Archive for May 2015


When did the left jump the shark?

Was it when they started talking about helicopter drops? Or perhaps the point where the LA labor unions asked to be exempted from the new minimum wage law?  Maybe, but I vote for this gem from The Guardian, which (believe it or not) is actually considered one of the UK’s respectable newspapers:

Landlords are allowed to deduct a wide range of expenses, on top of mortgage interest costs, before they have to pay tax on their rental income. These allowable expenses include the cost of insurance, maintenance and repairs, utility bills, cleaning and gardening, and legal fees. Ordinary homeowners are not entitled to similar privileges.

Tim Worstall and Britmouse beat me to it.

People sometimes ask me why I consider The Economist to be the best newspaper. Here’s one reason—can you even imagine a paragraph that idiotic in The Economist?

PS.  Full disclosure; I’m one of those “privileged” landlords.

The perfect villain

Poor Dennis Hastert.  He picked the wrong country to get born into.

1.  He picked a Puritan state in a Puritan country with a higher age of consent than any European country, save Ireland, Cyprus and Turkey.

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2.  He picked a country where (according to Politico) the GOP cares so little for the lives of blacks and gays that it won’t lift a finger to stop a needle/HIV epidemic until it starts hitting Red State voters.

3.  He picked a country where the Dems think it’s a crime to frequently withdraw $5000 in cash from your own bank account, and use the cash for perfectly legal activities.

4.  He picked a country where voters have so much faith in law enforcement that they make it a crime to lie to police, even to cover up an embarrassing personal scandal.

5.  He picked a country where people are obsessed over any sex where there is a “power imbalance.”

PS.  Attention commenters; I’m offering no editorial comment, just describing things as they are.  If you don’t like the post, don’t blame me, change America.

Bullard, et al, on NGDP targeting

Lots of people (including James Bullard) have sent me a new paper by Costas Azariadis, James Bullard, Aarti Singh, and Jacek Suda.  Here is the abstract:

We study optimal monetary policy at the zero lower bound. The macroeconomy we study has considerable income inequality which gives rise to a large private sector credit market. Households participating in this market use non-state contingent nominal contracts (NSCNC). A second, small group of households only uses cash and cannot participate in the credit market. The monetary authority supplies currency to cash-using households in a way that changes the price level to provide for optimal risk-sharing in the private credit market and thus to overcome the NSCNC friction. For sufficiently large and persistent negative shocks the zero lower bound on nominal interest rates may threaten to bind. The monetary authority may credibly promise to increase the price level in this situation to maintain a smoothly functioning (complete) credit market. The optimal monetary policy in this model can be broadly viewed as a version of nominal GDP targeting.   (emphasis added)

Obviously I like this paper, even though they rely on nominal debt contracts rather than my preferred sticky nominal wages as the key friction.

In their model, when the zero bound threatens to appear, policymakers deviate from standard policy by engineering a rise in the price level.  This sounds vaguely NeoFisherian:

The price level approach involves a promise to engineer an increase in the price level one period in the future sufficient to keep the net nominal interest rate positive. This promise is sufficient to ensure that the net nominal interest rate remains positive and the complete credit market policy remains intact.

As I indicated earlier, the NeoFisherians have a point when they suggest that raising interest rates can raise inflation.  Their claim is actually wrong in the context of current Fed operating procedures, but would be correct under certain policy regimes.  Notice that in this example, monetary policy raises interest rates and expected inflation together.

Continuing on:

However, this policy has a drawback: The price level policy harms cash-using households relative to the policy away from the zero lower bound. As additional shocks hit the economy, the zero lower bound situation will eventually dissipate and special policy actions will prove temporary.

We conclude that in economies where the key friction is NSCNC and the net nominal interest rate threatens to encounter the zero lower bound, monetary policymakers may wish to respond with a price level increase. A chief rival to this response observed in actual economies—forward guidance on the length of time the economy will remain at the zero lower bound beyond the time when that bound is actually binding—would be inappropriate in the theory presented here.

I absolutely LOVE this passage.  I’ve repeatedly criticized the New Keynesian view that the way out of a liquidity trap is to keep interest rates low for an extended period. Rather I’ve suggested using NGDPLT to keep interest rates from falling to zero in the first place.  I’ve argued that the “zero rates for an extended period” approach is hard to distinguish from Japanese policy, and that the only country with sufficiently expansionary policy during the Global Financial Crisis was Australia, which never hit the zero bound.  Australia had 6.5% NGDP growth from 1996 to 2006, and then 6.5% NGDP growth from 2006, to 2012.

As far as currency holders being hurt:

1.  They’d be helped far more by the positive employment affects of effective monetary policy.

2. If we care so much about people who choose to conduct their affairs in currency, then why was Dennis Hastert arrested?  Alternatively, if the government assumes that people dealing in cash are criminals, it seems plausible that the optimal rate of tax on currency would be even higher than implied by the occasional one time price level increases in this proposed regime.  (Yes, I’m being sarcastic.)

Eggertsson and Mehrotra (2014) follow authors like Benhabib, Schmitt-Grohe, and Uribe (2001), Bullard (2010), and Caballero and Farhi (2015) in modeling the zero lower bound as at least potentially a permanent outcome. In the present paper, the zero lower bound can be encountered because of large and persistent aggregate shocks, but is ultimately temporary.

Of course there is always a trend rate of inflation/NGDP growth sufficiently high to prevent the zero bound from being permanent.

How is it that the monetary policymaker can control the price level in this model? The policymaker supplies currency, H (t); to the non-participant households—the cash users.

It warms my heart to see people talk about controlling the price level by controlling the currency stock.  Eugene Fama must be smiling somewhere.

The bottom line is that although the policy implications are discussed in terms of price level adjustments, the policy implications are very close to NGDP targeting:

In terms of inflation rates, inflation would be relatively high at times when output is growing slowly and inflation would be relatively low when output is growing rapidly. On average, the net inflation rate would be zero (which we have defined as the inflation target here), and the policymaker would achieve the targeted rate of inflation in an average sense. It is the nature of the reaction to shocks which distinguishes the complete markets policy rule from the price stability rule, not the average rate of inflation.

.  .  .

Another way to view the optimal monetary policy in the low volatility economy is as nominal income targeting.

They cite previous research by Kevin Sheedy (2014) and Evan Koenig (2013), which reached similar conclusions.  If one were to add the sticky wage friction, I believe the argument for NGDP targeting would become even stronger.

Again, the key insight here is that you want a policy regime that prevents nominal interest rates from falling to zero.  In my view NGDPLT is the simplest and most politically feasible way of doing so.

Lots of catching up to do, I’ll get to the older comments eventually.

PS.  The Wall Street Journal indicated that Bullard made some additional comments about the research, which I discuss over at Econlog:

He said his model is consistent with the Fed maintaining its 2% inflation target, but would simply mean the central bank would work more aggressively to counter any undershooting or overshooting of that objective. For instance, a nominal GDP target would have likely prescribed even more aggressive Fed monetary easing during the crisis-ridden 2007-2009 period, Mr. Bullard said.

“If you took this paper seriously we should have done even more in 2007-2009,” he said. “Something like nominal GDP targeting, if it’s appropriately formulated, does look like optimal policy.”

🙂   🙂   🙂   🙂  🙂   🙂   🙂   🙂   🙂   🙂   🙂

America’s industrial juggernaut

If you are as old as me, you might remember the 1950s and 1960s, when America was an industrial juggernaut.  Here are a couple pictures from Ford’s giant River Rouge complex, from (I’d guess) the early 1960s:

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Now America has de-industrialized.  And yet, we somehow managed to increase industrial production from 83.7 in June 2009 to 106.2 at the end of 2014.  That’s an increase of 22.5.  But 22.5 is just the change in an index number, what does it actually mean?  Well in March 1961, soon after JFK took office, America’s industrial production stood at 22.2.  That’s right, Obama presided over a boom in industrial production larger than the entire industrial production of the US in March 1961!  (And recall that IP is a real index, adjusted for price level changes.)

Misleading?  Off course, but still kind of interesting.  Note that America’s population has grown since 1961, but it hasn’t even come close to doubling.  Meanwhile IP is up nearly 5-fold.

PS.  IP peaked at just under 46 in November 1973, generally regarded as the date when the post-WWII industrial boom ended.

Do I believe these numbers?  Not really, as I don’t believe the government’s price level numbers.  Lots of this “growth” occurred in the 1990s and is just Moore’s Law in computers, not the US actually producing more “stuff.”  I don’t consider my current office PC to be 100 times better than my 1990 office PC.


Seeing Lu Mountain

Brad DeLong has a post discussing a debate between Paul Krugman and Roger Farmer:

I find myself genuinely split here. When I look at the size of the housing bubble that triggered the Lesser Depression from which we are still suffering, it looks at least an order of magnitude too small to be a key cause. Spending on housing construction rose by 1%-age point of GDP for about three years–that is $500 billion. In 2008-9 real GDP fell relative to trend by 8%–that is $1.2 trillion–and has stayed down by what will by the end of this year be seven years–that is $8.5 trillion. And that is in the U.S. alone. There was a mispricing in financial markets. It lead to the excess expenditure of $500 billion of real physical assets–houses–that were not worth their societal resource cost. And each $1 of investment spending misallocated during the bubble has–so far–caused the creation of $17 of lost Okun gap.

(You can say that bad loans were far in excess of $500 billion. But most of the bad loans were not bad ex ante but only became bad ex post when the financial crisis, the crash, and the Lesser Depression came. You can say that low interest rates and easy credit led a great many who owned already-existing houses to take out loans that were ex ante bad. But that is offset by the fact that the excess houses built had value, just not $500 billion of value. I think those two factors more or less wash each other out. You can say that it was not the financial crisis but the destruction of $8 trillion of wealth revealed to be fictitious as house prices normalized that caused the Lesser Depression. But the creation of that $8 trillion of fictitious wealth had not caused a previous boom of like magnitude.)

To put it bluntly: Paul is wrong because the magnitude of the financial accelerator in this episode cries out for a model of multiple–or a continuous set of–equilibria. And so Roger seems to me to be more-or-less on the right track.

DeLong is certainly right that the housing bust is far too small, but it’s even worse than that.  The vast majority of the housing bust occurred between January 2006 and April 2008, and RGDP actually rose during that period, while the unemployment rate stayed close to 5%.  So it obviously wasn’t the housing bust.  On the other hand you don’t need exotic theories like multiple equilibria—the Great Recession was caused by tight money.  It’s that simple.

Or is it?  Most economists think that explanation is crazy.  They say interest rates were low and the Fed did QE.  They dismiss the Bernanke/Sumner claim that interest rates and the money supply don’t show the stance of monetary policy. Almost no one believes the Bernanke/Sumner claim that NGDP growth and/or inflation are the right way to evaluate the stance of policy.  Heck, even Bernanke no longer believes it.

And even if I convinced them that money was tight they’d ask what caused the tight money, or make philosophically unsupportable distinctions between “errors of omission” and “errors of commission.”

In previous blog posts I’ve pointed out that it’s always been this way.  If in 1932 you had said that tight money caused the Great Depression, most people would have thought you were crazy.  Today that’s the conventional wisdom.  If in the 1970s you’d claimed that easy money caused the Great Inflation, almost everyone except a few monetarists would have said you were crazy.  Now that’s the conventional wisdom.  Even the Fed now thinks that it caused the Great Depression and the Great Inflation.  (Bernanke said, “We did it.”)

The problem is that central banks tend to follow the conventional wisdom of economists.  So when central banks screw up, the conventional wisdom of economists will never blame the central bank (at the time); that would be like blaming themselves. They’ll invent some ad hoc theory about mysterious “shocks.”

The other night at dinner my wife told me that the Chinese sometimes say, “If you cannot see the true shape of Lu Mountain, it’s because you are standing on Lu Mountain.”

In modern conventional macro, most people look at monetary policy from an interest rate perspective.  That means they are part of the problem.  They are looking for causes of the Great Recession, not understanding that they (or more precisely their mode of thinking) are the cause.

Only the small number of economists who observed Mount Lu from other peaks, such as Mount Monetarism or Mount NGDP Expectations, clearly saw the role of central bank policy.  People like Robert Hetzel, David Beckworth, Tim Congdon, etc.

PS.  Before anyone mentions the zero bound, consider two things:

1.  The US was not at the zero bound between December 2007 and December 2008 when the bulk of the NGDP collapse occurred, using monthly NGDP estimates.

2.  Do you personally support having the Fed use a policy instrument that freezes up exactly when you need it most desperately?  Or might the problem be that they’ve chosen the wrong instrument?

PPS.  Yes, not everyone on Mount Monetarism saw the problem, but as far as I know no one on Mount Interest Rate got it right.  Perhaps Mount Interest Rate is Lu Mountain.

PPPS.  To his credit, Brad DeLong thought the Fed should have promised to return NGDP to the old trend line.  If they’d made that promise there would have been no Great Recession, just a little recession and some stagflation.