Better late than never

In 1933 a number of economists petitioned FDR to adopt a policy of reflation.  Why 1933?  Wouldn’t it have been much more sensible for economists to have petitioned Hoover during the severe deflation of 1930?  Wouldn’t it have been more sensible to prevent the Great Contraction, rather than wait until it was over before calling for monetary stimulus?

Yes, but in 1930 they did not yet recognize the problem as monetary.

Now it’s 2010 and the blogosphere is full of discussion of the need for easier money.  Why 2010?  Wouldn’t it have been better for the blogosphere to have been full of demands for easier money in 2008, before the massive downshift in NGDP dramatically worsened the financial crisis and raised unemployment from 6% to 10%?

Yes, but in 2008 they did not yet recognize the problem as monetary.

Here is Brad DeLong:

Obama’s Failure to Make His Federal Reserve Appointments in a Timely Fashion Looks to Have Been His Biggest Blunder

And it was a completely unforced error…

and Matt Yglesias:

Since at this point it’s clear that anything Congress does will be trivial, and the American Recovery and Reinvestment Act’s impact on the growth rate is now done, if anyone does anything it has to be the Fed. One can only hope that Barack Obama’s nominees to the Fed Board of Governors recognize the need for action and will be confirmed swiftly. The administration’s failure to act more decisively on this matter (and perhaps the decision to re-appoint Ben Bernanke) increasing look like a major blunder that’s inadvertently sinking the entire progressive agenda. People tend not to pay attention to these things, but poor monetary policy under Herbert Hoover destroyed small-government conservatism in America for decades.

According to the WSJ, DeLong and Yglesias are among the relatively small minority of economists who recognize the need for monetary stimulus.  But I suppose that should not be a surprise.  Elsewhere I have argued that Fed policy normally reflects the consensus view of economists.  So when the Fed is making mistakes, that means the entire profession is screwing up.

There are some other differences from the 1930s.  In the early 1930s there was less acceptance of the view that the government should try to reduce the severity of the business cycle (although it would not be correct to say that pundits viewed government as having no role.)  In 2008 there was a widespread understanding that something needed to be done.  Initially the focus was on stopping the banking crisis.  In 2009 the focus was on fiscal stimulus.  Only when it became clear that fiscal stimulus would not be enough (for whatever reason) did attention turn to monetary stimulus.

A few months ago when the economy seemed to be slowly recovering, I wondered whether there was any point in continuing my crusade for easier money.  Monetary stimulus was needed, but there was a sense that the train had left the station, and that the Fed had decided to stick with its ultra-cautious policy.   But with the recent slowdown it has become obvious to even some Fed officials that more needs to be done.   Ideally the Fed should shoot for 7% to 9% NGDP growth to speed up the recovery.  But in fact almost no one expects even the normal 5% growth.  Without 5% nominal growth any gains from wage and price cuts are simply washed away by sub-normal growth in demand, which necessitates further wage and price cuts.

Here’s something else to think about.  I know of two previous cases of economies where interest rates fell close to zero.  The US in the early 1930s and Japan in the 1990s.  In the US interest rates stayed near-zero for almost 20 years.  In Japan it is about 15 years and counting.  We might recover soon, but given that history we need to at least entertain the possibility that we are in for a long spell of near-zero rates.  It probably won’t be a depression (I doubt the price level will actually fall), but it could very easily be a Japanese-style Great Recession unless monetary policymakers wake up, or we luck out with enough growth in the developing world to pull us through (via a higher Wicksellian natural rate of interest.)

Because the Fed can’t cut the fed funds rate, and seems opposed to any alternative policy, we are relying on luck right now.  When nominal interest rates are stuck then economic models say the price level becomes “indeterminate,” unless the central bank uses some alternative strategy like inflation targeting.  In my view the only thing putting a floor on the nominal economy is the perception that Bernanke won’t allow outright deflation.  It could be worse, but that perception alone won’t get you a robust recovery in an economy that is severely depressed and has labor markets used to 2% inflation.  So although monetary stimulus would have been far more helpful if done in late 2008, even now it would be better than the status quo.

PS.  I occasionally see Fed officials excusing their poor performance with statements to the effect that the recovery will be slow because the economic crisis was so severe.  What they don’t say is that the recovery from the equally severe 1982 recession was several times more rapid.  Is the recovery slow this time because of some mysterious malady infecting the economy; or could it be that Volcker allowed 8% to 10% nominal growth during the recovery from 1982, whereas some Fed officials today think that 4% NGDP growth is a sign that we need to tighten policy?


Tags:

 
 
 

18 Responses to “Better late than never”

  1. Gravatar of JimP JimP
    15. July 2010 at 18:52

    Bernanke is due to testify before Congress soon. If only we could bombard the email of the staff of whatever committee he is to appear before with links to this post.

    Scott said to me that he thinks (and I hope) this horror we are in now is due to ignorance. Lets hope that is true – and we can act to remove it.

  2. Gravatar of JimP JimP
    15. July 2010 at 19:23

    This is totally nutty.

    http://www.washingtonpost.com/wp-dyn/content/article/2010/07/14/AR2010071406046.html?hpid=topnews

    We have 16% or more underemployment – and Obama is going around telling “the battery story”.

    The man is an idiot.

  3. Gravatar of Kosmo Kosmo
    15. July 2010 at 19:44

    “What they don’t say is that the recovery from the equally severe 1982 recession was several times more rapid. Is the recovery slow this time because of some mysterious malady infecting the economy….”

    Uh , have you given any consideration to the crushing levels of debt ?

    You had it just a moment before , then let it slip away :

    “I know of two previous cases of economies where interest rates fell close to zero. The US in the early 1930s and Japan in the 1990s.”

  4. Gravatar of Benjamin Cole Benjamin Cole
    15. July 2010 at 20:09

    It’s not only the web that people are chattering about need for monetary stimulus. See the NYT story re fed today. It is going mainstream.

    My theory is that the Fed is prepping the public for some more QE.

  5. Gravatar of Doc Merlin Doc Merlin
    15. July 2010 at 21:37

    Yet another reason why central arbitrary control of money is a bad idea. Central planning leads to planners who have to ‘realize’ things about the economy.
    It is a shame that they realized too late that they forced interest rates too low in 2002-2006 and that money was too tight in 2008 and 2009.

  6. Gravatar of woupiestek woupiestek
    16. July 2010 at 00:06

    Seeing as we didn’t have a crisis in 2002-2006, I would think monetary policy was just fine then, Merlin.

  7. Gravatar of John Papola John Papola
    16. July 2010 at 03:47

    “Without 5% nominal growth any gains from wage and price cuts are simply washed away by sub-normal growth in demand, which necessitates further wage and price cuts. ”

    Are you saying there’s a paradox of thrift?

  8. Gravatar of John Papola John Papola
    16. July 2010 at 04:04

    Scott,

    Isn’t this really all about the excess reserves (some bank zombie action) and plus low investment demand? Will an expansionary monetary policy fix those problems? Obama Regime Uncertainty, sovereign debt, private debt all must be weighing down on these factors and leading people to pull back.

    Will increased nominal demand due to aggressive Fed purchases of whatever-they-can lead to more hiring in this environment, or just more hoarding and perhaps increased prices?

  9. Gravatar of scott sumner scott sumner
    16. July 2010 at 08:01

    JimP, Yes, batteries won’t solve our problem, and it isn’t even the right way to address environmental problems.

    Kosmo, You have reversed cause and effect. The financial crisis got much worse in late 2008 precisely because of falling NGDP expectations. And when those expectations improved then the debt problem got far smaller (according to the IMF.)

    If you were right we should see stagflation. But we have both sub-par growth and sub-par inflation. That is a deficiency of AD.

    Benjamin, I hope you are right, but no one is talking about inflation or NGDP targeting, which is what we need most.

    Doc Merlin, I agree about central planning.

    Woupiestek, Yes, money was not too easy in 2002-03. Perhaps is was a bit too easy in 2004-06.

    John, No paradox of thrift. Just excessively tight money.

    You asked;

    “Will increased nominal demand due to aggressive Fed purchases of whatever-they-can lead to more hiring in this environment, or just more hoarding and perhaps increased prices?”

    We need more than just QE. But I believe more AD would raise both prices and output, as the aggregate supply curve is pretty flat with 9.5% unemployment.

  10. Gravatar of Kosmo Kosmo
    16. July 2010 at 12:26

    “If you were right we should see stagflation. But we have both sub-par growth and sub-par inflation. That is a deficiency of AD.”

    Hoo boy !

    So debt-deflation has nothing to do with this crisis. Or Japan’s. Or the GD. Or reduced AD.

    Got it.

    Carry on.

  11. Gravatar of johnleemk johnleemk
    16. July 2010 at 14:10

    Kosmo:

    Japan has been deflating/stagnating for years because of an AD deficiency. This is virtually thoroughly uncontroversial. Debt does not prevent monetary stimulus from taking place or being effective. Scott contends (I think convincingly) that the same is happening in the US right now.

    The Great Depression was definitely due to an AD deficiency which was definitely due to deflationary monetary policy. This is one of the most uncontroversial things ever, in a very controversy-ridden field.

  12. Gravatar of Kosmo Kosmo
    16. July 2010 at 15:28

    Richard Koo has studied the Japan saga as much as anyone.

    See this presentation for a preview of coming attractions in the U.S. :

    http://csis.org/files/media/csis/events/090326_koo_presentation.pdf

    Monetary easing can’t make people borrow who don’t want to , or couldn’t if they wanted to. Huge piles of money are stuck in stagnant pools today for that very reason.

    You guys will always be able to say that not enough was done. If 4% NGDP targeting didn’t work , they should have gone to 6% , and they should have done it sooner.

    The Fed has effectively been targeting NGDP for 30 years. They stopped because they realized they were just building a bigger bomb. Turns out the one they built was plenty big enough.

  13. Gravatar of johnleemk johnleemk
    16. July 2010 at 22:11

    Kosmo:

    That presentation is confusing. Most of it has nothing to do with the effectiveness of monetary policy. In Exhibit 19, he lumps the Great Depression, Japan post-’96 and the US/UK since 2007 together. The solution to the Great Depression virtually indisputably was monetary easing. So why can’t it work for Japan or for the US now?

    Exhibit 22 makes my head spin. The impression I got from the previous slides is that the Japanese government took on a huge deficit to little avail — and yet the recommended fiscal policy is more spending? Haven’t we learnt from Japan that unless the central bank accommodates fiscal stimulus, it will ultimately be pointless and only add to public debt?

    The monetary policy recommendations make my head spin even more. Basically he’s saying “monetary policy doesn’t work, except it does”. All three monetary options he recommends are tools that can be used to target NGDP. Devaluing the dollar is basically the same as monetary easing — that’s exactly what FDR did in the Great Depression!

    The rest of the presentation tells a neat story, but doesn’t actually offer much evidence. A lot of the slides are subject to the accusation that they confuse correlation and causation. As Scott and even Krugman have explained, there is no reason to believe the BOJ cannot inflate — they refuse to credibly target inflation.

    Australia and New Zealand have had credible inflation targets for about two or three decades, and they haven’t had anywhere near the same kinds of problems as the rest of the developed world despite housing bubbles and the like — I believe Scott did a post on Australia some time back.

    I don’t know where you get the idea that the Fed targets NGDP from. It has never done that. The Fed targets an interest rate. This is I suspect the only reason people believe in the myth of the zero bound. Interest rates are not a reliable indicator of the looseness or tightness of monetary policy.

    NGDP targeting is quite obviously falsifiable. All the Fed has to do is say “we want NGDP to grow at 5% annually, and we will do whatever it takes to guarantee this figure”. Throw out money from helicopters, if need be — even though Scott thinks it’s a ridiculous idea. If you do the helicopter drop and have a clear, credible target, and still NGDP doesn’t grow at 5% p.a., then you’ve falsified the theory.

    (Australia and New Zealand have successfully targeted inflation for a while, and Bernanke himself has a speech available somewhere on the merits of inflation targeting, given its application in some other countries too. There’s no reason to expect inflation targeting to fail, even if you doubt NGDP targeting.)

  14. Gravatar of Kosmo Kosmo
    17. July 2010 at 15:36

    “I don’t know where you get the idea that the Fed targets NGDP from. ”

    I said they had been ” effectively ” targeting NGDP for 30 years. I got the idea from :

    http://mpra.ub.uni-muenchen.de/20346/1/MPRA_paper_20346.pdf

    “Empirical evidence presented in this paper supports the view that the Federal Reserve increased its responsiveness to the growth rate of nominal spending and thus that the change in policy was a change in Fed doctrine. Unlike the earlier research, these models are estimated using the Greenbook forecasts of the Federal Reserve and therefore are able to capture the actual intent of policy and are not biased by ex post data revisions. What’s more, using
    estimated nominal income targeting models for the pre- and post-Volcker eras, this paper presents evidence that the responsiveness of the Federal Reserve to changes in nominal
    income growth in the earlier period was insufficient to offset shifts in aggregate demand thereby resulting in a potential for self-fulfilling expectations. In addition, it was shown that an increased responsiveness of monetary policy to nominal income growth can reduce the volatility of inflation and output. This research therefore suggests that the Great Moderation can be explained, at least in part, by an increased responsiveness of monetary policy to nominal income growth and an overhaul of Federal Reserve doctrine.”

  15. Gravatar of ssumner ssumner
    18. July 2010 at 05:32

    Kosmo, You said;

    “Monetary easing can’t make people borrow who don’t want to , or couldn’t if they wanted to. Huge piles of money are stuck in stagnant pools today for that very reason.”

    This is a complete non-sequitor. I am talking about monetary stimulus, not encouraging more bank lending. The Japanese can simply devalue the yen if they want a bigger NGDP. No one seriously disputes this. The Bank of Japan adopted tighter monetary policies three times in the past 10 years, that hardly suggest a country stuck in a liquidity trap.

    Kosmo, You said;

    “The Fed has effectively been targeting NGDP for 30 years. They stopped because they realized they were just building a bigger bomb. Turns out the one they built was plenty big enough.”

    Funny how the bomb went off AFTER they stopped targeting NGDP. What does that tell you?

    johnleemk, I don’t have time to read that now, but you did a very effective demolition.

  16. Gravatar of Doc Merlin Doc Merlin
    23. July 2010 at 07:57

    @Kosmo:
    Wow thats huge! Score one for Scott.

  17. Gravatar of Doc Merlin Doc Merlin
    23. July 2010 at 08:00

    Anyway, the efficacy of NGDP targeting points to debt having a stronger role in monetary stickiness than sticky prices. If sticky prices was the main reason for monetary stickiness then inflation targeting would be more effective than NGDP targeting.
    Since NGDP targeting seems to work better, this provides more evidence for the role of debt.

  18. Gravatar of ssumner ssumner
    24. July 2010 at 16:20

    Doc Merlin, I think NGDP targeting works because sticky wages ar emor eimportant than stickty prices.

Leave a Reply