Archive for March 2012


Germany is #1 (and we are too)

Germany has finally surpassed China, and now has the world’s largest current account surplus; $202.9 billion according to The Economist.  But the US has an even more impressive achievement; the world’s largest capital account surplus; and astounding $473.4 billion.  Germany may produce nice cars, but no one can beat our assets.

China may have lost it’s trade supremacy, but it will soon have the world’s largest building:

“Have you seen the world’s biggest building yet?” shouted Stephan Wurster, an affable 38-year-old Stuttgart native who moved here in December after three years in Beijing. Both he and Kamaljot Singh Panesar, a goateed British architect at the table, have offices in development zones mushrooming on the plains south of Chengdu, not far from a half-completed behemoth called Ocean Park. Under a single roof covering an area of about 25 football fields, Ocean Park is designed to include hotels, shopping malls, aquariums, amusement parks and a simulated ocean with a white-sand beach. (The ultimate “Truman Show” touch: the 660-foot-wide video screen that will allow beachgoers to enjoy brilliant digital sunsets, even when clouds and pollution block the real thing.)

I love Chengdu—can’t wait to visit and see that sunset!

PS.  I’ll be traveling and won’t have much time to blog for a few days.

John Taylor on monetary policy in 2008

Between 2008 and 2009 NGDP fell at the fastest pace since the Great Depression.  That suggests that monetary policy was probably too tight in 2008.  Oddly, John Taylor seems to think money was too easy, unless I misinterpreted this passage:

A third policy response to the financial crisis was the sharp reduction in the federal funds rate in the first half year of the crisis. The federal funds rate target went from 5-1/4 percent when the crisis began in August 2007 to 2 percent in April 2008. The Taylor rule also called for a reduction in the interest rate during this early period, but not as sharp. Thus the reduction was more than would be called for using the historical relation stressed at the start of this paper, even adjusting for the Libor-OIS spread as I suggested [5] in a speech at the Federal Reserve Bank of San Francisco and in testimony at the House Financial Services Committee in February.

It is difficult to assess the full impact of this extra sharp easing, and more research is needed.  The lower interest rates reduced the size of the re-set of adjustable rate mortgages and thereby was addressed to some of the fundamentals causing the crisis. Some of these effects would have occurred if the interest rate cuts were less aggressive.

The most noticeable effects at the time of the cut in the federal funds rate, however, were the sharp depreciation of the dollar and the very large rise in oil prices. During the first year of the financial crisis oil prices doubled from about $70 per barrel in August 2007 to over $140 in July 2008, before plummeting back down as expectations of world economic growth declined sharply. Figure 11 shows the close correlation between the federal funds rate and the price of oil during this period using monthly average data. The chart ends before the global slump in demand became evident and oil prices fell back.

When the federal funds rate was cut, oil prices broke out of the $60-$70 per barrel range and then rose rapidly throughout the first year of the financial crisis. Clearly this bout of high oil prices hit the economy hard as gasoline prices skyrocketed and automobile sales plummeted in the spring and summer of 2008. In my view, expressed in a paper [6] delivered at the Bank of Japan in May, this interest rate cut helped raise oil and other commodity prices and thereby prolonged the crisis.

Econometric evidence of the connection between interest rates and oil prices is found in existing empirical studies. For example, in early May 2008, the First Deputy Managing Director of the International Monetary Fund John Lipsky said: “Preliminary evidence suggests that low interest rates have a statistically significant impact on commodity prices, above and beyond the typical effect of increased demand. Exchange rate shifts also appear to influence commodity prices. For example, IMF estimates suggest that if the US dollar had remained at its 2002 peak through end-2007, oil prices would have been $25 a barrel lower and non-fuel commodity prices 12 percent lower.”

When it became clear in the fall of 2008 that the world economy was turning down sharply, oil prices then returned to the $60-$70 range. But by this time the damage of the high oil prices had been done.

Taylor mentions the big interest rate cut from August 2007 to April 2008.  But during this period there was no increase in the monetary base, so the fall in rates represents less demand for money, not more supply.  I can’t imagine why he would argue that money was too easy in 2008.  Wouldn’t tighter money have led to an even bigger fall in NGDP between 2008 and 2009?

I’m also puzzled that someone would look at the price of oil when deciding whether money was too easy or too tight.  Why not NGDP?

Why no sorry?

I suppose that’s bad grammar, but you’ll get my point.

Here are two views of the situation:

1.  The Fed has been given a relatively clear mandate, and it’s just a question of how best to implement the mandate.  Because of policy lags, FOMC members will have differing views of how best to meet that goals.  In August 2008 Richard Fisher thought higher interest rates were a good idea, other FOMC members did not.  Over the next few years a small group of FOMC member often preferred a tighter stance, while Evans preferred easier money.

2.  The Fed has been given a very vague mandate.  FOMC members have completely different policy goals.  Rather than being technicians trying to carry out the mandate given by our elected leaders, they are in fact unelected policymakers with enormous power.  They are able to create severe recessions at the drop of a hat.  And they can do so without attracting much attention, as easy money looks like tight money, and vice versa.

I think there are good arguments for both views of the Fed.  The first view seemed to fit the Great Moderation, and the second view seems to better fit the period since the onset of the Great Recession.

But whichever view you hold, there is an outrage that is being ignored by the American press.  If the first view is true, then it’s outrageous that FOMC members aren’t apologetic for their past mistakes.  I’m not saying they should say “I’m sorry,” we know that alpha males are too childish to do that.  But there should be some sort of general consensus that group one was correct and group two was incorrect.  Surely it ought now be possible to agree on whether Richard Fisher was correct in calling for higher interest rates in August 2008.

And if it’s not possible, isn’t that an extremely sad comment on the state of monetary policy-making?  Think about it.  Suppose it were true that we can’t say whether monetary policy was too tight or too loose in 2008 or 2009.  What would that imply about the subsequent growth in NGDP?  It would mean that it was “merely a matter of opinion” as to whether the biggest drop in NGDP since 1938 was too big or whether it should have been even bigger.  That Congress had no real opinion on the matter, and was leaving it up the Richard Fisher’s of the world to decide whether it’s be a good idea to whack $1.2 trillion off our nominal GDP relative to trend, right in the middle of the biggest financial crisis in American history.

I’m not very good at hiding my sarcasm, so I think you know where I come down on this issue.  I think the Federal Reserve System has been an absolute disgrace in recent years.  I respect Ben Bernanke, and assume he is doing his best.  It’s too bad he has so many colleagues who seem to be totally unaware of the grave responsibility in their hands.

PS.  I’m not calling the Fed a disgrace for not agreeing with my policy views, but rather for dodging their responsibility.  Was monetary policy too tight in late 2008 or not?  Was the fall in NGDP in 2009 undesirable or not?  Was the slow pace of recovery in NGDP after early 2009 undesirable or not?  There’s simply no accountability, and that’s the problem.

PPS.  After I wrote this I saw that Lars Christensen was thinking along the same lines; he’d already posted this:

In fact it is interesting that when central bankers describe the ups and downs in the economy nearly never hold themselves accountable. If inflation overshoots the inflation target we rarely (in fact never) hear central banks say “the failure to fulfil our inflation target was due to our overly loose monetary policy”. I wouldn’t really expect that and frankly I also hate admitting being mistaken. But this is nonetheless telling of the general tendency for macroeconomists – including those working for central banks – to fail to realise the importance of the monetary policy reaction function.

I’d recommend the entire post, it’s more thoughtful than this one.

The biggest roadblock to recovery

I’ve consistently argued that the Fed does what a consensus of economists thinks they should do.  There’s no great mystery as to why we don’t have faster growth in aggregate demand, faster growth in NGDP.  Most economists think were are doing just fine.  Here’s the latest survey:

WASHINGTON (Reuters) – U.S. business economists said the Federal Reserve’s easy money policies have been effective but they do not think the central bank should pump more money into the economy, a survey showed on Monday.

Just over 60 percent of economic professionals polled by the National Association for Business Economics felt the Fed’s two rounds of quantitative easing had been a “success,” the survey said.

However, 81 percent of economists surveyed said the Fed should not pursue another round of quantitative easing or bond-buying this year.

.   .   .

Although the majority of business economists said that Fed should commit to maintaining low rates for a period of time, only 6 percent said the central bank should keep the key federal fund rates at exceptionally low levels through 2014.

The latest National Association for Business Economics report was conducted between February 15 and March 6 of this year. It surveyed 259 business economists and others who use economics in the workplace.

It could have been worse.  At least most economists don’t believe in liquidity traps—that surprises me.  In 2007 I would have guessed that 10% believe in liquidity traps.  By 2009 I would have guessed 75%.  The actual number is apparently below 40%, although it’s hard to be more precise (as QE might fail for many reasons.)

DeLong and Summers are trying to convince their colleagues that we need fiscal stimulus.  A more productive use of their time would be to convince their colleagues that we need more stimulus.  Once that happens the Fed will snap to it.  And then we won’t need fiscal stimulus.

Jim Glass on Larry Summers

My commenters are much tougher on Larry Summers than I am.  Here’s Jim Glass discussing a quotation from the recent DeLong and Summers paper:

We presume … the central bank is unable or unwilling to provide additional stimulus “

Shame on Larry Summers. He was the #1 econ person in the Administration through the critical time “” with the levers of power in his hands “” and by all accounts seen so far, his own and others, he did nothing whatsoever to make the Fed willing to provide more stimulus.

There were two empty seats to fill on the BoG and the Dems had a 60-seat filibuster-proof majority. He could have told Obama, “Fill those seats with appointees who will vote for additional stimulus, students of everything Bernanke said about Japan.” He could have made the Fed willing to provide more stimulus, it was his job to do that “” but he did **nothing**. [1]

To me this is impossible to fathom. He didn’t want those seats filled? How does one avoid thinking he advised Obama to *not* fill those empty seats? Why?? (I don’t want to indulge my cynical imagination here). I don’t see how this is so different from if Truman had left two seats of the Joint Chiefs empty during the Korean war. How is this not dereliction of duty?

If the Fed was and is unwilling to provide enough stimulus during this recession, the #1 largest identifiable reason is: Larry Summers.

Now he writes: “We presume the central bank is unwilling to provide additional stimulus”. Please. Shame on Larry Summers.

FN: [1] Except write a planning memo to Obama saying there was only $300 billion of quality fiscal stimulus available “we do not believe it is feasible to design sensible proposals along these lines that go much beyond this total size”, with necessary amounts beyond that amount “not as effective as stimulus”. Now he is writing that deficits as large as one may desire are self-financing?

I’ve made the same argument in previous post, but nowhere near as effectively.

And here’s the commenter “Steve”:

DeSummers wrote: “We presume for the moment that monetary policy is constrained by the zero lower bound, and that the central bank is unable or unwilling to provide additional stimulus through quantitative easing or other means”

I feel like we are currently learning that Bernanke saying “we care about the dual mandate” and singing Kumbaya with the doves is even more powerful than QE.

Yes, we are to believe the Fed is out of ammo, yet somehow just the tiniest hint from Bernanke is enough to ignite a global equities rally.  Here’s another great Steve comment:

Also, I think the DeSummers argument might be worse than you suggest. When they say “the central bank is unable or unwilling to provide additional stimulus through quantitative easing or OTHER MEANS” they affirmatively argue that the Fed *WILL* sabotage their stimulus. After all, one of the “OTHER MEANS” is a commitment to keep rates at or near zero even after the economy begins to recover and the Wicksellian rate goes positive.

They are assuming that the Fed will sabotage their stimulus, and ignoring the contradiction in the result!


Update: Tyler Cowen has a good post on the hysteresis issue, which is central to the DeLong and Summers model.