I recently attended an economic conference with mostly conservative-leaning economists.  Someone had a paper that mentioned how certain types of deflation can actually be good, as when rapid productivity growth helped reduce prices in the late 1800s.

I agree with this, and mentioned that I rarely hear conservatives talk about “good inflation.”  Well I might as well have thrown a skunk into the middle of the room.  Let’s just say that the idea of “good inflation” didn’t go over too well.

And isn’t that the problem?  Isn’t that why we are where we are?  We have all sorts of models that are basically symmetrical.  You might argue that a stable price level is ideal, and that any inflation or deflation is bad.  But if you argue that some deflation is bad and some is good, then you implicitly have a model that distinguishes between demand and supply shocks.  So supply or productivity-driven deflation is good.  Of course those models imply that inflation caused by a fall in aggregate supply is also good.  The models are completely symmetrical.   This shouldn’t even be controversial.

So why don’t conservatives look at things that way?  And why do you rarely hear liberals talk about “good deflation.”  Maybe it’s just mood affiliation.  Or maybe people just don’t have the right model in their heads.  (I.e. the model I have in my head.)  Some people do understand that the argument is symmetrical.  (I seem to recall both David Beckworth and George Selgin making similar observations.)  But it seems to me that they (and a few others) are the exception.  And maybe that’s why the Fed is having so much trouble creating “good inflation.”

PS.  Notice that NGDP targeting automatically creates deflation when deflation is appropriate and inflation when inflation is appropriate.

Joe Stiglitz has a new article, where he continues to develop his rather unconventional view of business cycles.  Is his theory a real theory or a demand side theory?  I can’t quite tell, maybe one of my commenters can help me out.

Of course the most important stylized fact of the Great Depression was the horrific collapse in industrial production between 1929 and 1933.  And what caused this collapse?  Apparently productivity improvements in the farm sector.  Productivity gains that were also occurring in the booming 1920s.

And how does Stiglitz know this?

At the beginning of the Depression, more than a fifth of all Americans worked on farms. Between 1929 and 1932, these people saw their incomes cut by somewhere between one-third and two-thirds, compounding problems that farmers had faced for years. Agriculture had been a victim of its own success. In 1900, it took a large portion of the U.S. population to produce enough food for the country as a whole. Then came a revolution in agriculture that would gain pace throughout the century””better seeds, better fertilizer, better farming practices, along with widespread mechanization. Today, 2 percent of Americans produce more food than we can consume.

Interesting, but this has been going on for 120 years.  So why was the economy booming in 1929, and flat on its back in 1932?  And why doesn’t Stiglitz discuss what happened to the incomes for the other 80%, the people not in farming?  It turns out that their incomes also fell “between one-third and two-thirds,” indeed nearly 50% by the fourth quarter of 1932.   So nothing particularly interesting was going on in farming, and yet this somehow explains the far greater collapse in output in manufacturing, mining, and construction.  There may be a model there, but I don’t see it.

What about the conventional explanation, that it was an adverse demand shock?  The view that errors of omission or commission by the Fed explain the 50% fall in NGDP:

Many have argued that the Depression was caused primarily by excessive tightening of the money supply on the part of the Federal Reserve Board. Ben Bernanke, a scholar of the Depression, has stated publicly that this was the lesson he took away, and the reason he opened the monetary spigots. He opened them very wide. Beginning in 2008, the balance sheet of the Fed doubled and then rose to three times its earlier level. Today it is $2.8 trillion. While the Fed, by doing this, may have succeeded in saving the banks, it didn’t succeed in saving the economy. Reality has not only discredited the Fed but also raised questions about one of the conventional interpretations of the origins of the Depression. The argument has been made that the Fed caused the Depression by tightening money, and if only the Fed back then had increased the money supply””in other words, had done what the Fed has done today””a full-blown Depression would likely have been averted. In economics, it’s difficult to test hypotheses with controlled experiments of the kind the hard sciences can conduct. But the inability of the monetary expansion to counteract this current recession should forever lay to rest the idea that monetary policy was the prime culprit in the 1930s.

.   .   .

Monetary policy is not going to help us out of this mess. Ben Bernanke has, belatedly, admitted as much.

Readers of Vanity Fair are being led to believe that Bernanke went into this downturn thinking that monetary stimulus was the answer to depressions, and then had a sort of epiphany that monetary stimulus doesn’t work.  Is this really true?  Has Bernanke suddenly become an adherent to the view that the Fed is out of ammunition?  Or that they have ammo, but that nominal growth can’t solve real problems (as RBC adherents believe.)  I’ll pay $100 to the first person who can convince me that Bernanke believes monetary policy can’t boost AD, or that he believes AD can’t boost output.  (I should offer $10,000, but proportional to wealth my offer is just as generous as Mitt Romney’s.)

Stiglitz is a distinguished Nobel Prize winner.  But he didn’t win for business cycle theory.  I doubt even his fellow progressive Paul Krugman could make heads or tails out of Stiglitz’s essay.  That doesn’t make Stiglitz wrong (I’m also a contrarian.)  But if you are going to make that sort of argument, you need more evidence than farm incomes falling during the Great Depression.

Paul Krugman likes to show a graph indicating that each country began recovering from the Depression right after it adopted expansionary monetary policies (i.e. currency devaluation.)  If Stiglitz has an explanation for that, I’d love to hear it.

Back in the 1930s many people thought the Great Depression was caused by too much output.  This led FDR to adopt programs aimed at reducing output (such as the AAA and the NIRA.)  They “worked.”  Today economists tend to scoff at such ideas, as falling output is essentially the definition of a depression.  But not Stiglitz:

Throughout the 1930s, in spite of the massive drop in farm income, there was little overall out-migration. Meanwhile, the farmers continued to produce, sometimes working even harder to make up for lower prices. Individually, that made sense; collectively, it didn’t, as any increased output kept forcing prices down.

HT:  Gregory Barr, Larry

Update: I see Ryan Avent is equally puzzled by Stiglitz’s model.  And so is Nick Rowe.  Will Krugman give Stiglitz the Fama/Lucas/Cochrane treatment?

Two graphs:

And:

Let’s see if we can’t do better in January, by which time the three hawks will be gone.

BTW:  Fed announcements come at 2:15 pm.

At least Evans dissented from this embarrassing statement:

Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. The Committee continues to expect a moderate pace of economic growth over coming quarters and consequently anticipates that the unemployment rate will decline only gradually toward levels that the Committee judges to be consistent with its dual mandate. Strains in global financial markets continue to pose significant downside risks to the economic outlook. The Committee also anticipates that inflation will settle, over coming quarters, at levels at or below those consistent with the Committee’s dual mandate. However, the Committee will continue to pay close attention to the evolution of inflation and inflation expectations.

We expect to fail, but we’ll keep a close watch on things just to make sure.

Here is Robert Hetzel discussing a Tim Congdon essay on liquidity traps:

If the public is sufficiently pessimistic about the future so that asset prices are low and the demand for money is high, the central bank might have to create a significant amount of money to influence the expenditure of the public. The institutional fact that makes a liquidity trap an irrelevant academic construct is the unlimited ability of the central bank to create money. One can make this point in an irrefutable manner by noting that the logical conclusion to unlimited open-market purchases is that the central bank would end up with all the assets in the economy including interest-bearing government debt, and the public would hold nothing but non-interest-bearing money. Because that situation is untenable, individuals would work backward from that endpoint and begin to run down their money balances and stimulate expenditure in the current period.

What drives the conclusion that the central bank can control the dollar expenditure of the public is that the central bank can conduct monetary policy as a strategy, say, by altering the monetary base and the money stock by whatever amount necessary to maintain nominal expenditure on track. Historically, however, the FOMC has never been willing to communicate its behavior as a “policy” in the sense of systematic procedures designed to achieve an articulated, quantifiable objective (a reaction function). Instead, it communicates individual policy actions such as changes in the funds rate or, since December 2008, changes in the size and composition of its asset portfolio. Just as importantly, it explains those individual policy actions using the language of discretion.

The FOMC Minutes released after each meeting package the current policy action as optimal taken in the context of the contemporaneous state of the economy. As a matter of political economy, the FOMC can then attribute adverse outcomes to powerful real shocks originating in the private sector. In the event of inflation, as in the 1970s, it can blame the greed of powerful corporations. In the event of recession, as in the Great Depression and now with the Great Recession, it can blame the greed of bankers who made excessively risky, speculative bets. From this political-economy perspective, a “policy,” which requires a numerical objective, say, steady nominal expenditure, and an articulated strategy, say, a feedback rule running from a path for nominal expenditure to money creation, suffers two defects.

First, the explicitness of an objective communicates to the political system that the FOMC can take care of a problem that the FOMC considers to have been not of its making. A problem arising as a real shock should possess a solution coming from the political system, for example, through expansionary fiscal policy. Second, an explicit objective, by its nature, highlights misses. As a matter of accountability, however, that is the point. The FOMC must then explain rather than rationalize the miss by defending the miss as a real shock originating in the private sector rather than as arising from faulty policy based on a misunderstanding of the economy.

Hetzel has a new book coming out that will revolutionize the way economists look at the Great Recession, much as Friedman and Schwartz changed the way we look at the Great Depression.  Here is the title:

Hetzel, Robert L. The Great Recession: Market Failure or Policy Failure? Cambridge: Cambridge University Press, 2012.

HT:  David Levey