Nice exit strategy. When can we expect an entrance strategy?
This is my most requested post so far (and thanks to JKH for the idea for the title.) I hope it’s not as “awful” (to quote Bill) as my previous post.
Here’s how Bernanke started off his recent editorial in the WSJ:
The depth and breadth of the global recession has required a highly accommodative monetary policy. Since the onset of the financial crisis nearly two years ago, the Federal Reserve has reduced the interest-rate target for overnight lending between banks (the federal-funds rate) nearly to zero. We have also greatly expanded the size of the Fed’s balance sheet through purchases of longer-term securities and through targeted lending programs aimed at restarting the flow of credit.
These actions have softened the economic impact of the financial crisis. They have also improved the functioning of key credit markets, including the markets for interbank lending, commercial paper, consumer and small-business credit, and residential mortgages.
Isn’t this basically what Herbert Hoover’s Fed did? Didn’t they also cut rates to near zero levels? Didn’t they also massively expand the Fed’s balance sheet, causing rapid growth in the monetary base? Didn’t Hoover also bail out the banking system with taxpayer money through his Reconstruction Finance Corporation? So does that mean the Fed was also “accommodative” in the early 1930s? And if so, what’s the difference between ‘accommodative’ and ‘expansionary.’
Am I being too hard on Bernanke? After all, the Fed has done a lot. But so did Hoover’s Fed, the question is whether the Fed is doing anything effective. The only difference I can see is that the base rose even more under Bernanke than under Hoover, but that was fully neutralized by the policy of bribing banks to hoard excess reserves. (A mistake that in the Great Depression wasn’t made until late 1936, when they adopted an “exit strategy” of raising reserve requirements.)
But what about all the QE this year? Isn’t Bernanke finally coming around to my view? See what you think:
To some extent, reserves held by banks at the Fed will contract automatically, as improving financial conditions lead to reduced use of our short-term lending facilities, and ultimately to their wind down.
As I have been arguing for some time, that’s not QE. Rather than targeting the monetary base, the Fed is passively accommodating changes in the banking system’s demand for loans. In the old days it was called the “real bills doctrine.” I was under the impression that that view had been discarded by the Fed.
Here is what Bernanke says about the policy of interest on reserves:
Even if our balance sheet stays large for a while, we have two broad means of tightening monetary policy at the appropriate time: paying interest on reserve balances and taking various actions that reduce the stock of reserves. We could use either of these approaches alone; however, to ensure effectiveness, we likely would use both in combination.
Congress granted us authority last fall to pay interest on balances held by banks at the Fed. Currently, we pay banks an interest rate of 0.25%. When the time comes to tighten policy, we can raise the rate paid on reserve balances as we increase our target for the federal funds rate.
Fair enough. But then doesn’t it also stand to reason that when the time comes to loosen policy, you should reduce the interest rate on reserves? In October 2008 the Fed raised the interest rate on reserves from 0% to somewhere between 1% and 2%. Was October 2008 a “time to tighten policy?” Or was it the time to loosen policy?
I’ve also argued that by paying interest on reserves at a rate higher than banks can earn on T-bills the policy discourages banks from moving the excess reserves out into circulation. It seems that Bernanke agrees:
Thus the interest rate that the Fed pays should tend to put a floor under short-term market rates, including our policy target, the federal-funds rate. Raising the rate paid on reserve balances also discourages excessive growth in money or credit, because banks will not want to lend out their reserves at rates below what they can earn at the Fed.
I was also interested in seeing Bernanke’s outlook for the economy:
Overall, the Federal Reserve has many effective tools to tighten monetary policy when the economic outlook requires us to do so. As my colleagues and I have stated, however, economic conditions are not likely to warrant tighter monetary policy for an extended period.
That’s what I was afraid of. The term “extended period” brings back unpleasant memories of Japan. What I can’t figure out is why not a more expansionary policy right now? We know that unemployment is likely to be too high for an extended period, and all the forecasts show inflation well below the Fed’s target for years to come. And Bernanke clearly indicates that these are the Fed’s two policy targets:
We will calibrate the timing and pace of any future tightening, together with the mix of tools to best foster our dual objectives of maximum employment and price stability.
So why not adopt an explicit price level or NGDP target?
After taking office in March 1933, FDR discarded Hoover’s failed policies and adopted an effective monetary policy—an explicit promise to raise the price level to pre-Depression levels. Four months later industrial production had risen 57%. Something to think about.
He also missed one important part of the exit strategy, fiscal policy. Bernanke called for fiscal stimulus last year. Fiscal stimulus has a far worse impact on the budget deficit than monetary stimulus. It stands to reason that fiscal policy should be wound down before any monetary tightening occurs. At the appropriate time will Bernanke then make the following statement to Congress:
“We believe AD over the next few years is likely to grow too fast without some contractionary policies by the government. We call on the Congress to repeal the fiscal stimulus that has not yet been spent. If you do not do so we will tighten monetary policy enough to neutralize the impact of the remaining stimulus. That means all of the remaining stimulus will merely add to the national debt, and will have no impact on expected growth in AD.”
My next post will be about the only central banker in the world who seems to understand that we do need an explicit price level target, and a policy of negative interest rates in reserves.
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22. July 2009 at 11:36
I’m wondering if others noticed the same as I when I read his article: I was struck and somewhat perplexed that Bernanke spent more than a third (perhaps closer to half) his op-ed discussing interest on reserves (IOR)and the role that it will play in an exit strategy. Considering it is a relatively new tool (and it seems clear that the Fed has not been very proficient in its use) it seems quite odd, if not foreboding that IOR will be a primary pillar of any exit strategy. I’m guessing his focus on IOR in the article reflects his anticipated criticism of Fed action from Congress and their desire to tighten the reigns around the way the Fed does business. Or maybe he is just trying to make Congress feel good about allowing IOR? I’m throwing this out there, because I haven’t really been following the issue: Does Congress have buyers remorse for passing the IOR law?
22. July 2009 at 13:38
I think the interesting question here is, what does Bernanke define as deflation? And does he think the Fed should be actively fighting it at this point?
The first place to go is Fed meeting statements: in the June meeting, they dropped the phrase pointing to the risk that “inflation could persist for a time below rates that best foster economic growth and price stability in the longer term.”
From the statement, we can glean that: 1) deflation is (downward) price instability inconsistent with l.t. growth; and 2) the risk of deflation, as of June, is no longer worth mentioning.
Why would they reach such a conclusion? Did they address the potential causes of deflation so as to erase the risk?
Through much of his 2002 “Deflation” speech, Bernanke comes up with a tautological construct for the cause of deflation. He argues that the difference between a normal recession and deflation is the existence of falling prices combined with a interest rates stuck at the zero bound: “In a period of sufficiently severe deflation, the real cost of borrowing becomes prohibitive. Capital investment, purchases of new homes, and other types of spending decline accordingly, worsening the economic downturn.”
If you think deflation is caused by falling prices, and prices don’t fall (because you fixed the banks and eliminated the deflationary transmission mechanism), then you think there is little danger of deflation. That would explain why Bernanke is no longer focused on pumping up aggregate demand — there is no longer any need to.
The question is, will prices fall? Will the FOMC be wrong in downplaying this risk? IMO, their mistake may be in losing sight of incomes. It is entirely likely that the decline in hours worked, average wages, rents, etc. will bring down nominal incomes in the second half (that incomes have held up so well in the face of these just points to potential data revisions for 1H09). If that happens, the Fed will be scrambling to again fight deflation, only it will by then be severely behind the curve. There will be no time to experiment with half-measures, and the cost will be paid in the form of a high long term inflation target needed to change expectations.
In essence, the Fed is betting that incomes will follow banking profits and inventory builds, as they do in a typical recession.
Let’s hope they’re right.
22. July 2009 at 13:50
Aaron, Yes at least one and maybe two commenters mentioned that in earlier posts, as they were encouraging me to do this post. I can’t figure out what his reason was, you might be right.
David, That’s very interesting about the phrase being dropped from the June statement, I hadn’t noticed that. In some ways I think it is even worse, as the Fed tends to define price stability as two percent inflation. If they think two percent inflation is likely over the next few years. they’re nuts, It’s very likely going to be below that level, unless there is a huge oil spike.
Your comments about the second half are very perceptive, I think people may be surprised by how low inflation goes.
22. July 2009 at 14:19
Scott,
One question is, what impact does the dramatic rise in Chinese M2 have on deflation/inflation? As you can see from this chart, the cummulative one-year growth in Chinese M2 almost exceeds that of the U.S., Europe, the UK and Japan combined.
Here’s the chart:
http://2.bp.blogspot.com/_eKH-tiSXFbc/SmV40krAOoI/AAAAAAAAFmg/uV-vxYIcdBY/s1600-h/MONEY+GROWTH.GIF
So we have one country ignoring AD, and the other pumping it furiously. The exchange rate is fixed between the two. Could the effect be that tradeables prices hold up or even rise, while domestic non-tradeables — services — decline in price?
22. July 2009 at 17:07
Scott,
I have another suggestion, although you may have covered this territory previously.
The interest rate on reserves is a natural lower bound for the fed funds rate. The reserve rate should be positive when the fed funds target is positive, at least until the fed funds target or target range gets sufficiently close to zero.
The fact that the Fed is not currently charging interest on reserves is defensible IN A QUALFIED WAY on the basis of the Fed’s refusal, so far, to move the fed funds target range any lower than the zero bound. That’s not meant to be a defence of the fed funds target; it is only a defence of a decision not to charge interest on reserves, given the fed funds target range and the reserve rate that would be consistent with that range.
If the lower bound for the target funds rate is currently zero, the interest rate on reserves should probably be zero. It’s not clear to me why the Fed has in fact set this rate at 25 basis points, because that is also not consistent with a zero lower bound for fed funds. In a sense, paying interest of 25 basis points and charging interest of 25 basis points are each equally and symmetrically wrong, GIVEN the current lower bound of zero for the fed funds rate. This is a bit of a puzzle.
I cover all of this because I think your strategy for charging interest on reserves should be framed within a larger policy framework that includes the parallel movement of the fed funds target range from positive to negative interest rate territory. In other words, your idea for reserve interest rate policy should be part of a conjoined fed funds/reserve interest rate policy.
So when you recommend charging interest on reserves, I think you should do so within such a framework, where you are effectively recommending a fed funds target range that at least intersects with negative interest rate territory, if not moving completely into it.
A negative interest rate on reserves in itself would tend to propagate negative interest rates to a broader market for other instruments such as treasury bills. A negative fed funds rate would be consistent with this more general market effect.
Then your recommended policy for interest on reserves then becomes part of a more general movement to negative nominal interest rates. The zero bound is no longer a bound. Monetary policy easing continues seamlessly through the zero level.
I think that’s the more complete framework for the entrance strategy you are recommending.
23. July 2009 at 04:43
David, First of all I am a bit confused by the vertical scale on the graph, which doesn’t show things in percentage terms. But let’s assume the graph is correct. The first thing I would note is that China has more growth than all those other countries combined, as they all have negative growth. But even that may not fully explain the graph. BTW, another commenter told me that China has actually had deflation over the past year, but because real growth is high, NGDP is still growing. I also know that the Chinese government has been pushing the banks to do a lot of lending, and since they are partly state-owned, they have been successful. So lending for housing and other construction projects has risen fast, and perhaps explains some of the M2 growth.
You said:
“So we have one country ignoring AD, and the other pumping it furiously. The exchange rate is fixed between the two. Could the effect be that tradeables prices hold up or even rise, while domestic non-tradeables “” services “” decline in price?”
This confuses me for some reason. Traded goods prices have been falling haven’t they? I’d expect just the opposite, wouldn’t the local prices rise because of all the new money? And wouldn’t the tradeable goods prices be held down by a combination of the fixed exchange rates and the weak international prices? Or do I have my facts wrong?
JKH, That is a very good question, but I have a somewhat unconventional take. We need to start on a seemingly off topic issue—currency. The standard argument is that it is not possible to push interest rates significantly negative (i.e more than a few basis points negative, which is the cost of storing cash), as the rate on cash is zero, and people would simply hold cash rather than a T-bill with negative rates. At the same time I have argued that it is possible to charge a significantly negative rates on ERs, say a few hundred basis points. So what does all this mean?
1. The Keynesian view is that once you hit the zero bound, monetary policy becomes ineffective. It is like a black hole, add some stuff to a black hole, and it’s still a black hole. They would say that a negative rate on reserves wouldn’t help, because cash would still earn zero, and thus real world lending rates could be depressed no further. Mankiw suggested this point of view in an email to me.
2. The monetarist view is that you can still do QE at the zero bound, so that monetary policy can be further loosened. And importantly, they believe this to be true even if the fed funds target can’t go significantly below zero. The argument is that by putting more money out there, people will have more than they want, and try to spend it driving up AD. How do you get the extra base money in circulation? With a penalty rate on ERs.
Now you may already know all this but not all readers do. What I take from this is that the fed funds target cannot be depressed much below zero. If a bank has some excess reserves, they’d rather take them and buy a T-bill with zero yield, rather than lend it to other banks at negative interest rates.
You might ask what happened to the equilibrium condition that the fed funds rate should equal the rate paid by the Fed on ERs. My answer is that it breaks down, causing ER demand to fall to very low levels. Indeed this is exactly how things were in the old days when the Fed paid zero interest, but banks could lend ERs out at say 5%. ERs were very low.
This means that there is an asymmetry at zero. At zero or above the interest on reserves will closely parallel the fed funds rate, just as you say. But below zero there is a discontinuity, because of the oddity of currency always having zero interest. The fed funds rate stays near zero even as the interest on reserves goes significantly negative.
Sorry for being long-winded, but it is a very confusing issue.
23. July 2009 at 05:02
Scott,
The chart is of absolute dollar one-year growth. I believe its about $600b for the U.S. and $1.8tr for China. So you can see that its not just the growth RATE, but that in dollar terms, the Chinese are really making a meaningful contribution to global M2 growth. A contribution that has to be taken into account when forecasting price levels, I think.
As for prices, commodity prices have certainly been impacted by Chinese M2 growth during the first half of the year — upwards. Whatever positive headline CPI growth we see in the U.S. is coming out of China, I believe, since a real core-CPI calculation (with an accurate assessment of housing prices) would probably be showing declines. That’s why I think commodities-up, domestic prices-down could be in the cards as long as the Chinese keep pumping up their AD.
As for the price levels in China, I think you’re right, and it bears thinking about. How can you pump 50% of GDP in through bank lending growth and experience domestic price deflation? It implies deflation has really taken hold in China, probably because all that fixed asset investment is just creating more overproduction. What they really need is to pump up consumer demand.
In any case, your posts are invaluable in understanding the situation. I hope you continue writing this blog.
23. July 2009 at 16:50
For those who share Scott’s frustration at Bernanke’s inexplicable policies, please see my theory.
23. July 2009 at 17:17
I would love to hear your response to this Univ. of Missouri-KC piece on the Bernanke op-ed.
Link here
24. July 2009 at 04:40
Thanks David, I am really struggling to make sense of all this China data. Many of your individual points make sense, but I am having trouble fitting it together. The commodity price rebound may be partly caused by China’s real growth turnaround—I agree with that. At the same time, Chinese prices are falling, so if M2 is strongly boosting AD, why don’t they have inflation? Yes, there may be over-capacity, but I would have thought that would also have depressed commodity prices. Perhaps commodity prices are more forward looking and are picking up the expected recovery in Asia, whereas Chinese CPI prices are more backward-looking, showing the slowdown in China last winter, which is still affecting sticky prices.
My other issue is M2. Monetary aggregates can be misleading, and I don’t know enough about China to to have a firm opinion, but I certainly think you hypothesis is very plausible.
BTW, because I have a substantial portion of my pension in Hong Kong, I have followed trends in China with great interest, and recently with great pleasure. I wonder if there is a way of testing whether the huge growth in Asian markets has affected Wall Street at all. To the casual eye there looks like a correlation.
Thanks Bob, That’s a bit too conspiratorial for me, but I admit I have no good explanation.
JTapp, That seems to be the endogenous money view, which I don’t buy. It is the view of groups like the post-Keynesians. Banks don’t create reserves, the Fed does, as we have just seen in the last year.
24. July 2009 at 06:36
Ssumner,
It seems that you did not respond JTapp’s question.
In the U. S., when a bank makes a loan, this loan creates a deposit for the borrower. If the bank then ends up with a reserve requirement that it cannot meet by borrowing from other banks, it receives an overdraft at the Fed automatically (at the Fed’s stated penalty rate), which the bank then clears by borrowing from other banks or by posting collateral for an overnight loan from the Fed.
This is not theory so far, it is what happens in the real world! It seems that you do not get real world banking…
With regard to increases in monetary aggregates, the article was clear saying that “A closer look at the 1980s and 1990s help us understand the relationship between monetary aggregates such as M1 and M2 and inflation. This is a relationship that did not hold up either in the 1980s nor in the 1990s. As Benjamin Friedman (1988) observed “[a]nyone who had relied on prior credit-based relationships to predict the behavior of income or prices during this period would have made forecasts just as incorrect as those derived from money-based relationships.” (Benjamin Friedman, 1988:63)
A recent study conducted by the FRBSF also concluded that “there is no predictive power to monetary aggregates when forecasting inflation.” What about the Japanese experience? As the figure below shows, the monetary base exploded but prices actually fell!
“Consumer price inflation pressures can be caused by struggles over the distribution of income, increasing costs such as labor costs and raw material costs, increasing profit mark-ups, market power, price indexation, imported inflation and so on. As explained above, monetary aggregates are not useful guides for monetary policy.”
24. July 2009 at 12:29
China stimulus program is one of the important factors that have positively influenced the Wall Street. There were many others – stress test program, positive economic data surprises (2nd derrivative improvements), QE, fiscal stimulus.
Chinese papers write:
”
In fact, economic growth recovery in China is being driven by investment. Some 6.2 percent of the country’s first half GDP growth rate can be credited to investment, while consumption accounted for 3.8 percent. The net export business contributed a minus 2.9 percent to the growth rate figure. ”
Scott, do you think this Chinese investment will be productive?
25. July 2009 at 05:26
Economist, You are mostly preaching to the converted. In this blog I have argued over and over again that the monetary aggregates are very misleading. All of them. They are not good indicators of monetary policy. What is important is expectations of NGDP growth over the next year or two. This is roughly what Keynes meant by “confidence.”
The only area I somewhat disagree is the endogenous money theory. Even when the Fed uses a procedure that makes the base endogenous in the very short run (such as interest rate targeting) as long as they use something like a Taylor rule, they can kept control of the MB in the long run.
I don’t know if you are a post-Keynesian, They often argue for endogenous money. But their model is flawed because it has no explanation for the price level.
123, I travel to China frequently and see lots of productive investment. The new airports are better than ours. They recently built an interstate highway system almost as big as ours. They are building massive subway systems in places like Shanghai and Beijing at breakneck pace. Shanghai’s will be the world’s largest. These are very productive investments.
The quality of the new housing is far better than the old, but is marred by incredible energy inefficiency. Much of the light industry is private, and is thus at the appropriate efficiency for China’s wage levels.
I don’t know much about the heavy industry (which is often state-owned.) I presume it is a mixed bag, perhaps at a typical “second world” level. Despite all the news about China’s growth, much of it is still a third world country. A statistic I like to give people is that when China get’s as rich as Mexico (in about 10 years) it will have the world’s biggest economy. So in talking about China it is always a “compared to what” question. Even w/o further reforms their current track will take them to second world levels. And that’s a huge improvement. But to reach the productivity of Japan/HK/Singapore they will need far more economic reforms, so that they don’t have so many wasteful projects.
I don’t know if my meandering answer satisfies, but I keep going back to how poor China was under Mao—it makes almost any reasonable policy today look good by comparison. So yes, there is a lot of waste in many of these investments, but the Chinese economy will grow rapidly despite that waste.
26. July 2009 at 08:56
Dear ssumner,
We are making progress.
#1 Banks extend loans to creditworthy borrowers to meet the needs of trade. In this process, loans create deposits.
If the bank then ends up with a reserve requirement that it cannot meet by borrowing from other banks, it receives an overdraft at the Fed automatically (at the Fed’s stated penalty rate), which the bank then clears by borrowing from other banks or by posting collateral for an overnight loan from the Fed. Banks do not wait for the appropriate amount of liquid resources to exist to provide new loans to the public. ‘Money is created as a by-product of the loans provided by the banking system’.
#2 You mentioned that “as long as they[the Fed] use something like a Taylor rule, they can kept control of the MB in the long run.”
Let us look at this in more detail.”In order to hit the overnight rate target, the central bank must accommodate the demand for reserves””draining the excess or supplying reserves when the system is short. Thus, the supply of reserves is best characterized as horizontal, at the central bank’s target rate.” The central bank cannot control even HPM! Reserves cannot be a discretionary variable
from the point of view of the central bank. There are a number of reasons for this. Many, including Basil Moore (1988), have argued that because required reserves (in those nations that have them) are always calculated with some
lag, based upon deposits that are “history” (issued by banks at some point in the past), banks cannot adjust deposits to cope with a position of insufficient reserves to meet requirements. This means that only reserves can be adjusted””so that a bank caught short will turn to the fed funds market.
However, if the system as a whole is short, at least one bank will not be able to meet requirements. In practice, central banks always and automatically lend reserves to such banks, booking a shortfall as an overdraft or loan of
reserves. If they did not, they would force the bank to fail to meet legal mandates. Further, if the central bank did not provide desired reserves, banks with insufficient reserve levels would bid the fed funds rate above target.
(Note that the reverse is also true: if the system as a whole has excessive reserves, the fed funds rate is bid below target””at the limit it will fall nearly to zero.) Hence, an orderly fed funds market requires that the central bank provide/drain reserves to eliminate deficiencies or surpluses.
In addition, timely and orderly check clearing among banks requires that the Fed automatically provide reserves as required. Banks use reserves for net clearing of checks (recall the discussion of a mono-reserve system). If
the Fed refused to routinely make up for aggregate reserve shortfalls, the payments system could not operate smoothly. Indeed, if the Fed stopped lending reserves as needed, checks would bounce. If a bank was suspected of nearing a position of a shortage of reserves,other banks would refuse to accept its checks. It is because the Fed always credits reserves to the account of a receiving bank without first ensuring that the bank upon which a check is drawn has sufficie nt reserves that bank checks always clear at par. Indeed, this was a primary purpose of the creation of the Federal Reserve System, before which bank notes commonly circulated below par. Finally, payments to the Treasury by bank customers (tax payments, mostly) are also made using bank reserves.
#3 You argued that “post-Keynesian…their model is flawed because it has no explanation for the price level.”
However, the theory of prices was the subject of a whole chapter in Keynes’s General Theory. (Chapter 21.THE THEORY OF PRICES). In addition, there are several publications on the theory of the price level such as “Post Keynesian Price Theory” by Frederic S. Lee; “Pricing Theory in Post-Keynesian Economics”. by P. Downward,and many others.
26. July 2009 at 09:19
Scott: “I travel to China frequently and see lots of productive investment. The new airports are better than ours. They recently built an interstate highway system almost as big as ours. They are building massive subway systems in places like Shanghai and Beijing at breakneck pace. Shanghai’s will be the world’s largest. These are very productive investments.
The quality of the new housing is far better than the old, but is marred by incredible energy inefficiency. Much of the light industry is private, and is thus at the appropriate efficiency for China’s wage levels.”
I am an electronic engineer and I frequently work with chinese enterprises. I’m not at all convinced that investment is generally good.
The “private light industry” you praise is funded by state run banks that are currently supplying it with credit at negative interest rates. I think a lot of them are make-work schemes in disguise.
In the past few years I’ve seen concerns about the manufacturability of electronics take a permanent back seat. Instead labour is used to solve every problem. The labour intensiveness of electronic devices I work on seems to be increasing not decreasing.
26. July 2009 at 09:41
Economist, what you are saying about banks is mostly correct. The Fed don’t control the situation fully in the short term. They can however exert control in the longer term (by which I mean about a couple of months) through the penalty rates, through regulations and various other means.
Economist: “before which bank notes commonly circulated below par. ”
The reason banknotes circulated below par was mostly because of branch banking laws in the US. The stability of banks that were geographically distant wasn’t well known. So, as a precaution their notes were sometimes discounted.
Think about the situation. If you think a bank is a bit wobbly and you hold one of their notes then what do you do. Do you (a) attempt to redeem it at full value or (b) attempt to exchange it below par? The answer is clearly that you first try (a) if you can cheaply travel to the bank. That creates a bank run.
So, in most cases banks are either trusted or not. The US branch banking laws made things different there.
In the current US payment system the Fed performs the clearinghouse role you mention. Before that clearinghouse banks did the same job.
26. July 2009 at 10:08
The situation with banks is rather similar to that with electricity.
I have an electricity supply to my house. I may draw from it as much energy as the supply can technologically support, which is quite a lot.
So, in the short term the supply of electricity to me is perfectly elastic. It is though entirely illegitimate to draw a diagram of electricity supply with a horizontal supply curve and then plot a “price” on it. Though these things can be plotted the price doesn’t belong on the plot.
The price I pay for electricity per kW/hour has been decided between myself and my electricity supplier. The supply and demand situation between myself and the electricity supplier during each billing period is not what sets the price. The price is set when the electricity supplier and the customer arrange it. And it is set by some sort of formula that depends upon energy usage.
The situation with money supply and interest rates is similar.
26. July 2009 at 16:57
Economist, You said;
“The central bank cannot control even HPM!”
Of course they can control HPM, the question is whether they want to.
Chapter 21 of the GT is an abomination. It does not contain any sort of coherent theory of the price level. The US NGDP is about $15 trillion. If someone asked you why it isn’t $15 billion, or $15 quadrillion, how would you answer? Does the GT chapter 21 provide an answer?
Current, Casual empiricism can be very misleading. China would not be able to achieve it’s rapid economic growth if factors of production weren’t being used in increasingly efficient ways. Yes, China’s economy is still mind-bogglingly inefficient, and there are millions of such examples that one could come up with. But it is also becoming much more efficient than it used to be. Remember that when labor is cheap a lot of practices that would be crazy in the US, make perfectly good sense in China.
What is the negative interest rate currently set at? The current inflation rate is negative, or at least I’ve been told it’s negative. Are you referring to real or nominal rates?
Much of the light industry is financed privately, either by local entrepreneurs in places like Zhejiang, or by HK and Taiwanese companies in places like Guangdong.
I’m not disputing you impressions, but overall things are so much better than when I first visited in 1994 that it seems like another country.
Current#2, I agree the branch banking laws were a big problem. Indeed without them the Great Depression might not have even happened (although I still think there would have been a depression of some sort.)
Current#3, The electricity analogy is a good one.
26. July 2009 at 17:35
ssumner,
You did not replied my points. You just denied them!!
First, you said that there was no post-keynesian theory of prices and then I gave you at least TWO books in which the whole content is about prices(this shows that you are not familiar with the literature). This point you did no mention.
Second. You first recognized that money is endogenously created bu the you said that “as long as they[the Fed] use something like a Taylor rule, they can kept control of the MB in the long run.” I then explained that in order to hit the overnight interest rate target the Fed must accommodate the demand for reserves in order to hit the target.(even in the long run). If banks, overall, are short of reserves this will put pressure on the overnight interest rate -it puts an upward pressure on overnight rates”” relieved by central bank open market purchases.In order to hit the target the Fed will supply those reserves.Conversely, if the banks, overall, have excess reserve positions, overnight interest rates will be bid down by banks offering the excess in the overnight interbank lending market. Unless the central bank is operating with a zero interest rate target, declining overnight rates trigger open market bond sales to drain excess reserves.
From this perspective Fed’s policy is accomodative (non discretionary). The central bank cannot control HPM. Almost all central bankers recognized this.
The claim that reserves are supplied “horizontally” at the rate set by the central bank is, I think, beyond dispute. Reserves cannot be the “raw material” from which loans are made, and it is more appropriate to see reserves as the result of loan-making activity.
The supply of bank money is endogenous, with demand deposits created each time a bank makes a loan. If required or desired reserves rise in consequence, the central bank accommodates by providing more reserves.
It is true that households hold credit cards with pre-approved lines of credit up to some limit at a fairly constant cost (fees and interest rate); utilization of these lines up to those limits would almost certainly impact rates and fees charged on additional borrowing, but this can be attributed to movement into a higher risk class. Firms also negotiate credit lines that typically trigger higher fees and rates as they are utilized, but this, too, can be seen as transition to riskier classes. Commercial loans (and mortgage loans) require individual negotiation, with loan quantities and uses carefully established at the time interest rates are quoted. The firm must meet very specific performance requirements to continue to draw upon the loan. Further, loan (and mortgage rates) can be partially or even mostly variable rate (depending on institutional arrangements). In these cases, it is difficult to see what it means to say that the supply of loans is “horizontal”, except that the lender will supply credit at the negotiated rate and up to the negotiated limit.
Moore’s important contribution was the recognition that loans are not reserve constrained and that they are made at a negotiated, or “administered”, rate. There is thus no necessary relation between the quantity of loans made and the interest rate charged. Further, any impact that the central bank might have on the loan rate comes through its overnight interest rate target and not through manipulation of the quantity of reserves.
Ps: Good reading here: http://www.levy.org/pubs/wp_512.pdf
27. July 2009 at 04:52
Economist, You said,
“You did not replied my points. You just denied them!!
First, you said that there was no post-keynesian theory of prices and then I gave you at least TWO books in which the whole content is about prices(this shows that you are not familiar with the literature). This point you did no mention.”
I don’t read all books recommended by commenters. You also recommended Keynes’s GT, Chapter 21, which I reread on your recommendation. That was more than most bloggers will do. It was horrible. Keynes can’t decide whether the quantity of money affects the price level at all, and thus he has no theory of the current price level. And if you have no theory of the current price level, then ipso facto, you can’t explain how it changes over time.
I am familiar with the Levy Institute, it mostly focuses on post-Keynesian analysis that I view as very wrong-headed.
You said;
“The central bank cannot control HPM. Almost all central bankers recognized this.”
I think this would be news to Bernanke.
You said;
“There is thus no necessary relation between the quantity of loans made and the interest rate charged.”
I would hope everyone agrees with that statement, it is simply S&D from Econ101.
I take it that you don’t think the Fed is capable of doing QE, even if they wanted to. Suppose they stopped targeting interest rates? Why would QE not work?
27. July 2009 at 08:22
I’m British, I view the Post-Keynesian school as a sort of minor national embarrassment rather like “The News of The World” newspaper or Gordon Brown.
The situation here is quite easy to understand. The Federal reserve is the maker of a fairly centralized market. In that role it automatically supplies reserves on credit when necessary as “Economist” mentions.
This line of credit is similar to that which I have with my bank, or with my electricity or telecoms supplier. The business relationship between the parties is also quite similar. There are short term and long term elements to it. In the short term the Fed must provide funds, however, in the long term the Fed retain several ways of fining banks that demand too much. There is the penalty rate, for example.
Ceteris paribus the Fed can control high-powered money. That is, suppose the commercial banks are in a particular set of long-term situations. The Fed then buys a large quantity of treasury bonds. Now, the consequences of this are be obvious.
(The question of whether the term “high-powered money” is very useful or if the multiplier model does what some say it does is separate).
However if the longer-term aspects of the relationship change at the same time as the bond purchase then that will clearly have an effect. Of course it’s also possible that a short-term change will create longer term complications. Banks may go bankrupt because of large changes in the interest rate.
The same sort of situation occurs in the telecoms and electricity industries. For example, think about those internet suppliers who offer “unlimited broadband”. Most of these “unlimited” contracts have “abuse” clauses that allow the company to cut off user who download too much. So, although technically speaking the users of the broadband can use as much as they like, in practice things are different. If you use too much first you get a snotty letter. Then if you continue a month or so later you get thrown off. Broadband supplier shape demand by changing prices to new customers and by the threshold that triggers the snotty letter.
27. July 2009 at 09:50
I assume Economist works at UM-KC. I appreciate reading these comments for the educational value, and it was a greater response from Dr. Sumner than I was hoping for. Thank you!
27. July 2009 at 13:07
“What is the negative interest rate currently set at? The current inflation rate is negative, or at least I’ve been told it’s negative. Are you referring to real or nominal rates? ”
Real rates were ridiculously negative two years ago in China. Backward looking real rates are now positive, I have no information about proper forward looking real rates. Does anybody have reliable forward looking estimates of Chinese CPI and PPI?
I agree that China has made enormous progress since the Mao. But their export industry is efficient because they have to compete in global markets. Now that the export growth has stopped, do you think their non-export related investments will be more efficient than the ones made under Obama’s Recovery and Reinvestment plan?
27. July 2009 at 14:48
Ssumner,
Note that your first mentioned that “”as long as they[the Fed] use something like a Taylor rule, they can kept control of the MB in the long run.” As I explained above, this is just plain wrong.
Goodhart (1994) observed that “[a]lmost all those who have worked in a [central bank] believe that [deposit multiplier] view is totally mistaken; in particular, it ignores the implications of several of the crucial institutional features of a modern commercial banking system….’ (Goodhart, 1994:1424).
As explained in more detail here (http://www.levy.org/pubs/wp_512.pdf), in order to hit the overnight interest rate target the Fed must accommodate the demand for reserves in order to hit the target. The Fed has no choice but supply reserves on demand otherwise the it will not be able to hit its target.
Bernanke knows this…There is no dispute.
The other point, tou mentioned that “Of course they can control HPM, the question is whether they want to.” I expect more from you…
Note that at the end of 1980s, Monetarist doctrine was in question because the Monetarist experiment at controlling the money supply had been such a disaster in the US (and also in the UK). (Ben Friedman 1988)
As Wray put it “Both theorists and policy makers quickly abandoned the belief that the Fed could control the money supply and that the money supply determines the rate of spending and thus of inflation.”
Check also here: http://www.cfeps.org/pubs/wp-pdf/WP21-Wray.pdf
Now, you mentioned QE. Let’s look at it in detail.
“What is quantitative easing?
With very tight credit markets at present (that is, banks have upped their lending standards and made it harder for firms and households to access credit), central banks have started talking about using what is called quantitative easing to free up credit flowing especially as short-term interest rates fall towards zero. In fact, near zero interest rates are required if the central bank is to engage in quantitative easing!
Quantitative easing merely involves the central bank buying bonds (or other bank assets) in exchange for deposits made by the central bank in the commercial banking system – that is, crediting their reserve accounts. The aim is to create excess reserves which will then be loaned to chase a positive rate of return. So the central bank exchanges non- or low interest-bearing assets (which we might simply think of as reserve balances in the commercial banks) for higher yielding and longer term assets (securities).
So quantitative easing is really just an accounting adjustment in the various accounts to reflect the asset exchange. The commercial banks get a new deposit (central bank funds) and they reduce their holdings of the asset they sell.”
“Does quantitative easing work? The mainstream belief is that quantitative easing will stimulate the economy sufficiently to put a brake on the downward spiral of lost production and the increasing unemployment.
It is based on the erroneous belief that the banks need reserves before they can lend and that quantititative easing provides those reserves. That is a major misrepresentation of the way the banking system actually operates. But the mainstream position asserts (wrongly) that banks only lend if they have prior reserves. The illusion is that a bank is an institution that accepts deposits to build up reserves and then on-lends them at a margin to make money. The conceptualisation suggests that if it doesn’t have adequate reserves then it cannot lend. So the presupposition is that by adding to bank reserves, quantitative easing will help lending.
But this is a completely incorrect depiction of how banks operate. Bank lending is not “reserve constrained”. Banks lend to any credit worthy customer they can find and then worry about their reserve positions afterwards. If they are short of reserves (their reserve accounts have to be in positive balance each day and in some countries central banks require certain ratios to be maintained) then they borrow from each other in the interbank market or, ultimately, they will borrow from the central bank through the so-called discount window. They are reluctant to use the latter facility because it carries a penalty (higher interest cost).
The point is that building bank reserves will not increase the bank’s capacity to lend. Loans create deposits which generate reserves.
The reason that the commercial banks are currently not lending much is because they are not convinced there are credit worthy customers on their doorstep. In the current climate the assessment of what is credit worthy has become very strict compared to the lax days as the top of the boom approached.
To refresh your ideas check here: Quantitative easing 101
http://bilbo.economicoutlook.net/blog/?p=661
28. July 2009 at 06:41
Current, Yes, I think the electricity example is a good analogy. They often set a short term interest rate target, and the base is exogenous as long as they hold that target (obviously unless the rate is zero.) But they can change the target whenever they want, so the base is actually controllable.
Thanks JTapp.
123, I think the problem with most analyses of China is that they want to call the glass empty or full. It is half full. China is making a lot of the same sort of investments that other middle income countries made. The quality is very variable. To me, a lot of the infrastructure looks pretty good (airports, roads, subways, etc.) But if you look at the building that recently collapsed in Shanghai, you can see that lots of the construction is pretty bad. So it’s a mixed bag.
The most important point for China is to keep liberalizing. If they stop reforms now, their growth will level off at second world levels. If they keep reforming they will reach first world levels.
BTW, You can make a good argument that due to the Balassa-Samuelson effect, which says the price level of fast growing countries will rise faster than the price level of slow growing countries, that real rates should be negative in China.
Economists,
You said:
“Note that your first mentioned that “”as long as they[the Fed] use something like a Taylor rule, they can kept control of the MB in the long run.” As I explained above, this is just plain wrong.
Goodhart (1994) observed that “[a]lmost all those who have worked in a [central bank] believe that [deposit multiplier] view is totally mistaken; in particular, it ignores the implications of several of the crucial institutional features of a modern commercial banking system….’ (Goodhart, 1994:1424).”
I don’t understand this, the Taylor rule has nothing to do with the deposit multiplier.
You said:
“As explained in more detail here (http://www.levy.org/pubs/wp_512.pdf), in order to hit the overnight interest rate target the Fed must accommodate the demand for reserves in order to hit the target. The Fed has no choice but supply reserves on demand otherwise the it will not be able to hit its target.
Bernanke knows this…There is no dispute.”
I never denied this, I said they could choose to change their interest rate target if they wanted to change the base. Bernanke knows that too.
Regarding your other points on QE, I think banks have little to do with monetary policy. Monetary policy boosts AD by putting more money into peoples’ hands than they want to hold. As they try to get rid of it AD rises. My mechanism will work with or without banks even existing. Your mechanism requires the existence of banks. Lending is tangential to what is going on—Zimbabwe would have had hyperinflation regardless of whether banks were lending, indeed regardless of whether banks even existed.
28. July 2009 at 07:51
Ssumer,
Let’s sum up.
First, bank lending is not “reserve constrained”, any serious central banker knows this.
Second, the central bank cannot control the MB. This is an old debate which monetarists lost, that is the central bank cannot control the MB. The Monetarist experiment in 1980s at controlling the money supply had been such a disaster in the US (and also in the UK). (Ben Friedman 1988). As Wray put it “Both theorists and policy makers quickly abandoned the belief that the Fed could control the money supply and that the money supply determines the rate of spending and thus of inflation.” But you cannot understand this.
Third point, you are being too simplistic in you monetary policy transmission mechanism. You said, “Monetary policy boosts AD by putting more money into peoples’ hands than they want to hold. As they try to get rid of it AD rises.” You just assume that people will increase spending following a monetary expansion, you miss the point that they can increase their hoardings of money for example. Or they can use this money to buy assets that do no lead to an increase in employment and output.
Japan’s monetary base rose 85 percent between 1997 and 2003; deflation continued apace.
Japan’s recovery came from massive fiscal policy and an export boom.
By the way, is that all you have in terms of theory of prices? Too much money chasing to few goods? That inflation is always and everywhere a monetary phenomenon? No wonder why Chigago economists are so discredited nowadays…
p.s: I suggest you read chapter 17 (“The Essential Properties of Interest and Money”) of Keynes’ GT: http://www.marxists.org/reference/subject/economics/keynes/general-theory/ch17.htm
These essential properties [Keynes, 1936a, pp. 230-231]are:
[1] the elasticity of production of all liquid assets including money is zero or negligible, and
[2] the elasticity of substitution between liquid assets (including money) and reproducible goods
is zero or negligible.
See also here: http://econ.as.nyu.edu/docs/IO/8801/DavidsonKeynesMonetary.pdf
28. July 2009 at 09:59
“The most important point for China is to keep liberalizing.”
I’m afraid they have stopped that, just look at their stimulus package.
Balassa-Samuelson effect explains half of the negative interest rate puzzle. Another explanation is that interest income is expropriated by state.
28. July 2009 at 12:07
“Economist” you have written several things here that are completely correct, but you’ve written much that is dubious.
Let’s begin with your criticism of early Monetarism.
Economist: “The Monetarist experiment in 1980s at controlling the money supply had been such a disaster in the US (and also in the UK). (Ben Friedman 1988). As Wray put it ‘Both theorists and policy makers quickly abandoned the belief that the Fed could control the money supply and that the money supply determines the rate of spending and thus of inflation.'”
In the early 80s the central banks in the US and UK targetted the money supply. It was this policy that failed. Now, I’m not convinced that either bank was really particularly committed to the policy.
However, it didn’t work. There are good reasons in principle why it should not work, some of which you have outlined. Such as the problems with the money multiplier. So, even if we consider the experiment “tainted” by the lack of conviction of the central banks it is still not to be trusted.
There are three reasons why it didn’t work. Firstly, there is the issue of money holding. Benjamin Anderson and Ludvig Von Mises had this sorted out by ~1917. See Hazlitt’s article about this from 1968 http://mises.org/story/2916 .
Hazlitt wrote regarding MV=PT:
“It is perfectly true, to begin with, that the quantity of money affects the value of the monetary unit, just as the quantity of wheat, say, affects the value of an individual bushel of wheat. In both cases, an increase of supply, other things being equal, reduces the value of a given unit, and a reduction of supply increases the value of a given unit. But no one assumes, in the case of wheat or of any other commodity, that the reduction in value of a unit is exactly proportional to the increase in the total supply (or an increase in value exactly proportional to a reduction in the total supply). And neither should we assume that there will be an exactly inverse proportional variation between the value of a unit of money and the supply of money.”
…
“what we have to deal with, in the so-called circulation of money, is the exchange of money against goods. Therefore V and T cannot be separated. Insofar as there is a causal relation, it is the volume of trade which determines the velocity of circulation of money rather than the other way around.”
Individuals hold money in order to hedge against uncertainty. They hold it rather than holding useful goods because they can spend it when they want on any sort of useful good. Another (perhaps more confusing) way of saying this is to say that every buying decision involves the liquidity of the good bought and the liquidity of the good sold for it.
So, if an economy does well then the central bank may attempt to reduce the expansion of the money supply. However people may decide they are less uncertain because of the growth and hold less money. So prices may continue rising on a path that was not expected. The opposite may occur during a recession (and many other things may happen too).
The second problem relates to what money is. Mises and Menger wrote that money arises from the market. It is a means of indirect exchange. As such agents must mutually accept it. It is quite possible though for a community to reject one form of money and choose something else. On a more fine-grained level it’s quite possible to create new sorts of money like things. Money-market mutual funds were an example of this. It was “regulation Q” that made what money was clear. Now though we have a much more complicated ranking of Ms. This was one of the main problems in the early 80s. People moved to money-market funds. (Notice how this problem is related to the first one).
Thirdly, there is the problem of the fractional reserve multiplier. Technically, all that the multiplier tells us is the maximum amount of money that could be created for a particular quantity of reserves. It can’t tell us if that amount would be created.
All of these things I mention prevent central banks from changing the price level by a specific amount. And the prevent the central bank from changing the money supply by a specific amount, which isn’t the same thing. That this was not possible was quite well known a long time ago unfortunately.
Now, you above you mention the fact that the central bank must provide reserves for the commercial banks if they are short. From this you draw the erroneous conclusion that demand for loans determines supply of loans and no thought is given to reserves. Go back up the thread and read my comments about broadband. What you are saying is rather like supposing that all users of broadband will always exceed their limit. This isn’t what happens. The central banks have long-term relationships with the commercial ones through which they can and do punish the commercial banks for overshooting reserves too often.
On the other side of things, the commercial banks certainly need sound borrowers to lend to. That can’t be denied and I don’t think Scott is denying it. I believe that he thinks that they do have enough sound borrowers. I’m not so sure personally.
Presuming though that Scott is correct he is quite correct to say that the size of the monetary base could be expanded. We may not be able to say *by how much* any specific action will expand the monetary base, or if there is some offsetting action at work in the rest of the economy. But it is certain that the base can be expanded upon what it would have been, ceteris paribus.
It is as certain as the existence of printing presses.
29. July 2009 at 06:41
Economist, You said,
“Third point, you are being too simplistic in you monetary policy transmission mechanism. You said, “Monetary policy boosts AD by putting more money into peoples’ hands than they want to hold. As they try to get rid of it AD rises.” You just assume that people will increase spending following a monetary expansion, you miss the point that they can increase their hoardings of money for example. Or they can use this money to buy assets that do no lead to an increase in employment and output.”
Actually, I have spent extensive time on this blog discussing hoarding. My statement in no way implies that people never hoard money. But your approach implies they always hoard money, because you deny a non-bank transmission mechanism.
You said:
“Japan’s monetary base rose 85 percent between 1997 and 2003; deflation continued apace.
Japan’s recovery came from massive fiscal policy and an export boom.”
Once again, I am not a monetarist, which you seem to assume. I used the exact same arguments as you do against people like Anna Schwartz and Alan Meltzer. I guess you haven’t been reading what I write. And the Japanese case doesn’t support fiscal stimulus either, as Keynes claimed that fiscal stimulus boosts NGDP. In Japan the NGDP is the now same as in 1993, despite 15 years of huge budget deficits. So it didn’t “work.”
You said,
“No wonder why Chigago economists are so discredited nowadays…”
I don’t know if this is the best argument for a post-Keynesian to use. Shall we judge post-Keynesianism by how well respected it is among economists? Chicago economists have one far more Nobel prizes (some very recent) than any other school. How many post-Keynesians have won Nobels?
123, I don’t know whether China has stopped liberalizing or not. All I know is that one cannot trust the news media, and that all we have is the news media to rely on. I expect China will continue to liberalize, in fact I am almost certain that many of the firms now state-owned will be private within 10 or 20 years.
Current, I think Economist would argue that if you suddenly increased the monetary base 10-fold, instead of hyperinflation you’d get zero interest rates. And I think he agrees QE is possible at zero interest rates. But I’ll let him respond.
29. July 2009 at 08:23
Let’s hope that China will continue to liberalize. I just don’t have a good theory that can be used to predict who will continue to liberalize and who will not.
30. July 2009 at 04:38
123, Almost all countries have liberalized since 1980, with a few exceptions like Cuba, N Korea, Zimbabwe and perhaps the US. I see no sign the trend is slowing down.
Scott
30. July 2009 at 06:55
First,how money is created in your economy?
Second, how people increase their holdings of money? You said “Monetary policy boosts AD by putting more money into peoples’ hands”. helicopter money (a central banker dropping money on people from a helicopter)?
Suggested reading of the day: http://krugman.blogs.nytimes.com/2009/07/15/deficits-saved-the-world/
BTW, increase in spending does not necessarily lead to an increase in prices.
Confessions of an Undergraduate Economics Student from Chicago
“I went to the University of Chicago several years ago. I studied in their illustrious economics department as an undergraduate. There are nearly 400 graduates per annum.
After I graduated I felt I was missing something in my economics education. I went back and read the General Theory. Had I not done this, I would have never heard of Keynesian economics, except in passing about how it is “wrong”. (Sadly this is not an exaggeration.)
I can safely say that, at a minimum, 80% of those UofC graduates were in the same position of ignorance as me. And they were fine with it because there were Nobel winners giving them A’s and applauding their work of regurgitated free market drivel.
For example, the entirety of our required macro education consisted of two quarters’ hashing and rehashing the GE models from Robert Barro. The most ironic thing, as I see it in hindsight, is that so much of this book was built around refuting Keynesian ideas: But these were ideas we had never actually learned in the first place!
I fell in love with that Gothic campus but I do see how we were living in the Dark Ages. I think about the leaders who came from the same position as me and I shudder to think of how many mistakes we are making as a result of this ideology.”
“” UChicago, Class of 2005
Available at http://krugman.blogs.nytimes.com/2009/06/26/a-thought-about-macroeconomics/#comment-190529
Award prizes to Gary S. Becker, Robert C. Merton, Myron S. Scholes (recall LTCM…), Robert E. Lucas Jr., does not make the Chicgago school any better. J.M. Keynes, Joan Robinson, and Paul Davidson to name a few contributed to economics in more productive ways than those economists with nobel prizes.
31. July 2009 at 01:08
Shall we stop grumbling about who got awarded Nobel prizes and who didn’t. Who is respected makes no necessary difference to who is right.
Economist, if you look at the post I have set out in very clear terms what I think. Where I think you are wrong and where I think you are right. Scott has also criticized you quite clearly.
So, where are we wrong?
31. July 2009 at 13:17
Economist, No, I am not talking about helicopter money, just ordinary OMOs. But no banks.
I’ve already discussed the Krugman post, there is no evidence that deficits saved us from a depression, indeed I think the idea is absurd. The Fed had no intention of allowing a depression, they would have eased policy enough to prevent it.
I’ve read much more Keynes than most Keynesian economists have, so a Chicago education doesn’t mean you aren’t exposed to Keynes. And of course his views were always changing, and indeed were much more conservative both before and after the GT was written, than when it was written, which was 1932-34. That was his most left wing period, but he got over it.
Current, I only mentioned the Nobel Prizes because Economist raised the issue. He said Chicago economists aren’t respected. I agree it should be irrelevant.
31. July 2009 at 16:43
Scott: “I only mentioned the Nobel Prizes because Economist raised the issue. He said Chicago economists aren’t respected”
Yes, I understand that, and I agree Chicago economists were the main force that brought economics through the dark ages of the last few decades.
(That said, have you ever read the “Helliconia” trilogy by Brian Aldiss? Those with sympathies in Chicago or Vienna are made to last the centuries long Weyr-winter. Perhaps now summer has come, what we contribute to it is what was learnt in the last summer. But we must be careful that King JandolAnganol doesn’t come along and rip up our furnaces before we have finished using them.)
1. August 2009 at 07:01
Current, No I haven’t read that one, so I’m afraid I missed the metaphor. But I’ll take your word for it.
1. August 2009 at 08:08
I was being a bit cryptic, it was late at night in Ireland. I’ll be more explicit….
In many ways Chicago economists, and even Austrian economists are quite conventional. They both come from what Pete Boettke calls the “mainline” of thought though they may not be part of the mainstream at a particular time.
Both groups, and many others too, have spent a great deal of time refuting erroneous economic ideas. And they’ve spent a great deal of time ensuring that their own ideas continue to be understood and taught. To some extent this has come at the expense of further progress.
There is a perception, even if it isn’t true, that a set of articles of scientific knowledge are incorrect if they are not continually being expanded. If the ideas of a school of thought are not seen to be progressing or changing then they are seen as wrong. I understand a Imre Lakatos is to blame for this, though I don’t know much about it.
This sort of situation also seems to draw people with a rather long-range view, though I think you’re an exception. People who see changing minds as a job of decades or centuries.
I think this is part of the reason why we are currently being trumped by Krugman and co. It is easy to make an set of incorrect doctrines that grow and change rapidly. So, to the casual observer who thinks using Lakato’s ideas those are the schools-of-thought more likely to be correct.
P.S.
The “Helliconia” trilogy is a set of sf books set on a planet in a binary star system. The planet Helliconia orbits the white-dwarf star Batalix which in turn orbits the larger star Freyr. The orbit takes about 1500 earth years. The produces a set of seasons on that scale. During the 600 year weyr-winter most of the planet is covered with ice, which then melts in the subsequent summer. Humans adapt to this in various ways.
A set of guilds are set up to guard knowledge through the winter. They make books from leather that contain the knowledge necessary to do things like forge metal and other sorts of basic industry that can’t be practiced in the great winter. During winter each guildsman carefully appoints a successor they avoid all danger in order to ensure that the knowledge they hold survives. However, when summer comes the guilds have become very set in their ways. As guardians of knowledge they have neglected the part they could play in creating it. The despotic King JandolAnganol punishes them for that. The implied result (though the books don’t consider it much) is that the guilds go into the next winter in a much weakened state.
2. August 2009 at 12:00
Current, So I gather the books are an allegory for the Dark Ages. But are they also attacking fossilized dogma?
I should say that I’m not exactly a “Chicago economist” on this blog. There aren’t any other Chicago economists talking about ignoring the monetary aggregates and targeting NGDP futures contracts. But I suppose my EMH stuff is pure Chicago.
2. August 2009 at 17:38
The Demise of Monetarism
Milton Friedman’s monetarism provoked hot debates on the conduct of monetary policy from the 1950s through the 1970s. The monetarists wanted the central bank to stop setting interest rates and instead to target growth in a monetary quantity, a stock of money by one or another definition, from the monetary base to intermediate aggregates as inclusive as M2 and M3. For hitting at least some of these monetary targets setting a money-market interest rate might be the operating mechanism.
In the last two decades the sway of mechanical monetarism of this kind faded away. A principal reason was institutional change, which made the velocities of the various M’s even more variable and uncertain than they already were. Money substitutes multiplied, and definitions of M’s couldn’t keep up. Regulatory reforms and market developments allowed market-determined interest to be paid on deposits that had formerly been interest-free or subject to legal ceilings.
One proposal to avoid the problems created by volatility of money velocity V was to target nominal Gross Domestic Product, that is M times V, instead. The implicit terms of trade between rates of growth of price level P and real GDP Y, in responding to a shock to MV would then be one percent to one percent, and this might result in excessive short-run volatility of Y and P. This whole approach to monetary policy seems to have lost support, as it came to be understood that central banks did not need the discipline of intermediate M-growth targets to achieve more fundamental goals, including the control of inflation.
Source: http://cowles.econ.yale.edu/P/cd/d11b/d1187.pdf
3. August 2009 at 13:11
Scott: “So I gather the books are an allegory for the Dark Ages. But are they also attacking fossilized dogma?”
I’m not sure about that, I don’t think that Helliconia is really an allegory. In Helliconia the books don’t attack anything, they just contain facts. What they must be protected against is the planet which is a sort of anthropromorphic protagonist in the story.
The point I was trying to draw is that reasonable economists have tended to spend a lot of their careers attacking bad economics and protecting what they have. This necessarily limits progress.
3. August 2009 at 13:26
Hawk, And how is that essay relevant to my post. Is it in support of what I am arguing, or opposition? As you know, I don’t favor money targeting, including monetary feedback rules to stabilize NGDP.
Current, OK, I see you point. I agree that economics needs to keep moving forward. For instance, if we go to all electronic money, then interest rate rules might work once again.
3. August 2009 at 13:38
Scott: “if we go to all electronic money, then interest rate rules might work once again.”
That’s a very interesting idea isn’t it.
Think though about things like pre-pay mobile phones. It seems to me that there are electronic ways to make things that are like banknotes. Just as there are electronic ways to make things like checking accounts.
Anyway, we’re getting into thread drift now.