Bernanke was right!
Ben Bernanke has been widely mocked for statements like this:
7/1/05 – Interview on CNBC
INTERVIEWER: Tell me, what is the worst-case scenario? We have so many economists coming on our air saying ‘Oh, this is a bubble, and it’s going to burst, and this is going to be a real issue for the economy.’ Some say it could even cause a recession at some point. What is the worst-case scenario if in fact we were to see prices come down substantially across the country?BERNANKE: Well, I guess I don’t buy your premise. It’s a pretty unlikely possibility. We’ve never had a decline in house prices on a nationwide basis. So, what I think what is more likely is that house prices will slow, maybe stabilize, might slow consumption spending a bit. I don’t think it’s gonna drive the economy too far from its full employment path, though.
Obviously he can’t predict housing prices, but then no one can. But he was right about the business cycle:
Jan. 2006: starts = 2,303,000, completions = 2,058,000, average = 2,180,000, U-rate = 4.7%
April 2008: starts = 1,008,000, completions =1,014,000, average = 1,011,000, U-rate = 4.9%
October 2009: starts = 527,000, completions = 745,000, average = 636,000. U-rate = 10.1%
If the great housing construction crash of January 2006 to April 2008 didn’t “drive the economy too far from its full employment path,” I think we can safely assume that no housing crash will ever cause a recession in the US.
Too bad the Fed let NGDP fall in late 2008.
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27. March 2012 at 08:09
the key problem as i see is that Ben has no market-based forward looking indicators for gdp. many levels of real gdp can be consistent with 2% inflation, so TIPS are an imperfect indicator if wages are sticky. economic forecasting models tend to be very similar so no shock they make the same wrong prediction based on the past. the stock market is ok but the signal to noise ratio is too high (margin compression, supply inflation, productivity, all could drive stocks – stocks overall are far more volatile than gdp, one really needs to know how much is revenue growth/ngdp related, which reasonable people can disagree on).
27. March 2012 at 08:15
Of course, he was talking about housing prices, not housing starts. This might not change the results, but this is an apple and oranges comparison. To the extent that housing had effects on the macroeconomy it would seem to be through asset prices and securitized debt, not the construction industry.
27. March 2012 at 08:30
In early 09 Svensson made a very similar argument about the Swedish housing market affecting the labor market and listeners were highly skeptical, even people that I knew to be highly educated. I think that most people have an issue with the use of the term “cause”. Most people tend to think that something can “cause” the labor market to tighten in the sense that someone dumping a lit cigarette might cause a fire that destroys a house.
If you look at the issue as an economist, when you say “X causes Y” you mean that X is the proximate cause of Y, in my example the fire caused the destruction of the house, hence if you are covered against fire insurance you’re safe.
In ordinary language though, “cause” would be interpreted as the dropping the lit cigarette. For economists this makes little sense because this starts an infinite loop, as maybe a bird pooping on the maid might have caused her to drop the cigarette which caused the fire, so maybe the cause of the fire is the bird’s bowel movement.
I think this is kind of similar to the misunderstanding that arises when an economist talks to a non-economist about rents; some terms in ordinary language are simply making things too complicated when integrated with their economic meaning. Perhaps Bernanke should have explicitly mentioned that the labor market is safe from any housing slump in the same sense that a house right next to the fire brigade’s station is safe from fire: it can only be in severe danger if the fire brigade fails to do what people expect it to do in case of fire; in this sense the fire brigade would be the cause of the house’s destruction just like the Fed’s failure to keep NGDP at trend is the cause of the excess unemployment.
27. March 2012 at 08:30
Something I never quite figure out reading this blog is the large disconnect that seems to figure so prominently in Scott’s posts between some aspects of real economy on the one hand, and NGDP-employment nexus on the other.
Take this post. Way I read it is that “crash in constuction did not cause unemployment to skyrocket; fall in NGDP caused unemployement to skyrocket.” But it’s not as if the “crash in construction” has nothing to do with NGDP. It’s a component of NGDP, no? A big one too, right?
Now, if you mean to say that on the aggregate basis, the drop in construction employment was but a blip, the point is well taken. But it’s no good to just say that “NGDP decline caused unemployment to rise” or that “Too bad the Fed let NGDP fall in late 2008” as these statements contain little to no information about the actual causes, nor any actionable instructions. To wit: WHY did the NGDP fall? And don’t say, “the Fed did it” – they Fed may not have reacted appropriately, but clearly bad stuff was set in motion without the active desire on Fed’s part to that effect. And it seems to me that a housing crash — but not so much on the construction side of things but actually on the asset-values (a.k.a collateral values) side of things — had a lot to do with the crash in NGDP from market monetarist perspective. Bernanke deserves all the stick he gets and then some for failing to contemplate a possibility of that happening.
27. March 2012 at 08:40
I’m maybe not smart enough to understand Bernanke’s argument here, nor Sumner’s.
But I will say this: If huge swaths of land were gobbled up by developers, zoned residential, and turned into subdivisions, then those are huge swaths of land that cannot now – or anywhere within the foreseeable future – be used for any purpose other than housing.
When Austrian School economists talk about capital reallocation and malinvestment, they’re not saying that the bubble causes an explosion of artificial value that eventually pops, and then we experience “slow growth for a while.”
Instead, what they’re saying is that there was good land on which someone might have opted to build a factory or shipping/receiving center, or farm or whatever… but NOW, rather than allocating the land according to what would have been a productive use, the land is fully occupied by a huge pile of cheap homes that offer the economy less value than the alternative use would have offered if the bubble hadn’t have distorted investment patterns.
It’s not about an NGDP shock, it’s about capital misallocation and opportunity cost.
27. March 2012 at 08:43
Josh,
Housing prices started to decline before NGDP tanked. In fact, up to the point that NGDP tanked you’ll be hard-pressed to explain NGDP in terms of housing prices. When NGDP tanked however you can explain a good part of the movements in housing prices in terms of changes in NGDP.
See this graph (and data) for example:
http://research.stlouisfed.org/fred2/graph/?g=61v
Housing therefore did not have an effect on the macroeconomy, the marcoeconomy (I take it you meant NGDP with that?) did however have an impact on housing and other asset prices.
27. March 2012 at 08:46
But what he said was: “It’s a pretty unlikely possibility. We’ve never had a decline in house prices on a nationwide basis.” So it’s not about whether “he can’t predict housing prices.” It’s about whether it’s possible for an intelligent person with an education in economics to think that a capital asset is unlikely to go down *for the reason* that it never did so before.
Believing such a thing is utterly embarrassing, inexcusably stupid, and completely contrary to any concept of efficient markets. A capital asset that only goes up! Come on!? The chairman of the Fed believed that??? Like every other sub-prime lemming borrower??? “Ameeeeerica, Ameeeeerica, where houses only go uuuuuup…” *What* a moron!
27. March 2012 at 08:47
Ryan,
For someone favoring the Austrian explanation you have little faith in markets. What the data shows – it seems – is that the economy is very good at re-allocating capital, it’s just not very good in dealing with (government-induced) shortages in the medium of exchange.
27. March 2012 at 08:59
K,
re-read Bernanke’s statement:
“Well, I guess I don’t buy your premise. It’s a pretty unlikely possibility. We’ve never had a decline in house prices on a nationwide basis. So, what I think what is more likely is that house prices will slow, maybe stabilize (..)”
He never asserted that housing prices could only go up: he asserted that there might be a possibility that they would slow and/or stabilize. Also, from what and how he says it you can infer a belief in the EMH.
27. March 2012 at 09:00
The issue wasn’t the collapse in home construction, since a decline in house construction would INCREASE house prices all else equal. No, the issue was the collapse in home PRICES. That occurred soon after the easy money started to tighten up in 2005 and into 2006, when the Fed slowed its rate of reserve growth, and raised the target rate from less than 2%, to 5%, in order to combat consumer price inflation. THAT is what finally pricked the housing bubble. All that cheap money dried up.
The longer term repercussions that a collapsed housing market had on the economy in terms of prices, specifically mortgage backed securities, is what then led to bank insolvency and a credit crunch. That is when unemployment really got going, because so many jobs DEPENDED directly and indirectly on cheap money.
Just look at our present situation since 2008. Just imagine how many new projects have been started and how many new jobs have been created on the basis of not just less than 2% fed funds rate, but on a 0-0.25% fed funds rate.
Once the Fed has to tighten up again, to avoid runaway consumer price inflation which I say is coming soon if current trends continue, what do you think is going to happen to the US economy that has been built on over 4 years of near zero fed funds rate? And I am not just talking about businesses that depend on cheap money in the direct sense in terms of direct loans, but also all the businesses that depend on revenues derived from cheap money being respent.
If the Fed should start ignoring price inflation and interest rates, and they start targeting NGDP instead, they will of course delay the corrections since that would lead to even more monetary inflation, but it won’t be a permanent policy that can make investment errors disappear. It will just lead to the creation of new investment errors, which will require even more inflation to sustain, and soon. With this policy, money supply growth will exponentially rise, just like it’s exponentially rising in Australia, and in so many other countries that “avoided recession because their central banks were awesome in not letting NGDP fall.”
NGDP targeting, because it totally ignores cash balances, is just as dangerous as price inflation targeting. Targeting only one portion of the function that money provides, be it spending, prices, whatever, if it ignores the full nature of money, which includes holding money, an attribute just important as the attribute of spending it (since spending money logically presupposes holding money, prior and subsequent to spending it), targeting spending at the cost of everything else, can only breed eventual destruction of its holding attribute. Destroying the holding attribute of money is just the destruction of money itself.
Just look again at the Australian money supply chart (totality of all money held). Money is being systematically destroyed. An exponential rise in money supply that asymptotically approaches the vertical is the same thing as the holding value of money approaching zero. In other words still, the Australian central bank is systematically destroying what constitutes Australian money. Each new Australian dollar held, meaning each new dollar created, is having a smaller and smaller effect on “sustaining” the economy’s NGDP.
It is simply mind boggling how PhD economists can be looking at the exponentially rising money supplies around the world, and then NOT understand the logical conclusion that this cannot possibly be maintained.
Let me ask you this DR. Sumner, Chicago trained, tenured economist, do you honestly believe it’s possible for NGDP to be maintained at 5% if it requires an exponentially rising money supply? Do you have any idea how quickly hyperinflation sets in, regardless of what is happening to nominal spending? The Fed cannot possible maintain control over NGDP if they have already created so much money and have inflated cash balances to maintain 5% NGDP, that once people start to say enough is enough, there is nothing the Fed owns that they can sell to soak up all the liquidity? Even the assets on all the world’s central bank balance sheets combined, cannot soak up enough liquidity once cash balances reach a high enough level, and people begin to fly into real values. At that point, NGDP targeting will, just like the others, be rightfully relegated to the dustbin of monetary nonsense.
27. March 2012 at 09:01
Martin, I’m not sure why my argument shows a lack of faith in markets. You’ll have to elaborate on that for me. The simple fact is that markets cannot at all change zoning laws, and where zones are dedicated to multiple uses, any building that is raised must be demolished if the land itself is to be put to an alternative use. So, tell me which is the more productive path: One in which the market is undistorted and land is put to its most efficient use by the highest bidder, or one in which the market is systemically distorted, the least urgent want partially satisfied, value eviscerated, debt cleared, buildings demolished and THEN the highest bidder puts the land to its most efficient use?
What I’m suggesting is that it doesn’t really matter how efficient a market can follow the 2nd path inasmuch as it will always be less efficient than the 1st. Why is that a lack of faith in markets?
27. March 2012 at 09:07
… And once again we are left with nothing. The Fed erred. How do we know that the Fed erred? Because NGDP fell. What was the error? Letting NGDP fall. What should they have done differently? Pursued a more expansionary monetary policy which would have prevented the fall in NGDP.
This is an empty ex-post argument which tells us nothing about what, ex-ante, the Fed missed.
27. March 2012 at 09:14
D R:
… And once again we are left with nothing. The Fed erred. How do we know that the Fed erred? Because NGDP fell. What was the error? Letting NGDP fall. What should they have done differently? Pursued a more expansionary monetary policy which would have prevented the fall in NGDP.
This is an empty ex-post argument which tells us nothing about what, ex-ante, the Fed missed.
Wow, the first thing D R said that I fully agree with.
The answer you get D R, will no doubt be ultimately based on the EMH way of understanding the economy, which means you won’t be getting an actual answer.
27. March 2012 at 09:19
“and raised the target rate from less than 2%, to 5%, in order to combat consumer price inflation. THAT is what finally pricked the housing bubble.”
Pointing out, of course, that the target was over 5% for most of the late 90’s when the housing bubble actually started, I don’t entirely disagree.
27. March 2012 at 09:20
Major,
Ha, I had written my last comment before seeing yours!
27. March 2012 at 09:32
“Ben Bernanke has been widely mocked for statements like this: I think what is more likely is that house prices will slow, maybe stabilize, might slow consumption spending a bit. I don’t think it’s gonna drive the economy too far from its full employment path”.
It is bit of a cheap shot to mock central bankers for statements like this. They have to express confidence in the economy, especially if asked about it. Imagine what would have happened if Bernanke had said “the housing market looks fragile to me”. Remember the fuss when Greenspan merely said “HOW DO WE KNOW WHEN irrational exuberance has unduly escalated asset prices”. We now know from the FOMC transcripts that at the time Greenspan was sufficiently worried to contemplate increasing margin requirements for leveraged stock purchases. My advice would be to discount anything any economic official says that he/she is supposed to say.
27. March 2012 at 09:49
Martin: “slow, maybe stabilize (..)” means won’t go down. My comment stands. It was a truly idiotic thing to think.
27. March 2012 at 09:51
And… He reasoned from the fact that they hadn’t gone down *before*. Inexcusable.
27. March 2012 at 09:59
D R:
“and raised the target rate from less than 2%, to 5%, in order to combat consumer price inflation. THAT is what finally pricked the housing bubble.”
Pointing out, of course, that the target was over 5% for most of the late 90’s when the housing bubble actually started, I don’t entirely disagree.
Oh I think you mistook what I meant. I am not saying the Fed holding down interest rates to 5% ipso facto always causes a housing bubble, in the temporal sense of “If A then B.” Inflation never affects the economy in the same exact way. Sometimes it blows up a dot com bubble, other times it blows up a real estate bubble, and sometimes it blows up a sovereign debt bubble (wink wink). It doesn’t affect the same market the same way every time. And a given fed funds interest rate of “5%” doesn’t always have the same effect on the economy either. A 5% in the 1990s is not the same thing as 5% from 2005-2006. There is nothing magical about 5% in and of itself. What matters is what the 5% signifies given the prevailing conditions.
What we can say is that the housing boom 2001-2006 required the Fed to be flooding the banks with reserves and thus holding interest rates low. We can say that the housing boom lost its fuel once the Fed reduced inflation into the banking system and thus raised the fed funds rate.
The statement “Central banks lowering interest rates down to below market rates leads to bad investments, and raising them back up reveals the bad investments” is the theory, and the statement “The Fed lowering interest rates to below 2% led to the housing bubble, and raising them back up to 5% revealed the bad investments in housing” is the history.
There is nothing in the history statement that by itself reveals any constant economic laws, concerning either the 5%, the 2%, or the housing market.
Humans aren’t robots. They learn over time. But the reason why humans can’t learn how to avoid making bad investments and stop the business cycle is because the information they need to learn is unobservable, on account of the central bank becoming a part of the economy itself and thus the necessary making free market information impossible. If the Fed puts the overnight market rate to 2%, we have no way to observe the counter-factual world of what the rate would have otherwise been. We can only act on the basis of the information that exists, and “guess” what the real market rate is. But guesses are no substitute for the real thing.
Major,
Ha, I had written my last comment before seeing yours!
Is that a coincidence or what? If you really want your mind blown ask if that was meant to happen.
27. March 2012 at 10:03
K:
Martin: “slow, maybe stabilize (..)” means won’t go down. My comment stands. It was a truly idiotic thing to think.
K, you don’t realize who you’re dealing with. Sumner is a ninja. He’ll just say that Bernanke was still right, because while he didn’t see the recession coming, it’s because he chose to incorrectly let NGDP fall, and not because the housing market collapse had anything to do with it.
27. March 2012 at 10:10
K:
And… He reasoned from the fact that they hadn’t gone down *before*. Inexcusable.
The same reasoning is used by all positivists, including Sumner. He too will say markets never went down before as long as NGDP is maintained, and so that’s why it should work going forward. It’s why he calls for a 5% target, as opposed to a 25% target. It’s based on historical thinking. In the past REAL production has averaged 3%, and in the past, inflation has averaged 2%, so the “inexcusable” conclusion made is that 5% should work going forward.
Apparently not everyone has truly grasped the full implications of the Lucas Critique.
27. March 2012 at 11:04
Scott, my question has nothing to do with this post (nor any of the comments) but I don’t have a better place to ask it:
Do you think that NGDPLT is the optimal monetary policy for emerging market countries as well? Feel free to answer the question in terms of what you assume as necessary in order for NGDPLT to be the optimal mon policy (in fact, that might be preferable). Here are a couple of things that might make NGDPLT not feasible for EM: nominal contracts may be set based on some expectation that involves foreign currency, many contracts may be indexed to inflation and I guess I’m missing other objections.
27. March 2012 at 11:16
“Oh I think you mistook what I meant.”
I think you mistook what I meant. It is *despite* that observation that I do not entirely disagree.
27. March 2012 at 12:02
D R:
I think you mistook what I meant. It is *despite* that observation that I do not entirely disagree.
Ah, well a “despite” does change everything.
27. March 2012 at 12:16
@MF
So per your argument, who should control the money supply and credit markets. Can anyone issue money? Is it based on the faith and credit or the money issuer? Or does it have to be collateralized with a real asset. Can it be any asset? Or does it have to be gold? Who gets to set these rules and why?
27. March 2012 at 12:23
“It is bit of a cheap shot to mock central bankers for statements like this. They have to express confidence in the economy, especially if asked about it.”
Then why not lock central bankers in a sound-proof environment so that they don’t have to hear the question in the first place?
It’s not a cheap shot. How are we supposed to be better off with central bankers expressing false confidence in a bubble? Greenspan’s denial of the bubble back in 2002-03 helped sustain it. The best thing he could have done would have been talking about it.
27. March 2012 at 12:24
dtoh,
Why should anyone control the money supply at all?
27. March 2012 at 12:27
because while he didn’t see the recession coming, it’s because he chose to incorrectly let NGDP fall
In the past REAL production has averaged 3%, and in the past, inflation has averaged 2%, so the “inexcusable” conclusion made is that 5% should work going forward. Apparently not everyone has truly grasped the full implications of the Lucas Critique.
I am not seeing the problem, or any real issue except we should be using forward looking expectations for the output gap (i agree, get that started for us, thanks). Almost every person on the FOMC will have a different idea whether the target is 5%,4%,3% etc. – which ultimately is not a big deal. Take the average and be done, maybe review it once in a while.
The crucial element is to commit to stabilizing nominal income (growth) at some level (which by now you seem to have conceded is a worthwhile idea). If you want to argue against 4.5% (or 5%, or 3%) tell me what the parade of horribles would be. We’ve been able to hit a 2% inflation target remarkably well. I see no evidence we could not hit an ngdp target equally well, if we had better forward looking indicators.
27. March 2012 at 13:12
dtoh:
So per your argument, who should control the money supply and credit markets. Can anyone issue money? Is it based on the faith and credit or the money issuer? Or does it have to be collateralized with a real asset. Can it be any asset? Or does it have to be gold? Who gets to set these rules and why?
Ask yourself this exact same question, but for potatoes, computers, and t-shirts.
Money is simply a commodity. That’s all it is. It has the distinct property of being the most universally accepted, the most marketable, but there is nothing about money that through economic principles compels it to being controlled by a single monopolist.
Many of today’s inflationist economists are like Dr. Jekyll and Mr. Hyde. When they think of monopolies, they’ll tell you all sorts of horror stories about them, why they should be abolished, the damage they cause, the moral hazard, and so on, but when it comes to money production, it’s like they do a 180 and all of a sudden, a monopoly is not only undesirable, not just neutral, but it’s positively desired and should be protected by the state! Think about that for a moment. Let it sink in. Something’s off with that.
The arguments typically given in response are just begging of the question, like “money is too important to be left to the market.” To this I say oh really? So money is more important than food, water, medicine, clothing, and shelter? If these commodities are more important than money, then where are the economist’s monopoly advocacy arguments for these commodities?
And around and around the logic goes, where it stops, only the inflationist economist knows.
27. March 2012 at 13:22
“Something’s off with that.”
Yeah. Like when economists worry about monopolies, it’s almost always that they produce too little. When Major complains about money, it seems that the monopolist produces too much.
Seriously though…
27. March 2012 at 13:29
dwb:
“In the past REAL production has averaged 3%, and in the past, inflation has averaged 2%, so the “inexcusable” conclusion made is that 5% should work going forward. Apparently not everyone has truly grasped the full implications of the Lucas Critique.”
I am not seeing the problem, or any real issue except we should be using forward looking expectations for the output gap (i agree, get that started for us, thanks). Almost every person on the FOMC will have a different idea whether the target is 5%,4%,3% etc. – which ultimately is not a big deal. Take the average and be done, maybe review it once in a while.
Take the average of random guesses, run with it, and then review it? Is the economy a laboratory for mad scientists, or is it a place where individuals are to achieve their goals in free exchange?
Goodness. Is this really the best we can do? A few bookworms with state “authority”, pretending to be important, sitting in an ivory tower, and like a bunch of Mayan witchdoctors, spin up a bunch of single digit magical numbers that are estimated aggregates for the collective actions of hundreds of millions of people, then agreeing on an average, and then imposing it on those hundreds of millions of people’s future economic affairs? Really? Not even Steve Jobs was that arrogant. I mean don’t you find this to be just a little overconfident? What does Bernanke know that nobody else knows? He’s been wrong about virtually everything. Google “Bernanke was wrong.” The guy is intelligent, but nobody is so intelligent so as to know what people will know in the future before they know it themselves. Bernanke can’t even predict what he himself will know next year.
The crucial element is to commit to stabilizing nominal income (growth) at some level (which by now you seem to have conceded is a worthwhile idea). If you want to argue against 4.5% (or 5%, or 3%) tell me what the parade of horribles would be. We’ve been able to hit a 2% inflation target remarkably well. I see no evidence we could not hit an ngdp target equally well, if we had better forward looking indicators.
Commit to “stabilizing” nominal income growth, even if it comes at the expense of destabilizing the currency?
27. March 2012 at 13:35
K,
“Martin: “slow, maybe stabilize (..)” means won’t go down. My comment stands. It was a truly idiotic thing to think.”
Your comment was and I quote:
“Believing such a thing is utterly embarrassing, inexcusably stupid, and completely contrary to any concept of efficient markets. A capital asset that only goes up! Come on!? The chairman of the Fed believed that??? Like every other sub-prime lemming borrower??? “Ameeeeerica, Ameeeeerica, where houses only go uuuuuup…” *What* a moron!”
Bernanke’s position was not that housing prices would only go up. Which is what you’re asserting here. That is a straw man.
“And… He reasoned from the fact that they hadn’t gone down *before*. Inexcusable.”
Why? Based on the information available, what should his judgement have been?
Let me ask you, have you ever borrowed money to for example attend university? On what did you base yourself that you would get out ahead after it? Did you ever go to your favorite restaurant and ordered your favorite dish? On what did you base yourself that you would like what you would order?
Re-read what Bernanke said about housing prices going down:
“Well, I guess I don’t buy your premise. It’s a pretty unlikely possibility.”
What is so outrageous about that?
27. March 2012 at 13:41
D R:
“Something’s off with that.”
Yeah. Like when economists worry about monopolies, it’s almost always that they produce too little. When Major complains about money, it seems that the monopolist produces too much.
Seriously though…
Not very funny.
Printing more money is not providing more real goods and services. It makes existing money worth less, and if controlled by a monopolist who operates outside the sphere of private property and market exchanges, of profit and loss, of bankruptcy, it just leads to economic distortions.
If I were you I would in fact worry about a monopolist producing too much, because all production comes at a cost, and it is possible to produce too much of one thing at the expense of other things that are more highly valued, and vice versa.
The only way to know how much money is “correct”, is by integrating money production into the sphere of private property and market exchanges, of profit and loss, of bankruptcy, of economic calculation. Then and only then can we know whether there is too much money production or too little money production at any given time, the same way the profit and loss system enables us to know whether too many cars were produced at the expense of other more highly valued things, or whether too many houses were produced at the expense of other more highly valued things.
When I say the central bank is creating too much money, I do that by comparing fiat money production with the quantity of precious metals, which I argue would have otherwise been the free market money. Fiat money production has exceeded precious metal production by multiple factors. It’s why gold is priced so high.
27. March 2012 at 13:42
“Why? Based on the information available, what should his judgement have been?”
Uh… because based on the available information it was exceedingly likely that house prices were going to fall? What? Did you think that rent prices were going to suddenly double to catch up with house prices?
27. March 2012 at 13:48
D R:
because based on the available information it was exceedingly likely that house prices were going to fall?
What available information are you talking about?
And exceedingly likely? The economists at the Fed admitted they had no clue, even as late as September 2008. The major financial institutions, like JP Morgan and Goldman Sachs, were threatened with bankruptcies when the housing market tumbled.
27. March 2012 at 13:53
“If I were you I would in fact worry about a monopolist producing too much, because all production comes at a cost, and it is possible to produce too much of one thing at the expense of other things that are more highly valued, and vice versa.”
Sorry. A profit-maximizing monopolist. You know, the kind economists are always going on about.
27. March 2012 at 14:12
“What available information are you talking about?”
Hm. Home prices, which remained more or less stable for more than a century, suddenly double relative to rent prices. Seeing as how those two are close substitutes, frictions or no, it’s rather unlikely to be a permanent state of affairs.
It would have required a large shock in preferences away from renting and toward owning with no corresponding activity to on the part of the market to exploit this opportunity for profit. And yet the vacancy rate bottomed out back in 2004.
“And exceedingly likely? The economists at the Fed admitted they had no clue, even as late as September 2008. The major financial institutions, like JP Morgan and Goldman Sachs, were threatened with bankruptcies when the housing market tumbled.”
Oh, so now the gold standard, if you will, is the behavior of a bunch of unelected bureaucrats?
As for Goldman Sachs, if they were not actually prepared for the fall in housing, then they should have gone belly-up. As it stands, one of the major criticisms is that they knew full well and bet against housing even while they collected fees pretending to be bullish.
27. March 2012 at 14:31
D R:
“If I were you I would in fact worry about a monopolist producing too much, because all production comes at a cost, and it is possible to produce too much of one thing at the expense of other things that are more highly valued, and vice versa.”
Sorry. A profit-maximizing monopolist. You know, the kind economists are always going on about.
The Fed is not even constrained to the profit and loss mechanism, the way a non-central bank monopolist is in the market. The monopolist is still competing for a finite set of revenues he has no control over.
With the central bank, they create money. They can buy government debt, earn interest, the member banks pay themselves a 6% dividend, and their salaries and other expenses, and the rest they send to the Treasury.
The Central bank is not revenue constrained, and it is not profit and loss constrained.
27. March 2012 at 14:44
D R:
Hm. Home prices, which remained more or less stable for more than a century, suddenly double relative to rent prices. Seeing as how those two are close substitutes, frictions or no, it’s rather unlikely to be a permanent state of affairs.
OK, but sometimes prices for things rapidly rise and then hit a long term plateau.
Reasoning from a price change is a faux pas.
“And exceedingly likely? The economists at the Fed admitted they had no clue, even as late as September 2008. The major financial institutions, like JP Morgan and Goldman Sachs, were threatened with bankruptcies when the housing market tumbled.”
Oh, so now the gold standard, if you will, is the behavior of a bunch of unelected bureaucrats?
Oh, so now the fiat standard, if you will, is the behavior of a bunch of elected bureaucrats?
See what I did there?
For me, the standard is individual property rights. The criticism above is actually levied against those who advocate for central banking, because their standard does indeed rest on the knowledge and ability of “a bunch of unelected bureaucrats.”
If the brightest and smartest people who are in control of the money printing press are too dimwitted to know what was coming, then isn’t that a good argument against central banking? Not for the socialist minded people of course. To them, it’s always “we just have to put the RIGHT people in charge, namely me, or people who agree with me and will make my name famous, and THEN everything will be okay.”
As for Goldman Sachs, if they were not actually prepared for the fall in housing, then they should have gone belly-up.
Agreed. I am just pointing out to you that what you are claiming to be “exceedingly available” information, was not as obvious as you portray.
As it stands, one of the major criticisms is that they knew full well and bet against housing even while they collected fees pretending to be bullish.
Sellers have to be bullish about what they sell, or else they won’t sell. But I see your point. But my point is that they would have gone belly up if not for the backdoor Fed bailouts. Either they knew they were going to get bailed out and so made bad bets for quick cash anyway, or they didn’t know and had to ask for bailouts. My guess is that they didn’t know, because I don’t think they would have exposed themselves to such risk, and I don’t think they could have gotten out of the market completely without sending signals that would have resulted in their own assets collapsing before they could sell them. But in all honesty I don’t know what they knew.
27. March 2012 at 14:48
D R – you asked an excellent question:
“Why should anyone control the money supply at all?”
That depends on what you mean by “money”. People can use whatever they want for exchange. Walmart can issue gift cards and accept them for payment, people can exchange gold, pork bellies, baseball cards, foreign currencies, etc. You can even issue DR coupons if you like, as long as you don’t call them “Dollars.” No one can, and no one should control that money supply. If you want to only accept your DR coupons as payment, you are free to do so. Likewise, the government is under no obligation to accept Walmart gift cards, gold or DR coupons as payment.
If by “money” you mean the US Dollar, or any government currency, then it is self-evident that the government should control the supply of the government currency. That’s no different than Walmart controlling the number of shares of Walmart stock it issues, or the number of gift cards it issues.
A nation’s currency is simply a security issued by the nation to conduct government business in (collecting taxes, fees, royalties, gov auctions, paying for services, employees, etc.) There’s nothing magical about it. It doesn’t have to be “backed” by anything other than the economy over which the government has authority. GDP is the closest approximation of that, so it’s a reasonable thing to tie the currency to.
27. March 2012 at 15:26
Scott Yes, BB was right. But then he messed up and now he embraces the conventional wisdom (as he clearly did in describing the “cause” of the crisis in his second lecture to GWU students.
I illustrated this point last year:
http://thefaintofheart.wordpress.com/2011/11/27/bashing-the-conventional-wisdom/
27. March 2012 at 15:34
Propagation of Ideology:
If by “money” you mean the US Dollar, or any government currency, then it is self-evident that the government should control the supply of the government currency. That’s no different than Walmart controlling the number of shares of Walmart stock it issues, or the number of gift cards it issues.
How about money defined as a universally accepted means of exchange?
Here, you can’t invoke analogies to Wal-Mart gift certificates, and yet we can ask if the state should be the one to monopolize the universally accepted means of exchange.
The answer is of course no.
27. March 2012 at 15:46
@MF
“Money is simply a commodity. That’s all it is. It has the distinct property of being the most universally accepted, the most marketable, but there is nothing about money that through economic principles compels it to being controlled by a single monopolist.”
So anybody can issue it?
Is it legal tender? Or does the seller/creditor have to agree to accept it?
Whose money do you use to pay taxes?
What is the denomination (unit of account)?
27. March 2012 at 15:58
So anybody can issue it?
In a free market, yes. In our society with a coercive monopolist? Not so much.
Is it legal tender? Or does the seller/creditor have to agree to accept it?
It can be legal tender, but it doesn’t have to be. As long as it is universally accepted.
Whose money do you use to pay taxes?
Aye, there’s the rub. If there is going to be a state, and thus taxation, the state will have to tax whatever commodity is the money. It can be coerced, or free market driven.
What is the denomination (unit of account)?
This is like asking me in 1945 what the components of a 2012 computer are.
27. March 2012 at 16:07
MF
So assuming it will take 67 years (2012-1945) to implement your new money system, who is going to issue money in the meantime and how much should they issue?
You also say, “the state will have to tax whatever commodity is the money. ” I assume by your use of the singular form of the verb, that there will just be a single commodity to be used as money. Who gets to decide what commodity it will be?
27. March 2012 at 16:24
dwb, That’s “a” problem, but not the key problem (which is failure to do level targeting.)
Josh, He had zero expectation of a financial crisis back in 2005. He was assuming that falling house prices would hurt the economy by depressing housing construction, but that other sectors would pick up the slack. And he was right.
orionorbit, I think I’m using “cause” in a very conventional way. I think the bigger problem is that 99% of the public doesn’t have a clue as to what tight money is, so they don’t recognize what the Fed is doing to cause falling NGDP.
Y, Alekseyev, Suppose the “bad stuff” setting things in motion had been Mexican drug dealers hoarding lots of US currency. Suppose rates rise because the Fed fails to accommodate that demand, and we have a recession. I say 90% of economist blame the Fed for causing the recession.
Ryan, But what the Austrians predicted would happen did not happen, the workers losing jobs in less housing construction gained other jobs in commercial construction and exports, which were booming.
Martin, Good points.
MF, How often has a country experienced hyperinflation with 5% NGDP growth? Zero times? That’s what I thought. Come back here when we get the “runaway inflation.”
DR, I don’t have time to go through the entire narrative in every single post. Read my old posts.
Rebeleconomist, I don’t recall Bernanke saying reassuring things in late 2008, just the opposite.
MF, You said;
“The same reasoning is used by all positivists, including Sumner. He too will say markets never went down before as long as NGDP is maintained,”
I no longer need to respond to you, just point to your own words. Just sad.
Federico, No I would target some other variable, perhaps domestic wage income.
DR, You said;
“Uh… because based on the available information it was exceedingly likely that house prices were going to fall? What? Did you think that rent prices were going to suddenly double to catch up with house prices?”
But most other countries that had big housing price run-ups at the same time didn’t see them fall subsequently. They went sideways or kept rising.
Marcus, Thanks for the link.
27. March 2012 at 16:31
“Reasoning from a price change is a faux pas.”
Ha. Look, there were plenty of folks who made arguments why the run-up made sense, but their arguments made no sense.
“If the brightest and smartest people who are in control of the money printing press are too dimwitted to know what was coming, then isn’t that a good argument against central banking?”
I think the problem there is that “the brightest and smartest people who are in control of the money printing press” are not necessarily “the brightest and smartest people” so yeah, we should pay a lot more mind to who we give such power. Same goes for Congress, the Presidency, the Supreme Court, your local Sheriff, the CEO of your telecom companies, your home inspectors, your dentist…
As for Goldman, I agree that they got plenty from the government. But even if they had not and the firm had collapsed, the folks at Goldman already profited tremendously from the bubble. Dick Fuld is not exactly on food stamps.
27. March 2012 at 16:48
“DR, I don’t have time to go through the entire narrative in every single post. Read my old posts.”
Right. That’s the answer you gave last time. As if I am going to waste my time to go through your entire archives looking for that needle– which I seriously doubt even exists– when you can’t even spend a moment to provide the slightest hint or even a link. Whatever.
“But most other countries that had big housing price run-ups at the same time didn’t see them fall subsequently. They went sideways or kept rising.”
Good for them. I haven’t looked at whether housing prices make sense in other countries. As for Spain and Ireland and the UAE, and a bunch of Eastern Europe, and… well, you’ll not get the point anyway. Why bother?
27. March 2012 at 17:34
Housing prices did decline nation-wide from 1926 to 1934, so Bernanke, the Great Depression historian, is wrong on this count. The Case Shiller historical data illustrates this–although the NY Times Case Shiller historical chart is adjusted for inflation, so my sense is it masks the massive deflationary price spiral of 1929 to 1934 (i.e., adjusting for inflation masks nominal shocks). It is amazing that he is wrong on this count.
27. March 2012 at 18:01
Hi Scott,
Long time reader, first time commenter. I apologize if this question has been answered elsewhere:
From what I gather, your objection to the recent DeLong / Summers paper is that it assumes an incompetent monetary authority. Viz, you seem to think fiscal stimulus won’t work because the monetary authority controls NGDP and any attempt by Congress to raise NGDP by increasing spending will be counteracted by the Fed tightening to maintain its preferred NGDP path.
It seems to me that this objection exists in tension with some of your other posts, including this one, in which you acknowledge that the Fed has lost control over NGDP. I think your criticism of Summers / DeLong is operative in a world where the Fed really does exercise total control over NGDP, but I don’t think we live in such a world, and I think the historical evidence indicates that we have never lived in such a world.
Certainly I think it’s worth exploring why the Fed so frequently seems to fail, perhaps someday when I’m a grad student I’ll try to explore the political economy of the Federal Reserve Board of Governors. But given a Federal Reserve that doesn’t exercise total control of NGDP, it does seem that fiscal stimulus may be a valid workaround.
From what I recall in your criticism of Summers / DeLong, you posited that in order for the multiplier to exist, the Fed needs to be dysfunctional in a specific way. From what I recall, Chairman Bernanke cautioned against further fiscal tightening a few months ago. If fiscal policy really is irrelevant, shouldn’t it not matter if Congress tightens?
27. March 2012 at 18:05
That’s “a” problem, but not the key problem (which is failure to do level targeting.)
FWIW its hard for me to see the Fed adopting a level (or growth) target with out the track record of a market based indicators (mgdp futures or the like). Ben is well known for a preference for forward looking market based information, so i see a futures market as a prior.
27. March 2012 at 20:11
Martin: “Why? Based on the information available, what should his judgement have been?”
It should have been that this is a high beta, high volatility asset that historically happens to have delivered a lot of upside, but since there is no free lunch in the capital markets, big returns must come with risk of big losses. Period.
You don’t judge the future path of a capital asset by extrapolating it’s past. It really *is* stupid. You can gauge the volatility and correlation with other assets, but never, *ever* try to measure a drift. For one, it’s econometrically impossible, and secondly, it’s theoretically utter nonsense. What model of asset prices do you have in mind, in which the higher something has gone, the more undervalued its likely to be? You, and Bernanke, are thinking like bubble lemmings. I’m going to buy it cause it went up???? You can’t be serious.
27. March 2012 at 20:26
Martin: “”Well, I guess I don’t buy your premise. It’s a pretty unlikely possibility.”
What is so outrageous about that?”
That actually sums it all up really well. We all know that house prices went way up. Here he is saying that it’s unlikely that they could also go down. It really is a rejection of efficient markets, plain and simple.
27. March 2012 at 20:30
ssumner:
MF, How often has a country experienced hyperinflation with 5% NGDP growth? Zero times? That’s what I thought.
Prior to 1971, when was the last time the entire world was on a fiat standard? Never? That’s what I thought.
Come back here when we get the “runaway inflation.”
Wouldn’t it be better to speak up before it happens? Johnny come lately is more the market monetarist style.
“The same reasoning is used by all positivists, including Sumner. He too will say markets never went down before as long as NGDP is maintained,”
I no longer need to respond to you, just point to your own words. Just sad.
Sad? I would have thought you’d be pleased or amused that I know what you would say.
You do realize the flaw in “It’s never happened before, so it will never happen in the future”, right? Think of the comment “National level home prices have never fallen in the past, so they will never fall in the future.”
Historical economic events do not tell us what can never happen. There is no constancy in human action.
27. March 2012 at 20:37
D R:
Ha. Look, there were plenty of folks who made arguments why the run-up made sense, but their arguments made no sense.
Made no sense from what economic principles? I’ve seen your criticisms, but they themselves depend on a view of the economy that makes no sense to me.
“If the brightest and smartest people who are in control of the money printing press are too dimwitted to know what was coming, then isn’t that a good argument against central banking?”
I think the problem there is that “the brightest and smartest people who are in control of the money printing press” are not necessarily “the brightest and smartest people” so yeah, we should pay a lot more mind to who we give such power. Same goes for Congress, the Presidency, the Supreme Court, your local Sheriff, the CEO of your telecom companies, your home inspectors, your dentist…
Nobody is intelligent enough to know what millions of other people’s learning and hence acting paths will be in the future, let alone his own learning and acting path.
As for Goldman, I agree that they got plenty from the government. But even if they had not and the firm had collapsed, the folks at Goldman already profited tremendously from the bubble. Dick Fuld is not exactly on food stamps.
Well if they would have went bankrupt, then at least their capital gains would have been wiped out.
28. March 2012 at 00:39
K,
“It should have been that this is a high beta, high volatility asset that historically happens to have delivered a lot of upside, but since there is no free lunch in the capital markets, big returns must come with risk of big losses. Period.”
Think of a game tree, starting point at t=1 with asset price of 100. At t=2 the price can go up with up% or down with down% with probability p and 1-p respectively. At t=3 similarly etc. The risk is that it can go up and down with up% and down% with probability 1-p and p.
You seem to assert that what happens at t=2 matters for the price at t=3. If asset prices can be described as a random-walk this is not the case.
As I read it, you’re arguing that because at a roulette table red came up the last ten times, black is due.
“You don’t judge the future path of a capital asset by extrapolating it’s past.”
I don’t know, but you did just that above. X went up in the past, therefore it has to go down now. The sole difference between people arguing that asset prices should go up and you is that you’re fitting a different curve through the points.
“What model of asset prices do you have in mind, in which the higher something has gone, the more undervalued its likely to be? You, and Bernanke, are thinking like bubble lemmings. I’m going to buy it cause it went up???? You can’t be serious.”
This is a straw man, nobody asserted that. I thought we covered that point?
“That actually sums it all up really well. We all know that house prices went way up. Here he is saying that it’s unlikely that they could also go down. It really is a rejection of efficient markets, plain and simple.”
If the current price is the market estimate and thus the best estimate, how is saying that it is unlikely that those asset prices will drop (change) substantially against efficient markets?
28. March 2012 at 04:39
Martin,
“As I read it, you’re arguing that because at a roulette table red came up the last ten times, black is due.”
I would never! On the contrary. What I’m saying is
1) It beat the risk free rate by a lot.
2) Either there must be arbitrage (Bernanke) *or* it must be a risky process (me).
Note that I *never* said it was more likely to go down than up. I just said that there was a high chance of it going down (as well as up). So I’m not making a (retrospective) prediction. Just saying that efficient market theory implies that the process was very risky.
“If the current price is the market estimate and thus the best estimate, how is saying that it is unlikely that those asset prices will drop (change) substantially against efficient markets?”
In principle, it is possible to believe that all the volatility has suddenly disappeared and the asset will now just grow at the risk free rate. Of course, no massive rally ever ended that way, and there is a good reason why: volatility tends to be depressed when the market is rallying and the reason for *that* is that it is the drop in volatility which causes the drop in risk premium which causes the rally. If, and when, volatility (the rate on information arrival) ever picks up again, the process is reversed. At best, claiming that that wont happen is inexcusably imprudent for a central banker. If you now anything about the historical record of big rallies, it’s also naive. At least Greenspan had the good sense to be concerned about the dot com bubble.
There’s one other theoretical point that I think is worth mentioning: you can’t short real estate. The price is therefore formed by a consensus of the longs. The people who think houses are overvalued are unable to express their opinion in the market. To the extent that markets can be out of equilibrium, this is one of the main causes. And it’s an extremely dangerous market, because it is the shorts who are the first buyers in a significant setback and without that you can get large price drops caused by a spike in liquidity premium. Anytime you have a massive rally there should be warning lights going off.
Note that I’m absolutely not faulting Bernanke for failing to make a prediction. But failing to see the risk?? Embarrassingly naive.
28. March 2012 at 06:01
DR, When I give the slightest hint (target the forecast) people keep moaning that’s not a policy. But it is a policy.
John Brennan, Bernanke was talking about post-war data, which is what everyone talks about when discussing housing price indices. He knows that housing prices fell in the GD.
JeffD, You said;
“It seems to me that this objection exists in tension with some of your other posts, including this one, in which you acknowledge that the Fed has lost control over NGDP. I think your criticism of Summers / DeLong is operative in a world where the Fed really does exercise total control over NGDP, but I don’t think we live in such a world, and I think the historical evidence indicates that we have never lived in such a world.”
I’m afraid you’ve misunderstood my argument. The Fed does control NGDP, they have not increased it as much as they should. The question of whether fiscal stimulus can work does not depend solely on the question of whether the central bank is failing, but also the particularly way it fails. Recently it has been failing in a way that suggests fiscal stimulus doesn’t work. And what makes you think that Congress could do effective stabilization policy if the Fed cannot? What can you point to that would give me confidence in Congress?
dwb, I agree.
MF, Actually, there have been many fiat money standards before WWII, and many hyperinflations. True, the entire world wasn’t on fiat money, but I can’t see how that affects your argument.
28. March 2012 at 06:22
Scott,
You wrote:
“Josh, He had zero expectation of a financial crisis back in 2005. He was assuming that falling house prices would hurt the economy by depressing housing construction, but that other sectors would pick up the slack. And he was right.”
He was correct about construction. But any macroeconomic effect of the housing market collapse was the corresponding decline in the value of the assets underlying MBS. As you know, I think that this is a monetary story. To the extent that MBS and other such assets were being used in repurchase agreements, they are effectively a medium of exchange. When home values started crashing, this resulted in significant haircuts that had to be taken and therefore for a given supply of these assets, there was a shortage of liquidity. The housing collapse is important to this story. It is not important because of its effect on construction, but rather its effect on liquidity. So while Bernanke may have been correct on construction, he was not correct in his assertion that falling home prices would have little effect on the economy.
28. March 2012 at 09:08
Jeebus but do you have a warm spot in your heart for arguments that depends for their lives on specious chronological inference. The banner on this blog ought to read, ‘The past is never dead because it never happened’.
As your logic here would have it- the sum total of it, I’m afraid- Enron, World Com, Tyco, and the rest of the massive spike in corporate bankruptcies that peaked over two years after the TMT bubble burst, were unrelated to the TMT’s bubble having burst. This, of course, notwithstanding the many direct and indisputable links between the two, for example that many of these companies used their own shares as collateral for speculative investments (e.g. Enron used its stock heavily to finance the special purpose vehicles it used to move liabilities off balance sheet, and that led directly to the loss of liquidity that ultimately triggered its demise).
It would have the European sovereign debt crisis as independent of the financial crisis that occurred two years prior to the deterioration of sovereign debt prices notwithstanding the fact that the culprits of the European crisis- the residential real estate bubble and attendant balance of payments/competitive imbalances- were the product of the same unholy orgy of speculation and leverage that caused the financial crisis.
And, as is consistent with goal of all of your post hoc arguments, it would deny the reality of the financial system’s dominant role in the determination of monetary conditions. Because as much as everyone from the credit rating agencies to the regulators to monetarists like yourself were willing to suspend disbelief at the unprecedented claims and asset price inflation of the oughties, inevitably rising delinquencies were going to expose the orgy of underwriting folly of that time. And inevitably those rising delinquencies would crush the thinnest slice of bank capital that until that point funds markets had considered adequate, and immediately begin to put the breaks on credit growth, a process that would ultimately precipitate the financial crisis and full blown deleveraging, which of course is the only way to properly account for recessions.
This is all, by the way, just as Minsky predicted. The Minsky Moment comes when the assets Ponzi borrowers are speculating on, in this case residential real estate, stop appreciating. Not when they decline, simply when they stop or even significantly slow their appreciation. Though there were plenty of institutional Ponzi borrowers by 2008, this is most easy to visualize in terms of the powder keg of borrowers on teaser rates and other negative am or liar loan products that were simply waiting for the moment when a rising asset price could no longer justify a fresh round of refinancing to paper over the costs and the cashout of the previous one. A moment at which they would default in droves. And inevitably that moment came to pass, and just as inevitably it exposed the length and breadth of the underwriting fiasco, very quickly resulting in the entire banking system’s being underwater until the bailouts (overt and less so) you so laughably claim not to endorse.
Ironically, the massive building that was being engaged in was very much part of the story by which asset price inflation slowed down, as were the massive quantities of IPOs that occurred during the TMT bubble, or the massive quantities of tulips harvested some 20 generations ago.
All of which is to say nothing about your contention that ‘no one can predict the direction of housing prices’, or as Calculated Risk used to call that level of devotion to ignorance, ‘Hoocoodanode?!’. Indeed, who could have known, except for all those people that made a lot of money knowing. As ever with a post from SS, pay no attention to the man behind the curtain.
28. March 2012 at 09:32
DR
I have been banging on this drum since happening on this blog. Alas, I have gotten no answers either. Happy to see someone else point out the vacuousness of ‘NGDP growth goes down during recessions, the N in NGDP stands for nominal, the Fed has a printing press, ipso facto, all recessions are the fault of the Fed’.
Amazingly for an argument that seems to have such sway in the policy community, this is the sum total of the evidence being marshaled here. I have asked repeatedly for some idea of what mechanisms the Fed has at its disposal for controlling NGDP and any evidence that it does and have received back similarly thin air.
At times SS appears to endorse QE, but since he’s been very clear in comments directed to me that he doesn’t advocate bailouts, and since QE is very clearly a bailout, especially as aimed at markets such as RMBS with depressed prices and high expected credit losses, the support appears oblique. At other times will point to something Bernanke said about the Fed powers at the zero bound, as if Bernanke can afford to say something different, and as if it would actually matter if he believed that given his record of statements (apropos of this post, subprime well contained, yada yada).
Of course, it behooves him to be politician-like vague about specifics, because its harder to rail against fiscal policy when you are forced to concede all of the massive and deleterious side effects of aggressively inflationist monetary policy, like QE, like telegraphed rock bottom short rates, like a policy of overwhelming easing during financial market duress and do nothinism at market tops.
All of these things have led us directly to the precipice, but God forbid we set up an infrastructure bank so that we can time worthy infrastructure projects so as to smooth out the business cycle. That just gets in the way of all the beautifully elegant monetary policy that has led to the collection of MASSIVE rents by those lucky enough to be in the financial sector.
And so we get ‘well I would make a statement’, or ‘I would target non-interest bearing monetary base’, as if that were any kind of an answer on this earth. As if Japanese officials hadn’t discovered over and over again that jaw boning the Yen doesn’t do anything when you don’t have a credible enforcement mechanism. As if Ben Bernanke’s desperate attempts to calm markets verbally during 2008 would have had any effect if the Fed’s balance sheet (and lets not forget agency balance sheets) hadn’t ballooned by trillions.
Orthodox economics is a shambles.
28. March 2012 at 10:40
Major – you say
“How about money defined as a universally accepted means of exchange?”
There is no such thing as a universally accepted means of exchange, so by your definition there is no such thing as money.
And don’t tell me gold is a universally accepted means of exchange, because I’m part of the universe and I don’t accept gold as a means of exchange. Anyone has the right to accept or reject anything in a free market.
28. March 2012 at 10:53
ssumner:
MF, Actually, there have been many fiat money standards before WWII, and many hyperinflations. True, the entire world wasn’t on fiat money, but I can’t see how that affects your argument.
My argument is that it is wrong to believe that because something has never happened before, it can never happen in the future.
You said:
“How often has a country experienced hyperinflation with 5% NGDP growth? Zero times? That’s what I thought.”
The reason why I said this:
“Prior to 1971, when was the last time the entire world was on a fiat standard? Never? That’s what I thought.”
Was to point out to you an obvious example of something that never existed in the past, but then it did exist in the future, thus NEGATING your claim that something never happening in the past somehow serves as proof that it can never happen in the future.
Your response is akin to someone saying, in 1960, “How often has the world been on universal fiat money? Zero times? That’s what I thought” to someone else who said that they expect the world to one day be on a universal fiat standard.
Well, my argument, that I expect NGDP targeting to one day lead to hyperinflation of the currency, is not refuted by telling me that it’s never happened before.
That was the point of my comment. I hope it’s clearer now.
You think backwards, not forwards. You drive by looking out your rear view mirror (economic history), and you’re insistent that the road is safe because it’s always been safe behind you. I’m looking at the map instead (economic principles), and trying to tell you that you’re heading for the ocean.
My fundamental criticism of NGDP, which I am holding my anonymous name to, for what that’s worth, is this:
Constant NGDP growth targeting leads to an acceleration in the rate of money supply growth, and hence eventual hyperinflation.
This is because NGDP targeting requires inflation, and inflation introduces distortions in the capital structure of the economy. These distortions can only be fixed by a cessation of inflation and allowing the people to make the corrections in an unhampered price system.
Corrections to a distorted capital structure that are the result of past inflation, MUST be accompanied by a level of nominal spending that free individuals desire in their economic calculations, which means if the distortions are great, and nominal spending falls a substantial amount, then the best thing to do is let it happen, and let the people fix the problems they didn’t create.
Since constant NGDP targeting seeks to inflate whenever people want to increase their cash balances so as to facilitate the needed capital corrections that are always present, it means that NGDP targeting prevents the capital distortions in the economy from being corrected. Capital distortions therefore BUILD UP OVER TIME. For an economy with distortions building up, it becomes more and more necessary to hold more and more cash relative to prices, i.e. purchasing power, to facilitate a correction to those distortions. The only way that inflation can therefore sustain an economy with a growing quantity of capital distortions, such that spending does not fall as per the NGDP policy, is if there is an acceleration in the rate at which the money supply increases!
It is like someone using water to get the ice off their driveway in a place with subzero temperature, thinking they can clear the driveway of ice.
This is a very long term analysis. It is not capable of being understood for the short run, which is where your mind is, and where most policy makers and economist’s minds are.
Why do you believe the Australian economy is “stable”? Is it solely because they have stable NGDP, stable output, and stable employment? It is not stable at all. It is unstable, it is massively distorted, as is our economy. This is why aggregate money supply in Australia is accelerating. It has to if NGDP is to remain on a “stable” growth path. If it ceased accelerating, the distortions could no longer be sustained, and NGDP would plummet. This is what happened in 2006 in the US. Inflation from the Fed never did cease. It just didn’t increase by enough to result in a continued acceleration in aggregate money supply growth. The massively distorted US economy requires an exponential money supply growth no less than the Australian economy. The difference is that the US ceased the exponential acceleration, whereas Australia did not. That is why NGDP plummeted in the US, but did not in Australia. But Australia incurred a cost the US did not. Australia got even closer to the vertical when it comes to aggregate money stock. Australia recently slowed the rate of aggregate money acceleration, and as a result of that, new housing starts there are at a 35 year low. That’s how distorted the economy is there. Nothing but a small reduction in the rate of money growth acceleration, and almost right away the built up distortions go into correction.
I am on record here as representing a school of thought most here are familiar with, and so let this serve as yet another test to see who’s right. It’s already way above 100-0 for “us”, let’s make it 101-0.
28. March 2012 at 11:12
My fundamental criticism of NGDP, which I am holding my anonymous name to, for what that’s worth, is this:
Constant NGDP growth targeting leads to an acceleration in the rate of money supply growth, and hence eventual hyperinflation.
but earlier you said:
It doesn’t take a rocket scientist to realize that Bernanke’s money printing is what is responsible for the last half year’s worth of employment growth. This again is not an advocacy.
http://www.themoneyillusion.com/?p=13715#comments
an ngdp TARGET means they adjust the printing presses BEFORE ngdp gets out of control (NGDP growth = inflation + real output growth; since wages are 70% of output, that implies wage inflation is under control with positive productivity).
thats why they call it a target!
It would appear that even in your mind the printing presses can coexist with stable output growth and moderate inflation (what we have now, albeit weak) and as we’ve had since the 80s, except for recessions.
28. March 2012 at 11:44
You embarrass yourself again Scot — misrepresenting or botching the arguments you pretent to address.
When you you stop laying games and give us something serious?
28. March 2012 at 11:44
You embarrass yourself again Scot — misrepresenting or botching the arguments you pretent to address.
When you you stop playing games and give us something serious?
28. March 2012 at 12:16
dwb:
Constant NGDP growth targeting leads to an acceleration in the rate of money supply growth, and hence eventual hyperinflation.
but earlier you said:
“It doesn’t take a rocket scientist to realize that Bernanke’s money printing is what is responsible for the last half year’s worth of employment growth. This again is not an advocacy.”
Those two statements do not contradict, dwb. I know it looks like they do, but you have to understand that the first statement is NOT an advocacy. It is not me saying that the boost in employment is “good.”
I distinguish between two types of employment, productive and unproductive. If Bernanke prints money, then I can say it can boost employment, without advocating for it, and even retain my conviction about what NGDP targeting leads to. I can do this because the employment I am talking about being boosted is unproductive employment. Jobs that are started because of easy money (unproductive) and not because owners of earned money are making it profitable to hire those workers (productive).
an ngdp TARGET means they adjust the printing presses BEFORE ngdp gets out of control (NGDP growth = inflation + real output growth; since wages are 70% of output, that implies wage inflation is under control with positive productivity).
Even if the Fed stopped printing money on the spot, if there is too much cash in the system, then NGDP can quickly get out of control and there won’t be anything the Fed can do, because it forced itself to commit to whatever inflation is necessary to MAINTAIN NGDP up to that point.
It would be like me committing to counterfeit any quantity of money to get you to spend a certain amount, and not caring if I have to print $1 million if it means getting you to spend an additional $10 more on dinner. You might think this is impossible, because you would only be thinking about your own personal affairs, but if you enlarge your scope of understanding, and include not only you and I, but everyone else, where we can only communicate with each other using the price system, then you will see what I mean. I mean I could just direct your attention towards Australia, and ask you why it is that they seem to require an exponentially growing M3 just in order to maintain a constant NGDP growth rate. One would think that a constant growth in NGDP would require a constant growth in the aggregate money supply, right? It’s intuitive, isn’t it? But it’s wrong. It’s wrong because it incorrectly assumes that money is non-neutral on the real productive structure of the economy in the long run. In fact, inflation is highly non-neutral in the long run. It generates a revolution in the structure of the economy that forever changes its future course.
thats why they call it a target!
Names mean diddly squat. In WW2 Germany, the leaders were considered themselves members of the “socialist worker’s party.” Today, people who believe in 10,000 space aliens changing the Earth through a volcano call themselves “scientologists.”
It would appear that even in your mind the printing presses can coexist with stable output growth and moderate inflation (what we have now, albeit weak) and as we’ve had since the 80s, except for recessions.
Sorry, but no, I don’t believe in that chimera. I liked your series of caveats there though, as if you know it’s all nonsense and so you had to anticipate your own conscience in apologizing for it through saying “albeit” and “except”.
I think when you say “It would appear that even in your own mind…”, you were really talking about you, not me.
28. March 2012 at 12:17
Greg Ransom:
That isn’t being very contributive in this thread.
28. March 2012 at 13:05
I know that you answered this, but I went back and viewed the original interview and he made no qualifications regarding the Great Depression related to housing prices. Indeed, prices did fall nationally, and the policy lessons drawn from the mortgage crisis of the 1930’s are poorly understood and largely unexamined. My guess is that Bernanke has never looked at data on a nationwide basis in regard to housing prices during the Great Depression(outside of the Case Shiller data, which is only reported as a national aggregate and does not look at the behavior of regional markets). Have you looked at the behavior of the various regions? Do you know of any sources? Don’t you think that he should have made this qualification–being an expert on the Great Depression? And if he was making an unstated exception (as you imply), isn’t that part of the problem? Some have argued that the problem with the “predictive models” of housing market vulnerability failed due to the lack of data from eras like the Great Depression. I would argue that you are assuming he knows something deeply about which he actually understands very little (or has given little thought). If you actually look at the data on residential housing during this era (the Case Shiller historical data), the national price aggregate began its decline 1925 and bottomed out in 1934–and was made worse by the nominal shock (1931) of the Great Contraction. To some degree, we are experiencing the exact same thing now–2005 peak, nominal shock of 2008, maybe bottoming out now. If you look at the log of the nominal price index over time, the only two eras that are similar are the Great Contraction and now. The nominal data are arguably the key indicator in that decisions are made day to day, in nominal terms, as you know. After Friedman and everyone else, we have learned nothing.
28. March 2012 at 13:20
Those two statements do not contradict, dwb. I know it looks like they do, …
if it looks like a duck, walks like a duck, quacks like a duck… shoot it, it will taste good roasted.
I distinguish between two types of employment, productive and unproductive. If Bernanke prints money, then I can say it can boost employment, without advocating for it, and even retain my conviction about what NGDP targeting leads to.
huh? does your butt hurt when you pull this crap out of it?
28. March 2012 at 13:55
dwb,
I think I have to side with Major on that one. Increased employment need not imply growth in NGDP. It *could* simply transform profits into wages.
Now, why anyone would think a firm would do this… I dunno.
28. March 2012 at 13:56
“outside of the Case Shiller data, which is only reported as a national aggregate and does not look at the behavior of regional markets”
Huh?
28. March 2012 at 13:59
Never mind. You don’t mean the Case-Shiller indices. You mean the data from Shiller’s book.
28. March 2012 at 16:34
dwb:
Those two statements do not contradict, dwb. I know it looks like they do, …
if it looks like a duck, walks like a duck, quacks like a duck… shoot it, it will taste good roasted.
You should listen to the animal a little more, because what you thought was a duck, is in fact a rooster.
You simply must understand the difference between an advocacy and communicating the mechanistic results of various policies, such as monetary policy on “employment.”
“I distinguish between two types of employment, productive and unproductive. If Bernanke prints money, then I can say it can boost employment, without advocating for it, and even retain my conviction about what NGDP targeting leads to.”
huh? does your butt hurt when you pull this crap out of it?
There’s no butt hurt dwb. You’re just massively confused. You WANT to see something in my comments that aren’t even there.
I can say that printing money can boost employment, and I can say that not as an advocacy for it, and I also can hold that targeting NGDP leads to exponential money growth.
Nothing you have said even remotely resembles a critique of this.
D R:
I think I have to side with Major on that one. Increased employment need not imply growth in NGDP. It *could* simply transform profits into wages.
Actually that wasn’t my argument, but I do think that’s right.
Bernanke printing money can boost employment and NGDP. That again is not an advocacy.
28. March 2012 at 18:40
You should listen to the animal a little more, because what you thought was a duck, is in fact a rooster.
roosters are tasty too.
You simply must understand the difference between an advocacy and communicating the mechanistic results of various policies, such as monetary policy on “employment.”
I can say that printing money can boost employment, and I can say that not as an advocacy for it, and I also can hold that targeting NGDP leads to exponential money growth.
Bernanke printing money can boost employment and NGDP. That again is not an advocacy
huh?
Trust your feelings young jedi. Remember: a Jedi can feel the Force flowing through him. it partly controls your actions, but also obeys your commands.
Thats why they call it a TARGET. bullseye, you know as in “hit here, not there” if you prefer, we’ll give Ben a safe word so he’ll stop printing money. we’ll all send him a text with the safe word when the ngdp forecast hits 4% cool? glad we resolved that. case closed.
incidentally, higher growth is usually off a smaller monetary base (higher velocity) once a recovery is self-sustaining.
28. March 2012 at 21:44
dwb:
roosters are tasty too.
Roosters aren’t ducks.
Thats why they call it a TARGET. bullseye, you know as in “hit here, not there” if you prefer, we’ll give Ben a safe word so he’ll stop printing money. we’ll all send him a text with the safe word when the ngdp forecast hits 4% cool? glad we resolved that. case closed.
Central banks can lose control of targets.
incidentally, higher growth is usually off a smaller monetary base (higher velocity) once a recovery is self-sustaining.
There is no such thing as a “self-sustaining recovery” in an economy with an activist central bank money printer.
29. March 2012 at 12:00
[…] Source […]
30. March 2012 at 18:22
Excuse me if this is a dumb question, but how could the Fed possibly have prevented NGDP from falling (when even massive inflation of the money supply hasn’t helped)?
I believe NGDP has tanked because several parts of the president’s agenda — not just ObamaCare but also the EPA’s and NLRB’s attempts to regulate new areas of behavior without bothering to get laws passed first — have made it much riskier to be in business in America than ever before. Perhaps if all three of these enactments are struck down by the courts, and not replaced with more new ones as fast as they fall, employment will be able to recover.
Until that happens, as far as I’m concerned, the depression is not over.
30. March 2012 at 19:41
JDG,
Sumner’s theories are based on a lot of your assumptions.
To him, the method of shrinking the government is to take the power out of the hands of the humans that run the Fed.
Put the US monetary supply on a computer program to run a NGDPLT target of 4.5% per year, and take the human hands off the wheel. Fire some Fed economists, or at minimum have them all work from home.
4.5% is nice a low-inflationary target, it means many years we’ll have less than 1% inflation.
It means we can draw a line on the graph and tell the whole world in 3.75 years the NGDP will be $X.XXX trillion, and in 5.25 years, 6, 9.5 years – the same line applies.
The pc continously steers us back to the center of the line, no matter what happens to gas prices (hint: they won’t climb like now), and no matter what social engineering goals Congress dream up (FAIL).
Under Scott’s plan Fannie and Freddie literally become impossible, politically it’d be easier to take away guns, than to backstop loans for millions of bad credit risks.
There could be 5x as many Barney Franks and under Scott’s plan they’d never come close to making those loans in 2005.
Think about what I’m saying there, Sumner gives you god’s logical handshake that there isn’t a housing crisis.
In 2004, NGDPLT hits 4.5%, and the machine starts depleting the money supply, rates go up.
5x barney swoops and screams “FREEEEE HOUSES!!!” and rates across board just keep climbing until literally Barney stops his grand plan, until the the economy is choked by the throat, so badly that hordes of MA business owners are banging down his door.
It also GUARANTEES the US a smaller public sector, with government taking up a smaller percentage of the economy from the day we adopt the policy.
Say we’re moving along at 4.5% ALL OF IT in RGDP and zero inflation, and guess what doesn’t happen?
Public employees don’t get raises. If they do, we have to choke the economy by throat RIGHT THEN, so now YoY there’s shrinkage in the public sector.
Watch this, there’s 4.5% inflation, and no private sector growth, guess what doesn’t happen? Public sector employees don’t get cost of living adjustments! Even with inflation at 4.5%, nothing!
Under Scott’s plan public employees actually trend back to private sector earnings, and fall BELOW the private sector unless they make productivity gains like private sector (ROFL).
Anyway, it’s not perfect, but its closer to your goal and you can see your goal better from Scott’s plan.
31. March 2012 at 06:45
Morgan, your answer pretty much just denied the argument JDG made.
JDG says the Fed couldn’t have prevented NGDP from falling, then you say the Fed could have targeted an NGDP, meaning they could have prevented NGDP from falling.
JDG says the Fed couldn’t have stopped NGDP from falling, no matter how much they inflated, on the basis that the problem wasn’t lack of liquidity, it was that hardly any investments were safe. The Fed could have given 10 times the new reserves than they did to the banks, and investors still would have abstained from investing.
Imagine there is an economy with 10 major and highly complex individual investment projects, each with a book value of $100 million, and that each project in its current orientation suddenly becomes a loser. Each are now insolvent in their current orientation. Imagine you have $10 million to invest. Accordingly, you will almost certainly wait for these projects to be scrapped, liquidated, and/or overhauled first, before you just invest your money in new projects.
Now suppose that instead of $10 million, I give you $100 million of new money to invest. Heck, let’s make it interesting. Suppose I give you $1 trillion of new money instead.
Question: Are you going to invest in losing projects solely because you have more cash to invest? Or will you still wait a period of time for the projects to be fixed first, before you start investing with your money?
31. March 2012 at 07:06
To add to my previous post, it is quite ironic that Sumner is ostensibly anti-Keynesian stimulus, because he doesn’t seem to realize that the only way aggregate demand can be boosted in an economy where nobody wants to invest, is to spend money on that which isn’t private investment. But who oh who can bring about more spending, if private investors and banks don’t want to invest to bring about that part of aggregate demand, which makes aggregate demand fall?
This is where Sumner’s worldview implicitly rests on fiscal policy. For he would invariably say that at the very least, the Fed can buy government debt. But then what kind of stimulus are we to call it once that money is spent? That’s fiscal “stimulus”! Aggregate demand will be boosted by government spending, not private investment.
Sumner is a closet Keynesian.
31. March 2012 at 07:40
That’s actually the very first question I started on when I landed here almost 3 years ago.
The transmission mechanism currently is Scott’s hot potato.
As in Fed just buys more and more assets until things get moving, they guy who would have bought the T-Bill the Fed bought, now still has that money in his hands, and he has to buy something else instead, etc. etc. etc.
But, what I’m actually speaking about in the NGDP Futures Market, that I think is best: it works like Forex, you dump in your cash account, and you start bidding.
If contract comes up to short, and NGDP is X on certain day, the Fed prints money and hands it to you.
If NGDP comes in to high, it take a chunk of your money and burns it.
My goal is to try and get Fed out of business of buying T-Bills from GS and into the business of handing freshly printed dollars to your grandma since she bet right.
Here’s another one to piss on liberals heads:
Maybe the Fed prints money and does a helicopter drop BUT only gives it to people who are sitting on cash – the ones who would normally be taxed on their savings, so there is less moral hazard – and just keep giving these savers cash until some of them finally go buys some luxuries.
The truth is Sumner is right, no Central Bank that wanted to inflate has ever been unable to.
But we can be far less cavalier about it.
REMEMBER: If we follow Sumner’s plan:
1. No house loans for the great unwashed.
2. No Barney Frank pay off to Dem voters.
3. No increase in public employee salaries since 1998.
4. No Wall Street financial crisis.
5. No bailout.
And on and on and on.
NO Gold Nut, no Austrian, no libertarian can look that that list and wave it away and say it’s no better than what we have now.
31. March 2012 at 10:56
@Morgan
“The transmission mechanism currently is Scott’s hot potato.”
I don’t think Scott has this quite right. Depending on the quantity of money, its return relative to other financial assets changes so economic players alter their allocation amongst financial assets (i.e. more cash less Tbills), but they don’t spend more.
What cause economic players to spend more is when the overall average price of financial assets (including money) rises relative to real assets and real goods. Players exchange financial assets and buy stuff like factories and hamburgers.
Borrowing is the same thing… just a reduction (i.e. negative holdings) of financial assets induced by higher prices (lower borrowing costs).
When economic players have too much cash they don’t spend more…. they reallocate to other financial assets. When they have too many financial assets overall, then they spend.
Fed action works by driving up the price of financial assets relative to real assets and real goods.
31. March 2012 at 19:01
If NGDP comes in to high, it take a chunk of your money and burns it.
You sure that’s how futures markets work? Futures markets see gainers and losers. Money isn’t “burned.” It is transferred.
2. April 2012 at 05:55
Josh, Any increase in the demand for liquidity could have and should have been accommodated by the Fed. Instead, the Fed sharply slowed the growth rate of the monetary base in late 2007 and early 2008.
Majorajam, In any market some people are right and some are wrong. In some countries those who cried “bubble” were right, but in most countries they were wrong–the “bubbles” never popped. It’s all random, if it weren’t it’d be easy to get rich, just invest in “bubble-popping” mutual funds. I don’t see many people getting rich, hence I assume bubbles are not easy to spot.
John Brennan, Perhaps he was referring to real housing prices, which did not fall during the Great Depression.
John David Galt, I’d look at some of my FAQs in the right margin of this blog. Regulations don’t reduce NGDP, they reduce RGDP. Monetary policy controls NGDP–that’s not very controversial. I have a $100 trillion bill from Zimbabwe in my office (thanks to Morgan) Do you think printing that much money might create a bit of inflation?