A risk-based recession?

Tyler Cowen has a new post entitled:

If we have a U.S. recession this year, it will be a risk-based recession

Not surprisingly, I don’t agree, but I’d rather focus on the question of what exactly this term means.  First let’s quote Tyler again, expressing views closer to mine:

2. In the more recent segment of world history, a lot of cycles have been caused by negative nominal shocks.  I consider the Christina and David Romer “shock identification” paper (pdf, and note the name order) to be one of the very best pieces of research in all of macroeconomics.  Sometimes central banks tighten when they shouldn’t, and this leads to a recession, due mainly to nominal wage stickiness.

3. Workers are laid off because employers are often (not always) afraid to cut their nominal wages, for fear of busting workplace morale, or in Europe often for legal and union-related reasons.

So that provides some context.  Tyler is saying that if there is a recession this year, it won’t be the sort of demand shock recession we’ve often seen in recent history. Next let’s consider some hypotheses:

Perhaps the claim is that we might have a recession this year due to risk, despite 3% plus NGDP growth.  If so, I very strongly disagree.  (This could be viewed as a version of real business cycle theory.)

Perhaps the claim is that if there is a recession, then NGDP growth will slow, but that this will not be the cause.  In other words, even in a counterfactual world where the Fed kept NGDP growing at 3% plus, there would still be a recession for non-monetary reasons.  If so, I very strongly disagree.  (Again, an RBC-type claim.)

Perhaps the claim is that falling NGDP growth is a necessary condition for a recession this year, but it will be caused by growing risk and there is nothing that monetary policymakers can do about it.  If so, I strongly disagree.  (A traditional Keynesian claim)

Perhaps the claim is that falling NGDP growth is a necessary condition for a recession this year, but it will be caused by growing risk that monetary policymakers are too cautious to do anything about.  If so, I mildly disagree.  (A New Keynesian claim.)

Why do I only mildly disagree with the last option?  Because it’s certainly possible, but on balance I believe that growing signs of risk in the asset markets are themselves caused by signs of excessively tight money, which is reducing expected NGDP growth.  In other words, in my view growing risk is the symptom of a recession, should it occur, not the cause.

Just to be clear, I am not predicting a recession this year (nor does Tyler in the post I linked to.)  But I certainly think the risk of one has increased in recent months, and I’d guess he does as well.

To summarize, I view the NGDP shock/sticky wage model as being very powerful, partly because we see this pattern over and over again, under all sorts of monetary regimes, and all sorts of triggers for monetary shocks.  Some intentional (the Fed 1920-21, 1929-30, Volcker 1981) and some unintentional (2008-09).  But always the same result.  NGDP falls much faster than hourly nominal wages, and unemployment soars.  Then wages adjust and unemployment falls.  That’s not to say real recessions are not possible, as Zimbabwe showed in 2008 and perhaps the US in 1974.

Don Geddis sent me a wonderful introduction to market monetarist ideas by Eliezer Yudkowsky, in Facebook.  I probably enjoyed reading this piece more than almost anything else in the past 10 years, partly because it’s very nicely done, but more because I feel gratitude that one of the smartest individuals that I have ever read finds the ideas appealing.  That doesn’t mean we are right, but it’s certainly a good sign.  On a related note, check out my newest post at Econlog, which discusses Yudkowsky, Newcomb’s Paradox, and long and variable leads.

 

 


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37 Responses to “A risk-based recession?”

  1. Gravatar of E. Harding E. Harding
    14. February 2016 at 08:44

    I thought the phase “risk-base recession” was completely lacking in substance and meaning. Typical Cowen.

  2. Gravatar of Kevin Erdmann Kevin Erdmann
    14. February 2016 at 10:02

    That Yudkowski post was great. Sadly many of the comments were complaining that monetary stability is just bailing out irresponsible speculators. Remember when populists were taken in by speeches about crosses of gold? 21st century populists are the worst kind of populists. The problem is we don’t have many farmers any more. If we could somehow make farmers and school teachers the first groups visibly harmed by bad monetary policy, we’d have complete monetary stability in about 10 seconds.

  3. Gravatar of Tom Brown Tom Brown
    14. February 2016 at 11:40

    One of my favorite podcasts (“Rationally Speaking”) took a look at Newcomb’s paradox recently:
    http://rationallyspeakingpodcast.org/show/rs140-kenny-easwaran-on-newcombs-paradox-and-the-tragedy-of.html

  4. Gravatar of Major.Freedom Major.Freedom
    14. February 2016 at 11:47

    Still there is a total absence of any explanation for what causes the repeated periods of dramatically rising cash holding preference.

    I is not the responsibility or duty of any producer to prevent recessions. Why would it be the responsibility of a legalized counterfeiter to do so?

    Recessions are not caused by falling spending. Recessions are caused by the same thing that causes the fall in spending. This is why you see your “powerful” beliefs in the correlations.

    In a division of labor, coordination between producers, in real terms, requires unhampered economic calculation. Unhampered economic calculation requires unhampered relative prices, and interest rates, both of which are made impossible by central banks. Recessions are not caused by insufficient spending or insufficient inflation, they are caused by insufficient market driven economic calculation, which has as one symptom periods or rising cash preference when the collection of investment errors are realized.

    Widespread errors in coordination cannot possibly manifest in unchanged prices, spending, or any other “nominal” variable, where otherwise the fault is on money issuers in particular. Occasionally real productivity declines. Are we to conclude the producers of iron or oil or electricity “failed” to produce enough iron or oil or electricity? Of course not, because no one individual can know how much iron or oil or electricity should be produced. Only the market process can tell us whether too much or too little was produced in the past. This truth often makes socialist minded ideologues very uncomfortable, because the ideology is incompatible with humility, with recognizing the existence of individual preferences, and with the morality of individual property rights. The ideology is compatible with arrogance, with preferences of special interest groups, and with the morality of individual sacrifice.

    This ideology is allowed to be defined as “pragmatic”.

  5. Gravatar of marcus nunes marcus nunes
    14. February 2016 at 12:18

    EY is Benjamin Cole´s #1 FAN!
    “Print More Money”

  6. Gravatar of Daniel Daniel
    14. February 2016 at 12:22

    Tyler Cowen says stupid things.

    In other news, water is wet and the sun rises in the east.

  7. Gravatar of Kevin Erdmann Kevin Erdmann
    14. February 2016 at 12:23

    Hm. On further review, most comments actually seem supportive. Observer’s bias on my part.

  8. Gravatar of Christian List Christian List
    14. February 2016 at 13:31

    @Major.Freedom
    “Still there is a total absence of any explanation for what causes the repeated periods of dramatically rising cash holding preference.”

    As far as I understood market monetarism (and Keynesianism) do not care too much for “the one cause” for several reasons. I assume they would say that’s the beauty of their theories. Not caring too much about causes is not a bug, it’s a feature.

    “It is not the responsibility or duty of any producer to
    prevent recessions. Why would it be the responsibility of a legalized counterfeiter to do so?”

    Well the “legalized counterfeiter” (as you seem to call the central bank) is always doing something. The “neutral position” you seem to prefer does not exist.

  9. Gravatar of Major.Freedom Major.Freedom
    14. February 2016 at 14:12

    Christian List:

    “As far as I understood market monetarism (and Keynesianism) do not care too much for “the one cause” for several reasons. I assume they would say that’s the beauty of their theories. Not caring too much about causes is not a bug, it’s a feature.”

    Suppose a doctor who doesn’t care about the cause of someone’s illness he is trying to understand, doesn’t realize that they are prescribing a treatment that causes or exacerbates the illness.

    Suppose a physicist who doesn’t care about the cause of a particular phenomena he is trying to understand, doesn’t realize that the physicist himself is inadvertantly causing the phenomena in his experimental method.

    Perhaps the bug is only being called a feature, because to call it a bug would lead to the realization that the bug is caused by their own theories imposed in practise?

    Studying and identifying causes of problems is the only way to actually solve the problems.

    “Well the “legalized counterfeiter” (as you seem to call the central bank) is always doing something. The “neutral position” you seem to prefer does not exist.”

    Where did I even hint that this is my preference? I never said or implied anything about “neutral” monetary policy. I have known for quite some time that money is non-neutral. No issuer of money, competitive or socialist, can issue money in a “neutral” manner. It is a curiosity that such a vain belief is considered as the alternative to monetarism.

    At any rate, this does not address the question being asked. The question was why would it be the responsibility of a central bank to prevent recessions.

    Nobody has ever proved they can do so, and given that nobody has ever proved they do not cause them in the very act of trying to fix previous ones.

    To say the central bank cannot engage in neutral activity, does not constitute a proof or explanation that the central bank ought to become a recession preventer. For what if the very cure being advocated is itself a cause? You would want to know whether your solution to the problem is not itself a cause, wouldn’t you? How can thinking differently be a “feature” of a good theory instead of the mother of all bugs?

  10. Gravatar of Postkey Postkey
    14. February 2016 at 14:49

    “A. It’s simple! You just declare an NGDP path target, set up a prediction market, tell an intern to do whatever the prediction market says, and then go on vacation for the rest of your life as a central bank!
    Q. This is madness!
    A. Madness? THIS… IS… MARKET MONETARISM!
    LikeShare”
    https://www.facebook.com/groups/674486385982694/permalink/896559330442064/#_=_

  11. Gravatar of Benjamin Cole Benjamin Cole
    14. February 2016 at 16:10

    3% NGDP growth is pathetic.
    The Fed is very ossified, I cannot imagine them adopting NGDPLT.
    An inflation floor actually makes more sense than an inflation target. A 3% inflation floor might actually prevent future recessions. But I cannot imagine the Fed adopting an inflation floor as opposed to a inflation ceiling.
    Monetary asphyxiation is a risk.

  12. Gravatar of Major.Freedom Major.Freedom
    14. February 2016 at 16:16

    3% NGDP growth at this time is far too much, if the free market process would otherwise result in less than 3%, which is almost certainly the case given the amount of inflation that has taken place over the last few decades.

    The world is choking on and being asphyxiated from an absence of free market pricing, interest rates, and spending. Too much toilet paper is clogging up the air filter.

  13. Gravatar of Benjamin Cole Benjamin Cole
    14. February 2016 at 17:18

    OT:

    “He has been very clear on the foreign policy side that the Iraq War was a disaster. I think a lot of people agree with that,” said Corey Lewandowski, Trump’s campaign manager. “We lost thousands of lives and $5 trillion for what?”
    –30–

    The GOP is outraged that Trump would tell the truth on the Iraq war.

    So who is the lulu and who is the kook?

    Ted Cruz says the world is on fire, he wants to carpet-bomb Syria, and that he does not want Trump’s finger on the button.

    And why does Cruz want to drop a lot of carpets on Syria anyway?

  14. Gravatar of Tom Brown Tom Brown
    14. February 2016 at 17:48

    Benjamin Cole,

    “The GOP is outraged that Trump would tell the truth on the Iraq war.”

    Yes, I do like Trump on W’s legacy. Pretty much all I like him on. Bush & Rubio seem to want to defend it. Trump tells them:

    W ignored the signals for 9/11
    W make a mistake getting us in Iraq
    W admin pushed the WMD story in spite of the facts
    W admin misrepresented Sadam’s role
    W destabilized the Middle East

    That crap is indefensible. OK, I’m not saying 9/11 definitely could have been prevented, but there’s some evidence there of incompetence. WMD & Sadam’s role is much different.

    Personally I never believed the WMD story. That’s basically when I stopped voting GOP. I looked around for any Republicans that felt the same way as I did and I came up with one (currently in office): Ron Paul. That was it! One guy. I’m not even a Paul fan, but I’ll give him major props for his position on that. I was absolutely outraged that everyone rolled over for that obvious BS: GOP, Dems, media. “Cakewalk” my ass. What a farce! It’s like not a single person in the admin had a brain. The only “mainstream” media letting the skeptical view through was NPR. At least the only one I was aware of. They’d bring on two people with some knowledge of the issue to debate and it wasn’t even close. To this day I can’t believe Iraq went down on those flimsy pretenses. HELLO!! Sadam HATED Al Qeda. It was a slow motion train wreck: absolutely preventable. Aside from the # of casualties, worse than Vietnam.

    I despise Trump, but it reminds me about neocons and how much I despise them. Now I’d like to see Trump #1 and Bush #2 in the primary so Trump can take a rest from race-baiting and spend more of his time tearing into W’s record, and forcing Jeb to defend it. I’d like to see Trump get conservatives to rethink that whole thing.

    And when this debacle of an election is over, I hope somebody has brought back the Whigs!

  15. Gravatar of Tom Brown Tom Brown
    14. February 2016 at 17:58

    And I’m not giving HRC a pass. She voted for Iraq too. But to put Benghazi on the same level is an insult to our intelligence. As far as I’m concerned, she could have flown over and personally killed each of the victims of Benghazi, … stabbed ’em in their faces… and it would pale in comparison, scandal wise, to Iraq.

  16. Gravatar of E. Harding E. Harding
    14. February 2016 at 18:51

    @Tom Brown

    In some ways, Libya was worse than Iraq. At least the Iraqi Civil War did not devolve into the Shiites splitting up into two governments. Libya split up into two governments+the Islamic State (though this was after Clinton left office; when she did, Libya was still a democracy). And her role in Syria was pretty bad as well, and set up the background for Obama’s re-creation of ISI under Kerry.

  17. Gravatar of Benjamin Cole Benjamin Cole
    14. February 2016 at 23:15

    Tom Brown:

    Will the U.S. right-wing ever give up its militarism? Vietnam, Iraq, Afghanistan, Syria, Lebanon, Pakistan–exactly where lately has US interventionism worked?

    A full-time, professional, permanently mobilized military is fantastically expensive (and an abomination to the Founding Fathers), and a useful tool for U.S. Presidents seeking to distract voters from their lack of domestic accomplishments….

    Only Trump seems to say so. So do you vote for the boob at the bar who tells it like it is even while harboring biases, or the smoothie who lies through his teeth, and then tries to believe it?

    Rubio proclaimed he thanks the supreme deity that George Bush jr., was President on 9/11 and not Gore. Really?

    And no, the Dems are not better…

    Ron Paul is an interesting guy. The one guy I like…and then he turns out to be a gold nut.

  18. Gravatar of Postkey Postkey
    15. February 2016 at 01:06

    “You can’t understand the conflict without talking about natural gas
    By Maj. Rob Taylor
    Any review of the current conflict in Syria {Iraq?} that neglects the geopolitical economics of the region is incomplete. (Nearly all media reports fit this description.) “
    http://www.armedforcesjournal.com/pipeline-politics-in-syria/

  19. Gravatar of E. Harding E. Harding
    15. February 2016 at 04:59

    @Postkey

    -No infrastructure is being built in Syria. A lot is prevented from getting built.

  20. Gravatar of Saturos Saturos
    15. February 2016 at 07:27

    What I especially like about the Yudkowsky post is that his views seem even closer to mine and Nick Rowe’s than to Scott’s, as he emphasizes for intuition not just the value of money as the medium of account asset changing with supply and demand and logically revaluing prices on everything else, but actually goes into the flow of actual media of exchange in two-sided final goods markets. So he talks about velocity of changing hands for the initial intuition, and only later might add an explanation about Cambridge k. And this makes the superiority of NGDP immediately intuitive. You can see how nicely it segues into the musical chairs model.

    If only it were broken up into parts and rewritten a bit for clarity, we could post this up as our official intro to market monetarism (replacing Scott’s current FAQ, perhaps). Sure he wouldn’t mind.

  21. Gravatar of Saturos Saturos
    15. February 2016 at 07:31

    The antibiotics analogy is truly great, though.

  22. Gravatar of Brian Donohue Brian Donohue
    15. February 2016 at 07:58

    @Saturos,

    Not sure if you are serious, but I’ve felt for a while that Scott could be the next Friedman… if only he could write like that great man.

    Yudkowsky has a certain gift in that regard, IMO.

  23. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    15. February 2016 at 08:03

    https://twitter.com/steve_hanke?ref_src=twsrc^tfw

  24. Gravatar of Dan W. Dan W.
    15. February 2016 at 08:20

    Scott,

    Is not the knowing purchase by a central bank of bad debt a “helicopter drop” and a form of counterfeiting, if not money laundering? Does such a plan increase or decrease risk in future pricing of financial assets?

    “The ECB are said to be in talks with the Italian government about buying bad loans under QE. Reuters cite Italian Treasury officials who say the ECB could buy them or would accept them as collateral for cash.”

  25. Gravatar of Steve Steve
    15. February 2016 at 09:47

    Ben, Tom,

    Blaming W for 9/11 is preposterous. The pilot hijackers had already entered the country in 2000, and OBL’s infrastructure, the US flawed Visa system, the flawed security architecture, and bureaucratic miscommunication all occurred under Clinton.

    It would be like blaming Obama for the unemployment rate on 9/2009. It’s a crazy, discrediting claim. You have to blame the previous president, or the bureaucratic government agencies.

    Iraq is another matter. W screwed up massively. Of course Obama made it worse by overriding the generals to pursue an early exit, and Hillary didn’t cover herself with glory in Syria or Libya.

    Counterfactuals are also hard. If Saddam were in power in 2008, I suspect he would have used $150 oil to make trouble and cause additional supply interruptions in neighboring countries. I suspect the next time we have an oil supply shock, Iran and Russia will do the same in order to make sweeping territorial gains. This is the “free market” at work, mid-east style.

  26. Gravatar of Tim Tim
    15. February 2016 at 09:56

    Scott,

    If we had negative interest rates on excess reserves could the rate of inflation increase significantly? Would negative rates on excess banking reserves increase the velocity of the money supply? How would this change m2 and m1?

    Thanks, Tim

  27. Gravatar of E. Harding E. Harding
    15. February 2016 at 10:14

    “I suspect the next time we have an oil supply shock, Iran and Russia will do the same in order to make sweeping territorial gains.”

    -Where? Central Asia? Iran is a peaceful country, and Russia is a fundamentally reactionary one. Turkey and Qatar, meanwhile, are revisionist powers, and are highly threatening to world civilization.

    “If we had negative interest rates on excess reserves could the rate of inflation increase significantly?”

    -Yes, but not a huge amount.

    “It would be like blaming Obama for the unemployment rate on 9/2009.”

    -9 months is enough for monetary policy to enormously affect the labor market.

    Brian, Scott’s writing skill is fine. What he needs to become the next Friedman is to publish lots of original academic work.

  28. Gravatar of Brian Donohue Brian Donohue
    15. February 2016 at 12:43

    @E Harding, I don’t think so. Friedman earned his reputation through scholarly work, but his influence was almost entirely due to his popular books.

  29. Gravatar of Eliezer Yudkowsky Eliezer Yudkowsky
    15. February 2016 at 13:53

    Heh, I actually considered that Facebook post a work in progress, and am still editing it in bits to improve organization and address further questions so on. But I posted it publicly, so can’t complain about linking.

    If you’ve already read it and spotted an error, please let me know! yudkowsky@gmail.com.

  30. Gravatar of E. Harding E. Harding
    15. February 2016 at 17:07

    @Brian

    -Then Scott should rub shoulders more with world leaders and write more popular books.

  31. Gravatar of How tight is monetary policy now?, and some remarks on ngdp and market monetarism – Marginal REVOLUTION How tight is monetary policy now?, and some remarks on ngdp and market monetarism - Marginal REVOLUTION
    15. February 2016 at 21:41

    […] is a recent Scott Sumner post, mostly about me.  It’s basically taking the other side of what I have been arguing, and I […]

  32. Gravatar of Saturos Saturos
    16. February 2016 at 03:42

    Eliezer’s writing style is a bit… niche, and it would put off just as many people as it attracts (I know this from sharing his Harry Potter stories amongst my friends). I think for instance his “Sequences” series was improved after it went through a bit of a rewrite and published as Rationality A-Z. (Highly recommend that to everyone btw, great intro to thinking through philosophical issues like a serious reductionist.)

    But again the emphasis on the reality of NGDP as a direct measure of money flow on the other side of the market to the sale of GDP components, is really necessary to get the point across about it as a simple, purely nominal variable, which the mainstream economist is still nowhere near picking up from whatever filters out from this blog. Case in point: Tyler’s reply to this post still seems irritated that NGDP is being used as a “cause” of recessions as though it were a variable representing directly a purely nominal shock – but which it is! So the intuitions need to be fixed further.

  33. Gravatar of TallDave TallDave
    16. February 2016 at 07:03

    That Facebook piece is delightful, thanks for sharing Scott.

  34. Gravatar of TallDave TallDave
    16. February 2016 at 07:10

    “Nominal interest-rate targeting as a control instrument is kind of silly to begin with, honestly! It’s like trying to steer a car with a wobbling, unsteady steering wheel, where the same steering-wheel position might be pointing in a different direction every time the car goes another meter.” Ha.

  35. Gravatar of TravisV TravisV
    16. February 2016 at 08:47

    Tyler Cowen has a new post on this topic:

    http://marginalrevolution.com/marginalrevolution/2016/02/how-tight-is-monetary-policy-now.html

    Nick Rowe has written a reply:

    http://worthwhile.typepad.com/worthwhile_canadian_initi/2016/02/targeting-tautologies-and-divine-coincidence.html

  36. Gravatar of ssumner ssumner
    16. February 2016 at 17:10

    Saturos and Brian, After reading that I thought Yudkowsky and I should write a book together.

    Tim, It’s hard to say. Ceteris paribus it raises inflation, but ceteris is rarely paribus.

    Eliezer, Let me know when it’s finished, I thought it was great.

    Thanks Travis.

  37. Gravatar of Joe Joe
    18. February 2016 at 15:02

    Kevin, I saw those comments on that Facebook post. It seems odd to me that it’s always about punishing the reckless borrowers. But if you have deposits in a bank, or own investments (not gold in a safe), then you’re just as at risk for recklessly lending. without the government protecting your deposits for you, you’d be just as at risk in a deflationary environment.

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