Archive for December 2015


Yurt place or mine?

[I am on vacation now, so I dug up an old piece that I never posted.  Also check out the piece on kidney markets, which the WaPo requested me to write.]

Back in 2009 I did a post on “The Aesthetics of Inequality.”  Here’s one excerpt:

A peasant village perched on a hillside in a third world country can be aesthetically beautiful, but a shantytown of former peasants on the edge of a large modern urban area (even if the peasants are now better off) is aesthetically ugly.

I was reminded of this while watching a recent video of Ulaanbaatar, which is attracting mass migration from the Mongolian countryside.  There are few more picturesque scenes of rural poverty that a bunch of yurts set up on Mongolia’s vast plains, under a cerulean blue sky:

Screen Shot 2015-09-21 at 4.01.37 PMFortunately, a mining boom has made Mongolia rich, and the peasants are flocking to the cities, and put up their yurts in shanty towns on the edge of Ulaanbaatar—which now has a majority of Mongolia’s population.

Screen Shot 2015-09-21 at 4.05.00 PM

The lady who narrated the show was a Westerner.  And she couldn’t quite get past the idea that this urbanization didn’t look very attractive:

It’s so funny because in the countryside it seems natural and it seems clean and it seems lovely, and here this is just poverty-struck, and so not natural.

It’s easy for Westerners and/or upper class people to think they know what’s best for the poor. But unless they’ve actually lived that life, they may end up substituting aesthetic judgments for utilitarian criteria. The Mongolians had to decide whether their country was going to be a place of yurts, or a place full of large open pit mines and cities with high-rise apartment buildings.  They chose the latter. The Mongolian she interviewed pointed out that Mongolians wanted to live in these modern apartment buildings because “they don’t have to make fire anymore, they don’t have to carry water anymore.”  They moved to the city to increase their chances of getting a modern place to live.  (Although it looks like most face a long wait.)

The average income of Hispanics is about 79% of the average income of all Americans. The IMF says that per capita income in Spain (PPP) is about 62% of per capita income of the US.  And yet in my mind Hispanics seem “poorer” than Spaniards. My mental image probably reflects the fact that I find Barcelona and Sevilla to be more attractive that the typical Hispanic neighborhood in a large Sunbelt city.  It’s fine to have those images in your mind, as long as your don’t confuse aesthetics with utility.

PS.  My God! Some of my 2009 posts were really long-winded.

PPS.  Yes, my previous example is slightly distorted by the above average size of Hispanic families, but not enough to change my point.

Long ago, in a GOP far, far away

Here’s something I didn’t know:

Such vitriolic sentiment stands in stark contrast to the unifying message of the most recent GOP occupant of the White House, President George W. Bush, in whose administration I was honored to serve for both terms. During the 2000 campaign for example, Bush praised the faith of Americans who regularly attended a “church, synagogue, or mosque,” met with Muslim American supporters across the country, and visited a prominent Islamic center in Michigan — the first major presidential candidate from either party to do so. The GOP convention in Philadelphia was the first in either national party’s history to feature a Muslim prayer. And after Muslim American community leaders expressed their civil liberties concerns regarding a provision of Clinton’s 1996 immigration enforcement legislation, Bush publicly promised to repeal the provision in the second presidential debate with Vice President Al Gore.

Bush’s inclusive efforts earned him the endorsement of eight major Muslim American organizations. By election day, more than 70 percent of the Muslim vote — including 46,200 ballots in just Florida — went in his favor. And after his 2001 swearing-in, Bush appointed a record number of Muslim Americans to senior positions in the White House and throughout his new administration.

I know, in a close election any bloc of votes could be viewed as decisive.  But raise your hand if you knew the GOP won 70% of Muslim votes in 2000.

Raise you hand if you think they’ll win 70% in 2016.

Fortunately the GOP hasn’t been demonizing other groups like blacks, Mexicans, Chinese, Japanese, etc.

PS.  Saw Star Wars today.

One shock to rule them all

Marcus Nunes directs me to a new Brad DeLong post, discussing six big shocks that have hit the US economy since 2005. But I agree with Marcus, I only see one. First let’s look at DeLong’s six:

(1) The collapse of residential investment after the end of the mid-2000s housing bubble, in order of their size (-3.8% of potential GDP):

(2) The wave of austerity–mostly state-and-local, but considerable at the federal level as well–hitting government purchases (-3.0% of potential GDP):

(3) The collapse of business fixed investment in the aftermath of the financial crisis (-2.9% of potential GDP):

(4) The blockage of the credit channel that prevented there from being much significant bounce-back to normal in residential construction (-1.8% of potential GDP):

(5) The (closely-associated with (3)) collapse of exports as the effects of the financial crisis spread beyond U.S. borders (-1.8% of potential GDP):

And (6) on a different graph (since it is not one of the four salient components), and also closely-associated with (3), the adverse shock to consumption as it became clear first that there was going to be a deep and then a long downturn (-1.8% of potential GDP):

All I see is a big monetary shock; a tight money policy in 2008 that caused NGDP to fall during 2008-09 at the steepest rate since the 1930s.

1.  Residential construction fell more than in half between January 2006 and April 2008, but unemployment merely edged up from 4.7% to 5.0%, and the consensus view of economists was that 2009 would be an OK year.  Yes, 2009 turned out not to be an OK year, but that wasn’t because of a housing collapse that economists were already well aware of, but rather because of a NGDP collapse that they did not predict, even in April 2008.

2.  What austerity?  Has government spending fallen as a share of GDP?   Yes, it’s slowed relative to trend, as you’d expect in a economy that has slowed relative to trend.  Sorry, but living within your means is not a “shock.”

3.  Yes, investment is highly cyclical, and falls sharply in deep recessions caused by too little NGDP.  It’s the effect of a shock.

4.  OK, this is an independent shock, but we’ve already seen that housing is no big deal.  With adequate NGDP growth the labor market would have been fine.

5.  Yes, money was also tight in Europe and Japan.

6.  Even DeLong admits the fall in consumption is an endogenous response to the deep recession.

Please don’t misinterpret this post.  The world is very complex.  The causes of the NGDP shock were very complex.  Perhaps all six items mentioned by DeLong played some indirect role in monetary policy going off course.  But the sooner we start thinking in terms of 2008-09 being a single shock, the sooner we’ll demand more from our central banks, and the sooner we’ll get better monetary policy.

Regardless of whether I am right or DeLong is right, it’s very much in America’s interest if the Fed believes that I am right.

PS.  DeLong ends as follows:

And they say: given those six shocks and their magnitude, haven’t we done rather well at stabilizing the economy? Haven’t we certainly done much better than the BoJ, or the ECB, or the Bank of England?

And they are right: they have.

Since late 2008, the Federal Reserve has a lot to be proud of.

I’m not so sure of that.  The US has faster population growth than Japan, and faster productivity growth than Britain, but haven’t their labor markets done much better, in the sense that employment population ratios are soaring to new highs, while ours languishes?  (I’m relying on memory here due to a hectic holiday schedule, correct me if I’m wrong.)

But yes, much, much, much better than the brain dead ECB.

Merry Christmas, and check out my Econlog post.


Barsky and Summers explain why low rates are contractionary

Most people seemed to think my previous post was crazy, and looked for weaknesses.  A few perceptive observers, such as Nick Rowe and Jonathan, noticed that it had the same implication as the IS-LM model.  Some people wrongly assumed I was simply talking about correlation, whereas I was claiming that lower interest rates cause falling NGDP.  Some wondered why that is not reasoning from a price change.

I think the best way to address this confusion is to start with the classic 1988 paper by Barsky and Summers.  They claim that the “Gibson Paradox” is caused by the fact that low interest rates are deflationary under the gold standard, and that causation runs from falling interest rates to deflation.  Note that there was no NGDP data for this period, so they use the price level rather than NGDP as their nominal indicator.  But their basic argument is identical to mine.

The Gibson Paradox referred to the tendency of prices and interest rates to be highly correlated under the gold standard. Initially some people thought this was due to the Fisher effect, but it turns out that prices were roughly a random walk under the gold standard, and hence the expected rate of inflation was close to zero.  So the actual correlation was between prices and both real and nominal interest rates.  Nonetheless, the nominal interest rate is the key causal variable in their model, even though changes in that variable are mostly due to changes in the real interest rate.

Since gold is a durable good with a fixed price, the nominal interest rate is the opportunity cost of holding that good.  A lower nominal rate tends to increase the demand for gold, for both monetary and non-monetary purposes.  And an increased demand for gold is deflationary (and also reduces NGDP.)

Of course that’s just the demand for gold, what about the supply?  It so happens that the supply of gold was fairly stable under the gold standard, rising by about 2% per year, whereas the demand for gold was much more unstable.  Thus changes in the value of gold (which was the inverse of the price level under the gold standard) were mostly caused by shifts in the demand for gold, which were in turn caused by changes in nominal (and real) interest rates.

An interesting question is how these changes impacted the real economy.  I would argue that sticky wages caused the fall in NGDP to result in a fall in hours worked.  A real business cycle proponent might deny that, and claim that whatever caused real interest rates to decline, also caused workers to want to take long vacations.  But anyone who denies the RBC model, and believes wages are sticky, should agree with me; causation goes from interest rates to NGDP to hours worked, even if the initial change in real interest rates was caused by a real shock.  Falling NGDP has an independent effect on hours worked even if caused by a real shock, just as a gunshot wound hurts someone who already has pneumonia.

As far as the claim that this is just IS-LM, I suppose that’s true, but it didn’t stop Barksy and Summers from getting their paper published in the JPE, nor did it prevent Tyler Cowen from calling it an enjoyable paper that addressed an interesting “puzzle”.

The puzzle of why the economy does poorly when interest rates fall (such as during 2007-09) is in principle just as interesting as the one Barsky and Summers looked at.  Just as gold was the medium of account during the gold standard, base money is currently the medium of account.  And just as causation went from falling interest rates to higher demand for gold to deflation under the gold standard, causation went from falling interest rates to higher demand for base money to recession in 2007-08.

There’s no “trick” in my previous post, I meant what I said.  But I’m not surprised that people are confused; after all, didn’t most economists believe the Fed was pursuing an “expansionary” policy in 2008?  Funny how those “expansionary” policies are almost always associated with recessions.  People tend to wrongly equate interest rate movements and “monetary policy”.  Most changes in interest rates reflect changes in the macroeconomy (growth and inflation) not monetary policy. When rates fall, the Wicksellian rate is usually falling faster, which means money is getting tighter in the NK model.

And finally, a word on reasoning from a price change.  Suppose you claimed that low rates should lead to more housing construction, or more investment in general.  That would be reasoning from a price change.  You’d be talking about the impact of the change in a price, on the quantity in the very same (credit) market.  Obviously if low rates are caused by more supply of saving, then the quantity of investment will rise, and if caused by less demand for investment, then the quantity of investment will fall.  But here’s what I’d like to emphasize.  Lower rates will reduce velocity and NGDP regardless of whether they are caused by more supply of saving or less demand for investment.  And that’s because interest rates are not the price of money, they are the price of credit.  So interest rates become a shift variable in the money market.  Lower rates shift the demand for money to the right, which raises the value of money, which is deflationary.  So there’s no reasoning from a price change in that case.  Of course if I didn’t hold the supply of base money fixed, it would be reasoning from a price change.

Lower interest rates are contractionary

No, this is not a NeoFisherian post.  I’m not claiming that a Fed policy that depresses interest rates is contractionary, I’m claiming lower interest rates are contractionary, ceteris paribus.  And ceteris paribus in this case means for any given money stock.  For simplicity, we’ll start with a simple model–no IOR— and then bring in IOR later.  And in doing so I’ll answer a question a commenter asked me: Is talking about the effect of IOR an example of reasoning from a price change?

Let’s start with this identity:

M*V = P*Y

Where M is the base and V is base velocity.  Now let’s build a model:

M*V(i) = P*Y

Since V is positively related to i, lower interest rates are contractionary, they reduce V and hence NGDP, AKA aggregate demand.  Larry Summers once wrote an article (with Robert Barsky) pointing this out, but only for the gold standard period.

So why do people not named Summers and Sumner not know this?  There are several reasons:

Sometimes, not always, reductions in interest rates are caused by an increase in the monetary base.  (This was not the case in late 2007 and early 2008, but it is the case on some occasions.)  When there is an expansionary monetary policy, specifically an exogenous increase in M, then when interest rates fall, V tends to fall by less than M rises.  So the policy as a whole causes NGDP to rise, even as the specific impact of lower interest rates is to cause NGDP to fall.

2.  Another problem is the Keynesian model, which hopelessly confuses the transmission mechanism.  Any Keynesian model with currency that says low interest rates are expansionary is flat out wrong.  That’s probably why economists were so confused by 2008.  Many people confuse aggregate demand with consumption.  Thus they think low rates encourage people to “spend” and that this somehow boosts AD and NGDP.  But it doesn’t, at least not in the way they assume.  If by “spend” you mean higher velocity, then yes, spending more boosts NGDP.  But we’ve already seen that lower interest rates don’t boost velocity, rather they lower velocity.

Even worse, some assume that “spending” is the same as consumption, hence if low rates encourage people to save less and consume more, then AD will rise.  This is reasoning from a price change on steroids!  When you don’t spend you save, and saving goes into investment, which is also part of GDP.  Now here’s were amateur Keynesians get hopelessly confused.  They recall reading something about the paradox of thrift, about planned vs. actual saving, about the fact that an attempt to save more might depress NGDP, and that in the end people may fail to save more, and instead NGDP will fall.  This is possible, but even if true it has no bearing on my claim that low rates are contractionary.

To see the problem with this analysis, consider the Keynesian explanations for increases in AD.  One theory is that animal spirits propel businesses to invest more.  Another is that consumer optimism propels consumers to spend more.  Another is that fiscal policy becomes more expansionary, boosting the budget deficit.  What do all three of these shocks have in common?  In all three cases the shock leads to higher interest rates.  (Use the S&I diagram to show this.)  Yes, in all three cases the higher interest rates boost velocity, and hence ceteris paribus (i.e. fixed monetary base) the higher V leads to more NGDP.  But that’s not an example of low rates boosting AD, it’s an example of some factor boosting AD, and also raising interest rates.

Again, I defy you to explain how low rates can boost NGDP, ceteris paribus.  If you think you have an explanation, it’s probably something that confuses consumption with total spending on NGDP.  An explanation that wrongly assumes the public’s desire to spend more on consumption, as a result of lower interest rates, is expansionary for NGDP.  Yes, an exogenous change in M will often cause short term rates to move in the opposite direction, but how often do you see exogenous changes in M?  If we were operating in a normal economy, with say 3% or 4% interest rates, and I told you rates would fall to zero in the next 12 months, would you predict a recession or boom?  Obviously a recession.  Yes, if the Fed perversely cut rates to zero in an otherwise stable economy, via fast growth in the base, that would be expansionary.  But more than 100% of the expansionary impact would come from the rise in the base (hot potato effect), and less than zero from the lower rates.

There is simply no mechanism in macroeconomics where low rates actually CAUSE more NGDP.  None.  Nada.  Lower rates reduce velocity, and that’s contractionary.  It’s not about “spending”, unless by “spending” you mean velocity.  If you mean “spending” vs. saving then you are hopelessly off track.  You aren’t even in the right train station.

Now for the hard part.  The Fed recently raised the fed funds rate, and did so without lowering the base.  So am I claiming that the Fed’s decision was expansionary?  No, but I wouldn’t blame you for seeing a contradiction here, especially if your last name is “Murphy.”

Suppose the Fed had raised the fed funds target, without raising IOR.  What then?  Then they would have had to reduce the monetary base enough to make the rate increase stick.  How much?  Fasten your seatbelts—by almost $3 trillion.  That’s right, without IOR, to even get a measly quarter point increase, they would have had to withdraw almost the entire previous QE (except the part that went into currency held by the public.)

Instead the Fed did something else, they raised IOR.  Even though IOR includes the term ‘interest,’ as part of its acronym, it actually has absolutely nothing to do with market interest rates as I’ve been discussing them so far.  It’s better to think of IOR as a tax/subsidy scheme.

Previously I claimed that higher interest rates are expansionary.  They are.  But higher IOR really is contractionary.  That’s why the New Keynesians love IOR so much.  It helps make their false “non-monetary” models of the economy less false, indeed sort of truish.  It really is true that higher IOR is contractionary.  So why the difference?  Let’s return to the simple model above.  I said that model applied to a world of no IOR.  If IOR exists, then the more general model is:

M*V(i – IOR) = P*Y

That is, velocity is positively related to the difference between the market interest rate and the interest rate on money.  This gap is the opportunity cost of holding reserves.  I wish there were no IOR, if only because it would make monetary analysis so much simpler.

In order to make monetary policy more contractionary, the Fed merely needs to shrink the gap between i and IOR.  That reduces the opportunity cost of holding base money, which causes more demand for base money (as a share of NGDP), which is contractionary.  Consider the weird situation we are in:

1.  Almost everyone assumed higher rates were contractionary, but almost everyone was wrong.

2.  Now IOR comes along, and higher IOR really is contractionary.

Now I fear that it will be even harder to slay the Keynesian dragon; the model now seems superficially even more plausible. If I was a conspiracy nut I’d think it was all a plot to make Woodford’s moneyless models appear more accurate.

To summarize, IOR is not really a market price, it’s a subsidy on base money, and negative IOR is a tax on base money. Just as it’s OK to reason from an increase in excise taxes on gasoline, it’s OK to reason from a change in IOR.  (Of course you also need to consider other changes that are occurring in monetary policy, as is always the case.)

So if lower interest rates are not the reason that monetary stimulus is expansionary, then what is the reason?  Why do more people want to go out and assume car loans when the Fed cuts interest rates via an easy money policy?  Here’s why:

1.  If the Fed lowers rates via an increase in the base, then more base money raises NGDP via the hot potato effect (AKA, laws of supply and demand).  Interest rates play no role, indeed NGDP would rise by even more if rates (and velocity) didn’t fall.

2.  The higher NGDP causes more hours to be worked, due to sticky nominal hourly wages.

3.  More hours worked means more output and more real income.

4.  Say’s Law says supply creates its own demand.  So as workers and capitalists produce more output and earn more income, they go to car dealers to splurge with their sudden newfound wealth.  Interest rates got nuthin to do with it.  Saving (and investment) as a share of GDP actually rises during booms created by monetary stimulus.  It’s not about “spending” (as in consumption), it’s about actual spending on C+I+G+NX, i.e. NGDP.

5.  Of course all this happens simultaneously, as we live in a Ratex world.

PS.  I’m begging you, don’t try to explain what you think is wrong with Say’s Law, unless you want me to be as insulting as possible in response.