President Obama: You need to talk to Christy

Note:  Because Christina Romer and I have both done research on similar topics, I know quite a bit about her views on monetary policy during the Great Depression.  Ironically, I was planning this post for today before two things happened:

1.  There was an announcement that Obama’s economic team would meet with Bernanke.

2.  Several commenters including Dilip and R McGarry sent me a link to a paper with her views.  I presume it was in the news today.

In any case, here is the post that I had already planned:

Mr. President, before taking office many of your supporters hoped that you would be able to turn things around in much the same way that President Roosevelt did in his first 100 days.  It is not too soon to conclude that things haven’t turned out that way.  After FDR had been in office for two months we were in the midst of the fastest growth in industrial production in American history (industrial output rose 57% in his first 4 months in office.)  I think it is fair to say that when you reach the two month point in a few days, output will not be rising, indeed it will probably be falling at one of the fastest rates since the Great Depression.  How did this come about?

In a comment on my blog, Tyler Cowen suggested that you talk to me about my ideas for monetary stimulus.  I have an even better idea—talk to Christy Romer, who is also an expert on the Great Depression, and whose opinion I imagine you would trust more than mine.  Ask her the following questions:

1.  Why have economists associated with the Democratic party recently placed more emphasis on fiscal stimulus, rather than monetary stimulus?

I imagine she would say that many economists feel that monetary policy is powerless once interest rates hit zero.  Or that the banking crisis must be addressed before monetary policy can gain traction.  Then ask her the following:

2.  Do you think that monetary policy is powerless once rates hit zero?

For her answer, I don’t need to use my imagination, here are her own words:

“A second key lesson from the 1930s is that monetary expansion can help to heal an economy even when interest rates are near zero.”

3.   Then ask her why FDR was so successful in boosting the economy in early 1933 when much of the banking system was shutdown.  Was it monetary policy or fiscal policy?

I think she will have to say monetary policy, as the evidence overwhelmingly points in that direction.

4.  Then ask her why your advisors are putting all their eggs into the fiscal policy basket, despite widespread expectations that the stimulus package will not revive the economy anytime soon.  Why aren’t they putting their creative energy into developing highly aggressive, unconventional monetary stimulus plans?  The plan was for you to be another FDR, not another Hoover.  See what she says.

Postscript, I wish I had posted this yesterday, before today’s meeting with Bernanke.



28 Responses to “President Obama: You need to talk to Christy”

  1. Gravatar of Alex Golubev Alex Golubev
    9. March 2009 at 13:41

    let’s attribute it to FDR’s monetary policy and TIMING. some might argue that he came in a little later in the process of deleveraging. (I didn’t buy obama’s empty rhetoric and in return wouldn’t blame him for something he wouldn’t be able to do much about. same goes for mccain. this is running a risk of turning into a left vs righ freeforall instead of focusing on economic issues).

  2. Gravatar of StatsGuy StatsGuy
    9. March 2009 at 16:58

    It’s rather important to note that simply increasing the money supply may prove insufficient. As Krugman has lately noted, base money may be growing, however credit is not. People are “stuffing money into mattresses”, and no amount of Presidential protest is going to stop this.

    Inflation is commonly misunderstood as too much money and too few goods. This is not true.

    Inflation is exactly what we all learned in 5th grade.

    Too much money _chasing_ too few goods.

    Without the chasing, there is no inflation. Merely potential for inflation.

    The lack of demand is now largely due to lack of willingness to spend, which is largely due to expectations. As Warren Buffett noted, the change in consumer psychology has exceeded everyone’s projections. Something needs to change expectations.

    If we dump massive capital into banks without any expectations of growth, we end up with massive _potential_ for inflation. This potential may continue to build until something finally triggers it. Then, rather than seeing modest (healthy) inflation, we’ll see a “rush to the exits” as liquid cash rapidly seeks inflation proof assets.

    In the meantime, we’ll have asset deflation and destruction, largely due to expectations of the same. The stock market, for example, is not cheap when everyone and their grandmother think it’s going to get cheaper next month.

    In the meantime, the govt. has gotten this crazy idea through it’s head that recapitalizing the banks will magically fix the economy. In the meantime, as the economy tanks, all of those impaired assets are turning into real losses as _potential_ bankruptcies become _real_ bankruptcies, and private losses are being shifted onto the public treasury (the taxpayer, which really means future generations). These are losses that will not be recovered.

    Thus, there is good reason for the fiscal stimulus. HOWEVER, if the fiscal stimulus occurs without monetary stimulus, then the govt. is simply substituting public investment (which may or may not be efficient) for private investment through a crowding out effect. Moreover, much of this stimulus goes abroad without other countries reciprocating to the same degree. Unfortunately, because the stimulus is being paid for by issuing debt rather than printing money, we are not creating adequate monetary stimulus.

    Instead, we are giving money to banks and hoping they will create money for us by lending it out. Yet they aren’t, and so we have this spectacle of Congress hauling bankers into committee testimony and asking why they aren’t printing money… when Congress is fully capable of printing its own money.

    The solution is quite simple, and was laid out by Bernanke years ago – print money, and use this to pay for the stimulus rather than vastly increase the debt load on future generations. Ideally, coordinate with the G20 to do this to avoid currency volatility.

    We face a stark tradeoff – inflate now and pay the price in higher interest rates, or watch the Debt-To-GDP ratio rocket to 85%+ while our economy shrinks, baby boomers retire, and tax revenue plummets along with our shrinking GDP.

    If the Obama administration fails to execute, they will have no excuses – they will solely bear the burden for their failures, and will have failed even with the ample history to learn from. That would be tragic, given the other severe crises the world faces.

  3. Gravatar of ssumner ssumner
    9. March 2009 at 17:47

    Alex, I don’t blame Obama for this money mess, I blame the muddled thinking of my profession.

    Statsguy, People were stuffing far more money under their mattresses in 1933 than today, and yet FDR succeeded in boosting prices with unconventional monetary policy. Your arguments against me would be valid if I had proposed conventional monetary policy, but I do have specific proposals aimed at the problem of hoarding and low velocity. I encourage you to check out some of my other posts, such as the petition. Thanks for checking out this site.

  4. Gravatar of JimP JimP
    9. March 2009 at 18:31

    Welcome to the blog StatsGuy. Nice to see you here.

    As Scott – and you – both say – it is a matter of EXPECTATIONS – and Bernanke can change those. All he has to do is commit to inflation – with a stated price level target. As you say – he can change expectations exactly because we all know that he can print to pay for the stimulus – among other things. He can change expectations, contra Krugman, because we know that the governtment certainly will spend that money – and therefore we all had also better start spending as well.

    Would only that he would only do so – and very very soon.

    I certainly do agree with you that to recap the banks is not the first priority – and that to do that in a time of deflationary expectations would be a disaster – another unforced error. A voluntary choice to kill ourselves – and so fulfill the deflationary dreams of the Andrew Mellons at Baseline.

  5. Gravatar of Rob Rob
    10. March 2009 at 04:51

    Chairman Bernanke spoke this morning to the Council on Foreign Relations (broadcast live) and made an interesting comment that might be relevant to this post:

    – “We’ve been very aggressive. We’ve cut rates essentially to zero…. We are now augmenting those conventional monetary policies with new, creative, unconventional policies to try to have additional impact on financial conditions.”

    He didn’t say whether “are now augmenting” meant that he was working real time on new measures or whether he was referring to recent initiatives….

  6. Gravatar of smokedgoldeye smokedgoldeye
    10. March 2009 at 05:40

    Statsguy is right. People have rational expectations that things will get worse, so they’re not spending. Businessmen, like me, have rational expectations that the Obama administration will continue its anti-business agenda (wealth distribution, cap & trade, card check etc. etc.). We aren’t planning new projects. We are reversing hiring. Every one is acting rationally in this environment (and I disagree with you Scott, mortgage lenders and banks weren’t lending money “insanely” during the boom years. They were acting rationally given Greenspan’s massive inflation of the money supply and the government imposed moral hazard of privatizing profits and socializing losses). We need a pro-business set of policies from Washington NOW! And, as you know, my preference is for government to exit the money supply business altogether so they can never cause these awful artificial booms and destructive contractions for future generations of enterprising Americans. Let Obama make a statement tomorrow: “The business of America is business.” The market will roar upwards and consuming and investing confidence will return.

  7. Gravatar of StatsGuy StatsGuy
    10. March 2009 at 11:02

    I’m not actually arguing against you, and I concur that we need more levers to control the velocity of money. Both on the upside _and_ the downside. As the Fed builds up the underlying monetary base, the potential for inflation increases, such that when everyone decides (all as a herd) that inflation is coming, it will really come fast. It might take a while before everyone concludes inflation is really coming because asset deflation is wiping out wealth so fast.

    Also, we have an issue with our understanding of inflation. We treat it as one thing, but clearly it’s not one thing. Go to the grocery store – prices on food have not come down. Oil has shown an ability to spike to 147 dollars, down to 35 dollars, and back up to 46 dollars within 8 months.

    The traditional interpretation of inflation – consumer price index – is woefully lacking. This is particularly true as household wealth makes relative gains against direct household income as a source of prosperity (partly due to an aging population going into retirement, partly due to flat real incomes, partly due to increasing wealth inequality). A drop in asset values translates into a drop in wealth which translates into a drop in effective (perceived) spending power. Notably, part of what launched the great depression was large investment in stock trusts which made aggregate consumption vulnerable to a wealth shock.

    In traditional macro theory, when income drops, households compensate by dissaving (to smooth out consumption). And I know we have data that observes this in typical situations. However, when wealth drops faster than income, people (rationally) compensate by saving as fast as they can to rebuild wealth. Savings thus become pro-cyclical, not anti-cyclical. Money stops chasing goods. And this doesn’t even take into account the psychological aspect of the thing.

    In terms of the ability to reign in the money supply when things get better so as to mop up inflation, rather than ramping up the interest rate (very painful), we might consider imposing direct constraints on the cap-asset ratio. Thus, when times are good, we restrict leverage (force banks to raise more capital). When times are bad, we increase leverage (allow banks to run a higher ratio of assets to capital base). Giving this ability to the Fed may extends its control a bit.

    The Fed Funds rate is a very crude way of impacting money supply, with it’s effect being largely psychological. Hitting the zero bound has driven this home, but it’s _always_ been crude. The problem with the Fed Funds Rate is that it has TWO effects – it alters the incentive structure for extending new credit, AND it affects existing adjustable rate credit and/or credit that is being rolled-over. One instrument to do two things means nasty tradeoffs. Thus, if the Fed raises rates to cut inflation it has the effect that anyone already in an ARM or with a home equity loan suddenly sees a sharp income loss. In practice, the Fed really just wants to limit the extension of new credit, not make people poor. Exerting direct influence over the cap-asset ratio gives the Fed a second instrument (however domestic banks would cry foul about foreign banks not facing the same restrictions, and therefore having a competitive advantage – so lax capitalization standards becomes an international “race to the bottom”).

    Also, maybe we need to start tracking some of these concepts that modern macro just doesn’t want to talk about – like household wealth. Unfortunately, that may raise some touchy subjects when we see what it actually looks like over time and across population strata. We already killed M3 (why is still a mystery, but one can posit because it made the financial system just a little too transparent).

    There, some more “radical” ideas to add to the mix.

  8. Gravatar of ssumner ssumner
    10. March 2009 at 11:57

    Jon, I agree. I haven’t had time to look closely at Baseline, but that doesn’t sound good.

    Rob, I wish I knew what the Fed was up to. I am pessimistic right now. They need a more explicit target. Tell us where they want to steer the economy.

    SmokedGoldeye, I think it is too easy to just blame the moral hazard problem. I do agree with you that moral hazard played a bigger role in this than most people realize, maybe far bigger. I go back to LTCM in 1998, which made people believe the big investment banks were too big to fail. And then there’s FDIC insurance, which we don’t even think about any more. Most people didn’t care if their bank was making lots of sub-prime loans. But even with all the bailouts, the banking sector has been devastated. There’s no doubt that “mistakes were made.” Bankers didn’t want this to happen.

    Statsguy, I also have problems with the CPI. My preferred target probably tracks wealth far better than the CPI, as NGDP growth has been rapid during the stock market boom years, and vice versa. I’m not so sure however that stock market wealth has much effect on consumption–at least in the cyclical sense. The stock market crash of 1987 seemed to have almost no impact, and academic studies generally don’t find much impact. I think housing wealth shows up stronger, and perhaps that’s what you are thinking of, as it obviously has recently been highly instable.

    I haven’t thought much about saving–but your wealth argument for countercyclical savings makes sense. Is that a counter to the old Keynesian view that said the propensity to save just mysteriously increased, causing recessions?

    The leverage idea also sounds good. Did you see in the news today that Bernanke talked about how under our current regulatory system banks are actually required to restrict lending during recessions?

  9. Gravatar of StatsGuy StatsGuy
    10. March 2009 at 12:45

    I suspect Bernanke’s comments were more targeted to support relaxing mark-to-market, but it’s the same general idea. Mark-to-market, by enforcing losses before they actually happen, requires banks to very rapidly set aside assets and build loss reserves. Since markets move faster than loans default (due to anticipatory losses), and cap-asset ratios restrict loans that can be made as a function of asset base, taking an anticipatory loss can create a massive reduction in ability to extend credit _as mandated by law_.

    Indeed, market manipulators (short funds) can actually create a recession in this manner by short-selling sufficient credit-backed securities (particularly in an illiquid market). This creates massive implied losses that must be marked down immediately, and therefore forces banks to instantly restrict credit (or call in loans), and hence we get what happened in September 08.

    As to the wealth effect – it’s essentially the same issue raised by Shulman in his article (Dec 08) on balance sheet recessions. It refers to total wealth, not just stock wealth. However, it’s important to recognize that household level wealth holdings are not all equally distributed. So while the average household may have suffered a net wealth loss of 27% in 2008, this means some suffered 70% or more while others actually gained.

    As to why the 87 crash did not cause a balance sheet recession, we know that stock holdings have become massively more broad-based since then. Also, the 87 crash was not driven by fundamentals, but by a bunch of computers all running black-sholes at the same time without any automatic-shutdowns on the exchanges. It was followed with a massive bounce-back over the next couple days (which according to stories was engineered by the Fed which promised the investment banks unlimited liquidity – that is, a totally one way bet), and was rapidly explained away to the public. Consumers did not perceive a permanent wealth loss. This is a vastly different situation – the CCI does not lie. Consumers see this wealth loss as permanent.

    I expect a lot of resistance in the economics profession to the concept of a wealth shock inducing a prolonged recession/depression. They’re still struggling to explain Japan. Krugman is still more outsider than insider, it seems. He’s not a popular guy because no one likes what he has to say.

    The challenge to introducing wealth into economic models is that it inherently brings in distributional consequences, which the standard “optimal allocation” market model doesn’t care about. In standard macro, wealth redistribution only affects who gets to consume, but doesn’t impact the efficiency of resource consumption.

    Suddenly, the wealth distribution would impact economic efficiency – dramatically. This is something that empirical economists like to argue (e.g. countries with large middle classes see higher growth), but it would cause free market purists physical pain.

  10. Gravatar of smokedgoldeye smokedgoldeye
    10. March 2009 at 13:51

    “The challenge to introducing wealth into economic models is that it inherently brings in distributional consequences” You seem to be darkly hinting that spreading the wealth is the key to economic prosperity. Which are those high growth countries you’re thinking of that don’t let rich people keep the money they accumulated by means of repeated voluntary transactions benefiting both buyer and seller? What is your definition of middle class anyway? And speaking of “economic models” — which model predicted say even 3 of the last 5 recessions? How about an economic model of private property and free markets (ie. no granting of special privileges by the government). When have we tried that? Don’t forget, the countries in the world where the poorest are best off are those that have the strongest private property rights.

  11. Gravatar of SteveGinIL SteveGinIL
    10. March 2009 at 20:52

    Stastguy said (9MAR 16:58):

    “It’s rather important to note that simply increasing the money supply may prove insufficient. As Krugman has lately noted, base money may be growing, however credit is not. People are “stuffing money into mattresses”, and no amount of Presidential protest is going to stop this.”

    As we all know from legendary history, people in 1930-1933 were doing exactly that – stuffing money into mattresses, because they didn’t trust that if they put their money into a bank that they would be able to get it out again.

    And FDR – after he declared a bank holiday the day after his inauguration and set bank examiners to assess each bank’s viability (a HUGE undertaking at the time with all the local banks around the country) – got people to take that money OUT of their mattresses. How did he do it? With his fireside chats. He was able to reassure them that their funds would soon be insured. By the time the banks reopened, depositors were lined up outside, waiting to put their money back into the banks.

    What is a possible parallel in the current scenario? And WHO is it that Obama has to reassure? Joe Main Street? Your Mom and Pop investors? The Chinese government? Other banks and financial institutions? Institutional investors? All of the above?

    From what I see among my friends, co-workers and my company’s vendor base, everyone IS stuffing money into their mattresses – or its equivalent. Why? Because any of us are unsure we will have a job – or a company – in 3, 6 or 12 months. And many of us are getting hours cut back or wages cut, so there goes Disney World this year, and the skiing vacation next year.

    How DOES Obama reassure us that we are going to have a job in 3, 6 or 12 months? What magic words does he speak that will tell us it will be alright?

    Well, FDR didn’t just SAY words and let it go at that. He ACTED first, and then he spoke.

    Alex Golubev pointed out that, “some might argue that he came in a little later in the process of deleveraging.”

    Alex, I am one of those making the rounds and making that assertion. By the time FDR was elected, the Depression had already been going on for almost exactly 3 years, and FDR had another 5 months before he took office. Add to that was that FDR and his advisors were able to watch Hoover and his efforts, all of which failed. SO, FDR already knew what NOT to do, before he raised his right hand on March 4th, 1933.

    NOw, also take into account that there were two other Depressions during FDR’s life. There was the Long Depression of 1873-1895. FDR was born in 1882, so he was 13 when the Long Depression ended, and he must have learned something about it from his elders. Certainly FDR’s older advisors knew even more about it. Then they were all completely informed about the Panic of 1901.

    Now, look at Obama. The September meltdown had occurred only 7 weeks prior to his election. And then he had only 11 weeks before he was inaugurated. 18 weeks vs 41 MONTHS. Obama is being asked to be a wizard.

    And almost none of his advisors has ever lived during a depression. Paul Volcker is pretty much the only one who was alive during the New Deal. The rest are experiencing this for the first time.

  12. Gravatar of ssumner ssumner
    11. March 2009 at 15:48

    Statsguy, Despite your name, you need to check your facts. There was no massive immediate bounce back from the 1987 crash (which was very similar to 1929.) The Dow peaked at 2722 in late August, fell below 2000 in late October, and never rose above 2014 the rest of the year. Stocks stayed on a permanently lower plateau, much lower, for the last part of 1987 and then recovered very gradually over several years.
    I also question your choice of words about stock ownership being “massively” more broad-based today. Somewhat yes, but enough to explain the virtual complete lack of a wealth effect in 1987? I doubt it.

    The argument that there were no fundamentals in the 1987 crash actually plays right into my hand. I have argued that the best way to understand the 1929, 1937, and 2008 October crashes is that a third factor caused both the stock crash and the subsequent drop in consumption (and other spending.) In each of those three cases there was a massive drop in AD (caused in my view by monetary factors, broadly defined.) This monetary policy failure depressed both stocks and consumption. In 1987, there was no monetary shock, and hence no reason for the stock market crash to impact consumption, precisely because stocks alone don’t have much impact on AD–especially if the central bank is targeting inflation or NGDP.

    The debate over wealth shocks also plays into the confusion over real and nominal variables. I am trying to explain why nominal GDP is falling. If we want to explain why a falling nominal GDP has an effect on real GDP, we go to a Phillips curve model, not a wealth model. But you can hardly argue that a loss of wealth would reduce nominal GDP, otherwise Zimbabwe’s nominal GDP should be plunging, instead Zimbabwe’s nominal GDP is growing faster than any other country in the world. You might say, “but that’s due to hyperinflation.” Exactly my point, if you want to explain nominal aggregates, go to monetary policy.

    SteveGinIL, Sorry, but I disagree with almost everything here. I don’t see how fireside chats would help, it’s no different from Hoover saying prosperity is just around the corner. Actions speak louder than words, and fortunately FDR backed his words with actions. By far his most effective policy was dollar devaluation, that’s what jump-started the economy (and there is enormous evidence to back up this assertion.)

    You say your co-workers are hoarding cash or “its equivilent.” From the perspective of monetary theory bank reserves are the only equivalent. So unless your friends own banks, I doubt whether they are hoarding large quantities of base money. In any case we have very accurate data on the total amount of base money in circulation, and it has fallen sharply in the last two months—see my post today. With FDIC insurance, I doubt we will see cash hoarding on the scale of 1933, but even if we do, the Fed can easily accommodate it.

    BTW, there was no depression of 1873-95, there was deflation. Those years saw one of the largest industrial expansions in world history. Check out George Selgin’s writings on this. The Panic of 1901 occurred in 1907.

    And finally, I do agree with you on one thing, we should not be blaming Obama for this mess, we should be blaming macroeconomists for not having the courage of their convictions. They say we should target the forecast aggressively when there is a threat of deflation, why aren’t we doing it?

    Sorry to be so negative, but I cannot let inaccurate facts pass by unchallenged.

  13. Gravatar of Vangel Vangel
    11. March 2009 at 16:46

    I am sorry but it is hard to take an argument seriously when one suggests that FDR’s policies were a success. From what I can see in the data from the 1930s neither fiscal nor monetary policies did anything to stop the crisis. In fact, the actions taken by Hoover/FDR managed to turn what should have been a painful contraction into a Great Depression.

    I suggest that instead of turning to Romer, Mr. Obama should turn to the economists who saw the crisis before it happened and were warning politicians and the public against the danger presented by the Fed’s inflation and the government’s reckless spending. They would tell Mr. Obama to follow the proven strategy that was taken by Harding, who cut both spending and taxes to end the post WWI depression in just over a year.

  14. Gravatar of ssumner ssumner
    11. March 2009 at 17:22

    Vangel, I shouldn’t have said dollar depreciation was FDR’s best policy, I should have said it was practically his only effective policy. FDR’s wage and price fixing probably delayed recovery for roughly 6 years (from 1935 to 1941), essentially doubling the length of the Depression. Harding’s laissez-faire policies allowed for a very quick recovery from the 1920-21 depression he inherited from Wilson. Harding also released many political prisoners, whose only crime was speaking out against Wilson’s policies, and he also was much less racist that Wilson, and I could go on and on. In my view Harding is one of the most underrated Presidents in U.S. history. (Yes there was Teapot Dome–but haven’t most presidents had corrupt cabinet secretaries?) And don’t get me going on Wilson’s foreign policy.

    I bet you are surprised by how much I agree with you.

    So what explains my statement about FDR? I couldn’t care less what political party someone belongs to, or whether they are a capitalist or a socialist, I call each policy as I see it. And FDR’s dollar devaluation program was on track to produce an even faster recovery that Harding; industrial production rose 57% in just his first 4 months in office. The recovery was later aborted by the NIRA in late July 1933, but the dollar devaluation was a very effective cure for deflation (which was Hoover’s biggest mistake.) He should have just done the devaluation, and waited for a quick recovery, but he couldn’t leave well enough alone. You might like my early post on FDR’s high wage policy, if you are not a fan of FDR.

  15. Gravatar of Vangel Vangel
    11. March 2009 at 18:09


    I am sorry but I can’t see a devaluation as a solution because it ultimately leads to a massive loss of purchasing power for savers and I consider that immoral. FDR devalued the dollar by 69.3% so one would expect the reported industrial production to increase sharply even if stays flat in real terms.

    I also have a problem with the idea that it was just the devaluation that caused the brief reversal of the trend. Actually, I think that you would agree that during any prolonged contraction we could see a number of very strong counter trend rallies. (That is exactly what we saw in Japan as the NIKKEI fell from its all time high of 38,916 to less than 8,000.) For a recovery to be significant it has to be real and has to last.

    Although I am familiar with the subject I look forward to looking at your posting about FDR’s wage policies. And even though I suspect that you are familiar with the piece let me recommend Robert Higgs’ great article, Regime Uncertainty. You can find it at or in Robert’s great book, Depression, War and Cold War.

  16. Gravatar of Joseph Joseph
    12. March 2009 at 04:44

    Mr Sumner,

    I would like to elaborate on something Vangel mentioned above.
    Over the last 10 years there were some people who did not overspend, did not take on massive debt but prudently saved. They (well, shall I say we) expected that when the madness on the housing market ends we will be able to use our savings to finally buy a property – reasonably priced one. We expected that we would not have to use 50% of disposable income to pay the mortgage off. Now our day has finally come or has it? We are not wealthy – we either rent or live in small houses, all we have are our deposits that should become our downpayments. And from what I can see most economists – including you, unfortunately – see the best way out in bringing in huge inflation, that will ruin our chances completely, at the same time helping those who indulged in “high life” all those years! So we – unlike many – suffered before and somehow we should suffer more and pay for this way out. Until problem is addressed in policy proposals, until there is something protecting the value of our deposits (and I do understand there is no fair way of doing it) I will consider any “pro-inflationary” proposals nothing but a daylight robbery and would want governments and central banks (and economists advising them! 🙂 ) to keep their hands out of my pocket and let the life take its course.
    I hope there is something positive you could say in response.

  17. Gravatar of ssumner ssumner
    12. March 2009 at 05:07

    Vangel, Thanks for the link. I agree with his view that the New Deal explains the slow recovery, although I also happen to think that most the the harm was done by FDR’s high wage policy. The other policies were also harmful, but the effects were not as dramatic. The wage post is already there, by the way, if you scroll back to early February, soon after I started the blog.

    The industrial production data is real, not nominal, so production did rise fast, but only for 4 months. The WPI went up just over 20% from March to early 1934 when the dollar was pegged at $35, the CPI (then called COL) went up about 10%.

    I disagree about the morality of the devaluation. If prices had previously been stable, the savers would have been ripped off. By the price level had just fallen by 30%, so FDR was correcting an earlier wrong. Some savers thought they were being ripped off because they got back less gold than promised, but they also got back more purchasing power, as even in the last half of the 1930s price levels remained far lower than the 1920s. So it seems to me that it was a reasonable compromise.

    Now just to make things more complicated, FDR could have got by with a much smaller devaluation (say raising gold to $28), if it hadn’t screwed things up by raising wages 20% by executive fiat in late July. So there is some truth to your assertion that the 69% rise was excessive.

    But I’m not a gold standard supporter, so I don’t worry too much about those things, except to the extent that it screws up the price level, or production.

  18. Gravatar of ssumner ssumner
    12. March 2009 at 09:16

    Joseph, I think you will be relieved to know that I do not favor high inflation. Over the past few decades the Fed has seemed to move toward a goal of roughly 2% inflation. I actually prefer 5% nominal GDP growth as a target, but since they would both produce the same long run inflation, let’s put that aside. My point is that all sorts of financial planning, debt contracts, wage contracts, etc, have an implicit built in expectation of modest inflation. If you don’t get any inflation, then companies who gave workers 4% pay increases suffer a big loss in profits, and have to lay workers off.

    The housing market certainly got overextended, and it is important that the house prices correct back to their long run equilibrium. My point is that we should not depress the entire economy while doing this. My model is the year or two prior to last September, when housing prices were already in the process of correction and yet the rest of the economy held up pretty well. Then the entire economy started plunging sharply lower as AD fell. Now housing prices might actually undershoot their long run equilibrium, if the recession gets very bad. So although I don’t like artificially inflated housing prices, I also don’t like an excessively tight money policy which pushes them even lower than their long run equilibrium. Since I favor roughly 2% long run inflation, not 10% or 20%, I don’t see how I can be accused of being an inflationist. If you read some of my other posts you will get a more balanced view. The FDR example was just showing that monetary policy can be effective, that is have an effect, even in the sort of conditions we have today. Since you are worried about inflation you already accept this technical point, but many people do not–hence the forceful argument.

  19. Gravatar of Joseph Joseph
    12. March 2009 at 13:08


    Thank you very much for your kind reply.
    Of course it is great to know that you do not favour high inflation. I do not want to take more of your time but there is just one more thing: taking into account QE policy is not something widely practiced before how likely it is it will not be easy to curb high inflation should it actually start? That is I am afraid the main problem. Expectations may take a long time to be set (that may explain why it took two years for house price “correction” to manifest itself in a broader economy) but once they are actually set they may be very difficult to change.

  20. Gravatar of Vangel Vangel
    13. March 2009 at 12:53


    I do not see how anyone can debate the morality of the devaluation. Devaluation rips off purchasing power from savers and sends a signal that saving is a sin that should be punished while consumption is a virtue that needs to be subsidized. I don’t know about you but I consider robbing prudent savers of their purchasing power to be a form of theft and that should be considered immoral in everyone’s book. Actually, all irredeemable paper money is immoral and a form of theft because Voltaire was right when he wrote that, “Paper money eventually returns to its intrinsic value–zero.”

    But even if we get beyond the morality issue we see the folly of devaluation. As an economist you know that savings are the only source of additional capital. After all, all the goods produced are consumed will not be able to invest in new capital. And without new capital how do we create new employment opportunities for people? The Higgs argument is very powerful because of that point. During the Great Depression business was seen as the enemy and Hoover/FDR increased taxes on the ‘rich.’ FDR was also a source anti-capital rhetoric that created a great deal of worry and uncertainty among investors. Why would a prudent investor take the risk of investing savings in a factory when the government caps returns if that factory turned out a profit? It is much safer to buy a government bond and live comfortably off the interest as the standard of living of most people declines.

    Writing from experience, I avoid investing in countries where property rights are not well defined unless I can get a massive discount relative to what I would pay for similar assets. While that approach protects my investment by offering a greater return for the added risk it harms the citizens of those countries because they are unable to charge as much for assets or labour as they would if their governments offered protection to investors. Whether Americans like it or not investors in the natural sector in Arizona or California will offer far less than they would for equivalent assets in Quebec.

    I support a gold standard because it offers a form of protection to workers, investors and savers from governments. It ensures that the money supply is independent from the policies and wishes of political parties and central planners and ensures that the purchasing power of savings are independent from the actions of national governments.

  21. Gravatar of ssumner ssumner
    13. March 2009 at 17:22

    Joseph, In some other posts I discuss forward-looking monetary policy, that tries to keep inflation expectations low and stable by using indicators like the spread between regular bonds and indexed bonds (the interest rate spread is roughly the expected rate of inflation.) If you use forward looking indicators you do not need to worry about policy lags sneaking up on you.

    Vangel, I believe that unexpectedly high inflation (not factored into nominal interest rates) robs savers, and unexpectedly low inflation or deflation robs borrowers. I would keep inflation low and fairly stable. Loan contracts would reflect about 2% expected inflation. I think that would be fair to both sides. We can agree to disagree about what should have been done in 1933, when prices had already fallen far too much, but in general I favor a stable policy that is fair to savers. I also agree with you criticism of the New Deal, and your view that property rights, etc, are absolutely key to a successful economy.

    BTW, I am not convinced that a gold standard will produce a stable purchasing power of money, but I do agree that a truly free market gold standard would avoid the worst excesses committed by monetary policymakers throughout history.

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