A Failure of Imagination (The Big Think, part one)

I was asked to participate in a bloginar called “The Big Think.”  Over the next few weeks we will be commenting on a number of interviews of leading experts on the financial crisis.  The participants are:

Marginal Revolution, Tyler Cowen
Reuters Finance, Felix Salmon
The Balance Sheet, James Surowiecki
Economist’s View, Mark Thoma
Beat the Press, Dean Baker
The Money Illusion, Scott Sumner
Café Hayek, Russ Roberts
The Atlantic Business Channel, Dan Indiviglio
Free Exchange/The Fly Bottle, Will Wilkinson
The Big Questions, Steven Landsburg
Econlog, Arnold Kling
Asymmetrical Information, Megan McArdle
Causes of the Crisis, Jeff Friedman
The American Scene/ The Corner, Jim Manzi
Economics One, John B. Taylor
Free Exchange/The Bellows, Ryan Avent
Naked Capitalism, Yves Smith
The New Republic, Noam Scheiber

I know what you are thinking, how did Sumner get included in that distinguished group?  I don’t know, but I have noticed that in the last few days “Sumnerian” has become a label for a certain type of monetary analysis.  (Here and Here.)  So maybe you must first become an adjective.

I’m going to be highly critical, but this isn’t really directed at David Wessel’s remarks, which can be heard here:

In Fed We Trusted

Who’s to Blame for the Financial Crisis?

The Future of Crises

Deconstructing the Fall

Economic Crisis, Meet the Press

Wessel (of the WSJ news page) holds fairly conventional views on the causes of the crisis.  I will be criticizing that conventional view through Wessel.

I don’t have strong feelings on the regulatory issues.  I expect Congress will pass reforms that interest them (consumer protection), not reforms that address the crisis (banning sub-prime mortgages.)  Indeed if Robert Pozen is to be believed, the Obama administration has begun subsidizing mortgages to people with no income and (effectively) no down-payment.

But regulation isn’t my area, so I’ll leave that to others.  Let’s talk about monetary policy, where I do have strong and heterodox ideas.  I believe that when NGDP growth plunges from its normal 5%, to roughly negative 3%, we can expect a severe recession.  (Doesn’t everyone believe that?)  And I believe the Fed has the tools and responsibility to prevent that from happening.  But first we need to understand how to read the stance of monetary policy.   Wessel argues:

We have 10.2% unemployment today and it’s not because of conventional monetary policy, raising interest rates because there was an increase in the consumer price index.  It’s the result of a finance bubble.

Yes, the Fed did not raise nominal rates during 2008.  But if there is one thing macroeconomists have learned over the last 100 years, it is that nominal rates are a lousy indicator of monetary policy.  Nominal rates fell during the Fed’s tight money policy of the early 1930s, and typically rise during hyperinflation.  Many economists prefer real interest rates.  I have some problems with that indicator as well, but I would point out that ex ante real rates on 5 year TIPS rose from about 0.5% to 4.2% between July and November 2008.  This is of course precisely when NGDP started its precipitous decline.  And Robert Hetzel provided a brilliant dissection of Fed minutes during those key months, which showed that policy was effectively tightened precisely because Fed officials were worried about high inflation (despite the fact that deflation was the real threat.)

Wessel argues that:

One thing is there was a failure of academic economics here.  Too many macro-economists underplayed the importance of finance and of financial institutions and their understanding of the world.

I see his point, which is that academics ignored the buildup to the sub-prime fiasco.  But once the crisis broke the opposite problem occurred.  Almost all macroeconomists blamed the recession on the financial crisis.  They should have had the courage to follow their own models, which tell us that demand-side recessions are caused by overly tight monetary policy.

Wessel was asked whether Wall Street or Washington was more to blame for the crisis.  Here is his response:

But while some aspects of the crisis were made in Washington, I think this one really falls more squarely on Wall Street.

I am one of the few macroeconomists who actually lived through the Great Depression.  No, I’m not in my 90s, but I spent about 10 years reading every NYT from 1929-38, and many other papers as well.  When you immerse yourself in a period in that way, you start to see events unfold as they were perceived at the time.  There were frequent Congressional hearings looking for all sorts of scapegoats, especially evil Wall Street traders and greedy bankers.

At the time, the stock market crash seemed a bolt from the blue, a shock that caused the subsequent fall in NGDP.  But as we learned in 1987, big stock crashes don’t reduce NGDP if monetary policy is set at appropriate levels.

The banking failures really did make the Depression worse, but people failed to understand that banks can’t be expected to make loans that will be repaid in national income falls in half.  (Bankers were actually quite conservative by modern standards.)

I suppose this is all understandable, monetary policy works in very counter-intuitive ways.  After all, the Fed cut rates sharply in the early 1930s and dramatically boosted the monetary base.  Sound familiar?  So it’s not surprising that it wasn’t until years later that economists like Milton Friedman, Anna Schwartz and Ben Bernanke established that the real problem was tight money, and that the Fed (or gold standard) was to blame.  But even if it is understandable, it is still demoralizing to experience (in real time) the same blindness that I read about in the 1930s.

In fairness to the other side, there were two differences in the recent crisis:

1.  Unlike the Great Depression, this time around the private sector really was partly too blame.  The sub-prime crisis of 2007 was caused by reckless lending practices.  But that crisis merely led to a lull in the economy between 2007:4 and 2008:2, with a small rise in unemployment.  The much more severe financial crisis of late 2008 was caused by the sharp fall in NGDP, which depressed the prices of non-subprime housing on the coasts, all housing in the heartland, and also commercial and industrial real estate.

2.  At least this time around the Fed was active enough to prevent a catastrophic 50% fall in NGDP.  Instead it merely fell 8% below trend (so far.)

Because many pundits focus on sectoral issues and miss the deeper monetary factors, there is also widespread misunderstanding about the role of exchange rates.  Here is what Wessel says about the Chinese decision to stop appreciating the yuan in 2008:

This may be something that they think is in their interest, but from where I sit, it’s slowing the process of readjustment and rebalancing the world economy and is not doing the world any favors even though it may be very popular with the Chinese exporters.

A managed exchange rate is first and foremost a monetary policy.  The Chinese decision to stabilize the yuan was an effective depreciation (given their high rate of productivity growth.)  It led China out of its deflationary slump in the dark days of March, and China led Asia out of the recession.  Given that US equity prices responded strongly to the Asian rebound in the spring, it is quite likely that the Chinese recovery removed the tail risk of a severe worldwide slump.

The mistake is to view exchange rates through a trade lens, as a zero sum game.  During a deep slump an expansionary monetary policy will raise both domestic and world output.  Holding other monetary policies constant, a more expansionary Chinese monetary policy means a more expansionary world monetary policy, and this boosts world aggregate demand.  When the US devalued the dollar against gold in 1933 it helped the entire world recover from the Depression.  When other countries devalued against gold, it further helped the world economy.  This time around it was China that led the way.

Again and again we see economists and other pundits focus on the headline news events, the storylines that compel our attention.  But these are merely the froth on the waves, and we have missed the deeper currents that are driving these events.  Most importantly, we are missing the role of monetary policy.  There is one Wessel statement with which I wholeheartedly agree:

In many respects, this crisis was a failure of imagination.

Yeah, I’d say so.



32 Responses to “A Failure of Imagination (The Big Think, part one)”

  1. Gravatar of Thruth Thruth
    3. December 2009 at 13:18

    Quoting Wessel:
    “We have 10.2% unemployment today and it’s not because of conventional monetary policy, raising interest rates because there was an increase in the consumer price index. It’s the result of a finance bubble.”

    Scott then said:
    “Yes, the Fed did not raise nominal rates during 2008.”

    Isn’t he referring to the Fed pushing up rates in the lead-up (say 2004-2006) to the housing downturn? He seems to be making the modest point that you can’t pin the blame for the bust on the rate rise over that period because it was already baked into the cake.

  2. Gravatar of ssumner ssumner
    3. December 2009 at 13:23

    Thruth, Yes, I understood that. But whatever time period he is using, his comment only makes sense if you assume higher nominal rates are tight money. That is what he is assuming, and it is wrong. My point is that if we shift to real rates as the appropriate indicator, as most economists say we should, then the Fed did raise rates (in July-Nov 2008) to kill off inflation.

  3. Gravatar of Bill Woolsey Bill Woolsey
    3. December 2009 at 14:25


    I read “conventional monetary policy” as a planned disinflation implemented by increases in nominal interest rates.

    For example, the recession of 81-82, engineered by the Fed to bring down inflation–implemented by increases in nominal inerest rates.

  4. Gravatar of yep yep
    3. December 2009 at 16:59

    Yes, it is monetary policy for China to intervene to keep the Yuan low. Was it good for China – yes. Was it good for the globe – yes. Was it good for America – doubtful. The Yuan is pegged to the dollar so it is a zero-sum game in that what they do that is expansionist for China is contractionary for the US. It might be that China leads the world to growth which helps the US, but what they are doing in the short term is counteractive a lot of what the Fed is trying to accomplish.

  5. Gravatar of Scott Sumner Scott Sumner
    3. December 2009 at 18:40

    Bill, Yes, but let’s be honest here, he must be arguing that the recent recession was not caused by any sort of adoption of tight money by the Fed in order to slow inflation. Otherwise the next sentence (blaming it on financial turmoil instead) would make absolutely no sense at all. I should have had more surrounding sentences for context. But I can almost guarantee that Wessel would agree with me that the quote was intended to basically say inflation-fighting tight money of any sort was not to blame. But, in fact, as Hetzel showed inflation fighting tight money was to blame. YOY inflation exceeded 5% in mid-2008, and the Fed was worried.

    yep, nope.

    (Sorry, I couldn’t resist.) The point is that monetary ease in China raised world AD, and that helps everyone. Again, it is not a zero sum game. It is not true that just because China gains the US loses.

  6. Gravatar of TGGP TGGP
    3. December 2009 at 22:11

    Daniel Indiviglio should also be mocked.

  7. Gravatar of Doc Merlin Doc Merlin
    3. December 2009 at 23:46

    “But, in fact, as Hetzel showed inflation fighting tight money was to blame. YOY inflation exceeded 5% in mid-2008, and the Fed was worried.”

    Yes, because of inflation/GDP expectations work, attempts to fight inflation are the same as causing deflation. This is why some Austrians say that the only way you can make inflationary economics work without having recession for monetary reasons is to keep ratcheting up the money supply faster than inflation, this however causes in the long run, hyperinflation.

    I don’t really see how the fed can do effective targeting without repeatedly breaking the economy over its metaphysical knee occasionally. It simply doesn’t have the flexibility, speed, or accuracy that a free market currency would with many competing currency issuers that are subject to failure.

  8. Gravatar of Van Van
    4. December 2009 at 05:59

    scott, what is the assumption on your assesment of chinese monetary policy? by cheapening chinese goods prices in non-yuan terms, that in fact increases world demand for chinese goods? if so, why ever stop depreciating? why should any country stop depreciating, if the assumption and conclusion is that world aggregate demand will go up based on these actions…it will just become a game of who depreciates when. what am i missing?

  9. Gravatar of ssumner ssumner
    4. December 2009 at 07:21

    TGGP, Hmmm, I had trouble following all that. The entire piece seems more reasonable, as he concludes by noting that their plan would be a logistical nightmare. But I can’t make heads or tails of that quotation. The argument would only make sense if you followed the plan to the reductio ad absurdum of rebating the exact amount each individual paid. But if that’s what he was trying to say, it didn’t come off very clearly.

    Doc merlin. NGDP was only growing at 3% in late 2007 and the first half of 2008. So with NGDP targeting you don’t face the problem that you mentioned.

    Van, I am not sure I follow your question, but you stop depreciating as soon as NGDP is expected to grow at the target rate. And that is not just true of China, but all countries should follow that policy.

    Otherwise, if you keep depreciating you get hyperinflation.

  10. Gravatar of M. Belongia M. Belongia
    4. December 2009 at 08:16

    Just one quibble with your post: Monetary economists have NOT learned that interest rates are a lousy indicator of the stance of monetary policy. Autopsies by Hetzel (FRB-Richmond) and Thornton (FRB-St.Louis), for example, both reveal that the FOMC considered monetary policy to be accommodative as of mid-2008 because the funds rate was low even though the five-year rate of growth for the base at this point in time was zero or slightly negative. That the funds rate might decline because of a leftward shift in the demand for reserves never seems to cross the minds of (most) monetary economists and, as a result, interest rates can be (of are) a terrible indicator of the stance of policy. But this is NOT a lesson the profession has learned. In fact, the adoption of the wrong lesson — that interest rates are the best indicator of the stance of monetary policy — has become more embedded since the funds rate been labelled, mistakenly, as the Fed’s “instrument” of policy rather than as its intermediate target. Words do matter here.

  11. Gravatar of happyjuggler0 happyjuggler0
    4. December 2009 at 08:54


    There are two issues here with regards to a country’s monetary policy. First, there is monetary policy’s effect on inflation and the real economy, or as Sumner would put it, its effect on NGDP. Second, there is the effect of monetary policy on the foreign exchange rate.

    A genuinely loose monetary policy has the effect of boosting NGDP, and all else equal will also devalue the currency’s value in the foreign exchange market. This correlation confuses many people into thinking that the devaluation is causing the increase in NGDP, while in reality it is the monetary policy that is causing them both. This causes them to talk of “beggaring they neighbor” and thinking in zero sum terms.

    With regards to China, the fact that it has its exchange rate pegged to the dollar at a quasi-fixed rate further adds to the confusion of those thinking in zero sum terms; nevertheless the same thing is happening. The only way for China to appreciate its currency vs the dollar when the Fed is pursuing a tight money policy is for China to also have a tight monetary policy.

    If China pursued a tight monetary policy, its country’s NGDP would be much lower than it is, and that would be a bad thing for the global economy. We need more global demand, somehow, someway. More global demand (created by China or elsewhere is still helpful to us) would be a very good thing, therefore we want China’s NGDP to rise at a significant rate, therefore we want China to have a “loose” monetary policy (for now anyway, while there is a dearth of AD), and since China’s currency is pegged to the dollar, then we most definitely do not want the yuan to appreciate vs the dollar (at least so long as the Fed isn’t pulling its weight), because that would mean that NGDP would be lower than it otherwise would have been.

    Scott Sumner has from time to time begged the *all* world’s central banks to engage in “beggaring their neighbor’s” via genuinely loose money. Now of course if all of the world’s central banks pursued a loose money policy, then they can’t all devalue their currencies against each other. This is irrelevant, the relevant issue is that there is too much demand to hold money (i.e. the velocity of money is too low in the MV=PY tautology), therefore the central banks need to increase the supply of money (M) in order for Aggregate Demand (PY) to rise like we desperately need it to.

    Devaluing your currency vs another’s, or maintaining a peg deemed “low”, doesn’t help the country that devalues by increasing exports; instead it is the policy mechanism (increasing the money supply) that causes the exchange rate of the currency to fall (all else being equal) that deserves the credit for improving the economy in question. And since we are all interconnected via trade and finance, their increase in AD helps us too.

    P.S. I am really just summing up what Scott Sumner taught us here on his blog, or at least my understanding of those lessons. Scott or Bill, if I am in the wrong please let me know ASAP!!! 🙂 🙂 🙂

  12. Gravatar of Van Van
    4. December 2009 at 09:38

    That cleared up a ton! thank you!

    But this section is confusing “Devaluing your currency vs another’s, or maintaining a peg deemed “low”, doesn’t help the country that devalues by increasing exports; instead it is the policy mechanism (increasing the money supply) that causes the exchange rate of the currency to fall (all else being equal) that deserves the credit for improving the economy in question. And since we are all interconnected via trade and finance, their increase in AD helps us too.”

    Are you saying exports dont rise when a country pursues depreciation thru loose money? i want to be clear i am understanding this because it seems vital to this blog’s key elements

  13. Gravatar of Mark A. Sadowski Mark A. Sadowski
    4. December 2009 at 09:56

    I’ve been leaving links to your blog in my usual econblog haunts. This particular post is so beautiful and crystal clear I just had to say something. Normally I’m very long winded but whenever I read your blog I’m typically left in speechless agreement. I’m almost at the point of describing my monetary economic views as “Sumnerian”. Keep up the good work.

    P.S. Thanks to you I’m also beginning to feel like some kind of blasted toady!

  14. Gravatar of JimP JimP
    4. December 2009 at 10:16

    Another plea for a more aggressive Fed:


    “A roadmap for more fed easing”

    But will we get it? No. Bernanke dare not do so alone – the hearings before the Senate banking Committee yesterday were clear – if you inflate we will destroy you. As with Japan, so here – the crazed deflationists are running the show.

    He will get a more aggressive Fed only if Obama backs Bernanke – and he does not have the nerve to do so.

  15. Gravatar of JimP JimP
    4. December 2009 at 10:16

    He = We

  16. Gravatar of Joe Joe
    4. December 2009 at 11:57

    So, the best solution is to target NGDP growth. What is the best approach from where we are now to move toward a solution that in effect is akin to Roosevelts devaluation vs. Gold. If the fed just provides money to the banking system, as it seems to now, does it make its way into the economy at large, or does it just impact bank speculation with all the added liquidity. The beauty of the Roosevelt devaluation it was almost like he just increased everyone’s cash balance overnight because everyone that had dollars was impacted. Should the fed print a 10,000 check for everyone, printing press financed? It seems as if the current approach does not get money into the system as a whole.

  17. Gravatar of StatsGuy StatsGuy
    4. December 2009 at 12:07

    Hetzel basically argues something that a number of us have been trying to convince you – the Fed was watching oil prices in summer 08 rather than TIPS. Note, specifically, the comment about concern for a depreciating dollar.

    Why should the Fed, directly, care about a depreciating dollar? They shouldn’t. But they were concerned about import prices and feed-through into commodity-push inflation. They perceived the beginning of a run on the dollar via commodity prices, and they effectively acted to protect the dollar (and the consumption-focused economic structure).

    But don’t think that this won’t happen again just because we now have history behind us… So long as oil (and other imported commodity) prices remain volatile and substantial, and so long as they feed-through into domestic prices, and so long as the Fed focuses on near-term (rather than expected) inflation (or prices), and IF other countries actually do manage to decouple from the US (and that, I think, was the big mistake in the hypothesis), then as the dollar devalues and oil prices go up (if global demand stays steady), the pareto curve between inflation and unemployment will shrink inwards. The Fed will raise rates to protect the dollar to stop commodity push inflation – this is another reason why NGDP is a better target than inflation. In an import dependent economy, it may be necessary to devalue the currency more rapidly than 2% because emerging economies are growing faster (and thus competing more heavily for scarce commodity resources, which pushes up prices). This is an endemic issue – and we have not dealt with it. We have only been given a brief reprieve at the cost of crippling the entire global economy (to temporarily suppress global demand). But as the EM countries increasingly supplant US demand, each successive wave will force a worse tradeoff between unemployment and inflation.


    separately, ssumner writes:

    “During a deep slump an expansionary monetary policy will raise both domestic and world output. Holding other monetary policies constant, a more expansionary Chinese monetary policy means a more expansionary world monetary policy, and this boosts world aggregate demand.”

    I noticed you added the phrase “holding other monetary policies constant”. So yes, in a deflationary environment, if country A foolishly commits to not expanding money supply, they are (all things being equal) better off if country B expands aggressively. vis-a-vis your argument that the income effect dominates…

    BUT, that’s _not_ what we balanced-trade-focused people are arguing. We’re arguing that the US would be better off, all things equal, if WE devalued a little more and CHINA devalued a little less, but that the US cannot directly control the bilateral exchange rate because the US does not use currency controls and China does. China’s policy FORCES the Yuan lower PRECISELY BY KEEPING THE DOLLAR OVERVALUED.

    But if your counterargument is that the US is doo dumb to run its own monetary policy during a demand crisis, and we’re better off if China does it for us, perhaps you are correct.

  18. Gravatar of rob rob
    4. December 2009 at 13:13

    Today Yglesias writes:

    “The fact that the kind of people likely to be personal friends with policymakers and pundits have been in okay shape since the stock market stopped tanking seems to be obscuring from a lot of people the basic reality that a dramatic situation calls for dramatic action.”


    Could this be a factor? The unemployment rate for white people with a college degree is only about 4%. If it weren’t for reading about it, I would have no idea there was any problem with the economy right now. Everyone I know–all in the private sector–are still making good money. Neither I nor any of my neighbors are out of work. What crisis?

  19. Gravatar of Don the libertarian Democrat Don the libertarian Democrat
    4. December 2009 at 14:15

    “These procedures require consistency (a rule-like character) because of the central role of expectations.”

    That’s from Hetzel. I’d like to recommend his other recent essays as well. Obviously, I believe that they’re generally spot on. With Scott and Nick Rowe, we’ve been provided with a very strong case for the central role and importance of monetary policy before and during this crisis.

  20. Gravatar of happyjuggler0 happyjuggler0
    4. December 2009 at 14:30


    I’m sorry about that bit. I realized after posting it that it is a bit too ambiguous in the section you quote.

    New exports help. However that is more of a secondary benefit. The real benefit comes from increased NGDP, and that comes from looser money which compensates for too much demand to hold money (i.e. too little velocity of money).

    Also, Sumner (and Krugman, merde) has persuaded me that the key is actually targeting expectations of future policy. Every time the Fed “assures” people that it has a viable “exit policy” from its alleged QE, it is making things worse because what we need right now is more *expectations* of monetary policy that is “too loose”, even if ultimately it is not actually “too” loose.

  21. Gravatar of Matthew Yglesias Matthew Yglesias
    4. December 2009 at 16:43

    Could this be a factor? The unemployment rate for white people with a college degree is only about 4%. If it weren’t for reading about it, I would have no idea there was any problem with the economy right now.

    It has to be a factor — 16.3 percent of African-American men are unemployed. If 16.3 percent of FOMC members’ friends and acquaintances were unemployed, I don’t think they’d be desperately generating rationalizations to avoid further easing.

  22. Gravatar of Doc Merlin Doc Merlin
    4. December 2009 at 17:17

    Matthew Yglesias, I don’t think easing will help. It will through inflation get rid of the minimum wage effect, but won’t get rid of the effects coming down the pipelines in the form of benefits mandates.

    Unemployment is high at the bottom for a reason! What we had is too easy money which caused a credit crunch combined with a legal crisis. These generated massive problems, the fed rushed in to fix the problems and we ended up with a monetary crisis. Any easing now, at current very low interest rates will get washed away by the carry trade. We have painted ourselves into a corner, monetarily and easing won’t fix it.

    On second note, unemployment is going to start dropping again, after December, because it looks like cap and trade has died, and there is a good chance the health insurance mandate will die. Both were seen by employers are a massive possible future expense and they were scared to hire.

  23. Gravatar of Doc Merlin Doc Merlin
    4. December 2009 at 17:18

    hrm, I didn’t mean to imply that the easy money from 2001 to 2007 caused the legal crisis. That was just coincident and not actually related.

  24. Gravatar of Joe Joe
    5. December 2009 at 11:12

    Business hire when they think they can make money. mandates and that BS DO NOT have an effect on my hiring decisions; If someone is going to help my firm make money, I hire them.

  25. Gravatar of Doc Merlin Doc Merlin
    5. December 2009 at 12:50

    Joe, you mean you don’t do a cost/benefit analysis when hiring people?

    Insurance costs and pay and such would go on the cost side and what they can produce for you on the benefits side. If the costs go up, then wouldn’t you be less likely to hire that marginal worker because they cost you more?

  26. Gravatar of rob rob
    5. December 2009 at 16:03


    I agree. I think this explains the complacency of the elitist left as well as the uberhypercountersumnerianism of the right.

  27. Gravatar of Doc Merlin Doc Merlin
    5. December 2009 at 17:35

    Did you just call the right wing, racist?

  28. Gravatar of rob rob
    5. December 2009 at 19:14


    No, I merely called them uberhypercountersumnerianismistic. I make no moral judgments over the meaning of that.

  29. Gravatar of Joe Joe
    6. December 2009 at 07:37


    Of Course, but if the margins were so thin to begin with they would be on the sidelines, because every employee we target is valued at 3x cost. So a small marginal bump in mandates makes no difference, especially if the manpower is needed to grow the business, improve my scale, and bring in other unique resources to my firm. Those are all benefits that are hard to value, but that I place a VERY high value on. Culture makes and kills an organization.

  30. Gravatar of ssumner ssumner
    6. December 2009 at 09:21

    M. Belongia, Yes and no. You can find all sorts of academic writings over the last few decades that explain why interest rates are not a good indicator of monetary policy. Our leading textbooks say it is not a good indicator. But you are absolutely right that this lesson seems to quickly be forgotten when people evaluate real world policy issues.

    And you are also right about the confusion over the distinction between instruments and targets.

    happyjuggler0, Well put. I am planning another post on this issue.

    Van, Exports may rise, but imports may rise even more. The trade balance of the US actually got worse after we devalued sharply in 1933 (and were accused of beggaring our neighbors). And China’s trade surplus has gotten much smaller over the past year. Because their expansionary monetary policy propped up their domestic economy, China’s imports have fallen less than China’s exports.

    Thanks Mark.

    JimP, Yes, I saw that as well, and did a newer post commenting on Free Exchange.

    Joe. The closer equivalent would be to set a CPI, or preferably a NGDP target path. FDR targeted the WPI, and said he wanted to raise prices to 1926 levels. He never got there in the 1930s, but he did raise them considerably.

    If we do that, we won’t have to print a lot of money. If necessary, reduce bank hoarding of excess reserves through a penalty rate.

    Statsguy, You said;

    “Hetzel basically argues something that a number of us have been trying to convince you – the Fed was watching oil prices in summer 08 rather than TIPS. Note, specifically, the comment about concern for a depreciating dollar.”

    You don’t need to convince me, I agree. I argue that the Fed should have looked at TIPS. But clearly they didn’t pay much attention.

    You are making an argument that I’ve seen others make, that more AD will create a supply shock (higher oil prices.) Maybe, but that would be good news nevertheless. And I agree with your punch line, that this shows why we should focus more on NGDP than inflation. NGDP growth was slow in the first half of 2008.

    Your final point about the US responding to China is related to a Free Exchange post that I plan to comment on, if I can ever find time!

    rob, I think Yglesias’ right. 10% unemployment is just a number to lots of people (including me.) You need to force yourself to think of the real world pain this causes.

    Thanks Don.

    Matthew, Yes, I think that is a good point. It isn’t that they don’t care. Bernanke would surely prefer lower unemployment. But the risks are nowhere near balanced. And it is the Fed’s job to balance those risks. Right now the risk of excessively high unemployment over the next few years greatly exceeds any inflation risk.

    Doc Merlin, I think only a small part of the 10% unemployment is due to minimum wage increases and extended jobless benefits. So I think AD would help a lot. Having said that, the minimum wage increase was poorly timed.

    And BTW, don’t assume health won’t be passed, I think it will pass.

    Joe, Perhaps. But a general comment regarding incentives and macro. A disincentive that only causes 1 out of every 50 workers to lose jobs, can still put us in a recession. Thus some incentive effects can have more of a macro effect than common sense would suggest. So it is misleading to imagine a “typical firm” and then thinking if that firm doesn’t lay off workers, there will be no macro effect.

  31. Gravatar of happyjuggler0 happyjuggler0
    12. December 2009 at 13:00

    Dec. 12 (Bloomberg) — China’s industrial production jumped, exports fell the least in 13 months and imports surged in November as rebounding trade with Asian nations underscored the region’s role in leading the world recovery.

  32. Gravatar of ssumner ssumner
    13. December 2009 at 08:27

    Thanks happyjuggler0. I also noticed that and was was thinking of doing a post on it. There is just too much to comment on. But China has definitely been an engine for the world economy. Not enough to prevent a severe recession, but enought to cut the tail risk of an outright depression.

Leave a Reply