Keynes vs. Hayek: A sterile debate

Mario Rizzo recently commented on a Keynes/Hayek debate from 1932.  Here is the link to the debate (which includes some other notable interwar economists.)

Keynes, et al, give a standard argument for discouraging thrift during depressions, based on the famous “paradox of thrift.”  I find this sort of argument very frustrating, as it is not clear what problem they are actually addressing.  However, if you look at the subsequent development of Keynesian economics, it is pretty clear that Keynes believed that his policy would reduce the problem of deflation by boosting aggregate demand, not aggregate supply.  So far so good.  If we wanted to use the famous MV=PY equation, then Keynes seems to be arguing that more spending would boost V, although it is possible that there are some indirect linkages that would also boost M.  But in either case this raises the question:  If you want more M*V, why not just increase M?  Keynes would probably respond with some sort of liquidity trap argument, which we now know is wrong.

Hayek’s response is just as maddening.  Is he saying that increased thrift would not raise AD?  Or is he saying that it would not raise RGDP?  He does mention the fact that they all agree that deflation is undesirable, but then suggests that this is an argument against cash hoarding, not against saving.  Well yes, but the Keynesian argument can be translated into monetary language as follows:  More saving will lower interest rates and thus encourage people to hoard cash.  That argument may or may not be correct, but nothing Hayek has to say addresses this issue.  Hayek’s letter also contains some arguments based on real factors, such as frictions and misallocation, but those don’t directly address the Keynesian claim that more thrift lowers AD, and hence causes deflation.  And Hayek also misses the opportunity to push for more monetary stimulus (instead he discusses reforms such as trade liberalization), probably because at that time he was opposed to more monetary stimulus.  Trade liberalization is a good policy at any time, but doesn’t do much to address the problem of deflation.

And Mario Rizzo may have been too generous in assuming that Hayek opposed deflation.  Here is Rizzo:

The letter signed by F.A. Hayek and Lionel Robbins (and others) is noteworthy because, first, it makes clear that “everyone” is in agreement that deflation is not desirable and should be avoided.

And here is the Hayek passage he was commenting on:

“It is agreed that hoarding money, whether in cash or in idle balances, is deflationary in its effects. No one thinks that deflation in itself is desirable.”

Note that a careful reading of the letter shows that Hayek did not indicate that he opposed deflation, rather he suggested that no one thinks “deflation in itself is desirable.”  In fact, in 1932 Hayek favored deflationary policies as a way of reducing wage and price stickiness.  He thought deflation was bad, but was a price worth paying to eliminate the greater evil of wage and price rigidity.  In the 1970s he changed his views and regretted supporting deflationary policies in the early 1932s.  (Lawrence H. White provides the quotations in this article.)

To get intelligent commentary on the interwar situation, forget about Keynes and Hayek, and instead read Irving Fisher, George Warren, Hawtrey and Cassel.  They made mistakes too.  But at least they understood that monetary policy was the key to the Depression.

Rizzo concludes with the following observation:

It does not take much to see that the issues are basically the same today. The positions of the opposing sides are also the same. As I have said many times before, the great debate is still Keynes versus Hayek. All else is footnote.

I have to admit that a few years ago I would have thought Rizzo was wrong.  I thought we were far past the sort of sterile debates that occurred in the 1930s. I thought we had the models and policy tools necessary to address demand shortfalls.  But as should be obvious from my recent posts, during this recession we have reverted back to the muddled arguments of the 1930s, where concepts are not well-defined and it is almost impossible to figure out what model people are using or what policy goals they have in mind.  And that’s a shame.

PS:  Please don’t write in and say I misunderstood Hayek, and that he was interested in time, capital, disaggregation, blah, blah, blah.  I know that.  And I’m not saying his opposition to fiscal stimulus was wrong, or that all his “real” arguments were wrong.  It is quite likely that building swimming pools is not the best way out of a depression. But his arguments don’t address Keynes’ claim that less thrift would boost AD and stop deflation.  Even worse, I have the feeling that Hayek thinks he did address Keynes’ claim.

HT:  Tyler Cowen


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72 Responses to “Keynes vs. Hayek: A sterile debate”

  1. Gravatar of Tyler Cowen Tyler Cowen
    6. July 2010 at 11:57

    I knew it was only a matter of time before you would turn to the Austrians…!

  2. Gravatar of Jon Jon
    6. July 2010 at 12:30

    Deflation in itself means deflation as a policy goal. Deflation resulting from productivity growth is what he means to tolerate.

  3. Gravatar of Lorenzo from Oz Lorenzo from Oz
    6. July 2010 at 13:03

    Then there is the argument that macroeconomics is still stuck in 1829.

  4. Gravatar of Lorenzo from Oz Lorenzo from Oz
    6. July 2010 at 13:04

    That’s a bit harsh: still going around and around a framing set in 1829 perhaps …

  5. Gravatar of Benjamin Cole Benjamin Cole
    6. July 2010 at 13:11

    OT, but see “Hard Knocks on Easy Money” in today WSJ, page A17, by Mr. Melloan.
    The op-ed is drenched in right-wing rhetoric and sneering, and calls for tight money, tight enough to keep interest rates high.
    This is what is wrong with our current-day right-wing: They keep calling for policies that are simply outdated, or not germane.
    We need qualitative easing, by the bucketloads, and we need reflation in property markets.

  6. Gravatar of Morgan Warstler Morgan Warstler
    6. July 2010 at 13:28

    Scott, I’ll give you $10 if you nail yourself down to EXACT policy prescriptions to increase M and AD.

    You say the Fed buys T-Bills, and simply buys enough of them, that other money goes somewhere and buys other things.

    Ok, so instead money goes to reserves and earns interest. No more loans.

    You say, Fed stops paying interest.

    Ok, reserves sit idle as banks prepare for the music to stop, and they buy up the cheap assets from failing banks who don’t have chair.

    —–

    My continuing point is: Prices are too high on ALL the assets banks have on books, but they have a vested interest in not having those prices fall.

    The current crisis can be seen not through AD, but through one group of people having a profound interest in a false price on real estate not being exposed.

    We want velocity on our money supply… so we want fire sales on toxic assets… maybe what we need is less money being spent on housing, so we have more disposable income.

    If prices on homes fall by 25%, and rents in housing market drop even more, then all of America has more money to spend elsewhere.

    Why isn’t the problem over-valued property prices chewing up far too much of our earnings?

    Why shouldn’t Fed unwind and liquidate of all the toxic assets it holds? Sell the homes, eat the losses…

    When there isn’t enough action in market, prices are too high.

    Yes I know… you want to discuss real prices, but a HUGE percentage of our income goes to mortgages and rent… it is ALL falsely inflated.

  7. Gravatar of Mario Rizzo Mario Rizzo
    6. July 2010 at 13:35

    My recollection is that Larry White argued that Hayek was not in favor of deflation. I believe Jon (above) is correct in saying that Hayek wanted to distinguish the secular price declines of the 19th century (“deflation” in a popular sense) from deflation due to depression-induced factors.

    (Btw, the evils of price rigidity are indeed “evils” in the context especially of England returning to gold at pre-war parity.)

    On muddles. There are at least two ways to get into a muddle. First, by not having a coherent model in mind when discussing policy. Both Hayek and Keynes were in the process of developing their theories in the early 1930s. Keynes was in the “muddle” of repudiating the Treatise on Money and developing the General Theory. Second, muddles can occur when the real world referents of theoretical frameworks are not clear. I venture to say that some modern theories have this problem.

    Finally, I should point out that Keynes’s advocacy of fiscal stimulus along with PIGOU is quite interesting. A few years later Pigou was one of those out-of-date “classical economists” much the inferior to Major Douglas. How cruel.

  8. Gravatar of david david
    6. July 2010 at 14:10

    @Morgan Warstler

    If prices on homes fall by 25%, and rents in housing market drop even more, then all of America has more money to spend elsewhere.

    Unless you own a house, of course. Or are a landlord. Then your wealth drops, cēterīs paribus.

    Repeat after me: the price of real estate is not the general price level. The price of real estate is not the general price level…

  9. Gravatar of pireader pireader
    6. July 2010 at 14:26

    From Hayek et al.’s letter–“many of the troubles of the world at the present time [1932!] are due to imprudent borrowing and spending on the part of the public authorities”

    In the US, deflation was rampant; real GDP had fallen by a quarter; and the financial system was collapsing. Only a diamond-hard ideologue, utterly immune to the evidence of the world around him, could put that down to a government deficit.

    Yet Hayek (and his co-signers) believed it. Whatver his other merits, he was a crackpot macro-economist.

  10. Gravatar of Grreg Ransom Grreg Ransom
    6. July 2010 at 14:36

    Scott, how are you ever going to know if you don’t ever actually read Hayek?

    “Hayek’s response is just as maddening.  Is he saying that increased thrift would not raise AD?  Or is he saying that it would not raise RGDP?”

    The amount of time you’ve spent “criticizing” Austrians and Hayek based on no knowledge is enough to have studies a good chink of Hayek.

    Your guessesmare alsways wrong.

    But this has a great tradition — Samuelson, Keynes & Friedman demonstrably had an empty and false understanding of what Hayek was doing — based self-evidently on no attempt to understand it. But from this platform of ignorance and false understandiing, each happily launched cutting attacts with self-evidently false and uninformed premises.

    What a profession.

    Krugman and Cowen have done the same thing.

    It’s a field of science beyond embarrassment. 

  11. Gravatar of Grreg Ransom Grreg Ransom
    6. July 2010 at 14:42

    Scott, as I’ve pointed out to you in private communication Hayek is clearly talking about the British situation post the 1925 deflation which he opposed.

    You are coming close tomlyimg and intentional intellectual malpractice by hiding tjis context from your readers.

  12. Gravatar of Grreg Ransom Grreg Ransom
    6. July 2010 at 14:43

    The above applies to this.

    “”  In fact, in 1932 Hayek favored deflationary policies as a way of reducing wage and price stickiness.  He thought deflation was bad, but was a price worth paying to eliminate the greater evil of wage and price rigidity.  In the 1970s he changed his views and regretted supporting deflationary policies in the early 1932s.  (Lawrence H. White provides the quotations in this article”

  13. Gravatar of Grreg Ransom Grreg Ransom
    6. July 2010 at 14:54

    Scott, this is NOT a “fact”. The record we have doesn’t show Hayek ever saying this.

      “In fact, in 1932 Hayek favored deflationary policies as a way of reducing wage and price stickiness.”

    Again and again Hayek 45 and 50 and 55 years later returns to 1925 and Britain and the problem in Britain posed by the return to gold at par deflation — thisnis whatbhe was recalling 45 years later and you don’t have any evidence otherwise.

  14. Gravatar of John Salvatier John Salvatier
    6. July 2010 at 15:03

    @Morgan Warstler

    I believe this has been answered for you before. The Fed could do many things. For example something that would end the recession reasonably quickly: The Fed comes out and says in 2012 we would like to see NGDP at a level of 2007 + 5% per year (or perhaps some somewhat later date since we’ve done significant adjustment already) and we are prepared to do as many asset purchases or sales as is necessary to make that happen whether it be though inflation or real growth. Then the Fed would go on a buying spree for a month or two to make the commitment credible. If they run out of Federal Government securities (fat chance) they can start buying state government bonds or perhaps corporate bonds or really whatever they feel like. After that the Fed should take stock of things, consult their modeling department, and decide whether they should be buying or selling assets (I suspect they should be selling at that point) and actively try to make sure NGDP comes as close to 2007 + 5% as possible (so that they will be just as surprised of overshooting it as undershooting it).

  15. Gravatar of John Salvatier John Salvatier
    6. July 2010 at 15:04

    @Morgan Warstler
    Really the most important part is the statement of a nominal goal. Managing expectations and all that.

  16. Gravatar of Morgan Warstler Morgan Warstler
    6. July 2010 at 15:14

    “Repeat after me: the price of real estate is not the general price level. The price of real estate is not the general price level…”

    Once again… I get it. Generally, productivity drives prices lower. And Scott wants target NGDP to stave off the “horrors” of deflation. He assumes (wrongly) that confronted with a crisis, we’ll let the Socialists win liek our idiot grandparents did, instead of using the crisis to crush Big Government.

    My question is does REAL ESTATE count in the general price level? If the price of homes factors into general price level, then we need deflation. Home prices are inflated. QED.

    You don’t seem to understand my point, too much of our spending is going to housing and the bankers owning the homes. Decisions we made wrongly and that need to be corrected fast. But, you are wrong… WE DON’T OWN THE HOMES… the banks do. And when everyone finally sees housing prices aren’t going back up, they are going down, down, down… and they are truly under water and staying there… we can see how many people will put the keys in the mailbox. We can become a nation of renters.

    Nothing will work until real estate prices go lower. The question is will we waste countless time fighting it off, or eat it fast?

    Fine, let’s liquidate on housing, crush the public employee unions, and then see what’s what. Once the pain has been properly placed, we can ALWAYS give Scott’s NGDP a good try… if we need it.

    Why accept the previous mistakes, and grow from there? We have a tremendous opportunity to use this moment to unwind horrible sins. We can capitalize on it.

  17. Gravatar of Morgan Warstler Morgan Warstler
    6. July 2010 at 15:27

    @John Salvatier

    I do not doubt you think this is obvious, but again, all that happens as I see it, is the Fed buying up Treasury Bills , so Krugman can argue we should borrow more… none of that equates to banks making loans… after all they know everything on their books is worthless, that they are really insolvent zombies.

    It seems to me, if the Fed wasn’t worried first about propping up banks, and it really wanted to spur along the economy… it would unwind its toxic MBS and sell them at auction… where the stated goal is to bring the private equity sitting on sidelines to market, because that’s the true expectation on price.

    One question: exactly how many Treasuries do you think the Fed has to buy, not to “look credible” but actually move the needle on NGDP?

  18. Gravatar of justanothereconomist justanothereconomist
    6. July 2010 at 15:37

    “The Fed comes out and says in 2012 we would like to see NGDP at a level of 2007 + 5% per year (or perhaps some somewhat later date since we’ve done significant adjustment already) and we are prepared to do as many asset purchases or sales as is necessary to make that happen whether it be though inflation or real growth. Then the Fed would go on a buying spree for a month or two to make the commitment credible.”

    All evidence points to this simply creating more excess reserves. 1 trillion more QE will create another trillion in excess reserves. How well is QE working to help us recover? Doubling the money base has done little to nothing for recovery.

    Moving the interest rate on reserves from 0.25% to 0% won’t change that. All this clamoring to create more excess reserves might feel good, but it won’t accomplish anything. QE has simply increased excess reserves. I welcome any evidence you can muster to the contrary.

  19. Gravatar of Greg Ransom Greg Ransom
    6. July 2010 at 16:03

    pireader, Hayek was (mis)remembering what he thought about Britain (and Britain only) in the 1920s in the period after Churchill forced massive deflation on the country in 1925 — a deflation Hayek and all other Austrians opposed.

    Scott is (wilfully) misleading you on this.

  20. Gravatar of Greg Ransom Greg Ransom
    6. July 2010 at 16:04

    Forgot the “?” … I think.

  21. Gravatar of david david
    6. July 2010 at 16:07

    @Morgan Warstler

    Once again… I get it. Generally, productivity drives prices lower.

    “Inflation is always and everywhere a monetary phenomenon” – M. Friedman

    (okay, okay, actually there are odd ways to conceptualize endogenous money, but those tend to be subtle)

  22. Gravatar of Indy Indy
    6. July 2010 at 16:07

    I wonder if we’ll still be having these same sterile arguments after the great crash of 2067. They might have two or three previous Great Depressions to judge from by that point, but I wonder if anyone will actually be able to make any persuasive arguments when the data will always be subject to alternative interpretations that fit in different political-philosophical .

    And I wonder if we resolve all our remaining resolvable problems, and all we have left is the unresolvable problems, then the rest of human intellectual history will consist of not much more than an infinite re-churning of sterile arguments, akin to theology in the middle ages.

    But for us and our descendants, that would be “The End Of Ideas”.

  23. Gravatar of Greg Ransom Greg Ransom
    6. July 2010 at 16:09

    Scott, this is NOT a “fact”.

    This as Hayek’s 45+ year old false memory from the 1970s about BRITAIN and NOT the U.S., misremembering the problem of what do do in Britain after _years_ of the massive Churchill created deflation Hayek and all Austrian _opposed_.

    Look how you have mislead “pireader” — this is disreputable, especially in light of our extended exchange where I provided you with much of the true history, which you chose to conceal.

    Scott write,

    “In fact, in 1932 Hayek favored deflationary policies as a way of reducing wage and price stickiness.”

  24. Gravatar of John Salvatier John Salvatier
    6. July 2010 at 16:12

    @Morgan Warstler

    I think you suffer some confusion; there is a difference between individual prices and the price level. All prices are affected by “the price level”; if you permanently increase the amount of money a 10000 times, you expect future prices to be 10000 times larger. But not all prices are equally informative about how “the price level” moves; prices move for all sorts of reasons some tend to move more some less and those properties are not stable over time. You can try to measure movements of “the price level” by measuring movements in prices; scott seems to think this is hopeless others think we do an OK job; I don’t know much about the subject so I don’t have much of an opinion.

    It is possible for some (for example housing) relative prices to be “too high” while “the price level” is too low. In fact, I would expect making the price level grow would help the relative price of housing fall, as you said was necessary. If housing prices stay constant, an increasing price level means housing prices fall relative to other goods; their real price drops.

    To answer your question: I don’t claim to know exactly how many bonds the Fed would have to buy; probably not very many, there’s a lot of excess reserves out there.

    @justanothereconomist
    The Fed has made it clear all along that the injection of money was merely temporary. They talk all the time about moving the money near in the future. Do you really doubt the ability of the Fed to make the price level ~15% higher 2 years from now if they set their mind to it (enough to make NGDP roughly on 2007 + 5%)? If you do, what about 5 years from now? 10 years? Perhaps you merely mean that the Fed should target expectations further out.

  25. Gravatar of pireader pireader
    6. July 2010 at 16:21

    Greg Ransom —

    Appreciate your concern, but I didn’t depend on Professor Sumner’s version. I read Hayek’s original 1932 letter (available at the link).

    At the 1932 trough of deflation and depression, he asserted that government deficits (“imprudent borrowing and spending”) were the cause of the problem.

    That’s crack-pot macro-economics.

  26. Gravatar of Doc Merlin Doc Merlin
    6. July 2010 at 17:00

    1. Sigh, more talk about the price level. I thought we agreed that total nominal cash expenditures, NGDP, etc were what was important?

    2. As far as I can tell, the price level for non-durable goods only matters relative to productivity growth, wages, nominal debt.

    3. For durable goods, the story is a bit more complicated, because they store value. The expected expansion of money relative to unit productivity increases in the manufacture of the durable good causes them to rise in price (relative to what they would be) for store of value reasons.

    —————————————-
    Anyway, this works out to aggregate price drops from supply side reasons are good and from demand side reasons are bad. So, lets stop talking about price deflation and price inflation; it gets far too complicated because it has widely diverging effects depending on the asset types and the movement in debt costs. Let go back to talking about PY, as its much more useful.

  27. Gravatar of Greg Ransom Greg Ransom
    6. July 2010 at 17:25

    “pireader” — Hayek’s macro says nothing of the sort, and Britain’s situation dated to 1925 and the Churchill created deflation.

    You seem to know nothing on the topic. Why pretend otherwise?

    “pireader” writes,

    “At the 1932 trough of deflation and depression, he asserted that government deficits (“imprudent borrowing and spending”) were the cause of the problem.”

  28. Gravatar of Doc Merlin Doc Merlin
    6. July 2010 at 17:30

    ‘But his arguments don’t address Keynes’ claim that less thrift would boost AD and stop deflation’

    There’s a far simpler argument against this.

    1. Deflation isn’t bad if its caused by supply side.
    2. Deflation isn’t the real problem. The real problems are RGDP loss (or low growth) and unemployment.
    3. There is only so much you can goose AD before you are just “eating your seed corn” and actually destroying future growth possibilities. Its impossible to tell exactly where this line is with the AS-AD formulation.

    This is one of the many reasons why we should stop thinking in terms of the micro-inspired AS-AD and think in terms of path levels!

  29. Gravatar of Doc Merlin Doc Merlin
    6. July 2010 at 17:38

    @piereader:

    ‘At the 1932 trough of deflation and depression, he asserted that government deficits (“imprudent borrowing and spending”) were the cause of the problem.

    That’s crack-pot macro-economics.’

    If you want to call Robert Barro (one of the founders of the new classical school) a crackpot. He and many others have looked at fiscal stimulus and found it has in-agregate a de-stimulating effect.

    Alberto Allesina has also found that massive budget cuts can have a stimulating effect. Robert Rubin (yes Clinton’s Sec. of the Treasury) believes that deficit cuts have a stimulating effect (aka Rubinomics).

  30. Gravatar of StatsGuy StatsGuy
    6. July 2010 at 17:53

    Scott – I think many of us did not predict – having not lived through the Great Depression – the cultural and political aspects of the situation. I see many things that do not fit into economic models in any sense – that is, models of people rationally acting in their own enlightened self interest.

    Such as:

    People who missed out on the asset boom of the 90s now _wanting_ to see everything plummet, as if to prove to themselves and others that they were always right (it was all fake!)

    The banks, caught in assets, using the government to transfer assets to the public treasury to move to cash positions at public expense, then holding onto cash until they can buy back assets cheaply. And, of course, a central bank that is more controlled by the banks than the electorate.

    The political gamesmanship – parties being more interested in seeing other parties fail than in permitting success

    Masochism, doomsdayism…

    The investor class more concerned about the value of their bonds than national income or employment

    The Fillibuster (and, in general, the senate)

    The lack of courage in the economics profession (most of it, anyway)

    The inability of Coasian bargaining to drive a compromise through the problem of unfunded obligations (pensions, social sec, medicare)…

    All of this, outside the model

  31. Gravatar of Mike Sandifer Mike Sandifer
    6. July 2010 at 18:20

    Is it not obvious that Keynes was right, though his policy recommendations suboptimal?

  32. Gravatar of Edwin Edwin
    6. July 2010 at 18:20

    I find it funny how it seems Hayek bit the monetarist bullet in his late years while Schwartz seems to be going Austrian on us.

  33. Gravatar of Morgan Warstler Morgan Warstler
    6. July 2010 at 18:23

    @StatsGuy

    You are exactly right, and while you do not mean it in a complimentary way, it should be read as a big giant positive.

    Scott makes all those mistakes, but more so he is 180 degrees in error to use the Depression as proof that a financial crisis will lead to more socialism. We are over it. Forever. Now it is just about defending against corporatism.

    What’s coming is cuts, deep meaningful cuts in public employees, through massive productivity gains – think 3-4% per year, that can pair $400B in annual cost of government. See New Jersey writ large.

    Please note: If all the technology gains in the private sector were duplicated by government, we would not have a financial crisis.

    The natural boom from technology in the late 90’s could have continued comfortably feasting on Local, State, and Federal employee rolls paring them back from $1.2T in pay to lower than $800B today.

    Technology was to recover, during the down years it should have transformed government operations. This is not waste, fraud, and abuse… this is organizational/operational structure driven by costs, what companies do all day long.

    The need to “find” another boom would have eased off the easy money housing situation and one suspects made Greenspan and Bush far less likely to suddenly see homeownership as a positive thing for credit scores of 620.

    @John Salvatier

    No amount of math or definitional debate will get you around mortgages and rents consuming 30-40% of many people’s income.

    As such, if they are “too high” we’re talking about a large chunk of money gong to the banks WHO THEMSELVES WANT TO BUY THE CHEAP ASSETS when the time comes.

    I’m saying it again after we a dramatic reduction in real estate prices and rents, so that the dry powder gets the good deals of a lifetime, if then we need to goose the economy along…. we can still do it by targeting NGDP to 5% since 2007, but first we can have a good moral blood letting and get the property into the hands of the guys who are supposed to have it – and not the banksters.

    So, even if it will work, let’s have ourselves a teachable moment, so we don’t get here again.

  34. Gravatar of Mike Sandifer Mike Sandifer
    6. July 2010 at 18:43

    I understand if you ignore this question or answer in a single word, but can fiscal stimulus be carried out effectively by municipalities? Say, a city wasnt to engage in stimulus via deficit, tax breaks, etc.

  35. Gravatar of Mike Sandifer Mike Sandifer
    6. July 2010 at 18:44

    city “was to engage in stimulus” that is

  36. Gravatar of pireader pireader
    6. July 2010 at 19:18

    Greg Ransom –“Hayek’s macro says nothing of the sort”

    OK, I’m confused. I directly quoted Hayek’s 1932 letter.
    Did you read the letter?

    Here’s the verbatim quote: “many of the troubles of the world at the present time [1932!] are due to imprudent borrowing and spending on the part of the public authorities”

    Here’s the link:

    http://thinkmarkets.files.wordpress.com/2010/06/keynes-hayek-1932-cambridgelse.pdf

  37. Gravatar of Greg Ransom Greg Ransom
    6. July 2010 at 19:21

    Hayek was never a crude monetarist. That’s the key fact that ignorant discussions of Hayek don’t get out.

    Why waste everyone’s time with false history and bogus theory?

    That’s the big question for Scott.

    Edwin writes,

    “I find it funny how it seems Hayek bit the monetarist bullet in his late years while Schwartz seems to be going Austrian on us.”

  38. Gravatar of Greg Ransom Greg Ransom
    6. July 2010 at 19:24

    pireader, you are confused because you know nothing of Hayek’s economics — and little or nothing of the history of the times, it would seem.

    Ever heard of WWI?

    Know anything about Hayek’s causal story of the malinvestment artificial boom, created by “animal spirits”, the credit cycle, leverage, bandwagon effects, and sometimes (but not necessarily) by central banks?

    pireader writes,

    “Greg Ransom -“Hayek’s macro says nothing of the sort”

    OK, I’m confused. I directly quoted Hayek’s 1932 letter.
    Did you read the letter?

    Here’s the verbatim quote: “many of the troubles of the world at the present time [1932!] are due to imprudent borrowing and spending on the part of the public authorities””

  39. Gravatar of pireader pireader
    6. July 2010 at 19:30

    Doc Merlin — “Robert Barro … and many others have looked at fiscal stimulus and found it has in-agregate a de-stimulating effect.”

    Hayek’s letter (linked above) made a very-speciifc claim–that the problems of 1932 (the trough of the depression) were due to government deficits.

    Can you show me where Robert Barro or Alberto Allesina or Robert Rubin ever endorsed that claim? I didn’t think so.

    It’s crackpot macro-economics

  40. Gravatar of pireader pireader
    6. July 2010 at 19:40

    Greg Ransom —

    Apparently you feel that you know what Hayek thought better than Hayek did.

    I quoted the man’s own words. Blazing dumb words, but his own.

    Then you tell me that they don’t capture his thinking. Your argument is with Hayek, not with me.

  41. Gravatar of Doc Merlin Doc Merlin
    6. July 2010 at 20:16

    @piereader:

    Not really, there are quite a few economists that believe the deficit government spending during the great depression exacerbated the problem by reducing the necessary expansion in investment.

    ‘Hayek’s letter (linked above) made a very-speciifc claim-that the problems of 1932 (the trough of the depression) were due to government deficits.

    Can you show me where Robert Barro or Alberto Allesina or Robert Rubin ever endorsed that claim? I didn’t think so.’

    No, he said that some of the problems were due to deficits, and, yes, Barro specifically has said that he believes that the depression was worsened by government deficit spending. Anyway, most right winged economists believe that the fiscal multiplier is below 1. This means that Hayek’s views aren’t that far out of the mainstream anymore.

  42. Gravatar of Lord Lord
    6. July 2010 at 20:40

    How sterile then and how sterile now. Deflation in itself may be undesirable but God forbid anything be done about it. Apparently nothing can be done, let’s change the subject to trade policy. No different now days. Statsguy is on point with the dynamics of the situation. It is all a prism through which participants focus their ideological agendas on. Keynes at least gets points for recognizing there is a problem. Hayek is oblivious.

  43. Gravatar of pireader pireader
    7. July 2010 at 02:13

    Doc Merlin –

    Re-read the craziness of what Hayek wrote: “many of the troubles of the world at the present time are due to imprudent borrowing and spending on the part of the public authorities”

    The preceding paragraphs of the letter make clear that ‘troubles of the world’ refers to the depression. And it doesn’t say that the governmeent defict made the depression incrementally worse, but rather that it caused it(‘due to’). That’s what’s so crazy.

    No ‘multipler’ would make the deficit reduce US GDP by 25% in just 4 years, while also deflating prices by 25% and collapsing the baanking system.

    Barro et al. believe no such thing, and never said it. If you have a citation to the contrary, please provide it.

  44. Gravatar of pireader pireader
    7. July 2010 at 02:56

    Lot of typos in that last comment. Sorry.

  45. Gravatar of StatsGuy StatsGuy
    7. July 2010 at 05:14

    @Morgan

    “Please note: If all the technology gains in the private sector were duplicated by government, we would not have a financial crisis.”

    Yes, and no. Under Clinton/Gore, federal staffing was reduced substantially (about 12%), and even more as a % of the labor force. This mostly represented introduction of IT into government. Many governments have likewise outsourced billing operations, or automated various functions. Certainly, they are moving slower than corporate america, though it’s possible that some of this is because of legal obstacles to outsourcing govt. functions (should police call centers be routed through India?). Under Bush, we saw a reversal of federal staffing policies, with massie growth concentrated in “homeland security” (TSA, etc.), and absolutely no accountability for expenses – no requirement to prove that we’re getting anything for our dollars other than very long lines or massive NSA data dumps of every telecom signal in the country.

    But even with all of what you are describing, additional massive cuts in the public sector will NOT fix the budgetary problems by themselves. MOST of the budget problem is not discretionary budget, or staffing – it’s transfers. Medicare overhead is incredibly low compared to private sector – (3%?). Cutting this 3% further won’t do much. The problem is the 97%. Same thing with Social Security. The only really big area where staffing reductions and better systems would yield large savings is the military, where we continue to field a force structure designed to meet our security needs circa 1980 (an 11 carrier fleet? as much tonnage as the next 13 countries combined? one might almost think we’re fighting a high seas war in Afghanistan).

    I’m afraid we have bigger problems. My mistake was in believing that most economists somehow stood outside the political landscape of the Fed, the European banking system, the self-flagellating zeitgeist. Not so.

    The deflationistas are SO LOUD, and they are given a massive voice precisely by those seeking to undermine the current folks in power (Bernanke is a republican, remember), that the Fed seems unable to act without an overwhelming consensus that deflation is here – and even then, they take the minimum action possible.

    There is an argument that the recession is permitting distributive changes in state govt that are otherwise hard to make (lowering public sector wages, which have grown relative to private sector). Perhaps, in the long run, this is functional. Of course, this (too) is outside the macro model. Moreover, it still leaves pensions intact – PAST wages that are still being collected by people who voted themselves high salaries – financed by debt laid on their children.

    All in all, however, I wonder if the problem of unfunded obligations would be easier or harder to deal with if we were not wrestling with repeated demand crises.

    David Frum (one of the three rational conservatives remaining) had a recent article discussing some interesting thoughts – among them, the issue of misallocation of infrastructure expenses (buying big cheaply built houses and lousy infrastructure, rather than small well built houses and solid infrastructure). But the solution to this would be to redouble our efforts to build infrastructure (rail transit stations, better airport infrastructure, bridges) – yet where is that?

  46. Gravatar of StatsGuy StatsGuy
    7. July 2010 at 05:16

    note – in the above, the comment about Bernanke being a republican is intended to note that the those seeking to undermine the current authority don’t seem to care that the authority is headed by a republican, not that Bernanke is seeking to undermine anything.

  47. Gravatar of scott sumner scott sumner
    7. July 2010 at 05:50

    Tyler, Remind me never again to stir up a hornets nest of Austrians and Post Keynesians within 24 yours.

    Jon, Not according to Larry White–read the article I attached.

    Lorenzo, No I don’t think it is too harsh.

    Benjamin, Thanks, I’ll take a look.

    Morgan, I have discussed my precise ideas ad nauseum. Peg the price of NGDP futures contracts so that NGDP growth expectations rise at 5% per year. Right now the rate should be a bit higher to catch up for losses. Then simply let the market decide how much money it will take. Inject money by buying T-securities.

    I’d rather rely on the market’s estimate of what houses are worth, not your opinion. I’m not the sort of socialist who thinks central planners know what things are “really worth.”

    Mario, I should probably do a post on this, because your view is a common misconception (assuming Larry White’s quotations are correct). Here is Hayek:

    “There can be little question that these rigidities tend to delay the
    process of adaptation and that this will cause a “secondary”
    deflation which at first will intensify the depression but ultimately
    will help to overcome these rigidities.”

    And here is how White characterized his views:

    “Hayek (1933c, p. 176) worried that the process of readjustment after 1929
    was being delayed by “the rigidity of prices and wages, which since the great war
    has undoubtedly become very considerable.” He blamed the rigidities for the
    magnified unemployment and thereby for the deflation (not mentioning the US
    banking crisis and monetary contraction in this context), but hoped that the
    deflation might restore price and wage flexibility the hard way:”

    Toward the end of the paper White quotes Hayek saying in the 1970s that he supported deflation in the early 1930s, and now (in the 70s) regrets that position. Unless these quotations are inaccurate, I don’t see how anyone can dispute my view.

    Has far as Keynes is concerned, I’d say his theory remained a muddle even in the General Theory. He has no explanation for how the price level is determined.

    david, I agree.

    pireader, I think that Hayek was a much better microeconomist than macroeconomist.

    Grreg, He is clearly talking about the early 1930s in the quotation I provided in response to Mario. Unless White simply made up those quotations then I am clearly right about Hayek and you are wrong.

    Morgan#2, I have no idea how many Treasuries the Fed should buy, that should be determined by the market.

    justanothereconomist, I agree that QE by itself may do little or nothing. Japan shows that temporary currency injections don’t work. It depends what else the Fed does. The most important policy is price level or NGDP targeting. If they are worried about policy ineffectiveness due to the liquidity trap (and there is no reason for them to be worried) then they can always use futures targeting.

    Indy, You said;

    “I wonder if we’ll still be having these same sterile arguments after the great crash of 2067.”

    I doubt it. By then we’ll have all electronic money, and thus there will be no zero lower bound.

    More to come . . .

  48. Gravatar of JimP JimP
    7. July 2010 at 06:09

    Fisher from the Dallas Fed says on tv just now that the Fed should buy nothing more.

    He says monetary policy is as accommodative as possible.

    The man is a clown.

  49. Gravatar of scott sumner scott sumner
    7. July 2010 at 06:17

    Doc Merlin, I get sucked back into talking about the price level because others talk about deflation.

    Statsguy, Those are good points.

    Mike, Keynes was right about the economy needed more AD.

    Edwin, Yes, one of my first posts was on Schwartz’s conversion to neo-Austrian views.

    Morgan, You said;

    “Scott makes all those mistakes, but more so he is 180 degrees in error to use the Depression as proof that a financial crisis will lead to more socialism. We are over it. Forever. Now it is just about defending against corporatism.”

    So the government did not just nationalize the auto industry? And the health care bill did not pass? Obviously I don’t think we are going to become socialist in the Soviet sense, but we are moving slightly in that direction.

    Mike. No. Their expenditure is heavily skewed toward imports.

    Lord, Yes, I have lots of posts discussing how people misinterpret nominal problems as real problems. They always think “this time it’s different” and come up with crackpot solutions, instead of just boosting AD through monetary stimulus.

    Statsguy, You asked:

    “should police call centers be routed through India?).”

    Yes.

    I agree with your comments about entitlements being the biggest budget items.

    You said:

    “But the solution to this would be to redouble our efforts to build infrastructure (rail transit stations, better airport infrastructure, bridges) – yet where is that?”

    I agree, and that’s why I favor switching to a high saving society. Also, the Northern Europeans now rely on private enterprise to build and run much of their infrastructure. I wish we would adopt those neoliberal ideas here. But we are stuck in the big government model. We have a old liberal party and a populist conservative party. Where are our neoliberals?

  50. Gravatar of Morgan Warstler Morgan Warstler
    7. July 2010 at 06:31

    Scott,

    YOU DO NOT ANSWER the response. And it isn’t just me, Doc has said the same thing. In debate this is saying, “your plan does not solve.”

    Our response is (sorry for needing to speak for Doc to get a real answer), Fed buying T-Bills = banks holding more reserves. Period. Nothing more.

    We give you the good cause: Everyone knows there are massively inflated housing assets going to be unwound and sold for a song for a brief market low, the banks intend to be the ones to buy them.

    After the bailout, this is of course compounds a MORAL WRONG. And you eat it. You shrug and punt. This is untenable.

    It appears to me that you have a personal reason to fear housing prices falling… you keep insisting that a capitalist, who KNOWS countless guys with dry powder waiting for housing prices to drop, is a socialist, because he looks at your monetary shenanigans and says wait a minute, we can’t just let the banksters walk away with the houses – is a socialist.

    Scott, the debate answer here is a hybrid wherein you figure out a way to target NGDP while rewarding the guys with cash, and keeping the banksters from using the reserves they have built up from the printing press to compete with the real dry capital during the coming fire sale.

    Until your NGDP plan rewards past thrift – you will never win the Tea Party crowd, who you need.

    Read all the analysis, everyone notes the “deflationists” intend to see justice regardless of its ill effects.

    So the LOGICAL thing for you to do is to BUILD JUSTICE INTO your NGDP plan to speak to it in volumes. Maybe it is as simple as giving all the new printed money to anyone who owns a small business. Wall street gets none, the guy with 5 dry cleaners gets his banks account doubled.

    That still sounds silly, but that is not my problem. Figure it out fast.

  51. Gravatar of Mario Rizzo Mario Rizzo
    7. July 2010 at 08:09

    Scott,

    You make good points. I was not precise in my statement about deflation. I think this was Hayek’s point (and incidentally why he says in the letter that deflation in itself is not desirable).

    Deflation in the monetary sense has bad consequences. It violates Hayek’s “theoretical norm” that MV should be stabilized. However, perhaps a little deflation could be a useful tool to break the back of price-wage rigidities which were a problem since Britain returned to gold. This was a conjecture that Hayek latter admitted was probably wrong — especially since it is hard to produce just a little deflation.

    And yet the point about rigidities is still around. Consider the recent discussion about whether continuing to extend unemployment insurance increases the duration of unemployment. There is an implicit wage rigidity claim here. Unemployment insurance may enable people to maintain an unrealistically high reservation price (wage) for their labor and thus contribute to unemployment.

    If this is true, then not extending coverage may deal with the “rigidities” without going the deflation route.

  52. Gravatar of Doc Merlin Doc Merlin
    7. July 2010 at 08:51

    Pireader you said:

    “‘Re-read the craziness of what Hayek wrote: “many of the troubles of the world at the present time are due to imprudent borrowing and spending on the part of the public authorities”

    The preceding paragraphs of the letter make clear that ‘troubles of the world’ refers to the depression. And it doesn’t say that the governmeent defict made the depression incrementally worse, but rather that it caused it(‘due to’). That’s what’s so crazy.”

    Baulderdash, that isn’t what he is saying at all. Note: ‘troubles of the world’ is preceded by the word ‘many.’ Its not clear at all he is blaming the entire depression on state fiscal problems, just that he is saying it is making things worse.

    “No ‘multipler’ would make the deficit reduce US GDP by 25% in just 4 years, while also deflating prices by 25% and collapsing the baanking system.”

    I agree that it wasn’t the entire story, we also had wage and price controls, and famine, and massive tariffs were put all around the world against our goods (radios and cars mostly), and we had a central bank that contracted money strongly.

    Now responding to my statement:
    “Barro specifically has said that he believes that the depression was worsened by government deficit spending. Anyway, most right winged economists believe that the fiscal multiplier is below 1. This means that Hayek’s views aren’t that far out of the mainstream anymore”

    You say:
    “Barro et al. believe no such thing, and never said it. If you have a citation to the contrary, please provide it.”

    He says it very politely and couches his words a lot, but here it is.
    http://fivebooks.com/interviews/robert-barro
    He does believe the Friedman and Schwartz story, but seems to have a model of fiscal spending that would say that fiscal profligacy worsened things.

    “So I don’t think you can reliably say what the effect is. But conceptually you’d expect the wartime spending to have a bigger effect for various reasons on the GDP than the equivalent amount of expenditure in a non-war situation. And the wartime effect you can estimate pretty precisely, and the multiplier is clearly less than one, even in World War Two – it’s in the order of 0.6, 0.7, something like that.”

    He couches his words a lot, but lets parse this paragraph.
    1. The wartime multiplier should be higher than non-wartime.
    2. The multiplier is smaller than one.

    This necessarily means that he believes that fiscal stimulus makes things worse, and thus that the depression was worsened by the fiscal stimulus. This is what “the multiplier is smaller than one” means.

    He goes on:
    “There’s a little bit of evidence from that that the multiplier is bigger when there’s more slack. But it doesn’t look like the multiplier gets up to one, even when the unemployment rate is nine per cent. It’s getting closer to that, but even then it is not one.”

  53. Gravatar of Greg Ransom Greg Ransom
    7. July 2010 at 09:01

    No, by hiding the historical context and ignoring the theoretical content, you are clearly engaging in intellectual malpractice.

    The science of psychology tells us that rationalizations of of the past are not very reliable in much shorter periods than 45 years. Hayek in the 1970s was focused on the problems of the unions in Britain, which reminded him of the high wage and union problems of the late 1920s in the post return to par years in Britain.

    Hayek clearly has his dates wrong in this off the cuff memory (you are quoting a Q & A with Hayek, not something Hayek wrote).

    I put it straight.

    I think you are being dishonest. And intentionally so.

    My remarks have nothing to do with White.

    Scott wrote.

    “Grreg, He is clearly talking about the early 1930s in the quotation I provided in response to Mario. Unless White simply made up those quotations then I am clearly right about Hayek and you are wrong.”

  54. Gravatar of Greg Ransom Greg Ransom
    7. July 2010 at 09:05

    The quote you take from White is from a Q & A with Hayek after a talk on a completely different topic.

    Hayek was 76 years old. In all of the interviews of this period Hayek is focuses on 1925 and the problem causes by the return to par in BRITAIN — he never says a word about America. Every time he talks about Keynes, he talks about the problem causes by the return to gold at par after the massive WWI inflation.

    Deal with it, Scott.

  55. Gravatar of Greg Ransom Greg Ransom
    7. July 2010 at 09:08

    Let me say it again. Every time Hayek is focused on the special problems of Britain, what to do after the deflation has ALREADY HAPPENED years in the past, but wage rates have not adjusted. IN BRITAIN. IN BRITAIN ONLY.

    Expanding on this:

    “Every time he talks about Keynes, he talks about the problem causes by the return to gold at par after the massive WWI inflation.”

  56. Gravatar of Greg Ransom Greg Ransom
    7. July 2010 at 09:14

    I won’t press this again here.

    I’ll be writing up something at “Taking Hayek Seriously” on the fact that for 80 years almost every “response” to Hayek has been basically just risible b*llsh*t from people who couldn’t bother themselves to learn the rival causal explanation they were attacking — and who have used a false history to smear this causal research program they don’t understand and haven’t studied.

    And the b*llsh*t starts with Keynes — who demonstrably failed to understand the basic logic of choice at the heart of capital theory. Keynes seems to have been the alpha male who set the disgraceful professional standard the profession continues to imitate.

  57. Gravatar of Greg Ransom Greg Ransom
    7. July 2010 at 10:57

    I see that Scott has put most of this in something closer to its appropriate context in a later post.

    In the comments there I link to a YouTube video where Hayek attributes the argument “use deflation to break union caused wage rigidity” to Keynes — so Hayek isn’t the one who made this argument, Keynes made the argument and Hayek was at some point persuaded by Keynes on this matter.

  58. Gravatar of pireader pireader
    7. July 2010 at 12:54

    Doc Merlin –“Baulderdash, that isn’t what he is saying at all. Note: ‘troubles of the world’ is preceded by the word ‘many.’ Its not clear at all he is blaming the entire depression on state fiscal problems, just that he is saying it is making things worse.”

    You’re too easy on Hayek here.

    First, he says flatly that “many of the world’s troubles at the present time [1932]” are “due to” government deficits. In plain English, ‘due to’ means that the deficits caused the troubles, not merely that the deficits made the troubles somewhat worse.

    Second, Hayek’s whole letter is about the right response to “the depression”; it mentions no other “troubles” (except, once, “deflation”). What were the “troubles” that he was blaming on the deficits, if not the depression?

    Doc Merlin–“[Barro] does believe the Friedman and Schwartz story, but seems to have a model of fiscal spending that would say that fiscal profligacy worsened things”

    After carefully re-reading the entire Barro interview …

    (1) Barro never says that government deficits caused the Depression, or even worsened it. And quite senibly … The downturn was already serious (-10%) in 1930, and worse(-15%) in 1931. But the US didn’t run a serious deficit until FY1932.

    (2) Barro never claims anywhere that ‘fiscal profligacy’ causes or contributes to downturns. Because he doesn’t believe that. To the contrary, he says that rasing taxes during the Depression to avoid deficits was “clearly a mistake”.

    (3) Barro does say that the “multiplier” is 0.6 or 0.7 … meaning that the GDP gain from a stimulus is smaller, not that there is a GDP loss. (The “multiplier” would have to be negative to make a downturn worse.)

  59. Gravatar of Doc Merlin Doc Merlin
    7. July 2010 at 14:05

    @pireader
    ‘(3) Barro does say that the “multiplier” is 0.6 or 0.7 … meaning that the GDP gain from a stimulus is smaller, not that there is a GDP loss. (The “multiplier” would have to be negative to make a downturn worse.)’

    The multiplier would have to be negative to make GDP lower, agreed. But it would only have to be smaller than 1 to make consumption and investment worse off.

    If we think of things purely in terms of RGDP we miss out what is important which is C+I. In order for the fiscal multiplier to cause investment + consumption to rise, it must be larger than one.
    (for a closed economy)
    Y=C+I+G
    If the multiplier for G is b then C+I must fall by 1-b.
    The whole reasons that the keynesians say that b is greater than 1 was to say that government spending increases increased private consumption (and investment). If Barro is correct, then government deficit spending decreases private consumption.

    The point of deficit financed fiscal stimulus was to raise private consumption. If Barro is correct and it lowers private consumption, then we are better off without fiscal stimulus.

  60. Gravatar of justanothereconomist justanothereconomist
    7. July 2010 at 15:45

    Sorry for the delay

    “jsaltier-
    The Fed has made it clear all along that the injection of money was merely temporary. They talk all the time about moving the money near in the future. Do you really doubt the ability of the Fed to make the price level ~15% higher 2 years from now if they set their mind to it (enough to make NGDP roughly on 2007 + 5%)? If you do, what about 5 years from now? 10 years? Perhaps you merely mean that the Fed should target expectations further out.”

    Of course it’s temporary. Does anyone support more than doubling the money base permanently? Money base nowhere near doubled in the 1970s. Why was inflation so much higher? The only difference that matters is that we weren’t in a liquidity trap then. I define a liquidity trap as any situation where open market operations or other injections of base don’t increase NGDP and simply appear as excess reserves. This usually happens at the zero lower bound.

    How can the Fed commit to higher inflation? Even if they were committed to it, they can’t produce it. Would tripling the base do it? Quadrupling it?

    This expectations argument is basically as follows. Assume the Fed can affect NGDP using monetary policy when rates are zero. (This is false). Then when the Fed commits to higher inflation, makrets believe it. Why would markets believe that the Fed can produce higher inflation? There isn’t a shred of evidence that the Fed can produce higher inflation right now. It assumes collective irrrationality. That’s the only way this expectations argument works.

    Basically, it comes down to this. If you believe a simple Fed committment can get you out of a liquidity trap, then what is the mechanism by which the Fed creates the credible higher inlfation (or higher NGDP, whatever)? Any argument that rests on circular reasoning is flawed. The mechanism that creates high inflation can’t rest on people believing the Fed can create higher inflation.

    Scott’s comments on this topic would be welcome as well.

  61. Gravatar of pireader pireader
    7. July 2010 at 19:08

    Doc Merlin — “If we think of things purely in terms of RGDP we miss out what is important”

    So now you’re saying that deficit spending does increase real GDP, but that’s not what’s important. Well, real GDP is what we were discussing.

    Hayek’s letter claims that the Great Depression (i.e., sharply lower real GSDP) was “due to” governemnt deficits.

    I said that was crackpot macro-economics. Apparently, you agree.

  62. Gravatar of johnleemk johnleemk
    7. July 2010 at 21:48

    justanothereconomist,

    How is the zero bound fact at all? See this Krugman piece from 11 years ago: http://web.mit.edu/krugman/www/trioshrt.html

    As he says, don’t bother targeting interest rates or even the monetary base. Target inflation, or as Scott proposes, NGDP. Then do whatever you need to do to get to that target — which probably means threatening to increase the monetary base as much as you have to.

    You say increasing the monetary base is impotent. What proof is there of that? Are you really saying that if we print a lot of money, nothing will happen? The Zimbabwean Reserve Bank would like to have a chat with you.

  63. Gravatar of johnleemk johnleemk
    7. July 2010 at 21:49

    If you remain unconvinced, here is another fantastic Krugman article on why and how printing money in a liquidity trap is a great idea: http://web.mit.edu/krugman/www/nikkei.html

  64. Gravatar of scott sumner scott sumner
    8. July 2010 at 06:45

    Morgan, You said:

    “Until your NGDP plan rewards past thrift – you will never win the Tea Party crowd, who you need.”

    NGDP targeting is fair to both lenders and borrowers.

    Mario, Yes, I agree with your comments about UI.

    Greg, I responded in the new post. But I don’t buy the 1925 argument. It wasn’t just in the 1970s he said that, the first quote I provide is from 1933.

    And my newest post is 100% consistent with what I said here. If you don’t think so, then you need to reread what I said here.

    justanothereconomist, There is no example in all of world history of a central bank that wanted to inflate but was unable to. If it happens someday I might believe it. But the BOJ has been running a tight money policy in all sorts of ways since 1994, so the one example that liquidity “trap” proponents often like to point to actually shows the opposite. Yes, temporary currency injections don’t do much at the zero bound, but they also don’t do much when you are not at the zero bound. The zero bound doesn’t change anything in a technical sense, but it does have a psychological impact, which the blogger Nick Rowe has discussed very well.

    Your mistake is to look at monetary policy in a static sense, whereas the current purchasing power of money is dependent on the future expected path of money supply and money demand. The Fed must commit to change those paths as needed to hit its target.

    If the Fed of BOJ committed to a higher price level target, and wasn’t believed, you might have an argument. But they refuse to do so, so why should we expected anything different from what we have?

    The Fed needs to set a higher price level or NGDP target, if it isn’t credible, then peg the price of a futures contract linked to the nominal target.

    johnleemk, Thanks, Yes, Krugman does understand these points, and has been quite critical of the Fed and ECB.

  65. Gravatar of justanothereconomist justanothereconomist
    8. July 2010 at 08:45

    johnleemk-

    “You say increasing the monetary base is impotent. What proof is there of that? Are you really saying that if we print a lot of money, nothing will happen? The Zimbabwean Reserve Bank would like to have a chat with you.”

    This proof:
    http://research.stlouisfed.org/fred2/series/BOGAMBNS?cid=124
    Compare September 2008- present versus the 1970s. Yet we are experiencing disinflation. We are printing a lot of money, and nothing is happening, that’s exactly what I’m saying. Zimbabwe’s not at the zero lower bound, are they? We weren’t there in the 1970s either.

    Scott-

    “There is no example in all of world history of a central bank that wanted to inflate but was unable to. ”

    The current Fed? They are missing even their implicit target, we are below 2% inflation. If you want NGDP, they are massively missing this target. If you want to look at it as money base, then they definitely are failing at stimulative monetary policy.

    “The Fed must commit to change those paths as needed to hit its target. ”

    How can it change these paths? Again I don’t see a mechanism, which is my biggest issue. It wasn’t asnwered in your current post from what I can tell.

    At the zero lower bound, injections of money base ALWAYS result in excess reserves. This happens whether there is payment of interest on reserves (the case today) and when interest on reserves aren’t paid (1930s). There were tons of excess reserves in Japan’s QE as well.

    “The zero bound doesn’t change anything in a technical sense” So today, the money base has more than doubled. In the 1970s, base nowhere near doubled. Since there’s no difference between then and today, inflation must be higher today than in the 1970s, right?

    “The Fed must commit to change those paths as needed to hit its target. ” Ok, fair enough. How does the Fed do this? Just becuase I commit to flying doesn’t mean I fly. What can the Fed do (not where they can commit to get to) to improve NGDP? The Fed can commit to go to the moon as much as they want, but they still need to build a rocket ship.

    “The Fed needs to set a higher price level or NGDP target, if it isn’t credible, then peg the price of a futures contract linked to the nominal target.” This is not a mechanism, just a commitment. This matters.

    “If the Fed of BOJ committed to a higher price level target, and wasn’t believed, you might have an argument. But they refuse to do so, so why should we expected anything different from what we have?”

    The BOJ massively increased the money base. Do you think that injections of money base have no real effects? The Fed has no lowered their target, and yet inflation is far below the 2% implicit target. If the Fed hasn’t changed their target, the money base has been expanded massively, and interest rates are as low as they can go. Surely you can be saying that the Fed committing to a target (that you still haven’t show HOW the Fed will hit the target) will significantly improve our situation?

    This is really Tinkerbell economics, though Krugman’s analysis of the liquidity trap is equally guilty (ironically).

    This is what I’m looking for: Fll in the blank-

    Once the Fed commits to a nominal GDP target, they will hit this target by doing _____.

    Replace nominal GDP target with whichever policy goal you’d like (that will deal with the current recession), but the blank should be filled.

    If this question can’t be answered, it really is Tinkerbell economics.

  66. Gravatar of pireader pireader
    8. July 2010 at 11:09

    justanothereconomist–“Once the Fed commits to a nominal GDP target, they will hit this target by doing _____. ”

    Fair question. Here’s an answer: by buying up long-dated assets? Start with Treasury bonds. If that doesn’t do it, then private-sector bonds and bank loans. If that doesn’t do it, then equities.

  67. Gravatar of johnleemk johnleemk
    8. July 2010 at 13:08

    justanothereconomist,

    Inflation is a monetary phenomenon. It’s called printing money.

    Okay, you say, so why has the Fed printed money and NGDP remained virtually stagnant? Because as Scott has pointed out, the Fed continues to pay interest on reserves — it actually raised them from what they were before if I am not mistaken (tantamount to removing this money from the money supply), and because it continues to dither about its targets.

    What is the Fed targeting? Krugman says they should target an explicit inflation rate. Scott says they should target an explicit NGDP growth rate. Instead, the Fed says “We’re done. We can’t do anything, we’re at the zero bound.” When the Fed has no confidence in itself, why would anyone have confidence in what it does? If anything, the Fed has been making noises from time to time about getting hawkish on inflation, for heaven’s sake! When the Fed acts as if it might withdraw the increase in the base the moment inflation presents itself, why would the markets expect the price level or NGDP to rise?

    You compare this to a guy committing to flap his arms and fly. But there is no reason — none at all — that the Fed cannot flood the economy with as much money as it likes. And why shouldn’t prices — and by necessity NGDP — go up when this occurs? All they have to do is say “We’re going to print money and we’re going to keep doing it until we see inflation hit 5%, or NGDP growth hits 5%.” Nothing about nominal interest rates prevents the Fed from printing more and more money.

    And if it doesn’t do anything, what have we lost? If monetary stimulus somehow doesn’t work, what are we out of? Essentially nothing. Monetary stimulus is a virtually zero-risk strategy, as long as you commit to your targets and demonstrate this commitment — as opposed to publicly fretting about inflation the moment the price level seems to creep upwards.

  68. Gravatar of scott sumner scott sumner
    9. July 2010 at 17:10

    justanothereconomist, You said;

    “This proof:
    http://research.stlouisfed.org/fred2/series/BOGAMBNS?cid=124
    Compare September 2008- present versus the 1970s. Yet we are experiencing disinflation. We are printing a lot of money, and nothing is happening, that’s exactly what I’m saying. Zimbabwe’s not at the zero lower bound, are they? We weren’t there in the 1970s either.”

    The monetary base data became meaningless in October 2008, as the injections were sterilized when the Fed began paying interest on reserves. They are effectively bonds.

    You said:

    “Scott-

    “There is no example in all of world history of a central bank that wanted to inflate but was unable to. “

    The current Fed?”

    That proves my point. DeLong asked Bernanke why he didn’t aim for 3% inflation. Bernanke said that would be a bad idea, as the Fed is opposed to inflation. So obviously the Fed is not trying to inflate, just the opposite, they are going out of their way to assure markets that the monetary injections will be pulled out in the future to prevent inflation. But that makes the monetary injections ineffective, as Krugman and Woodford showed years ago. The Fed also refuses to do level targeting, even though Bernanke himself said the Japanese needed to do level targeting to escape their liquidity trap.

    You asked,

    “How can it change these paths? Again I don’t see a mechanism, which is my biggest issue. It wasn’t asnwered in your current post from what I can tell.”

    It must say it wants to reform. An alcoholic must say he wants to stop drinking, and then he must actually stop. The Fed won’t even say they want inflation, and they continue with contractionary policies like interest on reserves.

    I do have lots of other posts that discuss various ideas. last year I did long posts on NGDP futures targeting, and on negative interest on reserves, etc. Even the Fed admits there are lots of things they could do but aren’t doing. Look at my recent “Fesses up” post, especially the Bullard quote. He makes it quite clear that the Fed could boost AD, but they simply don’t want to. He comes right out and says it.

    You said;

    “The BOJ massively increased the money base. Do you think that injections of money base have no real effects?”

    Long before Krugman, I wrote a paper showing the QTM breaks down if monetary injections are perceived as temporary. The BOJ promised the injections were temporary, and they were. The money was injected in 2003 and pulled out in 2006. Of course there was no effect, you wouldn’t expect one.

    You said;

    “The Fed needs to set a higher price level or NGDP target, if it isn’t credible, then peg the price of a futures contract linked to the nominal target.” This is not a mechanism, just a commitment. This matters.”

    If they peg the futures price, it is a mechanism. The market sets the base at the level expected to produce on-target NGDP growth. They pegged the price of gold at $20.67 for 54 years, they can certainly peg the price of NGDP futures contracts. There is no Tinkerbell here at all. I simply rely on the EMH. Alternatively, negative interest rates on bank reserves, including vault cash–again, not Tinkerbell, a specific action. Switch from inflation targeting to price level targeting, a specific action. And I haven’t even gotten into conventional actions like QE, which have not been tried by the way, as interest-bearing reserves don’t count.

    More broadly, you seem to think that monetary policy impacts the economy by affecting current interest rates and current levels of the monetary base. But cutting edge theory now suggests that the strongest effects work through expectations of future policy.

  69. Gravatar of Edwin Edwin
    10. July 2010 at 18:08

    If nothing works, worst case scenario is we can literally start throwing money from helicopters. If nothing can cause inflation like you say, lets give free newly printed money to everyone!

  70. Gravatar of ssumner ssumner
    11. July 2010 at 09:32

    Edwin, Don’t worry, we won’t need to do that.

  71. Gravatar of justanothereconomist justanothereconomist
    14. July 2010 at 00:03

    johnleemk-

    “Inflation is a monetary phenomenon. It’s called printing money.”

    Not right now.

    “Okay, you say, so why has the Fed printed money and NGDP remained virtually stagnant? Because as Scott has pointed out, the Fed continues to pay interest on reserves “” it actually raised them from what they were before if I am not mistaken (tantamount to removing this money from the money supply), and because it continues to dither about its targets.”

    All that from a quarter of a point? That’s the most powerful quarter of a point I’ve ever seen. Plus the excess reserves began in September 2008 with the crisis, not in October 2008 with the payment of interest on reserves. There were excess reserves in the 1930s with no interest on reserves. We were at the zero bound though.

    “What is the Fed targeting? Krugman says they should target an explicit inflation rate. Scott says they should target an explicit NGDP growth rate. Instead, the Fed says “We’re done. We can’t do anything, we’re at the zero bound.” When the Fed has no confidence in itself, why would anyone have confidence in what it does? If anything, the Fed has been making noises from time to time about getting hawkish on inflation, for heaven’s sake! When the Fed acts as if it might withdraw the increase in the base the moment inflation presents itself, why would the markets expect the price level or NGDP to rise?”

    The money base doubled from early 2008 levels, and has remained more than doubled for the next 2 years. What is permanent? a decade?

    “ut there is no reason “” none at all “” that the Fed cannot flood the economy with as much money as it likes.”

    The fed has- it’s just created excess reserves

    ” And why shouldn’t prices “” and by necessity NGDP “” go up when this occurs?”

    Because its a liquidity trap

    “And if it doesn’t do anything, what have we lost? If monetary stimulus somehow doesn’t work, what are we out of? Essentially nothing. Monetary stimulus is a virtually zero-risk strategy, as long as you commit to your targets and demonstrate this commitment “” as opposed to publicly fretting about inflation the moment the price level seems to creep upwards.”

    There would be a capital loss, as the Fed would buy bonds when they are expensive and sell them when they are cheap. I am not opposed to more QE though- I still think the costs are small. If a few trillion more in excess reserves are what it takes to put these silly arguments to bed, then it’s worth it.

    Scott-

    “The monetary base data became meaningless in October 2008, as the injections were sterilized when the Fed began paying interest on reserves. They are effectively bonds.”

    COnvenienly the money base becomes meaningless just when it is inconvenient for your theory. Again, it’s a quarter point. What kind of theory relies so heavily on a quarter point? It’s a weak reed to stand on, though you seem to continue to rely on this argument.

    Expansion of the money base with no increase in NGDP is a liquidity trap. Just because you don’t like liquidity traps doesn’t make the money base irrelevant.

    “That proves my point. DeLong asked Bernanke why he didn’t aim for 3% inflation.”

    But the Fed is still aiming for its implicit target, is it not? The Fed would like inflation to be 1-2%, and it can;t meet that target.

    It’s like a driver with his brakes cut. They want to go 60, they’re going 40 and slowing down. Just telling them to go 100 won’t do anything. How can they accelerate?

    “I do have lots of other posts that discuss various ideas. last year I did long posts on NGDP futures targeting, and on negative interest on reserves, etc.”

    Fair enough, but how does NGDP futures targeting help? It’s a liquidity trap. What would be different with NGDP targeting that doubling the money base wouldn’t?

    “But that makes the monetary injections ineffective, as Krugman and Woodford showed years ago. ”

    Theory is nice, but it needs mechanisms. Krugman never provides any in his liquidity trap papers. Obviously creating inflation would allow a country to escape a liquidity trap. You don’t need to be a tenured professor at Princeton to figure that out. But how can a central bank in a liquidity trap escape it- this is the important question.

    This expectations solution to the liquidity trap is the ultimate in “assume a canopener” economics.

    ‘he market sets the base at the level expected to produce on-target NGDP growth. They pegged the price of gold at $20.67 for 54 years, they can certainly peg the price of NGDP futures contracts.”

    This would simply create more excess reserves.

    “Alternatively, negative interest rates on bank reserves, including vault cash-again, not Tinkerbell, a specific action. ”

    This is not a bad idea, though banks could always buy foreign bonds or use foreign subsidiaries to hold cash. Mattresses come in many forms.

    “More broadly, you seem to think that monetary policy impacts the economy by affecting current interest rates and current levels of the monetary base. But cutting edge theory now suggests that the strongest effects work through expectations of future policy.”

    I think it works through current and through expectations of the future. My main point is that simply announcing a target without changing policy cannot be a credible policy with rational agents. It’s not a very Keynesian view- it’s actually very Chicago school.

    I tend to agree with many of your non-traditional methods like negative interest rates. But if the Fed simply changes what it says and doesn’t change its methods, I see no way that rational agents would see this policy as credible. All evidence points to further QE producing more excess reserves.

    Lucas would no doubt agree with the following statement- simply because theory predicts a result in no way mean rational agents will reach that result it if it requires irrational beliefs. There is nothing more irrational than believing that further QE (ceteris paribus) would have any effect on NGDP.

  72. Gravatar of ssumner ssumner
    14. July 2010 at 07:22

    justanothereconomist, Even at 1/4 point the IOR rate is higher than the rate banks earn on T-bills. That means reserves dominate T-bills and traditional monetary theory goes out the window. I do understand that. But I have never denied that without IOR the market rate might fall to zero, and you still might not get inflation. The most important determinate of monetary policy is the expected future stance of monetary policy. I am certainly not arguing that eliminating IOR would solve all our problems.

    The Fed needs a credible target. If 1%-2% inflation is their target, as you insist, then the Fed is basically hitting its target and there is no problem. It is not that monetary policy is ineffective, it is highly effective, just as in Japan. The BOJ has been highly successful in avoiding inflation, which is its primary policy goal. But in that case the fed shouldn’t have called for fiscal stimulus, what was the point?

    Even Fed officials admit trhat they could do much more, they just don’t want to. And that is the problem.

    BTW, Many economists have argued that the Fed’s decision to double reserve requirements in 1936-37 was a huge mistake. For those who think that nominal interest rates are important, you might be interested in knowing that that policy also increased rates by “only a quarter point.” So why is that generally viewed as being such a big mistake?

    You said;

    “I think it works through current and through expectations of the future. My main point is that simply announcing a target without changing policy cannot be a credible policy with rational agents. It’s not a very Keynesian view- it’s actually very Chicago school.”

    You misunderstood my argument. I agree they must do something. If the Fed sets a 3% inflation target, level targeting, then they need to increase (or decrease more likely) the monetary base to the point where the expected inflation rate is 3%. A mere anouncement is not enough.

    You said;

    “This is not a bad idea, though banks could always buy foreign bonds or use foreign subsidiaries to hold cash. Mattresses come in many forms.”

    Buying foreign bonds would not matter. Foreign subsidiaries of US banks could be policed by the Fed. Banks can’t move $100s of billions of federal reserve notes around without the Fed knowing about it, and they wouldn’t want to risk jail time for fraud when they could just as easily park the money in T-bills. In any case, it is a moot point because it woun’t happen (until we move to all electronic money and there is no cash—about 50 years from now.)

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