Some questions for various old monetarists, Austrians, gold bugs, and other conservatives:

1.  Japan has had interest rates near zero for nearly 2 decades.  Is this easy money, despite an NGDP that is lower than in 1993?  Despite almost continual deflation?  Despite a stock market at less than one half of 1991 levels.  Despite almost continually falling house prices?  If it’s easy money, how much longer before the high inflation arrives?

2.  The US has had near zero interest rates for more than 5 years.  Is this easy money?  If so, how much longer until the high inflation arrives?  If rates stay near zero for 2 more years, and inflation stays low, will you still call it easy money?  How about 5 more years?  Ten more years?  Twenty?

I constantly hear conservatives complain that elderly savers can’t earn positive interest rates because of the Fed’s “easy money” policy.  Is there any time limit on how long you will make this argument, before throwing in the towel and admitting rates are low because of the slowest NGDP growth since Herbert Hoover was President?  Or is your model of the economy one where decades of excessively easy money leads to very low inflation and NGDP growth?

In other words, is there some sort of model of monetary policy and nominal interest rates that you have in your mind, or do you see easy money everywhere and tight money nowhere?  What would tight money look like?  What sort of nominal interest rates would it produce?

Before beginning, let me point out that many people seemed to misread my previous post.  I was making no claims about causality.  God knows I’m no expert in criminology!  I was making a joke about people with a certain blind spot—incentive effects.

Over at Econlog I have a post discussing Edward Hugh’s recent piece on Abenomics.  At the end I cited a comment by Mark Sadowski.  This post will be another of his excellent comments:

Scott,
Off Topic.

This claim by Edward Hugh reveals he really doesn’t get it.

http://fistfulofeuros.net/afoe/the-growing-mess-which-will-be-left-behind-by-the-abenomics-experiment/

“But it’s worse, the monetary expansion has driven down the value of the yen but in the context of the second arrow – a double digit fiscal deficit – this drop in value is leading to a growing not a declining trade deficit. The FT’s Tokyo bureau chief, Jonathan Soble, has an enlightening recent piece on this…”

Although Japanese nominal exports have surged by 15.2% between 2012Q4 and 2013Q3, nominal imports are up by even more, or by 16.5%:

http://research.stlouisfed.org/fred2/graph/?graph_id=149566&category_id=0

Devaluation improves a country’s trade balance only if the Marshall-Lerner condition on trade elasticities holds, and research shows that they’re not met in the majority of cases, either past or present:

http://www.emeraldinsight.com/journals.htm?articleid=17056473

That’s not to say that currency devaluation isn’t beneficial, of course it is, but the benefit flows primarily from increased domestic demand. Here is a study of the competitive devaluations of the Great Depression by Barry Eichengreen and Douglas Irwin:

http://www.nber.org/papers/w15142.pdf

The Great Depression is a particularly important historical example because then, as now, most of the advanced world was up against the zero lower bound in policy interest rates.

An examination of Figure 4 on page 48 reveals that the only countries that experienced import growth from 1928 to 1935 (the UK, Japan, Sweden and Norway) were members of the sterling block that devalued early (1931). In most of these countries net exports actually declined over the period because imports rose more than exports.

The order of recovery from the Great Depression follows the order in which they abandoned the gold standard perfectly:

http://fabiusmaximus.files.wordpress.com/2009/03/gold.png

But this wasn’t because of increased net exports.

The US devalued in 1933 which immediately led to a swift recovery from the Great Depression. Nominal exports doubled from 1933 to 1937. But nominal imports increased by 110.5%:

https://research.stlouisfed.org/fred2/graph/?graph_id=120991&category_id=0

As a result net exports went from a small surplus (about 0.2% of nominal GDP) to being roughly in balance.

France was part of the Gold bloc of countries that devalued late (1936). From 1936 to 1938 nominal exports increased by 95.4% and nominal imports increased by 80.9%:

https://research.stlouisfed.org/fred2/graph/?graph_id=120992&category_id=0

However, since imports were already substantially greater than exports, the nominal deficit actually increased by 55.4%.

Japan’s original ryōteki kin’yÅ« kanwa (QE) was officially announced in March 2001 and concluded in March 2006. The following is a graph of the BOJ’s estimate of Japan’s real effective exchange rate which is trade weighted with respect to 16 different currencies and takes into account their relative inflation rates:

http://thefaintofheart.files.wordpress.com/2013/06/sadowski2b_1.png

The real effective exchange rate fell from 116.25 in February 2001 to 91.09 by March 2006, when the BOJ announced the completion of QE, a decline of 21.6%.

Exports rose from 10.2% of nominal GDP in 2001Q4 to 19.3% of GDP in 2008Q3. Imports rose from 9.4% of GDP in 2001Q4 to 19.5% of GDP in 2008Q3. From 2002Q1 to 2008Q1 real (adjusted by the GDP implicit price deflator) grew at an average annual rate of 11.0%. Real imports grew at an average annual rate of 12.1%.

So there was boom in both exports and imports. But imports grew faster than exports, and net exports actually moved from surplus (0.8% of GDP) to deficit (-0.2% of GDP) between 2001Q4 and 2008Q3:

http://research.stlouisfed.org/fred2/graph/?graph_id=120989&category_id=0

It’s very telling that today the only major currency area up against the zero lower bound in interest rates that hasn’t done QE (the Euro Area) is also the only major currency zone where the trade balance has improved substantially since 2009, going from 0.6% of GDP in 2009Q1 to 3.3% of GDP in 2013Q3:

https://research.stlouisfed.org/fred2/graph/?graph_id=149559&category_id=0

But this has occurred in large part because nominal imports have been falling since 2012Q3 due to falling domestic demand. Nominal exports have barely changed since 2012Q3.

I’d add that Greece has done an especially good job of “improving” its trade balance.

Here’s George Will back in 2008:

Listening to political talk requires a third ear that hears what is not said. Today’s near silence about crime probably is evidence of social improvement. For many reasons, including better policing and more incarceration, Americans feel, and are, safer. The New York Times has not recently repeated such amusing headlines as “Crime Keeps on Falling, But Prisons Keep on Filling” (1997), “Prison Population Growing Although Crime Rate Drops” (1998), “Number in Prison Grows Despite Crime Reduction” (2000) and “More Inmates, Despite Slight Drop in Crime” (2003).

George Will spoke too soon.  If it’s really a blind spot with progressives then they won’t be able to stop even if they try to, because they aren’t even aware of what they are doing.  Tyler Cowen directs us to another example from the New York Times:

What is happening in America today is both unprecedented in our history, and virtually unique among Western democratic nations. The share of our labor force devoted to guard labor has risen fivefold since 1890 “” a year when, in case you were wondering, the homicide rate was much higher than today.

Yup.  I was wondering was life was like before we had lots of guards.  Thanks for telling me.

Matt O’Brien has a great piece in The Atlantic on what went wrong during 2008. Read the whole thing.  Because of grading responsibilities, etc, I haven’t had time to read all the minutes.  But the picture is pretty much what I would have expected.  Here is his conclusion:

What was to be done?

None of this was inevitable. The Fed could have ignored oil prices that summer, and told us it was ignoring them. And it could have saved Lehman that fall. It wouldn’t have been easy””or popular””but it wouldn’t have been impossible, either. That’s clear if you look at what Rosengren was saying in real-time. With that in mind, here’s a look at what the Fed could have, and didn’t do, to make the Great Recession a little less so.

1. Oil shock. Graded on a curve, the Fed did okay. At least it didn’t raise rates that summer like the ECB did. But on an absolute scale, the Fed could have done better. It could have done in 2008 what it did in 2011, when another oil spike came along: say that the increase in inflation was transitory, and they were focused on long-term inflation expectations instead.

Now, more dovish language that summer wouldn’t have saved the world. But it would’ve kept money a little looser. And that could’ve given the financial system a little more breathing room to keep raising capital, like the Fed had been doing before.

2. Lehman. There are three magic words in central banking: whatever it takes. The Fed did that with Bear. It didn’t do that with Lehman. It could have let Lehman become a bank holding company, which is what Lehman wanted, and what the Fed ended up doing for Goldman Sachs and Morgan Stanley a few weeks later. Or it could have given Lehman bridge financing to try to finish a deal after everything fell through on September 14th. None of these would have been popular decisions, but what’s the point of an independent central bank if it won’t do unpopular things to save the economy?

After the fact, the Fed has said that it couldn’t do these things, that it had no choice. But the transcripts show that it was a choice, and they knew it. Some of them thought nothing bad would happen. And they were happy about it in September””well, all but Rosengren””until they realized what a world-historical error it was.

A few comments:

1.  The flawed monetary regime (failure to level target NGDP) made these seemingly small tactical errors in mid-2008 much worse than they would otherwise have been.

2.  I am pretty sure Matt is not a market monetarist, or at least he’s more Keynesian on issues like fiscal stimulus than I am.  Thus it’s heartening to see the MM interpretation of 2008 become increasingly accepted by the mainstream press. When people like David Beckworth and I were starting out on this crusade, the notion that excessively tight money was the problem was almost laughed off the stage.  “Interest rates were 2%, how can you claim money was tight in 2008?” Now the MM narrative is becoming increasingly accepted in the media.  That’s great news.

3.  Elsewhere Matt praises Frederic Mishkin.  He also directed me to a Hilsenrath piece that said Mishkin came off looking relatively bad in the transcripts.  But Hilsenrath was focusing on Mishkin’s jocular style.  If you look at content of his analysis he was ahead of most of his colleagues. (In terms of forecasting Rosengren seems to have been the best.)  I did a post over at Econlog a few days ago praising Mishkin’s farewell comments, but forgot that he had been equally brilliant at the final meeting of 2007.

4.  As you’d expect Marcus Nunes also has this period covered, in a thorough analysis.  Every once and a while someone tries to argue that Japan actually hasn’t done that poorly over the past few decades.  Marcus nicely shoots down that argument with this post.