Three widely held theories discredited in 5 minutes

I woke up this morning to find that my very useful commenters had provided me with information showing that 3 widely held economic theories were discredited last night between 12:45 and 12:50 am.  These theories are Keynesian economics, RBC theory, and the theory of beggar-thy-neighbor policies.  Yes, these theories have been totally discredited dozens of times before over the past few years (or decades if you wish), but piling on is fun!

Here’s the first comment, by Cameron:

http://www.bloomberg.com/news/2014-10-31/boj-unexpectedly-boosts-easing-amid-weak-price-gains.html

BOJ announces it will expand its QE program, Nikkei rises 4.5%!

The liquidity trap theory is dead. Please please please follow in their footsteps ECB.

Of course Keynesian economics predicts the QE announcement would have no effect on stock prices, as the new money would just sit there as excess reserves.  You are just swapping one low interest government asset for another low interest government asset.  (In fairness, I don’t know what the BOJ is buying in this case, but we also see big market effects when central banks just buy government bonds.)

And yet the economic blogosphere is full of people telling us “we just don’t know” if QE has any effect.  Yesterday I saw an article indicating that the “markets” were uncertain whether QE had had any effect.

Of course the real business cycle people will say; “yes, monetary stimulus will raise nominal stock prices, but that effect merely represents inflation.”  On to comment number 2, from Steve:

BOJ expands monetary base to 80T yen per year

The central bank says it will expand annual bond purchases to 80 trillion yen a year, up from the current 50 trillion yen. It will also extend the duration of bonds it holds to about 7-10 years.

The impact on markets was swift: dollar-yen jumped 1 percent to 110.26, while the Nikkei surged over 4 percent to its highest levels since September 25.

http://www.cnbc.com/id/102139427

So the Japanese stock market also soared in dollar terms, and if you look at the intraday data the huge spike was right after the announcement.  RBC theory says it’s just inflation, and that real values should not be affected.  And yet Noah Smith tells us that RBC theory is alive and well. And I’m sure it is, in the elite journals.

[As an aside, there are people who claim that some RBC models allow for nominal shocks.  Sorry, but the sine qua non of RBC theory is that nominal shocks don’t matter.  If both types of shocks matter it’s not an RBC model, it’s an NK model with both supply and demand shocks being important. When people say they don’t believe that RBC theory is correct, they mean that they think nominal shocks matter.  Everyone believes that real shocks also matter.  After all, the devastating earthquake/tsunami/shutdown of all nuclear power in Japan caused a  . . . oh wait; it didn’t cause a recession, or an increase in unemployment.  OK, everyone agrees that a real shock 10 times bigger than the Japanese tsunami could cause a recession. Say Godzilla destroying Tokyo.]

The last resort of the anti-QE crowd is to admit that it “works,” but only in a beggar-thy-neighbor way.  Stealing growth from other countries via currency depreciation and trade surpluses.  But macro is not a zero sum game.  Commenter Steve also provides this information:

I was wondering why the S&P500 futures abruptly spiked 15 points (0.75%) at 12:45am EDT. TheMoneyIllusion has the answer!

Steve, I’m sure that was a coincidence.  There must have been was lots of other news at 12:45 am that would have caused broad indices to spike sharply higher in the US.  And if it was Japan, it was surely only stocks in US companies with operations in Japan.

Seriously, the extent to which people go to try to deny the obvious is almost comical.  I think it has something to do with Bernanke’s comment that QE works in practice but not in theory.  That’s not true of course, it works in theory by raising the expected future money supply and expected future NGDP, but it gets at reasons why economic bloggers deny the obvious.  They live in a world of theories, of models, not reality.

PS.  Cameron also provides this nugget:

Also debunked is the belief that consensus is more important than policy stance. The vote was 5-4 in favor of expansion.

Make that 4 theories debunked.  Not a bad day’s work for my comment section!  I don’t have links, but all comments are quoted in full, and are listed among the first 8 comments of the previous post. They are easy to find.

PPS.  This is another reason why we need a NGDP futures market.  Hypermind has started one, but it’s still small, and appears inefficient in my view.  The market forecast 3.9% NGDP right before yesterday’s announcement, which seemed too low to me.  The actual figure was 4.9%.  So there are still $100 bills on the sidewalk.  The prizes at Hypermind will grow sharply in a few days, so when I make the announcement get in there and start picking them up.

Maybe the economics profession doesn’t want NGDP and RGDP futures markets because deep down they know that Keynesian and RBC models would be totally discredited almost immediately. I can’t think of any other rational explanation.


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41 Responses to “Three widely held theories discredited in 5 minutes”

  1. Gravatar of Brian Donohue Brian Donohue
    31. October 2014 at 06:12

    Gloves.Officially.Off.

  2. Gravatar of BC BC
    31. October 2014 at 06:56

    My initial thought was also that the rise in US equities debunked the beggar-thy-neighbor theory. Hadn’t thought of the other debunkings.

    On monetary offset, though, why does the Fed not offset BoJ policy in the same way that it offsets fiscal policy? If BoJ QE raises Japanese and global demand, why would US equities rise if the Fed offsets any impact on AD in the US? Do boosts in Japanese AD have positive *supply* effects in the US? For example, perhaps a Japan operating at full capacity makes for a good trading partner for the US, in turn boosting productivity of both nations?

  3. Gravatar of CMA (@CMAMonetary) CMA (@CMAMonetary)
    31. October 2014 at 07:11

    QE works because of supply and demand. Its only a question of how effective and equitable it is compared to other policy tools.

  4. Gravatar of Benoit E Benoit E
    31. October 2014 at 07:21

    These posts are very important because they are easy to understand and may have more influence over a wider audience.

    The situation is so desperate in europe and elsewhere. We need more people to understand!

  5. Gravatar of benjamin cole benjamin cole
    31. October 2014 at 07:32

    I have been saying since 2008 and I still say it: print more money, print way more money and don’t stop until they are using Ben Franklins for toilet paper.

    I am an extremist? No more than the lulu-sadists calling for absolutely dead prices.

    Excellent blogging.

  6. Gravatar of Dan W. Dan W.
    31. October 2014 at 07:38

    Since the intent of monetary stimulus is to raise asset prices why is anyone surprised in the market reaction? Add to this the announcement the government (ie Japanese pensions) will increase the purchase of equities and this is a simple exercise the first day of class in econ 101.

    The rise in global equity prices can be credited to investor demand as (a) historically stocks advance the last quarter of the year – they have been steadily advancing since the early October lows and (b) the BOJ and Riksbank announcements raise hopes that other central banks will be inclined to print money. Each nation that does this pressures others to follow.

    However, actions that increase asset prices now mean further gains in asset prices will be subdued, unless real growth accelerates or more monetary stimulus is injected. If economic problems are structural then real growth will falter. In this case investor expectations will hinge on additional monetary stimulus. This could beg the question of the relationship between central banks and stock investors: Who is the dog and who is the tail?

  7. Gravatar of James Oswald James Oswald
    31. October 2014 at 07:43

    RBC doesn’t unequivocally state that changes in monetary policy can’t have real effects. There are models with menu costs or other sources of sticky prices. I view RBC as a broader set of viewpoints which include anything that states the primary cause of recessions is supply side issues. RBC advocates would be foolish to flat out deny the impact of nominal shocks altogether, especially when they are so obviously verified by empirics.

  8. Gravatar of Philippe Philippe
    31. October 2014 at 08:25

    Dan W, you should stop thinking in terms of vague metaphors and try to think more clearly.

  9. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    31. October 2014 at 08:34

    Well if you want amazingly fast discrediting of economic theories;

    https://www.youtube.com/watch?v=5u4o6yMhL1w#t=3207

    Watch Laura Tyson tell a student at Berkeley (Q asked about 47 minutes in) that there’s no such thing as a free education…and a few minutes later forget all about that lesson.

    Though the best time of all comes starting about 19 minutes in when Dean Rich Lyons starts trying to get Tyson and Saez to provide some actual evidence as to why income inequality is really a problem.

  10. Gravatar of Dan W. Dan W.
    31. October 2014 at 08:51

    Philippe,

    You don’t have to be charitable but you could be more cooperative.

    Some trader in Australia provides his own metaphors including “double boost” and “pumping more cash”. Is he wrong?

    “Today you’re getting a double boost with talk of the GPIF increasing its shares allocation and the BOJ pumping more cash in at a faster rate,” Shane Oliver,

    http://www.bloomberg.com/news/2014-10-31/japan-stocks-rise-on-report-pension-fund-to-boost-shares.html

  11. Gravatar of BJ Terry BJ Terry
    31. October 2014 at 09:22

    Unfortunately, I don’t think this is as much of a rhetorical slam-dunk as it seems to be. According to the Bloomberg article the BOJ will be purchasing, in part, exchange-traded funds and REITs, which seems relevant to the impact it would have on equity prices separate from its impact on NGDP and RGDP. It would be hard to imagine the central bank purchasing stocks with newly-created Yen and yet seeing stock prices fall.

    http://www.bloomberg.com/news/2014-10-31/japan-stocks-rise-on-report-pension-fund-to-boost-shares.html

    “The central bank also said it would triple annual purchases of exchange-traded funds and Japanese real-estate investment trusts to 3 trillion yen and 90 billion yen respectively, and make ETFs that track the JPX-Nikkei Index 400 eligible for purchase. The JPX Nikkei 400 jumped 4.5 percent today to close at 12,172.62.”

  12. Gravatar of Tom S Tom S
    31. October 2014 at 10:59

    Or the Efficient Market Hypothesis was discredited. But that’s only one theory.

  13. Gravatar of Thomas Aubrey Thomas Aubrey
    31. October 2014 at 11:22

    Scott, I’m not sure it matters “whether the economics profession doesn’t want NGDP and RGDP futures markets because deep down they know that Keynesian and RBC models would be totally discredited almost immediately.”

    I think what matters more is getting financial practitioners involved. Most practitioners have little time for NK and RBC models as these models provide limited insight into how an economy actually works (leading to career limiting prospects)

    Once the cash prizes are resolved, it would be great to see a SS piece on Bloomberg/ CNBC / FT / WSJ on the NGDP futures market with links to the market.

  14. Gravatar of Fed Up Fed Up
    31. October 2014 at 11:27

    “Of course Keynesian economics predicts the QE announcement would have no effect on stock prices, as the new money would just sit there as excess reserves.”

    You need to look elsewhere like the amount of stock(s) being bought on margin.

    “Seriously, the extent to which people go to try to deny the obvious is almost comical.”

    Like demand deposits not being MOA when they are fixed (it just happens to be 1 to 1) convertible to currency thru the commercial banks.

  15. Gravatar of Fed Up Fed Up
    31. October 2014 at 11:30

    Take a look at the chart here on real wages in Japan.

    http://www.alhambrapartners.com/2014/09/30/common-sense-said-it-probably-wasnt-worth-it/

    “The immediate reaction to such “success” is “so what.” The effect of “inflation” on wages is trivial compared to that on prices so far, largely due to the disastrous acceleration of Japan’s trade deterioration. As nominal wages rise ever so slightly, “real” wages sink Japanese households further and further.”

    I don’t know if it includes the sales tax increase.

  16. Gravatar of TravisV TravisV
    31. October 2014 at 11:33

    Unfortunately, this link no longer includes the phrase “kiss of life”……

    http://www.hoover.org/research/reviving-japan

  17. Gravatar of ssumner ssumner
    31. October 2014 at 11:43

    BC, You asked:

    “On monetary offset, though, why does the Fed not offset BoJ policy in the same way that it offsets fiscal policy?”

    It’s possible they do. A demand stimulus in Japan is a positive supply shock for the US, just as a negative demand shock in the US was a negative supply shock for Canada in 2008-09.

    But it’s also possible they don’t. I think the bigger effect might be in Europe. If Japan demonstrates that QE “works” might that push the ECB in the same direction? I’m not claiming central banks never change their minds.

    CMA, Yes, but it must be at least partly permanent. The BOJ is doing better signalling than in the previous decade, but still not as good as I would like.

    Thanks Benoit.

    Dan, You said:

    “Since the intent of monetary stimulus is to raise asset prices why is anyone surprised in the market reaction?”

    Umm, maybe because Keynesian and RBC models predict no impact on real equity prices? But you wouldn’t know that unless you read the post . . .

    And the intent is to boost NGDP.

    I stopped reading after the first sentence.

    James, Yes, I know that this is their claim, but I don’t buy it. Neither do top macroeconomists like Bennett McCallum. They need to make up their minds. If they believe nominal shocks matter then they need to stop ridiculing economists that say high unemployment can be explained by a huge negative demand shock like 2008-09.

    BJ, Good point, but as I said stocks rise with any QE announcement, even if only Treasuries are purchased.

    Tom, And actually a theory with lots of empirical support, unlike the others.

    Thomas, Good point.

  18. Gravatar of ssumner ssumner
    31. October 2014 at 11:46

    Fed up, How would you expect monetary stimulus to impact real wages? And regarding MOA, that which has no practical implications has no theoretical implications.

  19. Gravatar of cthorm cthorm
    31. October 2014 at 12:46

    Off Topic:

    Scott,
    I just saw this: http://www.cftc.gov/PressRoom/PressReleases/pr7047-14
    “The U.S. Commodity Futures Trading Commission’s (CFTC) Division of Market Oversight (DMO) today announced the issuance of a no-action letter for Victoria University of Wellington, New Zealand (University), to operate a not-for-profit market for event contracts, and to offer event contracts to U.S. persons, without registration as a designated contract market, foreign board of trade, or swap execution facility, and without registration of its operators.”

    Sounds like iPredict WILL be able to have US persons participate in the NGDP futures market!

  20. Gravatar of bill bill
    31. October 2014 at 13:57

    Scott said: OK, everyone agrees that a real shock 10 times bigger than the Japanese tsunami could cause a recession. Say Godzilla destroying Tokyo.

    =Actually, how about Germany after World War II? About 10 times worse than Godzilla destroying Tokyo.

    PS – I know the quote I pulled was facetious. Just saying you can’t get facetious enough.

    :-)

  21. Gravatar of Cameron Cameron
    31. October 2014 at 14:09

    Thanks for the hat tips Scott!

    BJ Terry,

    That doesn’t explain the fall in the yen or the international reaction in equities. Japanese long term bond yields also moved down surprisingly little, suggesting higher demand from purchases was probably offset by higher inflation/growth expectations.

    The total value of the purchases are incredibly tiny as well. 3 trillion yen annually is $27 billion. Insignificant compared to the total market value.

  22. Gravatar of ssumner ssumner
    31. October 2014 at 14:14

    cthorm, That’s great, and my commenters learn this before me!

    Bill, Well I suppose it depends how much damage Godzilla did–greater Tokyo is like a third of the Japanese economy, maybe more. :)

    Cameron, I’d add that the Keynesians are still denying any effect, I heard a BBC reporter on the car radio driving to work. Japanese QE is ineffective.

  23. Gravatar of bill bill
    31. October 2014 at 14:22

    That’s a really strange thing for a Keynsian to say. They are very convinced that the “collapse of the housing bubble” caused the 2008-2009 recession through a negative wealth effect.

  24. Gravatar of Fed Up Fed Up
    31. October 2014 at 14:43

    More details:

    http://finance.yahoo.com/news/japan-inflation-slips-unemployment-sept-015716055.html

    “In addition to stepping up asset purchases, the Bank of Japan will triple its purchases of exchange-traded funds and real estate investment trusts and increase the average maturity of the assets it holds to 10 years from seven years.”

    And, “Coinciding with the central bank’s move, Japan’s $1.1 trillion public pension fund acted Friday to move money out of low-yielding bonds and into higher-yielding but riskier stocks to try to improve its investment returns and meet its obligations to a swelling number of retirees. Abe said the move was needed to ensure that the fund can meet its future obligations. Japan is rapidly aging, and its population is shrinking as birth rates decline.”

  25. Gravatar of Major.Freedom Major.Freedom
    31. October 2014 at 15:07

    It is incorrect to assert that RBC theories are purely based on shocks to supply, as opposed to Keynesian or Monetarist theories, which are based on shocks to demand.

    Technology-based theories of real business cycles for example imply that consumers will change their intertemporal consumption and savings decisions based on the real interest rate available to them, which is a shift in demand.

    Also, as Plosner (1989) points out, other RBC theories based on preferences implicate the demand side to an even greater extent.

  26. Gravatar of Major.Freedom Major.Freedom
    31. October 2014 at 15:15

    Also, the Japanese stock market rising in dollar terms after an announcement of Yen inflation does NOT in any way refute any of the real side class of business cycles.

    One currency rising against another, with one of them increasing in supply, are purely nominal variables that cannot even communicate with or respond to real side theories. Such reasoning a priori rules out any real side theory. Real side theories can only be refuted with theories that are not blind to them.

    A local stock market rising in value against a foreign currency says nothing regarding whether there was an increase in local production, or expected local production.

    RBC theories, which I reject for other reasons, are not at all falsified by what just transpired in Japan.

  27. Gravatar of Major.Freedom Major.Freedom
    31. October 2014 at 15:24

    Beggar thy neighbor theories, which I reject, are also not refuted by the US stock market rising after Japanese Yen depreciation.

    The flaw in the claim that they are falsified by recent events is thinking of the entire world’s economy as only reducible down to country stock markets. Beggar thy neighbor theories do not imply any zero sum game at the country level only. The US and Japanese stock markets rising in tandem after one country’s currency depreciates can and does have beggar thy neighbor effects on other countries besides the US or Japan, and, even more importantly, the zero sum transfer of wealth can and does take place WITHIN either or both the US and Japan.

    When the Fed inflates, national socialists like MMs pretend that the wealth transfer within the US is insignificant. Sumner should take his own advice and admit that he refuses to entertain Austrian business cycle theory because deep down HIS theory would be totally discredited in his own mind, as it has already been discredited in actuality.

    What a crappy, arrogant blogpost.

  28. Gravatar of OhMy OhMy
    1. November 2014 at 03:35

    So how did the QEs here translated into something more than stock market jerks, like employment and sales? #Crickets#…

  29. Gravatar of Major.Freedom Major.Freedom
    1. November 2014 at 07:17

    OhMy:

    An even better question is how did any of this translate into sustainable employment allocations and sustainable production?

    We here yammering about “employment” and “output”, as if we are not supposed to question any increase in employment and output because it is always good and never wasteful on net.

    ——–

    Sumner, you mentioned macro is not a zero sum game. In a free market yes that is true. But that isn’t the same thing as the zero sum game taking place with fiat inflation.

    There are winners and there are losers in what the Japanese state counterfeiter did:

    http://i.imgur.com/QXis01ll.jpg

    By the way, I wouldn’t have to point this out on an actual economics blog, but I must here: inflation isn’t zero sum because of any mathematical sum that can be garnered from that chart. This is just currency exchange changes. We still haven’t touched the real side of the world economy. I only posted that chart to disprove Sumner’s anti-economics on his own terms.

  30. Gravatar of Major.Freedom Major.Freedom
    1. November 2014 at 07:17

    *hear

  31. Gravatar of TallDave TallDave
    1. November 2014 at 11:28

    4.5% can’t be ignored.

    In my more cynical moments I’ve wondered if CBs like keeping money too tight because it allows them to have this kind of impact when they loosen.

    At any rate, it’s nice that out of terrible policy comes at least situations where the obviousness of the truth becomes more difficult to deny.

  32. Gravatar of TallDave TallDave
    1. November 2014 at 11:33

    OhMy,

    Unless you assume that stock markets looked at the announcement and said “aha, this will raise P/E ratios!” then the markets are saying (not to say shrieking) that they expect more sales, employment, and profit than they did before the announcement.

  33. Gravatar of ssumner ssumner
    1. November 2014 at 14:55

    OhMy, There is no model I know of (and certainly no Keynesian model) where monetary stimulus raises real stock prices without boosting AD.

  34. Gravatar of John Becker John Becker
    2. November 2014 at 05:46

    I don’t think that there is anything more valuable to know in an economic debate than the fact that ideas cannot be discredited by facts. There are too many moving parts and potentially confounding variables. People on both sides should stop talking about discredited theories in economics. Aren’t there still some Marxists and Socialists floating around? If any theories could be discredited by facts those people wouldn’t exist.

  35. Gravatar of John Becker John Becker
    2. November 2014 at 05:51

    Scott,

    If the government massively cut spending and the economy boomed, do you think Paul Krugman would wave a white flag? If the Fed announced they were adopting NGDP level targeting and the markets tanked, would you admit defeat or start scrambling for other reasons why markets might react that way? I don’t think either of you would be wrong in either case, I’m just trying to make the point that economics theories are non-falsifiable by external events.

  36. Gravatar of Major.Freedom Major.Freedom
    2. November 2014 at 05:53

    Sumner:

    You are assuming there has been a rise in real stock prices due to QE.

    OhMy’s point is that more dollars chasing the same stocks and the welcoming of higher stock prices, ignores real productivity.

    How would more dollars chasing the same stocks cause more output?

  37. Gravatar of ssumner ssumner
    3. November 2014 at 06:23

    John, See my new post.

  38. Gravatar of Fed Up Fed Up
    5. November 2014 at 09:18

    “Fed up, How would you expect monetary stimulus to impact real wages?”

    Depends on what is going on in the economy. Tightness of the labor market is high on the list.

    “And regarding MOA, that which has no practical implications has no theoretical implications.”

    Explain to someone that gold is MOA. Have a fixed conversion rate to currency. Both are MOA meaning there is a dual MOA. That someone agrees.

    Explain to someone that currency is MOA. Have a fixed conversion rate to demand deposits thru the commercial banks. Both are MOA meaning there is a dual MOA. That someone agrees.

    Explain that last one to a lot of economists. Oh no that can’t be right.

    Back to real wages. Do you want to raise prices so that real wages go negative?

  39. Gravatar of ssumner ssumner
    6. November 2014 at 06:40

    Fed Up. I don’t want the Fed to target prices or real wages, I want them to target NGDP.

    You didn’t respond to my point about MOA.

  40. Gravatar of Fed Up Fed Up
    6. November 2014 at 09:25

    NGDP is made of prices and real GDP. Do you want to target real GDP, prices, or both? If NGDP is below target, what do you want to raise? If you raise prices, real GDP may go up or down. Just saying raise the NGDP target does not mean both will go up. They could. They may not.

    Yes, I did. When I go to shop somewhere, prices are posted in terms of currency and demand deposits. An item can cost $1 of currency or $1 of demand deposits. They both are also MOE. That means banks and bank-like entities matter. It is both practical and theoretical.

  41. Gravatar of Fed Up Fed Up
    6. November 2014 at 09:27

    Check out the 4th chart here (Japan real wages):

    http://www.alhambrapartners.com/2014/09/30/common-sense-said-it-probably-wasnt-worth-it/

    If real wages are negative, should people spend more, the same, or less?

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