Archive for January 2010


Is Bernanke too melancholy?

Nick Rowe continues to provide interesting feedback.  This is the tail end of a much longer comment he left at the end of my Richard Rorty post from a few days back:

Here’s another one, that’s both fun, and deadly serious in current contexts:

Horizontal axis: belief that monetary policy is interest rate policy.
Vertical axis: truth that monetary policy is interest rate policy.
Here we have a positive feedback system. There are probably two (stable) equilibria: one in which monetary policy *is* interest rates, and we can get stuck in liquidity traps; and a second in which it isn’t, and we don’t get stuck. Social construction of reality, again, which is just an extreme form of a convention, which not only affects how we behave, but how we see the world. It defines the “social facts” of what central banks “do”.

Question: if this (above) view is correct, what exactly is it that Scott Sumner is *doing* (on this blog)? What *is* he? Not a policy advocate, in the standard sense.

And, if this view is correct, forget about trivia like cutting the overnight rate by 0.25%. Banning all public mention of the overnight rate would be a more effective policy!

I think I may have jumped the shark. Never mind.

He is being too modest; this raises all sorts of interesting issues.  Yes, other economists have discussed somewhat similar ideas.  I seem to recall Krugman used the “Peter Pan” analogy at one point.  Something to the effect of “if we think monetary stimulus can work in a liquidity trap, then it can work.”  But Nick’s comment raises some deeper issues.

In another post one commenter contested my view that investors were paying a lot of attention to Fed policy in October 2008, the period when I alleged that policy was too tight.  He argued that investors were focusing on falling GDP.  I replied that expectations of falling NGDP is exactly what I mean by tight money.  At this point you might say “but for the Fed to have been able to prevent this, they would have had to have been able to change NGDP growth expectations with their policy tools.  Unless investors see the connection, they won’t be able to do that.”

Normally it would be easy for me to swat away that objection, as stock prices often rise or fall 2% or 3% minutes after the 2:15 Fed policy announcements.  So clearly Fed policy has a powerful effect on expectations.  And I think my argument even applies to early October 2008, when the Fed funds target was still 2%.  But what about later, when there was a widespread sense that rates could be cut no further.  Was the Fed no longer able to affect market expectations of NGDP growth?

That is where Nick’s observations come in.  Nick and I have both argued that there are a variety of policy levers by which the Fed can impact nominal spending.  But suppose everyone else thinks the fed funds rate is the only possible tool?  Does that make the Fed powerless?  I am going to argue that the answer is no.  But first suppose that the answer were yes.  Then Nick is arguing that my blog (and by implication blogs like his and Bill Woolsey’s as well) are providing a valuable public service.  We are like those slightly ridiculous 60s hippies that were “trying to blow people’s minds, to get them to see reality in a new way.”  And if people can see there are other ways out of the liquidity trap, then they will be more optimistic that the Fed can avoid the worst case of another Great Depression.

[BTW, my blog started in February 2009, and caught on in March 2009.  Just saying . . . ]

Well this is all very flattering, but I don’t think it is that simple.  It’s up to the Fed to decide what sort of policy tools they want to use.  In the early 1980s the Fed announced it was targeting M1, and almost immediately the various Wall Street markets started reacting strongly to the unanticipated part of the money supply announcement.  When they stopped a few years later, the markets stopped reacting to M1 announcements.  In 1933 FDR announced he was using the price of gold as the level to move prices higher, and the markets immediately started responding to changes in the price of gold.  It’s really all up to the Fed.  Whatever tools they choose to use, the public will follow.  In my view the tool should have been NGDP futures prices.  If they had done so, the public would have followed these prices as closely as they now follow changes in the fed funds rate.

So I don’t buy versions of the Peter Pan argument that make success seem very iffy, very contingent on luck, on whether the well-intentioned Fed is able to convince to the narrow-minded public of their wisdom.  That’s getting the problem backward; the public knows exactly what is going on, it is the Fed that needs to wake up and “have its mind blown.”

But given where we are, stuck with a Fed that can’t think beyond interest rates, what would be the best type of Fed chairman?  In the 1980s and 1990s, when most academics thought the “time inconsistency problem” biased us toward excessively fast NGDP growth, there was a view that we needed a sober, conservative central banker.  Maybe even someone a bit heartless.  Someone who could hold down inflation expectations.  Of course macroeconomists are exactly like the generals who are always fighting the last war, and this was all an attempt to build models out of a single observation—the 1970s.  In retrospect the models were wrong.  So if we are stuck with interest rate targeting, what sort of central banker do we need?

During most times a sober, responsible figure like Volcker/Greenspan/Bernanke is fine.  They can use their Taylor Rules to try to keep NGDP growing at a low and stable rate.  But the minute interest rates hit zero (or even close to zero) there should be a provision that the entire FOMC is replaced with a new FOMC.  And who should be on the new FOMC?  Sit down before you read this . . .

I’m thinking of people like Jim Cramer and Larry Kudlow.  When I say “like them,” I don’t mean people with similar views on monetary policy, I mean people with similar personalities.  People who are optimistic about America, strongly pro-growth, people that are not passive, but rather want to make things happen.  You get the idea.  The point is to instill the public with a feeling that good times are just around the corner, and that they will pull out all the stops to make it happen.  The last thing we need right now is a central banker with shoulders hunched over, who solemnly intones about the looooong difficult period America has ahead if it.  Who keeps talking about how we need to tighten our belts, and get used to a lower standard of living.  Come to think of it, I’d like to nominate my commenter JimP to the FOMC.

Back to reality, I have two serious points in this post.  One is that Nick has correctly pointed to the key role played by beliefs in the transmission of monetary policy.  Academic economists have an enormous responsibility to make people understand that liquidity traps do not limit the effectiveness of monetary policy.  Unfortunately among the people who need to be educated are Fed Presidents like Janet Yellen, and what Krugman calls the “economic analysts” who advise them.  But my second point is that this “expectations” issue should not be misunderstood.  The previous examples of monetary policy at the zero rate bound (US in the 1930s, Japan more recently) make it crystal clear that (contrary to Krugman) there is no such thing as an expectations trap.  No central bank has ever tried but failed to reflate.  Central bankers set the agenda, it is up to them to provide leadership, if they wish to do so.  But right now the leaders of the Fed, ECB, and BOJ, have absolutely no desire to raise NGDP growth expectations.  And that’s a shame.

PS.  Regarding Nick’s proposal for no more discussion of the short term policy rate; my dream is a macroeconomics with no discussion of either interest rates or inflation.  Just aggregate hours worked for the real (cyclical) variable, and NGDP for the nominal variable.  Monetary policy targets NGDP expectations rather than the short term rate.

I never thought I’d see “Hayek” and “rap anthem” in the same sentence

For you Austrian rap music fans.

HT:  Russ Roberts and Tyler Cowen.  Russ did a superb job as producer.  I’m starting to understand why Austrians think the boom is the real problem.  I guess slow students like me absorb ideas better through music.

Update:  I forget to mention that the filmmaker was John Papola

Looking to economic analysts for guidance

Well at least this time he didn’t mischaracterize my views.  But I still think Paul Krugman slightly misunderstood my point.  If you don’t know what I am referring to, Krugman has just done his once a year comment on one of my blog posts.  It’s not that bad.  He’s right that my post was a bit naive—I did that to be provocative.  But I will also contest some of his views.  And his follow-up post raises some very important questions when he tries to explain President Obama’s failures.

First a bit of fun.  My post was entitled “What we should be debating,” and note the term ‘we.’  Krugman responds:

Scott Sumner argues that we should be debating the substance of monetary policy, rather than whether Ben Bernanke should be reappointed. I wish it were that simple.

Of course the underlying issues involve monetary policy. But the Senate doesn’t get a direct vote on that; the only vote it gets is on whether to approve a Fed nominee. And Senators are looking to economic analysts for guidance on that actual vote.

At first I wasn’t sure what to make of this.  Could Krugman have confused me with the new Senator from my home state.  We are both named Scott.  Seriously, I get the fact that Senators aren’t expected to debate the fine points of monetary economics.  But that wasn’t the point I was trying to make.  My complaint was that most of the blogosphere posts I saw (pro and con) didn’t discuss what I thought was the central monetary policy issue of our time—has monetary policy been too expansionary or too contractionary since mid-2008.  It would be like evaluating the job the head of FEMA did, without discussing his performance during Katrina.  In fairness, Krugman did briefly mention the need for more monetary stimulus in a recent post on Bernanke.  But for the most part the debate on the internet seems to have focused on regulatory issues, not monetary stimulus.

I do expect even Senators to have some view on the overall stance of monetary policy.  Plenty of Senators were demanding a more expansionary monetary policy in 1933, despite the fact that interest rates were near zero and the monetary base had recently expanded dramatically.  So they were able to look beyond the simple Keynesian and monetarist models.   Are our Senators today more ignorant of monetary policy than the Senators of 1933?  Actually yes, because 25 years of the Great Moderation have de-politicized monetary policy, leaving most non-economists (and plenty of economists) oblivious to any monetary options other than changing the fed funds rate.

OK, so far I am sort of with Krugman, our Senators do need advice from “economic analysts.”  That’s why I want to spark a debate on this issue, to help our Senators become more informed.

Since October 2008 I have been running around like Paul Revere yelling the deflation is coming, the deflation is coming.  (Well, actually falling NGDP, but deflation is easier to say.)  In February I started the blog and few weeks later I sent an open letter to Krugman asking him to support a full court press of every unconventional monetary tool we could think of.  Ideas such as quantitative easing via assets other than T-bills, inflation or NGDP targeting, stopping the payment of interest on excess reserves and considering a modest interest penalty on ERs.  Krugman basically blew me off, saying something to the effect that monetary policy is ineffective once rates hit zero.

In fairness to Krugman, I don’t think he necessarily disagreed with all my suggestions, rather my hunch is he never read much beyond the opening section of my letter.  There are other occasions when Krugman did mention the possibility of using unconventional tools.  But my point is this, the average reader looking at Krugman’s response to me back in March 2009 would have naturally inferred that I was delusional in thinking the Fed could do anything once rates hit zero.

I also argued that fiscal policy was not going to be enough, as it was much less stimulative than monetary policy.  We have just engaged in deficit spending nearly twice as big as Reagan’s famous 1981-83 deficits (as a share of GDP), and even Krugman himself has noted that the recovery is pathetically weak compared to the 1983-84 recovery (which saw real growth in the 6% to 8% range for about 6 quarters.)  BTW, the 4th quarter probably will be strong, but early indications  are that we will slow again in the first quarter.

Throughout much of 2009 I kept challenging liberals to push harder for monetary stimulus.  Last summer I pointed out that it was in their interest to do so, otherwise the Dems faced a debacle in the 2010 elections.  And yet I never seemed to see any sort of forceful statements coming out of Washington.  Why aren’t Obama, Pelosi and Reid pushing hard for more monetary stimulus?  Today, Krugman provides the most plausible answer that I have yet seen:

And Senators are looking to economic analysts for guidance

As I said, I have been working my butt off trying to provide guidance to our policymakers.  Yet despite this very generous compliment from Tyler Cowen, something tells me that isn’t the first thing the Democratic elite reads each morning.  No, my hunch is that they are much more likely to rely on what they read in the NYT, especially if it comes from the most famous liberal economist in America, who is a superb writer, and who just won the Nobel Prize.  Unfortunately, until recently he was mostly ignoring monetary policy, and instead kept insisting that fiscal stimulus was the only solution.  (Please don’t dig up early quotes where he mentions inflation targeting, for every such quote I can find 5 where he writes in such a way that the average Senator would assume there is nothing more the Fed could do.  “Period.  End of story.”)

Now we all know that Paul Krugman is very modest, so I’m sure he would deny having that much influence in shaping opinions.  After all, the fiscal stimulus was smaller than what he wanted.  But he is more influential than he might think.   He did seem to come around to my view late last year when it became obvious that the fiscal stimulus wasn’t going to get the job done, and became increasingly critical of the Fed.  He even started talking up quantitative easing.  And soon after that I started to see other liberal bloggers become increasingly critical of the Fed’s refusal to take additional steps to boost aggregate demand.  This is good, I just wish it had come in October 2008.

You might ask why I am giving the conservatives a free pass.  Some conservatives did push for additional stimulus, but the average Chicago-type economists did not.  In this case the problem was different; most agree with me that monetary policy can impact NGDP, even at zero rates.  But they didn’t seem to think additional nominal growth would have been helpful.  So I sort of wrote them off as hopeless cases, like the conservatives in the early 1930s who felt the biggest problem was the “inflationary” monetary policies pursued by Herbert Hoover’s Fed.  I won’t get into all the reasons for their failure to understand the danger of NGDP falling at the fastest rate since 1938, but it had to do with misunderstanding the reasons for the monetary base increase, focusing on inflation rather than NGDP, forgetting that a severe debt crisis is not the best time to downshift from 2% inflation to 0%, thinking wages are pretty flexible now that unions are weak, and focusing on backward-looking policy rules.  So to give the liberals credit, at least they consistently diagnosed the problem—too little AD.

Part 2.  Is Obama to blame?

In a follow-up post Krugman tries to assess what went wrong in Obama’s first year.  As a general rule, strong supporters of a candidate aren’t always the best person to evaluate their failures.  Krugman tries to put things into perspective by comparing the situations faced by Obama and FDR:

What seems clear to me is that the economics were bound to be difficult. Long before the bad numbers started rolling in, there were strong reasons to believe that the economy was in for a prolonged jobless recovery. For one thing, that’s what had happened after recent US recessions, and this slump seemed to share the same characteristics; for another, prolonged periods of weak employment are normal in the aftermath of financial crises(pdf).

So one case you can make is that Obama was just fated to have a bad first year. FDR had the good luck not to take office until more or less everything that could go wrong, had; the bank runs had already happened, the big decline in GDP was already nearing its end. Obama, by contrast, came into office early enough to take the blame for the continuing slump.

I don’t totally agree with the first paragraph; the two previous recessions were relatively mild and it is easier to get fast growth when coming out of a steep slump like 1920-21, 1929-33, 1937-38, and 1981-82.  But it is at least defensible.  But I can’t make heads or tails of the second paragraph.  When FDR took office in early March 1933 we were in the midst of the worst banking panic in American history.  Some states had already shutdown their entire banking system and FDR was about to close all of America’s banks.  Yes, the contraction ended in March 1933, but only because FDR made it end with the most expansionary monetary policy in American history—which caused both prices and output to rise rapidly in the months immediately after March 1933.

Here is one sense in which FDR had a slight advantage; things were so much worse in 1933 that the country gave him almost a free hand to do what he wished.  His most effective policy was doing an end run around the ultra-conservative Fed by devaluing the dollar, and threatening to issue billions of “greenbacks” (fiat money) if the Fed didn’t play ball.  I am certainly not suggesting that Obama had the political capital necessary to take steps that radical.  But if you go back to the previous post, Krugman seems to think Obama was even weaker than he actually was:

Nor is it necessarily the case, as Sumner suggests, that the Obama administration chose Bernanke because it favors the policies it believes he will follow. Again, it’s not that simple: administration’s choose Fed chairs to appease markets, or to avoid a fight with the other party, or because they think it will look good on TV.

When Obama took office he should have declared a national economic emergency and met with all the key policymakers, including Bernanke.  Or maybe he did and I forgot.  In any case he should have had this sort of discussion:

But could more have been done to turn things around? The best chance of averting the normal, dismal aftermath of financial crisis was to respond very aggressively on multiple fronts: really big fiscal stimulus, massive recapitalization of the banks to get them lending again (which in turn would have meant temporary nationalization of the weakest players). And aggressive action at the Fed, including really big quantitative easing and a higher inflation target, could have helped.

In fact, the Obama administration didn’t do any of these things. Instead, it pursued meliorative policies: a stimulus that was huge by historical standards but inadequate to the size of the problem, and a bank policy aimed at restoring confidence rather than promoting a revival of lending.

These aren’t my views BTW, these are the views of an enlightened liberal pundit.  There would be no reason for Obama to adopt my views, I’m not a Democrat.  If Bernanke didn’t agree with the monetary stimulus idea, Obama should have said “Thank you very much for your service, but we need to move on.”  And then picked some respected liberal monetary economist who did support additional unconventional monetary stimulus.

But now I think Krugman may be being a bit too hard on President Obama.  Yes, in retrospect this is what he should have done.  But how could you expect Obama to have known that at the time?  In February 2009 there were just a handful of us pushing aggressively for “really big quantitative easing and a higher inflation target.”  Krugman was fond of saying that QE didn’t work in Japan (even though they never really tried QE) and said we needed a much higher inflation target, and that central banks were way too conservative to do this.  In fact, even a 3% expected inflation target would have led to massive stimulus by the Fed, given the enormous slack in the economy.

So again, I ask this question:  How can we expect President Obama to have known when he first took office that the Fed needed to do much more stimulus?  Obama is not an economist.  Almost all non-economists think there is nothing more the Fed can do once rates hit zero.  How could Obama have known otherwise?  Perhaps the answer is that the policymakers in Washington were:

Looking to economic analysts for guidance

And did not find the guidance they needed from the most famous liberal economist in the world.

PS.  Yes, I know that this means Summers, Romer, et al, are also to blame.  And I’m sure Krugman believes no one in Washington listens to him.  But you know what I always say; it’s all about the zeitgeist.  And Krugman is as influential an opinion-maker as anyone.

PPS.  Every time I mention the open letter, a Krugman supporter tries to defend him.  So once again; I specifically asked him to support several “unconventional” monetary options like QE involving riskier assets, inflation targeting, etc.  I claimed he had once indicated those might work at the zero bound.  And this is true.  He answered my letter as if I claimed he had suggested conventional monetary stimulus could work at the zero bound.  He said he had never made such a statement.  True, but I never said he had.  Then he totally ignored my plea for more unconventional stimulus.  That is, until recently, when he started advocating policies I had asked him to support in the open letter last March.

PPPS.  Just before going to post this Krugman posted this:

So sure enough, we have Tim Geithner arguing that Ben Bernanke needs to be confirmed because otherwise the markets will be troubled.

I hate, hate, hate it when people say that we have to do something, not on its merits, but because otherwise we would damage market confidence. Nobody really knows how the markets will react; the right thing, always, is to pursue policies that look right on the substance.

The weird thing is that I had originally assumed that he was criticizing me for being naive in not understanding that Obama needed to consider the reaction of markets.  Now I think that he actually agrees with me, and that he was saying I was being idealistic for assuming that real world politicians wouldn’t kow-tow to markets, even if he and I both agree they shouldn’t.  Just one more example of how easy it is to misinterpret another blogger.  Did any of you guys also misread his criticism of me?  Or was it just me?

HT:  Dilip

Richard Rorty would be scratching his head

Nick Rowe is on a roll with a series of very clever posts on the EMH.  In this one he draws a S&D graph with the two axes labeled:

1.  Extent to which EMH is true

2.  Extent to which EMH is believed true

As a good Rortian I am trying to figure out the difference between the two axes.  I wonder if Nick realizes how deeply he is wading into an epistemological morass.  But don’t be put off by my sarcasm, it is a really clever way of framing the issue.  And like Oliver Sacks’ Anthropologist on Mars, I do know how normal humans think about truth.  In fact I used to be a normal human.  Really.

DeLong defends Bernanke

As you know, I am not a fan of Brad DeLong’s old-style Keynesianism.  But I have to give him grudging credit for this post, which is the best analysis of the Bernanke debate that I have read.  You can see how DeLong’s comparative advantage lies in economic history rather than pure theory–he is very good at weighing and analyzing a complex set of political and economic factors.

And that’s why I am focusing on my comparative advantage—getting people to think about monetary issues from a different perspective.  People know what I think the Fed should do, I’ll let those with better political instincts than me determine the best way to get there.

PS.  Matt Yglesias seems to agree with me that we need to be asking hard questions about what the Fed is trying to accomplish.