Archive for May 2013


Posner’s peculiar essay on Milton Friedman

Richard Posner has an essay arguing that the influence of Milton Friedman is declining, partly because the recent crisis showed weaknesses in laissez-faire ideology.  He specifically cited the deregulation of the financial markets as a cause of the crisis, even though the most persuasive studies suggest otherwise.

In fact, the profession is only beginning to catch up to what Friedman understood in 1998:

Low interest rates are generally a sign that money has been tight, as in Japan; high interest rates, that money has been easy.

.   .   .

After the U.S. experience during the Great Depression, and after inflation and rising interest rates in the 1970s and disinflation and falling interest rates in the 1980s, I thought the fallacy of identifying tight money with high interest rates and easy money with low interest rates was dead. Apparently, old fallacies never die.

Most of the profession thought money in Japan was easy, and that monetary policy was effective ineffective at the zero bound.  Friedman knew better.  Now in 2013 we are finally seeing what happens when a central bank does adopt a 2% inflation target—the currency depreciates sharply in the forex markets, in contrast to those (like Posner?) who believed in liquidity traps.  Friedman was one of the few to correctly diagnose the Japanese deflation, and to provide effective solutions.  It’s nice to see the world beginning to come around to his views.  “Expectations traps” are about as real as “confidence fairies.”  (Funny how some believe in one but not the other.)

I found this to be even more puzzling:

Although economic libertarians advocate a number of sensible reforms, such as ending the war on drugs, authorizing physician-assisted suicide, allowing the sale of kidneys and other organs, deregulating the adoption market, abolishing tax deductions for employer-provided health insurance, liberalizing immigration, privatizing the postal service, and abolishing agricultural subsidies, many of these and other libertarian reforms are politically infeasible.

Yes, it’s politically infeasible to achieve pure libertarian solutions in the political realm.  But surely a pragmatist like Posner does not view perfection as the relevant measure of influence.  In fact, libertarianism is making very important gains in many of the areas cited by Posner:

1.  Two states recently voted to legalize marijuana.  Given the strong support for legalization among the young, and the strong opposition among voters too old to have been hippies in the 1960s, support for legalization of marijuana will continue to spread, one funeral at a time.

2.  Two states have now legalized physician-assisted suicide.  And as with marijuana legalization, this trend is almost certain to spread.

3.  The Obama health care bill has a provision that gradually phases out the tax deductibility of health insurance.  Although I was very disappointed by many provisions of ObamaCare, this provision is a huge win against the medical-industrial complex.  It will eventually raise the cost of health care bought by insurance from 60 cents on the dollar, to the full cost of provision.  This will provide enormous incentives to hold down health care costs.  Yes, there are other provisions of ObamaCare that boost costs, but in the long run this provision is a big win.  Academic economists (liberal and conservative) beat an industry controlling 18% of GDP.

4.  I don’t know if the immigration liberalization plan will pass Congress, but the vote is so close that Posner can’t possible claim it is “politically infeasible.”  It might well happen.

5.  With the advent of email the younger generation is losing all interest in snail mail.  At some point they will view the Post Office as a dinosaur, and it will be privatized.  Matt Yglesias recently suggested it be turned into an employee-run company, with no subsidies.

And that’s not to mention all sorts of other ideas of Milton Friedman that have already happened (end the draft, lower MTRs on the rich, privatize SOEs, remove price controls and barriers to entry in fields like transportation), or are very much a part of the current political debate (education vouchers, HSAs, etc.)

Milton Friedman will remain relevant when other “giants” of his era (like Bob Solow) are long forgotten, or perhaps just a name attached to a growth model that has long since lost its relevance.

HT:  David Henderson

Neil Irwin ignores the elephant in the room

The Fed does monetary stimulus in late 2012, citing the need to offset the drag from fiscal austerity.  Then 2012 2013 turns out to be a pretty decent year, no worse than 2012.  Keynesians like Neil Irwin note the mystery and scramble around for explanations:

Why hasn’t austerity been more of a drag on the U.S. economy?

This is the U.S. economy in a nutshell, as revealed in Tuesday’s news ticker: Housing prices rose faster over the past year than they have in the past seven. Consumer confidence hit its highest level in five years. The stock market rallied another 0.9 percent to hover near an all-time high, as measured by the Standard & Poor’s 500. And the national retail price of gasoline has fallen for six days straight and is down 16 cents a gallon since late February, providing nice relief to drivers.

Which all raises an obvious question: Whatever happened to the austerity economy?

And yet not a single mention of monetary offset in the entire article.  There’s more work to be done.  I’ve got to start posting at a faster rate.

HT:  Keep them coming J

Krugman misses R&R’s point

Paul Krugman has a new post criticizing Reinhart and Rogoff’s view that fiscal stimulus in Germany might be counterproductive.  Here is R&R:

We don’t see your attraction to fiscal largesse as a substitute. Periphery Europe cannot afford it and for Germany, which can afford it, fiscal expansion would be procyclical.  Any overheating in Germany would exert pressure on the ECB to maintain a tighter monetary policy, backtracking some of the progress made by Mario Draghi. A better use of Germany’s balance sheet strength would be to agree on faster and bigger haircuts for the periphery, and to support significantly more expansionary monetary policy by the ECB.

Krugman has two and a half objections:

First, the half level: what, exactly, does it mean to call for expansionary monetary policy by the ECB? Like other major central banks, the ECB has near-zero policy rates, so we’re talking about some kind of unconventional monetary policy. Are we supposed to envision the ECB doing huge purchases of unconventional assets (over and above what it’s already doing in the form of lending to banks against sovereign debt and the promise of outright monetary transactions if necessary)? Alternatively, are we supposed to see a European version of Abenomics, with the ECB credibly committing to a higher inflation target? Both are strategies worth trying, but of uncertain effect “” and both would surely be viewed as anathema by the Germans.

Yes, monetary stimulus would be anathema to the Germans, but they have one vote out of 17 (although their power is admittedly greater than that ratio suggests.)  But fiscal stimulus is also anathema to the Germans, and they have one vote out of one for German fiscal stimulus.  Just a few years ago I was told by lots of worldly-wise commenters that the Japanese would never opt for monetary stimulus, because of the power of the elderly lobby in Japan.  OK commenters, where are you now?  I haven’t heard from you recently.

If the ultra-conservative BoJ can change its policy, I don’t see why the ultra-conservative ECB cannot do the same.

Second, and now we get to where I’m really baffled, if we’re against policies that are procyclical for Germany,what on earth do R&R imagine a more expansionary monetary policy (however achieved) does? Europe as a whole is deeply depressed; Germany is not. So any policy that causes overall European expansion is going to be pushing the German economy up against capacity, and pushing up German inflation. There is no difference at all between fiscal and monetary expansion as far as that issue is concerned.

Krugman doesn’t seem to be aware that R&R are arguing for monetary offset.  The argument seemed obvious to me, but perhaps Krugman read their letter so rapidly he missed that point.  If the ECB is targeting inflation at slightly under 2% (and it seems to be, as it raised rates in 2011 to prevent above target inflation), then higher German inflation forces tighter money, and thus lower non-German inflation.  Obviously that problem does not occur with monetary stimulus—so the two policies are very different, once you account for monetary offset.

Finally, aren’t policies that are procyclical for Germany, and raise inflation there, the whole point of the exercise? We have a competitiveness gap between the periphery and the core that must be closed through some combination of falling wages in Portugal, Spain, etc. and rising wages in Germany. The idea is to shift the balance of that adjustment somewhat away from the deflationary countries “” overheating in Germany isn’t a bug, it’s a feature, and indeed the crucial feature.

File this under “never reason from a wage change.”  Yes, for a given Portuguese NGDP, a lower wage level will help restore full employment.  But if German fiscal stimulus led to a tighter ECB policy, it would reduce Portuguese NGDP.  And falling wages caused by falling Portuguese NGDP are not expansionary.

Oh dear . . . now I’m beginning to sound like Keynes.

HT:  J

Why “Will Abenomics succeed?” is the wrong question

There’s a lot of speculation about how Abenomics will work out in the long run.  I don’t like much of this speculation, because it seems to conflate four quite distinct questions:

1.  Can the BoJ boost nominal aggregates?  I.e. is Japan stuck in a liquidity trap?

2.  Will the BoJ succeed in reaching its 2% inflation goal?

3.  Would higher inflation lead to better outcomes for the real economy?

4.  If 2% inflation is achieved, will Japan experience good times?

Before proceeding, let me indicate that I think the answers are:

1.  Yes, definitely.

2.  Probably not.

3.  Probably.

4.  Probably not.

Number one is easiest.  The BoJ can clearly devalue the yen, and they would not be able to do so if stuck in a liquidity trap.  That means, ipso facto, that they can boost inflation and NGDP.  There never should have even been a debate on this issue, but if there was it is now resolved.

But I doubt the BoJ will reach an inflation rate of 2%, because the BoJ doesn’t seem committed to that goal:

TOKYO (Reuters) – A rift within the Bank of Japan’s board over how to steer its radical monetary stimulus to end nearly two decades of damaging deflation underlined the early challenges Governor Haruhiko Kuroda faces in his efforts to foster sustained growth.

The differences of opinion were highlighted in the minutes of the April 26 meeting, which showed some policymakers opposed targeting 2 percent inflation in two years and called for more flexibility in guiding monetary policy.

I presume this rift contributed to the recent appreciation of the yen, and the sharp selloff in Japanese equities.

If they do boost inflation substantially, I expect that to lead to significantly faster RGDP growth.  But I’m agnostic on whether the growth will be all that impressive.  I sort of doubt it.  Japan’s problems are probably more on the supply-side.  Long term success there will require supply-side reforms.

As far as “good times,” even if the policy boosts RGDP growth it may be seen as a failure.  Perhaps the growth spurt will be short-lived.  Or perhaps other problems (i.e. fiscal issues) will dominate the headlines.  There are far more ways a macro economy can fail than succeed.  Most of the time the current situation is viewed negatively by most people.  Thus the safest course is to constantly be pessimistic—you’ll sound more intellectual and others will eventually see you as a sort of Nostradamus.  “He said it would all end in tears, and he was right.”  It’s especially smart to be pessimistic during those rare times when things seem to be going reasonably well, say 1999 or 2005.  It probably won’t last long.

PS.  An entire post w/o mentioning Paul Krugman!  But come to think of it he is almost always pessimistic, even after Obama took office.  No wonder he’s right about everything!

PPS.  And let’s not forget Tyler Cowen’s “Great Stagnation.”  Meanwhile I’m stuck being perceived as a China bull, which means it’s only a matter of time before my reputation lies in tatters.  There are no “happily ever afters” in macro.

PPPS. Don’t think resolving the first question is an unimportant achievement.  We now know for certain that Japan wasted enormous sums of money on pointless fiscal stimulus over the past 2 decades, in a futile attempt to arrest the relentless decline in NGDP.  In fact, all they had to do was try some monetary stimulus.  But they never even tried for a 2% inflation target.  Until this year.

PPPPS.  In contrast, check this out:

“There is no one under the age of 40 now [in Australia] who has experienced a recession as an adult member of the workforce,” said Saul Eslake, an economist at Bank of America-Merrill Lynch in Sydney.


Reinhart and Rogoff on monetary offset

Commenter J directed me to a passage by R&R from their now famous letter to Paul Krugman:

We don’t see your attraction to fiscal largesse as a substitute. Periphery Europe cannot afford it and for Germany, which can afford it, fiscal expansion would be procyclical.  Any overheating in Germany would exert pressure on the ECB to maintain a tighter monetary policy, backtracking some of the progress made by Mario Draghi. A better use of Germany’s balance sheet strength would be to agree on faster and bigger haircuts for the periphery, and to support significantly more expansionary monetary policy by the ECB.

If Germany stimulates their economy then German inflation will tend to rise, and at least to some extent this will raise overall eurozone inflation.  Now consider the fact that the ECB is supposed to be targeting eurozone inflation.  German fiscal stimulus would then force a tighter ECB policy, which would reduce inflation in the non-German part of the eurozone.  Because no fiscal stimulus would be occurring outside Germany (by assumption, and because they are broke) the lower non-German inflation induced by tighter ECB monetary policy would mean lower non-German NGDP and RGDP.  As an analogy, think of how the US tech boom of 1998-2001 reduced Argentina’s NGDP and devastated the Argentine economy.

This is a really good example of how people thinking in terms of “trade balances” are often led astray.  It seems like a booming German economy would help the rest of the eurozone.  And it could, but only if generated by a more expansionary monetary policy, or by supply-side reforms.

A few years back I did a number of posts criticizing the view that the Chinese trade surplus costs jobs in the US.  I pointed out that the alleged transmission mechanism (lower US AD) would not operate if the Fed was targeting inflation.  And even if it did operate, it would be entirely the fault of US policymakers, not China.

Of course Ken Rogoff advocated a highly aggressive monetary stimulus a few years back, and if the major central banks had followed his advice the AD situation in both the US and Europe would be far better, and we would not even be having this debate over fiscal austerity.