Because Kevin Warsh is apparently the frontrunner for Fed chair, his record has been attracting a lot of attention.  Here’s Ike Brannon of the Weekly Standard:

In 2010, in his waning days on the board, Warsh remained preoccupied with the specter of inflation despite the complete lack of evidence suggesting its incipient appearance. In an FOMC meeting late that year he argued that the Fed should consider pulling back on its quantitative easing despite the fragile nature of the economy, reasoning that if it were to do so it would prompt Congress and the White House to act with another round of expansionary fiscal policy.

Suggesting that the Fed play political chicken with Congress is, in a word, insane. The Federal Reserve has a legislative mandate to pursue both full employment and price stability in monetary policy. What Warsh suggested would have effectively set that aside and inserted the Fed into the middle of a highly charged political battle that could have harmed the economy. People who allege that Warsh’s appointment would make the Fed more political can point to this as Exhibit A.

I agree that this sort of policy would be insane, although I’m not sure that this is precisely what Warsh was proposing.  I found this passage in the transcript of the November 2010 meeting, which suggests a slightly different interpretation (albeit equally “insane”):

First, my views on policy. As I said when we met by videoconference, my views are increasingly out of step with the views of most people around this table. The path that you’re leading us to, Mr. Chairman, is not my preferred path forward. I think we are removing much of the burden from those that could actually help reach these objectives, particular the growth and employment objectives, and we are putting that onus strangely on ourselves rather than letting it rest where it should lie. We are too accepting of dangerous policies from others that have been long in the making, and we should put the burden on them.

I can think, Mr. Chairman, of a tough weekend that the Europeans had, particularly your counterpart at the ECB, in the spring or summer, when we all knew that the European Central Bank, rightly or wrongly, was going to take action. But Jean-Claude Trichet did not take action until very late that Sunday night, until the fiscal authorities did their part. He thought that if on Friday night he were to say all of the things he’d be willing to do, he’d be taking the burden off the fiscal authorities. He chose to wait. I think we would be far better off waiting. If we proceed on this path, as I suspect we will, I would still encourage you to put the burden where it rightly belongs, which is on other policymakers here in Washington, and to do so in a way that is respectful of different lines of responsibility.

A few comments:

1.  Warsh’s comments in the transcripts are consistently disappointing, on almost every level.  Unlike other people I often disagree with (Krugman, Summers etc.) he doesn’t have a first rate mind.  His reasoning process is poor and he lacks good communication skills.  He has very poor judgment when interpreting data.  I really don’t know what he’s trying to say here, but the reference to Trichet is interesting.  Trichet was trying to encourage fiscal authorities to adopt more contractionary fiscal policies, not expansionary policies.  Trichet did not want to “bail out” expansionary policies with ultra-low interest rates, and Warsh seems to be endorsing Trichet’s approach.  And given Warsh’s reputation as a conservative, and the massive deficits being run by Obama back in 2010, I find it odd that Warsh would be advocating fiscal stimulus, as Brannon suggests.  But again, the passage is so garbled that I could easily be wrong.

2.  Warsh doesn’t seem to take the Congressional mandate seriously.  He seems to believe the Fed should be free to ignore this mandate, as a way of pressuring Congress to do what a few unelected private sector bankers want it to do.  To say that’s deeply disturbing is an understatement.  The Fed’s only argument for policy independence is that they are selfless non-political technicians trying to achieve goals set by Congress.

It is, of course, good news that equity prices have moved up, but I’m less convinced of their durability if this achievement is mostly because of what we’re doing here in the FOMC rather than because of what’s going on in the real economy.

This is disturbing on so many levels.  Start with the fact that no one could care less whether Warsh thinks the rise is equity prices was “durable”.  His opinion is worthless.  The fact that he thinks his opinion is worth mentioning is itself quite revealing.  And of course it’s not a question of monetary policy vs. the real economy; policy impacts stocks precisely because it impacts the real economy.  And of course he was totally wrong; the rise was durable.  Indeed stocks could crash tomorrow, and still be far above 2010 levels.

Warsh was also totally wrong about the NAIRU:

I share the staff’s view that the NAIRU has moved up.

In researching this post I came across this very revealing passage:

CHAIRMAN BERNANKE. President Evans, did you have a question?

MR. EVANS. Well, I just wanted to ask a question and offer a reaction to something that has come up at the last several meetings. I second the proposal of characterizing what optimal policy is in some way that we could better appreciate. President Bullard was absolutely correct when he pointed out that, after a big shock, optimal policy could well lead to fairly substantial gaps, or however you want to describe this outcome. But it’s also the case that bad policy would lead to gaps like that, too, and we need to understand why the current situation should be characterized as optimal and not simply bad. [Laughter] I mean, there is just a presumption here.

MR. BULLARD. Can I just clarify?

CHAIRMAN BERNANKE. President Bullard. November 2–3, 2010 141 of 238

MR. BULLARD. I just said that merely saying that unemployment is high and inflation is very low doesn’t tell you anything one way or the other about the quality of the policy, so that’s consistent with what you’re saying. It could be that we are following completely horrible policy, but we can argue that.

MR. LACKER. My point was that we don’t want to lead people to believe that, if unemployment is ever high, it’s because we have failed and are doing bad policy. You’d agree with that, wouldn’t you? MR. EVANS. I second the proposal for clarity on all of these objectives. [Emphasis added]

This is an amazing exchange–just amazing.  It perfectly demonstrates why we need the sort of accountability I’ve called for in recent posts.  Evans is right, OF COURSE you’d want to be able to discriminate between bad outcomes due to bad policy, and bad outcomes due to bad luck.  The Fed needs to establish a criterion by which policy actions can be judged, at least retrospectively.  If the Federal Reserve cannot establish a set of agreed upon metrics by which to evaluate whether previous policy stances were too expansionary or too contractionary, then the Fed ought to be abolished, with monetary policy turned over to the Treasury.

I found the experience of reading this transcript to be very depressing, giving me even greater respect for Ben Bernanke.  There were many people resisting monetary stimulus for reasons that are very hard to understand.  Bernanke is very polite, but it must have been an incredibly frustrating experience for him, knowing that the economy needed more stimulus and finding so much resistance.  In retrospect, it’s clear that many of his comments at the press conferences were attempts to explain the views of the committee as a whole, not necessarily his personal views.  Here I’m especially thinking in terms of his warnings about costs and risks associated with QE.

Basically you had one group of people seriously trying to hit the Fed’s targets, and another group that looked for any excuse they could find to do nothing.

HT:  Stephen Kirchner, Adam Ozimek, Craig Torres

Off topic:  As a child I had a very severe case of hay fever (fortunately I outgrew it).  So I was pleased to see Japan’s number two political party plans to address this underrated problem:

Yuriko Koike’s ‘zero policy’ pledges:

Zero nuclear power

Zero corporate cover ups

Zero corporate political donation

Zero children waiting for places in day care

Zero passive smoking

Zero packed commuter trains

Zero putting down of unwanted pets

Zero food waste

Zero violation of labour laws

Zero hay fever

Zero disabled and aged people unable to receive means of transport

Zero overhead power cables

Vaidas Urba directed me to a very interesting talk by Vítor Constâncio, Vice-President of the European Central Bank. Here’s one item that caught my eye:

Increasing the inflation target real interest rates could then be effective to eliminate negative output and unemployment gaps. These benefits of a higher inflation target can be outweighed by the broader costs of higher inflation, depending on the chosen level. Historically, relatively higher inflation has usually been associated with more volatile inflation.^[30] Moreover, the ECB and many other inflation-targeting central banks have shown that other monetary policy tools are available when interest rates cannot be lowered further.

It’s true that the availability of alternative tools makes a higher inflation target unnecessary, but the first argument is a bit misleading.  While its true that “Historically, relatively higher inflation has usually been associated with more volatile inflation”, this isn’t actually relevant to the debate over whether the inflation target should be set at 2%, 3% or 4%.  Yes, inflation was both higher and more volatile during the 1960s-80s, but inflation was lower and more volatile during the gold standard era.

The greater stability of inflation since 1990 is due to the fact that central banks have started targeting inflation, whereas there was no consistent inflation target under either the Great Inflation or the gold standard.  Inflation will be more stable when it’s being targeted, regardless of whether the target is set at 2%, 3% or 4%. Now if you are talking about an extremely high target, say 17%, then I’d expect more volatility, as it’s unlikely the next government or central bank head would agree with that sort of specific number.  The real issue is not how high the target is, but rather the degree of consensus.  Maybe there is currently more consensus around 2% than 3%, but if the zero bound continues to be an issue then that consensus may reverse in the future.

The discussion also mentions NGDPLT, but doesn’t really offer any useful analysis of that proposal.

David Levey directed me to an interesting Vox essay by Athanasios Orphanides, which compares the debt situation in Japan and Italy:

For Japan, the dramatic rise of the debt ratio before the crisis reflects the lack of nominal growth.  While the long-term government bond yield appeared to be low (consistently below 2%), nominal GDP growth was even lower (about zero, on average). The adverse debt dynamics worsened after 2007, with the recession following the Global Crisis. Part of the problem was overly tight monetary policy: policy rates were constrained by the zero lower bound (ZLB), but the Bank of Japan was reluctant to employ the required QE policies. However, since 2013 the Bank of Japan has embarked on a decisive QE programme which has simultaneously boosted nominal GDP growth and depressed long-term government bond yields. Since September 2016, as part of its ‘Quantitative and Qualitative Monetary Easing with Yield Curve Control’ policy, the Bank of Japan has communicated explicitly its intention to keep the 10-year yield on government bonds close to zero and short-term interest rates negative until inflation rises to 2%, in line with its definition of price stability. This monetary policy has stabilised Japan’s debt dynamics and has provided the Japanese government more time to implement structural reform measures and complete the fiscal adjustment needed to bring its primary deficit under control.

Abenomics has modestly boosted inflation in Japan, but the rate remains below the BOJ’s 2% target.  In another sense, however, the policy has been a big success. Unemployment has fallen to 2.8%, NGDP growth has accelerated, and the debt ratio has stopped rising.  Japan is no longer on the road to bankruptcy.

That’s why I favored the monetary “arrow” of Abenomics, and I’m pleased to see even a partial success.  In contrast, Italy lacks its own currency and will have to combine fiscal austerity with supply-side reforms to solve its problems.  That’s much tougher to achieve.

PS.  Hester Peirce is my colleague at the Mercatus Center, where she focuses on financial regulatory issues.  In this link, she’s on a panel with Ben Bernanke, discussing Dodd-Frank provisions such as the “orderly liquidation authority”.

The labor market data out of Japan is nothing short of spectacular.  The most recent data shows the rate falling to 2.8%, the lowest rate in decades:

And that’s not just due to people abandoning the labor force, as has been claimed regarding US data.  In start contrast to the US, the employment to population ratio is soaring to new highs.  This is from a Matt O’Brien article in the WaPo:

Anecdotal evidence also suggests an ultra-tight labor market:

Every shop and restaurant in Tokyo seems to have a “positions vacant” sign, and many are scrapping 24-hour opening to save labour. Yamato Transport, the country’s largest logistics company, is raising prices for the first time in 27 years in a deliberate attempt to cut volumes to a level its network can handle. Rather than cutting costs, chief executives spend their time working out how to hire and retain staff.

After more than two decades when labour was cheap and abundant, Japanese companies are finding ways to cut back, reducing their lavish service standards rather than raising prices. But this can only go so far. Japan is primed for inflation.

The struggles of the stimulus must also be weighed against the global economic backdrop. The plunge in 2014 in commodity prices, followed by the 2015 slowdown in emerging markets, leading to a sharp appreciation of the yen, were a terrible environment in which to generate inflation. Only with the election of Donald Trump as US president, and the subsequent rally in the yen above ¥110 to the dollar, is the global economy once again a support.

That’s right, this success occurred against a backdrop of substantial headwinds. How did they do it?  After he took office at the beginning of 2013, Abe set a goal of raising NGDP from 492 trillion to 600 trillion yen.  The inflation target was raised to 2%, and Kuroda was appointed to lead the BOJ.  NGDP started rising almost immediately, breaking out of a two-decade period of sluggishness.

Japan is now almost half way to its NGDP target.

To be sure, there are weaknesses. Inflation has averaged less than the 2% target, and is expected to continue doing so.  There was no date given for the 600 trillion yen NGDP target.  But overall, Abenomics has been a big success.

It’s also boosting RGDP.  Here’s the Financial Times:

Japan has recorded its longest run of sustained growth in more than a decade as stimulative policy and a healthier global economy lead to a period of robust progress.

Growth for the first quarter of 2017 came in at an annualised 2.2 per cent, according to the Cabinet Office, marking five quarters of continuous expansion in gross domestic product.

The figure beat the consensus analyst forecast of 1.7 per cent and is far above Japan’s long-run growth potential of roughly 0.7 per cent. That suggests the economy is using up spare capacity and unemployment will keep on falling.

The lesson here is that when you have a labor market that is facing inadequate AD, the solution is simple—more NGDP.  But printing money can’t perform miracles. Relatively soon Japan will reach capacity, and RGDP growth will stop.  At that point the BOJ must keep NGDP growing at 2% per year to ease its public debt burden.

And all of this occurred against a backdrop of zero interest rates and fiscal austerity—something Keynesians insist is impossible.  I can’t emphasize enough that Keynesian economics has negative value added, it simply doesn’t help us to understand what’s going on around the world.

Commenter Jim Glass provided another Paul Krugman op ed, this one from 2001 2011:

Nonetheless, Mr. Koizumi is right about one thing: Japan cannot go on like this. Swelling public debt will eventually threaten the government’s solvency; the festering financial problems of the banks will soon require a government bailout that will swell that debt even further. Something must be done. But the actions Mr. Koizumi has proposed could tip Japan into full-blown depression.

There is an answer to this dilemma, one that has become almost orthodoxy among economists who have tried to think seriously about Japan’s plight. This answer involves unconventional monetary expansion, with the Bank of Japan buying dollars, euros and long-term government bonds; it also involves accepting and indeed promoting mild inflation and a weak yen. I could explain why this would probably work, but what’s the point? It’s not about to happen.

For the real tragedy right now is that however innovative and open-minded Mr. Koizumi may be, he will fail unless other important players — mainly the Bank of Japan, but also the U.S. Treasury Department — are prepared to learn from Andrew Mellon’s mistake. And all the evidence is that they are not. The head of the Bank of Japan insists that the country’s continuing slump is the result of inadequate reform — that is, insufficient purging of the rottenness. And although the details are in dispute, the U.S. Treasury secretary, Paul O’Neill, appears to have warned Japan not to let the yen weaken too much.

Poor Japan. It is the victim of those who refuse to learn from the past, and thereby condemn others to repeat it.

So even three years after the famous 1998 liquidity trap paper, Krugman was still favoring monetary stimulus over fiscal stimulus for countries at the zero bound. But I’d like to focus on the comment regarding our Treasury officials.  Krugman’s right that they have consistently warned the Japanese not to engage in “currency manipulation”.  What our Treasury doesn’t understand is that all central banks manipulate currencies—-that’s their job!  The only question is how.  And don’t say “It’s OK to manipulate the purchasing power of a currency but not the foreign exchange value.”  If the manipulation is done via central bank policy, then the two types of manipulation are identical. For decades, the US Treasury has been (unknowingly) warning the Japanese not to manipulate their economy out of deflation.

Ironically, a healthier Japanese economy would also be good for the US, boosting our exports and creating good jobs.  Pity that we are so dense.

PS.  Over at Econlog you’ll find a Trump post that is perhaps a bit less “unhinged” than usual.  At least I hope so.

Paul Krugman frequently suggests that his famous 1998 article (“It’s Baaack, Japan’s Slump and the Return of the Liquidity Trap”) led him to rethink the role of monetary and fiscal policy.  He says that the “expectations trap” model in that paper convinced him that monetary policy might be ineffective at the zero bound, and that fiscal policy might then become necessary.

Previously I’ve pointed to a 1999 Krugman essay that advocated monetary stimulus for Japan, and was quite dismissive of the idea of fiscal stimulus.  While cleaning out my office, I came across a Krugman editorial from the year 2000, which made similar arguments:

Japan has the dubious distinction of being the first major nation since the 1930’s to experience a “liquidity trap,” in which even cutting the interest rate all the way to zero doesn’t induce enough business investment to restore full employment. The result is an economy that has been depressed since the early 90’s, and that in 1998 seemed to be on the verge of a catastrophic deflationary spiral.

The government’s answer has been to prop up demand with deficit spending; over the past few years Japan has been frantically building bridges to nowhere and roads it doesn’t need.

In the short run this policy works: in the first half of 1999, powered by a burst of public works spending, the Japanese economy grew fairly rapidly. But deficit spending on such a scale cannot go on much longer. Japan’s government is already deeply in debt (about twice as deep, relative to national income, as the U.S. was before our own budget turned around). For the policy to do more than buy a little time, the recovery must become “self-sustaining”: consumers and businesses have to start spending enough to allow the government to return to fiscal responsibility without provoking a new recession.

Carping critics (like me) warned that there was no good reason to think this would happen. Sure enough, it hasn’t; as the big public works projects of early 1999 have wound down, so has the economy. . . .

Although the Bank of Japan has already reduced the short-term interest rate to zero, Western economists have pointed out that there are other things it can and should do: buy longer-term bonds, announce a positive target for inflation to encourage businesses to borrow. Indeed, textbook economics tells us that to adhere to conventional monetary rules in the face of a liquidity trap is not prudent; it is irresponsible. (Full disclosure: I personally have been the most visible and vociferous advocate of inflation targeting).

But the current government has actually slowed the pace of reform, and the Bank of Japan — which only recently acquired Federal Reserve-style autonomy — has adamantly refused to do anything unconventional. (When I was in Japan in December, I witnessed an argument between former B.O.J. officials and current officials of the Ministry of Finance. The former declared that it would be wrong to do anything risky; the latter reminded them, to no avail, that the current policy of running up huge debts to finance public works is already very risky.)

Of course Krugman turned out to be absolutely correct.  The fiscal stimulus never got Japan out of the liquidity trap, and it was only in 2013 that Japan finally adopted a 2% inflation target—and then prices started rising.  Krugman was very worried about Japanese debt levels when their national debt was less than 150% of GDP—now it’s 250%.  All those “bridges to nowhere” were a monumental waste of money, when a 2% inflation target back in 2000 would have been far more effective.

Later in 2000, Krugman wrote more articles on Japan, which criticized the BOJ decision to raise rates.  Again, Krugman turned out to be completely correct—Japan fell back into recession and had to cut rates again.

So when did Krugman become “Krugman”?   It seems like the turning point was around 2002, when he started advocating fiscal stimulus for the US:

Not many people realize that in some ways Japanese economic policy responded quite effectively to a sustained slump. It’s easy to make fun of the country’s enormous spending on public works — all those bridges to nowhere in particular, highways with no traffic, and so on. Without question enormous sums have been wasted. But it’s also clear that all that spending pumped money into the economy, preventing what might otherwise have been a full-fledged depression.

So what will be the U.S. equivalent? Right now we are in effect following the reverse policy: slashing domestic spending in the face of an economic slump. Some of this is taking place at the federal level; the Bush administration is nickel-and-diming public spending wherever it can, shaving a billion here, a billion there off everything from veterans’ benefits and homeland security to Medicare payments. More important, the federal government is doing nothing to help as state and local governments, their revenues savaged by recession, make deep cuts in spending on everything that isn’t urgently necessary, and many things that are.

This is a radically different Paul Krugman from the 1999-2000 version:

1.  Now Krugman is making things up—for instance suggesting that Bush had adopted a contractionary fiscal policy, when Bush’s policy was actually quite expansionary (huge tax cuts, massive increases on federal spending on education, homeland security, Medicare drug benefit, military build-up.)  This is a more ideological Krugman than the neoliberal of 2000.

2.  Krugman says it’s easy to make fun of the Japanese public works, but doesn’t tell his readers that back in 1999 he was one of those people ruthlessly mocking the Japanese public works spending:

What continues to amaze me is this: Japan’s current strategy of massive, unsustainable deficit spending in the hopes that this will somehow generate a self-sustained recovery is currently regarded as the orthodox, sensible thing to do – even though it can be justified only by exotic stories about multiple equilibria, the sort of thing you would imagine only a professor could believe. Meanwhile further steps on monetary policy – the sort of thing you would advocate if you believed in a more conventional, boring model, one in which the problem is simply a question of the savings-investment balance – are rejected as dangerously radical and unbecoming of a dignified economy.

Will somebody please explain this to me?

One possibility is that Krugman turned left due to “Bush derangement syndrome.” In fairness, however, you could see a similar pattern in Ben Bernanke, who was a Republican during this period.  In 1999, Bernanke was also contemptuous of the view that the BOJ was out of ammunition, but by late 2008 Bernanke was also advocating fiscal stimulus.  Indeed right about the turn of the century there was a gradually shift to the left in many places.  Regulations started ramping up in the US (i.e. Sarbanes-Oxley).  The British Labour Party abandoned their fiscal austerity, as did the Dems in the US.  So perhaps Krugman was merely a part of this gradual change in the zeitgeist.  I haven’t changed, so I’m not well placed to understand what caused so many other people to become more sympathetic to fiscal stimulus and regulation.