The German political party “Alternative for Germany” was founded in 2013 by a bunch of professors who thought the euro was a mistake, largely responsible for the depression in southern Europe.  Its other views tended to be fairly mainstream conservative.

Not any more.  In just three short years the AfD has morphed into a xenophobic, nationalist, pro-Russian party with nostalgia for the days when East Germany was run by the communists.  Many of its original supporters have abandoned the party:

It is not clear why the AfD is so popular in [low income, eastern] Mecklenburg. Its hallmark is anti-immigrant rhetoric. But Mecklenburg has just 23,000 refugees, or 1.5% of the population. Foreigners make up 3%, and most are Poles or ethnic Germans from Russia. Muslims are a rare sight. Yet even before the refugee crisis, about one in three locals told pollsters that “because of the many Muslims, I sometimes feel like an alien in my own country”.

Mecklenburg does have a longstanding core of far-right voters: it is the only state where the NPD, a party considered neo-Nazi, has seats in the assembly. But the AfD draws more support from former non-voters and The Left, a party descended from East Germany’s communists. In the West, that may seem illogical. But it matches the gut feelings of many locals. One of the AfD’s themes is Ostalgie, “nostalgia for East Germany”. It nurtures a sense of solidarity against all outsiders, including western Germans and cosmopolitan elites.  Since reunification people in the region have felt they were “overrun by the West”, says Mr Holm.

At campaign events Mr Holm evokes 1989, when Ossis marched in solidarity against the communist regime. Now the enemy is perceived political correctness imposed by Berlin. The tone is invariably pro-Russian and anti-American. Asked how they feel about Russia’s invasion of Crimea, supporters compare it with America’s war in Iraq. “If the Ami does it it’s okay, but if Russia does it, it’s wrong?” asks one.

Actually, yes.  We did not annex Iraq.

To give you an idea of just how bizarre this is, imagine an American analogy:

1.  Suppose that in just a few years, the formerly anti-big government Tea Party was taken over by a nationalist faction that favored a xenophobic, soft on Russia, big government, more spending, vastly bigger deficits, anti-trade, anti-free press candidate who railed against political correctness and elites in general.

2.  And suppose the core supporters of this candidate were not in affluent Republican areas, but rather in poor white areas like West Virginia.  And suppose those poor whites of West Virginia were freaking out about immigration, despite the fact that hardly any immigrants want to live in their poor, backward state.

I know, I know, it could never happen here.  But then 3 years ago I would have said there wasn’t one chance in a million that the AfD would suddenly change into a party with nostalgia for East Germany.

Lesson: As I keep saying, it’s not about who wins and loses elections, it’s about the nature of the parties, and how they change over time.  FDR and LBJ made the GOP more moderate (for a while).  Reagan and Thatcher made the Dems and Labour more moderate (for a while), and so on.  That’s what matters.

If you make a pact with the devil, and allow your favorite party to be taken over by evil people, and vote for them anyway as the “lesser of evils”, you’ll find out that in the long run you’ve only made the opposition stronger, and you’ve completely discredited your favored ideas, which won’t even be adopted by the usurper who stole your party.  No, your ideas will not be adopted.  But when he or she fails, as he surely will, your ideas will be blamed, and discredited.

The next president will be a failed president, and will be rejected by the voters in 2020.  The election you really want to win is the 2020 election, which will offer the possibility of dramatic policy reform.  What shape do you want your party to be in at that time?  Do you want it to be a discredited party, about to be steamrollered by the opposition?  Or the eager opposition party, about to take charge?

If I were a Republican (I’m not), I’d pray for Hillary to be defending her record in 2020

Bob Murphy directed me to a very interesting post where Paul Krugman discusses a recent paper by Christopher Sims (on the fiscal theory of the price level.)

Here’s Sims on fiscal policy:

Fiscal expansion can replace ineffective monetary policy at the zero lower bound, but fiscal expansion is not the same thing as deficit finance. It requires deficits aimed at, and conditioned on, generating inflation. The deficits must be seen as financed by future inflation, not future taxes or spending cuts.

I think he’s saying that fiscal expansion works only if it leads to a rise in expected inflation. Or maybe not – the truth is that I’m not sure, which is one problem with too purely verbal an argument. But it’s certainly something I’ve heard from helicopter money types, who warn that something like Ricardian equivalence will undermine fiscal expansion unless it’s money-financed.

But this is a misunderstanding of Ricardian equivalence, on two levels. First, as I’ve tried repeatedly to explain, a TEMPORARY increase in government purchases of goods and services will NOT be offset by expectations of future taxes even if full Ricardian equivalence holds. The kind of argument people like Robert Lucas made sounded Ricardian, but wasn’t – it was Ricardianoid.

Second, less relevant to Sims but very relevant to other helicopter people, a deficit ultimately financed by inflation is just as much of a burden on households as one ultimately financed by ordinary taxes, because inflation is a kind of tax on money holders. From a Ricardian point of view, there’s no difference.

So I’m trying to figure out exactly what Sims is saying. What, ahem, is his model? The little liquidity-trap model I devised way back in 1998 is forward-looking, does implicitly incorporate the government budget constraint, but doesn’t tell anything like Sims’s story. What is he doing differently, exactly? I’m confused – and I hope it’s not because I’m stupid.

Krugman’s obviously not stupid, and for the fiscal models of the sort discussed here he has better intuition than I do.  So this post will probably be wrong.  But I’ll give it my best shot.

Let’s start here:

I think he’s saying that fiscal expansion works only if it leads to a rise in expected inflation.

That seems like an odd way of putting it.  Any (demand-side) policy that is expected to be successful should lead to a rise in expected inflation, as long as the SRAS curve is not 100% flat (and it is not.)  And in any rational expectations model, a policy will only be successful if it’s expected to be successful. I think Krugman might have gotten on the wrong track by trying to frame this issue in Ricardian equivalence terms.

The quoted statement by Sims actually reminds me of Krugman’s 1998 paper, which says that currency injections are only effective if expected to be permanent—where permanent is defined as at least long enough to hold up until you are back in a monetarist world with positive interest rates.  If the currency injections are expected to be permanent, then they are expected to lead to future inflation.  That lowers real interest rates today (in the NK model) and boosts AD (NGDP) today.  Working backwards, a policy not expected to lead to future inflation is not expected to be effective.

Krugman’s right that inflation is a tax, but I think he relies too much on Keynesian reasoning in discussing the implication of that fact.  Consider Zimbabwe, which was hit back in 2008 by a massive inflation tax.  Certainly that hurt consumers badly, but nonetheless nominal consumer spending soared under the Zimbabwe government’s reckless policies.  Yes, it was all nominal growth, but that reflected the poor supply side characteristics of the Zimbabwe economy.  The AD curve was shifting rapidly to the right, so demand stimulus was “working” in that sense.  But it had nothing to do with consumers spending more because they felt richer.  They spent more because money was rapidly losing value

From a (market) monetarist perspective, the effectiveness of any demand-side policy depends heavily on the future expected path of policy.  Krugman and I agree that this is true of money, and everyone agrees that it is true of tax-oriented fiscal policy if you assume Ricardian equivalence.  The interesting question is what if you do not assume Ricardian equivalence?  Or what if the fiscal policy is more G, where G is output that is not a perfect substitute for C or I?

And that’s where my intuition tells me that Krugman is right, although personally I doubt the effect is very large.  In terms of the monetarist’s equation of exchange, I doubt whether G alone has much impact on V.  However if G is financed by a permanent increase in the money supply, it has a huge impact on M*V.  Even a credible future increase in M would by itself boost V far more than a sizable (current or future) increase in G.

Krugman’s 1998 paper can be generalized to show that any temporary change in M or V is ineffective at the zero bound.  I.e. that current M*V is strongly impacted by changes in expected future M*V.  In that case a temporary fiscal expansion probably has very little impact on demand.  On the other hand, in standard NK models it can still boost output, even if NGDP does not rise, as an increase in G will reduce C, and the newly impoverished workers will offer more labor, increasing aggregate supply—or something like that.

But Keynesians usually focus on the impact on fiscal policy on AD, and in that case I am inclined to support Sims’s claim that a policy not expected to boost inflation is also not likely to be effective.

That’s not to say I’m a fan of the fiscal theory of the price level; I don’t think it’s a useful theory for the US, although it obviously is for countries like Zimbabwe.

PS.  Krugman also says this:

Just to be clear, I’m all for fiscal expansion under whatever excuse. I’m even reluctant to question arguments for helicopter money, lest my intellectual skepticism give ammunition to those still possessed by austerian instincts.

I’m not at all reluctant to question arguments for helicopter money, as I do not worry at all about empowering people with austerian instincts.  So if you want to know what Krugman privately believes about helicopter money, read my posts showing why it did not work in Japan.

PPS.  On Wednesday September 7th, I will be presenting a paper at a joint Mercatus-Cato conference on monetary policy rules.  The conference will be livestreamed at mercatus.org/live.

There is a rising chorus in the economics community calling for the abolition of cash.  The argument is that cash is the cause of the zero bound problem—the fact that nominal interest rates cannot be cut (very far) below zero.  And, so it is claimed, this causes weak growth in aggregate demand.

Actually, the severe recession of 2008 had nothing to do with the zero bound, as interest rates were still above zero.  It was caused by tight money. And after 2008, Bernanke always insisted that the Fed could do more and that it simply chose not to do more.

I suppose one could argue that during 2009-15 the real problem was that the zero bound led to a need for unconventional monetary stimulus, and the major central banks are reluctant to do enough unconventional stimulus, even if in theory they could buy up the entire planet.  But in that case the solution would presumably be psychological counseling for central bankers, not abolishing cash.  Ironically, one of the few central bankers who did recently call for more aggressive monetary stimulus, Narayana Kocherlakota, has now joined the call for abolishing cash.

I believe that this is a bad idea on several different levels:

1. There is no good theoretical justification for abolishing cash.  That’s because abolition of cash is strictly dominated by an alternative policy option—a higher inflation target.  The usual argument against a higher inflation target is the so-called “shoe leather” cost of inflation, the fact that people will go to ATMs more often with high inflation, and this makes our monetary system slightly less efficient.  But this argument makes no sense if the inflation target is being raised due to a fall in the Wicksellian equilibrium real interest rate.  The whole point of a higher inflation target would be to simply keep nominal interest rates above the zero bound.  And since the nominal interest rate is the opportunity cost of holding cash, a higher inflation target would not hurt cash holders any more than they were hurt during the 1990s, when nominal interest rates were well above the zero bound.

But let’s say I am wrong and inflation hurts cash holders more than I assume.  I still say there is no justification for abolishing cash.  Try explaining this to the average America:  “We are concerned that if we raise inflation from 2% to 4%, you will have to go to ATMs slightly more often, and that will be annoying.  So our currency system would be slightly less efficient.  And so to spare you from this slightly less efficient currency system, we’ve decided to abolish all currency.  And by the way, those blisters you keep getting on your pinky finger—the doctor suggests amputating your right arm.”

2.  Now you might argue that the shoe leather cost is not in fact the major cost of inflation.  I agree, the biggest cost is the excess taxation of nominal investment income.  But the exact same argument applies there as well.  If the inflation target is increased merely to offset a fall in the equilibrium interest rate, then there will be no problem of excessive taxation of nominal investment income, at least relative to the 1990s, when most economists thought the inflation rate (2% at the time) was perfectly fine.

3.  If there is an argument for abolishing cash, it is to reduce tax evasion.  But I believe that intellectuals (who mostly live in a near cashless economy) underestimate the utility of cash.  Go to an antique show at Brimfield, Massachusetts in the summer, and you’ll see an entire economy of 5000 small time “antique” (i.e. junk) dealers, all operating in a cash intensive economy.  The poor often don’t have much access to banking facilities, and use cash for many transactions.  If you are an upper middle class professional, it’s easy to imagine operating without cash.  But for many people it is not.

4.  In a cashless economy with a ubiquitous internet, the government will know everything about you that it wants to know.  It will know where you drive your car, and what you purchase.  We will be living in a giant panopticon.

I’m not so paranoid that I think the government would actually pay attention to most of our transactions, there aren’t enough bureaucrats.  But the information will always be available, if they want to go after someone.  Fortunately, Hillary and Trump would never even think of using this information to go after their enemies.  They are not vindictive people, or so I’m told by their supporters.  But maybe in the future a “bad guy” will be elected President.

Most importantly, there are other much better solutions that are not susceptible to the zero bound problem.  Replace inflation targeting with NGDP level targeting, as distinguished monetary economists like Michael Woodford, Christina Romer, and Jeffrey Frankel have suggested.  Even some Fed officials have recently pointed to NGDP targeting as an option—it’s no longer a pie in the sky idea.  In contrast, taking away cash would be almost as controversial as taking away guns.  This country still has a strong libertarian streak, and the total confiscation of cash is not likely to occur for many decades, by which time we’ll have much better options available for the zero bound.

HT:  Stephen Kirchner