Archive for January 2015


The Great Recession happened because we ignored Friedman’s ideas

Patrick Sullivan directed me to a Brad DeLong article on the lessons of the Great Recession:

And yet, as recommendable as Wolf’s proposals may be, little has been done to implement them. The reasons why are found in the second book: Hall of Mirrors, by my friend, teacher, and patron,Barry Eichengreen.

Eichengreen traces our tepid response to the crisis to the triumph of monetarist economists, the disciples of Milton Friedman, over their Keynesian and Minskyite peers – at least when it comes to interpretations of the causes and consequences of the Great Depression. When the 2008 financial crisis erupted, policymakers tried to apply Friedman’s proposed solutions to the Great Depression. Unfortunately, this turned out to be the wrong thing to do, as the monetarist interpretation of the Great Depression was, to put it bluntly, wrong in significant respects and radically incomplete.

The resulting policies were enough to prevent the post-2008 recession from developing into a full-blown depression; but that partial success turned out to be a Pyrrhic victory, for it allowed politicians to declare that the crisis had been overcome, and that it was time to embrace austerity and focus on structural reform. The result is today’s stagnant economy, marked by anemic growth that threatens to become the new normal.

I think this is exactly backwards.  But first let’s get one issue out of the way; Friedman’s proposed 4% rule for M2 growth might well have failed in 2008.  On the other hand, clearly that’s not what DeLong (and Eichengreen?) had in mind.  Monetarism in the sense of the k% rule has almost zero influence today.  If people are claiming that “monetarist” ideas contributed to the failed policy response in 2008-09, they are clearly thinking of monetary policy more broadly—that the Fed can and should steer the nominal economy, and that we should not rely of fiscal or regulatory solutions to problems that are essentially monetary.  So let’s review what happened in 2008:

1.  Two days after Lehman failed, the Fed met and decided the US faced a financial problem, not a monetary/AD problem.  Thus they decided not to ease monetary policy. A few weeks later the Fed decided to pump enormous quantities of liquidity into the banking system.  Under a normal (monetarist) policy regime, that liquidity would have driven short-term rates to zero and increased the broader money supply.  But the Fed did not want that to happen.  They explicitly tried to avoid easing monetary policy, even as they rescued the banks, by implementing a new device called “interest on reserves.”  Paying banks not to move the money out into the economy.  This kept rates above zero until mid-December, when the Fed finally threw in the towel and lowered rates to 0.25%, where they remain today.

2.  In 1997 Friedman warned the profession that they were confusing low interest rates with easy money.  In 2003 Bernanke echoed that warning.  In Frederic Mishkin’s final FOMC meeting (in 2008) he made a heartfelt plea to the Fed not to confuse low rates with easy money.  Unfortunately, over the next few years the Fed (and most of the rest of the profession) did exactly that, assuming that low rates meant an easy money policy.

3.  By March 2009, the data were coming in much worse than expected, and it was clear that monetary policy had been far too tight in 2008 (when we were not at the zero bound), producing the biggest drop in NGDP since the 1930s.  I recall DeLong once expressing dismay that the Fed would acquiesce to such a large drop in NGDP, and do little to repair the damage.  They finally did act in March, with the QE1 program, and a weak recovery began.  But they needed a much more aggressive program, either more QE, or lower IOR, or more aggressive forward guidance, or the sort of level targeting that Bernanke recommended the Japanese undertake in the early 2000s, or all of the above. But it wasn’t until late 2012, when the Fed saw the approaching fiscal austerity that they moved more aggressively on the QE/forward guidance front.  Since the beginning of 2013 the unemployment rate has been falling fast.

I see a profession that wrongly thought the Fed was out of ammo (something Friedman would have never assumed) that wrongly thought low rates meant easy money (something Friedman never would have done), that wrongly thought fiscal stimulus was the answer (something Friedman never would have done), that wrongly thought it was a financial crisis and not a monetary/AD crisis until it was too late (suggesting they put more weight on Bernanke (1983) than Friedman and Schwartz (1963).)

Actually Bernanke was trying to do more, but when the “Fedborg” is hopelessly confused, and when the broader economics profession is hopelessly confused, well then there’s only so much one mild-mannered former college professor can do.

The people most off base in 2008-09 were the conservatives.  Friedman’s voice was dearly missed.

PS.  I hope DeLong doesn’t get annoyed if I tease him on one point.  He calls Martin Wolf a “conservative British journalist” and then spends several paragraphs discussing all sorts of Wolf views on a wide range of issues.  The only common thread I found was that Wolf’s policy views seem consistently left-of-center, at least where there is a clear left/right split (the euro seems ambiguous.)  So why not say “formerly conservative British journalist?”

(That’s not to say Wolf doesn’t have some good suggestions.)

Investment flows and population growth

I saw an interview of Robert Shiller and Kenneth Rogoff at Davos, where they were asked about the sluggish level of investment in the US.  They spoke of a lack of animal spirits, lingering effects of the financial crisis, etc.  I wonder if we are underestimating the role of population growth.

For instance, suppose houses lasted forever.  In that case a permanent reduction of population growth from 2% to 1%/year would cut housing investment in half.  Even in a more realistic model, where a small fraction of houses are demolished each year, housing construction might fall by 20% or 30%.

It also seems to me that the working age population might be especially important, as they need workplaces, which are provided via new investment.  Here’s a graph of the US population from age 16 through 64:

Screen Shot 2015-01-28 at 2.10.21 PM

It looks to me as though working age population growth suddenly slowed down around the onset of the recession.  Because the most recent datum is November 2014, I went back seven years to November 2007. The total growth from 2007-14 was 3.63%.  For the seven years before that it was 9.61%.  For the seven years before that is was 9.15%, and from 1986 to 1993 it was 7.21%.

So in the late 1980s and early 1990s working age population was growing at about 1% per year.  Then growth sped up to well over 1% for 14 years.  Then when the recession began growth slowed to about 0.5%.  That seems significant.

Is it just the recession?  We are now seeing unemployment falling sharply, but growth seems to be declining even further, to just 0.31% in the last 12 months, far below the growth rates that America has seen for many generations.  And with rising disability rolls, presumably the number of non-disabled working age people is growing even more slowly.

Two theories:

1.  Boomer retirements.

2.  Less immigration.

I’d guess some of each–does anyone have the data?

Whatever the cause, this seems like it might be able to explain at least some of the sluggish investment and low interest rates.  And if it was just the recession, obviously yields on 10 year bonds would not be below 2%.  After all, unemployment is down to 5.6% and falling rapidly.  The past 10 years have been subpar, but cyclical factors can’t very easily explain low yields for the next 10 years.  On the other hand, if working age population growth continues to slow, then we’ll begin to look more like Japan—the country that first entered the low investment/low interest rate environment.

BTW, Check out my post on Keynesian economics and the 2013 austerity, at Econlog.

PS.  With the appreciation of the Swiss franc, shouldn’t the Davos meetings be moved to Innsbruck, which uses the now “worthless” euro.

PPS.  James in London directed me to an article showing that the SNB is itching to get back in there buying assets to hold down the value of the SF.  No surprise to readers of this blog.

Clark Johnson on Afghanistan

A few years ago Lars Christensen hosted a multipart post Keynes, written by Clark Johnson.  I’ve known Clark for years, as we shared an interest in gold hoarding by central banks during the Great Depression.  Clark’s book on French gold hoarding also influenced Doug Irwin’s recent work in this area.  He reminds me a bit of David Glasner (who also wrote on gold hoarding during the 1930s, way back in the late 1980s.)  Both are independent thinkers who don’t follow a predictably liberal or conservative line.

What people may not know about Clark is that he is also an expert on foreign policy. His PhD was actually in history.  Over the years we had lots of fruitful discussions on both economics and foreign policy.  As you might expect from the arrogant tone of my blog, I always feel I can hold my own in economics debates. But I gradually noticed that when we argued about foreign policy, later events showed that Clark was right and I was wrong.  And it didn’t seem to matter whether I took the more hawkish or dovish line.  There’s a reason I don’t blog on foreign policy, my brain is not wired in such a way as to make me good at the nuances of that subject, which seems more an art than a science.

I’d like to highly recommend a recent Clark Johnson article on Afghanistan, which seems much more intelligent than anything I’ve read in the media.  I wish he was in a position with more influence over US foreign policy.  BTW, Clark has spent a substantial amount of time living in various hotspots.  I have memories of getting emails from Clark in places like Kabul or Baghdad, saying his hotel had been hit by mortar fire that morning.

Here’s the abstract, but the issues are so complex you really need to read the whole thing to do justice to his arguments:

US efforts in Afghanistan since 2001, and especially since the surge of 2010-2011, have emphasized military and to a lesser extend donor aid operations, while side-stepping political and cultural complexities.  The policy has failed, as evidenced by both persistence of the insurgency and by acknowledgement of Coalition leaders that they do not know how to reinforce credibility of GIRoA (Government of Islamic Republic of Afghanistan).  Going back to 1989, and certainly since 2001, the US has failed to construct a coalition of moderates that might be able to enhance legitimacy and increase stability, and hence to begin to defuse military tensions.  Indeed, the US has often supported factions that tended to undermine stability and energize insurgent activity.  An improved political strategy going forward would look for ways to collaborate with and strengthen moderate tribal and religious leaders, and to support GIRoA structures already in-place for neutralizing extremists and warlords.  In line with Afghan historical precedent, the US and Coalition should also seek to decentralize government finance and appointments, in order that some insurgents might choose to compete politically (non-militarily) in provinces and districts.  This can be accomplished over time even without negotiations between GIRoA and Taliban leaders, and with a minimum of Coalition military support.

In macro, Clark’s strength is the interrelationship between exchange rate policy and macro outcomes, as you might expect from someone who studied under Mundell.  He’s also a fan of Keynes’s Treatise, a book I need to reread.

American liberalism, circa 2007

Marcus Nunes directed me to a very interesting piece by Jonathan Chait in the American Prospectfrom 2001.  It begins by pointing out that by the early 1990s American liberals had turned against the deficit spending policy of Ronald Reagan. Then it moves on to the Clinton Administration:

All of these developments were known at the time, but they had not fully cohered when Clinton began to construct his first economic plan. The key decision was not whether to reduce the deficit——given its size, the White House had no other realistic option——but rather what effect this would have upon the economy. Everyone present assumed that raising taxes or cutting spending would, at least in the short run, dampen economic growth. White House economists gave serious consideration to the possibility that their plan would throw the economy into recession. The only way to avoid this dismal fate was if the Federal Reserve or the bond market would lower interest rates to spur economic activity and make up for the depressing effects of deficit reduction. According to Bob Woodward’s account in The Agenda, Clinton replied to this news in a half whisper: “You mean to tell me that the success of my program and my reelection hinges on the Federal Reserve and a bunch of fucking bond traders?”

The question that so bedeviled the White House in 1993——can the Fed and the bond market overcome the effects of tight budgets?——is no longer in doubt, and therein lies the great transformation of liberal economics. Previously, even liberals who favored deficit reduction considered it a painful trade-off: Reducing government borrowing would free up more savings for private investment and, in the long run, improve productivity, but in the short run, it would slow or even halt economic growth and throw millions out of work. The White House accepted this bargain in 1993 and hoped it would work out for the best. Now fiscal restraint is seen not even as a trade-off but, rather, as a way of getting the best of both worlds. This does not mean that forbearance is the one true answer, now and forever. It merely suggests that, under the present economic and political circumstances, the interests of current and future prosperity both argue for reducing deficits or expanding surpluses.

That intellectual breakthrough forms the bedrock of progressive fiscal conservatism. The principles of this economic synthesis are eminently clear. It begins with a recognition that the Federal Reserve and the bond market wield an effective control over the economy and that these instruments, rather than deficit spending, have become the most effective levers available to government for promoting economic growth. At the same time, there is an understanding among liberals that the burdens of fiscal restraint should fall primarily upon those most able to bear it and that the government should make a special effort to ensure that the benefits of economic growth also flow to those at the bottom.

Clinton’s 1993 budget bore out these tenets in their purest practical form. Its overall framework was deficit reduction, with the purpose of reducing interest rates and promoting economic health. It also had a strongly progressive tilt, raising the tax rate on the highest earners while expanding low-income subsidies such as the Earned Income Tax Credit (EITC) and Head Start. Six years later, Clinton and his advisers—and even like-minded economists outside the administration—continue to hold up the 1993 budget as their pinnacle achievement.  [The article seems to have typos, so I added dashes in the first two paragraphs.]

Recall that unemployment was pretty high when Clinton took office, much higher than today.  Of course today’s liberals would point to one key difference, interest rates were not stuck as zero.  (But that’s also true of the eurozone, circa 2008-12.)

As recently as 2007, the conventional wisdom of American liberals (on fiscal policy) was essentially market monetarist—they believed in monetary offset.  The fiscal multiplier is close to zero.  Deficits are bad.  And yet I get many Keynesian commenters who don’t know this. They act like I’m propounding some sort of weird theory.  They tell me that:

GDP = C + I + G

So “obviously” more G will boost GDP.  In fact, it is post-2007 liberals who are the “weirdos,” who have rejected the successful policies of Clinton and replaced them with the failed policies of Obama.  (Remember, this is the president who 5 years into the recovery was arguing that unemployment was still so bad that we needed to enact an “emergency” unemployment program.)

First the Keynesians argued that monetary stimulus was ineffective at the zero bound. That’s what got me into blogging.  But it soon became obvious that monetary policy was still effective. For instance, the dollar dropped 6 cents against the euro on the day QE1 was announced, in March 2009.  Then after 2011 we had a controlled experiment, both the US and eurozone did roughly equal amounts of fiscal austerity.  But the US did monetary stimulus and the eurozone did not.  Both regions had similar unemployment rates as recently at 2010, in the 9% to 10% range.  By 2014 the eurozone unemployment rate was twice that of the US (roughly 12% vs. 6%).  Monetary policy made the difference.

Then Keynesians claimed that even the Fed didn’t believe in monetary offset.  That theory lost a bit of force when (in late 2012) Fed officials said they were doing aggressive stimulus (QE3 and forward guidance) partly to keep the recovery going as Congress moved to austerity in 2013.  By early 2013 it was clear that if this new form of liberalism, this rejection of Clintonomics, was going to have any plausibility they needed to be able to show that the Fed could not or would not offset fiscal austerity. And calendar 2013 was the perfect test, as all sorts of austerity came together at the same time.  The budget deficit fell by $400 billion in fiscal 2013, but that year begins on October 1st.  The tax increases didn’t start until January 1st, 2013, and the deficit fell by an astounding $500 billion during that calendar year.  A near perfect test.

Some of my critics point out that GDP data is noisy, and that the speed up in growth in 2013 wasn’t particularly significant.  Agreed.  But the Keynesians didn’t just need a single, they needed a home run.  They needed a sharp slowdown.  The evidence in favor of monetary offset was becoming increasing persuasive.  The Fed doesn’t stop doing monetary policy at the zero bound.  If you are going to reject the previous liberal conventional wisdom, reject views held as recently as 2007, ask the public to spend a trillion dollars, you better damn well have a good reason.  They desperately needed a slowdown in 2013, and got a speed up in growth instead.  That’s why 2013 was so devastating.  Not because it was definitive, but because fiscal stimulus was already on its last legs, increasingly rejected even by liberals such as Jeffrey Sachs.  Once 2013 went against them, it was game over.

With my new Mercatus job, I think I’ll go back to my practice of doing off-the-wall stuff on Sundays–the day of rest.  I already did one today, here’s another.

While flying back from Hong Kong last September I read the Financial Times.  They have a glossy section discussing objects at their website

Then Mosqueda has commissioned many of the world’s most interesting designers to create pieces for the project. Maarten Baas has taken an old carpenter’s desk ($15,000) and done his famous burning act with it, while Matali Crasset for Nodus has produced strikingly geometric rugs ($5,900). Some of Holland’s top designers (Julius Vermeulen, Swip Stolk and the legendary Wim Crouwel) have brought out special fabrics, which have been used to upholster vintage furniture, such as the Theo Ruth & Swip Stolk chair ($6,300). There is a copper Dutch bicycle ($7,100) in an edition of 10 from Van Heesch Design, a skull sculpture ($6,700) by Nick Ervinck and a Botanica vase ($3,100) by Studio FormaFantasma, plus an amusing Naughty Bavaria pillow by Studio Job for Maharam ($415). Verging more towards art than functional pieces are Esther Janssen’s hand-sewn, leather artworks of natural disasters ($5,900), but alongside these there are also utilitarian pieces such as a steel floor lamp by Tom Dixon ($5,900) and a Piet Hein Eek chair ($7,500), as well as a stunning Camino vase by Alessandro Mendini ($7,100). A contemporary Nendo Deep Sea table for Glas Italia ($9,000), a stylish tray by Tord Boontje ($2,200) and a special Viktor & Rolf doll ($75,000) add to the curiosities.

Each new collection at Chamber will come with a limited-edition perfume. The scent for the gallery’s opening has been created by Julian Bedel of Argentine perfumery Fueguia 1833 and costs $350 for 100ml eau de parfum. Mosqueda asked Bedel, who is famous for taking his inspiration from South America and its culture (for example, a fictional library in one of Jorge Luis Borges’s short stories), to craft a unisex scent based on the experience of being in an old Louis Khan building. It is bottled in a porcelain vessel that was designed by Studio Job.

My first reaction was that if the rich need advice on how to spend their money, then maybe it’s time for a progressive consumption tax.  But of course first reactions aren’t always the best, and so for months I mulled the question of how to address this issue; do I want to mood affiliate with philistine populists or reactionary aesthetes?  Let’s consider a few arguments:

1.  The marginal utility argument.  Surely the rich receive less marginal utility from these objects that the poor would receive from an equivalent amount of money.

2.  On the other hand there are externalities involved.  People like me can get utility browsing the Chelsea gallery where these objects are displayed.  And jobs are created making these objects.

3.  But jobs are a cost.  The opportunity cost of making these objects is fewer objects for the poor. Many fewer, as objects for the poor are mass-produced in southern Chinese factories.  And people browsing that Chelsea gallery will also be fairly affluent; these objects do nothing for the working class and poor.

4.  But these jobs are a labor of love for those who feel called to the arts.  Do we really want to go back to the egalitarian 1950s, when Wallace Stevens had to sell insurance? The super rich support a large class of young artists.  Right now the 21st century equivalent of Venice is being created somewhere, we are just too close to see it.  (Let’s just hope it isn’t Macao.)

5.  Perhaps we could tax mansions and yachts on a sort of aesthetic basis, with much higher property tax rates on faux Versailles palaces in the Hollywood Hills than mid-century modern masterpieces.

6.  Are you kidding!  You expect IRS agents to be able to assess artistic merit?

And so it goes.  So I’m torn between these two arguments.  I suppose in the end it was the perfume that tipped me over the edge.  Now I’m as much a fan of old Louis Kahn buildings and infinite libraries as the next guy, but let’s consider the following hypothetical.  Suppose it cost $350 to create the Louis Kahn perfume and only $250 to create a perfume that will leave you smelling like an old Louis Sullivan building.  What is the marginal utility from that extra architectural cache?

So the philistine in me won out.  But how are we going to get the money to the poor? Matt Yglesias tells us that our next president (Hillary Clinton) plans to run on a platform to help the middle class, not the poor.  (I refuse to believe she has no idealism; rather (like Mitt Romney) she intends to lie her way into office and then tell us what she really believes.)  At the other extreme, after very wisely cutting the Kansas income tax, Governor Brownback had to wreck everything by a plan to raise the cigarette tax from 79 cents to $2.29/pack.  A blow right to the solar plexus of poor and working class Kansans.

The Dems want to subsidize NPR while the GOP doesn’t want to subsidize any radio stations.  Who will subsidize the stations that the poor listen to?

So I’ll keep advocating a progressive consumption tax/wage subsidy to help the poor. But I’m not very optimistic. The rich have their lobbyists and the middle class has their teachers/public employee unions.  No one listens to the poor cigarette smokers.

You might wonder why I am so obsessed with redistributing consumption from the rich to the poor, and so disdainful of those who want to help the middle class.  I suppose it’s partly because I believe the motivations are different, utilitarianism vs. envy.  Why is utilitarianism better? Consider the following from a recent piece in the New York Review of Books:

Aly’s emphasis on emotion (in this case envy) and psychology (concerning the reception of race theory), to say nothing of the topic of anti-Semitism itself, represents a significant departure from his earlier work. Here is a creative scholar who continues to grow in remarkable ways. In Aly’s portrayal the German paradox alluded to above disappears. If the Jews of Germany experienced the greatest success of any Jewish community in Europe in assimilation, social mobility, and the attainment of wealth and preeminence, they did so amid a Gentile population for which the modernization experience was more compressed, intense, and disorienting than in other countries. If envy of Jewish success was the driving motive behind modern anti-Semitism, as Aly argues, then it would be logical rather than paradoxical that the most intense anti-Semitic reaction would also occur in Germany, the land of the greatest and most visible Jewish success. This in my opinion is the most important contribution of Why the Germans? Why the Jews?

PS.  Would you rather smell like this:

Screen Shot 2015-01-25 at 6.38.25 PMOr this:

Screen Shot 2015-01-25 at 6.38.44 PM