Archive for January 2014


Farewell to Ben Bernanke

Morgan sent me this WSJ piece by Austan Goolsbee:

Bravo for Bernanke and the QE Era

Admit it: The Fed’s loose money policy worked. Now the challenge is how to manage the tapering.

.  .  .

Think back to the days before the 2008 crisis or recession. If confronted with the scenario that would follow””five years of GDP growth of only around 2% a year, five years of unemployment rates around or above 7%, core inflation consistently below 2%””the near-universal response of economists would have been for the Fed to cut interest rates.

So Goolsbee views this as success, but never tells us why.  He never explains what the Fed should be targeting, or by what criterion he judged the policy a success.

I believe Goolsbee is representative of the economics profession circa 2014.

His speech’s audience at the nation’s largest gathering of economists looked even more comical than normal with their snow boots and hat-head, but they gave his remarks a standing ovation. It was quite different from the icy reception he has grown accustomed to from his critics (including several on this page) over the past 3½ years during what could be called the QE Era.

The Fed did poorly over the past 5 1/2 years.  But perhaps Bernanke does deserve a standing ovation. Everything’s relative.  As far as I can tell Bernanke outperformed the profession, which is all we can really ask of a policy leader.  Here is some evidence:

1.  Polls show the profession was generally either equally hawkish or more hawkish than Bernanke. Before QE3 and the forward guidance decisions of late 2012 hardly any economists thought policy was too tight.  Many thought it too easy.

2.  However Ben Bernanke thought it was too tight. In mid-2012 he didn’t even have the rest of the Fed behind him even though it was mostly Obama appointees. During the summer of 2012 he had to twist arms and schmooze Fed officials to persuade them to sign on to a policy that successfully prevented the austerity of 2013 from driving the US into a double-dip recession.

3.  He outperformed the most comparable other large central banks, in the eurozone and Japan. And not by a small amount, he massively outperformed.

4.  Based on their recent public statements, either Greenspan or Volcker would have been complete disasters.  Trichet clones.  And remember that Greenspan and Volcker are two of the most successful Fed chairmen in history.  Thank God we had Bernanke and not either of those two. Don’t know if age was a factor, but they had clearly lost it.

[Last time I made that comment I got accused of ageism.  What nonsense!  How do you think Lebron James will be doing at age 85?  Bernanke served from age 52 to 60, peak years for a monetary economist.  BTW, I started blogging at age 53, and am currently 58.  If I live to be 85 I’ll be rambling incoherently about income, inflation, and interest rates all being completely meaningless.  Oh wait, I do that already.]

5.  Bernanke had studied both the Great Depression and the Japanese “liquidity trap” and hence was better prepared than almost any other economist to deal with the crisis of 2008.  From a market monetarist perspective he did poorly.  But market monetarism is a tiny fringe group that’s completely out of the mainstream. There was absolutely no way that Bernanke could have implemented the MM agenda even if he had wanted to.  Judging the Fed chairman by this criterion would be like judging a President of the US on the assumption that he was a dictator freely able to enact the preferred agenda of a Bryan Caplan or Matt Yglesias.  You judge people according to their marginal product.  Bernanke did better than most would have done in his shoes.  And for that he deserves thanks, and an enjoyable retirement.

If the economics profession had been solidly market monetarist in 2008 then I’m confident that Ben Bernanke would have gladly implemented NGDPLT.  The economics profession never gave him the support he needed to be more aggressive.  The profession failed us, the Fed was just a symptom.

OK, start hammering me in the comment section for being soft on Bernanke.  I don’t care.

Has Steve Williamson been advising the Turkish Prime Minister?

Nicolas Goetzmann sent me this FT story:

Mr Erdogan’s own resistance to interest rate rises goes deep: on the flight, the prime minister insisted that, contrary to economic theory, increases in interest rates cause inflation.

“I believe that inflation and interest rates are not inversely proportional but in direct proportion,” he told the reporters. “In other words, the relationship between inflation and interest is cause and effect: the interest rate is the cause, inflation is the result. If you increase the rate, inflation increases. If you reduce it, both drop together. When you think they are inversely proportional you always get much more negative results.”

The forces of evil easily triumph over Krugman and DeLong

Marcus Nunes already did a post on this, but now that the GDP numbers for 2013 are in it’s official, Greg Mankiw won by a landslide.  Here’s Mankiw back in 2009:

Paul Krugman suggests that my skepticism about the administration’s growth forecast over the next few years is somehow “evil.” Well, Paul, if you are so confident in this forecast, would you like to place a wager on it and take advantage of my wickedness?

Team Obama says that real GDP in 2013 will be 15.6 percent above real GDP in 2008. (That number comes from compounding their predicted growth rates for these five years.) So, Paul, are you willing to wager that the economy will meet or exceed this benchmark? I am not much of a gambler, but that is a bet I would be happy to take the other side of (even as I hope to lose, for the sake of the economy).

Krugman wisely decided to avoid this bet, which suggests he’s smarter than he appears when he is at his most political. In any case, the actual 5 year RGDP growth just came in at slightly under 6.3%. That’s not even close. Mankiw won by a landslide.

A few quick observations.  This data point does nothing to support the market monetarist model. Indeed some would argue that it contradicts any demand-side models. Ed Prescott might consider it a “proven scientific fact” that refutes all demand-side nonsense.  Of course Mankiw shares our belief that demand shocks matter, and I’m convinced by Bennett McCallum’s argument that the unit root problem mostly reflects the fact that GDP is hit by both supply and demand shocks, and that supply (or productivity) shocks tend to be very persistent.  The fall in the unemployment rate during a period of slow growth has helped to convince me that there’s something to Tyler Cowen’s Great Stagnation argument.

FWIW, I have argued that Keynesians underrate the importance of supply-side problems such as European-style labor market distortions.  I’ve argued that the British “output gap” is actually about 3/4th supply side.  So while I would have preferred a faster recovery from what I view as a strong demand shock, it’s at least a bit less embarrassing for us conservative demand-siders than for the Keynesians who focus obsessively on demand shocks.  I can’t speak for Greg Mankiw, but I wouldn’t be surprised if he had similar views.

For a guy who is right about everything Krugman sure seems to have been wrong about an awful lot of recent events.  Over at Econlog I’m about to do an important post documenting Krugman’s consistent attempts to shift position in order to avoid seeming to have been wrong about fiscal stimulus.  Of course on monetary policy nothing can prove him wrong.  If it works, great, he’s a fan. If not, well he was skeptical all along.

[Here’s the Econlog post.]

BTW, Mankiw was replying to this Krugman post.

Roots of evil (wonkish)

As Brad DeLong says, sigh. Greg Mankiw challenges the administration’s prediction of relatively fast growth a few years from now on the basis that real GDP may have a unit root “” that is, there’s no tendency for bad years to be offset by good years later.

I always thought the unit root thing involved a bit of deliberate obtuseness “” it involved pretending that you didn’t know the difference between, say, low GDP growth due to a productivity slowdown like the one that happened from 1973 to 1995, on one side, and low GDP growth due to a severe recession. For one thing is very clear: variables that measure the use of resources, like unemployment or capacity utilization, do NOT have unit roots: when unemployment is high, it tends to fall. And together with Okun’s law, this says that yes, it is right to expect high growth in future if the economy is depressed now.

But to invoke the unit root thing to disparage growth forecasts now involves more than a bit of deliberate obtuseness.

One point where I do agree with Krugman is the labor market, which does show clear trend reversion. That’s one reason I remain a demand-sider despite the unit root problem. Unemployment doesn’t rise and then stick, as in many European countries.  For those who don’t know, a unit root in a time series like RGDP implies that even after a change in RGDP, the optimal forecast of future RGDP is roughly the trend rate of growth.  No “bounceback” can be expected. Mankiw was pointing out that since RGDP fell sharply in 2009, if the optimal forecast of future growth after 2009 was near trend then the optimal forecast of future growth after 2008 was well below trend.

PS.  If Krugman regards Mankiw as evil, what possible adjective could he use to describe Ed Prescott?

PPS.  My comment about Krugman avoiding the bet was a joke. I actually don’t think academics are required to bet their beliefs.  Public humiliation is more effective in any case.

Update. I forget to mention that Krugman is covered either way.  If the economy bounces back it proves it’s a demand problem.  If not, well didn’t Keynes mention secular stagnation?

Monetary policy, interest rates and exchange rates

Nick Rowe has a nice new post that is loosely related to the “never reason from a price change” theme.  Nick suggests that it doesn’t make sense to talk about the effect of changes in exchange rates.  Instead one should either talk about the effects of factor “X” that caused the exchange rate to change, or if you are interested in public policy issues you might want to talk about the effect of a central bank policy aimed at preventing the exchange rate from changing.

On a related note, Tyler Cowen links to a new paper by Aart Kraay that discusses the effectiveness of raising interest rates when a currency is under speculative attack:

According to conventional wisdom, currencies that come under speculative attack can be defended with high interest rates. By raising interest rates high enough, the monetary authority can make it prohibitively costly for speculators to take short positions in the currency under attack. High interest rates may also convey a positive signal regarding the commitment of the monetary authority to maintaining a fixed exchange rate. According to the contrarian view, neither of these mechanisms is persuasive. Interest rates have to be increased to very high annualized rates in order to entice investors to hold local currency-denominated assets in the face of a small expected devaluation over a short horizon, and such extremely high interest rates are rarely observed in practice. The signaling value of high interest rates is also unclear. Although signals must be costly in order to be credible, often they impose costs that are too high for the monetary authority to take in stride. Moreover, as the costs of high interest rates mount, the monetary authority’s signal can become less credible over time, raising devaluation expectations. A vicious spiral can result, as expectations of a devaluation force higher interest rates, which in turn impose greater costs on the economy.  In the end, high interest rates can have the perverse effect of increasing the probability that a speculative attack ends in the devaluation of the currency.

I think that’s basically right.  But it’s also an odd way of stating the thesis.  Notice that changes in interest rates are implicitly viewed as a sort of monetary policy stance.  That’s especially dangerous during a speculative crisis, when rapid changes in the expected future exchange rate cause enormous and rapid changes in the Wicksellian equilibrium nominal interest rate.  The real question is not whether high interest rates help; it’s whether or not tight money helps.

Again, I’m not quibbling with the Kraay’s paper, which is sophisticated and seems accurate.  But using the term ‘monetary policy’ rather than ‘interest rates’ would help clarify the analysis:

1.  High interest rates might reflect expectations of devaluation, and hence policy failure.  In that case they will not reflect tight money and will be associated with policy failure, on average.

2.  High interest rates might reflect the liquidity effect from a tight money policy, which makes devaluation less likely.

3.  Even if high interest rates reflect tight money, the policy may fail in the long run of the tight money leads to politically unacceptable output losses, which forces an eventual change in policy. (see Argentina 1998-2002, the USA 1931-33 and Britain 1992.)

Off topic, Matt Yglesias has a nice post on the issue “everyone” is overlooking, monetary policy. Among the “everyone” is Jonathan Chait:

The basic underlying fact of the situation is that the economy is growing very slowly because Congressional Republicans have done everything in their power to apply the fiscal brakes to the recovery. Among macroeconomic forecasters, this is not a remotely controversial assertion but rather an obvious fact that they wearily plug into their models.

File that away in your “obvious facts” folder along with Prescott’s claim that it is a proven scientific fact that monetary shocks have virtually no effect on the business cycle.

HT:  Ramesh Ponnuru

The 4% and the real problems

I’ve been arguing that while inequality is a real problem, it is far down the list of serious problems faced by this country.  Certainly behind unemployment, poverty, and the war on drugs and probably behind global warming, access to health care, and government waste.  According to the Boston Globe, the public seems to agree:

THOUGH PRESIDENT Obama insists that income inequality is the “defining challenge of our time,” most Americans beg to differ.

“What do you think is the most important problem facing this country today?” asked Gallup in a nationwide survey this month. Dissatisfaction with the federal government “” its incompetence, abuse, dysfunction, venality “” topped the list, with 21 percent of respondents saying it was their key concern. The overall state of the economy was second, at 18 percent. Unemployment and health care were tied for third, with each cited by 16 percent as the nation’s most pressing problem.

How many shared Obama’s view that the gap between rich and poor is the issue that should concern us most? Four percent.

And even that 4% figure is misleading.  If you take away all the economics bloggers blathering on about inequality, it would probably be closer to 3%.

BTW, Free Exchange has a wonderful post by G.I. (Greg Ip?) on the myth that microeconomics is more scientific than macroeconomics.  The post also contains some excellent analysis of the minimum wage debate.  

The people who claim micro is more scientific are the same sorts of people who claim physics is more scientific than economics.  Economists can predict business cycles more accurately than applied physicists can predict the stuff we really care about, like weather and earthquakes and tsunamis.  The retort is that applied physicists are good at predicting stuff we don’t care about, like the orbits of Jupiter’s moons.

HT:  Joel Lidz

Update.  Some commenters pointed out that these problems are interrelated, at least to some extent. Here’s my response:

Sure, all problems are at least somewhat correlated and interrelated. But policies like a higher minimum wage that (supposedly) reduce inequality also (supposedly) increase unemployment. We can address inequality much more effectively by direct subsidies like the EITC, although I agree that ending the War on Drug Using Americans would indirectly reduce inequality. Think about the specific problem you are trying to address, and address that problem in a way that doesn’t worsen other problems.

Transferring money from Bill Gates to the middle class doesn’t reduce poverty, it makes it worse. If you had not taken the funds from Gates and given it to the middle class, he was planning on donating the money to reduce poverty in places like Africa.