Archive for August 2013


Recent links

I’m still catching up on things, but here are a few pieces worth reading.

Ramesh Ponnuru at Bloomberg:

My guess is that Obama doesn’t know, think or care much about monetary policy. That’s usually a good disposition for someone in the Oval Office to have. A president who was too interested in monetary policy would be tempted to interfere with the Fed. Indifference beats the attitude of many Republicans, who are still convinced, contrary to all the evidence, that rampant inflation is just around the corner.

While presidential apathy about central banking is usually a virtue, once every 70 years or so the economy suffers through a calamity of tight money. We found ourselves in that circumstance when Obama took office. The country could have been well served by a president who favored monetary looseness, a policy the Democratic Party has supported for about a century. Because of Obama’s indifference, we had no such luck.

A lot of conservatives have adopted screwy ideas about monetary policy during the Obama years. They have been urging the Fed to tighten a policy that is already too tight. But the monetary mistakes of liberals have been the most consequential ones during these years. The likely nomination of Summers doesn’t suggest that we’ll see an improvement anytime soon.

Exactly.  And here’s an earlier Ponnuru article in National Review:

Many analysts on the left and right accept this basic story but disagree about what caused the mortgage bubble. Conservatives tend to emphasize Fannie Mae, Freddie Mac, and the Federal Reserve’s low-interest-rate policy. Liberals tend to emphasize predatory lenders who tricked people into borrowing more than they could afford, Wall Streeters who took on too much risk, and regulators who allowed all of it to happen. These are not mutually exclusive explanations, of course, so it is possible to mix and match.

Yet it may be that both sides are mistaken, and mistaken precisely in their point of agreement: that the housing boom and bust is the fundamental explanation for our recent economic troubles. It may be that this crisis was indeed brought to us by government policies, but not the ones that the dominant voices on either side of the political divide have in mind.

If so, it will not be the first time that an economic depression was misunderstood by the people living through it. The modern view of the Great Depression, held by almost everyone in the field of economics, is that monetary contraction was the chief cause of the disaster. At the time, though, the prevailing view was that the depression resulted from a stock-market crash and banking crisis that in turn resulted from financial speculation.

Contemporary observers, including most influential economists, certainly did not see extremely tight money as the root cause of the Depression. Indeed, they did not believe that money was tight at all. Interest rates were very low, and the monetary base was growing: both things that many people, then and now, associated with expansive monetary policy. Officials and commentators worried that loosening money “” loosening it, they thought, still further “” would lead to more of the speculation that had started the calamity.

It was not until decades later, with the 1963 publication of Milton Friedman and Anna Schwartz’s A Monetary History of the United States, that the monetary mistakes of the era were understood. Interest rates were low not because money was loose but because it was tight: Monetary contraction had depressed the economy and thus expected returns to investment.

It’s good to see the press paying more attention to MM views of the crisis.

Lars Christensen sent me the following from The Guardian:

If you want to know the likely outcome of the next general election or the Eurovision song contest, consult a bookmaker. Bookies’ odds have a long and honourable record of being ahead of the game, for good reason: they reflect the opinions of specialists and insiders who are prepared to back their views with hard cash.

Could the principle work for economic forecasting?

The Adam Smith Institute, in mischievous mode, has encouraged Paddy Power to open betting markets covering the rate of UK inflation and the rate of unemployment on 1 June 2015. It’s 9-4 that CPI inflation will be 3.01%-4% and 5-2 that unemployment will still be in the 7%-8% range.

“The Bank of England‘s economic forecasts have been wrong again and again,” says the thinktank. It wonders if the fabled “wisdom of crowds” can do better.

.  .  .

The Adam Smith Institute is dreaming if it thinks the government would ever get rid of its experts and outsource its forecasts to “prediction markets”.

It may seem like a dream today, but it’s only a matter of time before the economics profession wakes up to the fact that markets are better than bureaucrats at stablizing the path of NGDP.  In the future, monetary policy decision-making by committee will seem something like voodoo, another barbarous relic.


The third way

Yichuan Wang has an excellent post discussing the two ways to think about recessions. First goods and money:

Any macroeconomy can be broken down into two main markets: a real market for current goods and services, and a financial market for claims on future goods and services. For brevity, I will reduce the model for financial assets to the market for money, which, because of money’s role as a store of value and medium of exchange, captures the notion of “claims on goods”. To simplify further, I take all the markets for goods and reduce them down to one composite market, say, for apples. From this caricature, we can start thinking about how markets fit together.

In normal times, people receive apples and money from the sky in the form of endowments (i.e. their wealth), and they make decisions about how to spend their cash and apple balances. Apples are transacted, bellies are filled, and life is good.

But suddenly, a recession hits. What does this look like? By definition, a recession is when there is a general glut of goods that aren’t consumed.

And then adding financial markets:

The goods market by itself is not enough to generate a recession with a general glut of goods. Only when there is the possibility of excess demand in money markets can recessions actually occur. Therefore the market for money is what gives a macroeconomy its business cycle feel. This is why money is so important for macro — fluctuations in the money market are the proximate cause for any general fluctuation in the goods market. This is why, as Miles Kimball says, money is the “deep magic” of macro. While this “apples and money” approach is the canonical presentation of general equilibrium, it is not the only representation. For another interpretation, think about what the financial market really is. Since it represents the entire universe of claims on future goods, finance can be understood as a veil between the present and the future. So instead of focusing on the relationship between goods and financial markets at one point in time, we can cut out the middle man and instead think of general equilibrium as a sequence of goods markets that occur across multiple points in time. In this version, there is no financial market per se, but buying an apple in “tomorrow’s goods market” represents buying a financial contract in the canonical model. Therefore, instead of thinking about the markets for goods and money, we can instead think about the markets for goods today and tomorrow.

The same excess supply and demand relationship works in this model. If there is an excess supply of goods today, then it must mean that there’s an excess demand for goods tomorrow. So we get a corollary to the first diagnosis of recessions: If there is an excess supply of goods today, it must be the result of an excess demand for goods tomorrow.

The first definition is something I associated with monetarists like Nick Rowe, and the second seems New Keynesian.  Monetarists tend to worry that the second approach doesn’t pin down the price level:

Each of these stories has its own strength. Since the first goods-money model includes actual money, it can help us understand how the price level is determined through monetary neutrality. On the other hand, since general equilibrium is only concerned about relative prices, and since individual dollars are not transacted in the second story, the second story has no “goods/money” relative price — i.e. the second story cannot pin down an aggregate price level. However, the second story does a better job of being explicit about intertemporal choice. And for now, this intuition about relative prices between the past and the future will be powerful enough that I will focus on this second approach.

I certainly like the Rovian goods and money story better than the intertemporal substitution story, but I greatly prefer a third approach; labor and money.  Indeed I don’t even like the definition of “recessions” that Yichuan starts off with.  I don’t see the problem during recessions as being excess supply of goods.   Or goods that are not consumed.  Rather the goods market seems to be in equilibrium, it’s just that equilibrium output has fallen. I see excess supply of labor as the key characteristic of recessions, at least demand-side recessions.  Yes, in theory output could drop while we remained at full employment due to falling productivity, but how often does that occur in the US?  In practice, recessions mean excess unemployment.

So my recession model is one where nominal wages are sticky, and monetary shocks cause aggregate nominal income to fall. That leads to less hours worked, and thus less employment.  There is no need to assume disequilibrium in the goods market.  Some object to sticky wage theories because real wages don’t seem to behave as predicted.  Actually real wages are very countercyclical in flexible-price competitive industries such as commodity production.  However, most industries are monopolistically competitive, and hence you really want to look at the ratio of hourly nominal wages to NGDP.  And that does correlate quite closely with the unemployment rate.


To conclude, interest rates don’t matter.  Any monetary shock that affects current NGDP will impact the ratio of wages to NGDP, and hence create a business cycle.  Monetary policy can fix the problem without having any effect of interest rates; just stabilize the path of NGDP.  That’s the fatal flaw in intertemporal models.  They don’t pin down the price level or NGDP, and hence cannot explain the path of W/NGDP, or the business cycle itself.

PS.  I just got back from a week in Australia, and will gradually try to address a mountain of comments.

Why would tapering hurt Indonesia?

Tyler Cowen has a new post discussing the financial strains in developing Asia. At the end he suggests that some of their problems are due to expectations that the Fed will taper QE. I doubt that plays much of a role, but would acknowledge that the alternative explanations are not very appealing either. When the picture is this muddled, it almost always suggests that more than one factor is involved.

So what’s wrong with the tapering explanation of Indonesia’s problems? Tyler even suggests that it fits the market monetarist methodology—market indicators suggest tapering is the problem.

Maybe they do, but it’s also the case that market indicators fit another explanation just as well—Indonesia is being hurt by expectations of stronger growth in the US, in much the same way that America’s 1929 boom caused problems for the rest of the world (via higher interest rates.) The question is not why is the Indonesian stock market down 21 percent. The real mystery is why are US stocks higher than when the taper talk began? Perhaps they should also be down 21 percent. Long term real interest rates have risen sharply in recent months. That should cause a stock market crash, unless the higher rates are caused by something that would also raise equity prices. And what might that be? Obviously stronger real growth in America is one possibility (although there are others as well.)

However Evan Soltas showed that although US stocks have done well in recent months, they’ve tended to fall on days where taper talk raised long term yields. OK, but that implies that the mysterious X-factor driving up US stock prices is even stronger than we thought, as it’s also had to overcome the negative effect of taper talk. And I admit that I just don’t see the signs of stronger economic growth. But then what’s going on with US equity markets?

I’d encourage everyone to take a deep breath and let’s wait 12 to 18 months, by which time it may be easier to see what’s going on right now. Here are some other issues to consider:

1. The article Tyler links to implies that Indonesia’s being hit by an adverse supply shock (lower RGDP growth and higher inflation.) But the numbers provided suggest the shock is mild, at least so far. Could this be the China slowdown hitting Indonesian commodity exports? Australia has recently been hit by this shock. Or are higher real interest rates reducing investment in Indonesia, and hence forcing “re-allocation?” This is where QE tapering could hurt Indonesia.

2. Why blame QE? If the mechanism is higher real interest rates caused by changing conditions in US credit markets, then it’s the exact same mechanism as in the late 1990s, when the US high tech boom made things difficult for many developing countries.

In other words, some countries may be more sensitive to volatility in global real interest rates than other countries. And again, if QE were causing that volatility then US equity prices should be reflecting that fact. But with a few exceptions they are not.

Here’s another way of making the same point. Write down on a piece of paper a monetary rule that makes real interest rates less volatile than NGDPLT. Can’t do so? Neither can I. That means that monetary policy actions by the Fed that are aimed at stabilizing NGDP, do not obviously make US real interest rates more volatile, and hence can’t be blamed for hurting fragile economies that are sensitive to real rate shocks. In that case tapering may be a problem, but only because it destabilizes NGDP. In that case the Fed is erring not because rates are rising, but because NGDP growth would be slowing.

Just to be clear, I’m not saying that higher global real interest rates that are caused by changing conditions in US credit markets cannot hurt Indonesia. They can, just as higher global oil prices caused by Chinese factors hurt the US in mid-2008. But if someone said that the higher Chinese oil prices were caused by less Chinese oil supply, and not more Chinese demand for oil, a skeptic would ask why Chinese consumption of oil had increased. And if someone claims that higher global real interest rates are caused by tighter money in the US, and not stronger RGDP growth expectations in the US, a skeptic will ask why US equity prices are much higher than a few months back.

I am skeptical of my own analysis here, as I just don’t see the faster growth that stock investors seem to see. But I’m also skeptical of alternative explanations. We need to let the dust settle to figure out what’s going on here.

PS. Did the Indonesian central bank take advantage of QE by allowing faster NGDP growth? If so, then they arguably contributed to the current instability.


Random observations

I’m still relying on my iPad, hence this will have to be short. I’ll have more to say on both issues when I return home.

1. Evan Soltas has a very important post on unemployment comp in North Carolina. Unlike Soltas, I am not surprised that the reduction from 73 weeks to 19 weeks has reduced the number new claims. However I am surprised by the size of the decrease. If it persists I’ll have to reexamine my priors. I strongly recommend that people follow this issue over the next few weeks; it won’t take long to know whether the current data is a fluke.

2. Paul Krugman has a new post that is mostly accurate, but seems very misleading to me. You can read it for yourself and see what you think. He begins by praising a Matthew Klein post that is highly critical of a Robert Hall paper. I think most readers would assume that he agrees with at least some of Klein’s criticisms of Hall. But I very much doubt that. For instance, Klein criticizes Hall for talking about banks “lending out reserves.” But of course Krugman does the same, and gets (rightly) outraged when MMTers criticize him for doing so. As an aside, it would be better if people said “banks sell off unwanted reserves.” In Klein’s other criticisms of Hall I think he simply misunderstands what Hall is claiming, although I haven’t had time yet to read the Hall paper, so I can’t be sure. I’ll read it when I get back home and apologize to Klein if he got it right.

Some might argue that I did the same thing to Cullen Roche that I’m accusing Krugman of doing to Hall. But here’s the difference. Krugman leads off by thanking Klein for a post criticizing Hall. It sure looks like Hall made an error. On the other hand I never mentioned Roche’s name. Most Krugman readers don’t follow up the links, and would never suspect that Krugman agrees with Hall. Krugman should not have mentioned Hall’s name. That’s why many economists get upset with Krugman’s style. Or maybe I’m being unfair to Krugman, and readers would not draw that inference. What do you think?

BTW, Krugman’s right that there’s nothing special about banks, so I agree with the main point of his post. But I believe there might be a typo—didn’t Krugman mean “inside money”, not outside money?

The main story however is Soltas, who has what might become the post of the year.

Where Obama went wrong

In the previous post comment section Jim Glass provided me with this quotation from President Obama:

“I want a Fed chairman that can step back and look at that objectively and say, let’s make sure that we’re growing the economy, but let’s also keep an eye on inflation. And if it starts heating up, if the markets start frothing up, let’s make sure that we’re not creating new bubbles.”

So that’s it. The reason America is about to suffer through 8 years of high unemployment is not GOP obstructionism, but rather because our President is listening to the wrong set of progressives. We either have the monetary policy Obama wants, or we might even have a more expansionary policy than he’d prefer.

Suddenly Obama’s mystifying behavior back in 2009 doesn’t look so mysterious.

BTW, I just wasted an hour of my life looking for the Fed’s new growth forecast (from the recent meeting.) My iPad is almost worthless for searching the Internet. Does anyone know the Fed forecast of 2013 and 2014 RGDP growth?