Archive for November 2009


Should we laugh or cry?

From today’s WSJ:

But excess reserves have surely made banks feel safer, something backed up by history. The Fed’s moves to trim excess reserves in the late 1930s, by raising minimum requirements, arguably helped create another economic downturn. “The Fed apparently wasn’t aware that banks wanted to hold these reserves,” says Paul Kasriel, economist at Northern Trust. “The result was that banks started to cut lending.”

The current Fed has extra tools to avoid such mistakes, such as the ability to pay higher interest on excess reserves to keep them dormant if necessary.

More and more I think this whole crisis was caused by mysterious bout of mass stupidity.

PS.  I suppose calling the whole world stupid, is well. . . kind of stupid.  So just treat this as a cry of frustration.

Krugman’s getting tougher on the Fed

Make it eight posts today.  I couldn’t resist giving kudos to Krugman for this outstanding post.  I take pride in the fact that I have been making some of these points all year.  But he has some sharp observations that I did not make:

As far as I can tell, what’s going on in monetary policy debate is a policy in search of a justification. Many central bankers just hate, absolutely hate, being in the position of being so accommodating; yet economic analysis offers no justification for tightening. So they’re inventing new policy doctrines on the fly to justify doing what they want to do.

Krugman’s like a good attorney.  You may not like him.  You may not agree with him.  But you want him on your side during a debate.  Right now he’s on my side—telling the Fed to get more expansionary.  (Recall that hawkish Fed talk is equivalent to a contractionary policy, in both his model and mine.)

PS.  Krugman and I both like to bring up 1937-38.  The revised 3rd quarter NGDP numbers are out—making it almost certain that 2009 will see the biggest drop in NGDP since 1938.  The 4.3% NGDP increase was revised down to 3.3%.  The normal rate is 5%.  How’s that fiscal stimulus doing?  But give the US economy credit.  Even with Fed hawks doing all they can to inhibit AD, and even with the government restraining SRAS with 40% minimum wage increases and a tripling of the duration of unemployment benefits, the economy eked out 2.8% growth, as the SRAS curve shifted a bit to the right with sharp wage cuts.  But there has to be a better way to run a modern economy.  This is pathetic.

HT: rob

Support for the Thompson/Selgin approach to monetary policy

David Stinson recently sent me an interesting article on monetary economics written by Peter Howitt.  The author reminds me of people like Nick Rowe and David Laidler, as he can be sympathetic to mainstream new Keynesian ideas, but also understands the importance of older monetarist traditions.  The entire paper is worth reading, but this passage on page 22-23 caught my attention:

Moreover, it is not just the policy makers that are learning from monetary theorists. Often the conduct of monetary policy is way ahead of the theory, and we academic economists often have more to learn from practitioners than they have from us.  I came to realize this when I was a participant in monetary-policy debates in Canada in the early 1990s. The Bank of Canada was moving to inflation targeting at the same time as the country was phasing in a new goods and services tax. The new tax was clearly going to create a problem for the Bank by causing an upward blip in the price level. Even if the Bank could prevent this blip from turning into an inertial inflationary spiral, the immediate rise in inflation that would accompany the blip threatened to undermine the credibility of the new inflation-reduction policy.

The bank dealt with this problem by estimating the first-round effect of the new tax on the price level, under the assumption that the path of wages would not be affected, and designing a policy to limit the price blip to that estimated amount.  It announced that this was its intention, and that after the blip it would stabilize inflation and bring it down from about six percent to within one percent band over the coming three years.

At the time I was very skeptical.  Along with many other academic economists I thought it was foolish for the Bank to announce that it was going to control something like inflation, which it can only affect through a long and variable lag, with such a high degree of precision.  To me the idea reeked of fine-tuning, and I thought the Bank was setting itself up for a fall.  But I was wrong.  In the end the Bank pulled it off just as planned.  The price level rose by the amount predicted upon the introduction of the new tax, and then inflation quickly came down to within the target range, where it has been almost continuously ever since.

Two things struck me about this passage.  The first is that economists often overestimate the problem of “long and variable lags,” especially when the goal is to stabilize a nominal aggregate.  If the policy is credible, lags do not prevent the central bank from hitting short term targets, as the short run is strongly influenced by expected longer term outcomes (as Woodford has shown.)
Den ganzen Beitrag lesen…

Equity vs efficiency in health care: Let’s pretend there’s a third way

In a recent post, Mankiw favorably reviews a David Brooks column that argues that health care boils down to an equity/efficiency trade-off—the US vs. Western Europe.  Mankiw concludes:

David Brooks gets it right today about the debate over healthcare reform. The fundamental question is, Should Americans embrace a more robust social safety net at the cost of much higher marginal tax rates, reduced work incentives, and a smaller economic pie?

From a strictly economic perspective, there is no right answer to this question. Arthur Okun said long ago that the big tradeoff in economic policy is between equality and efficiency. The pending healthcare reform bill moves us along that tradeoff. Let’s just not pretend, as some healthcare reformers would have us do, that we can easily get more equality without paying the price in efficiency.
Den ganzen Beitrag lesen…

Japan: I beg you to start beggaring your neighbors

After 6 years of relatively stable consumer prices, the BOJ has returned to its deflationary policies:

TOKYO (AP) — Japan got word Friday that prices fell again in October, just as a surging yen threatens to worsen the deflation that is undermining the country’s fragile economy.

AP – Jobless people sleep with their belonging at a park in Tokyo, Japan, Friday, Nov. 27, 2009. The number …
The core consumer price index, which excludes volatile fresh food, retreated at a near-record pace of 2.2 percent from a year earlier, the government said. Prices have now fallen for eight straight months — a trend that the government highlighted last week for the first time in three years.

The news came amid heightened concern over the Japanese currency, which hit a new 14-year high against the dollar in early Asian trading. The greenback touched 84.41 yen before recovering to low-86 yen levels.

A strong yen and deflation represent a perilous combination for the world’s second-biggest economy.

Falling prices, which plagued Japan during its “Lost Decade” in the 1990s, may sound like a good thing. But deflation can hamper economic growth by depressing company profits, sparking wage cuts and causing consumers to postpone purchases. It also can increase debt burdens.

Meanwhile, a strong yen erodes the overseas profits of Japan’s big exporters like Sony Corp. and Toyota Motor Corp. It can also aggravate deflation. Prices of imports and raw materials decline, which then pushes domestic consumer prices lower.

“In the midst of deflation, such a sharp rise in the yen is a very serious problem and could drag down the economy,” said Fujio Mitarai, head of the Nippon Keidanren, the country’s biggest business group. “I certainly hope the government responds with emergency steps.”

Concerns overnight about debt problems afflicting Dubai have driven investors to the yen as a safe haven. Dubai World, a government investment fund with debts totaling around $60 billion, has asked creditors if it can postpone payments until May.

The yen also strengthened because of the disappointing comments Thursday by Japanese Finance Minister Hirohisa Fujii, analysts said. He sharpened his tone Friday, calling the yen’s recent rise “one-sided” and saying the government would take appropriate measures if needed.

“What the market wants is for him to go a step further and say he is actually going to do something,” said Akane Vallery Uchida, foreign exchange strategist at The Royal Bank of Scotland in Tokyo. “Unless he becomes more specific about taking action, it’s not convincing enough.”

Japan hasn’t intervened in the currency market since March 2004. But it looks to be edging closer to some sort of action with prices expected to continue falling. The core consumer price index for Tokyo, seen as a barometer for prices nationwide, declined 1.9 percent.

There are so many frustrating things in this article that one hardly knows where to begin.  Is it really true that in the year 2009 one has to explain to readers of financial news that deflation can be a really harmful process?   Do falling prices really “sound like a good thing?”

And how about the government statement that appropriate action would be taken “if needed?”  The yen rises from 110 to 85 to the dollar, deflation accelerates, and the homeless are sleeping in Tokyo parks.  What sort of evidence would indicate a weaker yen “is needed?”

Or are you more depressed by the many American economists who would say there is nothing the Japanese can do to halt the deflation?  After all, they’re in a liquidity trap, aren’t they?

And please don’t send me any comments about how bad it would be for the world economy if the Japanese stopped their highly deflationary strong yen policies.  For the millionth time; ECONOMICS ISN’T A ZERO SUM GAME.

BTW, Japan should be booming; they are perfectly positioned to benefit from China’s voracious appetite for sophisticated capital goods.