A Keynesian grapples with QE

Back from vacation and still alive.   (Just missed a head-on collision in the Ted Williams tunnel last night–think about what that means.)  I noticed that commenters sent me lots of Paul Krugman columns.

Part 1:  Each week Krugman seems to inch a bit closer to adopting the ideas that I asked him to support in my open letter of March 2009.  A few months back he endorsed Joe Gagnon’s call for QE plus eliminating interest on reserves—both of which were included in my open letter.  And now he seems to endorse price level targeting.  (In the past he generally discussed inflation targeting.)  Level targeting was the third and final item in my post.

Unfortunately, Krugman still doesn’t seem to understand that we don’t need a very high inflation rate, just a figure slightly higher than the 1% we’ve recently been experiencing:

What am I talking about? Something like a commitment to achieve 5 percent annual inflation over the next 5 years “” or, perhaps better, to hit a price level 28 percent higher at the end of 2015 than the level today. (Compounding) Crucially, this target would have to be non-contingent “” not something you’ll call off if the economy recovers. Why? Because the point is to move expectations, and that means locking in the price rise whatever happens.

It’s also crucial to understand that a half-hearted version of this policy won’t work. If you say, well, 5 percent sounds like a lot, maybe let’s just shoot for 2.5, you wouldn’t reduce real rates enough to get to full employment even if people believed you “” and because you wouldn’t hit full employment, you wouldn’t manage to deliver the inflation, so people won’t believe you. Similarly, targeting nominal GDP growth at some normal rate won’t work “” you have to get people to believe in a period of way above normal price and GDP growth, or the whole thing falls flat.

As I wrote way back, the Fed needs to credibly promise to be irresponsible “” at least from the point of view of the VSPs.

Krugman seems to think that you need high inflation in order to get real interest rates low enough to produce robust growth in aggregate demand.  He should have gone to the Karl Brunner conference I attended in Dallas, where he would have learned that money affects all sorts of asset prices, not just T-securities.  I suppose he would argue that QE would also fail to boost those other asset prices (because we are in a liquidity trap) unless the real interest rate falls low enough to significantly boost AD.  But we know that is wrong for both theoretical and empirical reasons:

Empirical evidence:  Haven’t we just seen stock and foreign exchange prices rise briskly in response to hints of Fed easing?  And recall that an extremely modest program is being advocated (Krugman’s right about that), with every indication that Bernanke is not willing to go past QE and adopt level targeting.  Just imagine how the markets would respond if the Fed said they’d do whatever it takes to raise core inflation expectations to 2.7% over 2 years (to catch up for the recent undershoot.)  Unless I misunderstood Krugman, he seems to think there is no monetary policy capable of doing that—i.e. that policy would either under- or overshoot 2.7% inflation.  It would need to produce high inflation expectations in order to get any serious boost to AD, and if we didn’t have high inflation expectations, we’d be stuck around 1% inflation.

Theory:  Krugman’s theory ignores the fact that as the expected NGDP growth rate rises; the Wicksellian equilibrium real rate also rises.  For instance, suppose that given the current expectation for weak nominal growth, it would take a minus 5% real short term rate to significantly boost AD.  Now assume the Fed does enough QE to raise one year NGDP futures to 8% above current levels.  Krugman himself argues the SRAS is currently quite flat, so this implies the 8% NGDP growth would be associated with only 2% or 3% expected inflation, and 5% or 6% expected RGDP growth.  Krugman might argue that 2% or 3% inflation expectations are not enough to get the needed reduction in real rates.  But if people really did expect 8% NGDP growth, then real rates would not have to fall nearly as far to boost spending—all sorts of other asset prices would be rising fast and that would help generate the required boost in AD

On many issues I disagree with most traditional monetarists.  I think they put too much weight on the monetary aggregates, and I think some are too worried about an inflationary time bomb being embedded in current Fed policy.  I think some are too enamored of the Austrian explanation for how we got in this mess, overlooking just how tight money was in 2008 (I’m of course exempting monetarists like Robert Hetzel.)   But they are completely right about one thing; we’ll never get anywhere as long as we keep evaluating monetary policy solely in terms of an interest rate transmission mechanism.  QE raises future expected NGDP, and that raises current asset prices and current AD.  Which assets?  Stocks, commodities, commercial real estate, foreign exchange, etc, etc.  Given how flat the current SRAS is, we can do a lot more stimulus without triggering much inflation.  Indeed back in 1993 (JEP) Robert King argued that in a rational expectations model monetary stimulus might well raise real interest rates, as a result of expectations of much higher levels of investment.  Real interest rates are not the issue.

Part 2:  Krugman’s completely correct in this post about why common sense doesn’t help much in macro.

Part 3:  Krugman continues to insist Milton Friedman was dishonest in asserting that the Fed caused the Great Contraction, a charge he made in a NYR of B article right after Friedman died (a time when many of his fellow liberal economists were praising Friedman.)

You can see, by the way, why I get so annoyed with the vulgar-Friedman claim that the Fed caused the Depression, as opposed to, perhaps, failing to prevent it: monetary base actually rose substantially from 1929 to 1933.

I agree that the point is debatable, but given that eminent Depression expert Ben Bernanke agrees with Friedman, it’s a bit over the top to accuse him of dishonesty.  And why the monetary base data?  Since when is that an indicator of whether money is too easy or too tight?  Neither Keynesians nor monetarists favor targeting the base, and the Fed was given the responsibility of being a lender of last resort, not base targeting.  Even as far back as the 1930s prominent economists like Hawtrey and Fisher accused the Fed of abandoning NY Fed President Strong’s counter-cyclical policies after his death in late 1928.  My own view is that both the Fed and the Bank of France played major roles in the Great Contraction.  But the Fed’s role was particularly important between October 1929 and October 1930, when the US monetary base fell about 8%.  This important episode of tight money is almost impossible to see on Krugman’s chart.  Yes, the base did subsequently rise during the banking panics, but not enough to offset their effect on the multiplier.

This argument is actually about the merits of laissez-faire capitalism.  Keynes argued that the Depression showed why laissez-faire was bad.  Friedman and Schwartz showed that big government wasn’t needed, that laissez-faire would work fine as long as the central banks didn’t adopt deflationary policies.  It’s not hard to see why Krugman doesn’t like that message; he shares Keynes’s preference for a big and active government that relies heavily on . . . well, smart economists who also believe in big and active governments.

Krugman also misunderstands the role of monetary policy in the recovery, but I’ll skip over that as Gauti Eggertsson already corrected him on that point.

He ends the post by arguing that our task is much more difficult than the one that FDR faced, as we need higher inflation, whereas they simply needed to return to the 1929 price level.  But as I argued above, Krugman grossly exaggerates how much more inflation we actually need.

Part 4:  Krugman likes to criticize conservatives who believe all poor people are welfare queens.  So what are we to make of the fact that Krugman seems to approve of this idiotic statement which stereotypes financial asset market investors?  (Note, the quotation is in a Krugman post, it is not his words.)

The markets want money for cocaine and prostitutes. I am deadly serious.

Most people don’t realize that “the markets” are in reality 22-27 year old business school graduates, furiously concocting chaotic trading strategies on excel sheets and reporting to bosses perhaps 5 years senior to them. In addition, they generally possess the mentality and probably intelligence of junior cycle secondary school students. Without knowladge of these basic facts, nothing about the markets makes any sense””and with knowladge, everything does.

Yes, I get the fact that there are good reasons why it would be much more offensive to do this sort of stereotyping of poor people.  But is it really any less stupid?  Over the past three years these drug-addled traders have been much more accurate than the world’s central banks in their predictions about the macroeconomy.  They saw the AD problem long before the Fed.  And didn’t Keynes say our capitalists needed to keep their “animal spirits” revved up?

Part 5:  In this recent post Krugman claims, with some justification, to have foreseen the current situation before the rest of us.  So it’s a pretty good post.  But there’s just one problem; when Krugman makes this statement:

The slide toward deflation despite huge increases in the monetary base hasn’t shaken either the paleomonetarists who still predict hyperinflation or the it’s-all-the-Fed’s-fault crowd.

he overlooks the fact that his own model says “it’s-all-the-Fed’s-fault.”  They need to set a higher inflation target.  They refuse to do so (just as the BOJ refused to shoot for even 2% inflation.)  It’s not that they are powerless; it’s that they refuse to exercise the power they have.

Part 6:  Here is Krugman arguing that the Bank of Japan was just spinning its wheels when it tried QE.

But the Bank of Japan tried that “” and found that pushing more reserves into the banks didn’t even lead to rapid growth in the money supply, let alone end the problem of deflation. Here’s a chart of growth rates of the monetary base and of M2, Friedman’s preferred monetary aggregate:

We both agree that temporary currency injections are ineffective, and we know that the real demand for base money will rise when nominal rates fall close to zero.  I’d be the first to agree that the “paleomonetarists” have not adequately addressed these issues.  But notice the graph he uses stops at December 2005.  Could that be because the monetary base fell about 20% in 2006, thus showing the increase was partly temporary?  Remember, the BOJ needs to promise it will leave enough base money in circulation to produce a higher price level.  It refuses to make that promise, and it refuses to actually do that policy.  No surprise that QE hasn’t worked.  I’ve debated Krugman on this issue before, and he certainly is aware of the 2006 data.  Was the data left off because he wished to hide an “inconvenient truth?”  Or was it merely a random decision to end his graph in December 2005?  You make the call.

Part 7:  OK, one more Paul Krugman post then I hope you Krugman-haters will be satiated.  Here he scratches his head over the modest increase in inflation expectations that have occurred since the Fed started talking about QE2:

Financial markets seem convinced that quantitative easing will be highly effective at solving at least one problem: inflation running well below the Fed’s 2-percent-or-so target. The chart above shows the difference between interest rates on 5-year inflation-protected bonds (which are now negative) and rates on unprotected bonds; implicitly, the market forecast of inflation over the next five years has risen half a point.

But I really don’t understand this.

I’m not surprised he’s confused, given that (as we saw in Part 1) Krugman doesn’t think this is possible.  He doesn’t think the Fed can create a modest increase in inflation expectations—it’s all or nothing.  And don’t say he was talking about the level of inflation needed for a robust recovery in RGDP.  He’s also on record arguing the SRAS curve is relatively flat right now.

PS.  Apologies to fans of Krugman, but when I returned from vacation I found my commenters were demanding blood.  And I did say one and two-thirds of his recent posts were excellent–how many right-wingers would have given him credit for those posts?

PPS.  Apologies to other bloggers that I may have inadvertently plagiarized.  I haven’t had any time yet to catch up on other blogs.

PPPS.  My taxi driver rounded a bend last night in the TW tunnel, and some idiotic lady was coming right at us in our lane!  Not more than 100 yards away.

HT:  JimP, Marcus Nunes, David Beckworth and others (I still have many comments to read.) David is also cited by the WSJ, and his blog has some Krugman rebuttals that partly overlap with my post.



25 Responses to “A Keynesian grapples with QE”

  1. Gravatar of C C
    1. November 2010 at 19:24

    This post is good except for this part:

    ” Friedman and Schwartz showed that big government wasn’t needed, that laissez-faire would work fine as long as the central banks didn’t adopt deflationary policies. It’s not hard to see why Krugman doesn’t like that message; he shares Keynes’s preference for a big and active government that relies heavily on . . . well, smart economists who also believe in big and active governments.”

    You’re (a) assuming Keynes a priori liked “Big Government” (b) that Krugman shares Keynes’ normative values in favor of BG and thus, both consequently do not like monetary policy to combat a recession.

    I think you do both K’s an injustice here.

    It seems to me that the argument is actually (a) *true* lessaiz faire capitalism – no Fed or a Fed that prints a fixed amount of money every year – is too volatile (b) this volatility has huge real effects on particular people and their lives (c) there is a mechanism by which a government can mitigate this volatility and thereby save capitalism from itself (in someone’s famous words).

    Which point do you think is wrong and why?

  2. Gravatar of Doc Merlin Doc Merlin
    1. November 2010 at 19:28

    “It’s not that they are powerless; it’s that they refuse to exercise the power they have”

    I thought his model was that they tried and failed?

  3. Gravatar of W. Peden W. Peden
    2. November 2010 at 03:02

    Doc Merlin,

    I think it’s both.

    As for Keynes scholarship, I think that there are laissez-faire elements in Keynes (remember, he wanted someone like Friedrich von Hayek to control the levers of economic management because someone like von Hayek would only use them when totally necessary) that get overlooked because they are inconvenient to both the “left” and the “right”.

    Liberals, in American parlance, have a tough time dealing with the fact that Keynes was a 19th century classical liberal who loved speculation, thought nothing of anything Marx said, preferred local government to central government and wanted a laissez-faire state 90% of the time.

    Conservatives, again in American parlance, have a tough time dealing with the fact that Keynes is not the socialist bug-bear of legend. The difference between Keynes and Keynesianism is apparentely as difficult for conservatives as for liberals.

    However, since very few people (and I’m talking about professional economists) are willing to take the time to actually read the General Theory, let alone the Treatise, the Tract etc., the mythology of Keynes-the-critic-of-laissez-faire can proceed and people can ascribe beliefs to Keynes that have more in common with Joan Robinson or Joseph Stiglitz than J. M. Keynes.

    This is all compatible with Keynes’s work becoming the key intellectual arsenal for interventionists and hyper-interventionists. Krugman certainly seems to quite like big government, albeit not as much as most of the American left. However, if there is a Nobel prize winner who loves big government a priori, surely it is Stiglitz and not Krugman?

  4. Gravatar of James in London James in London
    2. November 2010 at 04:06

    Your debates with other macroeconomists over whether to target NGDP or not, do still seem to very much assume that there is a readily measurable, analysable, manageable NGDP. I think your biggest problem is that you want to to use monetary expansion to control something that is far bigger than what you think you are dealing with.

    The dollar is a global currency. As a result the NDGP you are then influencing is not the American one, but a global (or at least $-area) NGDP. I think that that, almost unmeasurable, global (or at least $-area) NGDP is already growing much faster than US NGDP. The danger that most of the world appreciates from QE2 is that the “benefits” of QE1 leaked out of the US into the global (or at least $-area) NGDP.

    That wider area NGDP includes a large part of China, given its tie to the $, but also lots of other places too, and lots of other parts of economies with their own “independent” currencies that have large dollarised sub-economies (Mexico, Turkey, Phillipines, Mid-East, etc, etc). I think your whole project to target merely US NGDP falls because you and Krugman and most others who debate on this site are essentially little Americans, who don’t seem to understand there is no pure US NGDP. Dollar-area NGDP is a multiple of little America. I think the mainstream economics profession calls this “leakage”. I’d call it a torrential flood of newly-minted US$ out of little America into the wider, dollarised, world where NGDP is rising rapidly.

    That is why the G20 and markets are worried about QE2. That bond markets keep going up is because of the big buyer in the room, using printed money. If the US were merely printing money to pay its bills directly rather than through the bond markets then US bond prices would be more free to find their own level and would be considerably higher. Although the value of US sov bonds has already fallen heavily as the US$ currency has fallen, even if yields haven’t moved. The only option for little America to get it’s NGDP growing again is control the deficit and give people confidence that the US is not on a path to fiscal ruin.

  5. Gravatar of scott sumner scott sumner
    2. November 2010 at 05:16

    C, Yes, I think it is fair to say Krugman favors big government.

    The laissez-faire question is beside the point. The US economy was not laissez-faire in 1929–the Fed was run by the government. Friedman and Schwartz argued the Fed made things worse, that the Depression was worse because of the Fed’s actions (as compared to the pre-Fed era.) But of course we weren’t completely laissez-faire before the Fed either.

    BTW Friedman was not a laissez-faire purist–he thought the government should have a role in monetary policy. That’s a separate issue from “big government.”

    Doc Merlin, No, Krugman has criticized the Fed for not adopting the sort of effective monetary stimulus that he favors–which would be a higher inflation target.

    W. Peden, You can find Keynes’s quotations for any point of view–pro or con. But in the 1930s he advocated the socialization of investment. He said we shouldn’t import things than can be made at home. So he certainly didn’t favor small government at that time. Perhaps during WWII he became disenchanted by the size of government.

    James. I wrote my dissertation on currency hoarding, so I am well aware of the dollar holdings that exist outside the US. Your comment confuses two completely unrelated issues:

    1. Currencies that are pegged to the dollar
    2. Countries that hold large amounts of Federal Reserve notes.

    It’s up to each individual country to decide whether it wants to inflate if the US decides to do so. The Chinese have already indicated that they do not wish to inflate, and just as in 2005-08 they will revalue the yuan to avoid that fate. Indeed they have already begun doing so.

    The Fed’s ability to conduct monetary stimulus is not in any way affected by foreign holdings of cash. They simply accommodate that demand, and then target the domestic nominal aggregate that reflects the policy objective. They have always been able to easily adjust to changes in foreign demand for currency (such as when the Soviet bloc collapsed.)

  6. Gravatar of W. Peden W. Peden
    2. November 2010 at 06:08

    Prof. Sumner,

    It’s true that Keynes certainly said different things over time. But even the most left-wing quotes one can find, like “socialisation of investment” are misunderstood. Keynesian public works are nothing you won’t find in Adam Smith.

    Keynes’s views on trade tended to be more consistently interventionist, although it’s unclear to what extent he simply assumed that was an inevitability, especially in the 1940s. His work in the 1940s clearly assumes that the state will maintain strong controls on trade and major industries, otherwise his proposals have big inflationary problems.

  7. Gravatar of Blackadder Blackadder
    2. November 2010 at 06:10

    Let your conscience be clear, Scott. You don’t inadvertently plagiarize someone just because you and they have the same idea.

  8. Gravatar of Liberal Roman Liberal Roman
    2. November 2010 at 07:34

    I think the problem about our current situation can be summed up if you go and look at what Krugman is discussing right now on his blog. He is arguing with people who don’t believe in accounting identities.

    Since, the beginning of this crisis, I’ve felt the whole public discourse has been incredibly depressing. Instead of arguing about what stimulus is proper and necessary to get us out, the argument is always do something versus do nothing.

    And the do nothing crowd dominates the debate, especially online and in the blogs.

    Of course, in the end comes down to the fact that those people continue to believe that the real problem is _______.
    And as Scott so brilliantly put it in his FAQs, there is no real problem, it’s all a nominal problem.

    This is why, despite being more or less convinced that monetary stimulus should be tried over fiscal stimulus, I will still vote Democrat. Yes, they are wrong, but they are not insane.

  9. Gravatar of Lee Kelly Lee Kelly
    2. November 2010 at 07:48

    Krugman’s in a liquidity trap, not the economy.

  10. Gravatar of W. Peden W. Peden
    2. November 2010 at 08:03

    Liberal Roman,

    I can certainly appreciate that argument for voting Democrat.

    Of course, Krugman has his own problems with identities, e.g. separating components and aggregates, but Krugman is at worst 50% wrong, whereas so many seem to be at least 75% wrong or worse. And Krugman still supports monetary stimulus, albeit for no good reason.

  11. Gravatar of James in London James in London
    2. November 2010 at 08:20

    “They simply accommodate that demand, and then target the domestic nominal aggregate that reflects the policy objective.”
    “It’s up to each individual country to decide whether it wants to inflate if the US decides to do so. The Chinese have already indicated that they do not wish to inflate, and just as in 2005-08 they will revalue the yuan to avoid that fate.”

    It’s all so easy in macroland. Country A decides X and Country B decides Y, and it happens. All countries are self-contained boxes governed by enlightened dictators in charge of the key levers of policy. How can anything possibly go wrong?

    In the real world there are plenty of real actors gaming governments, leakages (especially with limited capital controls), grey areas (dollarisation, smuggling, poor quality macro data) and unintended consequences. Best to get the micro right and leave the macro to look after itself. That’s true laissez-faire and it works very well.

  12. Gravatar of Jim Glass Jim Glass
    2. November 2010 at 08:55

    “The seductive sound of Quantitative Easing.”

    How could even Krugman resist?

  13. Gravatar of marcus nunes marcus nunes
    2. November 2010 at 10:14

    Arnold Kling has doubts:

  14. Gravatar of DanC DanC
    2. November 2010 at 10:22

    What would you think of the Taylor post

    “One concern expressed at the time (March 2009) was that such extraordinary measures would become a “new normal” for monetary policy, in which the Fed would not restrict its massive doses of QE to times of panics and other emergencies. Such a new normal would likely breed uncertainty and reduce the Fed’s independence, eventually leading to economic instability and inflation. I put it this way in my paper in the book, Road Ahead for the Fed, which came out of the conference:

    “The danger I see is that as the recovery begins, or after we are a couple of years into it, people may feel that it’s not fast enough, or there is an unpleasant pause. Either could generate heavy pressure on the Fed to intervene…. Why would such interventions only take place in times of crisis? Why wouldn’t future Fed officials use them to try to make economic expansions stronger or to assist certain sectors and industries for other reasons?”

    Many Fed officials dismissed the concerns about such a scenario, saying that the crisis was unique. Yet this is exactly the scenario that is now playing out. Sure enough, the recovery paused, and lo and behold, there is a QE2 in the works.”

    Or Becker’s comments

    “Of course, perhaps other factors, such as the uncertainty about the business environment that Congress and the President created through their rhetoric, and also through their actual and proposed legislation, offset powerful effects of the fiscal stimulus itself in reducing unemployment. The unpleasant fact we economists have to face is that there is not strong evidence on the actual effects of governmental spending on employment and GDP. The usual claimed effects are generally based on predictions from highly imperfect theoretical models of the economy rather than from strong direct and clear evidence on the employment consequences of different fiscal stimuli.”

    While he is talking about fiscal stimulus isn’t the same potentially true for QE?

    Becker goes on.

    “It is informative to contrast this British approach with that of the US. Federal government spending during the past few years increased to about 25 percent of GDP from a level that had been rather stable for a couple of decades, under both Democratic and Republican administrations, at close to20 percent of GDP. The federal fiscal deficit in 2009 was about 12% of GDP, and is expected (or hoped!) to decline in 2010 to about 8%. These are two of the highest deficit ratios in many decades. Essentially nothing is being done in Washington about these enormous deficits, aside from some proposals to raise taxes on the rich that will bring in very little additional tax revenue. ……..

    However, I am convinced that the British way is a far better way to improve the long-term growth prospects of an economy. That is, reductions in the bloated levels of government spending and fiscal deficits will do much more to stimulate the longer-term growth of the British economy, mainly by encouraging private investment and innovation, than will the present American approach. ”

    If true long term growth will only occur with fiscal reform, isn’t QE, potentially, just giving an alcoholic a drink to avoid the DT’s.

  15. Gravatar of Shane Shane
    2. November 2010 at 10:34

    No need to resort to the “big govmint” name-calling, unless you think the Austrian right is somehow going to wake up and favor QE.

    In any case, no one is fooled. I still think you are a secret liberal Prof. Sumner because the argument for NGDP targeting rather than inflation targeting is inherently progressive: it is better to use carrots rather than sticks, to be good cop rather than bad cop, to appeal to a sense of positive opportunity rather than to threaten with a punitive erosion of the value of the dollar. After all, in the latter case, what guarantee is there that people won’t just go out and buy Goldline rather than invest in productive areas of the economy? None.

    Like I said, I’m not buying the lip service to the “big govm’t” fearing right. Neither are they. Embrace your inner leftist!

  16. Gravatar of Jim Glass Jim Glass
    2. November 2010 at 11:41

    Ben Bernanke Could Fix the Economy Pretty Quickly … any moment he wishes, he could announce that he no longer thinks the Federal Reserve’s inflation target should be 2% per year but rather 4% per year–and that he will strive to hit that target.

    But he is not going to do anything like that anytime soon, is he?

    It looks like some of the Keynesians are swinging around in spite of their former skepticism. (Even forgetting it.) Better late than never.

  17. Gravatar of JTapp JTapp
    2. November 2010 at 12:43

    Krugman has to be feeling lonely. Even Brad Delong has disagreed with him in posts both on China and on QE. Matt Yglesias, Ryan Avent and Tyler Cowen have piled on as well. Tyler Cowen’s post calling the liquidity trap “a shaggy dog” that someone pulls out of the closet was hilarious, IMO.

  18. Gravatar of Dustin Dustin
    2. November 2010 at 14:05

    Glenn Beck is officially opposed to more QE. He says it means more debt for us and bad inflation is headed our way. I didn’t stick around to hear him expound upon it more, so I have no clue what he is talking about.

  19. Gravatar of david david
    2. November 2010 at 17:54

    It’s good to hear that you’re still alive 😀

  20. Gravatar of Jeff Jeff
    2. November 2010 at 19:52

    smart economists who also believe in big and active governments

    OK, somebody has to point out that this is an oxymoron.

  21. Gravatar of Jeff Jeff
    2. November 2010 at 20:10


    Becker is right, the Brits are on the right track. There isn’t much evidence that fiscal policy works, but it sure is expensive. Monetary policy is much cheaper and there’s far more evidence that it works.

    Scott, in your response to C above you mentioned countries that have pegged their currencies to the dollar. Just yesterday I read a neat little paper (Rodriguez, Gabriel & Rowe, Nicholas, 2007. “Why U.S. money does not cause U.S. output, but does cause Hong Kong output,” Journal of International Money and Finance) that makes a neat point that is related. It goes like this:

    If the Fed aims to smooth output, then variations in output growth are really just Fed forecast errors, otherwise they would have been smoothed away. As such, they are uncorrelated with any and all information available to the Fed at the time it made its forecasts. Hong Kong maintains a fixed exchange rate with the dollar, so they are importing whatever the Fed policy is. However, the Fed doesn’t care about smoothing Hong Kong’s output, so their regressions find that US money Granger-causes Hong Kong output, even though it doesn’t have much effect on US output.

    A very cute little point, and one worth remembering.

  22. Gravatar of Doc Merlin Doc Merlin
    2. November 2010 at 22:57


  23. Gravatar of Was Fed completely clueless in Great Depression? « Mostly Economics Was Fed completely clueless in Great Depression? « Mostly Economics
    3. November 2010 at 00:47

    […] says Friedman’s monetary analysis does not work in a liquidity trap and other side we have Scott Sumner, David Beckworth etc who say it is not as bad (am still to read the […]

  24. Gravatar of scott sumner scott sumner
    3. November 2010 at 18:07

    W. Peden, I’m still not convinced he favored small government in the 1930s. I’ve read many of his letters from that period, and he seems fairly left-wing to me.

    Blackadder, That’s a relief.

    Liberal Roman, I do agree with you and Krugman that we need more stimulus.

    James, The Great Depression and WWII is what happens when governments “leave the macro to look after itself.”

    Jim Glass, Yes, that’s pretty seductive.

    Marcus. I don’t think Krugman would like being called my evil twin.

    Taylor thinks monetary policy has been extremely expansionary. I guess if you start from that premise, the rest follows. I just don’t see the inflation.

    Becker is right about fiscal policy, but we’ve already seen rumors of QE drive down the dollar and drive up stock prices. Since QE is costless (unlike fiscal stimulus) there is no harm in trying. The worst case is that we save money by paying less interest on the national debt.

    Shane, Are Bill Woolsey and David Beckworth and Bennett McCallum also secret liberals?

    Jim Glass, Yes, DeLong’s getting much more aggressive in pushing for monetary stimulus–which is good to see.

    JTapp, I look forward to catching up on other blogs when I have time.

    Dustin, Someone needs to tell Beck that monetary stimulus means less debt, not more.

    David, Thanks, it’s good to be alive.

    Jeff, Touche!

    Jeff, That HK study is very interesting. Last year I was thinking of doing an article on the HK Phillips curve, which since the early 1980s is the most perfect in the developed world. And the reason is related to that article. Monetary policy is exogenous for HK, so you generate the same relationship that you saw under the gold standard. Low and stable inflation expectations, and random AD shocks.

    Maybe I’ll do a blog post on that.

  25. Gravatar of Potpourri Potpourri
    9. November 2010 at 07:16

    […] accumulating mainstream critiques of his worldview, the better to smell him with. Tyler Cowen and Scott Sumner have some good thoughts. I have also switched out of pizza and into low-fat cottage cheese. Mmmmm, […]

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