Archive for the Category Heterodox macro


An excellent new monetary blog

It’s getting harder and harder to keep up.  In addition to the new David Glasner blog, there is another noteworthy blog that I overlooked, called Free Banking.  This blog has about a dozen distinguished monetary economists, mostly working in the Austrian/free banking tradition.  I’ve been critical of some of the pop Austrianism on the internet, but these economists are very thoughtful.  George Selgin is the name most frequently mentioned over here, and of course he favors a productivity norm, which is not all that different from NGDP targeting.

I’m sure most of the people at Free Banking think I’m slightly unhinged in my relentless claim that money is actually far too tight.  But on many other issues we would tend to agree–such as distrust of having the Fed trying to fine tune the economy, and the need for monetary rules.  Kevin Dowd and I both published papers on CPI futures targeting.

The real ideological divide

Paul Krugman recently started off a post as follows:

I’ve been watching with sympathy as David Beckworth and Scott Sumner discover that their updated monetarism actually puts them on my side of the great ideological divide “” cast into the outer darkness along with John Maynard Keynes and Milton Friedman.

But what does the other side believe? Someone, I don’t know who at this point, sent me to this post by Robert Murphy, which is the best exposition I’ve seen yet of the Austrian view that’s sweeping the GOP

I certainly understand the point Krugman is making, and in a sense I agree.  But I also think this slides over a much more important ideological divide; one I still don’t fully understand.

Suppose you asked the top 100 macroeconomists in America whether they were with the 5 economists in the first paragraph, or Bob Murphy.  My guess is that at least 90 would be with us (and yes, that even includes new classicals like Robert Lucas.)  So the “outer darkness” is not all that lonely a place.

But here’s what I don’t know.  Why weren’t those 90 macroeconomists out picketing the Fed in October 2008, demanding easier money?  Well 89 of the 90, the other is in the Fed.   Back in late 2008 and early 2009 a few of us quasi-monetarists were just about the only people insisting on the urgent need for much more monetary stimulus.  A tiny handful of others (including Krugman) half-heartedly agreed it was worth a shot, and almost everyone else completely ignored monetary policy.  One argument was they assumed we were at the zero bound.  Actually, we weren’t at the zero bound in October 2008, but let’s say we were close.  The main problem with the zero bound argument is that there was no general understanding that monetary policy was ineffective at the zero bound among the macro elite.  Indeed many of them (Bernanke included) argued forcefully that the BOJ needed to do much more in the late 1990s and early 2000s

I seem to recall Krugman once saying something to the effect that Bernanke discovered things were much harder than it looked from the outside, once rates hit zero.  Yes, that’s right, but the thing Bernanke found out was not that the ideas he gave the Japanese don’t work, he found out that it was difficult to get his colleagues to agree to implement those ideas (or at least that’s what I assume.)   But whatever you think of Bernanke, none of that explains the behavior of the 89 economists discussed above.  Why weren’t they speaking out?

The reality is that the Fed almost always does roughly what the broad consensus of macroeconomists thinks they should do.  In late 2008 and early 2009 those 89 macroeconomists didn’t think we needed more monetary stimulus, or if they thought so didn’t speak out (I’d guess Svensson would have agreed with me.)  Naturally the Fed didn’t provide the needed monetary stimulus.  If the consensus of the 89 had been that QE2 should have been adopted in November 2008, not November 2010, it probably would have been done then.

I still don’t think the views of Murphy have broad acceptance among elite macroeconomists (if they do God help us.)  They certainly didn’t in 2007.  The big mystery is not explaining wacky views of Austrian bloggers and GOP economists who hope to get a gig as Sarah Palin’s chief economic advisor, but the broad mainstream of Ivy League macroeconomists.  I just did a post showing that Charles Calomiris opposed QE2 even though his rationale suggested it was needed.  Earlier I did a post showing that Frederic Mishkin did not think Fed stimulus was inadequate in late 2008 and early 2009, even though the key insights of his textbook clearly and unambiguously suggest it was.  Indeed the explanation of the crisis added to the 8th edition of his textbook is completely contradicted by his 4 key insights into monetary policy, which come just one page later!  I recall a talk by Robert Lucas a couple years ago, where he mentioned how in this situation the Fed needed to boost the money supply to offset a fall in velocity, but then for some strange reason suggested he though Bernanke was doing a good job.  I could go on and on.

The big mystery Krugman should investigate is not why people like Bob Murphy hold wacky opinions, but why his fellow elite macroeconomists seemed to suffer from mass amnesia in late 2008 and early 2009.

Krugman makes this observation later on:

Why is there such a strong correlation between nominal and real GDP? Why is there overwhelming evidence that when central banks decide to slow the economy, the economy does indeed slow? And on and on.

I’d love to know why our elite macroeconomists were not loudly demanding that the Fed do something to prevent (in 2009) the biggest fall in NGDP since 1938.

BTW, I appreciate the support from Paul Krugman; despite our previous disagreements I consider him the most brilliant macroeconomist in the blogosphere.  But I was slightly bemused by his comment that I had just “discovered” I was on Krugman’s side regarding demand shocks.  I feel like I’ve been here all along.  I can’t help remembering when I tried to remind Paul Krugman that we were (should have been?) on the same side in March 2009.  As Matt Yglesias pointed out, on the issue of monetary stimulus it is others that need to do some soul-searching:

The Great Recession has revealed a lack of capacity for dealing with monetary issues to be a major institutional weakness of the progressive movement.

Matt himself doesn’t lack an understanding.  I’d like to think that’s partly because he reads quasi-monetarist bloggers.  You know, the ones who said that rumors of QE2 would depreciate the dollar, raise equity prices, and raise inflation expectations—months before rumors of QE2 actually did depreciate the dollar, raise equity prices, and raise inflation expectations.

I suppose this sounds like I’m being a poor sport.  Two positive mentions in a row from Paul Krugman!  Let’s celebrate that fact and not look back on unpleasant memories that are best forgotten.


Bob Murphy explains the Ben Ber-nank’s policies to his son

For some reason I imagined Bob Murphy talking to his son when I watched this video:

My God, what a big mistake the Fed (and the profession) made in talking about monetary policy in terms of inflation!  The following would be the sort of video I’d envision if I was trying to explain things:

Son:  What’s all this QE2 talk about?

Bob the Austrian:  The Fed is printing more money to boost national income.

Son:  Why do they want to boost national income?

BTA:  Because we’ve had a severe recession and the economy is still weak, more income would make Americans better off.

Son:  But won’t that money just blow up more bubbles, isn’t a painful adjustment necessary after the housing bubble?

BTA:  You need to study Hayek.  The initial re-allocation of resources was necessary, but the secondary deflation that began in late 2008 caused an unnecessary fall in national income.

Son:  Why then do so may conservatives oppose QE2?

BTA:  They have two objections; they say it won’t have any effect, and they say it will cause lots of inflation.

Son:  But aren’t those two effects logically inconsistent?

BTA:  Yes.

Son:  Then why do left-wingers oppose the QE2?

BTA:  They favor fiscal stimulus instead.

Son:  But won’t fiscal stimulus balloon the budget deficit much more than monetary stimulus?

BTA:   Yes.

Son:  But why are so many countries opposed to QE2?

BTA:  The Chinese are worried that a weak dollar will cause the Chinese currency to also become weak, causing inflation.

Son:  But if the Chinese think the US dollar is not a good currency, then why do they fix their own currency to the dollar?  Did we request they fix their currency to ours?

BTA:  Not exactly.

Son:  Why is QE2 so unpopular with the public?

BTA:  Because the Ben Ber-nank keeps saying they are trying to create more inflation.

Son:  Are they trying to create more inflation?

BTA:  No, they are trying to raise NGDP.

Son:  If they rise NGDP is the hope that this will also raise inflation?

BTA:  No, they hope that for any given increase in NGDP they get as little inflation and as much real growth as possible.

Son:  Then why does the Ben Ber-nank use such an unpopular argument to sell such a good idea.  I think most Americans would like to see their incomes rise.

BTA:  The Ben Ber-nank was a professor of economics, not marketing.  In addition, the Ben Ber-nank has not been exposed to the incredible beauties of NGDP targeting, as his job at the Fed leaves him little time to read the wise thoughts of Friedrich Hayek and Scott Sumner

Son:  I can’t wait to read the thoughts of those two wise men.

PS.  Regarding the Hayek link; scroll down far enough and you’ll find his picture.

Comment on Murphy and Thaler

Bob Murphy thinks he has an argument that blows away my critique of income:

A few weeks ago I promised to “eviscerate” Scott Sumner’s blog post, in which he claimed that income was a “meaningless, misleading and pernicious” concept. It is now ready for your inspection. Flowers and condolences can be sent to Scott Sumner’s widow, c/o Bentley University.

Not so fast there partner, I’m not dead yet.  Here’s a comment from his essay:

In the comments section of his first post, I asked Sumner if he had a problem with the standard definition of income. I reminded him that it is the amount of consumption that one could afford, without reducing the value of capital. Sumner replied, “I do not object to your definition. … I guess ‘meaningless’ was a bit strong, but what possible use is there for a concept that measures how much consumption one could do [without] impairing one’s wealth?”

This reply actually flummoxed me; it’s akin to asking what possible use there is for the concept of profit. Specifically, a household needs to calculate its income, in order to know if it is “living beyond its means.” We can make the analysis more esoteric if we wish. For example, one of the key issues in Austrian business-cycle theory is that people during the boom period enjoy a false prosperity “” a high standard of living “” because they are unwittingly consuming their capital. These crucial issues are dependent on the basic definition that Sumner finds useless.

I hate it when people quote my comments; often my brain is fried by the time I answer my 100th comment in a day.  But I’ll stick by this one.  Profit is useful because it tells firms whether to enter or exit an industry.  Positive economic profit suggests you should enter, and negative economic profit is a signal to exit.  But income is a signal for  . . .  what?  Surely not for consumption.  Yes, it tells you how much you can consume without digging into capital, but why would you want to consume that much?  I had negative income in 2008, but I didn’t decide to do negative consumption.  I dug into my capital—which Bob suggests is violating the recommendation of Austrian business cycle theory.  Entschuldigen sie bitte!  (That’s ‘sorry’ in Austrian.)

Bob also finds an inconsistency in my critique of income taxes.

By the same token, I could challenge Sumner’s own argument for a tax on consumption. Imagine two identical people who could each hold a $100,000-per-year job. Person A goes to work, and spends his entire income on goodies each year. Because the government imposes a Scott-Sumner-approved 11 percent tax on consumption, this man pays $10,000 to the government, and actually only consumes $90,000 worth of goodies.

On the other hand, person B decides to be a drifter. He only works occasionally at odd jobs; he spends most of his days hitchhiking, watching the sunset, and working on his great American novel. He doesn’t cheat on his taxes, though: out of the $10,000 in annual income that he earns, he saves none of it, sends $1,000 to the government, and consumes the remaining $9,000 in goodies.

I could very easily condemn this hypothetical consumption tax, and along Sumnerian lines. After all, the two men had equal abilities at the start of their adulthood. Person B could have chosen to work in the office and earn enough money to spend $90,000 each year on consumption. But instead, person B chose a different path. So why in the world should the government tax him far less than it is taxing the “equivalent” person A?

So far, so good. I am showing that the (immoral and inefficient) consumption tax cannot hold up to scrutiny; it isn’t really true that people who “consume” more are necessarily “richer” and therefore able to pay more, as Scott Sumner and other advocates of the consumption tax seem to think.

But what if I went further? Suppose I went on to argue, “Indeed, the very concept of labor income is meaningless, misleading, and pernicious. In our example, person A earned ten times as much ‘labor income’ as person B, but there is no reason to suppose that person A somehow has a better life, since person B could have made the same choices. Indeed, ‘labor income’ is really just forfeited leisure. The drifter could have devoted his hours to office work, but instead he chose to ‘purchase’ $90,000 worth of his time from himself. Therefore, to count ‘labor income’ as a form of freebie flow of wealth is to count the same hours twice.”

Now, regardless of how one feels about the validity of a consumption tax, does anyone want to go so far as to say that a paycheck isn’t really a form of income after all? I submit that Sumner made an analogous mistake in his own analysis. Just because we can imagine scenarios in which an income tax (that includes interest and capital gains) is patently unfair, does not mean that interest income therefore isn’t “really” income. Rather, it simply means that the conventional calls for progressive income taxes are misguided.

OK, whenever I lose an argument on logical grounds, I fall back on pragmatism.  I agree that consumption doesn’t really measure the theoretically relevant concept.  People get utility from goods, services, and leisure.  In practice it’s hard to tax leisure, or even measure leisure, so we tend to estimate living standards based on consumption, and we tend to tax consumption despite the fact that it distorts the labor/leisure choice.  We could avoid the distortion with a head tax, but that is probably too regressive.  On the other hand a land tax just might work.

Of course Bob will say the tax discussion is off-topic (I always use sleight of hand when losing); he showed that my argument against income could just as easily apply to consumption on purely logical grounds.  And I admit that my critique was more about specific uses of income (taxes, Gini coefficients, etc) than the concept itself.  Consumption is also less than perfect, as a tax base and as a way of judging living standards.  But I still think it’s much better than income.  So income is truly evil, and consumption is just a little bit naughty.

Oh, and my wife says she’d prefer red roses.

Part 2:  Richard Thaler tries to defend the indefensible

First, it is incorrect to say the estate tax amounts to double taxation. The wealth in many large estates has never been taxed because it is largely in the form of unrealized “” therefore untaxed “” capital gains. A 2000 study found that for estates worth more than $10 million, unrealized capital gains represented 56 percent of assets. For estates with active farms and businesses, the percentage is much higher. If no estate tax is imposed, capital gains taxes can be avoided indefinitely.

In fact, any tax on capital income is double taxation of labor income.  That’s why a consumption tax is best.  What Thaler should have said is that the estate tax is not necessarily triple taxation.  Triple taxation would occur if you earned some labor income, paid taxes, saved some of the remainder, earned capital gains on the saving, paid capital gains tax, and then was taxed when you died and left the remainder to your niece.  We need to abolish the estate tax and replace it with a progressive consumption tax (i.e. payroll tax.)

Greg Mankiw replies to Thaler, and has much better arguments.

Living in a country with Hayek’s stable NGDP monetary rule

A recent post by Bill Woolsey showed that Japan’s NGDP has been amazingly stable since the early 1990s (with just a dip in late 2008.)  This article in the NYT describes what happened after Japan adopted a stable NGDP monetary policy:

OSAKA, Japan “” Like many members of Japan’s middle class, Masato Y. enjoyed a level of affluence two decades ago that was the envy of the world. Masato, a small-business owner, bought a $500,000 condominium, vacationed in Hawaii and drove a late-model Mercedes.

But his living standards slowly crumbled along with Japan’s overall economy. First, he was forced to reduce trips abroad and then eliminate them. Then he traded the Mercedes for a cheaper domestic model. Last year, he sold his condo “” for a third of what he paid for it, and for less than what he still owed on the mortgage he took out 17 years ago.

“Japan used to be so flashy and upbeat, but now everyone must live in a dark and subdued way,” said Masato, 49, who asked that his full name not be used because he still cannot repay the $110,000 that he owes on the mortgage.

Few nations in recent history have seen such a striking reversal of economic fortune as Japan.

.   .   .

The downsizing of Japan’s ambitions can be seen on the streets of Tokyo, where concrete “microhouses” have become popular among younger Japanese who cannot afford even the famously cramped housing of their parents, or lack the job security to take out a traditional multidecade loan.

These matchbox-size homes stand on plots of land barely large enough to park a sport utility vehicle, yet have three stories of closet-size bedrooms, suitcase-size closets and a tiny kitchen that properly belongs on a submarine.

“This is how to own a house even when you are uneasy about the future,” said Kimiyo Kondo, general manager at Zaus, a Tokyo-based company that builds microhouses.

.   .   .

The decline has been painful for the Japanese, with companies and individuals like Masatohaving lost the equivalent of trillions of dollars in the stock market, which is now just a quarter of its value in 1989, and in real estate, where the average price of a home is the same as it was in 1983. And the future looks even bleaker, as Japan faces the world’s largest government debt “” around 200 percent of gross domestic product “” a shrinking population and rising rates of poverty and suicide.

But perhaps the most noticeable impact here has been Japan’s crisis of confidence. Just two decades ago, this was a vibrant nation filled with energy and ambition, proud to the point of arrogance and eager to create a new economic order in Asia based on the yen. Today, those high-flying ambitions have been shelved, replaced by weariness and fear of the future, and an almost stifling air of resignation. Japan seems to have pulled into a shell, content to accept its slow fade from the global stage.

.   .   .

The classic explanation of the evils of deflation is that it makes individuals and businesses less willing to use money, because the rational way to act when prices are falling is to hold onto cash, which gains in value. But in Japan, nearly a generation of deflation has had a much deeper effect, subconsciously coloring how the Japanese view the world. It has bred a deep pessimism about the future and a fear of taking risks that make people instinctively reluctant to spend or invest, driving down demand “” and prices “” even further.

.   .   .

A Deflated City

While the effects are felt across Japan’s economy, they are more apparent in regions like Osaka, the third-largest city, than in relatively prosperous Tokyo. In this proudly commercial city, merchants have gone to extremes to coax shell-shocked shoppers into spending again. But this often takes the shape of price wars that end up only feeding Japan’s deflationary spiral.

There are vending machines that sell canned drinks for 10 yen, or 12 cents; restaurants with 50-yen beer; apartments with the first month’s rent of just 100 yen, about $1.22. Even marriage ceremonies are on sale, with discount wedding halls offering weddings for $600 “” less than a tenth of what ceremonies typically cost here just a decade ago.

.   .   .

“It’s like Japanese have even lost the desire to look good,” said Akiko Oka, 63, who works part time in a small apparel shop, a job she has held since her own clothing store went bankrupt in 2002.

This loss of vigor is sometimes felt in unusual places. Kitashinchi is Osaka’s premier entertainment district, a three-centuries-old playground where the night is filled with neon signs and hostesses in tight dresses, where just taking a seat at a top club can cost $500.

But in the past 15 years, the number of fashionable clubs and lounges has shrunk to 480 from 1,200, replaced by discount bars and chain restaurants. Bartenders say the clientele these days is too cost-conscious to show the studied disregard for money that was long considered the height of refinement.

“A special culture might be vanishing,” said Takao Oda, who mixes perfectly crafted cocktails behind the glittering gold countertop at his Bar Oda.

After years of complacency, Japan appears to be waking up to its problems, as seen last year when disgruntled voters ended the virtual postwar monopoly on power of the Liberal Democratic Party. However, for many Japanese, it may be too late. Japan has already created an entire generation of young people who say they have given up on believing that they can ever enjoy the job stability or rising living standards that were once considered a birthright here.

Yukari Higaki, 24, said the only economic conditions she had ever known were ones in which prices and salaries seemed to be in permanent decline. She saves as much money as she can by buying her clothes at discount stores, making her own lunches and forgoing travel abroad. She said that while her generation still lived comfortably, she and her peers were always in a defensive crouch, ready for the worst.

“We are the survival generation,” said Ms. Higaki, who works part time at a furniture store.

Hisakazu Matsuda, president of Japan Consumer Marketing Research Institute, who has written several books on Japanese consumers, has a different name for Japanese in their 20s; he calls them the consumption-haters. He estimates that by the time this generation hits their 60s, their habits of frugality will have cost the Japanese economy $420 billion in lost consumption.

“There is no other generation like this in the world,” Mr. Matsuda said. “These guys think it’s stupid to spend.”

Deflation has also affected businesspeople by forcing them to invent new ways to survive in an economy where prices and profits only go down, not up.

Yoshinori Kaiami was a real estate agent in Osaka, where, like the rest of Japan, land prices have been falling for most of the past 19 years. Mr. Kaiami said business was tough. There were few buyers in a market that was virtually guaranteed to produce losses, and few sellers, because most homeowners were saddled with loans that were worth more than their homes.

Some years ago, he came up with an idea to break the gridlock. He created a company that guides homeowners through an elaborate legal subterfuge in which they erase the original loan by declaring personal bankruptcy, but continue to live in their home by “selling” it to a relative, who takes out a smaller loan to pay its greatly reduced price.

“If we only had inflation again, this sort of business would not be necessary,” said Mr. Kaiami, referring to the rising prices that are the opposite of deflation. “I feel like I’ve been waiting for 20 years for inflation to come back.”

One of his customers was Masato, the small-business owner, who sold his four-bedroom condo to a relative for about $185,000, 15 years after buying it for a bit more than $500,000. He said he was still deliberating about whether to expunge the $110,000 he still owed his bank by declaring personal bankruptcy.

Economists said one reason deflation became self-perpetuating was that it pushed companies and people like Masato to survive by cutting costs and selling what they already owned, instead of buying new goods or investing.

“Deflation destroys the risk-taking that capitalist economies need in order to grow,” said Shumpei Takemori, an economist at Keio University in Tokyo. “Creative destruction is replaced with what is just destructive destruction.”

Before commenters like Greg jump all over me, re-read the intro.  I never claimed the adoption of the 0% NGDP growth policy had anything to do with the dreary story described by the NYT.  And I’m not sure it does.  There’s nothing wrong with touting a country as a smashing success in one area, even if you disagree with its policies elsewhere.  I’m always praising Singapore’s fiscal policy, yet I detest many policies of the Singapore government.  It could well be that the bad performance of Japan’s economy was caused by supply-side factors unrelated to monetary policy.  Some bloggers even claim the Japanese haven’t done all that bad.

And yet . . . let’s be honest.  This is a big problem for the 0% NGDP growth fans.  Japan’s slide into stagnation co-incided almost exactly with the (de facto) adoption of a stable NGDP rule.  And it’s the only country I know that has adopted this policy.  And before the policy was adopted most mainstream economists thought deflation was a really bad idea.  Put that all together and I think “zero percenters” have got a massive PR problem.

Yes, the US grew rapidly in the late 1800s under deflation, but we had strong NGDP growth.  Japan doesn’t.  Are there any examples of countries doing well with stable NGDP?  I don’t know of any.  Unless someone can find plausible counterexamples, that makes Hayek’s argument a really hard sell.

Why is this important?  Because Hayek’s argument underlies the Austrian view that monetary policy was too “inflationary” during the 1920s, despite no rise in the price level.  He argued NGDP should have been kept stable, so prices could fall with productivity gains.  This argument also underlies some of the critique of Fed policy in the 2000s, as price inflation wasn’t all that high.  In fairness, some point to the rapid NGDP growth after 2003 as a problem, and I partly agree.  So the critique of the Fed in this case seems stronger from a NGDP targeting perspective.  But still nowhere near as strong as the critique of their policy of allowing NGDP growth to plummet in the midst of a financial crisis.