It’s complicated

With all the grading I have to do I shouldn’t be posting.  But life doesn’t provide many opportunities, and my National Review piece has led a number of very smart bloggers to mull over my ideas, including Brad DeLong, Tyler Cowen and Ryan Avent.  So grading will have to wait.

I’ve noticed is that it’s easier to see flaws in others than to see one’s own flaws.  For instance, I think I can see flaws in Paul Krugman’s analysis of China’s predatory trade policy, or his analysis of why Japan got stuck in a liquidity trap.  But strangely enough, I have trouble find major flaws in my own arguments (although I certainly see some modest weaknesses.)

If I try to crawl out of my own ego and look at things dispassionately, then I need to take seriously an issue raised by not one but two highly respected bloggers.  I’m referring to a recent Ryan Avent post that favorably quoted a question Tyler Cowen recently asked me.   Here’s Ryan Avent, followed by the Tyler Cowen question:

At a recent dinner here in Washington, Mr Sumner discussed his views and took questions. One, from Tyler Cowen, struck me as more psychological than economic, and also as one of the most potent criticisms of the Sumnerian approach:

“Let’s say that at the peak of a financial crisis, the central bank announces a firm intention to target a path or a level of nominal GDP, as Scott suggests.  If everyone is scrambling for liquidity, and panic is present or recent, and M2 is falling, I wonder if the central bank’s announcement will be much heeded.  The announcement simply isn’t very focal, relative to the panic.  A similar announcement, however, is more likely to work in calmer times, as the recent QEII announcement has boosted equity markets about seventeen percent.  But for the pronoucement to focus people on the more positive path, perhaps their expectations have to be somewhat close to that path, or open to that path, to begin with.

(Aside: there is always a way to commit to a higher NGDP path through currency inflation, a’la Zimbabwe.  But can the central bank get everyone to expect that the broader monetary aggregates will expand?)

The question is when literal talk, from the central bank, will be interpreted literally.”

And here’s what Ryan Avent said immediate after the quotation:

Had the Fed said, in the thick of the financial crisis, that it would maintain NGDP growth at 5%, who would have listened? There was a palpable sense at the time that the economy was in need, first and foremost, of serious repair to the banking system. A bit later, op-ed pages rang with calls for fiscal stimulus, as pundits explained that in an atmosphere of panic monetary policy was impotent since no one would borrow at any interest rate.

After that, Avent becomes supportive of my critique of Fed policy.  And Tyler Cowen has also said some good things.  Nevertheless, I need to address an issue that two sympathetic critics see as one of the least persuasive parts of my message.  How can I overcome the fact that others see our flaws more clearly?  By relying on the fact that others also see our models less clearly.  My argument is sort of like a jigsaw puzzle, with many interconnected pieces in areas such as monetary theory, efficient markets, economic history, policy constraints, monetary transmission mechanisms, unconventional monetary instruments, reverse causation, etc, etc.  An outsider will usually fixate on a few notable aspects of the argument, and may not see the entire picture as a unified whole.  OK enough navel gazing, so how do I respond?  Let’s assemble some pieces:

1.  The NGDP and RGDP collapse, (at estimated monthly frequencies) occurred almost entirely between June and December 2008.  I argue that NGDP targeting could have prevented that collapse.

2.  I argue that the dramatic worsening of the banking crisis after Lehman was mostly endogenous, as sharply falling NGDP expectations one, two, and three years out reduced current asset prices, and made bank balance sheets deteriorate sharply.

3.  I argue that NGDP growth targeting might not have been able to arrest the sharp fall in forward estimates of NGDP, but that NGDP level targeting could have done so.

4.  I argue that the crucial errors were made before we were in a liquidity trap (i.e. when rates were still 2% in September and early October.)

5.  I argue that the financial crisis of September 2008 did not cause a stock market crash, as the markets expected the Fed to continue its multi-decade policy of keeping NGDP growing at about 5%/year.  If the markets had given up on the Fed in September 2008, they wouldn’t have waited until October to crash.

6. I argue that stocks crashed 23% in early October on little financial news.  Instead, there were ominous reports of rapidly falling orders all over the industrial world.  Markets then sniffed out Fed passivity, a failure of the Fed to do what it takes to maintain the Great Moderation.  They became demoralized.

7.  I argue that the only significant Fed policy during the October crash was the IOR program, which was termed contractionary by leading monetary economists such as Robert Hall and Jim Hamilton.

8.  I argue that the Fed has many powerful tools even when rates hit zero, and even when the banking system is near collapse.  I cited FDR’s 1933 policies as a precedent.

9.  I argued that the recent market response to QE2 shows that monetary policies are powerful at the zero bound, and work through expectations channels.

10.  I argued that the failures of Fed policy in September 2008 were a clear example of the superiority of forward-looking monetary policy over backward-looking monetary policy.

11.  I argued that the Fed could have prevent the extraordinary increase in real interest rates on 5-year TIPS during July to November 2008 (from 0.6% to 4.2%) if it had moved aggressively.  This would have also prevented the sharp increase in the foreign exchange value of the dollar, something almost unprecedented in a financial crisis.

12.  I noted that many contemporaneous observers felt the Fed was powerless to arrest the 50% fall in NGDP during the early 1930s, because of financial panic.  Today much of the profession (including Bernanke) has accepted Friedman and Schwartz’s revisionist view that it was possible for the Fed to arrest that decline in NGDP.  But they don’t think the Fed could have done much in late 2008, under very similar circumstance.

13.  I’ve pointed out that cutting edge research in macro (i.e. Woodford) suggests that the most powerful determinant of current movements in AD is future expected movements in AD.  So if the Fed could credibly commit to boost AD when the banking crisis was over, it would have sharply boosted AD while the banking crisis was still going on.

14.  I’ve argued that even if banking problems are a real problem, and could not be papered over with more money; falling NGDP was also most certainly something that would reduce RGDP, above and beyond any decline due to banking.  Sharp declines in NGDP don’t suddenly become harmless when the economy has other problems, just as a knife wound doesn’t become harmless just because the patient also has pneumonia.

15.  I’ve argued that the banking problems of 2007 morphed to a NGDP crisis (needing different treatment) without the profession knowing it.  Just as my cold of last week morphed into bronchitis this week (again needing different treatment.)

16.  I’ve argued the Fed can tell right away if its policy has worked (in the TIPS markets) or if more is needed.  Contrary to what 99.9% of economists believe, there is no “we need to wait and see if it’s working” problem in monetary and fiscal stimulus.

I guess 16 is enough for now.  Now let’s see how this relates to Tyler’s argument.  Tyler asks how we can realistically expect markets to be convinced by aggressive Fed action in the midst of the banking crisis.  One response is that the banking crisis was caused by tight money.  Another response is that markets didn’t need to be convinced in the midst of the banking crisis (when stocks weren’t falling that sharply), but rather in the first 10 days of October, when the stock market did crash.  And I am arguing that the stock market crashed in part because of a growing realization that policymakers would not do anything to arrest the decline.  This does not mean each trader has a fully formed model of monetary policy in his or her head, much less my model.  That’s not how markets aggregate information.

Here’s an analogy.  I’ll bet you’d find more people on Wall Street who disagree with my views on the miraculous ability of QE2 to boost asset prices, than you would people who agree with my views (if you interviewed them.)  But in September and October the markets acted as if I am right.  FDR was hated by Wall Street, and all the business press thought the 1933 dollar devaluation was a horrible idea.  But asset markets soared on the news.  Money talks, and very loudly.

It’s hard to emphasize enough how un-radical the Fed’s QE2 policy really is.  It’s ultra-cautious.  They are buying some T-notes, with modest price risk.  That’s an open market operation.  They deliberately passed over all sorts of “nuclear options,” including a higher inflation target, or level targeting, or negative IOR.  And yet the markets still became totally obsessed with Fed rumors during September and October of this year.  Admittedly the news backdrop was more intense in late 2008, but not all the time.  Here’s Ryan Avent:

People remember the sharp decline in share prices in September and October of 2008, but from the end of 2008 until March of 2009, the Dow fell by a third. Ben Bernanke didn’t need to get everyone’s attention on September 15, 2008, or even that particular week.

I’d go further, there were plenty of slow news days in October when the Fed could have electrified the markets.  I know I’m going to be ridiculed for this, but what the heck.  I recall seeing Jim Cramer on TV one morning (in October 2008 I believe) and he was utterly despondent.  Why?  Because the Brits had cut rates sharply, initially leading to hopes on Wall Street that the ECB would do the same later in the morning.  But then the ECB made  a weak move, and US markets fell sharply on dashed hopes.  Cramer seemed forlorn, and berated the ECB.  If even Jim Cramer is grasping for straws from ECB rate decisions on national TV, just imagine the reaction to the United States Federal Reserve doing something bold.

If I were to critique my argument it would be as follows.  The Fed is what it is, a large bureaucratic institution.  I naively thought they could handle this sort of crisis.  Krugman correctly predicted they could not.  So there is a sense in which Tyler in right.  I may have been asking for something that the Fed simply wasn’t set up to do.

My response would be to go back and look at the 1930s.  You could argue that the Fed of the early 1930s wasn’t institutionally set up to prevent the sort of fiasco that we actually observed.  But we learned from that mistake.  And the Fed changed in ways that make another 50% fall in NGDP almost inconceivable.  So that’s progress, and we have Friedman and Schwartz to thank for that progress.

So maybe I was wrong that the Fed was implicitly targeting NGDP during the Great Moderation at roughly 5% growth.  And maybe Tyler’s right that it would not have been credible for them to suddenly start doing so in the midst of the banking crisis.  I’m still not convinced, but maybe he’s right.  Then my fallback is that I’m already fighting the next battle, we need to learn lessons from this fiasco that are analogous to the lessons we learned from the 1930s.  So that next time we’re near the zero bound everyone knows the Fed plans to immediately shift to NGDP targeting, level targeting, with a catch up for any near term undershoot.  Even better, let’s shift before the next crisis.  If we can learn that lesson from this crisis, we can make the next crisis even smaller.  (All battles over economic history are disguised battles over current and future policy.)

PS.  When I saw Jim Cramer I said to myself; “Even he gets it.  He understands the need for more monetary stimulus.  Why can’t Bernanke and all the other elite macroeconomists see the same thing?”  (I hope the term ‘even’ didn’t come across as condescending, but you know how academics look down on the shouters and the showman.)

PPS.  I still plan to say something more about Tyler Cowen’s longer critique, when I have more time.

HT:  Marcus Nunes


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73 Responses to “It’s complicated”

  1. Gravatar of Morgan Warstler Morgan Warstler
    21. December 2010 at 07:27

    This is what I mean by pissing on booms being the real issue.

    When Avent asks, “who would have listened?”

    The answer is everyone if previously the Fed had been sucking money out of the system when NGDP got over 5% and saying, “sorry, it was time to take away the punchbowl.”

    What you really have to convince people of is:

    1. The Fed will have the strength to do this.
    2. If unemployment is still 7.5% while we are running along with 5% NGDP, we’ll have a strong indication unemployment is structural.

  2. Gravatar of marcus nunes marcus nunes
    21. December 2010 at 07:33

    Who would have listened? Everyone listened to the Fed insisting that inflation was the problem and KNEW the Fed was making the wrong call. So they also know what the RIGHT call sounded like. If only the Fed had obliged!

  3. Gravatar of marcus nunes marcus nunes
    21. December 2010 at 07:40

    How do we know this? Monthly NGDP estimates began to “detach” from trend slowly in early 08. Following a sequence of FOMC meetings that alerted to the inflation danger (with dissenting votes in favor of an increase in rates in every meeting through August),after June NGDP began to drop continuously and even on the Sept 16 FOMC meeting (right after Lehman) they kept insisting on the risk of inflation!

  4. Gravatar of Cameron Cameron
    21. December 2010 at 08:35

    Reading this reminded me of this calculated risk post in December 2008 titled “What if the Fed had a meeting and no one cared?”

    http://www.calculatedriskblog.com/2008/12/what-if-they-had-fed-meeting.html

    To this day I don’t think I ever remember people caring less about a Fed meeting. Of course it may have been because people were too focused on financial matters, but when the Fed surprised markets and cut to 0.00-0.25% rates (and also hinted at QE) the S&P rallied nearly 5%!

    It’s hard for Avent and Cowen to imagine the Fed mattering because the Fed made it look like it didn’t matter. When the Fed actually started getting “aggressive”, markets pretty clearly did react, even to relatively standard policies. Imagine what would have happened if the Fed promised to target an NGDP growth path.

  5. Gravatar of marcus nunes marcus nunes
    21. December 2010 at 09:00

    @ Cameron
    And it was after December 08, following the Fed´s aggresive action (and talk) that monthly estimates o NGDP stopped falling!

  6. Gravatar of MikeDC MikeDC
    21. December 2010 at 10:02

    So the quick answer is that if the Fed has waited around until there’s a full blown crisis, it has already messed up and let the horse out of the barn?

  7. Gravatar of K K
    21. December 2010 at 10:34

    17. Isn’t the Fed supposed to manipulate NGDP futures up towards 5%?  I.e. throw gobs of future money at anyone who cares to bet it will be lower.  Doesn’t that make a pretty convincing case???

  8. Gravatar of Contemplationist Contemplationist
    21. December 2010 at 10:41

    Yeah this is baffling. Its not like the verbal/vocal announcement is the ONLY trick in the bag. It will be accompanies by OMOs and other tangible actions that will build credibility. What does ‘listening’ have to do with that?

  9. Gravatar of Benjamin Cole Benjamin Cole
    21. December 2010 at 11:40

    The Fed should keep pointing at Japan, and saying “That is the option. Perma-deflation, and shrinking investment portfolios. You want that?”

  10. Gravatar of Luis H Arroyo Luis H Arroyo
    21. December 2010 at 12:12

    I remember that by october 2008, I was quite disappointed with the Bernanke passivity. He is not Greenspan, I used to say. It is possible that the FED was wrong with so much cautious, but I remember that then, Greenspan was unanimously accused as the cause for the crisis. So, I can imagine the reason for Bernanke being quite prudent in his words. Simply, he could not announce that he would follow an inflationist policy al cero interest rate and Ilimited quantitative easing.
    It is not easy. In 1933, only FDR was able to cut the Gordian of deciding a very risk politics, never used: reflating economy, restablishing price level of some years before. I think that Bedrnanke has been quite prudent because his margin is not so ample. In any case, I agree with Advent in that too many people were thinking in the priority of saving the banks, anda that a FEd with an unique objective on the NGDP, had not got a good result.

  11. Gravatar of Luis H Arroyo Luis H Arroyo
    21. December 2010 at 12:14

    gordian knot, sorry

  12. Gravatar of Luis H Arroyo Luis H Arroyo
    21. December 2010 at 12:23

    did you know that in Spain the libertarians always talk about jailing Greenspan & Bernanke? Imagine…

  13. Gravatar of Richard W Richard W
    21. December 2010 at 14:06

    Prof. Sumner, how do you account for markets giving significantly mixed if not outright conflicting signals? For example, December 2008, equity markets were forecasting a moderate recession. Whereas the bond market was forecasting something much more severe. Effectively the January to March period of 2009 of collapsing equity prices was the equity markets catching up with the bond market.

  14. Gravatar of jj jj
    21. December 2010 at 14:23

    I think this thought experiment illuminates the issue: what would have happened if the Fed was secretly doing NGDP level targeting in 2008? This is an even more extreme scenario than what Cowen raise — namely the fed announcing it, but the market completely disbelieving either the fed’s intentions or ability.

    So in October 2008 the market starts falling, but the fed is secretly buying massive amounts of treasuries, propping interest rates up. Does this stop the fall? I don’t know; let’s say it doesn’t. The Fed moves on to buying assets, say stocks. This would definitely stop the fall in stocks.

    During this period there would be massive volumes of buying and selling, but nobody could point to a sell-off if prices didn’t fall. The market would either conclude that on average there was nothing to be scared of, or that SOMEBODY was supporting a floor in prices. That could only be the fed.

    I don’t know if I presented this convincingly, but I’m convinced: the Fed’s actions will work regardless of how the market interprets its intentions or ability. If the market does hear and believe the Fed, the amount of buying required would be a lot smaller. But sometimes words aren’t enough and it takes action to prove that you’re serious.

  15. Gravatar of Luis H Arroyo Luis H Arroyo
    21. December 2010 at 14:50

    JJ I agree.

  16. Gravatar of Gregor Bush Gregor Bush
    21. December 2010 at 14:51

    Scott,
    I think you left out an important aspect of Sumnerism from this post, which is that the Fed rarely or never deviates from the Consensus of the profession. And the consensus of the profession was, and, amazingly, STILL is, that the Fed was a relatively unimportant factor in the downturn and that there is little that it can do now. An article on Bloomberg the other day showed that most Wall St. economists STILL thought that QEII had minimal effect (and others though it was a net negative) – despite the fact that these forecasters all were frantically marking up their forecasts due to a mysterious and completely unexplainable uptick in the economic data in the fall.

    So the blame lies not just with Bernanke, Fisher and Plosser but also with Feldstein, Krugman, DeLong, Schwartz, Kling, Cowen, Kudlow, Malpass, Laffer, Hamilton and Rajan – all of whom at one time or another either argued explicitly against monetary stimulus or argued that it was a waste of time. If all of these economists and commentators had been arguing as viciously as you have for the need for monetary stimulus the unemployment rate would be much lower today.

    It turned out that the ‘standard’ New Keynesian model – where the central bank targets a forecast of a nominal variable – was actually understood and accepted by very few people.

  17. Gravatar of Master of None Master of None
    21. December 2010 at 16:01

    “the Fed can tell right away if its policy has worked (in the TIPS markets)”

    You’re relying on the government’s measure of inflation.

    How certain are you that our statisticians won’t be corrupted over time?

  18. Gravatar of Master of None Master of None
    21. December 2010 at 16:05

    “I’m already fighting the next battle…So that next time we’re near the zero bound everyone knows the Fed plans to immediately shift to NGDP targeting”

    I think right now we’re ~75% of the way there… there are a lot of people in the financial community who are afraid to be more bearish, because they believe that the Fed WILL BE THERE to step in when things in Europe get shaky.

  19. Gravatar of Benjamin Cole Benjamin Cole
    21. December 2010 at 16:09

    BTW, Ryan Avent, The Economist magazine, says Scott Sumner has become prominent.

    Mr Sumner, an economist at Bentley University, came to prominence during the recession and recovery for observing that the Fed was doing far too little to support the economy, and (perhaps more important) that it had helped precipitate the deep recession by doing too little in 2008, during which time nominal GDP was falling sharply….

    Prominent! I wonder how much longer Sumner will deign to respond to lowly posts by his unwashed blog readers.

  20. Gravatar of Master of None Master of None
    21. December 2010 at 16:14

    At a higher level, one thing that I always come back to is how the Sumnerian approach would have handled steadily falling housing prices.

    Specifically, can you convince me that the model would work if large financial institutions went bust because they simply made bad bets? Even without a financial crisis to tip the scales, several large institutions would have been on very shaky ground (e.g. Bear Stearns, Lehman, Citi, BofA).

  21. Gravatar of tsummers tsummers
    21. December 2010 at 16:42

    @ Scott Sumner, Where could I find a formal presentation of your macro-models?

  22. Gravatar of Lucas Lucas
    21. December 2010 at 17:44

    @Master of None,
    “You’re relying on the government’s measure of inflation.”
    You’re mistaken. The TIPS spread is a market forecast of expected inflation. It doesn’t rely on government data of any kind.

    @Scott,
    I’d like to know your take on this:
    “There is extensive debate as to whether the standard tools of economics are even valid (…)But is anyone at least trying to do something original with the standard toolkit? (…) The answer on this occasion is yes, at least as far as Michael Kumhof and Romain Ranciére, go. In a new paper, they present a DSGE model with the following parameters: the top 5% of the income distribution value wealth more than everyone else, for whatever reason, and specifically, they want AAA-rated assets. Further, these are intermediated through the financial sector. Then, they run a simulation of the macro-economy assuming that there is a negative shock to the bargaining power of labour resulting in a shift in the income distribution.
    The simulation results were that the financial sector balloons in size, that total private debt in the economy expands hugely, and that credit acts as a substitute for rising average wages in the short run. Eventually, the model produced a massive financial crisis and a brutal recession, followed by a blow-out of the government budget.” [1]
    A DSGE model parameterized with the socioeconomic environment caracteristic of the last 3 decades produces an accurate prediction of the financial crisis.

    1- http://fistfulofeuros.net/afoe/economics-and-demography/sunshine-at-the-imf-of-all-places/

  23. Gravatar of scott sumner scott sumner
    21. December 2010 at 18:31

    Morgan. Again, it’s level targeting that’s needed, don’t just focus on growth rates.

    Marcus, I agree.

    Cameron, That’s a good point.

    MikeDC, Yes, but it’s not too late to make the crisis smaller.

    K, I agree.

    Contemplationist, I agree.

    Benjamin, Yes, they should have made more use of the Japanese cautionary tale.

    Luis, I agree that the obsession with banking caused them to take their eye off the ball.

    Richard, I’m not sure, but it’s important to remember that stocks and bonds are not mirror images of each other. At times they respond to similar stimuli, but at other times they are reacting to different events. In any case, both were signaling that much easier money was needed.

    jj, It’s just not realistic to think the Fed can do those sorts of things in secret, it’s not how they work.

    Gregor, That’s a great line about the Wall Street pundits. Wall Street people are stupid, it’s the markets that are smart. The Wisdom of Crowds . . .

    Master on None, I’ve criticized the CPI, but I thinks it’s more that they are asked to do the impossible, and not that they are corrupt. The BLS is not partisan.

    But I’d feel much happier if we had a NGDP futures market.

    Benjamin, You said;

    “Prominent! I wonder how much longer Sumner will deign to respond to lowly posts by his unwashed blog readers.”

    Maybe I’ll cut it in half, just respond to my fans. :)

    tsummers, My model of futures targeting in is the Berkeley Electronic Journals, Contributions to Macroeconomics (2006.) Are there other models you are thinking of? I use lots of models developed by others, such as the EMH.

    Lucas, I’m not a fan of those sorts of models, as they tend to assume the financial crisis caused the recession, whereas I think it was the other way around.

  24. Gravatar of Jj Jj
    21. December 2010 at 23:04

    Scott, you misread my comment — it’s ok, you’ve mentioned 10 times how busy you are (and have no time to post or go through comments ;)).
    Of course the fed wasn’t doing anything in secret. I clearly called it a thought experiment, designed to show that it is close to irrelevant whether the market believes the fed or not, as long as the fed is willing to follow through.

  25. Gravatar of James in London James in London
    22. December 2010 at 00:44

    Is Scott Sumner an anti-Japanese racist?

    Constant comments on this site about Japanese deflation are meant to scare Americans into supporting NGDP-targeting. The Japanese are ridiculed for expecting (very) modest defation for the next eight years. The negative impact on stocks and house prices is said to be an obvious. problem.

    But, why are the Japanese so stupid they can’t see all of these problems. The answer is they don’t suffer and don’t want to suffer from money illusion.

    Why is suffering from money illusion held up to be such a wonderful thing? I don’t know. It seems to me if you suffer from one (big) money illusion you will suffer from others.

    Like the Sumner Put as a solution to essentially political issues like the deficit that are to hard to deal with face on.

    Dream on all you Sumner’ites and wake up one day to high, tough to control inflation and an impoverished (US-defined) middle class. The banking elites will be just fine, as usual, having got their hands on the newly-minted money first.

  26. Gravatar of James in London James in London
    22. December 2010 at 00:48

    And strangely, for all you Sumnerites, the Yen will keep appreciating against the US$. And although Americans may feel they are better off, money illusion tells us they won’t really be better off; while the Japanese will feel about the same, and not suffer from illusions.

  27. Gravatar of 123 – TheMoneyDemand Blog 123 - TheMoneyDemand Blog
    22. December 2010 at 04:01

    Scott, You said:
    “I argue that the only significant Fed policy during the October crash was the IOR program, which was termed contractionary by leading monetary economists such as Robert Hall and Jim Hamilton.”

    The only significant Fed policy was the one that ended the October crash, and it was a regime change that was announced in October 13:
    “The BoE, ECB, and SNB will conduct tenders of U.S. dollar funding at 7-day, 28-day, and 84-day maturities at fixed interest rates for full allotment. Funds will be provided at a fixed interest rate, set in advance of each operation. Counterparties in these operations will be able to borrow any amount they wish against the appropriate collateral in each jurisdiction. Accordingly, sizes of the reciprocal currency arrangements (swap lines) between the Federal Reserve and the BoE, the ECB, and the SNB will be increased to accommodate whatever quantity of U.S. dollar funding is demanded. The Bank of Japan will be considering the introduction of similar measures. ”

    So in the middle of the crisis the Fed declared “US dollar money market interest rates are too high, and we will do whatever it takes to bring them down”, and it was a regime change that worked! They should have started NGDP level targeting, the effect would have been much more dramatic…

  28. Gravatar of OGT OGT
    22. December 2010 at 05:55

    Off topic, James Hamilton has a good, fun post on the relationship of M and V. (I tried to post earlier but was blocked due to the link, maybe? Apologies if the previous attempt shows up later).

  29. Gravatar of Blackadder Blackadder
    22. December 2010 at 07:53

    @Lucas,

    The TIPS spread uses the CPI as its measure of inflation for calculating its interest rate.

  30. Gravatar of marcus nunes marcus nunes
    22. December 2010 at 08:44

    Scott
    The Austrians are openly “recruting”:
    http://mises.org/daily/4886
    “I conclude my comments by hoping that this crisis forces the economics profession to take a fresh look at what Austrian economics can offer”.

  31. Gravatar of Benjamin Cole Benjamin Cole
    22. December 2010 at 09:35

    James in London-

    Your comment is unworthy and unwarranted. If you think Japan is following an excellent monetary policy, then say so. Why impugn the sentiments or motives of others?

    Besides, if I truly harbored any ill feelings towards the Japanese, I would advise them to stay the course forever, and cursed they would be.

  32. Gravatar of Benjamin Cole Benjamin Cole
    22. December 2010 at 10:04

    BTW, another very depressing article about Japan, at Slate.

    http://www.slate.com/id/2278792/pagenum/all/#p2

  33. Gravatar of Lucas Lucas
    22. December 2010 at 10:13

    @Blackadder,
    You’re referring to the fact that the principal in TIPS is adjusted by the government-calculated CPI. This is not what we mean by “TIPS spread”. Let me quote verbatim:
    “In principle, comparing the yields between conventional Treasury securities and TIPS can provide a useful measure of the market’s expectation of future CPI inflation. At a basic level, the yield-to-maturity on a conventional Treasury bond that pays its holder a fixed nominal coupon and principal must compensate the investor for future inflation. Thus, this nominal yield includes two components: the real rate of interest and the inflation compensation over the maturity horizon of the bond. For TIPS, the coupons and principal rise and fall with the CPI, so the yield includes only the real rate of interest. Therefore, the difference, roughly speaking, between the two yields reflects the inflation compensation over that maturity horizon.” [1]
    Check also here: http://www.frbsf.org/publications/economics/letter/2009/el2009-34.html

    @Scott,
    I also believe your theory that the fall in NGDP is the main cause of the Great Recession and the financial crisis. That said, the subprime crisis and the collapse in securitization are events prior to the beginning of the decline in NGDP growth, if I’m not mistaken (correct me if I’m wrong). I believe that a “real” recession was already present before the occurrence of the nominal shock. This nominal shock was the primordial cause of the run in shadow banking, the collapse of financial markets and the September/October panic. Also, it’s interesting to see some of the most obvious features of the 1980-2006 period appear as the output of a standard macro model:
    “The simulation results were that the financial sector balloons in size, that total private debt in the economy expands hugely, and that credit acts as a substitute for rising average wages in the short run.”

    1- http://www.wikinvest.com/wiki/TIPS_spread

  34. Gravatar of Blackadder Blackadder
    22. December 2010 at 13:02

    @Lucas,

    I know what the TIPS spread is. The TIPS spread is a forecast of what the CPI will be in the future. It’s not a forecast of future inflation, unless you accept that the CPI is (or will be) an accurate measure of inflation.

  35. Gravatar of marcus nunes marcus nunes
    22. December 2010 at 13:48

    @OGT
    DB “deconstructs” Hamilto´s arguments:
    http://macromarketmusings.blogspot.com/

  36. Gravatar of Mark A. Sadowski Mark A. Sadowski
    22. December 2010 at 16:18

    I see that core PCE in 2010 Q3 just got revised down today from 0.8% to 0.5% at an annual rate, the lowest level in the quarterly series’ 51 year history. Deflation here we come.

  37. Gravatar of Doc Merlin Doc Merlin
    22. December 2010 at 16:23

    @Blackadder:
    You are wrong.
    Because the TIPS market is significantly less liquid than the treasury market (as Lehman found out much to their detriment), the spread between the two doesn’t actually forecast CPI.

    If EMH is true and there is a liquidity premium on treasuries, the TIPS spread should under-forecast CPI by that liquidity premium.

  38. Gravatar of liberalarts liberalarts
    22. December 2010 at 17:27

    @Scott -is your sense that NGDP targeting involves credible statements from the fed or just doing it? In other words, do you believe that the fed should have (1) bought more bonds in 2008 or (2) announced that it will do whatever is necessary to cause NGDP to rise 5% and then buy bonds as necessary? In other words, do you believe that more open market purchases were required or that a more serious commitment to do that was necessary? I apologize if you have covered this issue ad nauseum.

  39. Gravatar of johnleemk johnleemk
    22. December 2010 at 17:54

    James in London,

    I think you are confusing positive and normative statements. I don’t think anyone here actively advocates people being under the money illusion. What we’re saying is that for better or for worse, most people are subject to the money illusion. There is more than adequate empirical evidence of a kink in the graph of nominal wage changes around <0, where people are drastically less likely to accept a nominal pay cut no matter what. If there were no money illusion and no sticky wages, the graph would be more of a line or curve, but the kink is very apparent. This money illusion is why nominal variables sometimes matter as much as real variables.

    I don't know who you are or what information you have to comment on what the Japanese think of their situation. And believe it or not, appreciation of a currency is not unambiguously a good thing.

  40. Gravatar of scott sumner scott sumner
    22. December 2010 at 17:59

    JJ, OK. You are right that I go too fast sometimes.

    James in London. You said;

    “Is Scott Sumner an anti-Japanese racist?”

    I’m a huge fan of Japanese art, film and (to a lesser extent) literature. One of my dreams is to visit Japan someday. Does that answer your question?

    But I do think they’d be better off with a bit faster NGDP growth.

    And how’s that strong yen working out for the Japanese?

    123, The policy you describe did not occur during the crash, it occurred after it. In any case, it didn’t do much as the economy continued getting worse until March 2009, as did NGDP growth expectations. Maybe it slowed the rate at which things were getting worse.

    OGT, The marble analogy is silly because marbles aren’t a medium of account. But he’s right that in a modern economy where the central bank is stabilizing NGDP, M and V will look like mirror images.

    Marcus, I like Austrian microeconomics.

    Benjamin, Yes, that’s a good article. I don’t see how James finds Japan to be an appealing model.

    Lucas, I agree with your comment. BTW, I think the term ‘recession’ just gets in the way. You are right that the sub-prime “crisis” happened first (I’d rather call it the sub-prime problem, because without the fall in NGDP growth it would have been a footnote in the history books.)

    The economy was flat in the first half of 2008. That probably reflected the sub-prime mess and the impact of high energy prices on the auto sector.

    Marcus, I don’t have a big problem with Hamilton’s post, which I saw as a criticism of simple-minded monetarists who think inflation is just around the corner.

    Mark, That can’t be right, Weimar-style hyperinflation is coming.

    Doc Merlin, That’s right, but in normal times the premium is rather small. So it’s a good index of changes in inflation expectations. There are also CPI futures markets, BTW. But it’s NGDP futures that we really need.

  41. Gravatar of scott sumner scott sumner
    22. December 2010 at 18:05

    liberalarts, The key is credible statements by the Fed. Then it’s up to the markets to determine how much money is needed. My sense is that with 5% NGDP growth, the money supply would have been smaller than what actually occurred. Most of the money increase reflected a rush for liquidity because NGDP was falling so fast.

  42. Gravatar of Dan Thomas Dan Thomas
    22. December 2010 at 21:25

    @Everyone,

    I wish I had more time to read your comments. It is almost unbearable to believe and see the human race tied in knots about the economic system of the united States and the rest of the world. You guys really don’t get it. And I assume that you guys would sit in these blogs and chat until the world caves in you.

    I know you won’t appreciate this, but if you really want to understand our so called economic system, you should start and end with Carl Marx. Marx not only discovered capitalism, he named it capitalism. Adam Smith and John Maynard Keynes are irrelevant mediocs. For the record. It is not a system at all. It is a patch work of ponzi schemes. I am computer scientist. Real Systems are predictable/knowable. Economists can’t fix the economic system because themoneyIllusion aka capitalism is not a system. It is an illusion. A fitting title for this blog. You are all chasing your tails and it will never end. It is just an illusion.

    If you really want to know what’s going on with our economies, you will need to read http://www.deathbytechnology.us.

    Disclaimer:::: This is my book. If you can’t afford it, no sweat. My website is a good starting point – http://www.osixs.org.

    FIGHT THE CAUSE – NOT THE SYMPTOM

  43. Gravatar of Full Employment Hawk Full Employment Hawk
    22. December 2010 at 23:13

    It looks like Peter Diamond was not confirmed for the Fed seat before Congress left town. If that is correct, Obama needs to recess appoint him.

  44. Gravatar of Contemplationist Contemplationist
    23. December 2010 at 07:22

    Hey Dan

    Its ‘KARL’ Marx, not Carl. But clearly you seem to know a lot (or not).

  45. Gravatar of Contemplationist Contemplationist
    23. December 2010 at 07:44

    Scott I found a gem of an interview of Milton Friedman in a Hoover Digest from 1999.

    Check out this quote!

    [Friedman: …]Japan has the capacity to make a tremendous recovery. There’s nothing to prevent Japan, a year or two from now, from being in a boom. And Japan’s recovery could destabilize the U.S. economy by raising global interest rates.

    BRIMELOW They do seem to be accepting your recommendation, espoused in our last talk, that they should print money.

    FRIEDMAN Who knows? You hear so many contradictory stories about Japan. The mechanism of recovery is monetary expansion plus reform of their banking system. In the short run, nothing other than monetary expansion [will work]””that plus a reduction in the misdirected fiscal stimuli. Japan is wasting its capital assets by building public structures that have a negative rate of return.

    http://www.hoover.org/publications/hoover-digest/article/6583

  46. Gravatar of StatsGuy StatsGuy
    23. December 2010 at 08:19

    “Full Employment Hawk
    22. December 2010 at 23:13

    It looks like Peter Diamond was not confirmed for the Fed seat before Congress left town. If that is correct, Obama needs to recess appoint him.”

    Yes, I noticed that too – it seems to be related to the fact that Diamond commented negatively on the recent tax “compromise”. I’m not sure Obama cares to recess appoint him – he’s not quite as docile as the the current administration desires. Obama may choose to present his negligence on Diamond as a sudden move to the “center”, and a willingness to “compromise”.

    @ ssumner – much of your response to Cowen et. al. boils down to this notion that NGDP targeting would have prevented the worst of the crisis in the first place. Cowen et. al.’s respone might be to point to the same argument DeLong uses – “yes, it might prevent monetarist or keynesian depressions, but what about a Minsky shock?”.

    DeLong makes a thoughtful point there – in essence, he’s arguing that in a Minsky recession no one sees it coming, and so it would have happened anyway. Yet I still think that he, and many others, have slightly revised the history of 2008 in their memories slightly (something I do all the time). There is this overwhelming sense, much propagated by the media and banking pundits (self serving, eh?) that the crisis was unavoidable and IT HAPPENED. What can you do about something that just HAPPENED. It’s a HAPPENING, right?

    My (and your) recollection of 2008 is much different. I recall the stock market looking to the Fed for guidance EVERY DAY that it would actually do something, since everyone figured that Bernanke (of all people) ought to understand what was going on. Instead, we got a bunch of economists with statistical models saying that, based on our (poorly specified, low degree of freedom time series) models, we’re heading into a “normal” cyclical downturn, and the Fed shouldn’t overreact. Of course, the historical data was based on cases where the Fed DID react aggressively (by manipulated rates).

    It was precisely this Fed nonchalance that spurred the overreaction, because it became abundantly clear that the Fed just didn’t get it. (And Congress was paralyzed.) What turned the crash into a calamity was the sudden awareness that everything was going downhill, AND that no one seemed capable or even interested in trying to stop it.

    @ Lucas & ssumner – I wouldn’t blowoff simulation models too quickly. While economists still rely heavily on comparative statics, most of the statistics field has moved to simulation based approaches (markov chain models, simulated annealing, resampling, etc.). The model Lucas cites doesn’t say exactly that a financial crisis caused the depression… but it points to what is rapidly becoming a major issue – structural problems in the fiscal situation which are at least partly driven by wealth distribution issues, and fiscal commitments to low income groups that are not being funded by taxes on higher income groups. The power elite can’t win elections by telling lower income groups they need to radically cut consumption, so they borrow, recognizing that a looming fiscal crisis is imminent. Meanwhile, wealthier echelons try to protect themselves from the looming fiscal crisis by allocating assets appropriately. This was already happening in 2008 – remember the commodity bubble? But the financial wizards missed a big part of the equation that pesky thing called “Demand”. The ‘decoupling’ thesis got blown out of the water, the commodity markets imploded, and the dollar saw the MoaSS (the Mother of all Short Squeezes). Everyone misunderestimated [sic] the Fed’s response function – they seemed quite pleased the dollar was spiking. And, boom.

    Anyway, I truly hope you feel better soon. Haven’t been commenting much lately since most of the latest action seems to be repeating your original arguments to folks who are finally waking up, but I still reading everything. [PS, I told you a long time ago that you and Brad DeLong were a lot closer together on issues than you thought.]

  47. Gravatar of Full Employment Hawk Full Employment Hawk
    23. December 2010 at 09:17

    StatsGuy

    I googled to find out what Diamond had said about this. The comment that struck me is the following quote:

    “The monetary people are pushing as hard as they can, the fiscal people are not, and it would be nice to have them more in synch with each other.”

    It is clear that the monetary people are not pushing as hard as they can. For example, the Fed should be buying real estate based securities and ending payment of interest on excess reserves.

  48. Gravatar of spencer spencer
    23. December 2010 at 10:23

    I do not have anything against nominal GDP targeting, but from a business economist view point and some 40 years experience as a fed watcher I fail to see how it would make much difference.

    For example from July 2007 to July 2008 as it became apparent the economy was plunging the Fed cut the funds rate from 5.25% to 2.0%.

    If they had been targeting nominal GDP what would have they have done differently? What information would the decision makers have had on a real time basis that would have caused them to have had a different reaction function? Quarter to quarter nominal GDP growth did not fall significantly below 5% until the fourth quarter of 2007 and they would not have known that until months after they were already easing. Maybe I have missed it, but I would like to see you do a post addressing these questions.

  49. Gravatar of marcus nunes marcus nunes
    23. December 2010 at 10:50

    @Spencer
    The economy was not plunging in 2007 early 2008. Go check the unemploymento and growth data for this period. The plunge you talk about began in July 08 when it became clear the Fed was set on reducing AD!

  50. Gravatar of marcus nunes marcus nunes
    23. December 2010 at 10:53

    @Spencer
    The economy was not plunging in 2007 early 2008. Go check the unemployment and growth data for this period. The plunge you talk about began in July 08 when it became clear the Fed was set on reducing AD!

  51. Gravatar of StatsGuy StatsGuy
    23. December 2010 at 11:01

    FE hawk…

    “It is clear that the monetary people are not pushing as hard as they can. For example, the Fed should be buying real estate based securities and ending payment of interest on excess reserves.”

    While I agree the Fed could do more, I still don’t think the profession can even agree on what is fiscal and what is monetary. Buying and holding real estate assets when demand for real estate is low – is that fiscal or monetary? It represents an injection of base money into the economy, but arguably it’s “overpaying” for assets, in which case that money is a subsidy to one sector of the economy, and the Fed may think it oversteps their mandate. There would be backlash.

    I’m not so sure how out of step the Fed and fiscal policy are, however, at least in the short term. Congress is spending, and the Fed is monetizing. The net increase in US debt held by the public this year will likely be zero or negative. (However, the Fed will be selling some MBS to finance this.) This represents a real injection of money into the economy. Where is this going? Mostly to finance transfer payments, medicare/medicaid, and our giant military/security complex. Actual discretionary spend isn’t moving much, and discretionary spend (with proper oversight) is where government spending comes closest to actual investment – basic infrastructure, primary R&D, etc. (While some military spend goes to R&D, for instance through DARPA which is actually a major source of grants for private company research, this budget is being squeezed as health care and retirement expenses for NON-combat troops goes through the roof.)

    I think the bigger issue is the structural balance of how this money is being allocated – consumption-supporting transfers, vs. investment (and yes, I do believe government investment can create wealth). Scott views this as a propensity to save problem, but the Keynesians challenge this because demand for investment is a function of expected future demand. I accept that at some point monetary policy can close the gap even in a super-savings environment, but it might require CB action (or response to credible CB threats) to stongly impact other aspects of the economy.

    Maybe a year ago ssumner asked, “Why can’t the stock market function at a permanent PE ratio of 20?” I think we tried a few times recently, and every time we tried it seemed that the financial sector overleveraged as yield-chasing overwhelmed risk aversion and we saw a collapse.

  52. Gravatar of Full Employment Hawk Full Employment Hawk
    23. December 2010 at 11:42

    StatsGuy:
    “It represents an injection of base money into the economy, but arguably it’s “overpaying” for assets, in which case that money is a subsidy to one sector of the economy, and the Fed may think it oversteps their mandate.’

    When the Fed buys government securities it is “overpaying” for them in exactly the same way as when it buys real estate securities.

    One major mandate of the Fed is to achieve maximum employment. Since a decline in real estate prices creates a negative wealth effect, reducing consumption expenditures and therefore slowing RGDP growth, purchasing real estate based assets is within its mandate.

    “Where is this going? Mostly to finance transfer payments, medicare/medicaid, and our giant military/security complex. Actual discretionary spend isn’t moving much, and discretionary spend (with proper oversight) is where government spending comes closest to actual investment”

    Where the expenditures are made is very important in determining the growth of potential output, but as far as affecting RGDP growth, in what part of the economy the expenditures are made does not have a significant effect. (Most of the transfer payments go to people who are very liquidity constrained and will spend most of the additional income they get.)

  53. Gravatar of Full Employment Hawk Full Employment Hawk
    23. December 2010 at 11:49

    StatsGuy:

    “it seems to be related to the fact that Diamond commented negatively on the recent tax “compromise”. I’m not sure Obama cares to recess appoint him – he’s not quite as docile as the the current administration desires.”

    Obama’s postion has been that he only wanted the tax cut for the 97% and only went along with giving it to everybody because the Republicans could and would have kept it from passing without that. In light of this, what Diamond said is not inconsistent with Obama’s position. Obama needs to put another one of his people on the BOG to help counter the pressure the Fed is going to be subjected to by Ron Paul being in charge of the House subcommittee overseeing the Fed.

  54. Gravatar of Full Employment Hawk Full Employment Hawk
    23. December 2010 at 12:31

    CORRECTION:

    That obviously shoud reat “but as far as affecting NGDP growth”

  55. Gravatar of Mark A. Sadowski Mark A. Sadowski
    23. December 2010 at 12:56

    CORRECTION (on FEH’s behalf):
    “shoud reat” should read “should read”.
    😉

  56. Gravatar of james in london james in london
    23. December 2010 at 13:37

    “And how’s that strong yen working out for the Japanese?”

    Rather well. It makes the rest of the world’s goods and services cheaper, so improving living standards in Japan. Duh!

    I know it is a madly frustrating for mainstream economists (like Scott) and punidts but as this (unintentionally) ironic recent article says: “Japan is a puzzle””and not only to foreign visitors who wonder how a stagnant economy can feel so prosperous.”
    http://online.wsj.com/article/SB10001424052748703814804576035233040817642.html
    It’s damn frustrating that when the theory is falsified. Deflation isn’t a disaster, proven by Japan. This should tell honest scientists that the theory has some problems, but somehow it is Japan that is “wrong” not the wonderful theory. And all the bankers, politicos, pundits and economists quoted in the article worrying about deflation are basically making fools of themselves.

    Sure, Japan could grow a bit faster if it broke down some of its numerous supply-side rigidities, but so could most countries. However, creating inflation would do nothing to help change the statist mentality of the Japanese intellectual and political classes. Just like the US in that respect.

    Embrace deflation and the get to work on the supply-side rigidities!

  57. Gravatar of james in london james in london
    23. December 2010 at 13:37

    “And how’s that strong yen working out for the Japanese?”

    Rather well. It makes the rest of the world’s goods and services cheaper, so improving living standards in Japan. Duh!

    I know it is a madly frustrating for mainstream economists (like Scott) and punidts but as this (unintentionally) ironic recent article says: “Japan is a puzzle””and not only to foreign visitors who wonder how a stagnant economy can feel so prosperous.”
    http://online.wsj.com/article/SB10001424052748703814804576035233040817642.html
    It’s damn frustrating that when the theory is falsified. Deflation isn’t a disaster, proven by Japan. This should tell honest scientists that the theory has some problems, but somehow it is Japan that is “wrong” not the wonderful theory. And all the bankers, politicos, pundits and economists quoted in the article worrying about deflation are basically making fools of themselves.

    Sure, Japan could grow a bit faster if it broke down some of its numerous supply-side rigidities, but so could most countries. However, creating inflation would do nothing to help change the statist mentality of the Japanese intellectual and political classes. Just like the US in that respect.

    Accept,even welcome, deflation and the get to work on the supply-side rigidities!

  58. Gravatar of Lorenzo from Oz Lorenzo from Oz
    23. December 2010 at 17:09

    On Krugman’s errors, this article has fun with some 1999 predictions he made: wrong and wrong in the negative direction.

    Dan: Karl Marx’s theory of value is nonsense, as I show by a systematic critique of his argument for it here, his theory of exploitation contradicts his theory of value, as I show here, and every attempt to follow his ideas has been a grotesque — typically a murderous and tyrannical — disaster directly connected to his Hegelian roots — see Etienne Gilson’s very perceptive critique. But, apart from all that, he’s great.

  59. Gravatar of Full Employment Hawk Full Employment Hawk
    23. December 2010 at 19:54

    Mark:

    “CORRECTION (on FEH’s behalf):
    “shoud reat” should read “should read”.”

    I cought that right AFTER I pressed the submit button. But I did not want to post a correction of a correction. I am going to have to take greater care to closely proofread what I post.

  60. Gravatar of Full Employment Hawk Full Employment Hawk
    23. December 2010 at 19:59

    With respect to Diamond, Obama is going to renominate him next year.

  61. Gravatar of Doc Merlin Doc Merlin
    23. December 2010 at 21:03

    @Lorenzo from Oz: Couldn’t have said it best.

    @Scott:
    Agreed about the liquidity premium probably being small. The real worry I have is if the Fed is buying too many or too few treasuries the market won’t accurately reflect CPI at all.
    Hrm, I should actually do a study on how good the the spread is a predictor of CPI, as a way of measuring fed involvement and money neutrality. Someone probably has already done this, however.

  62. Gravatar of Doc Merlin Doc Merlin
    23. December 2010 at 21:07

    I mean, I couldn’t have said it as well.

  63. Gravatar of Mark A. Sadowski Mark A. Sadowski
    24. December 2010 at 01:57

    Scott,
    Based on a comment I delivered elsewhere today I was accused of being part of the “money side” of someone else’s audience. In my opinion you should take that as a compliment.

  64. Gravatar of Morgan Warstler Morgan Warstler
    24. December 2010 at 02:44

    Scott, I still don’t think you go far enough.

    I KNOW you mean level targeting, and not just growth rates. Level targeting is my second favorite thing about your efforts ((after no more Fiscal (government spending) stimulus)).
    But, my point still stands… the crucial function of believability, in fact to your entire thinking, is pissing on booms.

    No one talks about what Fisher said to keep us from getting into a crisis, and you never talk about it either. There’s a reason:

    When we’re been tripping along at 5% on target for a couple years, and suddenly we run 5.5%-6% for 6 months, and things have just started to get FUN – no one is going to listen to Scott Sumner screaming, “piss on it!, piss on it!”

    And if the market doesn’t BELIEVE the Fed will have such intestinal fortitude, then suddenly there’s NEVER any assumption of “tighter money” done on purpose – where money is truly loose, and everyone agrees it must be tighter.

  65. Gravatar of Ben Alford Ben Alford
    24. December 2010 at 04:04

    @Dan;
    I realize I am replying to what is I suspect is merely an advertisement for a book and said author will likely never read my reply, but as an undergraduate student of economics (and coincidentally, minoring in the field of computer science) who frequently intermingles with students of the social sciences, I feel compelled to respond. Besides, I’m on winter break and I’m bored.

    Firstly, I find it rather odd that one who professes to despise capitalism would so aggressively engage in what is a thinly veiled ploy to get hits on your blog and find some buyers for your new book. You have quite the entrepreneurial spirit.

    I agree that the economy is not a “system.” It is a large number of people freely engaging in mutually beneficial exchange, albeit perhaps with restrictions imposed by another group of people who possess a monopoly on forceful coercion (in other words, the government). As for your comment on predicting the direction of the economy, it is very true that economists have a poor record of making predictions. This is partly due to some fundamental differences between the nature of variables and their measurements in a science like economics and those in the natural sciences. However, the difficulties that arise in making predictions of the future do not diminish the ability of economics to explain events which have occurred in the past, nor does it imply that we are better off not even attempting to make predictions.

    There are very good reasons reason why Marx is not taken very seriously by mainstream economists. Marx’s labor theory of value is a flawed economic theory, as even the neoclassical economists refuted it with ease. To paraphrase Marshall in his Principles:

    “The strength of Rodbertus’ and Marx’s sympathies with suffering must always claim our respect: but what they regarded as the scientific foundation of their practical proposals appears to be little more than a series of arguments in a circle to the effect that there is no economic justification for interest, while the result has been all along latent in their premisses; though, in the case of Marx, it was shrouded by mysterious Hegelian phrases, with which he ‘coquetted,’ as he tells us in his preface….

    …[Marx] argued that labour always produces a ‘surplus’ above its wages and the wear-and-tear of capital used in aiding it: and that the wrong done to labour lies in the exploitation of this surplus by others. But this assumption that the whole of this Surplus is the produce of labour, already takes for granted what they ultimately profess to prove by it; they make no attempt to prove it; and it is not true. It is not true that the spinning of yarn in a factory, after allowance has been made for the wear-and-tear of the machinery, is the product of the labour of the operatives. It is the product of their labour, together with that of the employer and subordinate managers, and of the capital employed; and that capital itself is the product of labour and waiting; and therefore the spinning is the product of labour of many kinds, and of waiting. If we admit that it is the product of labour alone, and not of labour and waiting, we can no doubt be compelled by inexorable logic to admit that there is no justification for interest, the reward for waiting; for the conclusion is implied in the premiss…

    …if it be true that the postponement of gratifications involves in general a sacrifice on the part of him who postpones, just as additional effort does on the part of him who labours; and if it be true that this postponement enables man to use methods of production of which the first cost is great; but by which the aggregate of enjoyment is increased, as certainly as it would be by an increase in labour; then it cannot be true that the value of a thing depends simply on the amount of labour spent on it. Every attempt to establish this premiss has necessarily assumed implicitly that the service performed by capital is a ‘free’ good, rendered without sacrifice, and therefore needing no interest as a reward to induce its continuance; and this is the very conclusion which the premiss is wanted to prove.”

  66. Gravatar of spencer spencer
    24. December 2010 at 05:55

    From mid 2007 to mid 2008 the unemployment rate jumped from about 4.5% to 6.0%. Yes the economy was not collapsing but it was weakening enough that the Fed began easing.

    That is exactly my point, in 2007 the Fed began easing aggressively well before nominal GDP growth collapsed.

    If they had been targeting nominal GDP growth would they have dome more? The Taylor rule was calling for ease in 2007, for example, but would have a nominal GDP rule have called for easier monetary policy in 2007?

    In retrospect easing in the second half of 2007 was the correct policy but would a nominal GDP target have told the Fed to ease in the second half of 2007 ? It does not look like it to me and your argument that GDP was not collapsing in 2007 just demonstrates my point.

  67. Gravatar of Scott Sumner Scott Sumner
    24. December 2010 at 11:28

    Dan Thomas, I don’t think Karl Marx has the answers to our problems.

    Full Employment Hawk. Yes, he needs to do a recess appointment, but I heard he won’t.

    Contemplationist, Yes. that’s more evidence that Friedman became a quasi-monetarist late in his life.

    Statsguy, Those are good points. If I had more energy I’d comment on some recent posts by Thoma/Yglesias that seem to confuse two issues; balance sheet recessions and monetary policy ineffectiveness. In my view (perceived) monetary ineffectiveness is all about the zero rate bound, and has nothing to do with the type of recession. If we are going to face more balance sheet recessions in the future the answer is not to look for fiscal stimulus, but rather to raise the trend inflation rate to 4% or 5%. Obviously I don’t favor that, but it’s the lesser of evils if the other choice is Japan–i.e. massive fiscal imbalances and perceived monetary ineffectiveness.

    I like the way you gave credit to the recent finance oriented research, while also pointing to their failure to address demand and monetary policy options.

    FEH, I was probably the only person in the blogosphere who agreed with Shelby that Diamond wasn’t qualified for the Fed. I suppose the other bloggers didn’t ridicule me because I supported him anyway. But that quotation shows just how unqualified he is. The Fed is doing all they can!?!?! Has he never visited Zimbabwe? Is 6 trillion in QE not more than 600 billion in QE? What would 6 trillion in QE do to TIPS spreads?

    Spencer, I have done many posts suggesting that their policy was not far off cource until after July 2008. The first major mistake was the September 2008 meeting, which should have slashed rates. But the biggest mistake was not moving to level targeting when they hit the zero bound which they should have hit in October.)

    Statsguy, You said;

    “Maybe a year ago ssumner asked, “Why can’t the stock market function at a permanent PE ratio of 20?””

    I sure don’t remember this. I’ve never favored targeting the stock market.

    James, You said;

    “Rather well. It makes the rest of the world’s goods and services cheaper, so improving living standards in Japan. Duh!”

    The same could be said for the Fed in the early 1930s, they allowed Americans to buy goods at lower prices. I’ve read many stories suggesting that the younger generation is increasingly frozen out of the job market in Japan. Then there’s the Japanese public debt, which rises higher and higher as their NGDP falls. The fiscal situation there looks increasing like a Ponzi scheme. The large deficits are being done because the Japanese government is trying to provide the stimulus the BOJ refuses. I’d rather have 5% NGDP growth than ever bigger government deficits. I read that Japanese taxes currently cover social security and interest on the debt–and nothing else.

    Lorenzo, That’s an interesting set of predictions. Tyler Cowen has a defense, but I don’t really buy it. All predictions eventually come true–a time frame is the key to any prediction.

    Mark, Thanks for the compliment.

    Morgan, I just say what I believe and let the chips fall where they will.

    Spencer, I am certain the markets would have favored easing in late 2007 under a NGDP rule. By December the markets were clearly indicating the Fed hadn’t eased enough, and that a recession was likely.

  68. Gravatar of Full Employment Hawk Full Employment Hawk
    24. December 2010 at 15:20

    “From mid 2007 to mid 2008 the unemployment rate jumped from about 4.5% to 6.0%. Yes the economy was not collapsing but it was weakening enough that the Fed began easing.

    In the first half of 2008 the economy was experiencing the beginning of a genuine adverse supply shock caused by the run up in the price of petroleum. The worldwide recession put an end to this in the latter part of 2008. Keeping NGDP growth constant when there is a genuine supply shock will cause a slowdown in real GDP growth and an increase in the unemployment rate. Clearly the NGDP growth target needs to be modified to correct for adverse supply shocks.

  69. Gravatar of TheMoneyIllusion » From the comment section TheMoneyIllusion » From the comment section
    25. December 2010 at 11:47

    […] another Cameron comment, in response to a recent post where I discussed Tyler Cowen’s suggestion that the markets […]

  70. Gravatar of ssumner ssumner
    26. December 2010 at 21:28

    Full employment hawk, I agree with your macro analysis, but not your policy analysis. It is during a adverse supply shcok that NGDP targeting is far superior to inflation targeting. If you inflation target, NGDP (and RGDP) growth will slow sharply during a supply shock. With NGDP targeting, RGDP growth will slow somewhat (which is unavoidable) but much less than if you were targeting inflation. That’s one of the strongest arguments for NGDP targeting. An alternative approach is nominal wage targeting—I’m not exactly sure how that would compare to NGDP targeting during a supply shock. In any case, either target would be such a vast improvement over current policy that I be thrilled in either case.

  71. Gravatar of 123 – TheMoneyDemand Blog 123 - TheMoneyDemand Blog
    27. December 2010 at 09:53

    Scott, You said:

    “The policy you describe did not occur during the crash, it occurred after it. In any case, it didn’t do much as the economy continued getting worse until March 2009, as did NGDP growth expectations. Maybe it slowed the rate at which things were getting worse.”

    The policy has generated a 11.6% rally in the S&P 500 – it was the biggest daily gain since the Great Depression. On the other hand, the gain was also driven by the fact that many governments have announced bank loan guarantee programs over the weekend.

    11,6% rally was not sufficient to generate recovery, it only slowed things down. NGDP level targeting announcement was needed, we can only guess the size of the one-day S&P 500 rally (20%? 25%? 30%?)

  72. Gravatar of Scott Sumner Scott Sumner
    28. December 2010 at 09:14

    123, Fine, but I don’t recall denying it might have been a net plus, just that it didn’t start a recovery.

  73. Gravatar of TheMoneyIllusion » Reply to Tyler Cowen, part 2 TheMoneyIllusion » Reply to Tyler Cowen, part 2
    2. January 2011 at 13:31

    […] already taken one stab at addressing Tyler’s post, today I’ll take a couple more.  BTW, you should read his […]

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