QE II is arriving right on schedule

The Great Depression started in August 1929. The Fed first began increasing the monetary base in late 1930, in response to the first bank run (which was rather small.)  The second QE was announced in February 1932 (30 months into the Depression), and was not a reaction to financial distress but rather was an attempt to boost aggregate demand.

This time around things are different.  The Great Recession formally began in December 2007, although I put July 2008 as a mini-peak, before the sharp drop in AD.  The first QE was in response to bank distress, and occurred in late 2008 and early 2009.  Now we will have a second QE announced in early November, either 28 or 35 months into the recession, depending on when you start it.  In other words, it’s right on schedule.

I know what you are thinking: “Don’t be so sarcastic, in other respects we are doing much better this time.  For instance, the Fed has cut rates close to zero.”  The problem is, they also cut rates close to zero in the early 1930s.

“But at least we aren’t raising income tax rates like Hoover did in 1932.”  Well Obama’s trying to.

“But at least we aren’t following Hoover’s high wage policy.”  Didn’t we raise minimum wages by over 40% in the last few years?

“But at least we are not following Hoover’s protectionist policies which started a trade war.”  That’s true, but we have a Nobel Prize-winner trying to push us into a trade war.

“But at least we understand the real problem this time.  In the Depression you actually had lots of conservatives warning about high inflation, even as low prices were the real problem.”   No comment.

“But at least we don’t have people claiming the recession was punishment for speculative excesses abetted by easy money.  Surely Friedman and Schwartz ended that myth about the 1920s once and for all.”  Actually the myth has been revived, by Anna Schwartz.

“But at least we don’t have people claiming that a sharp cut in interest rates and a big increase in the monetary base means money is “easy.”  Surely Friedman and Schwartz’s highly influential work on the Depression dispelled that myth.”  No comment.

“But at least we don’t have the bizarre scenario of the 1930s, where both liberals and conservatives made bogus “pushing on a string” arguments, while simultaneously warning of the risk of high inflation.”  No comment.

“But at least we no longer have people claiming the recession was caused by income inequality–we now understand the root cause is insufficient AD.”  No comment.

“But at least we no longer have people claiming the unemployment is mostly structural.”   No comment.

“But at least we don’t have people arguing that monetary policy should be used to pop speculative bubbles—the disastrous effects of the Fed’s attempt to pop the 1929 stock bubble drove a stake into the heart of that misguided idea.”  No comment.

Want more parallels?  The European debt/exchange rate crisis occurred 5 to 8 months before QE II was announced as a debt crisis hit Germany in June 1931 and Britain left the gold standard in September 1931.  What happened in Europe during the spring of this year?

In fairness to my critics, I should point out that QE II was greeted ecstatically by the stock market.  (The largest 2-day rally in history.)  Yet the policy failed.  In my favor, the reason for it failing (a large gold outflow mostly neutralized the bond purchases) is not operative this time.  But there is certainly a possibility that it will fail again, and that the Fed will need to use more powerful tools like negative rates on excess reserves and level targeting.

In 2002, Ben Bernanke assured us that we have learned the lessons of Friedman and Schwartz:

Let me end my talk by abusing slightly my status as an official representative of the Federal Reserve. I would like to say to Milton and Anna: Regarding the Great Depression. You’re right, we did it. We’re very sorry. But thanks to you, we won’t do it again.

In fairness, they did move aggressively enough to prevent what otherwise would have been a depression in 2002-03.

But have we really learned our lessons?  I’m not so sure.  What do you think?



47 Responses to “QE II is arriving right on schedule”

  1. Gravatar of marcus nunes marcus nunes
    16. October 2010 at 09:51

    Great parallels. Makes you wonder if “knowledge” really advances and how much people (especially academics) undervalue “historical understanding”. All the “fomalization” encapsulated in “models” have only served to pigeonhole people in different schools of thought! 30 years ago Lucas wrote that the main function of theoretical economics was to provide fully articulated, artificial economic systems that can serve as laboratories in which policies could be tried out at low cost. People took the word artificial literally, so that History, the greatest economic laboratory, well articulated in F&S Monetary History, is ignored!

  2. Gravatar of Joe C Joe C
    16. October 2010 at 10:02

    “But at least we no longer have people claiming the unemployment is mostly structural.” No comment.

    There is always a structural component to unemployment but typically its small; I believe it has been exacerbated by the current downturn, mostly because of housing (reduced labor mobility). I also believe over time structural unemployment has increased but the main cause of the downturn has obviously been reduced AD.

    There is lack of high skill workers in this country and consequently there are many technical positions that remain unfilled. I think this problem will ultimately work itself out however by either importing high skill workers or companies will be forced to produce less.

    I dont know why the arguments have to always be either this or either that when there are typically multiple issues occurring simultaneously.

  3. Gravatar of Benjamin Cole Benjamin Cole
    16. October 2010 at 10:06

    More excellent commentary by Scott Sumner.

    J. Crickey Almighty, you still have conservative columnists pettifogging about inflation. 0.8 percent core CPI, and Boskin says that reads 1 percent high, due to adaptive consumer and business buying patterns.

    In other words we are in deflation now.

    Thank goodness it is Ben Bernanke, and not the intellectual midget of Richard Fisher, who is in charge. If Bernanke can stick to his intellectual guns he may go down as the great Fed Chair of all-time (though he needs to hurry up). He studied the Great Depression in depth, he was an adviser to Japan. This is a stroke of luck for the economy.

  4. Gravatar of marcus nunes marcus nunes
    16. October 2010 at 10:25

    From Krugman:
    “What I have always suspected is that the real risk the Fed fears is that it will do unconventional stuff but fail to move the economy, and hence lose face “” which was the primary reason the Bank of Japan was so unwilling to act back when Professor Bernanke used to criticize it. So it’s important to understand two things: first, this should not be a consideration “” the Fed’s job is to save the economy, not its own reputation. Second, half-hearted measures are a good way of guaranteeing that unconventional policy fails”.
    But history teaches that “saving face” (reputation) was always a Fed priority. Not only in the GD but also during the high inflation of the 70´s!

  5. Gravatar of W. Peden W. Peden
    16. October 2010 at 10:44

    Great parallels, Professor Sumner. One can make a case that economists and policy makers, as groups, have learnt absolutely nothing from the Great Depression. 70 years of marcoeconomics have ended with making the same mistakes twice.

    Clearly, this means that Friedman’s place in the history of economic thought has to be reconsidered. His analysis, with Schwarz, of the Great Depression, has apparently been far less influential than his other work. Is Friedman’s legacy, after all, simply to be a rather unconventional (neither Austrian School nor Objectivist) kind of libertarian with some cred. from being a Nobel Prize winning economist?

    I consider his work on monetary history and the quantity theory to be his greatest single contribution to economics, with his empirical approach to the question of the relationship between inflation and unemployment coming a close second. (Interestingly, Friedman himself considered his work on consumption to be his best contribution to economics.)

    Talking of the history of economic thought, perhaps the last three years have been the greatest argument for not ignoring it. Faced with their biggest challenge in thirty years, economists and policymakers reverted to the crudest possible theories to justify their normative aims: Krugman became a stone-age Keynesian, monetarists (with a few exceptions) reverted to blind inflationphobia, supply-siders reduced everything to taxation and so on. Perhaps, if they were all steeped in the story of von Mises, Hayek, Keynes, Friedman, Mundell and so on, things could have been different.

    I am often asked, by younger philosophy student, why they are made to spend so much time studying the history of philosophy. No-one notable in the field is still a 5th century Platonist or a Stoic or a Peripatetic, so why teach them about these ideas? Why does every good first-year course in philosophy start with reading a text by Plato? Because it’s almost impossible to understand the questions in philosophy without understanding the history of philosophy.

    The same is true in economics and I think any discipline. I had absolutely no idea what was so important about the quantity theory of money and what question it was supposed to answer, when I first went from reading Friedman’s normative work to reading his positive work.

    Perhaps, if monetarists were a bit more familiar with why Friedman wrote what he wrote, they would have realised the true nature of the problem. As it happened, it was generally only those monetarists who are students of (or, like Tim Congdon, figures in!) economic history who realised what was happening. As the tragic case of Schwarz shows, even those who answered the questions can have trouble seeing why the same questions are relevant today.

  6. Gravatar of W. Peden W. Peden
    16. October 2010 at 10:50

    Marcus Nunes,

    I think the “face-saving” analogies with Japan in the 1990s/turn of the century and with the USA in the 1970s is an excellent one.

    Central banks have a history of being more afraid of a policy measure not working than they fear failing to solve the current problem. That was what scuppered the plans for monetary base intervention by the Bank of England in the late 1970s/early 1980s in the UK: all the non-politicians who would be implementing it (the BoE and the Treasury) opposed the idea, usually on the basis that they thought it might not work and would thereby harm the reputation of the BoE and the government. The result was that much of the Medium Term Financial Strategy, particularly in the early years, was done using variable (and punitive) interest rates.

    Friedman was apparently exasperated when he gave a hearing to the committes in London, saying something along the lines of “No-one who has been familiar with the developments in monetary economics in the last 15 years could have devised the list of techniques that are supposed to execute this strategy”!

  7. Gravatar of Doc Merlin Doc Merlin
    16. October 2010 at 11:07

    @ W. Peden

    “No-one who has been familiar with the developments in monetary economics in the last 15 years could have devised the list of techniques that are supposed to execute this strategy”

    I think a better model for central banks is to treat them as monopoly institutions with approximately MR=MC.

  8. Gravatar of Luis H Arroyo Luis H Arroyo
    16. October 2010 at 11:12

    mr Nunes, I aagree with you that the history is the best laboratory for economist. mathematical economy has been a great mistake. Specially when it is in the hands of mediocrity. Lucas´best contributinos can be lovely explained without mathematics. The worst of keynesians has been to transform keynes in mathematics, when himself said it was wrong.

  9. Gravatar of marcus nunes marcus nunes
    16. October 2010 at 11:18

    W Peden:See this piece from Orphanides, especially pages 3 to 14. A great “save facing” exercise by the Fed in the second leg of the GD!


  10. Gravatar of marcus nunes marcus nunes
    16. October 2010 at 11:30

    @ Luis
    I´m not against mathematics, just against the view that if you cannot write something as an equation it is not worth paying attention. My preffered “languages” are “words and pictures”. You will be surprised by the amount of “leads” and “insights” that a nicely constructed graph can give you. Check out these pictures in a post I did 2 weeks ago:
    (Just click on the figures to enlarge them)

  11. Gravatar of Joe C Joe C
    16. October 2010 at 12:27


    I like the charts on your link…but, could you translate a few words…

    Espaco Sideral, Volatihdade?

    Look like cool charts but I dont want to assume I know what those words mean.

    Also, to address Scott’s question: Its seems we have not learned our lessons as illustrated by the examples above. I think many people, academics included, are distracted with worthless information…I believe people still read in this country but I think many people do not read the correct material…such as this blog!

  12. Gravatar of Richard A. Richard A.
    16. October 2010 at 12:30

    Alan Blinder and John Taylor were on the Newshour Friday. This is what Blinder had to say —

    ALAN BLINDER: Well, they don’t have the option they would love to have, which is to drive the interest rate down to negative territory. That is their conventional policy, go through zero, and come out the other side. That is not an option.

    One thing they could do is buy other sorts of assets, private assets, as opposed to Treasury assets. Another thing they could do is try to manipulate market expectations by their words. As you know, the Fed has been saying, we’re going to hold the interest rate at zero, essentially, for — quote — “an extended period.”

    You could change that terminology to make it sound even longer, you know, like a hyper-extended period or something. Or, my favorite idea, what you could do is, the Fed is now paying money to banks, about a quarter of a percent, on the accounts they hold at the Fed. These are called their reserves.

    It is like the checking accounts that each bank has at the Federal Reserve. It’s earning a quarter of a percent. The Fed could lower that to zero. It could even go negative, that is, to start charging banks in order to kind of sandblast that money out of the banks, and in — in some sense, to the economy.

    Video and transcript at —

  13. Gravatar of Lee Kelly Lee Kelly
    16. October 2010 at 12:53

    Perhaps fedoras will come back in fashion. I hope so!

    Anyway, one interesting difference this time is how the bank runs occurred. It wasn’t ordinary depositors who ran on the banks, because they are protected by the FDIC. Instead, it was apparently large financial institutions and businesses that held shadow banking accounts. This reduced the money supply like any other bank run, and increased demand for more conventional forms of money. The Fed did not satisfy this increase in demand with additional supply, or at least not fast enough to prevent the most significant fall in NGDP since the Great Depression

    How much money was lost? If there had been something equivalent to an FDIC for shadow banking, then any of us be having these discussions? I think Gary Gorton wants something like this. I am not so sure it’s the best solution, though it surely would have worked.

  14. Gravatar of JTapp JTapp
    16. October 2010 at 12:57

    @Richard A, I subsequently posted the NewsHour link on another post as well. Good timing.

    @ssumner Re: The Anna Schwartz link in your post. In the Lawrence White paper that talks of how Hayek believed in stabilizing nominal income but then contradicted himself in the Great Depression, I find this piece:
    “Since US real GDP grew a cumulative total of 29.6% between 1921 and 1929 (Johnston and Williamson 2005), the norm of constant nominal GDP implies that the US price level should have declined by 22.8%. (1/1.296 = .772). Given that the US was on an international gold standard, however, world figures
    would be more appropriate. The US growth rate was greater than the world’s, so a smaller price level decline was warranted.) The actual price level (GDP deflator) decline over that period was 3.2%. Thus the price level was due for a downward adjustment of 19.6% (given real GDP remaining at the 1929 level).”

    So, the Austrian argument made from this data is that monetary policy was too expansionary in the 1920s…which Friedman and Schwarz disagreed with, quoting you: “not only do they dispute the view that policy was too easy during the stock bubble, they actually argue that it should have been even easier! And this despite that fact that they implicitly acknowledge that easy money helped fuel the boom.” Hayek argued that the Fed wouldn’t let the real interest rate rise as it naturally should with an increase in demand for investment due to Y growth.

    But how is the Austrian argument different from David Beckworth & John Taylor’s argument about the housing bubble–ie: the Fed kept rates too low? They responded to a disinflationary increase in productivity by cutting the fed funds rate to 1 and giving speeches about dropping money from helicopters?

    Is my question clear? How is it possible that Friedman and Schwartz are “right” about Fed policy in the roaring 20’s but Beckworth is also “right” about Fed policy in the 2000s? If the Fed had pursued NGDP level targeting in both periods, wouldn’t it have slowed the growth of the money supply during both of those periods, and wouldn’t that be contrary to what Friedman and Schwartz are prescribing?

    I don’t see the answer in the comments of that previous post on Friedman & Schwartz vs. the Austrians.

  15. Gravatar of Lee Kelly Lee Kelly
    16. October 2010 at 13:14


    That’s exactly what I was thinking.

    The Austrian argument is that, on a gold standard, nominal income stabilisation and rising productivity imply gradual deflation. Since this would not be deflation caused by monetary disequilibrium, it would not frustrate output and threaten recession. However, the 1920s Fed treated all deflation (and inflation) alike; offsetting the innocuous type of deflation persistently forced the market interest rate below the natural rate. This type of monetary policy makes for a more bubblicious economy and subsequent malinvestment, just like the Austrian business cycle theory describes.

    This is why inflation targets are bad, and nominal income/spending targets are better.

    I do not pretend to know as much about the matter as Friedman and Schwartz, nor Scott. But it have to be a pretty good argument to convince me otherwise at the moment.

  16. Gravatar of marcus nunes marcus nunes
    16. October 2010 at 13:16

    Joe C
    I gather you got the drift of the “story” told by the pictures. The figures show “volatility = volatilidade” and AD growth and also level of inflation and its volatility. “Espaço Sideral” means “The Universe” (like all the stars spread out in the firmament). And last, “Destino Final” = “Final Destination”.

  17. Gravatar of Liberal Roman Liberal Roman
    16. October 2010 at 13:19

    Here is a broader question: why are we so much more prone to the shocks that require aggressive Fed action than before? Are the central banks just so obsessed with fighting inflation that they have systematically created deflationary expectations every time anything bad happens? Or are the liberals and Krugman right that an unleashed and unregulated financial sector is the culprit here? Any ideas?

  18. Gravatar of Joe C Joe C
    16. October 2010 at 13:42

    Thanks Marcus….that’s sort of what I was thinking but the verification helps complete the story.

  19. Gravatar of Nick Rowe Nick Rowe
    16. October 2010 at 13:45

    Powerful post Scott.

    But at least we don’t have the Gold Standard to worry about this time?

  20. Gravatar of marcus nunes marcus nunes
    16. October 2010 at 14:09

    @ liberal roman
    I favor the your first alternative. Actually the post I did 2 weeks ago linked above is called (Obsession can be costly) That´s the “obsession” with inflation.

  21. Gravatar of marcus nunes marcus nunes
    16. October 2010 at 14:13

    @Liberal Roman
    The “Great Moderation” came about, I think, not because after the early 80s shocks became smaller, but because Policy was better at limiting their propagation.

  22. Gravatar of Mark A. Sadowski Mark A. Sadowski
    16. October 2010 at 15:50

    History rhymes doesn’t it?

  23. Gravatar of Doc Merlin Doc Merlin
    16. October 2010 at 17:02

    “But how is the Austrian argument different from David Beckworth & John Taylor’s argument about the housing bubble-ie: the Fed kept rates too low? ”

    It really isn’t any different. Rates being artificially held below market rates leading to future deflationary recessions (the ABCT) has been accepted by a large percent of the right wing econo-sphere, even if they won’t call it ABCT.

  24. Gravatar of scott sumner scott sumner
    16. October 2010 at 17:36

    Marcus, Yes, and here’s the great irony. When people ask Lucas how he knows that nominal shocks have real effects, he points to the Monetary History, a book w/o a single regression, vector-autoregressive or not.

    Joe, I completely agree.

    Benjamin, Let’s hope so.

    Marcus, And as the article you sent me pointed out, even in 1937.

    W. Peden, Good observations. I like Milton Friedman’s monetary economics, especially the monetary history and the critique of Keynesianism. I also like his pragmatic libertarianism, which I think is under-rated.

    Luis, Good point.

    Richard, Thanks, Blinder also presented the negative IOR idea in a WSJ op-ed.

    Lee, It would have worked this time, but wouldn’t it have stored up even more moral hazard for next time?

    JTapp, NGDP grew at about a 3% rate in the 1920s, whereas Beckworth favored a 5% rate in the 2000s. So I don’t think Beckworth would regard money as being too easy in the 1920s. Sure, you can argue for zero NGDP growth like Japan has, but that’s not the only plausible NGDP target.

    Lee, Actually, on the gold standard prices tended to be stable in the long run, NGDP grew by quite a bit. Also, on a gold standard it is world NGDP growth that is relevant, not American NGDP growth. So any Austrians using American data, and also defending an international gold standard, are mixing apples and oranges.

    Liberal Roman, I’m not sure we have that many shocks. We just had a big one, but before that things had been quiet for several decades.

    Krugman’s half right about regulation. Banks have an incentive to take too many risks. But he sees this in ideological terms–laissez-faire vs regulations. Many aspects of government were extremely dysfunctional, and contributed greatly to taxpayer losses (Fannie and Freddie and FDIC, and the bailouts of GM and Chrysler, etc) All of that is government failure, not market failure. The bottom line is both the government and the free market screwed up.

    Nick, Yes, and the lack of gold standard is one of the main reasons NGDP won’t fall 50% this time.

  25. Gravatar of JTapp JTapp
    16. October 2010 at 18:06

    Thanks to all for the responses. So, why is a 5% NGDP target better than a 3% target or a 0% target? Do you have a post on this somewhere?
    If real GDP growth averaged 3.7% from ’21-’29 then did the Fed really miss that badly with average NGDP growth at 3%? Why would, say, a 5% target be preferable there?

    Initially I think the answer is “because a little bit of inflation makes it easier to avoid a liquidity trap.” But I think you’ve proven pretty well that liquidity traps are a myth.

    (Aside: I find the White paper interesting b/c we used White’s Theory of Monetary Institutions as a textbook in my undergraduate Monetary Economics course. I find it odd now given his Austrian leanings, my professor certainly wasn’t Austrian and never mentioned ABCT.).

  26. Gravatar of Charles R. Williams Charles R. Williams
    17. October 2010 at 04:09

    Unlike 1932, private sector employment is growing, nominal and real GDP are growing, inflation is positive, inflation expectations are positive, money is growing, the stock market is nearly back to fall 2008 levels. Now it is true that the Democrats are pursuing the kind of Hoover-FDR policies that pushed the economy down so far and delayed recovery for so long and this explains why the recovery underway is so slow. And it is true that a limited program of QE would make a marginal contribution to speeding the recovery. It would be important to tie any such program to objective and sensible targets to calm the fears of those who fear inflation due to the long run fiscal problems we face.

  27. Gravatar of ssumner ssumner
    17. October 2010 at 06:16

    JTapp, I wasn’t criticizng Fed policy in the 1920s as being too expansionary–others were. I think 3% NGDP growth is defensible.

    But the US has been growing at 5% for decades. Loan contracts and wage contracts have been based on that assumption. It makes no sense to downshift to zero NGDP growth, or even 3% growth, in the middle of a financial crisis. It just makes the crisis worse, as borrowers have more trouble earning the incomes necessary for re-paying loans. In the long run 3% might be better. 0% NGDP growth scares me, as it doesn’t seem to be working well for Japan.

    Charles, NGDP grew at 11% in the first 6 quarters of the 1983-84 Volcker recovery. It’s growing 4% in this recovery. That’s why the recovery is so slow. The bad supply-side policies do slow the recovery, but only slightly. Without them we might have 4% growth and zero percent inflation, rather than the current 3% RGDP growth and 1% inflation. But there’s no way we’d get the 7.7% RGDP growth of the Volcker recovery w/o much more NGDP growth. And that requires easier money.

  28. Gravatar of Charles R. Williams Charles R. Williams
    17. October 2010 at 09:23


    Does slow growth in NGDP cause slow growth in RGDP or does it work the other way around? Let us imagine a set of supply side policies pursued aggressively since the fall of 2008. RGDP would be higher, NGDP would be higher and inflation would be 0% rather than 2-3%, mainly due to a stronger dollar. Interest rates would be rising.

    You analysis is stuck on treating NGDP as exogenous – but there are two problems with that. First, the connection between fed actions and NGDP is indirect at best and second the fed is not treating NGDP as a policy variable.

    The comparison between the robust Reagan recovery and the limp Obama recovery fails for another reason. The recession of the early eighties was engineered by government macroeconomic policy to dampen inflation. Reversal of those policies lead to a quick recovery. Macroeconomic policy was largely passive in the 2007-1H/2008 period. Tight money did not cause the recession and expansive monetary policy will do little to reverse it, at least directly. There will be a small benefit from ameliorating balance sheets and some reduction in real wages. The international fallout could be negative.

  29. Gravatar of Charles R. Williams Charles R. Williams
    17. October 2010 at 09:44


    You cite John Cochrane’s ideas for achieving price level targets. But Cochrane’s position is that QE, as typically conceived, would do nothing to boost aggregate demand – which is why he is making his unorthodox proposals. The heart of his analysis is that money and T-bonds are near perfect substitutes. Then you have to do something “fiscal” with monetary policy to get any bang for the buck you print. If the fed is going to accomplish anything with QE other than spook the markets, they need to buy some sort of risky debt – debt that is not a substitute for money – and they need to do it in a controlled, transparent fashion without the sightest hint of credit allocation.

    It is not at all clear that QE will do anything to NGDP.

  30. Gravatar of Doug Bates Doug Bates
    17. October 2010 at 10:12

    Those of us who learn from history are condemned to watch others repeat it 😉

  31. Gravatar of Mattias Mattias
    17. October 2010 at 10:31

    At least we don’t have a gold standard and France is hoarding gold. Or what do you think of Douglas Irving’s conclusions on that issue?

  32. Gravatar of Doc Merlin Doc Merlin
    17. October 2010 at 13:36

    Doesn’t matter if we have a gold standard or not. If things have high substitutability with money for store of value, and Douglas Irving’s argument for gold is correct, then it applies to those things too. By his argument, “hoarding” raw materials, land, and government debt should also have this same effect.

  33. Gravatar of Doc Merlin Doc Merlin
    17. October 2010 at 13:38

    Oh, I should make it clear. I don’t think a private individual hoarding wealth would have this effect. This only works if the goods were not gotten in voluntary trade (voluntary trade makes transactions positive sum value), but were taken off the market through force.

  34. Gravatar of Mattias Mattias
    17. October 2010 at 23:18

    @Doc Merlin

    I’m not sure I understand what you mean with “Doesn’t matter if we have a gold standard or not.” And even if France was paying for the gold with money (which I assume) doesn’t that, all other things equal, raise the price of gold compared to other things that money could buy. And under a gold standard, wouldn’t that be deflationary?

    It’s Irwin and not Irving. Sorry!

  35. Gravatar of Doc Merlin Doc Merlin
    18. October 2010 at 10:28

    I should have been more clear. I mean that because of the substitution effect, close substitutes for money (in store of value, such as land, gold, t-bills, etc, etc) should have the same effect as money on the price level even if you don’t have a gold standard.

    So, if Irwin’s theory is correct, hoarding close substitutes for money (oil or gold or land, or any other very high salability good) nowadays would have a similar effect to france hoarding gold after ww1.

    I don’t think he’s completely correct, though… I think he is missing part of the story, hoarding isn’t bad when its not done through force or not using funds collected by force (taxes).

  36. Gravatar of Randall Randall
    18. October 2010 at 13:57

    Lee- you make a great point. The primary actors is most important and doesnt get the scrutiny it deserves. The “shadow banking system” caused the last crash. In this case it was Quant Hedge funds unwinding trades to meet capital reserve requirements that caused a liquidty crises. QE1 was designed to reinflate bank balance sheets and correct and fix the commercial paper market, the later is a key tool used by hedge funds to manage positions. This is commonly referred to as the “shadow” banking area but its also called dark pools because the underlying assets are commonly unregistered securities and are not subject to clearing and reporting as registed securities are. The problem then, as is now. is that dark pools increase counter party risk and reduce capital effeciency in several ways. But to the point, QEII does not address these problems and the underlying systemic flaws that caused the first market crash are still a key problem for counterparties which was evidenced by our mini crash a few months back. QEII assumes that capital is tight, and that is not the case, credit is tight which is a different problem. Until the economist factor (credit risk) into their models along with fixing the systemic flaws in the market, lending to drive AD will not happen. New capital the comes into the market will be managed by Bankers and traders, (like me) in the same way we are handingly the huge volumn of capital we have on hand now. We will use the carry trade (currency & interest rate arbitrage) to invest capital in foreign exchanges where the returns are higher and the credit risk is lower.

  37. Gravatar of scott sumner scott sumner
    18. October 2010 at 18:00

    Charles, I am not focusing on the exceedingly mild recession of early 2008, but rather the very deep recession of late 2008. My entire blog has tried to show why this was due to tight money. So I can’t accept the premise of your comment. I do believe the severe recession was caused by tight money, could have been prevented with easier money, and a much stronger recovery could have been engineered with easier money. Why do you think money can’t boost NGDP? In all of world history, is there a single case of a fiat money central bank that tried to inflate, but failed? If we do increase NGDP, it is theoretically possible RGDP wouldn’t rise. But for all sorts of reasons I think it would.

    The fact that the Fed doesn’t target NGDP is not relevant. Had they used a forward looking Taylor rule, it would have been almost identical to an NGDP target.

    I don’t follow the Cochrane comment. I recall that I recently discussed Cochrane’s support of futures targeting as a way out of the liquidity trap. I share that policy preference.

    The stock market and commodity market and foreign exchange market seem to think QE is stimulus–that’s good enough for me. But I concede there are much better ways, and I wish the Fed would do level targeting.

    Doug, Yes, I agree.

    Mattias, Yes, that’s pretty much common knowledge among Depression researchers. I published the same idea back in 1991.

    Doc Merlin, No, it’s different under a fiat money system. You can costlessly run money off the printing press, gold is hard to find.

  38. Gravatar of Randall Randall
    19. October 2010 at 04:26

    Scott – How do you distinguish tight money from tight credit?

  39. Gravatar of ssumner ssumner
    19. October 2010 at 10:47

    Randall, I characterize money as being loose or tight depending on NGDP growth expectations relative to target. If NGDP is expected to grow below the desired rate, money is too tight, and vice versa.

    There is no generally accepted definition of “tight” and “easy” money, so I think it best to refer to excessively tight, and excessively easy money.

    Tight credit might refer to high real interest rates, or perhaps a scenario where borrowers have difficulty getting loans because banks are more picky than usual. I don’t use the concept of tight credit in my analysis of the macro economy, hence I haven’t given the term much thought.

  40. Gravatar of Randall Randall
    19. October 2010 at 14:35

    Scott, Stiglitze FT piece on why QE will not have the intended affect. Would love to hear your view.


  41. Gravatar of Scott Sumner Scott Sumner
    21. October 2010 at 05:24

    Randall, Will do not one by two posts on it today (hopefully.)

  42. Gravatar of 123 123
    23. October 2010 at 03:40

    Bretton Woods II is the new gold standard. France was hoarding gold, China is the new France.

  43. Gravatar of Scott Sumner Scott Sumner
    23. October 2010 at 06:10

    123, You can’t print gold, so the cases are not at all similar. In any case, the Chinese don’t hold American dollars. But even if they did, we could just print more.

    Also, the magnitudes are completely different. The Chinese CA deficit is not big enough to have a huge impact, even if my argument was wrong.

  44. Gravatar of 123 123
    24. October 2010 at 06:08

    Scott, try printing more dollars with the current composition of FOMC, soon you will think that gold mine supply is more elastic 🙂

    Yes, magnitudes are different, that explains why the current crisis is milder.

  45. Gravatar of ssumner ssumner
    25. October 2010 at 07:01

    123. OK, but you then need two arguments–bonds are money, and money can’t be printed. In that case I guess China could reduce AD here. But I still wouldn’t “blame” China. I think France deserved more criticism than China.

  46. Gravatar of 123 123
    26. October 2010 at 15:41

    Scott, treasuries are money, and I’ve heard a rumour that Chinese purchases are concentrated at the short end on the curve where the degree of moneyness is very high. Money printing technologies are very limited politically, even though it should be a very profitable business for America, but it is very hard to divide the spoils. The only kind of criticism China deserves is Cochrane’s “idiotic investment decision” type of criticism, they cannot afford such investment mistakes.

  47. Gravatar of ssumner ssumner
    27. October 2010 at 17:22

    123, I agree with Cochrane.

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