Newly fashionable ideas
In the previous post I criticized this FT piece by Joseph Stiglitz. But I left out his most intriguing comment:
In certain circles, it has become fashionable to argue that monetary policy is a superior instrument to fiscal policy – more predictable, faster, without the adverse long-term consequences brought on by greater indebtedness. Indeed, some advocates wax so enthusiastic that they support recent drives for austerity in many European countries, arguing that if there are untoward effects they can be undone by monetary policy.
I don’t recall these ideas as being particularly fashionable in early 2009, when I argued that both sides of the fiscal stimulus debate were missing the point. I’m glad to see they have become so fashionable that the British government is now cutting spending and relying on easier money to offset the negative effects.
I thought it might be interesting to create a list of newly fashionable ideas:
1. Using monetary stimulus instead of fiscal stimulus (recently adopted in Great Britain)
2. Cutting the IOR as an expansionary policy tool (an option discussed recently by Bernanke.)
3. Negative IOR (recently advocated by Alan Blinder and adopted by the Swedish Riksbank.)
4. QE (likely to be adopted by the Fed.)
5. Level targeting (being widely discussed at the Fed.)
6. NGDP level targeting (recently mentioned as an option in the minutes of a Fed meeting.)
7. Monetary policy might currently be restrictive despite low rates and a large monetary base (recently suggested by Chicago Fed President Charles Evans.)
Of course some of these ideas (such as QE) are hardly novel. And others (such as level targeting) are well known in academia. But I think it’s fair to say that we quasi-monetarists were ahead of the curve in most of these areas.
In a complex field like economics all arguments are tentative—subject to further revision. Objective proofs are almost impossible. What matters is whether an economist is able to change the conversation, to shift the perspective of others. I think we quasi-monetarists (including both bloggers and commenters) have had real success in that regard. We shouldn’t be discouraged by Stiglitz’s criticism; it shows how far we’ve come.
Tags: QE 2
21. October 2010 at 10:21
I wonder, can someone just crash a party like this:
http://www.bos.frb.org/RevisitingMP/agenda.htm
Also, there are some individuals who are closely tied to the Fed structure who have been fighting the good fight since day 1. Again, Joe Gagnon.
http://www.iie.com/publications/interviews/interview.cfm?ResearchID=1691
Re: Stigler, while it’s fun to poke at inconsistencies (particularly the fiscal stimulus issue), please note that in some ways Stigler is trying to account for aspects of the international policy regime that most domestic-focused macro folks (including Krugman) don’t seem to care about. A decade ago, Krugman wrote that international trade was not a major source wage depression, reasoning that trade was a small fraction of total economic flows. He’s recently changed his mind, but his initial stance was flawed. In a swimming pool with a 1 gallon per hour leak and a recycling system that moves 10000 gallons an hour, the leak seems inconsequential. Not so. Stigler has been quite aware of some of the secondary effects that lots of macro people shoulder off as inconsequential. For example, the carry trades or the dollar reserve currency impact – of which I see virtually no mention on this or Krugman’s blog, nor even any sentiment that such things are even vaguely important.
So yes, I’m defending Stigler. He’s not always right, but he thinks out of the box.
21. October 2010 at 10:48
Statsguy, I agree about Stigler, but not Stiglitz. 🙂
Seriously, it’s not enough to address issues you think are important, you need cogent arguments. Believe me, this isn’t the first example from Stiglitz, take a look at how Rogoff exposed his ignorance of basic monetary economics a couple years back (I’m sure you can still Google the letter.)
There is general agreement among macroeconomists that you cannot address serious long term imbalances with monetary policy. Stiglitz doesn’t seem to share this view, but presents no evidence to the contrary. There are lots of real problems out there in the international realm, and monetary policy might have a short run affect on some of them. But not a long run effect. Are we willing to sacrifice millions of jobs on some hypothetical about the carry trade? The bottom line is that the US economy needs more stimulus, Congress won’t provide it, and Stiglitz opposes having the Fed provide it.
I wasn’t invited to the conference in Boston. Joe Gagnon has been right about the need for monetary stimulus. But I don’t think he has talked about some of the items on my list, and in other cases he responded to ideas already put forth by us quasi-monetarists (such as lower IOR.) But yes, Gagnon has done a great job on making the case for stimulus–and he’s more influential than I am, so I am very pleased about all the effort he has put into promoting stimulus.
21. October 2010 at 11:39
To go from a minority view to a fashionable idea in 18 months is quite an achievement. The Stiglitz article was baffling. I think his overriding concern is hot money flows into emerging markets but he did not make a lot of sense to me.
I doubt whether you would like how they are doing the consolidation in Britain.
They are aiming for a total managed expenditure deficit by 2014/15 of 2% through 76% spending cuts and 24% tax rises. However, they are phasing in the spending cuts but front-loading the tax rises on the first two years. Taking 2011/12 prices the retrenchment will be 96% tax for the first two years. They would have been better saving the tax rises for the latter part of the fiscal consolidation.
The economy is going to get hit with a lot of tax rises next year. There is every chance that doing it that way will discredit the tight fiscal loose monetary policy especially if the US have good growth with no fiscal retrenchment. No matter what it will be an interesting comparison watching NGDP growth in both economies. It is almost certain now that the Bank will conduct more QE with only one hawk on the MPC. Although there was a three way split at the last MPC meeting.
21. October 2010 at 11:42
Scott, although I agree with almost all of your policy recommendations and have all along, I’m not so sure that the brilliance of your arguments is why people seem to be coming around. Milton Friedman used to say that his job was not to persuade policymakers that his ideas were right, rather it was to have a coherent theory and policy prescriptions ready for them after all the alternatives had failed. You have been doing that pretty well.
21. October 2010 at 11:59
Stiglitz has an interview up at Ezra’s blog:
http://voices.washingtonpost.com/ezra-klein/2010/10/stiglitz_we_need_more_stimulus.html
21. October 2010 at 12:46
The “fashionable” idea Stiglitz criticizes is “in all of the leading textbooks” as Mankiw would say. Is there really anyone out there who thinks the business cycle should be regulated by fiscal policy? Even Paul Samuelson didn’t think so by the time he died.
Scott, I disagree with you on your perception of Rogoff. He was one of the first to call on the Fed to do more and to pursue higher inflation, he was a big monetary approach guy when he was at the IMF and, besides, his seminal work on exchange rates following a random walk is pro-EMH stuff, right?
21. October 2010 at 12:54
I want to add that none of the Keynesians I’ve read criticizing the U.K. right now have told me why this is any different from when Thatcher pushed through reforms to reduce the deficit that Keynesians said would destroy the U.K.
Quoting Thatcher circa 1981 in The Commanding Heights:
“We have recently been told by no less than 365 academic economists that such a thing cannot be, that British enterprise is doomed…I sometimes wonder whether they back their forecasts with their own money.”
What’s the difference between then and now?
21. October 2010 at 13:16
Scott,
I told you you won…
It´s not about optimism, simply there are no options. Something has to be done.
Meanwhile, here in Brazil people are going insane. It must be the elections…
21. October 2010 at 13:38
Scott
Is this the Rogoff piece you mentioned to Statsguy above. It´s from July 29 2008, and he´s asking the Fed to slow the economy down. They sure listened to him!
http://www.ft.com/cms/s/0/29a40a90-5d6f-11dd-8129-000077b07658.html
21. October 2010 at 14:51
It’s this piece I think Marcus… which, oddly, is still up on the IMF website. Rather confrontational. Then again, so is Stiglitz. I wonder how these guys sit in a room together.
http://www.imf.org/external/np/vc/2002/070202.HTM
From rogoff’s piece:
“We earthlings have found that when a country in fiscal distress tries to escape by printing more money, inflation rises, often uncontrollably. Uncontrolled inflation strangles growth, hurting the entire populace but, especially the indigent.”
Hmmm.
One doesn’t get the same perception of Stiglitz’ obvious idiocy when one reads his comments on the IMF response to the asian currency crisis…
http://www.mindfully.org/WTO/Joseph-Stiglitz-IMF17apr00.htm
The IMF sounds rather less heroic in Stiglitz’ rendition. Note the comments about the IMF insisting that countries running 30% savings rates and prior year budget surplusses cut expenditure and tighten money supply in the middle of 16% GDP reductions. Note the asset inflation that resulted from a wave of short term capital surging into, and then fleeing from, those economies after the introduction of financial market liberalization. Differs a little from Rogoff’s version. Hmm. Double Hmm.
It’s easy for Rogoff to lambast Stiglitz for not working within the IMF consensus when the IMF consensus would have diluted his voice to meaninglessness and thus ensured IMF standard operating procedures continued to be implemented.
It seems that Rogoff believes the proper way to handle things is to implement the SOP, watch a situation detonate, and spend the next 5 years gainfully employed and gaining academic notoriety writing academic work about the spectacle. And I guess that worked for Rogoff quite peachily, so maybe he has a point.
Nonetheless, wherever you come down, Stiglitz was making arguments that strongly challenged the comfortable consensus, and he was one of the few making those arguments. As a lone voice challenging the economist-herd, that’s quite valuable.
21. October 2010 at 15:28
Scott
From the 6pc IT you mentioned in your latest post, I gather this is the Rogoff piece you mentioned.
http://www.telegraph.co.uk/finance/financetopics/financialcrisis/4701569/Ken-Rogoff-says-Fed-needs-to-set-inflation-target-of-6pc-to-help-ease-crisis.html
Very funny: From asking for the Fed to “step on the brake”, 6 months later he is suggesting “full force forward”. It´s a “minute by minute economist”
21. October 2010 at 16:30
Actually, as I recall the last few years, the newly fashionable macroeconomic idea in the age of ZIRP was fiscal stimulus. It’s only after its many disadvantages were fully revealed that monetary policy has come back to the forefront (but this time with necessary policy innovations).
21. October 2010 at 18:05
I’d have to agree with Jeff. In those complex sciences where no theory occupies a dramatic global maximum (where no theory is radically “better” than its rivals at explaining all data) the next best thing is to provide at least a coherent self consistent narrative. Now this narrative may also not be the absolute “truth” but it provides first, a new frame of reference to interpret the world (a hodgepodge of partial truths does not make a framework), and second, a testable hypothesis.
And that is really quite important, that is what Scott has done. He provided – compiled from existing macro textbooks if he is to be believed – a coherent and self consistent framework of macro beliefs that one can either believe or reject.
There are few alternatives and that is the crux. The real problem in academic theory now is not a dearth of solutions proven to work for the world economy. I don’t think anyone asks for miracles. The problem is a dearth of any other framework or belief that has not yet been much discredited, about how global macro works at all. When I talk to friends in econ academia or in global trade, the theme is rather that people don’t have any strong opinion anymore about how stuff works.
Chances are Scott will be proven partially wrong in the long run – sorry Scott, happens to the best! – but that’s a lot better than not even being wrong (if you get my drift – through absence of any conviction to begin with).
21. October 2010 at 19:03
Richard, I agree about taxes, raising the top rate to 50% was a big mistake.
I don’t know enough about the UK to have an opinion about how things will work out. But I like the way they are approaching the problem–use money to stabilize NGDP and get the fiscal house in order.
Jeff, I’d go further, I’m 100% sure that the alleged “brilliance of my arguments” has little to do with these policy changes. I agree that it is all about being in the right place at the right time.
colintj, Thanks. We aren’t going to get more fiscal stimulus.
JTapp, I think you misunderstood—I was praising Rogoff.
JTapp, Yes, that Thatcher story is quite revealing.
Thanks Rafael.
Marcus, Not the best timing.
Statsguy, Based on everything I’ve read by Stiglitz, I find the Rogoff letter to be highly credible. It’s exactly my impression when I read stuff Stiglitz writes on monetary policy. I don’t have strong views on IMF policy, as that’s not my area of expertise. But it’s absurd to say we “lost Russia.” The Russians do whatever they please, in the way they want to do it. Waiting for good institutions there is just as hopeless as shock therapy. It could take 40 years. The economy was already sliding into a deep depression under Gorbachov, it’s just that the official figures didn’t show it yet. They weren’t able to take things slowly like China. Take at a look at the communist countries that didn’t reform–look at their GDPs after 1989. Ukraine fell even more sharply than Russia.
Marcus, I saw the 6% figure all over. Krugman linked to some studies arguing that the Taylor rule implied we needed negative 6% real rates, hence at least 6% inflation.
Mark, That’s right, fiscal stimulus was the newly fashionable idea.
mbk, Those are very astute comments, but what about this!
“And that is really quite important, that is what Scott has done. He provided – compiled from existing macro textbooks if he is to be believed – a coherent and self consistent framework of macro beliefs that one can either believe or reject.”
If he is to be believed? I provided exact quotations and page numbers from the number one money textbook. Do you really think I’d create these ideas, and then not claim them as my own, but pretend they are in his textbook. 🙂
22. October 2010 at 00:43
Scott,
“…I provided exact quotations …”
Sorry my “If he is to be believed” was just unnecessary rhetoric, I’m always overcautious in my formulations, never state anything as fact just because I happen to believe it etc. No offense intended!
22. October 2010 at 00:52
Better would be to use legislation to cut the number of things that the government does that enhance price stickiness, imo.
22. October 2010 at 06:14
JTapp
21. October 2010 at 12:54
‘ I want to add that none of the Keynesians I’ve read criticizing the U.K. right now have told me why this is any different from when Thatcher pushed through reforms to reduce the deficit that Keynesians said would destroy the U.K.
Quoting Thatcher circa 1981 in The Commanding Heights:
“We have recently been told by no less than 365 academic economists that such a thing cannot be, that British enterprise is doomed…I sometimes wonder whether they back their forecasts with their own money.”
What’s the difference between then and now? ‘
The current governor of the BoE was one of the academics who wrote the letter. If you believe that currently monetary policy has no traction then I suppose the situations are not comparable. They did have lots of leeway in the early 1980s for monetary policy to be more expansionary and it was this that proved the letter signers wrong. The BoE do not believe that the zero bound makes monetary policy ineffective. Therefore, they will offset the fiscal retrenchment. The letter writers did not believe monetary policy would be effective in the 1980s.
22. October 2010 at 06:48
Richard W, inflation has been over 3% in England– much higher than in the U.S., so there’s no way I can buy that there’s a liquidity trap there.
Here’s another question for the Keynesians– what’s the difference between the U.K. today and the U.S. in 1920-1921 when Harding slashed the deficit in the middle of a nasty recession and the result was unemployment fell from 12.3 to 2.4% in 2 years?
22. October 2010 at 07:11
I agree, JTapp. However, I am looking at it from the perspective of those who believe that monetary policy has no traction at the zero bound. They now believe that monetary policy offset the fiscal retrenchment in the 1980s. The real debate is around how fast they should consolidate on the fiscal side. I worry that they might be going too fast. Moreover, many on the right think tax is taking too high a proportion in the early years of the consolidation.
23. October 2010 at 03:27
“Krugman linked to some studies arguing that the Taylor rule implied we needed negative 6% real rates, hence at least 6% inflation.”
I thought Taylor rule implied we needed negative 6% nominal rates.
23. October 2010 at 03:37
Scott,
UK: I can see the reduction in fiscal stimulus, but where’s the monetary stimulus, exactly?
Here are the Bank of England’s money supply figures for September, published 20th October: http://www.bankofengland.co.uk/statistics/m4/current/index.htm
I recall that you watch the monetary base, but, if M4 lending is the speedo on the car …
We’ve been destroying money since 2007 like we’re involved in a traditional potlatch competitive destruction ceremony, (which anthropoligically we might have been.)
23. October 2010 at 05:42
mbk, No problem, I was sort of half joking–pretending to be outraged.
Doc Merlin, I completely agree about price stickiness.
Richard, Thanks for that info–I have my fingers crossed hoping the BOE does the right thing.
JTapp, That’s a good point.
123, At the given rate of inflation. But you can’t do minus 6% nominal, hence the desire to create negative 6% real rates through higher inflation. In the Taylor rule, it is real rates that drive AD–indeed that explains the Taylor Principle.
W le B, I don’t put much weight on MB as an indicator, as MB demand is unstable. I view it as my definition of ‘money’. Having said that, you might be right. I don’t follow the UK closely enough to have a good sense of whether policy is on target. What sort of NGDP growth are they getting (in the last year?)
23. October 2010 at 09:36
2008 NGDP 1,448,391 RGDP 1,330,088 GDP def (’05 = 100)108.89
2009 NGDP 1,395,872 RGDP 1,264,646 GDP def (’05 = 100)110.38
average forecasts for 2010: growth 1.6% CPI 2.8 RPI 4.3
24. October 2010 at 06:05
Scott, I have a different interpretation of Taylor rule. If minus 6% nominal rates are not possible, then there is a desire for higher inflation. But higher inflation target should change the coefficients of Taylor rule, so I don’t see how you can get negative 6% real rate.
24. October 2010 at 07:31
W le B, Thanks. That looks like an excessively contractionary policy–but I’d also want to see NGDP for 2010.
123, I think the problem here is that most Taylor rules are backward-looking. Since they use historical inflation data, there is no way to reduce real rates via higher inflation expectations. If the Taylor rule were forward-looking, as it should be, then there would be no problem here. The key point is that it is the real interest rate that drives AD in the Taylor rule, it’s just poorly specified.
All this may be wrong as I am only familiar with the simple Taylor rules taught in textbooks. Perhaps in the real world much more sophisticated models are used.
25. October 2010 at 04:51
@Scott
Nah, in the “real world,” it seems central banks rely mostly on IS-LM style analysis. 🙁
If Barro is right and the fiscal multiplier is less than one (and they are using a 1.6), this would mean that they will always excessively tighten when there is a large fiscal stimulus and excessively loosen when there is fiscal rectitude.
25. October 2010 at 06:27
Vince Cable, Business Secretary, said today that if the UK fiscal consolidation proved too restrictive they could always (then) use monetary policy. They just don’t get it.
They think that fiscal contration will impact monetary policy through rates of interest, but surely fiscal contraction will reduce MV – unless it is accompanied by an increase in the money supply, it will be deflationary.
25. October 2010 at 06:50
Doc Merlin, That’s a very good point about what happens if the Fed tries to offset fiscal stimulus, and overestimates the fiscal multiplier. I’d add that they might underestimate the power of monetary policy.
W le B, I’m confused, aren’t you agreeing with Cable? More M can offset lower V.
25. October 2010 at 13:28
Sorry not to make myself clear, I’m saying it needs to be done now … because his Government’s policies reduce V. He says it *could* be done later if reducing G does not lead to their hoped for increase in I – not recognizing the impact of fiscal policy on MV. Both left and right here have ideological reasons for not accepting connection between MV and PT.
25. October 2010 at 15:48
So Simon Ward is wrong on V? Why?
http://www.moneymovesmarkets.com/journal/2010/10/22/its-the-velocity-stupid.html
26. October 2010 at 05:50
W le B, Ok, in that case the question of whether more money is needed cannot be resolved without looking at expectations. Is NGDP growth expected (by the market) to be too high or too low. That tells you whether more money is needed right now.
Morgan, Is that question for me?
27. October 2010 at 02:57
Scott, you said:
“I think the problem here is that most Taylor rules are backward-looking. Since they use historical inflation data, there is no way to reduce real rates via higher inflation expectations. If the Taylor rule were forward-looking, as it should be, then there would be no problem here. The key point is that it is the real interest rate that drives AD in the Taylor rule, it’s just poorly specified.
All this may be wrong as I am only familiar with the simple Taylor rules taught in textbooks. Perhaps in the real world much more sophisticated models are used.”
I was talking about the regular Taylor rule. I view it as a rule of thumb that has no theoretical support, as I obviously don’t agree with mechanisms that do not use expectations.
On one side of the Taylor rule we have something close to the NGDP gap, on the other side we get the equilibrium nominal interest rate. We know that the Taylor rule “worked” during the Great Moderation. If we assume that all those missing variables have not changed since the good days (TIPS breakeven expectations are equal to 2%, there was no shift in the full employment natural interest rate etc.), then we get a prediction that ffr should be equal to -5%, if only for a period before the next portion of backward looking data arrives. Unless you are a hawk and believe that temporary -5% ffr would unanchor long term inflation expectations upwards, or if you believe that there are some non-linearities present that soften the the impact of NGDP crash to the equilibrium nominal interest rates, according to the Taylor rule of thumb, you should support temporary monetary monetary stimulus equivalent to negative 5% ffr. This is why we are hearing Krugman talking of gazillion-sized QE.
27. October 2010 at 17:25
123, I think we agree. Neither of us seem to be fans of the Taylor Rule. There are certainly nonlinearities here–some level of QE might push us into hyperinflation. Perhaps even the level Krugman wants.
28. October 2010 at 02:19
According to the Taylor rule, this mega-QE should be temporary, and it will not push the economy into hyperinflation.
What we are observing is an interesting match Krugman vs. EMH. Krugman is using a dumb rule of thumb and says markets are believing Bernanke too much. Krugman says cheap talk will not work forever.
4. November 2010 at 17:28
123, Part of it should be temporary and part should be permanent. Just enough to hit the long run NGDP target.
5. November 2010 at 04:09
But the monetary base is already larger than any plausible estimate of the permanent part. So the problem is with the size of the temporary part.
5. November 2010 at 04:17
Have you seen Richard Clarida’s paper he presented in FRB Boston Low Inflation Conference?
http://www.bos.frb.org/RevisitingMP/papers/Clarida.pdf
There was a good trashing of backward looking Taylor rules and a good advocacy of following expectations, but I hated this part:
“As such, I am not suggesting an Lsap program combined with an announced price level – as opposed to an inflation – trigger. Such a policy is not time consistent (Woodford (2003); Clarida – Gali- Gertler (1999)) and, in my judgment, runs the danger of confusing rather than anchoring inflation.”
7. November 2010 at 04:51
123, In that case there are two possible reasons QE affected the markets:
1. ERs are not perfect substitutes.
2. QE was regarded as an implicit signal that the Fed was slightly raising its medium term price level target.
I think both are very plausible, but obviously I don’t know any more than anyone else.
Regarding Clarida, I haven’t read the paper, but I’m glad for progress on any front. Do you know whether anyone has noted that the gold standard was a sort of “level targeting” albeit only one price?