I think it’s fair to say that we’ve all been impressed by Noah Smith’s brilliance as a blogger.  But a new Smith post leads me to believe that he used to be even smarter.  Smith points to 7 areas where other bloggers have changed his views.  At least three or four would probably make my list as well, but I also see three where I think Noah moved in the wrong direction—two where Paul Krugman was the culprit.  Here’s one:

Paul Krugman convinced me that Japan’s 1990s stimulus had some positive effects.  Living in Japan in the mid 2000s, I picked up the conventional expat wisdom that Japan’s “fiscal stimulus” was a total waste, driven by clientelist construction spending and LDP corruption, concreting over the riverbeds and building bridges to nowhere. And while I still believe there was a ton of waste, Krugman blogged some data showing how mild Japan’s two recessions in the 90s were, despite the incredible severity of the country’s financial crisis. That’s a powerful argument. I now believe that though Japan’s 1990s spending spree probably wasn’t worth it on balance, it probably was not quite as unmitigated a waste as I had thought.

Actually that’s a very weak argument.  Krugman’s right that the recessions were not particularly severe, but it had nothing to do with fiscal stimulus.  The performance of Japanese AD over the past few decades is mind-bogglingly bad, even in per capita terms.  To that extent that RGDP growth has been non-disastrous, that’s due to growth in aggregate supply.  If Greece or Spain was hit by the AD shock that hit Japan, they would have 20% unemployment.

And here Noah is convinced by Steve Williamson:

Steve Williamson convinced me that the macro field is structurally biased toward monetarism.  I can’t find the post(s) now, but Williamson has pointed out that central bank macroeconomists have a strong incentive to choose and promote models in which independent, active central banks are the most important stewards of macroeconomic stability. Since a big percent of top macroeconomists work at central banks, this is a non-trivial observation. I was trained to be pretty monetarist (by Miles Kimball and somewhat by Bob Barsky), but Williamson’s point was a good one, and has given me pause. Of course, it’s a bit of a cynical Marxist type point, but a good one nonetheless.

Actually the profession is nowhere near monetarist enough.  Very few macroeconomists blamed the Fed’s tight money policy for the 2008-09 slump.  Even worse, not many thought the Fed could do much about it, despite the fact that our textbooks say monetary policy is highly effective at the zero bound.  The markets have been way ahead of the economists for many years, and it’s finally starting to sink in.  With markets reacting strongly to even tiny hints of further tightening, even people like Paul Krugman are warning that tapering could slow the recovery.

Many economists underestimate the importance of monetary policy because they think in terms of a money –> interest rate –> investment –> AD transmission mechanism.  A very non-monetarist mechanism, I might add.  For instance, here’s Smith in another recent post:

Econ 102 says that banks lend money to long-term risky projects. They choose to lend if the expected real rate of return from a risky project is greater than r + S, where r is the safe real rate of return, and S is some required spread.

With IROR > T-bill rate (as now), the IROR is the safe asset. With IROR < T-bill rate, the T-bill rate is the safe asset.

The IROR is 0.25%. The T-bill rate is just over 0%. This means that the difference in the expected real rate of return between a world with an IROR and a world without an IROR is about 0.25%. In a world without an IROR, banks lend to any risky project with an expected real rate of return of S. In a world with an IROR, banks lend to any risky project with an expected real rate of return of S + 0.25%.

Therefore, what Feldstein is asserting is that there is an absolutely huge number of risky projects whose expected return is between S and S+0.25. He is asserting that if we lowered the safe rate by 0.25%, a huge panoply of projects would then become worth investing in, and a huge torrential flood of reserves would be released into the economy, boosting inflation and lowering unemployment in the process.

Does that seem reasonable? 

This makes me want to pull my hair out.  Yes, an EC 102 student might look at things that way.  But Smith studied graduate macro under Miles Kimbell.

YOU CAN’T TELL ANYTHING ABOUT THE STANCE OF MONETARY POLICY BY LOOKING AT INTEREST RATES.  (or if you can, low rates probably mean tight money.)

Back in 1937 they didn’t think the higher reserve requirements would do much harm, as interest rates only rose 0.25% in response.  But the demand for base money rose, and that’s deflationary.  If IOR increases the future expected demand for reserves, relative to the supply, it could have a huge contractionary effect, despite the fact that interest rates hardly budged.

If you insist on using Woodfordian NK language, the IOR program increases real interest rates in two ways, higher nominal rates and lower expected inflation.  Indeed a cut in IOR might boost NGDP growth expectations so much that it would be expansionary even if market interest rates don’t fall at all.

Now it’s very possible that IOR did not have a major contractionary impact.  In fact I agree with Noah that it probably did not.  As with any other Fed tool, what matters most is the impact on future expected Fed policy.  I can make plausible arguments either way.  Ironically, the sorts of arguments that Keynesians use to defend fiscal policy (i.e. the Fed doesn’t like to do QE, and hence won’t do monetary offset) actually make it more likely that IOR had a major contractionary impact.

The best way to think about monetary policy is through the lens of the expected hot potato effect.  Any Fed action should be judged in terms of its impact on the long term trends in monetary base supply and demand, not interest rates.  Policies that make the expected future base rise relative to expected future base demand are expansionary, and vice versa.  That approach doesn’t tell us that IOR was highly contractionary, but given that the IOR rate is higher than what banks earn on T-bills, it certainly might have sharply increased base demand.

PS.  Here’s my short course on money for any misguided folks who still evaluate monetary policy through the lens of interest rates.

PPS.  I hope Noah Smith doesn’t take this personally; I had just as many problems with Cardiff Garcia’s list, and I’m sure they could find fault with many items on my list.  If I had one.

HT:  TravisV and Tyler Cowen

Last month I did a post pointing to a number of surprising similarities between Utah and Denmark.  The NYT just found another:

In previous studies of mobility, economists have found that a smaller percentage of people escape childhood poverty in the United States than in several other rich countries, including Canada, Australia, France, Germany and Japan. The latest study is consistent with those findings.

Whatever the reasons, affluent children often remain so: one of every three 30-year-olds who grew up in the top 1 percent of the income distribution was already making at least $100,000 in family income, according to the new study. Among adults who grew up in the bottom half of the income distribution, only one out of 25 had family income of at least $100,000 by age 30.

Yet the parts of this country with the highest mobility rates “” like Pittsburgh, Seattle and Salt Lake City “” have rates roughly as high as those in Denmark and Norway, two countries at the top of the international mobility rankings. In areas like Atlanta and Memphis, by comparison, upward mobility appears to be substantially lower than in any other rich country, Mr. Chetty said.

It doesn’t make much sense to compare inequality in a large ethnically diverse country with inequality in smaller and more homogenous countries.  How many Roma (aka gypsies) born in Hungary end up as rich as the typical Vienna resident?  And yet both groups are “caucasian” and live only a few hundred miles apart.  That’s the “hard problem” that even the Europeans haven’t been able to solve.

However ethnic diversity is not the only factor explaining America’s high level of inequality.

HT:  Tyler Cowen

Update:  Lars Christensen has a post that discusses an article I wrote for an Australian think tank.  I will speak at their conference near Brisbane next month.  To save time I’ll quote Lars:

Would you like to read more? You can if you get a copy of Australia’s leading free market think tank Centre for Independent Studies’ excellent quarterly journal Policy. Policy is edited by Stephen Kirchner. Stephen also blogs at Institutional Economics.

You can subscribe to Policy here.

And there is more good news for the Australians. Scott will soon visit the country Down Under. Scott will attend CIS’s Consilium conference next month.

Don’t anyone tell Noah Smith, but yesterday (July 20) I was on Larry Kudlow’s radio show and during the intro (around the 45:30 mark) he indicated that market monetarism had influenced his thinking on monetary policy.

PS.  I was invited to give a talk at the Mont Pelerin Society next year.  My panel is: “The Coming Inflation Threat.”  The 500 classical liberals in the audience will be surprised to learn that the threat is that inflation will be too low over the next 5 years.

My commenters let me down.  My previous Summers “bleg” was unable to turn up a single instance of Summers criticizing policy as being too tight over the past 5 years.  He seems to think the slowest NGDP growth since Herbert Hoover was president is just fine.  Or else the Fed can do nothing about it.  I’m not sure which view would be worse.

In this column Summers falls into the trap of thinking low interest rates mean easy money, so what’s the point of doing more?  That view has been discredited by Friedman, Mishkin, Bernanke, and many other monetary economists.  How does Summers not know this?  The entire piece is an exercise in reasoning from a price change.

Even worse, in an Ezra Klein column he suggests they couldn’t do more stimulus even if they wanted to:

But the policymakers who would have needed to create that inflation aren’t so sure. “It’s difficult, if not impossible, to create persistent inflation without demand exceeding potential supply over an extended period,” says Donald L. Kohn, who served as vice chairman of the Federal Reserve Board until 2010. “Yes, changing expectations might push inflation higher, but why would expectations change materially and persistently under current circumstances?”

.  .  .

Summers, who had the inside track to chair the central bank if the Obama administration decided against renominating Bernanke, echoes Kohn’s skepticism. “In the model I understand,” he says, “inflation is mostly driven by demand, and when you increase demand, you increase inflation. And if you don’t increase demand, you don’t increase inflation. But if you’ve solved demand, you’ve solved your problem.”

Update:  The original post left out the comment from Summers–my apologies.

Um, maybe because the Fed promised a more expansionary policy in the future?  I wonder why Summers thinks the Japanese markets responded so strongly to the increase in their inflation target?  Why does he think Bernanke keeps saying the Fed can do more?

BTW, don’t assume things are getting any better just because Summers has left the Obama administration.  Treasury Secretary Jack Lew has a memo to the G20 urging faster growth in AD.  So far so good.  But the discussion is all fiscal policy.  He doesn’t even criticize the ECB, which raised interest rates several times in 2011 (so this isn’t just about the zero bound.)  Here’s his only comment on the Fed:

The Federal Reserve has provided the US economy with vital support tied to its dual mandate of full employment and price stability.

That’s like saying Captain Schettino of the Concordia provided the passengers with vital support in their endeavor to reach port safely.

Obama’s defenders often tell me that the economy is not Obama’s fault, as he doesn’t control monetary policy.  And yet he appointed 6 of the 7 members of the Board, and there is no indication that the Fed’s policy is at all different from what the Obama administration prefers.

Some have asked me who I favor for Fed chair.  I don’t really have strong views, but I certainly would prefer Yellen over Summers.  Here are a few names that would be even better than Yellen, in no particular order:

Lars Svensson, Mark Carney, Michael Woodford, Christina Romer, Robert Hetzel, Nick Rowe, anyone from the Reserve Bank of Australia, even the janitor.

Greg Mankiw has kept quiet recently, but I suspect he’d be good.  I suppose I could even add Krugman, but (like me) he probably doesn’t have the right personality.

Paul Krugman argues that Janet Yellen is a better choice for Fed chair than Larry Summers.  I agree.  But this puzzles me:

First of all, what do we need in a Fed chair? Above all, a committed dove “” someone who will not succumb to the pressure to tighten policy too soon, and almost equally important, someone who will be seen by investors as resistant to this temptation. We’ve just seen how much damage even a hint of Fed hawkishness can do; it’s really critical to not follow the far worse step of making an appointment that gives the wrong signal.

As it happens, both Janet and Larry have good credentials on those grounds, at least in terms of what they’ve said in recent years.

Maybe he’s right, but every Summers piece I’ve seen on monetary policy has been appallingly bad.  I know of no evidence that Summers pressed Obama to appoint committed doves to the Fed.  Or that he complained Fed policy was too tight.  Krugman often complains Fed policy is too tight.

So here’s my request:  Please send me articles where Larry Summers says sensible things about Fed policy over the past 5 years.