Archive for November 2010


An open letter to conservatives

There has recently been a lot of pushback against QE from conservatives.  In this post I pointed out that plenty of conservatives support monetary stimulus.  Here I’d like to direct 7 arguments against my fellow right-wingers:

1.  The Fed isn’t really trying to create inflation.

The Fed doesn’t directly control inflation; they influence total nominal spending, which is roughly what Keynesians call aggregate demand.  Whether higher nominal spending results in higher inflation depends on a number of factors, such as whether the economy has a lot of underutilized resources.  But it’s certainly true that for any given increase in NGDP, the Fed would prefer more RGDP growth and less inflation.  Even after QE2, the Fed still expects less than 2% inflation for years to come.  If the Fed had any marketing sense, they’d be telling the public they are trying to boost recovery by increasing national income, not increasing the cost of living.  It would also have the virtue of being true.

2.  “But doesn’t economic theory teach us that printing lots of money creates high inflation?”

In general that is true.  But there are three important exceptions:

1.  If the monetary injections are expected to be temporary, the inflationary effect is far smaller.  The Japanese central bank did lots of QE in 2003, but pulled much of the money out in 2006 when deflation ended.  It worked in preventing high inflation, indeed it may have worked too well.

2.  If interest rates are near zero, the public demands more liquidity.  The Fed can supply that liquidity with little impact on the price level.

3.  If the Fed pays interest on reserves, then the quantity theory of money (more money means more inflation) doesn’t necessarily hold.  They recently started paying interest on reserves, and that’s one reason why the big injections from 2008 didn’t have an inflationary impact.  The Fed can adjust the rate as necessary, and indeed in my view a lower IOR would be more effective that QE2.

3.  “But isn’t the gold market signaling high inflation?”

Possibly, but the indexed bond market is superior to gold prices for two reasons.  First, gold is trading in a global market, and we are interested in US inflation.  More importantly, gold prices reflect all sorts of factors (industrial demand in Asia, central bank demand, a recent drop-off in new discoveries, a hedge against all sorts of financial risks, including eurozone turmoil.)  Furthermore the indexed bond market (TIPS spreads) has recently been more accurate than gold—correctly predicting low inflation in the US since late 2008.

4.  “Doesn’t printing money just paper over real (structural) problems in the economy?”

There are structural problems, but there is also a shortfall of nominal GDP.  The structural problems showed up when growth slowed in late 2007 and early 2008 as a result of sharply lower housing construction.  This is necessary re-allocation of resources and should not be resisted.  But even Friedrich Hayek suggested that we needed to avoid a “secondary deflation”, which would show up as falling NGDP, and would depress output in even those healthy industries that had not over-expanded.  In late 2008 output fell across the board as NGDP declined.  Monetary policy can only address the insufficiency of total nominal spending, not the structural problems.  Furthermore, more nominal spending would boost employment, which would speed up the time when Congress eliminates the 99 week extended UI benefits–which is one of the structural problems.

5.  “Isn’t this just hubris—the idea that money can be centrally planned?”

Most right wing economists are not comfortable with the idea of giving discretion to the central bank.  I am no exception.  I happen to favor making the dollar convertible into NGDP futures contracts as a way of stabilizing NGDP growth expectations at a low and stable rate.  Milton Friedman favored a stable money supply growth rate, but late in his career (after velocity bounced around) endorsed a policy of stabilizing market expectations of inflation in the indexed bond market.  These systems would allow the market, not the Fed, to determine the appropriate level of money for the economy’s needs.  But we aren’t there yet, and given the Fed does use discretion, Friedman was not at all hesitant about recommending policies that he thought would do the least damage.  I believe that is stable NGDP growth expectations.

6.   The conservative critique of stimulus is incoherent

When I started my blog in early 2009, fiscal stimulus was the hot issue.  Many conservatives were opposed to fiscal stimulus, arguing (correctly in my view) that it would fail.  And they made it quite clear that “failure” meant deficit spending would fail to boost nominal spending.  The implicit assumption was (almost everyone agreed) that more nominal output would be desirable, and the argument was that fiscal stimulus could not deliver it.  With monetary stimulus, the right is making exactly the opposite argument—they are opposed to QE because it might succeed in boosting NGDP.  Both fiscal and monetary stimulus boost NGDP (if they work at all) by shifting AD to the right.  Whether that extra spending shows up as inflation or real growth is of course an important issue.  But it makes no sense to argue fiscal stimulus would fail because it would not boost NGDP, and simultaneously argue that monetary stimulus would fail because it would increase NGDP.  I’m sure the right doesn’t think of its views in those terms, but that is essentially the message they are sending out, and it is an extremely incoherent message.

7.  “Won’t monetary stimulus just paper over the failures of the Obama administration, allowing him to get re-elected?”

That’s an argument unworthy of principled conservatives.  After 30 years of major neoliberal reforms all over the world (even in Sweden!) it’s time for conservatives to become less defeatist about the possibility of making positive improvements in governance.  We need to do the right thing, and let the political chips fall where they may.  If monetary stimulus is tried, and succeeds in boosting NGDP (which even conservatives implicitly acknowledge can happen when they worry about inflation) then it would drive a stake through the heart of the Krugmanite fiscal stimulus argument (for future recessions.)

I don’t think conservatives realized it at the time, but I (and a few other quasi-monetarists) had the strongest argument against fiscal stimulus in late 2008 and early 2009.  We said; “Yes, stimulus is needed, but monetary stimulus is much more effective and less costly than deficit spending.”  At the time, most on the left argued that monetary stimulus wouldn’t work if rates were near zero.  Well rates are still near zero, and many of those same liberals are now insisting that the Fed is responsible for fixing the AD shortfall.  They’ve come over to our side.  Just as in earlier decades they gradually accepted the Friedman/Schwartz argument that monetary policy errors caused the Great Contraction of 1929-33, not the failures of capitalism.  If conservatives keep predicting inflation that the financial markets don’t see, Krugamn will continue to rub their faces in failed predictions.  If we adopt the view that monetary policy is the appropriate way to keep NGDP growing at an adequate rate, then we win and Krugman loses.  So which will it be?

Bentley rulz

The Fed Challenge is a monetary policy debate held each year for teams of undergraduate college students.  Our team usually does pretty well, but yesterday’s performance was especially noteworthy.  They competed in the Northeast semifinals against some obscure colleges such as:

Harvard, Brown, Dartmouth, MIT, Yale, Tufts, Framingham, Salem, Middlebury, Bryant, BC, BU, Bridgewater, Clark, Northeastern, WNEC, Quinnipiac, UNH

And won.  Which means it’s on to the national contest in DC.

Congratulations to our team:

Christina J. Harstad

Satyajeet Jadhavrao

Pranay Kumar Jain

Peter Jurik

David Norrish

Maximillian Barco

Shohana Jannat

Victoria Lee Tran


David Gulley

Aaron L. Jackson

My colleagues David Gulley and Aaron Jackson have done all the work setting up our team and advising them, but I did get to meet them a couple times and saw their practice session.  One of the team members (David Norrish) offered a fairly persuasive argument against NGDP targeting.  He said something to the effect; “Is it really wise to have the largest economy in the world experiment with a policy that has never once been tried anywhere else?”

Because I am a pragmatist, I found this critique pretty impressive.  After all, inflation targeting was first pioneered in small economies like New Zealand.   And it got me thinking about NGDP targeting in small countries.  Suppose there was a huge rise in the world price of copper, and as a result the Chilean copper industry went from 10% of NGDP to 15% almost overnight.  Under strict NGDP targeting, this would require the non-copper parts of the Chilean economy to shrink by 5% of GDP.  I suppose you could argue that workers should be reallocated to the copper mining industry.  But that industry may be capital intensive, and/or the supply may be rather inelastic in the short run.  Some ideas:

1.  This thought experiment suggests NGDP targeting might work better in very large and diversified economies where no single industry is dominant.

2.  This example suggests Bill Woolsey might be right about nominal domestic final sales being superior to NGDP, after all, most Chilean copper is exported.

3.  Recall that I once argued nominal wage targeting was theoretically superior, but NGDP was a pragmatic compromise.  This example shows where NGDP is no longer a good proxy for nominal wages.

4.  It might be better to set the NGDP target a bit further out in the future—say a policy of targeting 2-year forward NGDP (as some of my commenters suggested.)

The bottom line is that I don’t expect NGDP targeting to be adopted by a small country.  Nominal domestic final sales is still a possibility, however.

PS.  It’s especially gratifying beating the school portrayed in The Social Network.  Let’s see if Greg Mankiw does a post on this.  🙂

Update:  In the comment section Bill Woolsey mentioned that he favored targeting nominal final sales, and my example was actually referring to nominal final purchases.  Also in the comment section George Selgin observed that this post raises the question of optimal currency zones.  Or perhaps I should say optimal monetary policy zones.  I think he is right, but I also think the dollar zone is smaller than generally perceived.  For instance, many would include China, despite the fact that the yuan is up about 3% in recent months, and over 20% since 2005.  It’s clear China has raised the yuan precisely because they wanted to avoid the high inflation that would result from a dollar peg.  The three or four countries that actually use the dollar would definitely qualify, but they are quite small.  Those with rigidly fixed rates are also part of the dollar zone, although I believe most of them are also fairly small.  Are there any large countries that have rigidly pegged their currencies to the dollar for a long period?

Conservatives for monetary stimulus

This article in the National Review is a very fair and balanced look at the pro- and anti-monetary stimulus camps.   Ramesh Ponnuru points out that a number of economists generally regarded as right of center have favored monetary stimulus and/or a higher inflation target.  He mentions John Makin, Greg Mankiw, David Beckworth and yours truly.  There are others as well, many of whom have blogs (Bill Woolsey, etc—I won’t try to mention all the names because I’m never sure who likes being called conservative.  I prefer the term ‘right-wing liberal.’)  The article also mentions George Selgin’s productivity norm.  BTW, people have asked me about his co-authored piece on the Fed (which is excellent) and I plan a post soon.

The article points out that the left is also split, although among professional economists I think liberals are significantly more in favor of stimulus.  Brad DeLong has a new post that shows the famous graph of NGDP growth falling far short of trend, and then makes this point:

The problem with our economy is not that something bad happened to our productive capacity while the flow of nominal spending continued to blip along, it is that something bad happened to the flow of nominal spending and that carried real production and employment down with it. At the moment our flow of nominal spending at $14.7 trillion per year is some 12% below its pre-2008 trend. And in the absence of any 12% decline in prices and wages, that shortfall in spending has to produce our current macroeconomic distress: there is not enough “money” to support enough of a flow of spending to chase all the goods we could produce. We don’t have a deficiency of real supply (for whatever reason). We have a deficiency of nominal demand.

That’s what John Walter Bagehot would say. That’s what Irving Fisher would say. That’s what Jacob Viner would say. That’s what Milton Friedman would say.

And they would say that it is a central bank’s business to intervene in asset markets to boost the flow of nominal spending back to what everybody expected it to be and counted on it being

Excellent points.  But before DeLong does too much conservative bashing, he might want to ask which two blogs were best known for presenting quite similar arguments for monetary stimulus in February 2009, and what was the political orientation of those two bloggers.  And by late 2009 you could have added Bill Woolsey.

HT:  JimP, for both links.

Bob Murphy explains the Ben Ber-nank’s policies to his son

For some reason I imagined Bob Murphy talking to his son when I watched this video:

My God, what a big mistake the Fed (and the profession) made in talking about monetary policy in terms of inflation!  The following would be the sort of video I’d envision if I was trying to explain things:

Son:  What’s all this QE2 talk about?

Bob the Austrian:  The Fed is printing more money to boost national income.

Son:  Why do they want to boost national income?

BTA:  Because we’ve had a severe recession and the economy is still weak, more income would make Americans better off.

Son:  But won’t that money just blow up more bubbles, isn’t a painful adjustment necessary after the housing bubble?

BTA:  You need to study Hayek.  The initial re-allocation of resources was necessary, but the secondary deflation that began in late 2008 caused an unnecessary fall in national income.

Son:  Why then do so may conservatives oppose QE2?

BTA:  They have two objections; they say it won’t have any effect, and they say it will cause lots of inflation.

Son:  But aren’t those two effects logically inconsistent?

BTA:  Yes.

Son:  Then why do left-wingers oppose the QE2?

BTA:  They favor fiscal stimulus instead.

Son:  But won’t fiscal stimulus balloon the budget deficit much more than monetary stimulus?

BTA:   Yes.

Son:  But why are so many countries opposed to QE2?

BTA:  The Chinese are worried that a weak dollar will cause the Chinese currency to also become weak, causing inflation.

Son:  But if the Chinese think the US dollar is not a good currency, then why do they fix their own currency to the dollar?  Did we request they fix their currency to ours?

BTA:  Not exactly.

Son:  Why is QE2 so unpopular with the public?

BTA:  Because the Ben Ber-nank keeps saying they are trying to create more inflation.

Son:  Are they trying to create more inflation?

BTA:  No, they are trying to raise NGDP.

Son:  If they rise NGDP is the hope that this will also raise inflation?

BTA:  No, they hope that for any given increase in NGDP they get as little inflation and as much real growth as possible.

Son:  Then why does the Ben Ber-nank use such an unpopular argument to sell such a good idea.  I think most Americans would like to see their incomes rise.

BTA:  The Ben Ber-nank was a professor of economics, not marketing.  In addition, the Ben Ber-nank has not been exposed to the incredible beauties of NGDP targeting, as his job at the Fed leaves him little time to read the wise thoughts of Friedrich Hayek and Scott Sumner

Son:  I can’t wait to read the thoughts of those two wise men.

PS.  Regarding the Hayek link; scroll down far enough and you’ll find his picture.

A note on life expectancy and development

Dani Rodrik has an interesting post discussing how some North African countries have done surprising well in terms of the human development index, despite seeing much slower rates of GDP growth than the more famous East Asian models:

Which are the countries that have improved their human development indicators the most since 1970 relative to their peers? You’d be surprised, as I was, to find that the top 10 is dominated not by East Asian superstars, but by Moslem countries: Oman, Indonesia, Saudi Arabia, Tunisia, Morocco, and Algeria. This year’s Human Development Report is full of neat analysis and results, including this one.

Leaving aside the oil exporting countries, the North African cases are particularly interesting. As Francisco Rodriguez and Emma Samman, two of the report’s authors, note, Tunisia, Morocco, and Algeria have experienced remarkable gains in life expectancy and educational attainment, leaving many Asian superstars in the dust.

Rodriguez and Samman make the following claim:

Consider the following comparison. In 1970, a baby born in Tunisia could expect to live 54 years; one born in China, 62 years. Today, life expectancy in Tunisia has risen to 74 years, a year longer than that of China. So while China’s per capita income grew almost three times as fast as Tunisia’s, Tunisia’s life expectancy grew twice as fast as China’s. Since it also significantly outperformed China on the education front, Tunisia gives China a run for its money in the overall development story (as captured by the HDI).

I don’t wish to challenge this finding, partly because I am not an expert in this area.  Tunisia’s performance does look impressive, and we all know China’s health care and education systems have some gaping holes.  Instead I’d merely like to suggest we need to be very careful when considering the impact of economic development on life expectancy.  Life expectancy at birth is a sort of snapshot that reflects conditions over a very long period of time.

I believe that life expectancy at birth in China is now much higher than the official statistics show, as those data are measuring life expectancies for people born at various times over the past 100 years.  And I hope to convince you that the average person born in China today will live longer than the average person born in Denmark today.

One factor that has held back China is the poor health of its rural population.  Part of that reflects poor health care facilities and part reflects environmental risks.  But I also think a large part reflects poor health when young.  Chinese who are 50 years old were born during the Great Leap Forward, when between 20 and 40 million Chinese starved to death, and many more suffered malnutrition.  This link has data from an interesting study of Dutch people born during the 1944-45 famine in Holland.  It turns out those people had consistently worse health during their entire lives.

Admittedly, only a small share of the Chinese population was born during the GLF, but most older people were born during periods of political and economic turmoil.  Indeed until the land reform of 1979 sharply boosted food output, much of the countryside was chronically malnourished.  Old people dying today (which make up a large part of the data from which we estimate life expectancy at birth), lived most of their lives in a country as poor as India and Sub-Saharan Africa were during the same time period.  That’s much poorer than Tunisia.

The following list is the CIA estimate of life expectancy in 2009, which is the most recent I could find.  I excluded nations with fewer than 100,000 people.

1.  Macao  84.36

2.  Japan  82.12

3.  Singapore  81.98

4.  Hong Kong  81.86

5.  Australia   81.63

5.b  Shanghai in 2008   81.28

6.  Canada  81.23



40.  South Korea    78.72

46.  Denmark   78.30

50.  U.S.   78.11

72.  Tunisia  75.78

105.  China  73.47

What do you notice?  I see East Asian countries scoring really high, and the highest western countries being places with lots of East Asian immigrants.  I also see Korea and China lagging somewhat, with indications (from Shanghai) that the problem in China is in rural areas.  The other laggard (Korea) is also a country that suffered extreme poverty and war during the 1950s.  I believe that Shanghai was less affected by famines than the countryside, although it also has better health care, so it’s hard to know what explains the difference.  But I find the Korean case especially interesting; it suggests that the long cloud of history affects life expectancy for quite some time, at least when conditions were extremely bad in previous decades.

This data also suggests that environmental factors may be overrated.  Obviously air pollution is extremely bad in Hong Kong and Shanghai, yet both places have extremely high (and fast rising) life expectancy.  Undoubtedly there are industrial areas of China where local health suffers due to chemical spills, etc, but I’d guess the nationwide life expectancy is more affected by other factors, such as childhood nutrition, smoking, and current health facilities and access.

I claimed that I would try to convince you that Chinese born today might live longer than Danes born today.  That’s already true for Chinese living in places like Beijing, Shanghai and other wealthy coastal cities.  My claim is that today even children in the Chinese countryside generally do not suffer from malnutrition (with very localized exceptions) and by the time they are old enough where medical facilities become very important in longevity (say in 50 or 60 years), even interior China will be at least as rich as Shanghai is today.

Why do Asian countries lead the world in life expectancy?  Not because they spend a lot on health care, but rather some other factors (perhaps diet, culture, lifestyle, genetics, etc.)  Whatever the reason, I’d expect the East Asian/Western gap to become even more noticeable over time, as the older generation of Chinese and Koreans dies off, and all of East Asia converges to Japanese life expectancies.

One reason I indicated that I didn’t wish to challenge the Rodriquez and Sammon finding is that they look at changes in life expectancy–and Tunisia’s has risen faster than China’s.  Whether my argument is at all relevant to that claim is a surprisingly complex question that I’ll just hint at here.  It depends on both the change in current health care, environmental, and nutrition conditions, as well as the extent to which chronic health problems developed in earlier decades can be ameliorated by those improvements.  I’ll leave that to others.  And of course they also look at many other indicators of development, such as education.