it’s already an over-long post.)

This post was motivated by a Ryan Avent post, which asked me to respond to three arguments for fiscal stimulus.  I’ve responded to his second argument.  Here’s his third:

Finally, American government debt is extremely cheap during some severe recessions (like this one), and useful as a monetary tool. Resources and labour are also quite cheap during a downturn and slow recovery. If we’re anxious to minimise the cost of public investments, there seems to me to be a strong case for building a public investment project pipeline that can be accelerated during periods of economic weakness. Save the taxpayers money by borrowing and hiring when the demand for loans and labour is low.

I agree with this argument.  Projects such as infrastructure should meet a cost/benefit test.  Because real rates are lower during recessions, more infrastructure will pass that test during recessions.  But this isn’t how American states behave.  California spends money like a drunken sailor when the capital gains revenues pour in from Silicon Valley, and everything gets put on hold when the bubble collapses.  (BTW, for all you leftists who think the housing bubble shows capitalism doesn’t work, note that our governments are just as irrationally exuberant.)  Yes, I’d love to see our fiscal regime become more like Singapore, but it would be far easier to reform our monetary regime to make fiscal stimulus superfluous, then it would be to reform our dysfunctional fiscal regime.  I agree with Ryan’s logic; I just don’t see it happening.

If the states don’t save money in the good years, they have nothing to spend in the bad years.  At this point fiscal advocates call on the deus ex machina of federal spending.  But the federal government’s not good at quickly implementing shovel-ready projects; in our system that’s mostly done at the state level.  Plausible federal projects, like high speed rail, are far from being shovel-ready.  (There was a proposal to build high speed rail from Madison to Milwaukee, now cancelled.  Having grown up in Madison I can assure you no one would have used that high speed rail service.  Normal people do the very easy 75 minute trip by car, and poor people take Badger Bus, much cheaper than high speed rail.)

Ryan Avent also argued:

Mr Sumner suggests that the Fed controls the glide path, such that any fiscal boost will be offset by monetary policy and will therefore have a multiplier of zero. I don’t quite agree, for a few reasons. First, sometimes the Fed messes up, as it did in 2008. If Congress had passed a massive, immediate stimulus measure to go along with TARP, I believe Mr Sumner would agree that it would have done some good. He would prefer the Fed not to mess up, but given that the Fed will sometimes mess up, strong automatic stabilisers strike me as a very nice thing to have.

The honest answer is I don’t know, but here’s a few reasons I am skeptical:

1.  Fiscal stimulus is slow.  It wouldn’t prevent the initial slump, and the actual date of passage (early 2009) is about as fast as thing happen in the US.  But by that time it was obvious monetary policy had also failed.  The Fed knew it was behind the curve.  So Avent’s argument is that fiscal authorities were willing to act more aggressively than monetary authorities in early 2009.  The argument is (presumably), that a bigger fiscal stimulus bill would not have led the Fed to forgo QE1 in March 2009.  Maybe.  The argument is that no stimulus bill would not have forced Bernanke to pull out the nuclear option, level targeting, which is likely to be highly effective.  Maybe.  The argument is that the actual fiscal stimulus produced benefits in the form of faster recovery, which outweighed its costs (a big future deadweight burden on the economy, through higher taxes.)  Maybe.

2.  Given all this uncertainty, I can’t argue Avent is definitely wrong.  If I had my way the fiscal stimulus would have involved the elimination of the employer share of payroll taxes in 2009.  That’s effectively a 7.65% wage cut that doesn’t affect worker-take-home pay at all.  It essentially neutralizes the negative impact of falling NGDP combined with sticky wages.  Then I’d tell the Fed to get its act together and make sure it had enough monetary expansion in place to take over in 2010, once the taxes went back to normal.  I seem to recall that Singapore and also a few European countries do this sort of thing.

3.  I hope people reading this post will understand why even if I am wrong, we’ve got to stop building models of fiscal stimulus that rely on ever more epicycle-type arguments, and just get on with implementing a simple monetary regime of targeting the &%$@#%$ nominal GDP forecast, level targeting.

PS.  Readers who skip my comment sections can sample Morgan here at 2/10, 7:07am and 2/10, 13:23pm.  If only I could combine Morgan’s Hunter S. Thompson-like gonzo style with my knowledge of macro, I could be the Krugman of right-wing blogging.


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75 Responses to “Don’t mind the gap”

  1. Gravatar of Jon Jon
    12. February 2011 at 12:38

    There is latitude for fiscal policy but sometimes people seem to be stuck in the 18th century when governments still had bit vaults of money, and consequently a decision to draw down that vault reflects a simultaneous expansion in the supply of money and a reduction by the government of it’s own cash balances.

    This is about as far away from the present situation as we can be. Now people presume that the government does need a pile of cash, it just needs to issue debt and spend. This isn’t really the same thing at all.

    What it does is pump the flow of funds and can maintain nominal income, but its not obvious the funds keep circulating. Once the governebt stops issuing new debt the pump stops. This is a post-war style shock, and its anticipated which negates the present effect. This combines with displaced private flows of funds. Thats Ricardian equivalence for you.
    Second the pump can do nothing to directly accommodate the increased demand for money; at best the pump by maintaining national income forestalls and increased deman to hold money.

    I dont think national income drives the propensity to hold money, fear does. It’s the unmet demand for money that drives ngdp to fall. So using ngdp as an indicator is useful but it does not follow that simply replacing ngdp via fiscal policy after the fact will absolve the expectations driving an increased demand for money.

  2. Gravatar of Ram Ram
    12. February 2011 at 12:50

    You have remarked upon the tendency of many commentators to treat fiscal & monetary stimulus asymmetrically. Supposedly fiscal stimulus boosts (or fails to boost) real GDP, while monetary stimulus boosts (or fails to boost) the price level. If this asymmetric treatment is consistent with the views of politically influential groups, then perhaps the Fed & the Congress face asymmetrical pressures when it comes to their respective powers to stimulate. In other words, maybe politically powerful groups want more real GDP, but want no more inflation; thus they use their influence to hamstring the Fed, while empowering the Congress to stimulate. If the Congress is hamstrung, this may reflect a conflict over fiscal priorities rather than genuine opposition to deficit spending.

    In that case, to the extent that stimulus of whatever kind is desirable (to the extent that AD is insufficient), one may be more successful pushing for fiscal stimulus than monetary stimulus. Moreover, if the Fed is pursuing a contractionary policy only because of these outside pressures, it would have no reason to neutralize fiscal expansion. So proponents of stimulus may find that under these circumstances, their time is better spent convincing people to support further fiscal expansion.

    This might sound like a highly contrived situation, but the more I observe the public debate over macroeconomic policy, the more compelling I find this characterization of the political environment. Again, this does not excuse claims that monetary stimulus is impotent once the ZLB is reached. But if the only politically possible route to greatly increased AD is fiscal stimulus, then I suppose that is the way to go.

  3. Gravatar of Scott Sumner Scott Sumner
    12. February 2011 at 13:05

    Jon, OK, but any comments on my post?

    Ram, I’ve said people make that argument, but also that the argument is wrong. If anything, monetary stimulus is more likely to result in RGDP growth, and fiscal stimulus (which hurts the economy’s supply-side, if based on more spending) is more likely to result in inflation.

  4. Gravatar of Jon Jon
    12. February 2011 at 13:10

    Incidentally the reason the old Keynesian models were wrong was that they assumed that demand gap was an independent variable and the level of cash balances was a dependent residual. They assume that closing the demand gap reduces the excess demand for money. This assumption has it exactly backward. An increased demand to hold money is an aggregate preference change that then drives an imbalance in all markets. The government gets its funds by selling bonds so it contributes to the demand for money in exact proportion to the supply of money it creates.

    Fiscal stimulus does not resolve the unmet demand for cash balances.

    Ngdp does have a secondary effect. Nominal contracts do embed an ngdp expectation, and an ngdp shortful does cause a secondary recession. This smaller effect can be lessened buy only if expectations of future ngdp are changed. Again ricardian equivalence works against fiscal policy.

    Ngdp can server as a nominal anchor for money policy and helps avoid secondary effects from ngdp fluctuations, but an elastic money supply does the real work.

  5. Gravatar of Ram Ram
    12. February 2011 at 13:24

    Right. I don’t buy that argument either. But if enough well-placed individuals or groups find it compelling, as seems to be the case, then it substantially changes the policy possibility set. Maybe it is worth trying to disabuse people of this confusion, but until that effort succeeds, it may remain the case that fiscal loosening is more politically feasible than monetary easing, especially in the wake of a doubling of the monetary base (to be clear, this consideration doesn’t diminish the first-best case for monetary easing, just the second-best political case for it).

    If we consider the Reinhart & Rogoff perspective, we can sketch a typical sequence of events: A financial crisis causes a severe nominal shock, in response to which the country loosens both monetary and fiscal policy. Unfortunately, the looser monetary and fiscal policy get, the more opposition they breed towards further loosening. So both monetary and fiscal policy remain too tight after large financial crises, not because of any intrinsic difficulties with loosening, but because the political environment places limits on how much loosening can take place. In this telling, the political problems I mentioned above are not just a pathology of this moment in US politics, but are instead a characteristic consequence of large financial crises.

  6. Gravatar of dtoh dtoh
    12. February 2011 at 13:33

    Maybe the reason that people mind the gap is because current Fed policy tools (asset purchases, etc) are so imprecise. The Fed would be much more effective if it could flexibly set equity reserve ratios for different assets held by financial institutions. Equity reserve ratio setting could be implemented together with the introduction of an explicit Fed guarantee for participating institutions (mandatory for large institutions and voluntary for smaller institutions) and the elimination of the existing implicit Fed guarantees on which the markets currently rely. This would be trivial to implement and would fix nearly all the problems with the current financial system in one fell swoop. It eliminates the moral risk… institutions would no longer be able to borrow cheap with an implicit taxpayer guarantee and then lever up on risky assets because the Fed would set the equity reserve ratio high enough to make this unprofitable or at least more risky. It allows the Fed to prick specific asset bubbles with great accuracy and precision (e.g. raise the reserve ratio on South Florida mortgages not held by the originating institution). Finally it gives the Fed tremendous control over credit and the money supply during a recession even if real interest rates are near zero, e.g. the Fed would not only be able to drop the overall average reserve ratio it would also be able to raise the ratios for Treasury securities and balances held at the Fed while setting lower or negative ratios for increases in consumer or corporate loan balances.

  7. Gravatar of Indy Indy
    12. February 2011 at 15:09

    The real key to this is the non-falsifiability of the epicycle-like theorizing about the “god of the gaps”. What is it we’re trying to assume or explain away here? It is, essentially, the unknowable psychology of the human beings in charge of the Federal Reserve’s policy. These governors have taken care to maximize their discretion and room-for-maneuver while simultaneously minimizing their accountability.

    How do you know if they failed? How do you know what they were trying to actually achieve? Transcripts of conversations known to be recorded in transcripts will never be enough to penetrate the real motives of these individuals’ decisions and votes.

    So we have all this discussion about their concerns, anxieties, politics, what they’re willing to do, what they’re hesitant to do, whether they’ve been “ideologically captured”, and it’s all about as valuable as the analysis of the Kremlinologists of yore – which was, we now know from archives, almost always completely worthless.

    And we’re supposed to be basing economic theory and fiscal policy in a special-interest-riven democracy on *that*?! That’s absurd. Maybe even insane.

    The markets, at least, communicates information and expresses the beliefs of its participants in the form of prices in a way that almost cannot be concealed (perhaps unless you’re John Paulson). We might even be able to tease out that whole “Fed’s credibility” perception out of market data. But there is, currently, no similar motivation-revelation device for the Fed’s “policy participants”.

    If pragmatic arguments about policy cannot be settled in the field of Economics without reference to these kinds of speculations, then that makes one of the strongest arguments possible for the Fed’s role to be simple, clear, and predictable; a formula which transcends unknowable human factors and which we can put into our models when we debate.

    Level Targeting The NGDP Forecast is the best regime possible that satisfies these worthy characteristics. The very fact that we are having these strange “god of the gaps” debates cries out for it.

  8. Gravatar of Nick Rowe Nick Rowe
    12. February 2011 at 15:12

    In the recent debate between proponents of monetary and fiscal policy, something’s been missed.

    In the textbooks we distinguish between bond-financed deficits and money-financed deficits. The latter is both monetary and fiscal policy. Both sides seem to have been ignoring whether the fiscal deficits will in fact be money- or bond-financed.

  9. Gravatar of Nick Rowe Nick Rowe
    12. February 2011 at 15:17

    Put it another way: would fiscal policy be a good way to increase the money supply?

  10. Gravatar of TheMoneyIllusion » Don't mind the gap | ameripridetaxgroupavoidaudits.com TheMoneyIllusion » Don't mind the gap | ameripridetaxgroupavoidaudits.com
    12. February 2011 at 15:23

    […] the original post: TheMoneyIllusion » Don't mind the gap This entry was posted in Uncategorized and tagged during-some, extremely-cheap, fiscal-stimulus, […]

  11. Gravatar of Liberal Roman Liberal Roman
    12. February 2011 at 16:20

    These arguments would be much easier if had a functioning NGDP futures market.

    Also, I can’t wait till Morgan chimes in…

  12. Gravatar of ssumner ssumner
    12. February 2011 at 16:23

    Jon, I agree.

    Ram, Our crisis is very different from typical financial crises. In many cases the problem is real, and the result is high inflation. In our case the problem is nominal and the result is excessively low inflation. So I don’t think we have much to learn from crises like Mexico, Indonesia, Russia, etc.

    dtoh, I’m all for higher capital requirements, especially for risky assets. But remember, banks are good at hiding risk.

    Indy, I agree.

    Nick, Yes, but what is money? Is the large increase in interest-bearing reserves an example of an increase in the money supply sterilized by an increase in money demand? Or is it not money at all, but rather government deficits financed with interest-bearing reserves, which are basicially debt, not money.

    Japan showed that monetizing huge deficits won’t work. You need a positive inflation or NGDP growth target, level targeting. If the BOJ wants 1% annual NGDP growth (pretty conservative I think you’d agree) they need to shoot for 16% NGDP growth in 2011, because NGDP hasn’t grown since 1994.

    You asked:

    “Put it another way: would fiscal policy be a good way to increase the money supply?”

    A good way to increase the money supply is buying T-bills, (which are low risk for the Fed), but increasing the money supply isn’t a good way of boosting NGDP growth. We already have far more base money than we need to get even 10% NGDP growth expectations. We need to increase base velocity with a higher NGDP growth target, level targeting. If that does work then do negative IOR.

  13. Gravatar of ssumner ssumner
    12. February 2011 at 16:26

    Liberal Roman, Morgan’s probably a great guy. It’s just that unlike most of us he doesn’t hold back–let’s us know what he’s really thinking.

    And yes, we desperately need an NGDP futures market.

  14. Gravatar of Jon Jon
    12. February 2011 at 16:35

    Nick writes:

    In the recent debate between proponents of monetary and fiscal policy, something’s been missed.

    In the textbooks we distinguish between bond-financed deficits and money-financed deficits. The latter is both monetary and fiscal policy. Both sides seem to have been ignoring whether the fiscal deficits will in fact be money- or bond-financed.

    Isn’t this my point–I realize my first post wasn’t completely clear, peeking that out on the iphone discourages editing, but still agree, agree, agree.

    If you pay for fiscal policy through bonds, you do little to resolve the unmet demand for cash balances. If you implement fiscal policy by having the government drain down its own stocks of money, you lessen the demand to hold money and expand the amount of circulating currency, and therefore implement a form of monetary policy; however, the only way to accomplish this in the 21st century is if the CB monetizes the government’s debts. What Western government has a treasury in the traditional sense of the word? Its a fantasy idea at this point. So we’re left back in the original corner: the CB drives policy.

    Scott’s point also holds that the CB may neutralize any money-supply excursion undertaken by the fiscal authority because the CB moves ‘last’ and moves often. That part is definitely true too.

  15. Gravatar of Jon Jon
    12. February 2011 at 17:19

    Jon, OK, but any comments on my post?

    I think my comments were directed at your post; the gap cannot be bridged by debt-funded fiscal policy. The CB must monetize the debt, therefore the CB still determines the equilibrium.

  16. Gravatar of Morgan Warstler Morgan Warstler
    12. February 2011 at 18:15

    Ryan and Scott’s back and forth, pretends that the Fed does not have a political preference, by getting into monetary navel gazing on whether Fiscal gets neutered.

    “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.”

    Pretty soon we’re going to be talking about what happened yesterday, and having lengthy interpretations about it.

    This shit just happened! We can remember it! We recorded it daily in a blog.

    During early 2010 and into last summer there were a continued series of cries for the Fed to do more…. from many of you.

    Scott says…

    “In the spring of 2010 even I had trouble coming up with persuasive arguments against the Keynesian proposals for fiscal stimulus.”

    And I argued the Fed is Republican and since they had their mojo back, there’s no way they were going to aid and abet Obama / Pelosi. I taunted liberals here routinely that the Fed has different policies based on who’s in political power. I remember the first Greenspan / Clinton meeting in 1993 like it was yesterday.

    This was Greenspan saying Clinton got read the riot act in earlier January, and had given up on all possible forms of “investing in” government:

    “In other words, the evidence that President Clinton and his
    associates are very seriously focused on “” this long-term budget deficit “” has impacted in the marketplace, as we have seen in recent days.”

    http://www.archive.org/stream/1993economicrepo01unit/1993economicrepo01unit_djvu.txt

    He very specifically gave Clinton the choice of government spending OR keeping short interest rates lower… because of Reagan’s maximum debt strategy is ugly but it WORKS.

    This was my formative Fed experience. Don’t you people remember how jarring it was that Clinton’s first act was DADT? It was the only free thing he could do for the left. He put Alan on the dais next to Hillary, and Reich and Carville went bat shit crazy.

    —-

    Even though I was against QE2, it was obvious they were holding off and holding off through 2010… the market responds quickly, who could chance three months positive news before the election cycle.

    I taunted folks here about it mercilessly – many of you cried about it. The Fed Board was as enthralled with election results as the GOP campaign managers.

    So, of course the Fed controls the gas peddle, but they are far more lenient when one of their kids is driving than when the other one is.

    And frankly, right now Obama has to worry deeply about, “no QE for you!”

    ——

    As a thought exercise, think about this like the wikileaks public truth thing.

    The moment that everyone HAS TO admit that the Fed is “Arbiter de Fiscal Policy,” the moment it becomes known, this puts liberals into a new position; they HAVE to finally support a massive effort to make government more productive – or die.

    (We’re seeing this out of Matty right now, he senses his own livelihood with CAP is leading the left into the barren wilderness of weakened public employee unions.)

    Because faced with the truth that banks run the show, liberals GAIN the public understanding that the Bernanke Put is real…. anytime inflation drops down towards 0%, he’s going to do QE until he’s sure it’s headed up over 1.5% but by 2% all bets on QE are off.

    Which means the final cards of Reagan’s strategy get played: faced with no more deficit money to pay of Dem voters, and proof that higher taxes will reduce growth, we have to find real cuts – not to SS, not to Medicare, not to Defense (Obama’s damn war!) – nope it’s time cut $400B per year in compensation to public employees, just in time for the 2012 elections.

    So my argument is this: since this all looms over the left, the smart guys (Obama) will/should/are seize on the public knowledge of “Arbiter de Fiscal Policy,” and take up the reins of good government is frugal government, and stop paying attention at all to cries to “do something,” better to blame the Fed if they fail.

    Suddenly, the Ben is exposed – it is all on him, he has good reason to do level targeting, he’s been handed total public control of the economy.

    Which means to me, the more productive we make the fat bloated public sector, the more deflationary effects we’ll see on AD, the more the Fed will push down the gas.

    If the Dems want to sit on Dad’s lap and drive the car, they are going to have to drive it like the Republicans.

    Once they know this, it’s better for them politically that everyone know who’s really doing the driving.

  17. Gravatar of dtoh dtoh
    12. February 2011 at 18:42

    Scott,
    1) The point is that the ability to set and change capital reserve ratio requirements would give the Fed a monetary tool that is much more powerful and effective than tweaking the FF rate or buying assets. It’s amazing to me that no one has proposed or explored this.

    2) Adding stability to the financial system is an ancillary benefit.

    3)I think you’re mistaken about banks hiding risks. They often don’t understand risk (especially liquidity related risk), but it would be trivial to monitor and put in place reserve ratios based on asset class and the length of time the bank has held the asset.

    4) Why do you favor higher capital requirements. I agree that you need to do it if the government provides either an implicit or explicit guarantee. Also, if you are just thinking about risk to the system, the requirement should probably be tied more to liquidity than to risk.

  18. Gravatar of Jeff Jeff
    12. February 2011 at 18:43

    Scott, I think most of us quasi-monetarists think the distinguishing characteristic of money is that is the medium of exchange. This is a bit different from Milton Friedman’s notion that money, particularly M2, was a store of readily available purchasing power. So, for example, Friedman would count small time deposits, which are part of M2, as money, while Nick Rowe and Bill Woolsey probably would not.

    If you’re not a bank or the Fed itself, the stuff you exchange for goods and services is either currency or a liability of a bank. Reserves are neither.

    I wrote about this in a comment several weeks ago: when the Fed buys a Treasury bond, it pays with a check (or wire transfer) that the seller deposits in his bank. So the money supply immediately goes up by the amount of the purchase.

    The bank takes the check to the Fed and exchanges it for reserves. Required reserves are 10 percent of transactions deposits (once you get past the low-reserve tranche, which all large banks do), so 90 percent of those new reserves the bank has are excess reserves. If the Fed is paying a competitive rate on excess reserves, the bank just leaves them there and that’s the end of the story. In this case the money multiplier is one.

    If the bank thinks it can do better by lending out its excess reserves, it does so, and whoever it lends them to deposits the funds in his bank, and thus 90 percent of the loaned-out funds again become excess reserves. They get loaned again and the process continues until there are no excess reserves left because deposits have gone up by ten times the original Fed purchase.

    My point is that paying interest on excess reserves reduces the money multiplier from 10 to 1. So long as the Fed pays as much or more interest than the risk-adjusted rate banks can get on their own, there’s no reason for them to lend to anyone but the Fed. You would expect banks to let all their other loans run off until their only assets, other than buildings and office equipment, are reserves. Amusingly, the monetary base then becomes a very good measure of money supply.

  19. Gravatar of Tweets that mention TheMoneyIllusion » Don’t mind the gap — Topsy.com Tweets that mention TheMoneyIllusion » Don’t mind the gap -- Topsy.com
    12. February 2011 at 18:47

    […] This post was mentioned on Twitter by Al Wagner, Mark Lennox. Mark Lennox said: Don’t mind the gap: In philosophy the “god of the gaps” hypothesis suggests that while science can … http://bit.ly/fpvDCP – $ Illusion […]

  20. Gravatar of dtoh dtoh
    12. February 2011 at 18:58

    Jeff,
    You say “there’s no reason for them to lend to anyone but the Fed.” To my point on capital reserve requirements, if the Fed could jack up the capital reserve ratio at will on deposits with the Fed, it wouldn’t need to worry about the deposit rate.

    Similarly to your point “You would expect banks to let all their other loans run off until their only assets, other than buildings and office equipment, are reserves.” Not if the Fed sets a negative equity reserve requirement on net changes to those assets.

  21. Gravatar of StatsGuy StatsGuy
    12. February 2011 at 19:08

    @ Nick Rowe

    “In the textbooks we distinguish between bond-financed deficits and money-financed deficits. The latter is both monetary and fiscal policy. Both sides seem to have been ignoring whether the fiscal deficits will in fact be money- or bond-financed.”

    Hallelujah!! This is the Joe Gagnon argument. In essence, Keynesians can argue cash/debt equivalency at the zero bound, and Monetarists can argue Ricardian equivalency, but if the Fed prints money and Treasury spends it, the price level MUST go up.

    To expand on this argument, let’s pretend – more like a fantasy – that Congress is brilliant. In 2009, they realize three things:

    1) The Fed is being run by a bunch of monkeys worshipping dead economists, and figure that if the Fed only cares about the sanctity of the dollar and the health of the banks

    2) They know that monetary policy is a lot more powerful than fiscal policy

    3) However, they also realize that if they run BIG enough deficits, then given the US’ lower savings rate than Japan, it’s unlikely that Treasury will be able to float the deficit needs without Fed support. Even the monkeys at the Fed don’t dare let a US bond auction go unsuscribed, so bingo – monetization! In essence, Congress plays a game of chicken and wins.

    ssumner also writes

    “Fiscal stimulus is slow.”

    Actually, not exactly – remember, the expectation of stimulus is quite nearly as effective as stimulus. States budget out for a year, so in 2009 state expenditures hadn’t really started dropping as rapidly as they would, but everyone expected them to. If states believed the Treasury would send them checks to support projects, then this would at the minimum have encouraged states to budget in these funds, and avoided cuts. To an extent, this happened. Moreover, private contractors (in expectation of getting contracts) retain workers, buy equipment, etc.

    Fiscal stimulus is not necessarily slow, assuming one believes it’s effective in the first place.

  22. Gravatar of StatsGuy StatsGuy
    12. February 2011 at 19:15

    ssumner:

    “Japan showed that monetizing huge deficits won’t work. You need a positive inflation or NGDP growth target, level targeting. If the BOJ wants 1% annual NGDP growth (pretty conservative I think you’d agree) they need to shoot for 16% NGDP growth in 2011, because NGDP hasn’t grown since 1994.”

    Not true. As you have argued many times, the BOJ showed that if you stop monetizing debt just when it starts to do it’s job, then it “doesn’t work”. Moreover, deficits in Japan would have needed to run much higher than in the US to have an equivalent effect (that is, to support the necessary levels of monetization) due to the higher savings rate.

  23. Gravatar of Richard W Richard W
    12. February 2011 at 20:19

    In 2009 underfunding the deficit by the USG borrowing direct from the US banks and not issuing any new treasuries would have been a much more effective QE. Bernanke was creditist obsessed. They could even have used as collateral central bank bills which some central banks issue. Although, I am not sure if it would be legal in the US. It would have stopped the huge flow of funds warehousing in newly issued treasuries.

  24. Gravatar of Jon Jon
    12. February 2011 at 20:40

    Statsguy writes:

    “Fiscal stimulus is slow.”

    Actually, not exactly – remember, the expectation of stimulus is quite nearly as effective as stimulus.

    Scott has made that same point before, but the delicacy of the matter is this: suppose I promise to spend money thirty years hence, sure that has an immediate effect but that effect is reduced substantially by the discount rate.

    Now lets think in more practical (less extreme terms). Congress takes 6-12months to decide to act. Then they decide to fund a set of expenditures. For some reason they’re obsessed with infrastructure spending, so those expenditures are slated to come 5yrs hence. In five years time, the Fed isn’t going to allow the economy slack, so that announcement has no effect.

    Okay what about those expenditures slated to come within one year? This is a point Scott has made before: the expectation of those expenditures lead to near immediate effect. So we should get an immediate boost, we don’t need the spending to play out first (contrary to the Keynesians who insisted we had to wait to see it work). Trouble is, no such boost appeared in the statistics.

    This is consistent with expectations being that the Fed determines NGDP.

  25. Gravatar of Morgan Warstler Morgan Warstler
    12. February 2011 at 20:42

    “3) However, they also realize that if they run BIG enough deficits, then given the US’ lower savings rate than Japan, it’s unlikely that Treasury will be able to float the deficit needs without Fed support. Even the monkeys at the Fed don’t dare let a US bond auction go unsuscribed, so bingo – monetization! In essence, Congress plays a game of chicken and wins”

    THANK GOD.

    Finally, someone steps the hell up – this is exactly what happened.

    In fact, I argued the play before that was the size of Bush’s TARP, and even a conservative willingness to do TARP, was an effort to spend the all the money bailing out the banks on GOP terms, before Obama got to spend it.

    I’m sure they thought “make it as big as possible” – better this than a jobs program.

    You can’t really understand Bush unless you get that his JOB was to spend every last dime in eight years. His daddy screwed it up, he wasn’t about to.

    Tax cuts? Greenspan TESTIFIED that is wasn’t healthy for government to run a surplus as soon as Bush got in office.

    Medicaid Part D was a massive payoff to Pharma and a way to move the Seniors once and for all into the R category.

    The wars? Pah-leez Pedro, who you kidding? If it hadn’t been the wars – it would have been privatizing education.

    Infact, my only complaint with Bush (the MBA), is that during his time there, he didn’t demand the productivity gains out of the public sector to weaken the unions.

    —-

    So yes, Obama knew thats what Bush was doing in 2008… and his guys REALLY believed, even many Republicans believed, that the crisis of capitalism, would let them be FDR2 – somehow escape the gravity of Reagan’s debt gambit – but it is unbeatable.

    So Obama took the biggest bite they could, even as Krugman screamed for more. But TARP had awakened the Tea Party, already Local Wealth was pissed off.

    —–

    StatsGuy, I thank ye, and it’s good to have you down in the dirt where I will win.

    1. Bush spent it all.
    2. Obama tried to win with Fiscal.
    3. Debt Gravity took over, and liberals are left not only desperate for Scott’s medicine, but best served politically by thinking WAY OUTSIDE their box.

    Productivity gains in the public sector is just their first play.

    The only truly winning strategy for progressives against the Reagan Debt Gambit is a Balance Budget Amendment. And how far they are away from playing this card, is how far away they are from really running the government.

  26. Gravatar of Jon Jon
    12. February 2011 at 20:45

    Jeff writes:

    The bank takes the check to the Fed and exchanges it for reserves. Required reserves are 10 percent of transactions deposits (once you get past the low-reserve tranche, which all large banks do), so 90 percent of those new reserves the bank has are excess reserves. If the Fed is paying a competitive rate on excess reserves, the bank just leaves them there and that’s the end of the story. In this case the money multiplier is one.

    Watch the pea. Large banks hold almost no required reserves. They can do this because although the funds go into your checking account, the bank sweeps those into a time-deposit classification. End of story. A simple bit of math from the H.6 and H.3 reports will show you that the effective reserve rate is less than one-percent.

  27. Gravatar of Full Employment Hawk Full Employment Hawk
    12. February 2011 at 20:51

    The most immediately relevant question is whether the Fed will offset the contractionary effect of the cuts in government spending that will take place during the next two years with a more expansionary monetary policy. With people like Plosser on the FOMC things do not look hopeful.

    In an article about an interview with Plosser in the Wall Street Journal: (I don’t have a subscription, so I am quoting from a restatement of this part of the article posted by Krugman on Feb 12).

    “Mr. Plosser’s answer is unequivocal: This mess was caused by over-investment in housing, and bringing down unemployment will be a gradual process. “You can’t change the carpenter into a nurse easily, and you can’t change the mortgage broker into a computer expert in a manufacturing plant very easily. Eventually that stuff will sort itself out. People will be retrained and they’ll find jobs in other industries. But monetary policy can’t retrain people. Monetary policy can’t fix those problems.”

    With people like that on the FOMC, I would conjecture that any offset by the Fed of the government spending cuts will be very partial and incomplete, so that the spending cuts by the Federal Government will slow the recovery and keep the unemployment rate high.

  28. Gravatar of Mark A. Sadowski Mark A. Sadowski
    12. February 2011 at 21:30

    Scott
    You wrote:
    “Projects such as infrastructure should meet a cost/benefit test. Because real rates are lower during recessions, more infrastructure will pass that test during recessions.”

    And wrote:
    “At this point fiscal advocates call on the deus ex machina of federal spending. But the federal government’s not good at quickly implementing shovel-ready projects; in our system that’s mostly done at the state level. Plausible federal projects, like high speed rail, are far from being shovel-ready. (There was a proposal to build high speed rail from Madison to Milwaukee, now cancelled. Having grown up in Madison I can assure you no one would have used that high speed rail service. Normal people do the very easy 75 minute trip by car, and poor people take Badger Bus, much cheaper than high speed rail.)”

    I came across some posts by Tyler Cowen and David Beckworth today on total factor productivity (TFP) and the Great Stagnation. (For those of you not familiar with TFP it is the variable which accounts for effects in total output not caused by inputs, so it can be taken as a measure of an economy’s long-term technological change or technological dynamism.) I don’t know why it didn’t occur to me before, as my research is on growth and I’m teaching Economic development this semester, but TFP is really what Tyler Cowen is thinking about when he contrasts the pre and post 1973 periods.

    The BLS maintains a database of annual TFP for the US back to 1948. A good source of data for TFP growth prior to that is a couple of papers by Alexander J. Field: “US economic growth in the gilded age”, “The Most Technologically Progressive Decade of the Century” and “The origins of US total factor productivity growth in the golden age”. The data however is given in periods and not annual.

    Average annual TFP growth is as follows:
    1835-1855-0%
    1855-1869/1878-(-0.5%)
    1869/1878-1892-2.0%
    1892-1919-1.1%
    1919-1929-2.0%
    1929-1941-2.8%
    1941-1948-0.5%
    1948-1973-1.9%
    1973-1982-(-0.2%)
    1982-1995-1.0%
    1995-2005-1.5%

    The first thing that should grab your attention is that TFP growth was at its most rapid during the Great Depression. The second thing you should observe is that TFP growth was at 1.9% or higher from the 1870s through 1973 with the exception of 1892-1919 and 1941-1948. TFP growth has picked up since 1995 (but has slowed since 2005). So this pretty much supports Tyler Cowen’s conjecture.

    Now, why was TFP growth faster during the periods mentioned?
    Well, Field analyzes the growth by sector and sector size and comes to some interesting conclusions. TFP growth was fast from the 1870s through 1892 because of railroads (which peaked in track mileage in 1916) and to a much lesser extent because of the telegraph. Almost all growth in TFP in the 1920s can be accounted for my manufacturing and that probably fed that decade’s stock market boom. Why did manufacturing TFP explode in the 1920s? According to Field it was due to the widespread electrification of factories (which had started in the 1880s). In the 1930s manufacturing TFP, although still relatively fast, slowed down. (He also points out that private R&D experienced a golden age of sorts in the late 1930s.) But transportation TFP soared mainly due to the growth of interstate trucking and its interaction with railroad transportation. And he argues that this was largely responsible for the growth seen from 1948-1973, as manufacturing TFP actually went negative for part of that period.

    TFP growth was negative from 1855 to the 1870s primarily because of the Civil War. And note the period I claimed (to Chris T) that I remembered as the “Dark Ages” (1973-1982), primarily because of its effect on cars, truly was dark. Those are the only two periods in the historic record with negative TFP growth. Field aggregates 1973-1982 and 1982-1995 and claims energy had no effect. But when you separate the two I think it becomes clear that the oil price shocks are probably responsible for the horrible TFP performance in 1973-1982.

    The percentage of interstate freight hauled by truck rose from about 2% of ton-miles in 1929 to almost 10% by 1941. It reached 18% by 1956 and peaked before leveling off at about 23% in 1973. What led to this development? (Notice that the biggest increase occurred before 1941.)

    More in a bit…..

  29. Gravatar of Mark A. Sadowski Mark A. Sadowski
    12. February 2011 at 21:32

    Continued….

    The state of the US road network at the end of WW I is reflected in the experience of a fleet of Army vehicles that attempted a cross country transit in 1919. It took them 62 days, averaging about 50 miles a day. Assuming they drove 10 h a day, this is an average speed of about 5 miles an hour. West of Kansas City, the roads were mostly dirt.

    The 1921 Highway Act pledged that paved roads should link every county seat and required that states identify which of its roads should be linked together into a national system. The politics of doing this were difficult so the list of US routes was not finalized until 1926. It was primarily during the Depression years that the United States built its first national road network. The expenditures that made this possible, which included projects administered by the PWA and the WPA, have usually been interpreted as being motivated by a Keynesian make work rationale, and that is often how they were justified politically. But these projects had already been planned and would have been undertaken anyway even if the economy not suffered. During the Great Depression, the stock of street and highway capital in the US virtually doubled, and the interstate (small i) network whose outline had been agreed upon in 1926 was completely finished by 1941.

    The Interstate Highway System, launched in 1956, significantly expanded the system, and improved its quality, but its routes were built alongside of or on top of those of the US highway network that had already been built during the Great Depression. Interstate 95, for example, parallels US 1 and sections of several interstates have replaced US 66. Thus by 1941 a significant transformation of US surface transportation system had already taken place. The network of national routes that we have today, although expanded and paralleled by the Interstate system, was essentially complete.

    According to Field this transition is major explanation for the high economy wide TFP growth rates that prevailed in the United States during the Great Depression and 1948-1973. The growth of trucking’s share of interstate shipments was a product of both infrastructure investment and important technological advances which included the pneumatic tire and the internal combustion engine, and facilitated the development of a complementary and symbiotic relationship between a growing trucking industry and a pared down rail sector. And it interesting to note if you subdivide the 1948-1973 period there was a surge to an average rate of 3.0% over 1958-1966, precisely when investment in the Interstate Highway system was at its peak. Evidently it’s not a coincidence that 1973 marks the year when both TFP and the US highway capital essentially stopped growing. But Field is equivocal about whether additional infrastructural spending would have forestalled the decline. Perhaps the slowdown was the result of a reduced potential for gains from additional investment.

    One thing we can draw from this is that the rapid growth in TFP from 1929-1973 was in large part due to Federal government investment in infrastructure. The expansion of the railroads in the late 19th century was similarly aided by Federal government subsidies. Even the faster growth of the IT revolution (1995-2005) can trace much its roots back to government investment. After all, the singular achievement of the IT revolution, the internet, owes its origins to the United States Advanced Research Project Agency in 1969. The big exception to this pattern appears to be the electrification of factories. The urban electrification that made that possible was almost entirely financed privately.

    It could be that government might have a role in arresting the Great Stagnation. I don’t pretend to know what form that should be. But clearly if history is a clue public investments should not be made simply to solve short term shortages in AD. They should be judged purely on their cost/benefit ratio. High speed rail might be such a project but as Scott points out it make no sense for short distances (cars are better). Everything I’ve read about it suggests that it makes the most sense between 150 and 400 miles, where its use is faster than either cars or planes.

  30. Gravatar of Mark A. Sadowski Mark A. Sadowski
    12. February 2011 at 21:35

    So in short. Mind the gap, not in fiscal stimulus, but in investment in infrastructure:

    http://www.youtube.com/watch?v=cJhS63oe5-M

  31. Gravatar of Morgan Warstler Morgan Warstler
    12. February 2011 at 22:33

    “One thing we can draw from this is that the rapid growth in TFP from 1929-1973 was in large part due to Federal government investment in infrastructure.”

    See DARPA/ARPANET, much greater returns, but you are not factoring in the economic value of free.

    Took less time to build, at far less cost – highest level of economic return per dollar in human history.

    Raises the bar so high on Public Spending ROI, anything else sounds and is likely silly for soem time to come.

    Infatc, the nest 5 years of Internet should be all about GOV2.0, remaking government using the Internet.

    This should provide us $400B less per year spent in Public Employee Compensation… and if we are really serious closer to $1T per year by 2020.

    This would mean spending about 33% less on public employee compensation per year over trend – which is easy.

    Question for economists: If 50% of potential college students decide to borrow no money and get the free online education in 2020, is that a positive or negative to GDP?

  32. Gravatar of Doc Merlin Doc Merlin
    12. February 2011 at 23:29

    GDP is inherently stupid (its beyond flawed) in part because of what you describe, Morgan. You can’t measure free, you also can’t measure exchanges in like goods. So, someone blogging freely and providing a valuable service to a community isn’t measured at all.

  33. Gravatar of Doc Merlin Doc Merlin
    13. February 2011 at 04:47

    @Morgan:

    It gets even worse when you start measuring GDP and you are measuring the effects of derivatives bought over international markets.

  34. Gravatar of StatsGuy StatsGuy
    13. February 2011 at 05:44

    @ Jon and Scott and Mark

    Re – speed of stimulus. Perhaps it’s better to differentiate between expenditure _preserving_ stimulus, and expenditure _enhancing_ stimulus.

    TARP roughly broke down to 1/3 tax cuts (immediate, but not necessarily augmenting due to question of marginal savings rate), 1/3 support to states (has an immediate impact on reducing imminent cuts to state budgets), and 1/3 other discretionary (longer term).

    [Has anyone tried to measure the impact of the hiring tax credits, btw, which always sounded to me like a rather far fetched gambit?]

    @ Morgan – I love dirt, it grows wonderful things. I don’t know that Congress really is that smart, but Bernanke clearly expressed his frustration in several hearings that the Fed’s hands were being forced by the size of the deficit.

  35. Gravatar of StatsGuy StatsGuy
    13. February 2011 at 05:58

    @ Mark –

    I’m not sure I understand the TFP issue. Is the argument that changes in TFP ==> natural employment rate, or vice versa, or that they are both caused by a third factor?

    One can imagine that TFP increases when AD goes down because of unused capacity – which causes employers only to retain employees with the highest marginal productivity.

    You cite the great depression, but that datapoint runs up through 1941, which includes the buildup to WWII. In the 1970s period, you cite low TFP, but 1973 really was the beginning of the oil shocks, in which existing manufacturing and transportation capacity was very misaligned to world energy needs, suggesting that the oil shocks caused the relationship.

    I’m still confused by Cowen’s argument – is it HIGH technological progress that causes unemployment and AD gaps (we had a high rate of exogenous technological change in the 20s and 30s, many think), and if so, whence comes the arguments that we’ve seen little technological progress in the last 20 years (itself controversial) and thus we have unemployment problems? We had decent TFP growth in the late 90s through early 2000s, and unemployment bottomed…

    I don’t doubt there’s a deep relationship somewhere, but I don’t know what it is, and I don’t even know if we have good measures of “technological progress”, or even good definitions (since so many of us can’t agree on whether we’ve had rapid or slowing tech progress in the past 30 years). Or how important this is compared to demographic bubbles or globalization/development trends.

  36. Gravatar of mbk mbk
    13. February 2011 at 07:51

    Mark,

    Government investment in infrastructure, there must be lots of data from non Soviet countries with decent economics to assess this numerically through research. Not that I have any to show for… But, from Europe, say France (hi speed rail, nuclear power), to Asia: Japan, Korea, Singapore … not to mention China… are full of massive, massive government infrastructure investments. Without the benefit of any data I’d guess they’re probably as hit and miss on TFP just as if it had been large private firms. What I mean by this is, on average the market works, but take company by company and a lot of investments don’t work out as planned. Why would it be different for government,m even if it’s competent? Anecdotally say, I heard S Koreans complain that their country’s blanketing with wireless technology for the sake of hoped productivity gains was largely unproductive.

  37. Gravatar of Scott Sumner Scott Sumner
    13. February 2011 at 07:52

    Jon, Keynesians claim debt-financed fiscal stimulus raises velocity. Why is that wrong?

    Morgan, You are right that the left is now in a position where they have to gut one of their sacred cows. Will it be benefits or public employees?

    My hunch is benefits. They care much more about teachers unions than welfare recipients. (By “they” I mean politicians, not people like Yglesias.)

    dtoh, I think higher capital requirements are basically regulatory policy, not monetary policy. I also think risk is the much bigger problem. The Fed can always supply unlimited liquidity when needed.

    You said;

    “3)I think you’re mistaken about banks hiding risks. They often don’t understand risk (especially liquidity related risk), but it would be trivial to monitor and put in place reserve ratios based on asset class and the length of time the bank has held the asset.”

    I meant that bonds that are seemingly safe (AAA bonds), might actually be quite risky, as we’ve seen. I wasn’t talking about fraud.

    Jeff, You said;

    “Scott, I think most of us quasi-monetarists think the distinguishing characteristic of money is that is the medium of exchange.”

    That’s true of Nick and Bill, but not me. I think the key attribute is that it is the medium of account.

    If the new money goes into ERs (which has been the case recently) then the money multiplier is zero, not one.

    Statsguy, You said;

    “Hallelujah!! This is the Joe Gagnon argument. In essence, Keynesians can argue cash/debt equivalency at the zero bound, and Monetarists can argue Ricardian equivalency, but if the Fed prints money and Treasury spends it, the price level MUST go up.”

    No, this is a common mistake. If the money supply goes up permanently, you get inflation with or without fiscal stimulus. If the money supply increase is temporary, you get very little inflation even if the debt is monetized.

    Current inflation is determined by the expected future path of M. End of story. That’s not to say that helicopter drops can’t work. In the real world the public might interpret a helicopter drop as an intention to permanently increase M. But when they don’t (as in Japan) the price level won’t rise.

    The high saving rate in Japan cannot explain the ineffectiveness of the fiscal/monetary stimulus. First, because savings rates don’t impact the path of NGDP. And second, because even if you are right the saving rate in Japan has plummeted in recent decades, so your own theory would predict high inflation, not the deflation they have had.

    The monetary base in Japan fell 20% during 2006. That’s the best way to understand why prices were stable prior to 2006.

    Your scenario about the Fed being forced to monetize the debt is theoretically possible, but of no real world relevance.

    You misunderstood my lags comment. I agree with what you said, I was talking about how it takes time for Congress to meet and discuss the issue.

    I am happy to have Keynesians admit that fiscal stimulus works through expectations. Just as soon as they take back all the insults they hurled at GOP Congressmen in early 2009 (for asking where the jobs are) maybe I’ll start taking them seriously. Until then Eggertsson and Woodford are the only two Keynesians I can take seriously.

    You said;

    “Not true. As you have argued many times, the BOJ showed that if you stop monetizing debt just when it starts to do it’s job, then it “doesn’t work”.”

    Close, but my point was slightly different. The key question is; What “job” does the BOJ want done? They think their job is to avoid inflation. So rather than say the money was pulled out just when it was starting to do its job, it would be more accurate to say the money was pulled out just when it stopped doing its job (of avoiding inflation.) Why nitpick? Because I’m a jer … er, because the key point is the BOJ’s target. If the target had been 2% inflation, level targeting, the the monetary base increases early in the decade would have worked immediately, indeed they might not have had to increase the base at all.

    Richard, I have trouble seeing how that would make much difference.

    Full Employment Hawk, It depends on whether QE2 works in driving up the Walrasian equilibrium nominal rate. If it does, Bernanke won’t need Plosser’s vote, he can just hold the line on the fed funds target.

    But I certainly do share your worry. This will be a big test of leadership for Bernanke. It looks like he’ll have the entire BOG and the NY Fed prez behind him. That should be enough.

    mark, I agree with most of your comments. A few observations.

    1. The TFP debate can’t really resolve the Tyler Cowen debate, as the debate is mostly about the accuracy of those numbers. I claim growth in recent decades has been slightly less than the government reports (albeit still substantial.) I think they overstate growth in computers.

    2. High speed rail is unlikely to work in the US in the near future (except perhaps LA to SF.) The place where it is needed (the East Coast), isn’t even being considered. Instead there are proposals to build it in places like Tampa/Orlando, which is idiotic.

    3. The 1973-82 period was slightly better than it looked, as much of the investment went into environmental cleanup.

    Doc Merlin, You said;

    “So, someone blogging freely and providing a valuable service to a community isn’t measured at all.”

    Yes, and that’s been really bugging me lately.

  38. Gravatar of Scott Sumner Scott Sumner
    13. February 2011 at 07:54

    mbk, I recall a study comparing Singapore and HK (I think by Barro). Singapore had much more public investment and total investment, but no higher growth than HK, suggesting much of the public investment was wasted.

  39. Gravatar of JimP JimP
    13. February 2011 at 08:41

    I think Obama should give a press conference and simply read this speech aloud – and then simply demand that the Fed do it.

    http://www.chicagofed.org/webpages/publications/speeches/2010/10_16_boston_speech.cfm

  40. Gravatar of mbk mbk
    13. February 2011 at 08:42

    Scott, thanks for the pointer, nice way to go at the issue. Relatedly, the problem with assessing the efficacy of government investments is that very often they are only measured against the yardstick of any return, say some form of ROI at best. Probably not even expressed as true economic profits. The true yardstick would be to compare with what could have been achieved with the same investment in other forms.

  41. Gravatar of Jon Jon
    13. February 2011 at 09:36

    Scott asks:

    Jon, Keynesians claim debt-financed fiscal stimulus raises velocity. Why is that wrong?

    Unmet demand to hold money is a stock not a flow problem. That argument depends on the desire to hold money being dependently solely on expected demand. In a NK model, raise expected demand and you eliminate their desire to hold more money (supposedly). If you accept that as true or dominate, there is still the Ricardian equivalence issues.

    More broadly fear contributes to the desire to hold money. In particular even if the aggregate trend-rate of growth is maintained, the individual trend-rate of income may have high variance. This can arise from uncertainty about how a new regulatory scheme or a contraction in the housing market will distribute its effects, for instance.

    The choices are to accommodate the desire to hold money or resolve the real-shocks which are driving the desire to hold money.

    So, I’m saying: fundamentally you need to accommodate their desire to hold money, and if you do so keep current and demand steady. As I stated, the desire to hold money is a preference; an increase in that desire is an aggregate preference change. Its not wrong to think that the demand gap itself contributes to this, but that isn’t exclusively so, and its more probably a secondary or tertiary effect.

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

    @Morgan,
    I agree. ARPA probably had a huge ROI but it is difficult to measure.

    @statsguy#1,
    Just to be annoyingly nitpicky, you said TARP when you obviously meant ARRA.

    @statsguy#2,
    You wrote:
    “I’m not sure I understand the TFP issue. Is the argument that changes in TFP ==> natural employment rate, or vice versa, or that they are both caused by a third factor?”

    It depends on what you mean by the TFP issue. I look on it as a long run issue and so would choose not to read to much into it in terms of business cycles. However, anything that yields increased labor productivity reduces the natural rate in the sense that it is possible to have a lower unemployment rate for a given inflation rate. This seems to have happened in the late 1990s coincident with the boom in ICT. However, NGDP targeting implies we shouldn’t worry about variations in labor productivity growth since we’re not targeting inflation.

    And wrote:
    “One can imagine that TFP increases when AD goes down because of unused capacity – which causes employers only to retain employees with the highest marginal productivity.”

    Actually TFP is procyclical so it tends to slow down or fall during recessions. And grow faster in recoveries. However, just to add some nuance, Timothy Bresnahan and Daniel Raff have shown for the automobile industry, some older and less productive plants that had persisted in operation during the the 1920s simply shut down between 1929 and 1933, and it was the remaining higher productivity facilities that supplied output when the economy recovered. Field argues that some of the continued high manufacturing TFP growth during the Great Depression may have been due to this “creative destruction” (not his words).

    And wrote:
    “You cite the great depression, but that datapoint runs up through 1941, which includes the buildup to WWII. In the 1970s period, you cite low TFP, but 1973 really was the beginning of the oil shocks, in which existing manufacturing and transportation capacity was very misaligned to world energy needs, suggesting that the oil shocks caused the relationship.”

    Annual TFP estimates for 1929-1941 can be found in John Kendrick’s “Productivity trends in the United States”. I don’t have a copy handy but I do know that TFP growth averaged 1.6% from 1929-1937 and 5.3% from 1937-1941. Because TFP is procyclical Field was careful to average TFP growth over 1929-1941 because labor markets had more or less recovered by 1941 (6% unemployment counting FER workers as employed).

    Which brings to mind my disaggregation of 1973-1995. I mentioned the slow TFP growth of 1973-1982 as perhaps being the result of the oil price shocks. But 1973 was a peak and 1982 was a trough. In retrospect Field was very careful in choosing start and end dates for his periods to eliminate the effects of business cycles. So perhaps 1973-1995 should be viewed as one long stagnant period with TFP growth averaging 0.5%. This has the additional effect of making the 1995-2005 period stand out as an improvement. It was probably wrong of me to brak the period in two.

    And ditto for 1958-1966. 1958 was a recession year and 1966 was a boom year. So it was also probably wrong of me to break out that period from 1948-1973. Still the early to mid 1960s stand out in TFP growth.

    And wrote:
    “I’m still confused by Cowen’s argument – is it HIGH technological progress that causes unemployment and AD gaps (we had a high rate of exogenous technological change in the 20s and 30s, many think), and if so, whence comes the arguments that we’ve seen little technological progress in the last 20 years (itself controversial) and thus we have unemployment problems? We had decent TFP growth in the late 90s through early 2000s, and unemployment bottomed…”

    I’m still somewhat confused by Cowen’s ZMP argument so you’re not alone. My sense is that it is best to view this as a continuum rather than a black or white issue. Cowen thinks a substantial proportion of the current unemployment is structural but a lack of AD is also a culprit. Scott thinks that it is much more (but not entirely) related to an AD shortfall. I’m if anything on the Scott end of the continuum.

    Annual TFP measurements are subject to variations in AD. Long run TFP on the other hand are largely independent of business cycles. The Great Depression is testament to that. The greatest improvement in TFP occurred during the Great Depression. Although I emphasized the role of Federal investment in highways it has to be viewed as a confluence of several factors. There was also the tail end of electrification of factories, a quintipling of private R&D, and a broadbased improvement in TFP in every sector. It’s actually kind of awe inspiring to think so much technological change could occur in the midst of such devastation to aggregate demand.

    And wrote:
    “I don’t doubt there’s a deep relationship somewhere, but I don’t know what it is, and I don’t even know if we have good measures of “technological progress”, or even good definitions (since so many of us can’t agree on whether we’ve had rapid or slowing tech progress in the past 30 years). Or how important this is compared to demographic bubbles or globalization/development trends.”

    I agree. A big part of the problem is agreeing on what constitutes “technological progress”. But if I had to commit myself to a single measure I’d choose TFP, but obviously I don’t expect everyone to agree with me.

  43. Gravatar of dtoh dtoh
    13. February 2011 at 10:16

    Scott, you said.

    1) The Fed can always supply unlimited liquidity when needed.

    Yes, but the liquidity works not because financial institutions have increased balances on deposit with the Fed but primarily through the expansion of credit to companies and consumers (together with the expectation of this happening). So why use a chainsaw to do this, when manipulation of capital reserve ratio would give the Fed a scalpel instead.

    Further to this point is the case of Japan, where the failure of monetary policy is in least in part a failure to influence expectations because the market does not believe liquidity added to the banking system will translate into an expansion in credit.

  44. Gravatar of dtoh dtoh
    13. February 2011 at 10:24

    One other thing. Scott you need to stop giving credibility to high speed rail in the U.S. It will not work anywhere….full stop…. not LA/SF (too far apart) or the Boston/NYC/DC (not enough passengers). Tokyo/Osaka is the only economical high speed rail corridor in the world. It has at least 10x the traffic of Boston/NYC/DC. The sooner we stop fantasizing about HSR in the U.S., the sooner we can focus on useful alternatives like automated buses and lower cost air transport.

  45. Gravatar of Mark A. Sadowski Mark A. Sadowski
    13. February 2011 at 10:54

    mbk wrote:
    “Government investment in infrastructure, there must be lots of data from non Soviet countries with decent economics to assess this numerically through research. Not that I have any to show for… But, from Europe, say France (hi speed rail, nuclear power), to Asia: Japan, Korea, Singapore … not to mention China… are full of massive, massive government infrastructure investments. Without the benefit of any data I’d guess they’re probably as hit and miss on TFP just as if it had been large private firms. What I mean by this is, on average the market works, but take company by company and a lot of investments don’t work out as planned. Why would it be different for government,m even if it’s competent?”

    I can’t say that I’m familiar with all the TFP literature but on the other hand there’s been surprisingly little research done on the effects of public fixed investment on economic growth. There’s really only been a half dozen papers or so (I reviewed them for my MA). What they all find is no correlation between growth and public fixed investment. So my guess is that you’re absolutely right.

    And wrote:
    “Anecdotally say, I heard S Koreans complain that their country’s blanketing with wireless technology for the sake of hoped productivity gains was largely unproductive.”

    Interestingly, South Korea had terrific TFP growth over 1970-2003. Japan on the other hand, like most other advanced countries, has seen TFP growth stagnate since 1973. And as we all know, Japan has spent an obscene amount on infrastructure over the years. In fact to offer another piece of anecdotal evidence, Japan, a country the size of California, consumes nearly as much cement annually as the entire US. At this rate the entire island will be buried in dams, airports, highways, bridges, tunnels etc. (But then, you’re in Singapore (right?), so you know all that.)

    So I suspect the quality of the public investment matters a great deal. I don’t know why South Koreans are so dissapointed with their awesome wireless networks but I wouldn’t mind a taste of the widespread availability of the big broadband in South Korea. 20Mbps is now nearly universal, 100Mbps is very common and 1Gbps is on the way (and all with government encouragement). It probably would make Morgan drool.

  46. Gravatar of Mark A. Sadowski Mark A. Sadowski
    13. February 2011 at 12:37

    @Scott,
    You wrote:
    “1. The TFP debate can’t really resolve the Tyler Cowen debate, as the debate is mostly about the accuracy of those numbers. I claim growth in recent decades has been slightly less than the government reports (albeit still substantial.) I think they overstate growth in computers.”

    I know there is still disagreement over whether outsourcing has inflated manufacturing productivity but I came across this paper by Bart van Ark recently:

    http://www.ceps.eu/system/files/article/2010/02/forum_van%20Ark_0.pdf

    In a nutshell it shows the boost in TFP from 1995-2004 was in distribution, not manufacturing. Does that mean that the IT revolution failed to contribute to the big increase in TFP growth over that period? On the contrary. (Are you listening Morgan?) Ark argues that it was the widespread adoption of ICT technology that led to the rapid growth in distribution TFP. (Would big box Walmarts even be possible without the internet and computers?) What I find neat about this result is that it nicely mimics the symbiotic interaction between highways and railroads that led to a quantum increase in transportation TFP during 1929-1973. And it leads to a similar simple homely outcome from the application of superior technology. Just plain old transportation and distribution.

    And wrote:
    “3. The 1973-82 period was slightly better than it looked, as much of the investment went into environmental cleanup.”

    I addressed this issue in a comment addessed to statsguy. It was probably wrong of me to divide 1973-1995 into two periods. I’m not sure about your environmental cleanup hypothesis but it’s worth looking into.

    @dtoh,
    You wrote:
    “One other thing. Scott you need to stop giving credibility to high speed rail in the U.S. It will not work anywhere….full stop…. not LA/SF (too far apart) or the Boston/NYC/DC (not enough passengers). Tokyo/Osaka is the only economical high speed rail corridor in the world. It has at least 10x the traffic of Boston/NYC/DC. The sooner we stop fantasizing about HSR in the U.S., the sooner we can focus on useful alternatives like automated buses and lower cost air transport.”

    LA and SF are about 380 miles apart by road and 330 miles by plane. This is right in the sweet zone (between 150 and 400 miles). Would you rather take a plane and spend loads of time checking in and out while getting the thrill of having your naughty bits squeezed by the TSA?

    And there are no riders in the Northeast Corridor right now because (no matter what Joe Biden might say) Amtrack sucks. Build it and they will come. (I know Paul Krugman will.)

    I don’t know about automated buses but I’m deeply sceptical about the benefits of lower cost air transport. The big problem is that the skys are way overcrowded as it is and I think the cost/benefit ratio of the necessary additional airport construction has reached its logical upper limit.

    I’m not one of those HSR nutbags but I do think some application of the technology in the US would be beneficial. The fact that much of the rest of the civilized world is adopting it gives one pause. It reminds me of the condition of American roads in the first decades of the twentieth
    century. Other countries at comparable stages of development had intercity road networks that were far superior. France, for example, had consistently devoted public resources to
    roads. In the early 1920s US farmers paid 21 cents a ton mile to haul crops over dirt roads, whereas French farmers paid ten cents a ton mile to haul over paved roads. Proponents of highway spending in the United States referred to this as a “mud tax” arguing that it cost US farmers over
    $500 million per year (in early 1920s dollars of course). We could, and we did, do better.

  47. Gravatar of Richard W Richard W
    13. February 2011 at 14:22

    Scott Sumner
    13. February 2011 at 07:52

    ” Richard, I have trouble seeing how that would make much difference. ”

    Increasing the quantity of money without expanding the central bank balance sheet, which stops the real interest rate from rising. Moreover, it allows the government to monetise outstanding debt (good) without monetising the deficit (bad). Tim Congdon refers to it here in this letter.

    Eurozone governments can still create money

    Published: July 21 2010 01:51 | Last updated: July 21 2010 02:51

    From Prof Tim Congdon.

    ” Sir, Martin Wolf (“Why the battle is joined over tightening”, July 19) seems to believe that when interest rates are close to zero, monetary policy remains available only to “countries with their own central banks” since these “can finance fiscal deficits directly”. He claims that monetary policy is unavailable “for members of the eurozone, which are, in effect, operating with a foreign currency”. There are two misunderstandings here.

    First, the quantity of money is dominated by the deposit liabilities of the commercial banking system. Governments can therefore create new money, in the form of bank deposits, by borrowing from commercial banks. They are not obliged to borrow from the central bank, which can indeed be entirely bypassed. Since deposits are not “printed” in any meaningful sense, this type of money creation also avoids the unfortunate image of the “printing press”. The option to borrow from commercial banks is available to governments in the eurozone as well as to governments in traditional monetary jurisdictions. This option may not accord with the spirit of the Maastricht treaty, but it does not breach the strict letter.

    Second, Mr Wolf appears to think that – once interest rates are zero – money creation arises exclusively from the financing of fiscal deficits. (That presumably is his meaning when he says that monetary policy is ineffective “except to the extent that it supports fiscal loosening”.) Again, he is wrong. The government can simultaneously carry out two types of operation. It can borrow on a large scale from commercial banks and use the proceeds of that borrowing to buy back its own medium- and long-dated debt from non-banks (thereby creating new money), and at the same time it can reduce its fiscal deficit. Aggressive debt monetisation (not deficit monetisation) can occur in conjunction with strong fiscal consolidation.

    The Bank of England’s quantitative easing programme was an example of debt monetisation, although undertaken by the central bank, not the government. If the economy appears to be faltering in the next few years while fiscal consolidation is proceeding, QE remains available as a stimulatory weapon. On a large enough scale, it will always work. Nevertheless, my preference is in fact for the government to manage its own debt in order to influence the rate of money growth. That avoids the silly hullabaloo that accompanies large fluctuations in the size of the central bank balance sheet and the supposed resort to the “printing press”. ”

    Tim Congdon,

    And here in this interesting debate with Robert Skidelsky

    http://www.skidelskyr.com/site/article/what-would-keynes-say-a-dialogue-with-tim-congdon/

  48. Gravatar of dtoh dtoh
    13. February 2011 at 15:40

    Mark,
    Don’t get me wrong; I’m a big rail fan. I think it’s the best way to travel, but unfortunately it won’t work in the U.S. SFO/LA is only in the sweetspot for distance if you construct a truly high speed rail (straight, lots of tunnels, no crossings, concrete rail bed). Anything that is likely to be built in the U.S. will only get you speeds which will result in a 5 hour train ride, which is outside of the sweetspot. Also like the north east rail corridor, LA/SFO doesn’t have the population needed to support it. The NE corridor moves maybe 1000 people an hour combined rail and air. Tokyo/Osaka moves close to 2000 people every 5 minutes during peak hours on rail alone. The other problem is that you need not only density, but you also need a massive commuter rail network to feed an intra-city line. For comparison purposes, Grand Central gets 250k passengers a day. Shinjuku in Tokyo gets 2.5M a day and it is just one of the big stations.

    Very few big city airports are operating near capacity and most have room for runway expansion. It’s all about cheap for both air and rail, and there is a lot going on in air that continues to bring costs down….better turbo-probs, geared turbofans, composites, etc.

  49. Gravatar of mbk mbk
    13. February 2011 at 17:37

    Mark

    re: concrete. Interesting about Japan, but it doesn’t have to mean it’s all going to be paved over. Here in SG they tear down 20 year old condo blocks (an 80% majority of owners selling can force the rest of the 20% to sell, and if valuations rise it’s often done) to replace them with higher end blocks, or with blocks that squeeze more and smaller units out of the same land size. So a lot of concrete in these mature Asian economies goes into rebuilding the same thing over and over again. Raises GDP in the process of course, although sometimes this reminds me of the hamster in his wheel.

    re: S Korea and wireless. The question is not whether it’s nice, it’s whether it has any returns in productivity. Except for gaming and illegal entertainment downloads of course. First one has to wonder, is broadband speed the limiting factor in S Korea’s productivity to begin with? And even if so, from my SG experience the bottlenecks are usually not the local distribution speeds but the servers, routers, and especially the undersea cables to the US. Often your real life speeds hardly change when you double your home connection speed. Now they’re trying to sell us on home fiber optic connections here but I can’t see how this is going to change my life, so far I refused. Scott’s blog is text only and 28kbps woulda been’nuff… (I know I am calling Morgan’s wrath on me. To my defense I now watch very low quality Youtube music videos too, so I appreciate my 3 Mbps connection, then again, all of this lowers my productivity).

  50. Gravatar of StatsGuy StatsGuy
    13. February 2011 at 17:43

    ssumner:

    “No, this is a common mistake. If the money supply goes up permanently, you get inflation with or without fiscal stimulus. If the money supply increase is temporary, you get very little inflation even if the debt is monetized.”

    Yes on the second point. No on the second point – or at least, not necessarily.

    1) First, you need a ‘ceteris paribus’, and ceteris is almost never paribus. The Fed could double the monetary base, but then say “sure, we promise that is permanent, but if we see inflation above 1%, we’ll spike interest rates”, effectively cutting the expected multiplier. Also, recessions usually occur because something is already causing the multiplier to contract, like deleveraging in the shadow banking system, which ALSO might be expected to be permanent. (The world was ending 2 years ago, remember?)

    2) How does the Fed REALLY commit to making it permanent (and not offsetting it by cutting the multiplier)? It’s not so easy, because if inflation spikes to 4% they will probably react to reduce the multiplier and even cut the base – particularly if they are under political pressure. Fiscal spending serves as a commitment device of a sort. If deficits are large enough, then given tax dynamics, no amount of austerity can repay them – and the Fed will be forced to choose between letting Treasury default and inflation of 4%.

    But I’m not making up this latter argument as a hypothetical – it’s already being tossed around in the financial press as proof that QE3 is coming.

  51. Gravatar of StatsGuy StatsGuy
    13. February 2011 at 17:54

    @ Mark

    I’m going to watch Tyler’s argument carefully – I still don’t think I understand it.

    I think, at the minimum, if he wants to link technology in general to employment, then he needs to divide technological progress into two types – the type that expands opportunities for demand, and the type that increases efficiency of supplying existing demand.

    Even so, if TFP is a measure of tech, and it’s procyclical, then I struggle with the link to unemployment – I suppose one could argue that unemployment spikes at the end of a long period of high TFP because new tech has come online, there was a big growth spurt to build the capacity, and that leads to excess capacity. So maybe he could argue that right now we’re paying the price of a decade worth of high TFP. Or maybe the link is between rate of change in TFP, because if you have a long period of steady state TFP, then why would you have economic dislocation (unless you’re a marxist)?

    Or, maybe the link runs through asset values and AD – when TFP changes, perceptions of future growth change, which decreases the NPV of growth assets, which triggers a fall in AD (and the vicious circle).

  52. Gravatar of StatsGuy StatsGuy
    13. February 2011 at 18:14

    @ Scott –

    Congdon’s argument is loopy, literally.

    “Governments can therefore create new money, in the form of bank deposits, by borrowing from commercial banks.”

    That is only true if the banks lend, and the banks can only lend if they have funds, which usually means the banks need deposits and/or floated bonds. Access to a national discount window is meaningless (if investors are paying attention, which they are now) because the money at the national level comes from the deficit (which the govt is already borrowing from the banks). This only works if either the nation, OR the banks, receives a credible backstop from the ECB or from another creditworthy country (like Germany). Otherwise, rates spike and CDS explode – which they have. Euro countries can’t actually print money, but they can backstop/nationalize banks (which other European banks have lent to) and demand national banks subsidize the deficit, effectively threatening a Euro banking crisis if the countries are not bailed out.

    “It can borrow on a large scale from commercial banks and use the proceeds of that borrowing to buy back its own medium- and long-dated debt from non-banks (thereby creating new money), and at the same time it can reduce its fiscal deficit. ”

    This only works if the markets perceive the country as long term solvent. Otherwise, the country is merely shortening its average maturity, and rolling continuously. This accelerates as interest rate spikes move from long, to medium, and finally to the shortest end of the curve – eventually, interest rates spike, but this need not be accompanied by money spiking because the quantity of the base hasn’t changed. IF, however, the countries are truly solvent (at the current price level), then this lowers debt servicing costs at the expense of increasing debt rollover risk.

    I would not call this monetizing of debt at all.

  53. Gravatar of Morgan Warstler Morgan Warstler
    13. February 2011 at 18:45

    “I think, at the minimum, if he wants to link technology in general to employment, then he needs to divide technological progress into two types – the type that expands opportunities for demand, and the type that increases efficiency of supplying existing demand.”

    I need examples of these pls. To me technology = time savings, money savings, good reason to fire people – all of which free up time money and people to do more things.

    In tech, you routinely look for stuff that you get to keep $1 for every $5 someone doesn’t have to spend, so some other guys gets $5 less.

    At the goofy end, even with the patent side, when there is a new drug, one of the coolest things about it is that even if the new drug is 10% better, the old drug is 5x cheaper.

    So I view technology as “makes things cheaper” and as things get cheaper, things you couldn’t do yesterday you can do today.

    Doc is of course right, if suddenly 50% of college students get to go to school online for free – that’s a WIN, and if GDP doesn’t go up it’s still a win.

    It may be interesting to think about what they’ll do with the money they save, it may be interesting to think about the new businesses built out of fired teachers – you COULDN’T do X before because Phd’s cost too much money – well not anymore!

    I don’t look at a flood of cheap 35 year old Phd’s onto the market as a bad thing – I think it’s GREAT, I’m psyched to see them default on their student loans, and the program shut down. That’s a huge productivity gain.

    I’m charged to see what new kind of web businesses get built with Phd’s no one wants to teach anymore… and I’m frankly positive that the profit derived from them in the future far surpasses what they’d do before college went online.

    1. Target NGDP.
    2. Cheer technology.
    3. Fight wage / price deflation.

    I’m not sure, but it doesn’t seem to me you can do all three.

  54. Gravatar of Mark A. Sadowski Mark A. Sadowski
    13. February 2011 at 18:50

    statsguy wrote:
    “I think, at the minimum, if he wants to link technology in general to employment, then he needs to divide technological progress into two types – the type that expands opportunities for demand, and the type that increases efficiency of supplying existing demand.”

    I think this may get to the heart of the matter. Demand is always and everywhere unlimited (to paraphrase Friedman).

    The way TFP is defined it has absolutely nothing to do with demand in the long run. In my opinion one cannot explain demand shortfalls in terms of the supply side. I understand there may be an interelationship, But personally I suspect the effect of demand on supply is far stronger.

    Ultimately all of this revolves on what percentage of people seeking jobs are unemployable given whatever conditions one thinks are appropriate (usually in terms of inflation, and usually 2% annually). Until recently that unemployment level was about 4.8%. Reasonable estimates put it at about 5.65% currently. Those same estimates conclude it will fall back to 4.8% given enough AD.

  55. Gravatar of Richard W Richard W
    13. February 2011 at 19:39

    @ StatsGuy

    Here is the same argument in more detail from one of Congdon’s colleagues. The banks do not need the funds in any meaningful way, they just need to expand their balance sheets. It is pointless for the government to buy assets from the banks, they should only buy assets from non-banks. The government should be borrowing from the banks and not the bond market. That way the fiscal deficit is being financed by newly created money that then becomes deposits. Assets and liabilities of the banks still balance.

    http://www.parliamentarybrief.com/2009/03/now-is-the-time-for-quantitative-easing

  56. Gravatar of Stephan Stephan
    14. February 2011 at 06:57

    Monetary Policy is slow and its actual outcomes are diffuse and unsure. Fiscal Stimulus is immediate and can be very targeted. If the Federal Government announces tomorrow a Federal Job Guarantee for everybody able and willing to work for a decent minimum wage you’re done. Voila. Fiscal Stimulus worked in the matter of two days.

    http://www.cfeps.org/

  57. Gravatar of Jeff Jeff
    14. February 2011 at 09:54

    Scott, by “money multiplier” I mean the change in transactions deposits divided by the change in reserves. The ratio is 1, not 0, for the IOR regime because whoever it was that sold Treasuries to the Fed ends up with a deposit equal to the amount he sold. He had a T-bill before, now he has a demand deposit. Deposits have increased.

  58. 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 16:10

    […] Sumner)がこんなことを書いている。 隙間なんて気にするな(Don’t mind the […]

  59. Gravatar of StatsGuy StatsGuy
    14. February 2011 at 18:11

    @ Richard

    Thank you – I think I see the argument now, but I still don’t see how it overcomes the bank solvency issue. If the govt buys non-bank assets using loans from banks (debt that the banks bought), then if the govt is perceived as insolvent, the banks end up being perceived as insolvent. This is not theoretical – it’s a major problem in Europe. To avoid a banking crisis, nat. govts backstop the banks, but this only works to the degree that the backstop is credible. If nat. debt is seeing interest rates and CDS spike, then it’s not perceived as credible, and the banks may experience a run anyway. I suppose this works if the nat. govts infuse the banks with capital, sweep deposits, and loan back to the govt at 25 to 1 cap asset ratios – at least, it works as long as the BIS and ECB remain complicit.

    However, I don’t think it’s the same thing as literally printing money, since the new money is linked to debt that (theoretically) needs to be paid back. Unless other countries in the EU inflate or the country forces domestic banks to lend at rates below the inflation rate, the debt in the country using this policy expands faster than it gets inflated away. Again, witness Greece.

    If this stratagem were effective, the question must be asked – why are debt and CDS markets bidding up rates on Greek instruments? Still something I’m missing.

  60. Gravatar of Drivel Absurd: Globalisierung – ein totales Durcheinander? « Seeing Beyond the Absurd Drivel Absurd: Globalisierung – ein totales Durcheinander? « Seeing Beyond the Absurd
    15. February 2011 at 10:18

    […] Ergebnissen. Das stimmt nicht. Die Politik war gezwungen (nicht von den Neoliberalen und war sie überhaupt gezwungen?) aufgrund eines Marktversagens – oder funktioniert er gerade so perfekt? – der Finanzkrise […]

  61. Gravatar of Scott Sumner Scott Sumner
    15. February 2011 at 18:52

    JimP, He blew it in 2009 when he re-appointed Bernanke without getting a commitment. Now it’s too late.

    mbk, I agree.

    Jon, You said;

    “Unmet demand to hold money is a stock not a flow problem.”

    1. I don’t know what unmet demand is
    2. I don’t know why it’s a stock and not a flow
    3. I don’t know why it’s a problem.

    And that’s just your first sentence. You need to go much slower if you want me to follow your argument.

    Mark, I’m too late to get deeply into to this now. I just saw Arnold Kling has a post mentioning that all sorts of new unmeasured goods are making Americans happier. But he ignores the fact (I think it’s a fact) that there is no evidence that Americans are any happier than in 1973.

    dtoh, I’d rather have the Fed target NGDP, and let the free market determine the amount of credit. The regulatory role of the government in credit markets should be trying to minimize risk of bailouts, with really high capital requirements and high down-payments on mortgages (from banks.)

    Richard, I think Tim Congdon is half right. He’s right in criticizing Wolf–it isn’t necessary to support fiscal stimulus.

    But he’s wrong that euro-zone members can inflate on their own. I doubt that.

    MBK, Where is SG?

    dtoh, I consider myself a high speed rail skeptic in the US. The only line that I think might be built and might work is LA/SF, and I expect that to be built poorly, and to end up failing cost benefit tests. The northeast won’t be built, and the rest of the US won’t have enough passengers.

    Statsguy, You said;

    “1) First, you need a ‘ceteris paribus’, and ceteris is almost never paribus. The Fed could double the monetary base, but then say “sure, we promise that is permanent, but if we see inflation above 1%, we’ll spike interest rates”, effectively cutting the expected multiplier.”

    This is a non sequitor, as all talk about temporary and permanent money injections is couched in terms of inflation (or NGDP) targets. If the target is 1% inflation, obviously they are saying the injection won’t be permanent, or else that it will be sterilized by IOR.

    You said;

    “Also, recessions usually occur because something is already causing the multiplier to contract, like deleveraging in the shadow banking system, which ALSO might be expected to be permanent. (The world was ending 2 years ago, remember?)”

    Velocity shocks aren’t usually permanent, but it wouldn’t matter if they were. The Fed can easily offset a permanent velocity shock. (Multiplier and velocity are basically the same thing.)

    You said;

    “2) How does the Fed REALLY commit to making it permanent (and not offsetting it by cutting the multiplier)? It’s not so easy, because if inflation spikes to 4% they will probably react to reduce the multiplier and even cut the base – particularly if they are under political pressure. Fiscal spending serves as a commitment device of a sort. If deficits are large enough, then given tax dynamics, no amount of austerity can repay them – and the Fed will be forced to choose between letting Treasury default and inflation of 4%.”

    This has no bearing for any real world fiscal stimulus decisions in the US. We are so far from where the Fed would be forced to monetize debts that it isn’t even worth thinking about. Japan’s debt is something like twice ours, and they haven’t even started inflating yet. Hoping that fiscal stimulus will scare markets into expecting inflation is far-fetched for a country like the US. Suppose Obam annouced that we were going to spend another trillion in the hope that people would loss all faith in the US and expect the Fed to start printing money to monetize the debt. They lock up Obama in an insane asylum. There are far easier ways to raise NGDP. Just have the Fed announce an NGDP target. That’s not easy to do, but it’s far easier than spending yourself into poverty in the hope it will indirectly create inflation.

    We agree on Congdon’s argument being loopy.

    Stephan, You said;

    “Monetary Policy is slow and its actual outcomes are diffuse and unsure. Fiscal Stimulus is immediate and can be very targeted.”

    Just the opposite. It takes Congress a long time to decide on a fiscal stimulus, and it doesn’t do much. Cuts at the S&L level may offset it. Krugman’s now claiming it did almost nothing, after earlier claiming it had worked. Monetary policy works very fast, and is much more reliable.

    Jeff, You can’t assume that–indeed it has not been the case recently in the US. The multiplier fell below one, EVEN INCLUDING CASH!

    After they sell the T-bill, they might buy another asset from a bank. It depends how much DDs people want to hold. You can’t force them to hold DDs.

  62. Gravatar of Mark A. Sadowski Mark A. Sadowski
    15. February 2011 at 19:18

    Scott wrote:
    “Mark, I’m too late to get deeply into to this now. I just saw Arnold Kling has a post mentioning that all sorts of new unmeasured goods are making Americans happier. But he ignores the fact (I think it’s a fact) that there is no evidence that Americans are any happier than in 1973.”

    Don’t expect me (of all people) to defend Kling’s views. My point is that there is a measurable increase in the rate of TFP growth from 1995-2005. That is due to ICT technology. Will it continue? The evidence seems so far to be no.

    As for happiness, since when did that become the standard for technological progress? The World Bank has a huge database that makes it quite clear that economic growth does not improve happiness. However, as W. Arthur Lewis wrote in “The Theory of Economic Growth”:

    “The advantage of economic growth is not that wealth increases happiness, but that it increases the range of human choice.”

    That Lewis fellow was a really bright guy.

    P.S. You sound both busy and unhappy. But I bet your choices are increasing as we speak.

  63. Gravatar of marcus nunes marcus nunes
    15. February 2011 at 19:32

    @Mark
    Don´t forget that sometimes “too much of anything” even “range of choices” can be what, overwhelming? (maybe bad for your “sanity”)

  64. Gravatar of StatsGuy StatsGuy
    16. February 2011 at 12:19

    ssumner:

    “We are so far from where the Fed would be forced to monetize debts that it isn’t even worth thinking about.”

    Um, a lot of people disagree with you. The Fed is running a deficit of 1.6 trillion right now. If the Fed wanted (for some reason) to NOT support this with QE, rates would spike – arguably, they might spike sufficiently to cause a debt crisis wherein auctions are not fully covered. This is particularly true if the interest rates then further depress asset prices and spike perceptions of US default as debt service costs go up and tax revenues plummet.

    Without Fed intervention, the US would probably be set on a trajectory of default – that sounds like it’s being forced to intervene. Or so many people think, and that’s what matters.

    “Suppose Obam annouced that we were going to spend another trillion in the hope that people would loss all faith in the US and expect the Fed to start printing money to monetize the debt.”

    First, why is this relevant? The simple question is this: Does, or does not, a 1.6 trillion dollar deficit vs. a 0.8 trillion dollar deficit increase, decrease, or leave unchanged public perceptions of the likelihood of the Fed conducting QE to monetize that spending? Simple question. You’re answering, there’s no changes in perceptions of likelihood of monetization. That is plain wrong.

    Second, why would he ever announce this? You don’t have to believe in conspiracies to believe that politicians say one thing and do another. Indeed, that’s a fundamental precept of revealed preference theory.

    “There are far easier ways to raise NGDP. Just have the Fed announce an NGDP target. That’s not easy to do, but it’s far easier than spending yourself into poverty in the hope it will indirectly create inflation.”

    Really? I don’t know what’s “easy” anymore. Maybe there’s something called revealed policy theory – the policy that transpires reveals what’s actually easier. So, look at what transpired in 2008.

  65. Gravatar of ssumner ssumner
    16. February 2011 at 19:20

    Mark, You said;

    “As for happiness, since when did that become the standard for technological progress? The World Bank has a huge database that makes it quite clear that economic growth does not improve happiness. However, as W. Arthur Lewis wrote in “The Theory of Economic Growth”:”

    Fine, but once you do this then Kling’s argument for unmeasured goods increasing happiness doesn’t work. But then what’s the use of all this unmeasured stuff on the internet? The 100,000,000 channels to watch. How does it make us better off, if not through happiness?

    You said;

    “You sound both busy and unhappy.”

    In a few weeks I’ll be either much happier, or no longer blogging.

    Statsguy, You said;

    “You’re answering, there’s no changes in perceptions of likelihood of monetization. That is plain wrong.”

    The TIPS markets say I’m right. Inflation expectations are low. Yes, a bit higher since QE2, but consistent with ordinary monetary stimulus, not monetizing the debt (which produces ultra-high inflation.) The problem is that you are wrongly assuming the Fed is monetizing the debt. It’s not. The so-called money (actually excess reserves) is just another form of debt. It is now interest-bearing. Monetizing a debt is when the Fed prints zero interest cash and buys up lots of T-bills yielding 3% or 5% or 7%. That’s not happening, and no serious person in the financial markets expects it to happen. Inflation expectations fell sharply as our national debt ballooned. But even now the net debt is expected to level off around 80% of GDP–not even close to where you’d have a crisis.

    You said;

    “Really? I don’t know what’s “easy” anymore. Maybe there’s something called revealed policy theory – the policy that transpires reveals what’s actually easier. So, look at what transpired in 2008.”

    By that logic if in 1930 I suggested easier money, you’d say that the fact that the Fed wasn’t taking my advice showed it was politically impossible. But of course policymakers do learn from their errors. Indeed QE2 shows we are making a little progress. Why not keep pushing, maybe they’ll do even more? Even more need not be QE3, it might just mean refraining from tightening for longer than the market currently expects.

    If I was fatalistic about changing policy, I never would have started this blog, and the first paragraph in the following link never would have been written.

    http://www.economist.com/blogs/freeexchange/2011/02/fiscal_policy

  66. Gravatar of Mark A. Sadowski Mark A. Sadowski
    16. February 2011 at 19:28

    Scott wrote:
    “Fine, but once you do this then Kling’s argument for unmeasured goods increasing happiness doesn’t work.”

    Exactly. Kling is arguing up a blind alley. It’s more than wrong, it’s obtuse.

  67. Gravatar of Mark A. Sadowski Mark A. Sadowski
    16. February 2011 at 19:42

    Scott wrote:
    “In a few weeks I’ll be either much happier, or no longer blogging.”

    Whoa, cryptic!

    This eliminates a couple of other possibilities, namely: 1) happier and blogging or 2) unhappier and not blogging. That leaves: 1) happier and not blogging and 2) unhappier and blogging.

    Either you are retiring from blogging (leaving you happier) or you may be on the verge of blogging even more (which will leave you unhappy but expanding your range of choices). Welcome to the dilemma of economic growth.

  68. Gravatar of Mark A. Sadowski Mark A. Sadowski
    16. February 2011 at 20:13

    Scott,
    From my experience Blue Money comes in useful sooner or later:

    http://www.youtube.com/watch?v=S4EWtcwaVdQ&feature=player_embedded

  69. Gravatar of StatsGuy StatsGuy
    17. February 2011 at 08:27

    ssumner:

    “The TIPS markets say I’m right. Inflation expectations are low. Yes, a bit higher since QE2, but consistent with ordinary monetary stimulus, not monetizing the debt (which produces ultra-high inflation.) The problem is that you are wrongly assuming the Fed is monetizing the debt. It’s not. The so-called money (actually excess reserves) is just another form of debt. It is now interest-bearing. Monetizing a debt is when the Fed prints zero interest cash and buys up lots of T-bills yielding 3% or 5% or 7%. That’s not happening, and no serious person in the financial markets expects it to happen.”

    YES IT IS.

    This year, The Fed remitted 80 billion dollars in interest income to Treasury, far more than… ever. Next year, unless the Fed sells a lot of bonds, it will remit even more. This, effectively is interest cost that Treasury is not repaying, even as inflation (slowly) creeps forward. How is this not monetizing the debt?

    Are we doing it all at once? Of course not. That would be insane. But we are slowly, incrementally monetizing the debt.

    How is TIPS telling us that we’re not monetizing the debt? TIPS only tells us about inflation expectations, and it may very well be that in order to keep inflation expectations closer to 2% (instead of falling, due to secular deleveraging), we NEED to monetize some portion of the debt.

    I’m not against monetizing some debt (enough to keep NGDP target stable), but let’s call it what it is.

  70. Gravatar of ssumner ssumner
    17. February 2011 at 20:35

    Mark, Thanks, that’s a good song.

    statsguy, You said;

    “This year, The Fed remitted 80 billion dollars in interest income to Treasury, far more than… ever. Next year, unless the Fed sells a lot of bonds, it will remit even more. This, effectively is interest cost that Treasury is not repaying, even as inflation (slowly) creeps forward. How is this not monetizing the debt?”

    Basic finance theory says you are wrong. They are swapping short term debt (reserves) that pays low rates for longer term debt paying high rates. But the expectations hypothesis of the yield curve says there’s no free lunch from doing that. A ten year bond yielding 3.5% does not have a constant yield over time, indeed the expected yield over the next 12 months is probably less than 1%.

    The key problem with your assumption is that reserves offer a higher yield than T-bills. That can’t happen when a central bank is actually monetizing the debt. Read Jim Hamilton’s recent post on this.

  71. Gravatar of StatsGuy StatsGuy
    18. February 2011 at 09:06

    @ssumner

    I’m afraid I can’t find anywhere he writes that the Fed’s remittance of 80 billion dollars of bond income is not incremental monetization of the debt. Either that, or I just can’t find it.

    “Basic finance theory says you are wrong. They are swapping short term debt (reserves) that pays low rates for longer term debt paying high rates.”

    I am not talking about that aspect of QE – Hamilton does address that. DeLong addresses that. The issue is not the rate structure, it’s the _remittance_ to treasury. This was about 80 billion dollars last year (a lot? not compared to Medicare or Defense, certainly)

    Here’s a simple and extreme example: The Fed buys 1 trillion dollars worth of bonds. Long, Medium, Short – who cares. It then proceeds to pay the interest from those bonds (whatever it is – lower on short, higher on long – it’s not important to the argument) back to treasury. It holds the bonds for 30 years, rolling over the bonds dollar for dollar as they come due, and during that time remits ALL the income back to the treasury. By the end of 30 years, let’s say the Fed actually sells the bonds.

    During that 30 years, several things have happened – the Treasury received all the interest income, the real value of the bonds declined due to inflation, the money supply has grown (which it always does), and the ratio of the Federal govts debt to the money supply is lower because of the remmitance. In essence, the difference between the real value of the bonds now and the real value of the bonds 30 years from now was remitted to the Treasury over the course of that 30 years. That is monetization.

    There is a more complicated, and tenuous, argument for monetization that has to do with expectations that the Fed will ever sell an instrument (vs. hold it forever and repurchase it when it rolls, thus permanently expanding credit supply with no expectation of repayment), but this requries a much more expansive definition of monetization.

  72. Gravatar of Doc Merlin Doc Merlin
    18. February 2011 at 09:54

    @Scott
    “The key problem with your assumption is that reserves offer a higher yield than T-bills. That can’t happen when a central bank is actually monetizing the debt. Read Jim Hamilton’s recent post on this.”

    Sure it can, if they are buying long term treasury debt. The yield curve isn’t really a market yield curve due to the sheer size of the Fed’s involvement and the fact that they pay profits back to the treasury. (So they borrow money, pay the interest back to the treasury. In effect this is just a method to price control treasury debt, by adjusting the money supply.)

    In other news, bitcoins just passed dollar parity.

  73. Gravatar of Scott Sumner Scott Sumner
    19. February 2011 at 06:37

    Statsguy, You said;

    “I’m afraid I can’t find anywhere he writes that the Fed’s remittance of 80 billion dollars of bond income is not incremental monetization of the debt. Either that, or I just can’t find it.”

    I don’t see what that’s supposed to prove. The Fed always earns tens of billions in bond income. Yes, it’s bigger recently, partly because the Fed bought some distressed assets during the worst of the crisis, assets which offer above normal earnings. I don’t see that as having anything to do with monetizing the debt. BTW, it also supports my argument that the “bailout” aspect of Fed policy is overrated.

    As for the rest of your argument, you still don’t understand the yield curve aspect of the problem. Suppose the T-bill yield is 0% and 30 year bonds yield 4%. Suppose the Fed buys a 30 year bond, and holds it for one year. Your analysis suggests the Fed earns 4% on that investment. And that’s the number that goes into your $80 figure (4% of 2 trillion.) But actually modern finance theory suggests the Fed earns nothing. Instead, the 4% coupon rate should be offset by a 4% expected fall in the price of the T-bond.

    Now assume they hold the bond to maturity. Don’t they get the 4% per year for 30 years in that case? Yes, but the yield curve also implies the IOR will gradually rise to 4%, and then go even higher, and this will offset the huge inflow of interest income on the T-bonds.

    There is only one way to monetize the debt—with lots of cash. And cash in circulation isn’t doing anything strange. That’s the message of Hamilton. When cash in circulation skyrockets, then the Fed’s monetizing the debt.

  74. Gravatar of Scott Sumner Scott Sumner
    19. February 2011 at 06:38

    Doc merlin, See my response to Statsguy

  75. Gravatar of TheMoneyIllusion » Ben Bernanke does not have a secret plan to stymie stimulus TheMoneyIllusion » Ben Bernanke does not have a secret plan to stymie stimulus
    14. October 2011 at 08:08

    […] I’ve never denied that fiscal stimulus might work.  One can always construct “God of the gaps” […]

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