What caused the Great Recession?
A collapse in AD. But what caused that?
Excessively tight monetary policy. But what caused that?
Mistakes by the Fed. But what caused that?
Misdiagnosis of the crisis by most macroeconomists. But what caused that?
I’m not sure, but here’s an example from Jeffrey Sachs:
The US economic emergency in late 2008 and early 2009 wasn’t really an aggregate demand crisis but a financial crisis.
BTW, his essay makes lots of good arguments against foolish and wasteful fiscal stimulus. But that sentence really jumped out at me.
Does anyone know of a model that suggests a big drop in nominal spending causes mass unemployment when the economy is otherwise healthy, but doesn’t cause mass unemployment when the economy also has financial problems? And how would you expect a collapse of AD to affect the financial system?
HT: Liberal Roman
PS. Lars Christensen just sent me the most recent nonsense from John Tamny, the man who thinks New Keynesian inflation targeting means the Fed is trying to stabilize each and every single individual price in the economy. I kid you not. Forbes magazine continues its crusade to discredit the entire conservative movement.
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10. March 2013 at 10:13
It jumped out at me too. I later was even more surprised to see that Tyler Cowen thought that was a great paragraph from Sach´s piece!
http://marginalrevolution.com/marginalrevolution/2013/03/jeffrey-sachs-on-paul-krugman.html?utm_source=feedburner&utm_medium=feed&utm_campaign=Feed%3A+marginalrevolution%2Ffeed+%28Marginal+Revolution%29
10. March 2013 at 10:31
Scott, I was one of those who got Q2’08 wrong. It was clear then that monetary policy was loose with respect to its inflation target. This came off several years of policy running hot. The trouble is this was caused by limitations in AS. These factors became particularly bad in the oil markets of 2008 due to technical errors in managing production growth in several countries, including a blotched transition to horizontal wells in Saudi Arabia, terrorism in Africa, and decapitalization of Latin American oil companies.
When long term inflation expectations looked ready to unmoor, I favored tighter policy. When the markets started to tank in q3 as tightening came to bear this was clearly wrong…. I knew it was wrong but not why.
The media was quite unhelpful–seemed like.a parade of elect Obama by fomenting panic. Other blogs focused on strange theories about financial regulation and toxic securities. Knowing how regulated the financial industry was these turned me off. As for the so called toxic securities, most proved merely illiquid. Four years out, there are very few losses to speak of in those AAA tranches despite a bad recession and slow recovery.
You were the only one clearly presenting a narrative that fit all the facts: monetary policy needs to accept AS shocks and let inflation rise when the price mechanism needs to signal scarcity of certain goods.
10. March 2013 at 10:33
Huh. I missed the part when “demand is a function of supply first” became “the most basic of economic truths.”
Prof, you might have written a post on this, but if the Fed doesn’t keep NGDP on target, isn’t fiscal policy a good option?
The transfer payments disproportionately benefitted the poor, and even if the economic argument isn’t there, I think an argument is to be made for the value of employing someone otherwise laid off, perhaps helping make end’s meet.
Similarly, I see the argument for building roads and fixing crappy power grids in the need for those particular facilities more than any “economic” effect they might have, that’s secondary. To me it’s a shame that infrastructure investment has become such an economic discussion.
10. March 2013 at 10:59
Proponents of tighter policy always complain about the absurdity of the idea that more pieces of green paper can create real economic growth. They think that anyone who supports the use of monetary policy to help recoveries must think that, at any time and under any circumstances, more pieces of green paper will lead to real economic growth.
Perhaps the right way to phrase the call for more aggressive monetary policy today (actually you are obviously good at doing this) is to call for stability in a monetary aggregate, as opposed to an increase in it. It seems quite intuitive that if the government went around and took $100 from everyone, then our economy would suffer. So, when NGDP drops, we have to boost it to keep it stable. If it hasn’t dropped, then boosting it will not help the economy.
The article also shows a problem with the language of NGDP targeting. He seems to conflate NGDP with RGDP. The AD-AS framework is nice because it makes it clear that NGDP and RGDP are different. In fact, when talking about monetary issues, GDP should never be used without an ‘N’ or an ‘R’ before it.
10. March 2013 at 11:07
My previous comment was referring to the Tamny article. Sorry, that wasn’t clear. I got so caught up in the insaneness of the article that I forgot about the rest of your post.
10. March 2013 at 11:12
“What caused the Great Recession?”
“A collapse in AD. But what caused that?”
“Excessively tight monetary policy. But what caused that?”
This answer does not address why there was a collapse in AD in the market, such that the Fed found itself in a position of having to increase its monetary inflation in order to maintain a historical AD trend in the market, such that MMs find themselves looking back and thinking “The Fed was excessively tight.”
Why did so many participants in the market suddenly decide to reduce their spending around the same time, i.e. suddenly increase their cash preference, despite the fact that the Fed was not destroying units of money, nor even stopping its OMOs at all?
10. March 2013 at 11:19
“Misdiagnosis of the crisis by most macroeconomists. But what caused that?”
The crisis was 100% “micro” grounded. Explaining the micro factors then explains, by consequence, all the macro-aggregate changes that are not themselves causes, but symptoms of the crisis.
Macro-economists failed to correctly diagnose the crisis because the crisis wasn’t macro caused.
One can’t observe a fall in NGDP unless there are real world individuals who reduced their spending and increased their cash preference (some individuals even increased their spending during the crisis, e.g. hedge fund managers). We have to ask why these individuals did this.
One cannot observe a fall in M3 money supply unless there are individuals who literally destroy what constitutes money (credit default, credit repayment, burning of money, etc). We have to ask why these individuals did this.
Focusing on macro aggregates and the Fed’s lack of activity to explain economic crises is like focusing on a patient’s complexion or their doctor’s lack of activity to explain why they are sick. It would be like saying the patient is sick because the doctor failed to give the right medicine. This of course does not explain why the doctor was needed to give medicine in the first place, in other words, why the patient was internally ill and needed the services of a doctor.
NGDP falling (increased cash preference) is such a symptom, not a cause, and blaming the Fed is an evasion of explaining why the market needed the Fed in order to maintain historical spending trends. We have to ask why the Fed “doctor” was needed to “help” people “spend” at least the same amount as they were spending before, despite the fact that the Fed was not destroying money or ordering people to increase their cash preference.
Consumers don’t just capriciously increase their cash preference for no reason. There was something else going on, apart from latter “solutions” considerations for how to reverse the effects of increased cash preferences, such as declining NGDP.
Why did so many investors make incorrect predictions of future cash preference increases in the market, and why did the Fed “doctor” have to be there to “help” with the symptom of declining NGDP?
10. March 2013 at 11:39
J:
“They think that anyone who supports the use of monetary policy to help recoveries must think that, at any time and under any circumstances, more pieces of green paper will lead to real economic growth.”
So you’re against constant printing of paper which is needed for constant NGDP growth targeting.
You’re also against price inflation targeting.
You’re also against any and all ongoing central bank activity.
You must only want the central bank to act during certain circumstances, apart from constant price inflation or NGDP targeting.
You’re throwing ongoing monetary policy under the bus just like Krugman did in his response to people who asked him to explain how printing green pieces of paper can make society wealthier. He too defended it using “only in certain circumstances” rhetoric, that contradicts his own desire for the Fed to target a positive consumer price inflation.
“Perhaps the right way to phrase the call for more aggressive monetary policy today (actually you are obviously good at doing this) is to call for stability in a monetary aggregate, as opposed to an increase in it.”
NGDP is growing at 4% yearly. Calling for more inflation is not calling for NGDP “stability”, but a higher growth rate of NGDP.
10. March 2013 at 11:57
Dr. Sumner, please forgive me for duplicating this question. I asked this one in a previous post but you might have missed it unless you had ignored it. My question was:
“It may not be proper to ask here but your recent blog post on Canada has already been in the next page, I guess it will be the best to ask you a question on it here. Do you think export should be included in AS, instead of AD, unlike the Keynesian model? I have thought including export in AD is a little problematic in measuring national income because it is not purchased within the border. Import is also reflected in domestic consumption or investment, so it may not be right to include import in measuring national income as a negative component. Just excluding the entire net export from AD and including export in AS might be better calculation because first export should be a part of domestic supply but not a part of domestic expenditure. Do you think my understanding makes sense?”
10. March 2013 at 12:07
So maybe I’m missing the obvious point — is it the position of Prof. Sumner that “correct” monetary policy would have (largely) prevented the Great Recession? In other words, if Prof. Sumner (or a like-minded adherent) had been Fed Chairman, most or none of this would have happened? Millions of laid off home construction workers were going to find new jobs quickly (or would never be laid off, because they could have kept building $400,000 houses for people making $25,000 a year)? The folks who were using their houses as ATMs were going to keep refinancing their HELOCS to keep spending forever? Banks holding AAA rated subprime paper would be just as sound as those with US Treasuries? And this would be sustainable over time? It seems like there is a tangible reality that is ignored here. Again, I admit i may be missing the point….If so, please explain.
10. March 2013 at 12:28
@maynardG
Note the timing in this post:
http://thefaintofheart.wordpress.com/2012/09/21/it%C2%B4s-all-in-the-timing-it-was-not-the-financial-crisis-but-the-drop-in-ngdp-that%C2%B4s-responsible-for-deleveraging/
Additionally, all the way to May 2008 unemployment barely budged. Home buiding construction workers were being employed in other construction and other industries. But the “dream” ends with NGDP tanking, not by the ‘hand of God’, but from the Fed´s ‘sins of the Fed’.
10. March 2013 at 12:31
Re Sachs and Tyler Cowen – why oh why does this have to be so complicated? Where I agree with both: the need for long term growth strategies in terms of actual infrastructure need, and reducing the deficit. Without such definitive, groundbreaking dialogue, the “dance” between AS and AD cannot really happen in a way that realistically raises wealth potential over time. Market expectations for the long run especially depend on overcoming the gridlock which contributes to our supposed “zero bound”. And real optimism that such economic access selfishness can actually be overcome, matters for the Fed as well.
10. March 2013 at 12:59
Prof. Sumner,
I think you’d be interested in this post by Noah Smith:
“How is Abenomics doing?”
http://noahpinionblog.blogspot.com/2013/03/how-is-abenomics-doing.html
10. March 2013 at 13:12
@Geoff
I agree that everything has a micro cause. There is a reason money demand went up, but that does not really matter. Here we are talking about montary policy.
Maybe the individual actors acted irrationally maybe the didn’t, either way rising the money supply to match money demand is the right policy. Maybe pre-2009 montary policy was not optimal as well, maybe it created the housing bubble maybe not.
It would be useful for a microeconomist or somebody to look closer into what was going on there but when we talk about money it doesn’t matter.
10. March 2013 at 13:14
Geoff:
“So you’re against constant printing of paper which is needed for constant NGDP growth targeting.
You’re also against price inflation targeting.
You’re also against any and all ongoing central bank activity.
You must only want the central bank to act during certain circumstances, apart from constant price inflation or NGDP targeting.
You’re throwing ongoing monetary policy under the bus just like Krugman did in his response to people who asked him to explain how printing green pieces of paper can make society wealthier. He too defended it using “only in certain circumstances” rhetoric, that contradicts his own desire for the Fed to target a positive consumer price inflation.”
Wow – that is not at all what I said. I understand that a NGDP growth rate target, if positive, requires the constant printing of more pieces of paper. Yet, there is a quota for each year (once NGDP growth has hit 5% or whatever the target is). Printing more money, beyond that point, will not create real economic growth (except maybe in the very short run). I think you misunderstood what I said and what Austrian economists often say. They ask why, if an economist thinks monetary policy can help boost RGDP now, why the economist doesn’t always support more aggressive monetary policy — essentially to no limit. My point is that printing money, up to a point, can boost RGDP. Right now, we haven’t reached that point yet.
“NGDP is growing at 4% yearly. Calling for more inflation is not calling for NGDP “stability”, but a higher growth rate of NGDP.”
Fair enough. Still, you are not seriously addressing anything I said. It is accepted by most people — economists and non-economists — that the money supply should grow over time. When I say NGDP stability, I mean a stable growth rate in NGDP. Right now, the growth rate of NGDP has been below target over the past 6 years. Many people seem confused by the idea that more paper can lead to RGDP growth. But, if, in normal times, NGDP grows at 5% per year, then right now the claim isn’t that more paper creates RGDP growth but rather that less than normal paper hurts RGDP growth. The goal isn’t to push NGDP above trend, but rather to prevent it from falling below trend or to help it come back to trend. After a recession, we expect RGDP to grow at a faster than usual pace and jobs to be created at a faster than usual pace. To get that, we must have NGDP grow at a faster than usual pace to recover its previous losses.
10. March 2013 at 13:26
All this has nothing to do with whether we want a 2% inflation target or a 0% inflation target. Even if we want a fixed price level, we still need NGDP growth to match RGDP growth. We would still, after below-average NGDP growth and a recession, want above-average NGDP growth to get back to trend. Otherwise the price level would fall, not remain fixed.
10. March 2013 at 13:34
nickik:
“I agree that everything has a micro cause. There is a reason money demand went up, but that does not really matter. Here we are talking about montary policy.”
Of course the reason why cash preference went up “matters”. It matters to at least consider it and analyze it, because it is possible that the “solution” you prescribe may in fact be counter-productive, without you realizing it, precisely because you are not considering the cause for why cash preference went up!
“Maybe the individual actors acted irrationally maybe the didn’t, either way rising the money supply to match money demand is the right policy.”
This is an incredibly irresponsible approach to take. If you won’t even care why it happened, how can you possibly know whether or not your solution is productive or counter-productive?
“Maybe pre-2009 montary policy was not optimal as well, maybe it created the housing bubble maybe not.”
Maybe, maybe not. Great.
“It would be useful for a microeconomist or somebody to look closer into what was going on there but when we talk about money it doesn’t matter.”
Money is a micro concept. Individuals value money relative to goods, and utilize money in making exchanges against goods. Micro ALWAYS matters, even to every single concept you believe to be, or are treating as, only “macro” ones.
I think you need to be far more serious, because this is millions of people’s lives we’re talking about. It’s not a video game.
10. March 2013 at 14:04
Geoff,
I agree that micro is important, but there are macro issues that can be understood without sophisticated micro (I say sophisticated because really, at this point, most macro models involve microfoundations). For example, suppose the Fed thinks there are speculative excesses in the market. Then, to curb these supposed excesses, the Fed cuts back sharply on NGDP growth and raises short-term rates. Now, in this fantasy world, it may be true that there was a bubble. Yet, the ensuing recession will have been caused by the Fed’s macroeconomic actions. We can understand the recession and the ways to fix it in macro terms.
I’m not saying that this is necessarily the case in the current downturn. But, sophisticated microeconomics (beyond even the Lucas island model) are not always necessary.
10. March 2013 at 14:09
J:
“Wow – that is not at all what I said. I understand that a NGDP growth rate target, if positive, requires the constant printing of more pieces of paper. Yet, there is a quota for each year (once NGDP growth has hit 5% or whatever the target is).”
Choosing as the relevant “period” of NGDP growth to be yearly is arbitrary. If there is a yearly quota, then if you’re not suggesting passivity for 11 months, with a year end sudden inflation spree that gets the growth rate “quota” up 5% for the year, such that the NGDP historical trend would look like a series of steps up a staircase, then talking about a yearly quota of spending is not fundamentally different from monthly or even weekly NGDP targeting periods. It is all ongoing money printing as opposed to the “only in special circumstances” money printing that you say is a valid defense against the charge that you and others (or whoever you’re defending) believe that printing green pieces of paper makes society wealthier.
“Printing more money, beyond that point, will not create real economic growth (except maybe in the very short run).”
5% point is arbitrary. How can you know that “the point” is 5% NGDP growth, when you can’t scientifically predict what other people’s future learning and preferences are going to be, including preferences regarding money?
It is possible that 5% can be insufficient, and it is possible that 5% can be too much. You can’t claim 5% is what the market should want. Only the market can reveal this information of what the proper supply, and growth of money, and thus statistics based on such growth, can be.
“I think you misunderstood what I said and what Austrian economists often say. They ask why, if an economist thinks monetary policy can help boost RGDP now, why the economist doesn’t always support more aggressive monetary policy “” essentially to no limit. My point is that printing money, up to a point, can boost RGDP. Right now, we haven’t reached that point yet.”
I think you’re misunderstanding the actual argument being made against those who say that inflation increases society’s wealth. They’re not saying “If inflation is so good, why not quadruple it, or quintuple it.” No, they’re asking those who want inflation “How can printing green pieces of paper make society wealthier?” And I am pointing out that the responses to this question, contradict what those who want inflation, are saying in other discussions with other people. With other people, they talk about the necessity of preventing price deflation, or preventing NGDP declines, ever, which of course requires continuous monetary policy from the central bank, not “only in some circumstances”.
Krugman for example has claimed that his “actual position” regarding inflation is that printing green pieces of paper is only beneficial during recessions. That those who say he believes printing green pieces of paper makes society wealthier are setting up a straw man. But then he also claimed that constant consumer price growth (consumer price inflation), which is of course an ongoing monetary policy plan that requires printing money even during non-recession periods, not just a “print money only when there is a recession”. So there is a contradiction there.
I see the same type of contradiction taking place within MM. MMs want there to be a constant aggregate spending growth, rather than a constant price inflation growth. But this is also an ongoing monetary policy plan. So any MM who claims that they don’t believe printing money makes society wealthier, that their “actual position” is that inflation is beneficial during certain periods of time only, they are also contradicting themselves.
If you believe that constant consumer price growth, or constant NGDP growth, is necessary for society to become wealthier, then you cannot them respond to those who ask why you believe printing green pieces of paper makes society wealthier, is a straw man. It’s what you are actually claiming. Not directly of course.
“NGDP is growing at 4% yearly. Calling for more inflation is not calling for NGDP “stability”, but a higher growth rate of NGDP.”
“Fair enough. Still, you are not seriously addressing anything I said.”
Not seriously addressing what you said? Are you joking? I am the only one seriously addressing what you have said. My not agreeing with it, does not mean I am not seriously addressing it.
“It is accepted by most people “” economists and non-economists “” that the money supply should grow over time.”
Your position is retreating to ad populum.
Whether or not the money supply should grow over time, if we answer yes, does not imply that you can answer it via your armchair. It is one thing to say that the money supply should grow over time. It is quite another to believe oneself intellectually capable of knowing what rate it should grow, either directly via money supply growth “rules”, or indirectly via NGDP growth “rules”.
“When I say NGDP stability, I mean a stable growth rate in NGDP. Right now, the growth rate of NGDP has been below target over the past 6 years.”
Below whose target? Certainly not the value that would prevail under individual market actor determined rates of spending and cash preference, since you’re not even considering other people’s judgments on this matter in a context of your opinion being constrained to respecting the property rights of others. You’re instead assuming that your own preference is some sort of objective preference that ought to be imposed by law, even if others disagree with you regarding their own plans for themselves.
“Many people seem confused by the idea that more paper can lead to RGDP growth. But, if, in normal times, NGDP grows at 5% per year, then right now the claim isn’t that more paper creates RGDP growth but rather that less than normal paper hurts RGDP growth.”
You’re just restating the belief that printing green pieces of paper makes society wealthier, but dressed up in a double negative and adding the oh so typical excuse of “right now it’s beneficial.”
The question is “How can printing green pieces of paper make society wealthier?” If you believe that it only increases wealth during “certain times”, then you have contradicted advocacies of all forms of ongoing monetary policy, such as positive price inflation targeting, and positive NGDP growth targeting.
It’s not an answer to assume that printing money makes society wealthier (i.e. your setting up of a “normal times” scenario, with a hypothetical drop in “normal times” rates of printing that reduces wealth). The question is relating to that “normal times” scenario itself: Why is constant paper inflation from a central bank necessary to increase society’s wealth during “normal times”?
“The goal isn’t to push NGDP above trend, but rather to prevent it from falling below trend or to help it come back to trend. After a recession, we expect RGDP to grow at a faster than usual pace and jobs to be created at a faster than usual pace. To get that, we must have NGDP grow at a faster than usual pace to recover its previous losses.”
Trends are not physical laws. They are set up by positive human choices. Why does the choice to increase NGDP, or price inflation, have to be made in order to increase society’s wealth?
10. March 2013 at 14:22
Marcus, Yes, it was a really odd sentence.
Thanks Jon.
Ashok, You said;
“Prof, you might have written a post on this, but if the Fed doesn’t keep NGDP on target, isn’t fiscal policy a good option?”
Probably not—I’ve actually done several dozen posts on this topic.
J, You said;
“Proponents of tighter policy always complain about the absurdity of the idea that more pieces of green paper can create real economic growth. ”
Yes, they seem surprised that some of us are more impressed by the analysis of Milton Friedman than the analysis of John Tamny.
I apologize to anyone reading Tamny’s article because I linked to it.
Chun, AD measures nominal output, and hence exports should be included.
Maynard, I’ve done many many posts showing that there is almost no correlation between the Great Recession and housing construction workers losing their jobs. The big drop in housing construction was mostly January 2006 to April 2008, and unemployment only rose from 4.7% to 4.9%. The huge jump in unemployment to 10% occurred later, and was caused by job losses across the board. Yes, we would have avoided the Great Recession with better monetary policy, although obviously a small recession (plus stagflation) might have occurred.
10. March 2013 at 14:26
Travis, Thanks, but there’s nothing really new there. We’ll have to wait and see whether Abe persists with the policy. Only time will tell.
10. March 2013 at 14:26
J:
“I agree that micro is important, but there are macro issues that can be understood without sophisticated micro (I say sophisticated because really, at this point, most macro models involve microfoundations).”
I am saying that there is ONLY macro. That every possible macro argument, or explanation, or scenario, is all 100% fully and completely a series of micro events and micro grounded principles. Individual humans think for themselves as individuals. One individual isn’t everyone or everything else. We are separately thinking and acting entities. Every possible economic phenomena is going to be the result of individual thinking, planning, and acting.
There are no conceivable macro phenomena that are ontologically independent or separate from micro phenomena. The same cannot be said the other way. There are micro phenomena that are not macro phenomena.
“For example, suppose the Fed thinks there are speculative excesses in the market.”
Whose speculations? Where? Are they talking about my speculative excesses? Your speculative excesses? Are they talking about every single human being’s speculative excesses?
Obviously not. They are necessarily talking about only a portion of the population. Who? Bankers? Which bankers? Where?
“Then, to curb these supposed excesses, the Fed cuts back sharply on NGDP growth and raises short-term rates.”
Are you saying greater than 5% NGDP can cause excesses, but less than 5% does not? Why would an individual’s knowledge, preferences, and behavior suddenly change from “speculative non-excesses” to “speculative excesses” once there is more spending on the other side of the country, in some other market, that puts NGDP growth for “the US” at greater than 5%?
“Now, in this fantasy world, it may be true that there was a bubble. Yet, the ensuing recession will have been caused by the Fed’s macroeconomic actions. We can understand the recession and the ways to fix it in macro terms.”
The Fed only acts micro-economically. They don’t buy everything in the market. They only buy certain things. They don’t buy from everyone, they only buy from some people. Their actions are completely micro-grounded. As soon as the first receivers spend the new money on that which NGDP targeting tracks, then total NGDP would be higher than it otherwise would be, ceteris paribus. So the “macro actions” are in fact micro actions, and the micro actions are macro ones SOLELY BECAUSE they are micro actions.
You cannot understand a recession nor ways to fix a recession that is constituted by micro events.
It would be like trying to describe a group of people marching in a line by abstracting from the fact that the line exists because the individuals that compose the line each independently chose to march in the way they do. It would be like interpreting what each of them are doing by attributing a causal force to the aggregate formation, and then reasoning that each individual did what they did because of what the aggregate formation was “doing”.
The order of causality is from the individuals to the formation, not the formation to the individuals. Without the individuals, the formation would not exist. But without the formation, the individuals can still exist.
“I’m not saying that this is necessarily the case in the current downturn. But, sophisticated microeconomics (beyond even the Lucas island model) are not always necessary.”
They are necessary if correct diagnoses are going to be made. It would be wrong to diagnose the break-up of a marching line formation by attributing a causal force to the aggregate shape change, and then reasoning from in in such a way that you conclude that the individuals did this or that because of what happened to the aggregate formation.
10. March 2013 at 14:30
J:
“All this has nothing to do with whether we want a 2% inflation target or a 0% inflation target. Even if we want a fixed price level, we still need NGDP growth to match RGDP growth.”
Why? Why does spending have to increase over time to “match” real growth over time? What does that even mean anyway? How can you measure real output growth in percentages, abstracted from money? If 10 more computers are made, 45 more shirts, and 65 more potatoes, what should happen to the money supply and volume of spending, and why?
“We would still, after below-average NGDP growth and a recession, want above-average NGDP growth to get back to trend. Otherwise the price level would fall, not remain fixed.”
What’s wrong with falling prices? If I can find a way to increase my real output, through technological innovation, and saving portions of my output, in a context of the same nominal spending, such that I sell more goods at lower prices, what is wrong with that?
10. March 2013 at 14:36
Sorry, typo:
“I am saying that there is ONLY micro.
10. March 2013 at 14:46
Geoff:
Maybe I misunderstand your argument against macroeconomist’s apparent disregard for micro. It seems like you are opposed to the idea of abstraction. The Fed buys bonds from particular people. Yes. But, how relevant is that? We cannot analyze every aspect of something. If we do not abstract away from certain parts of an issue, then we have no models, and we cannot decide what to do because the real world is simply too complex. Does the height of the CEO of the bank who sold bonds to the Fed matter? Maybe. But, it is not likely to matter in a significant enough way to impact the results of a policy. Of course, every aggregate is composed of many pieces. But, sometimes thinking in terms of the aggregate does not damage our ability to analyze policies enough to make it necessary to go through the more difficult, time-consuming, (and maybe not possible with current ideas) task of considering every micro piece of the macro whole.
10. March 2013 at 15:15
Geoff wrote:
“NGDP falling (increased cash preference) is such a symptom, not a cause, and blaming the Fed is an evasion of explaining why the market needed the Fed in order to maintain historical spending trends. We have to ask why the Fed “doctor” was needed to “help” people “spend” at least the same amount as they were spending before, despite the fact that the Fed was not destroying money or ordering people to increase their cash preference.”
One reason why the market needed the Fed is simple and obvious. The Fed has a monopoly on the creation of base money in the United States. Whether one likes this monopoly or hates it, sticking ones head in the sand and pretending it doesn’t exist is pointless, stupid, and unproductive. A market will “need” the Fed until such time as 1) the Fed no longer has a monopoly on base dollars or 2) the market no longer transacts in dollars.
10. March 2013 at 15:21
J:
“Maybe I misunderstand your argument against macroeconomist’s apparent disregard for micro. It seems like you are opposed to the idea of abstraction. The Fed buys bonds from particular people. Yes. But, how relevant is that?”
As relevant as economic science is relevant!
“We cannot analyze every aspect of something. If we do not abstract away from certain parts of an issue, then we have no models, and we cannot decide what to do because the real world is simply too complex.”
Excellent argument against socialist intervention of all stripes, including “monetary policy models”!
“Does the height of the CEO of the bank who sold bonds to the Fed matter?”
Micro-economics doesn’t include physical characteristics of people’s appearance. Only if such appearances are relevant to what people DO, does it become relevant to economics.
I think you’re taking my argument way too far in the other direction. I am not calling for the vibrations of molecules to be included in economics. There is a “stopping point”, if you are going in the direction of “big things” to “little things” economics related.
Micro concepts are all stopping at the level of individuals. Micro concepts don’t take into accounts arms and legs abstracted from individual people. It takes into account individual people.
I think ALL economic phenomena, can be described and characterized in terms of individuals, but that doesn’t mean that I claim to KNOW everything about individual knowledge, plans, and preferences.
“Maybe. But, it is not likely to matter in a significant enough way to impact the results of a policy.”
No, but it would definitely shed light on whether or not such “policy” is productive or counter-productive. For if a policy can be traced as having effects at the micro-level, and those micro-effects are ignored, but nevertheless constitute the macro phenomena that one observes, then it is possible that one’s “policy proposal” is counter-productive without one realizing it, because one isn’t considering the micro effects that the macro intended policy has.
“Of course, every aggregate is composed of many pieces. But, sometimes thinking in terms of the aggregate does not damage our ability to analyze policies enough to make it necessary to go through the more difficult, time-consuming, (and maybe not possible with current ideas) task of considering every micro piece of the macro whole.”
So you’re saying the real issue is of retaining control over the macro, and that coming up with a macro model to justify such control, however flawed or incomplete it may be, is secondary, because the macro control has to be done now and we have no time to lose?
What if the complexity is instead viewed as something to be embraced and viewed as something that no individual people (i.e. micro concept) ought to control?
If all individual people are “micro” entities, and act within micro contexts, then it makes little sense to believe that macro concepts should be controlled, by anyone. It’s one thing to accept that there is CB and it’s here to stay at least for the next little while. It’s quite another to interpret that institution as responsible for controlling macro variables, especially when the purpose of the CB, the activity of the CB, the views of those who control it and their view of who is benefited by it, is all purely micro grounded.
Governmental institutions should not be viewed as responsible for “the aggregate”. Just because they are powerful, and can be rather easily identified as being in part responsible for a particular aggregate variable, does not mean that it should “target” that aggregate variable. The companies Wal-Mart and Apple have relatively substantial influence in the market, and their activities can sometimes be known as significantly responsible for the movements of a certain aggregate variable. But that doesn’t mean that they have suddenly acquired the responsibility to target that variable.
Nobody ever really showed where or how or why the Fed has this responsibility for aggregate prices, or aggregate spending. The Fed was designed by bankers for bankers. It wasn’t designed as some benevolent “social” institution to help “society”. It is a special interest institution.
Nobody is responsible for any aggregate variable, and nobody really believes themselves responsible for any aggregate either. Bernanke for example would, if he is to remain chief, sacrifice aggregate price inflation targeting and aggregate spending targeting and every other aggregate in a heartbeat, if it meant saving the most powerful and connected banks from bankruptcy. That’s what the Fed is there to do.
Look at Iceland. Their “stern” central bank rescued the DOMESTIC component of their banks, and let the foreign banks crumble. The Icelandic central bank was created by and for the Icelandic bankers.
People need to stop considering themselves as little children who need mommy and daddy government to watch out for them. The central bank and the government are made to benefit special interest groups, not “society”. The proof of this is easy to see: Central banking is backed by the force of law, precisely because there are enough people who don’t benefit from it that would result in their abolition if those people were free to disassociate themselves from them in peace. Free choice would abolish both government and central banking, because they don’t actually benefit “society”. They benefit only some people, and that is why force is needed to perpetuate them.
The whole intellectual edifice of monetarism is grounded in the false notion that there exists a set of “rules” the special interests can follow that can finally and forever reconcile and abolish the eradicable conflict of interest between market activity and political activity.
No such rules exist.
10. March 2013 at 15:31
Michael:
“One reason why the market needed the Fed is simple and obvious. The Fed has a monopoly on the creation of base money in the United States. Whether one likes this monopoly or hates it, sticking ones head in the sand and pretending it doesn’t exist is pointless, stupid, and unproductive. A market will “need” the Fed until such time as 1) the Fed no longer has a monopoly on base dollars or 2) the market no longer transacts in dollars.”
So your argument is that the market needs X because…X exists? Seriously?
I don’t think it takes much thinking to realize the horrors that reasoning will lead.
So I guess the Soviet citizens “needed” the communists, because the communists were in charge. It would be stupid, pointless, and unproductive to put one’s head in the sand and pretend that the communists didn’t exist. So let’s spend all day and night figuring out what particular rules of potato quota enforcement the communists should go by, and we’ll leave how to introduce a market in the USSR to others, who we may also call dogmatists or ideologues if they’re too loud and vociferous about it.
Ah, opportunism. What an honorable and admirable philosophy. One can benefit oneself from the exploitation in the short term, and leave the mess for others to clean up, all the while advertising that one is really against it all. The best of both the materialistic world, and the moral world, all rolled up into one, “pragmatic” package. Call within the next 15 minutes, and you’ll get a free set of machetes that were bought from genocidal maniacs!
10. March 2013 at 15:32
Geoff wrote:
“One can’t observe a fall in NGDP unless there are real world individuals who reduced their spending and increased their cash preference (some individuals even increased their spending during the crisis, e.g. hedge fund managers). We have to ask why these individuals did this.”
The Fed can, any time it wants to, cause real world individuals to reduce their spending and increase their cash preferences (or vice versa). In the early 1980s, Paul Volcker changed the inflation trends of the 70s by doing exactly that. Since then, could have done the exact same thing any time it wanted to. Throughout its existence, there has never been a time when the “real” economy was so strong that a drastic contraction in the monetary base would not have caused real world individuals to reduce their spending and increase their cash preferences, thus causing a recession.
10. March 2013 at 15:35
Michael:
“The Fed can, any time it wants to, cause real world individuals to reduce their spending and increase their cash preferences (or vice versa).”
All hail the omnipotent Fed!
“In the early 1980s, Paul Volcker changed the inflation trends of the 70s by doing exactly that. Since then, could have done the exact same thing any time it wanted to. Throughout its existence, there has never been a time when the “real” economy was so strong that a drastic contraction in the monetary base would not have caused real world individuals to reduce their spending and increase their cash preferences, thus causing a recession.”
How about the causes for why a large number of individuals would suddenly desire to increase their cash preference, given that the Fed is not stopping or even reducing their OMOs?
10. March 2013 at 15:38
I wish I could stop being shocked by your intellectual dishonesty and opacity on this whole topic, and your incapacity or unwillingness to deal with the real world microeconomic facts and mechanisms across time involved in this whole complex of causal elements, geographic, cross-industry, and within the nitty-gritty specifics of construction itself. But I still find it shocking, and I still see no other explanation than the inconvenience for you of what honesty on this topic would lay out.
Scott writes,
“I’ve done many many posts showing that there is almost no correlation between the Great Recession and housing construction workers losing their jobs.”
10. March 2013 at 16:10
This Krugman entry spawned in the wake of Sachs’ piece is amusing.
http://krugman.blogs.nytimes.com/2013/03/10/crude/
Japan is supposed to be the example? How’s Japan doing with all that fiscal stimulus? They’ve pushed debt to incredibly high levels with virtually no growth to show for it. Krugman’s argument is “well, it could have been even worse!” Japan’s problem is that monetary policy has been too tight, which they’re finally figuring out after decades of crude Keynesian failure.
Then he argues there’s all kinds of evidence fiscal expansion works, except there’s actually none at all because no one in Europe is crazy enough to try it when the bond markets are already scared by current debt levels. Again, his argument is “things would be great if they’d only tried fiscal expansion, since things aren’t great that proves I’m right!” But fiscal expansion is how they got in this mess “” and despite all the talk of austerity most countries are still spending more than in 2007. The antidote to poison isn’t more poison.
Where Krugman is correct is that monetary policy has been too tight. But he keeps implying there’s nothing monetary authorities can do to push NDGP higher, which is obviously false. The reason he keeps saying this, as best anyone can tell, is that he does, in fact, favor fiscal expansion generally for ideological reasons.
Maybe the worst possible outcome is that ECB starts monetizing debt, like the Krugman/Delong camp want to happen, because the monetary side will work and they will fall all over themselves claiming vindication for fiscal expansion and we’ll get yet more of it.
10. March 2013 at 17:16
Geoff: “I’m saying there is only micro…”
Is there?
http://uneasymoney.com/2013/01/02/the-lucas-critique-revisited/
Or in a previous post:
http://uneasymoney.com/2012/12/25/the-state-were-in/
“In fact, the standard comparative-statics propositions of microeconomics are also based on the assumption of the existence of a unique stable general equilibrium. Those comparative-statics propositions about the signs of the derivatives of various endogenous variables (price, quantity demanded, quantity supplied, etc.) with respect to various parameters of a microeconomic model involve comparisons between equilibrium values of the relevant variables before and after the posited parametric changes. All such comparative-statics results involve a ceteris-paribus assumption, conditional on the existence of a unique stable general equilibrium which serves as the starting and ending point (after adjustment to the parameter change) of the exercise, thereby isolating the purely hypothetical effect of a parameter change.”
10. March 2013 at 17:40
Geoff:
It seems that you have a pre-conceived status quo and that the burden of proof rests on those who want to do otherwise. For example, you seem to believe that, since truly analyzing all the microeconomic effects of monetary policy would be impossible (indeed analyzing ALL the microeconomic or macroeconomic effects of anything would be impossible), we should not engage in monetary policy. But, why is not having NGDP growth targeting the status quo? I could argue that we can’t know anything and so I should just roll a die to decide what the best policy is.
The point is that decisions HAVE to be made. No monetary policy IS a monetary policy. No fiscal policy IS a fiscal policy. We can’t simply say “we can’t understand all the microeconomic effects of fiscal stimulus and so we must not use it.” We also don’t understand all the microeconomic effects of having NO fiscal stimulus. We develop models, we look at data, and we make an educated guess as to what the best policy is. (By the way, I’m not saying I support fiscal stimulus).
10. March 2013 at 17:46
Geoff wrote:
“So your argument is that the market needs X because…X exists? Seriously?
I don’t think it takes much thinking to realize the horrors that reasoning will lead.”
IF the Fed has a monopoly on base dollars, THEN markets that use dollars depend on the Fed. And markets that use dollars will continue to be dependent on the Fed as long as such a monopoly exists.
10. March 2013 at 17:52
TallDave –
“Maybe the worst possible outcome is that ECB starts monetizing debt, like the Krugman/Delong camp want to happen, because the monetary side will work and they will fall all over themselves claiming vindication for fiscal expansion and we’ll get yet more of it.”
I think whenever economic conditions improve, both the fiscalists and monetarists will claim victory. The recession officially ended in summer 2009, after the monetary base expansion but before the stimulus was passed, so I would think that would indicate that monetary policy is both necessary and sufficient. But the fiscalists would probably argue that the automatic stabilizers played a role. I disagree, but I can’t prove it.
That’s a difficulty with something like economics where you can’t do controlled experiments. There are so many interconnected things going on that you can always argue many causes for things.
10. March 2013 at 18:00
J –
“The point is that decisions HAVE to be made. No monetary policy IS a monetary policy. No fiscal policy IS a fiscal policy. ”
Outstanding comment. That point cannot possibly to stressed enough. One of my favorite posts from Scott was about there is no such thing as a neutral monetary policy. What would neutral monetary policy even mean? A stable gold price? A stable CPI? A 0% growth in the monetary base? A 0% growth of M2? Maybe a stable price of GDP? Or a stable growth rate of one of these variables?
10. March 2013 at 18:37
NoI — Well, obviously if a country cuts spending significantly even as they target healthy NGDP growth, the resultant going to be hard for the fiscal expansionists to swallow. They would have to look for some sort of exogenous effect to bail them out.
The test that can probably rule out is significant fiscal expansion with current monetary policy (i.e. without monetization). Japan, the U.S., and most of Europe just can’t. Germany might be able to pull it off, but wouldn’t, especially after all their lectures to the PIIGS. Canada also could but wouldn’t because they’ve been doing the opposite.
I’m really starting to get a little scared about what happens when China finally goes into recession, probably for a long time unless reformers move them away from the crony capitalism model. These giant sovereign debts could spark something truly awful.
10. March 2013 at 21:57
Here’s the problem, Scott.
You never seriously engage or answer most of the points made by people like Tamny, eg his arguments about problems with “GDP” as a target and a measure.
Maybe you have done this, and I missed it.
The deal is “he’s an idiot” isn’t a argument, its an appeal to authority, an informal logical fallacy in many contexts.
Not all of what Tamny says is the talk of an idiot.
To suggest that it is reflects badly on you, not on Tamny.
I share as much with your perspective as I do with Tamny, so I’m not taking sides on “who is right”, I think you both are wrong and both are right on different things.
The point is, how does it help to call people idiots while abandoning the duty to substantively say why in a non-question begging or radically incomplete or misleading or factually mistaken way.
If you fail to address an argument, are argue against claims that haven’t been made, you are not making arguments, you are behaving in bad faith.
10. March 2013 at 22:21
Greg Ransom,
You can’t seriously ask Scott to respond to arguments from someone who has argued that price stability would mean all prices in the economy would never change. It is not an appeal to authority to call some stupid for saying stupid things. If Tamny does not understand inflation targeting, how could he understand Scott’s critique of it?
I’d like you to lay out in these comments what part of Tamny’s post you think is “not all the talk of an idiot.” Which parts specifically do you think Scott should respond to?
11. March 2013 at 03:14
“How would you expect a collapse in AD to affect the financial system?” Given that the collapse in the financial system roughly began in 2007 and reached a head in the late summer of 2008 when AD or NGDP was quite high by historical standards strongly suggests that causation runs in the opposite direction from what you are suggesting. Inflation hit over 5% in the summer of 2008 when the crap hit the fan. In addition, real GDP growth at this point still looked positive. The argument that AD was too low when inflation and NGDP were over 5% seems ludicrous.
Isn’t it possible that supply side problems can limit NGDP to the point where the central bank is either ineffective or put the central bank in a position where actions that could actually boost NGDP growth would have costs that outweigh benefits in the medium to long term? For instance would you really find it advisable to attempt 7% inflation in the face of a 2% real GDP growth contraction?
11. March 2013 at 03:33
Ashok Rao,
The problem with more infrastructure spending at this point is that entitlements and defense spending have completely crowded out infrastructure spending to the point where the government is running trillion dollar deficits before they spend a dime on roads. Americans are unwilling, rightfully so in my opinion, to tolerate much hover deficits or pay higher taxes to finance that spending. In addition, the value of government spending is highly questionable. Theory aside, it is easy to name basket case economies that run high deficits (nearly any developing country at some point or Japan) cand very difficult to for advocates of deficits to point out economies that spent there way to prosperity. Keep in mind that during WWII, private consumption was lower than at any point during the Great Depression and post war prosperity returned with massive fiscal austerity (a nearly 40% drop in spending in one year!!).
11. March 2013 at 04:04
J:
“It seems that you have a pre-conceived status quo and that the burden of proof rests on those who want to do otherwise.”
Actually no. It rests on those who believe that they should use force and threats of force to interfere with what otherwise would be free market activity (with scientifically unpredictable money supplies, interest rates, price levels, and NGDP).
“For example, you seem to believe that, since truly analyzing all the microeconomic effects of monetary policy would be impossible (indeed analyzing ALL the microeconomic or macroeconomic effects of anything would be impossible), we should not engage in monetary policy. But, why is not having NGDP growth targeting the status quo? I could argue that we can’t know anything and so I should just roll a die to decide what the best policy is.”
Those two positions do not gel with one another.
“The point is that decisions HAVE to be made.”
That is precisely the problem view I addressed above. No, those decisions do NOT “have to be made.” They’re all choices, not physical obligations.
“No monetary policy IS a monetary policy.”
You mean no inflation and continued monopoly is a monetary policy.
“No fiscal policy IS a fiscal policy.”
Same as above.
“We can’t simply say “we can’t understand all the microeconomic effects of fiscal stimulus and so we must not use it.””
Sure we can.
“We also don’t understand all the microeconomic effects of having NO fiscal stimulus.”
Another reason not to have it.
“We develop models, we look at data, and we make an educated guess as to what the best policy is. (By the way, I’m not saying I support fiscal stimulus).”
Sloppy!
11. March 2013 at 04:14
Traditional boom-bust recessions are caused by differing rates of accumulation of liquidity and fixed assets. Thus, a positive demand shock creates more profits, but not more fixed assets in the short term. Therefore, the price of these assets is bid up, and continues to be bid up until the fixed asset construction cycle catches up to the liquidity cycle. We certainly saw this in late 2007 / 2008, and included housing, oil-related assets and shipping, to name just a few categories.
Now, 2008 was also related to a huge amount of capital accumulating in China and the oil producers, and this drove up asset prices without inflation (ie, it was real money, not just printed money). This money found its way to western economies and contributed to asset price rises (as it does to low interest rates today).
Finally, 2008 was a clear oil shock, from which we have yet to emerge. If you believe the IEA or BP, oil prices should collapse soon. If you believe us, then oil prices will continue to grind down the OECD economies over time.
11. March 2013 at 06:08
Greg Ransom, You said;
“Not all of what Tamny says is the talk of an idiot.”
Maybe, but can you provide any examples?
Talldave, Good point.
Negation, There are cases where monetary and fiscal policy go in opposite directions–late 1960s and 1980s. Monetary seems more important.
John, The big crash in NGDP occurred between June and December 2008. The big financial crisis was in October and November 2008. Yes, the financial crisis began first, as I’ve often acknowledged, but the AD collapse made it much worse.
11. March 2013 at 06:19
I just realised Tamny quoted Shadowstats. Oh lord…
I don’t envy your task Greg.