Archive for December 2009


Krugman says the pain in Spain was mainly due to excessive real wages.

It’s good to know that Krugman has retained some of his 1990s views:

We “” that is, the United States “” have a floating exchange rate. Spain, however, being part of the euro zone, does not. Its wages are too high compared with those of other eurozone members, now that the housing boom and massive capital inflows are over. If Spain still had a peseta, I’d say devalue it; since it doesn’t, wages have to give.

I imagine Krugman’s left wing fans might have choked on their lattes when reading this paragraph.  Wages need to be lowered to reduce unemployment?  That doesn’t sound like Krugman.  But at least he assured them that his conclusions do not apply to the USA.  Or do they?  Here is my argument in a nutshell:

We “” that is, the United States “” have an independent central bank.  The Fed insists that “price stability” is its goal.   Because of the sharp fall in NGDP, and sticky nominal wages, we need to cut real wages to restore full employment.  If Congress had control over monetary policy, I’d say raise the inflation target for a few years (as would Krugman); since it doesn’t employment costs have to give.  Cut the minimum wage and the employer share of the payroll tax.
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The definition of insanity is . . .

In a recent post I offered a half dozen arguments against Bernanke’s recent defense of Fed policy.  But I missed the most important one.  Here is Bill Woolsey commenting on Bernanke’s reply to DeLong:

For more than twenty years, making vague statements about high employment and price stability, while making monthly adjustments in short term interest rates with the apparent goal of having the CPI rise at a 2 percent rate from where ever it happens to be, appeared consistent with better macroeconomic performance than in the past. Unfortunately, this approach was not robust in the face of financial problems for a handful of large Wall Street investment banks.

Bernanke is just too focused on putting humpty dumpty back together. All during the crisis last fall, the focus was on jump starting securitization markets. Now, Bernanke appears willing to accept low production and high unemployment for years, because otherwise, they won’t be able to return to their traditional approach to monetary policy. And then there is this fantasy that they are going to get the regulations right this time so that there won’t be the sorts of financial disruptions that made their traditional approach to policy ineffective!

We’ve known for a long time that a low inflation target might be ineffective during a liquidity trap.  Woodford has argued that level targeting would be superior when rates fall to zero.  Now Bernanke has shown that those fears were well-founded.  And yet he wants to return to the failed policies that not only were unable to prevent this crisis, but were also the cause of NGDP falling 8% below trend in the 12 months after July 2008.
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Reply to McArdle

I don’t watch much TV, just sports and  One of the nice things about my blog is that people who I enjoyed watching on bloggingheads (and who seemed like larger-than-life figures) now pay attention to my views.  Matt Yglesias and Megan McArdle are examples.  In this post McArdle raises several objections to my argument that moral hazard was the root cause of our financial system problems.

Scott Sumner is a very smart guy, and I quail to disagree with him, especially on macroeconomic topics.  But I’ve been mulling over this argument a lot, and I’m just not convinced.  I go to a lot of pro-market think tank events where one speaker or another blames the financial crisis and the current recession on moral hazard, as well as basically everything else that has gone wrong in the last sixty years.  I’m afraid I don’t see it.

I appreciate the compliment but I am not that smart, and no one should “quail” to disagree with me.  Indeed until a few minutes ago I didn’t even know ‘quail’ could be used as a verb.  I only seem smart because for some reason I have always had an easy time understanding the paradoxes of monetary economics.  I got Cs in French, computer science, and freshman English.

Second, I don’t believe the current recession was caused by moral hazard, I believe it was caused by tight money.  But I do think a big part of the 1980s S&L crisis was caused by banks taking advantage of brokered $100,000 deposits to engage in real estate speculation.  I do regard that as an abuse of deposit insurance. 
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Response to Ambrosini

Ambrosini generally has excellent macro posts, so I thought I would respond to his criticism of those (like me) who seemed to take DeLong’s side regarding the desirability of a 3% inflation target.

In earlier posts I have argued for removing the concept of inflation from macroeconomics, at least from the cyclical side of macro (I understand that you need inflation estimates in fields like long term economic development.)  And I have advocated replacing inflation with NGDP growth, which I argue helps clarify what we are debating when we debate demand management.

I strongly believe that, certeris paribus, lower inflation is better–at least until NGDP growth falls close to zero.  But the problem is that right now other things are not equal.  I also believe the current severe recession is caused by the fact that NGDP recently plunged 8% below its trend line.  Unfortunately, new Keynesian economists don’t talk about boosting NGDP; instead they talk about boosting inflation, which is a side effect of AD shifting to the right.  Even worse, it is also a side effect of adverse supply shocks.  So what does it mean to aim for a higher inflation target?  If you are trying to say you want more AD, why not just say so?  Or just say you want more NGDP.
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We’re all Austrians now . . . make that Keynesians.

I plan to discuss a very impressive (unpublished) paper from 1991 written by Ronald W. Batchelder and David Glasner.  Then I hope to use this paper as a springboard to re-think the evolution of 20th century macro.  With apologies to Mr. Batchelder, I will refer to “David’s ideas” for simplicity.  (I know David, and he provides some excellent comments to this blog.)  David and I also share similar views on monetary policy, and in many cases he published his views first.  Unfortunately, the paper I refer to is not available on the internet.

The paper focuses on the views of Ralph Hawtrey and Gustav Cassel, two unjustly neglected interwar economists.  Both economists favored an international gold standard, but both were also concerned that the post-WWI system was potentially unstable.  During WWI many countries sold off their gold stocks to help pay for the war.  This big drop in the demand for gold caused the value of gold to plummet, which meant that the price level more than doubled.  Some of that was reversed in the 1920-21 deflation, but Cassel and Hawtrey feared that as countries rebuilt their gold stocks the price level might fall, causing higher unemployment.  They favored policies that would economize on the use of gold, such as replacing gold coins with gold-backed paper money.  Another idea was to supplement gold reserves with some sort of international accepted currency, such as the dollar and/or the pound.  And some of these reforms were implemented.

At first it looked like their fears were overblown.  Throughout most of the 1920s, prices in terms of gold were fairly stable.  After 1929, however, their worst fears came to pass.  Both central bank and private hoarding of gold caused severe deflation throughout most of the world, leading to mass unemployment.  So why didn’t they get credit for their predictions?  Why aren’t they famous today?  It turns out that the answer is surprisingly complicated, and tells us a lot about how macroeconomics evolves over time.
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