I regret my haste yesterday in posting a reply to Tyler Cowen on eurozone sticky wages.  I hadn’t fully digested the report, merely skimming it until I found data that confirmed my priors.  The reality is more complex.  My other regret is that I might have seemed to imply that the peripheral countries wouldn’t be in trouble if they had flexible wages.  Not so, flexible wages in Spain would not have prevented a sharp fall in eurozone NGDP and RGDP growth after 2008.  At a minimum, the ECB policy made a real estate depression in Spain almost inevitable.  Re-allocation was needed, and flexible wages don’t prevent the real costs of re-allocation.  Let’s rank the possible outcomes:

1.  With overbuilding some decline in Spanish housing was inevitable, even with perfect monetary policy

2.  With bad ECB policy, the decline in Spanish housing would be even worse, due to declining sales to non-Spanish residents.  This is true even if Spain wasn’t in the euro.

3.  With Spain in the euro, bad ECB policy would cause an even bigger decline in the Spanish housing industry.

Even in the best case (case 1) completely flexible wages in Spain might not have prevented an economic slowdown.  As we move to steps two and three the problem grow larger, even with completely flexible wages.  The analogy for the US is that overbuilding in the sub-prime states meant a pullback was inevitable (case 1) but tight money by the Fed (case 3) made it much worse than necessary.

Yesterday a reporter asked me how much QE3 would impact RGDP growth.  My guesstimate was in the 0.2% to 0.4% range over the next few years.  I didn’t completely pull that number out of thin air, but pretty close.  What I did was notice that TIPS spreads seemed to increase by 0.1% to 0.2% on the news.  Then I assumed that given the slack in the economy, a boost to NGDP would probably be roughly 2/3 RGDP growth and 1/3 inflation.  Obviously that’s a rough guess, but at least I think it gives us a sort of “order of magnitude ” estimate of the power of the Fed’s announcement.  Of course some sort of policy change was expected, so this just reflects the effect of the part of the Fed announcement that was more than markets expected—perhaps the open-ended QE and the promise to keep money accommodative well into the recovery.

Clive Crook has some very thoughtful comments on the Fed announcement, and what it means in terms of Woodford’s model.  I’d caution readers to read him very closely, as at one point he says that he agrees with Joe Gagnon that QE has some impact on spending.  Woodford disagrees.  Then Crook goes on to analyze what we should expect if Woodford’s model is true, and also if we take the Fed statement literally.  Recall that the Fed didn’t promise any catch-up inflation (i.e. above 2%), there were merely subtle hints of the Fed moving in that direction.  So the pessimistic take wasn’t actually Crook’s view, it was the outcome if Woodford’s model is right, and if the Fed can be taken literally.  Obviously I have doubts about both assumptions, and even Crook has doubts about one of them (Woodford’s QE views.)

Crook also points out that level targeting of NGDP might lack credibility in the current environment.  I think he’s partly right, but I don’t see it as a problem, because he’s actually considering a hypothetical that is both unlikely to occur, and too expansionary from even my perspective.  Recall that in 2009 I favored going back to the old pre-2008 NGDP trend line, but more recently have advocated going just a third of the way back.  The problem here is that while NGDPLT is completely automatic when fully implemented, discretion is required when deciding where to set the initial trend line.  Last year Christy Romer did a NYT column calling for a return to the old trend line.  Because we are roughly 10% below that line, this would entail quite rapid NGDP growth (and inflation) over the next few years.  Because a lot of time has gone by, and because many wage contracts now reflect the lower NGDP trend line, I no longer favor going all the way back, but rather looking for a pragmatic compromise.  I think Crook’s right that 100% level targeting right now (Romer’s plan) would currently lack credibility, there simply aren’t enough economists inside or outside the Fed that favor that degree of stimulus.

But I would warn readers not to become overly pessimistic about credibility on the basis of this thought experiment.  The Fed doesn’t stray far from what the consensus of economists favor, and hence any Fed policy that adheres to that consensus and is publicly announced is likely to have a high level of credibility.  Here is an example:  In the 1920s people like Warren and Fisher favored an inflation target (actually the price level) but the consensus of economists favored the gold standard, which does not allow for inflation targeting.  Except for a brief period of price level targeting in 1933 (which was intensely unpopular with mainstream economists) we stuck with gold.  Later inflation targeting became the consensus policy, and central banks all over the world were able to fairly quickly bring inflation down, and get long term bond markets to expect roughly 2% to 3% inflation.  That’s a big success.  If we can get the consensus of economists to shift to NGDPLT  (and so far we market monetarists have had much more success than I expected) then a future Fed may adopt NGDPLT, and it will be highly credible.  If economists as a class think level targeting is the right way to go, then a period of “catch-up” will not seem “irresponsible.”  Even better, level targeting keeps NGDP from wandering so far from trend in the first place.

PS.  The reporter who interviewed me also asked if QE3 might push up oil prices and hence derail the recovery.  I had three comments:

1.  Rising oil prices don’t derail the recovery if they are caused by QE3.  That’s because, at least at the global level, real oil prices only rise due to QE3 if it is expected to boost RGDP growth.  And QE3 only slightly depreciated the dollar.

2.  Oil prices increased only slightly on QE3 news.  That’s both good and bad.  It’s good because the effects of QE3 get immediately priced into asset markets (EMH) but it’s bad for the same reason–the markets are telling us to expect only a modest boost to growth.

3.  Oil prices rising due to non-QE3 reasons (say a war in Iran) could derail a recovery.

And finally, we already pretty much know the expected effects of QE3 on nominal aggregates.  If there is any “test” to be passed, it would relate to the impact (if any) of higher NGDP growth on RGDP.  That’s what people should keep their eye on.  Let’s hope we do better than Britain.

HT:  Saturos

Totally off-topic:  Alex Tabarrok has a new “back of napkin model” that should immediately go into all econ textbooks.  Also note that many people wrongly assume that it’s best to be at the top of Laffer Curve-type diagrams.  Not so, you want to be to the left of the peak.

PS.  I did a piece for Yahoo finance.  I was told to write it for an average reader, so it’s a bit lower level than my blog posts.

Tyler Cowen links to a Eurostat study that show nominal wages to be rising in every single European economy, even those deep in Depression:

Among the Member States for which data are available for the second quarter of 2012, the highest annual increases in hourly labour costs for the whole economy were registered in Romania (+7.1%), Finland (+4.9%), Bulgaria and Latvia (both +4.8%), and the lowest in Ireland (+0.4%), Spain and the Netherlands (both +0.5%).

This is obviously very different from the 1930s, and I’d be interested in knowing why.  Perhaps some of my European readers have some insights into the Eurozone labor markets.

PS.  Tyler looked at the same data and reached the opposite conclusion. I’m not sure why, but he seems to have focused more on unit labor costs, whereas I focused on hourly nominal wage costs.  Still, given the big slowdown in NGDP growth (and outright declines in many countries, it appears wage stickines sis a big problems, particulrly in Spain.

Update:  Mark Sadowski pointed out that this post was somewhat sloppy.  There is no 21012:2 data for Greece, where wages probably are declining.  And a few other countries saw declines during previous years.  Mea culpa.  Still, given the big slowdown in NGDP growth (and outright declines in many countries), it appears wage stickiness is a big problem, particularly in Spain.

HT:  Saturos

I notice that there are a lot of posts discussing who influenced whom on NGDP targeting.  Bill Woolsey and Ryan Avent have posts discussing influence in the NGDP targeting area.  Both posts are well worth reading, and I don’t find much to object to.   My general view on this topic is that when we’ve reached the point where even Bob Dylan gets accused of “plagiarism,” then you know our society has become overly obsessed with “originality.”  I agree with Bob, originality is overrated:

Bob Dylan has angrily responded to charges he plagiarized some of his lyrics, calling critics “wussies and pussies” and saying musical appropriation is “part of the folk tradition.”

The “new monetary economics” got interested in the “price” approach to monetary policy during the 1980s.  Then they noticed that Irving Fisher had beat them to it, with his Compensated Dollar Plan of 1913.  This involved adjusting the official price of gold to offset changes in the price level.  Fisher initially thought he had invented the idea, but then someone told him that Aneurin Williams had published a similar idea in the Economic Journal in 1892.  Then Fisher discovered even earlier inventors from the early 1800s, such at Attwood and Rooke.  Eventually he wrote an entire book on “The History of Stable Money” (stable in purchasing power.)  There were many previous inventors, most of whom didn’t know each other.

Woodford wrote a paper on using a variable interest rate on reserves as a policy tool to stabilize inflation, and then discovered later that Robert Hall had done the same in 1983.

The earliest refutation of the liquidity trap argument that I have been able to find was written by John Locke in the 1600s, and involved a sort of reductio ad absurdum argument of repeated reductions in the silver content of the British pound.  There’s nothing new under the sun (including cliches.)

I recall Krugman once suggesting that the market monetarists started out talking about printing money, and only later began to focus on the role of expectations.  Not so; we’ve been doing that from the beginning.  Many outsiders probably think that market monetarism is a new school of thought.  The name is certainly new (thanks to Lars Christensen), but the ideas are several decades old.  David Glasner, Bill Woolsey and I were all working on these ideas in the late 1980s and early 1990s.  People like Earl Thompson and Robert Hall were exploring similar ideas even earlier.

In my view “influence” usually occurs when the recipient has independently developed the idea, or something very close.  That makes the recipient more receptive.  Being receptive is the key, as there are so many ideas swirling around that unless you are in a receptive mood, they won’t stick.  Here’s couple of examples:

1.  Woodford’s student and co-author Gauti Eggertsson published a paper in the September 2008 AER that applied the Woodford/Eggertsson model to the Great Depression.  He cited three of my papers from the 1990s, included a never-published working paper.  I was pleased to see these obscure papers getting noticed in such a high profile way.  I presume that Bernanke tipped off Eggertsson (I believe they were all at Princeton back then) and Eggertsson saw that my analysis of the Great Depression also put a lot of weight on policy expectations.  Eggertsson already had the basic idea, but perhaps my work gave him a bit more confidence that it was applicable to the Great Depression.

2.  When I ran across Woodford’s papers on the importance of policy expectations, I saw that it was quite similar to the approach I was using. But I didn’t have any sort of rigorous theoretical model, and indeed I still find it very difficult to understand how all this works in the theoretical sense (mostly because these expectations models allow for multiple solutions.)  So Woodford’s work gave me confidence that much smarter people than me were able to back up my intuition with rigorous theoretical models.

In both cases we were receptive to what someone else was doing, but had worked out the basic idea on our own.

Off topic, Evan Soltas makes a very interesting argument in an article at Bloomberg on the new Fed policy.  He suggests that Fed’s recent decision creates an entirely new policy framework, and that we can expect the Fed to gradually add more specificity to this framework over time.

Much more likely is a definition of the Fed’s policy target that is clarified in increments. There is a direct precedent for this: the Fed’s introduction of forward guidance of when it would tighten policy. While the Fed first promised low interest rates “for some time” in December 2008, it later clarified its forward guidance — first “for an extended period” in March 2009 and eventually with the time period, “at least mid-2013” in August 2011.

“For some time” is as vague a time frame as “ongoing sustained improvement” is a goal for labor market gains. This obscurity weakens the potency of expectations-based monetary policy.

What seems most likely — and most similar to the evolution of forward guidance — is that the Fed will reapply its economic projections as policy targets. This could happen twice every quarter as it forecasts growth of real GDP, the unemployment rate, and headline and core PCE over the next three years.

George Selgin has a new post showing that the instability of final sales has been a bit greater than the instability of NGDP, and also that final sales might be a better benchmark as to whether money is excessively easy or tight.  Other market monetarists have also made this argument, as well as Bill Niskanen of the Cato Institute, who recent passed away. There’s not much to disagree with in George’s post, I’d just reiterate that if you stop the clock in early 2008, the preceding Fed policy might have been unstable enough to produce a mild recession, the sort we had in 2001, when unemployment peaked at 6.3%. I certain agree with George that we would have been better off in 1990-2008 with a more stable NGDP growth track.  However I still don’t see any causal link between the 2003-06 growth in final sales and the housing bubble, especially since neither final sales nor RGDP grew unusually rapidly during that expansion (compared to other expansions.)  I blame moral hazard and bad regulations.

David Henderson made some comments on my exchange with George Selgin and the issue of Fed credit allocation.  Interested readers can read my reply in his comment section.

Miles Kimball had this to say about Ben Bernanke:

.  .  .  let me say that Ben Bernanke is a superstar central banker in my book. It is a mistake to judge central bankers by a standard of perfection. Central banking is too hard for that. Ben has done a great job in difficult circumstances, as can be seen in David Wessel’s book In Fed We Trust. My guess is that Ben’s biggest mistakes as a central banker have come from deferring too much to other views that were less on-target than his own. Although making monetary policy decision-making less centered on the Chairman of the Fed is the right thing for the long-run future, I think we would have had better monetary policy in the last few years had Ben trusted his own judgment more and asserted himself more strongly. Ben’s mistakes of intellectual humility are the kinds of mistakes a serious seeker of the truth makes.

I wouldn’t call him a superstar, but I have often pointed out that the Fed generally does what a consensus of American economists thinks they should do.  Bernanke has now pushed the Fed a bit beyond that consensus.  That means he has positive value added.  Bernanke’s not the problem; the problem is America’s macroeconomists—they caused the Great Recession.

Miles Kimball also has a wonderful intro to macroeconomics.  Like me, he sees macro as being all about the “deep magic” of money, and the “deeper magic” of the supply-side.

HT:  Dilip

I’ve frequently pointed out that income inequality data is almost worthless.  I was “poor” from age 18 to 26, at least in an income sense.  So if every American had the same lifetime income pattern as I did, America would have about 13% poverty (assuming I end up being “poor” for 13% of my adult life.)  But I don’t think anyone except Paris Hilton would regard my student days as representing true poverty. Matt Yglesias has a new post showing that tax inequality data is also meaningless, for basically the same life-cycle reasons.  Lots of people have little taxable income when they are young, and also when they are retired.

I notice that conservatives like to talk about how 47% of Americans pay no (income) taxes, and liberals like to talk about the percentage of income earned by Americans in each income decile (with no age adjustments.)  Both are spouting nonsense.  We shouldn’t be talking about income inequality at all.  We should talk about homelessness, cyclical unemployment, single moms trying to raise kids on low wage jobs, etc.

Philosophers tell us that the most ineffective way to become “happy” is to focus directly on becoming happy.  And for similar reasons the worst way to reduce inequality is to focus on the “distribution of household income.”  Focus on the root causes of the real problems.  Change zoning laws to construct more low cost urban and suburban housing.  Increase AD when NGDP is depressed.  Provide wage subsidies to low wage single moms raising kids (financed by consumption taxes on the high consumers.)  Weaken patent and copyright protections for minor innovations.  Eliminate occupational licensing laws.

PS.  I notice that Scott Galupo at the American Conservative is also critical of the 47% figure, so I shouldn’t lump all conservatives (or liberals) together.

I haven’t seen anyone comment on this odd exchange at the Bernanke press conference:

STEVE BECKNER: Steve Beckner of MNI, Mr. Chairman. There have been concerns, raised questions raised by people like Columbia Professor Michael Woodford and others about the credibility of your forward guidance on the path, future path of the federal funds rate. The idea being that to the extent it’s conditional, it’s not really convincing and doesn’t provide the kind of confidence that you referred to. Now on this latest statement you’ve removed some of that conditionality. I am particularly struck by the statement that the committee expects that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the economic recovery strengthens. I assume that was done to make your forward guidance more credible and yet the question remains whether, you know, as the economy picks up steam, whether the FOMC will really follow through and keep rates low or whether you will do as the Fed has always done and begin to raise the funds rate.

CHAIRMAN BERNANKE: Well, that’s an important question. Michael Woodford who by the way is my former colleague and co-author and friend so I know him quite well and I know his works quite well. I think, actually, the thrust of his research is that forward guidance communication about future policy is in fact the most powerful tool that central banks have when the interest rate is close to zero. And he advocates policies like nominal GDP targeting for example that would essentially require a credibility lasting many years. The implication being that the Fed would target the nominal level of GDP. And promise to do that for many years in the future even if inflation, you know, rose as part of that policy. So his own perspective is that credibility is the key tool that central banks have in order to get traction at the zero lower bound. Whether we have the credibility to persuade markets that we’ll follow through is an empirical question. And the evidence which I also again discussed in my remarks recently is that when we’ve announced extended guidance that financial markets have responded to that, that private sector forecasters have changed their estimates of what unemployment and inflation will be when the Fed begins to remove accommodation. So the empirical evidence is that our announcements do have considerable credibility. And I think there’s good reason for that, which is that we have talked a lot both publicly and privately about the rationale for maintaining rates low even as the economy strengthens, and I think the basic ideas are broadly espoused within the Committee. And so there is a consensus that even as the personnel change and so going forward, that this is the appropriate approach, and that by following through, we will have created a reserve of credibility that we can use in any subsequent episodes that occur.

1.  The reporter asks about Woodford’s claim that level targeting can add credibility to Fed policy, but that the markets have to believe the Fed will actually carry through with the promises.  Note that the Fed didn’t adopt the sort of explicit level targeting that Woodford wants, so you might have expected Bernanke to defend the Fed’s decision to refrain from doing so.  (Level targeting would have required a higher short run inflation target, and hence would have been very controversial.)  But Bernanke’s answer basically defends Woodford’s argument, as he went out of his way to insist that the Fed’s promises (to keep money accommodative well into a recovery) will definitely have credibility in the markets.  He’s on Woodford’s side.

2.  Even more surprisingly, much of the answer is devoted to NGDP targeting, even though the reporter never even mentioned NGDP, indeed it wasn’t really even alluded to.  And the entire answer is 100% pro-Woodford.  There’s not even a hint of disagreement with Woodford in the answer.  Why doesn’t Bernanke say the Fed avoided NGDP targeting because it’s a bad idea?

Perhaps because he’s privately hoping that the markets interpret the Fed’s recent action as NGDPLT in disguise?

Or perhaps that’s just the deluded fantasy of a blogger whose ego has been inflated to Hindenburg zeppelin proportions by some overly generous press coverage.

In late 2010 the Fed was concerned that inflation had fallen below 2%, and thus they adopted the QE2 program.  When the Fed announced that the intention was to raise inflation, there was a firestorm of criticism from the public.  I did about 20 posts arguing that the Fed shouldn’t announce the goal of raising the public’s cost of living, but rather they should say the goal is to raise peoples’ incomes, with the ultimate goal being more real output.  Not to deceive the public, but because that’s what they were actually trying to do.  The Fed has forecast that inflation will gradually rise to 2% over the next few years, but note that Bernanke no longer points to higher inflation as a policy goal:

STEVE LIESMAN: Mr. Chairman, I want to talk about that same line in the statement. Does that mean that your tolerance for inflation will be higher in the coming years in the middle of the recovery? And if not, what good is that language there if it doesn’t tell people that the reaction function relative to inflation has changed? Secondly, stock prices are up today, so are oil prices and gold. Why aren’t those part of the same reaction to the Fed’s acts today?

CHAIRMAN BERNANKE: Well our policy approach doesn’t involve intentionally trying to raise inflation. That’s not the objective. The idea is to make sure we provide enough support so the economy will grow fast enough to bring unemployment down over time.

That’s close enough for me, although I prefer he use the term ‘NGDP’ rather than “the economy.”