Archive for the Category Heterodox macro


Irving Fisher and George Warren

I am currently a bit over half way through an excellent book entitled “American Default“, by Sebastian Edwards. The primary focus of the book is the abrogation of the gold clause in debt contracts, which (I believe) is the only time the US federal government actually defaulted on its debt. But the book also provides a fascinating narrative of FDR’s decision to devalue the dollar in 1933-34.  I highly recommend this book, which I also discuss in a new Econlog post. Later I’ll do a post on the famous 1935 Court case on the gold clause.

Edwards has an interesting discussion of the difference between Irving Fisher and George Warren.  While both favored a monetary regime where gold prices would be adjusted to stabilize the price level, they envisioned somewhat different mechanisms.  Warren focused on the gold market, similar to my approach in my Great Depression book.  Changes in the supply and demand for gold would influence its value.  Raising the dollar price of gold was equivalent to raising the nominal value of the gold stock.  Money played little or no role in Warren’s thinking.

Fisher took a more conventional “quantity theoretic” approach, where changes in the gold price would influence the money supply, and ultimately the price level.  Edwards seems more sympathetic to Fisher’s approach, which he calls a “general equilibrium perspective”.  Fisher emphasized that devaluation would only be effective if the Federal Reserve cooperated by boosting the money supply.

I agree that Warren’s views were a bit too simplistic, and that Fisher was the far more sophisticated economist.  Nonetheless, I do think that Warren is underrated by most economists.

To some extent, the dispute reflects the differences between the closed economy perspective championed by Friedman and Schwartz (1963), and the open economy perspective advocated by people like Deirdre McCloskey and Richard Zecher in the 1980s.  Is the domestic price level determined by the domestic money supply?  Or by the way the global supply and demand for gold shape the global price level, which then influences domestic prices via PPP?  In my view, Fisher is somewhere in between these two figures, whereas Warren is close to McCloskey/Zecher.  I’m somewhere between Fisher and Warren, but a bit closer to Warren (and McCloskey/Zecher).

There’s a fundamental tension in Fisher’s monetary theory, which combines the quantity of money approach with the price of money approach.  Why does Fisher favor adjusting the price of gold to stabilize the price level (a highly controversial move), as opposed to simply adjusting the money supply (a less controversial move)?  Presumably because he understands that under a gold standard it might not be possible to stabilize the price level merely through changes in the domestic quantity of money.  If prices are determined globally (via PPP), then an expansionary monetary policy will lead to an outflow of gold, and might fail to boost the price level.  Thus Fisher’s preference for a “Compensated Dollar Plan” rather than money supply targeting is a tacit admission that Warren’s approach is in some sense more fundamental than Friedman and Schwartz’s approach.

Warren’s approach also links up with certain trends in modern monetary theory, particularly the role of expectations.  During the 1933-34 period of currency depreciation, both wholesale prices and industrial production soared much higher, despite almost no change in the monetary base.  Even the increase in M1 and M2 was quite modest; nothing that would be expected to lead to the dramatic surge in nominal spending.  That’s consistent with Warren’s gold mechanism being more important that Fisher’s quantity of money mechanism.  In fairness, the money supply did rise with a lag, but that’s also consistent with the Warren approach, which sees gold policy as the key policy lever and the money supply as being largely endogenous.  You might argue that the policy of dollar devaluation eventually forced the Fed to expand the money supply, via the mechanism of PPP.

A modern defender of Warren (like me) would point to models by people like Krugman and Woodford, where it’s the expected future path of policy that determines the current level of aggregate demand.  Dollar devaluation was a powerful way of impacting the expected future path of the money supply, even if the current money supply was held constant.

This isn’t to say that Warren’s approach cannot be criticized. The US was such a big country that changes in the money supply had global implications.  When viewed from a gold market perspective, you could think of monetary injections (OMPs) as reducing the demand for gold (lowering the gold/currency ratio), which would reduce the value of gold, i.e. raise the price level.  A big country doing this can raise the global price level.  So Warren was too dismissive of the role of money.  Nonetheless, Warren’s approach may well have been more fruitful than a domestically focused quantity theory of money approach.

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PS.  Because currency and gold were dual “media of account”, it’s not clear to me that the gold approach is less of a general equilibrium approach, at least under a gold standard.  When the price of gold is not fixed, then you could argue that currency is the only true medium of account, and hence is more fundamental.  During 1933-34, policy was all about shaping expectations of where gold would again be pegged in 1934 (it ended up being devalued from $20.67/oz. to $35/oz.)

PPS.  There is a related post (with bonus coverage of Trump!) over at Econlog.

Kocherlakota on negative supply shocks

Marcus Nunes directed me to an article by Narayana Kocherlakota, discussing the impact of negative supply shocks:

Let’s consider three ideas that have been popular on the campaign trail.

  • Increasing the minimum wage. What if Congress decided to increase the federal minimum wage by 10 percent a year over the next five years? Typically, economists would be concerned about the impact on employment: Higher wages might lead businesses to employ fewer workers. With monetary policy out of the picture, though, the move might actually help. The expectation of higher wages would cause consumers to expect more inflation over the next few years, leading them to buy more goods and services now, before prices went up. To meet this added demand, businesses would have to boost production and hiring.
  • Increasing import tariffs. Suppose Congress gradually raised tariffs on imported intermediate goods, such as steel and sugar. Economists would worry that this would reduce the benefits of free trade. But as long as the Fed didn’t respond by raising interest rates, there would also be a positive effect: Households would expect higher prices, which would again   prompt them to demand more goods and services today — creating much-needed demand for businesses.
  • Imposing restrictions on immigration. Most economists would oppose such a move, because immigration is seen as an important contributor to overall growth. Yet again, though, the logic changes somewhat if inflation is too low and the Fed is passive. Households might expect the relative scarcity of labor to drive up wages and prices, triggering purchases that would benefit businesses and the economy more broadly.

The Fed’s response is crucial in all these cases. Typically, the central bank reacts to increases in inflation by raising interest rates sharply — a move that would choke off any demand that the policy measures might generate. With inflation running well below target, however, it’s appropriate for the Fed to hold rates low even if it sees a modest increase in inflationary pressures. It’s this subdued reaction function that allows the policy initiatives to have more positive effects.

I find this peculiar, for a number or reasons.  First, I doubt that any demand-side effects of negative supply shocks would overcome the negative supply-side effects of these policies.  Second, I deny that these policies would boost demand, even at the zero bound. Higher minimum wages will lead to expectations of lower profits, and this will reduce investment.  What makes corporations invest more is higher expected NGDP.  What makes firms build more houses, is more immigration.  The crackdown on immigration in 2006 slowed the housing boom.

If you prefer Keynesian language, negative supply shocks reduce the Wicksellian equilibrium interest rate, making the “zero bound” problem worse.  Low immigration is exactly why the zero bound problem is most severe in Japan, and high rates of immigration is one reason why Australia never even hit the zero bound.  Fast NGDP growth leads to higher nominal interest rates, and no zero bound problem.

So even at the zero bound these policies do not work, as we found out when FDR raised wages sharply in July 1933, aborting a robust recovery in industrial production.  But it’s far worse.  We are not at the zero bound, and hence the Fed would simply raise rates to neutralize the effect on inflation.  Kocherlakota writes the final paragraph in a way that almost seems to suggest the Fed agrees with him, and would react the way he wishes.  But clearly they would not, or the Fed would not have raised rates in December.  So it’s a moot point.  Elsewhere, Kocherlakota says:

The Federal Reserve faces a big challenge: It wants to get inflation up to its 2-percent target, but so far its stimulus efforts have failed to reach that goal.

That’s simply inaccurate, for reasons that Kocherlakota has himself explained numerous times.  The Fed raised rates in December over Kocherlakota’s (wise) objections.  That means the Fed does not share Kocherlakota’s inflation objectives, or else they think they’ve already succeeded in the sense that expected future inflation is 2%.  But either interpretation is inconsistent with Kocherlakota’s “tried and failed” suggestion.  Either they are not trying, or they think they’ve succeeded. Take you pick, there are no other plausible options.

In fact, these initiatives would tend to reduce NGDP growth, as monetary policy would tighten to prevent any increase in inflation, thus reducing real GDP growth. Because wages are sticky, lower NGDP growth would boost unemployment.  And in the case of higher minimum wages, the unemployment effect would be especially large.

The fact that even a dove like Janet Yellen is aggressively raising interest rates to keep inflation from exceeding the Fed’s two percent target is a shot across the bow to progressives.  Yellen is essentially saying; “You go ahead and raise wages to $15/hour.  But we aren’t going to allow higher inflation.  Instead, we’ll raise interest rates enough to create lots more unemployment.”  The progressives have been warned, the only question is whether they care.

I’m starting to see a trend in the comment section that I never thought I’d live to see.  Progressives write in complaining that it’s cruel to have an economic system where low productivity people need to work (even with wage subsidies.)  Instead we should have a guaranteed annual income, so they can pursue other activities, such as hobbies, or volunteer work.

Maybe my lack of empathy comes from the fact that I was abused as a child.  My father tried to give away surplus games to charity, from his little store.  Things like Monopoly games with a few pieces missing.  But the charity would not take them, insisting that children receiving these slightly flawed gifts would be mentally scarred.  So instead he gave them to us.  Since then, I’ve never been the same.

Even worse, I ingested megadoses of lead.


Voodoo economics, then and now

Here’s me, back about 13 months ago:

I’d also love to know what Keynesians think of the Dems having a socialist as their lead member on the Senate Budget Committee, who then appoints a MMTer to be chief economist.  And Krugman says the GOP relies on voodoo economics!

Of course my liberals readers have been outraged at my Sanders bashing. But now we have this:

Paul Krugman is now accusing Bernie Sanders of “deep voodoo” economics.

That’s a particularly damning insult among liberals, who pride themselves on being on the side of reason, evidence, and general wonkishness. Krugman’s dis came on the heels of an open letter released today by four big-wig liberal economists—all of whom either served in the Obama or Clinton administrations—claiming that “no credible economic research” shows that Sanders’s spending-heavy economic plan will result in the big gains outlined in a paper endorsed by his policy director.

The paper, conducted by economist Gerald Friedman, predicts GDP growth of over 5 percent and an unemployment rate of under 4 percent in a Sanders administration. As Krugman notes, liberals have laughed at Jeb Bush for claiming he could produce 4 percent growth.

So Europeans work far fewer hours each year than Americans, because of their high-tax welfare state.  As a result per capita GDP in Europe is far lower than in America.  But somehow if we adopt their economic system our per capita GDP, already far higher than almost any other developed country, will start zooming ahead at 5.3%/year.  And I thought Trump was a clown.

Kudos to Krugman, for pointing this out.

(Just to be clear, I still greatly prefer Sanders to Trump—that’s how much I loath Trump.)

Update:  This good article on Sanders and Denmark quotes Lars Christensen.

Pop macroeconomics

Very few people understand economic theories such as supply and demand, the quantity theory of money, comparative advantage, AS/AD, etc.  As a result, if journalists explained things using these economic concepts, their readers would be hopelessly confused.  Thus even the elite news media tends to rely on some version of what Paul Krugman once called “Pop Internationalism.”  It’s hard to blame them, but unfortunately this analytical apparatus uses economic terms in a very different way from how economists use the terms.  So while their readers can follow the articles, I cannot.  Here’s an example of pop macroeconomics from the Wall Street Journal:

The global economy is awash as never before in commodities like oil, cotton and iron ore, but also with capital and labor””a glut that presents several challenges as policy makers struggle to stoke demand.

“What we’re looking at is a low-growth, low-inflation, low-rate environment,” said Megan Greene, chief economist of John Hancock Asset Management, who added that the global economy could spend the next decade “working this off.”

The current state of plenty is confounding on many fronts. The surfeit of commodities depresses prices and stokes concerns of deflation. Global wealth””estimated by Credit Suisse at around $263 trillion, more than double the $117 trillion in 2000″”represents a vast supply of savings and capital, helping to hold down interest rates, undermining the power of monetary policy. And the surplus of workers depresses wages.

Meanwhile, public indebtedness in the U.S., Japan and Europe limits governments’ capacity to fuel growth through public expenditure. That leaves central banks to supply economies with as much liquidity as possible, even though recent rounds of easing haven’t returned these economies anywhere close to their previous growth paths.

“The classic notion is that you cannot have a condition of oversupply,” said Daniel Alpert, an investment banker and author of a book, “The Age of Oversupply,” on what all this abundance means. “The science of economics is all based on shortages.”

I’m not quite sure what the WSJ means by “glut” or “stokes demand” or “oversupply” or “vast supply of savings and capital” or “surplus” or “abundance” or “surfeit of commodities” or “working this off” or “shortage.”  Yes, some of these terms are also used by economists.  For instance, we use the term ‘shortage’ to refer to a situation where quantity supplied exceeds falls short of quantity demanded.  But obviously “the science of economics” is not “all based on shortages.”  The authors obviously mean something entirely different.  Wealth also has a clear meaning in economics, but it is not something that “represents a vast supply of savings and capital, helping to hold down interest rates.”

When they say, “stokes demand” I’d guess they mean boost AD.  But if so, why would a “glut” of commodities make it more difficult to boost AD?  And exactly what does a “glut” of commodities mean?   Does it mean a surplus, reflecting a price above equilibrium?  Then why doesn’t the price fall?  Commodities usually trade in auction-style markets.  And what is “oversupply?  Is it increased supply, or a surplus?  If the “classic” model says you can’t have oversupply, then what’s wrong with the classic model?  We are not told.

Producers have their own share of the blame. In a lower commodity price environment, producers typically are reluctant to cut production in an effort to maintain their market shares.

In some cases, producers even increase their output to make up for the revenue losses due to lower prices, exacerbating the problem of oversupply.

“Generally, this creates a feedback cycle where prices fall further because of the supply glut,” said Dane Davis, a commodity analyst with Barclays.

If the price were artificially held above equilibrium, then it would not fall.  If it falls, then presumably price is determined by the forces of supply and demand.  In that case a “supply glut” presumably means an increase in supply.  But the most notable thing about the world economy in recent years is the extremely slow pace of increase in the aggregate supply curve. Thus even during a period of falling unemployment in the US (2009-15), real GDP growth has been quite slow, and the trend rate of growth (the rate LRAS shifts right) is even slower.  It’s even worse in Britain, the eurozone, and Japan.

Even if governments have the capacity for more fiscal stimulus, few have the political will to unleash it. That has left central banks to step into the void. The Federal Reserve and Bank of England have both expanded their balance sheets to nearly 25% of annual gross domestic product from around 6% in 2008. The European Central Bank’s has climbed to 23% from 14% and the Bank of Japan to nearly 66% from 22%.

In more normal times, this would have been sufficient to get economies rolling again,

This is a rather odd way of making the point.  Yes, an increase in the monetary base is usually associated with a rise in AD. But it is not the case that an increase in the base/GDP ratio is normally associated with higher AD, in fact just the opposite. Higher base/GDP ratios are usually associated with monetary policies that stop economies from “rolling again.”

Here’s how I’d look at the global picture:

1.  The data suggests that global productivity growth is slowing, as is global growth in the labor force.  The global AS curve is still shifting right, but more slowly.  The Wicksellian equilibrium real interest rate is falling.

2.  In some areas (particularly the eurozone) AD is too low because money was far too tight around 2011-12, leading to high unemployment.

I’m not sure what all the “glut” discussion adds to this.  But maybe that’s because I’m an economist who doesn’t live in the real world.  Or at least that’s what my commenters keep telling me.

HT:  Ken Duda

12 drummers drumming

A few days ago I discussed a long article on blogging in The Economist.  It turns out that the same edition also has a shorter piece (I presume it’s one of the short lead articles, which they often develop further in the middle of the magazine.)

Here’s an excerpt:

Previous publishing revolutions, such as the advent of printing, prompted similar concerns about trivialisation and extremism. But whatever you think about the impact of blogging on political, scientific or religious debate, it is hard to argue that the internet has cheapened the global conversation about economics. On the contrary, it has improved it.

Research (by two blogging economists at the World Bank) suggests that academic papers cited by bloggers are far more likely to be downloaded. Blogging economists are regarded more highly than non-bloggers with the same publishing record. Blogs have given ideas that failed to prosper in the academic marketplace, such as the “Austrian” theory of the business cycle, another airing (see article). They have also given voice to once-obscure scholars advancing bold solutions to America’s economic funk and Europe’s self-inflicted crisis.

A good example is Scott Sumner of Bentley University, who believes that America’s Federal Reserve should promise to restore “nominal” GDP (as opposed to “real” GDP, which takes account of inflation) to its pre-crisis path.

.   .   .

The back-and-forth between bloggers resembles the informal chats, in university hallways and coffee rooms, that have always stimulated economic research, argues Paul Krugman, a Nobel-prizewinning economist who blogs at the New York Times. But moving the conversation online means that far more people can take part. Admittedly, for every lost prophet there is a crank who is simply lost. Yet despite the low barriers to entry, blogs do impose some intellectual standards. Errors of fact or logic are spotted, ridiculed and corrected. Areas of disagreement are highlighted and sometimes even narrowed. Some of the best contributors do not even have blogs of their own, serving instead as referees, leaving thoughtful comments on other people’s sites and often criss-crossing party lines.

At the top of the on-line article is this close-up of the bigger illustration provided in the longer article.

Because I’m so vain my family was curious, I asked the artist if I was supposed to be the drummer.  Yep, it’s me.  Bob Murphy and Warren Mosler are also so honored. I never expected my picture to appear twice in my favorite magazine; and in caricature no less.

It makes me feel guilty to be singled out, so here are 12 other drummers that might have been included:

David Beckworth, Niklas Blanchard, Lars Christensen, David Eagle, David Glasner, Josh Hendrickson, Robert Hetzel, Doug Irwin, Kantoos, Marcus Nunes, Nick Rowe, Bill Woolsey.  I consider Hetzel to be the most distinguished market monetarist, although because he’s at the Fed he might not be comfortable with that label.

I’m being sent so much interesting stuff that it’s hard to keep up.  I hope to do posts soon on David Eagle and William Barnett, who have sent me material that relates to market monetarism.

PS.  The artist didn’t say which drummer; I’m hoping it’s not the one on the left.

PPS.  I apologize to any market monetarists if I left your name off the list; I wanted to stay at 12 for obvious reasons.

Update: My wife says the caricature looks much better than me.