Here’s the FT:

Shinzo Abe has demanded Japanese companies lift pay by three per cent next year as he uses his big victory in last week’s election to intensify his push to boost the country’s economy.

The Japanese prime minister’s decision to give a specific number marks a deepening of government interference in private sector wage settlements. Last year, Mr Abe simply called for pay rises at least as great as the year before.

Would higher wages be good for the Japanese economy?  It depends.  If the higher wages are achieved through more aggregate demand, then they might be associated with higher employment.  If implemented via less aggregate supply (as Abe proposes), they will lower employment.

Consider the following two options:

If the BOJ adopts an expansionary monetary policy, boosting NGDP, then the demand for labor will increase.  This will boost growth, increase wages, and employment will rise to point B.

If the BOJ does not boost NGDP but Abe pressures firms into raises wages anyway, then employment will decline to point C.

It’s very demoralizing that top officials in Japan the US and Europe continue to make the EC101 error of reasoning from a price change.  Over and over again.

Why do we even bother teaching EC101 in colleges?  What’s the point?

PS.  Now that taxes are in the news let me agree with Jeff Flake, who is calling for tax reform, not tax cuts.

Tax reform would be one of the very best things the GOP could do right now.  Tax cuts would be among the very worst moves they could make.

It’s often said that the modern GOP exists for one purpose only, to enact tax cuts.  I don’t think people have fully internalized the implication of that truth.  If and when the GOP does enact tax cuts and/or reform, it will no longer have a reason to exist.  Tax reform might end up being a major achievement, or it might not.  But either way the enactment of a major tax bill will mark the end of the modern GOP.  They will no longer have a reason to exist.

I have no idea what will take it’s place.  Perhaps a white nationalist Bannonite party.  National socialists.  But whatever it is, it won’t be the modern GOP—which will be dead.

PPS.  On the graph, I forget to label points B and C as a 3% wage gain.

Over at Econlog, I have another post that touches on reasoning from a price change.  I must have already done a hundred such posts.  And yet every day I see more examples of this EC101 error in reasoning almost everywhere I look.  Not just among the uneducated, but in elite newspapers like the WSJ, NYT, Economist, etc. Here’s a new example from the FT:

Loose monetary policy led to share buybacks that enriched mainly the wealthy

One of the great ironies of the 10 years following the financial crisis is the way in which low interest rate monetary policy — which was designed to get Main Street USA back up and running and to help people buy homes and start businesses — has bolstered share prices and the markets more than it has helped ordinary Americans.

This is just embarrassing, and yet it happens all the time.  Is there any way to make people see that this is flat out wrong?  We teach students in EC101 not to reason from a price change, but people don’t seem to get the message.  What are we doing wrong?  Is there any way to explain this that I haven’t yet tried?  Lots of you commenters are closer to people with “average opinion” than I am.  Some of you may have recently learned not to reason from a price change.  So what works? What allows people to see that low interest rates are not a loose monetary policy?

PS.  A few reporters such as Caroline Baum warn against the fallacy of reasoning from a price change, but most don’t seem to get it.

Vaidas Urba pointed me to a very clever post by John Carney of CNBC.  It includes parodies of many well known bloggers, on the theme of Christmas and economics.  Here’s an example–see if you can guess who:

If the Fed would simply announce a nominal target for presents, we’d all receive more presents on Christmas day.  There are many ways to do NCPT, but I prefer that the Fed creates a presents futures market.

A lot of people look at the amount of presents under the tree and attempt to derive the stance of Santa.  But this is wrong.  You need to examine the demand for presents as well as the supply.  In general, a large pile of presents is a sign that Christmas policy has been too tight, while coal in the stocking is a sign that it has been too loose.

At the risk of spoiling the joke, I’m going to try to improve it further

A lot of people look at the amount of presents under the tree and attempt to derive the stance the parents’ generosity.  But this is wrong.   The pile of presents represents the interaction of generosity and deserts.  In general, a larger pile of presents is a sign that the stance of Christmas policy has been relatively generous.  But the level of generosity also depends on how many presents are deserved, which depends both on the behavior of the child and the wealth of the parents.  An increased pile might represent greater generosity, but also greater deserts, due to improved wealth and/or better behavior by the child.

Yeah, I know, I’ve ruined the joke.

PS.  Although I am now a “somebody”, I am under no illusion that I am anywhere but at the bottom of the class of people called “somebody”.  But at least I’m not a nobody.

Rajat directed me to a post by Miles Kimball, entitled “Pro Gauti Eggertsson”. Over at Econlog I discussed one paragraph from his post.  Here I’ll discuss another:

Gauti has also taken a lead in applying the same principles he applied to the Great Depression to the Great Recession. A hallmark of his papers is very careful discussion of how they relate to key controversies in the academic literature, and indeed, they go to the heart of some of the biggest issues in the study of business cycles and stabilization policy. Price flexibility and advance anticipation of inflation are often said to be the keys to monetary policy having no real effect on the economy. But along with Saroj Bhattarai and Raphael Schoenle, Gauti argues in “Is Increased Price Flexibility Stabilizing? Redux” that, short of perfect price flexibility, greater price flexibility is likely to be destabilizing. This idea has a long history, but had not been fully addressed within the context of Dynamic New Keynesian models without investment. Along with Marc Giannoni, Gauti argues in “The Inflation Output Trade-Off Revisited” that contrary to the idea that anticipated inflation does not matter, it can matter greatly when raising expected inflation loosens the zero lower bound. The argument is made in a very elegant and clear way.

In my view, higher expected inflation is  not expansionary, holding NGDP expectations constant.  Thus if NGDP is expected to grow at 5%, then higher inflation is associated with lower real GDP growth.  The proponents of the alternative view would claim that I’m missing the point, that higher inflation expectations will cause higher NGDP growth expectations.  I don’t think that’s right. A more expansionary monetary policy may cause both inflation and NGDP growth expectations to rise.  On the other hand, supply shocks can affect inflation expectations without impacting NGDP expectations. Never reason from a price level change—always reason from a NGDP growth change.

In 1929-32, President Hoover discouraged companies from cutting wages.  This made the Great Contraction of 1929-32 even worse than it otherwise would have been.  In contrast, wages were cut sharply during the severe deflation of 1920-21. Some free market purists make too much of this comparison, suggesting that tight money is not a problem if the government allows wages to be flexible.  Not true, the 1921 depression was quite deep.

But also pretty short.  And one reason it was so short is that in 1921 and 1922, wages adjusted quickly to the lower price level.  If Hoover (and FDR) had allowed wages to adjust in the 1930s, the Great Depression would have been much shorter.

Stable NGDP growth and non-intervention in wages and prices, these policies work together like a hand and glove.

PS.  I encourage people to read Giles Wilkes’s new piece on blogging.  Wilkes was nice enough to include me in with a group of much more deserving bloggers.  I was also pleased to see him talk about Steve Waldman, a wonderful blogger and also a good example of how the blogosphere is a meritocracy, where professional credentials do not matter.

PPS.  Trump?  Still  . . . an . . . idiot.

HT:  Tyler Cowen, Tom Brown

Paul Krugman has an excellent post discussing why stock prices are relatively high.  Apart from the opening paragraph, where he (implicitly) dismisses the EMH and rational expectations, I almost entirely agree with his interpretation.  (OK, the last bit defending Obama is also a bit questionable.)  I have expressed similar views, although of course Krugman expresses his ideas in a much more elegant fashion.  David Glasner was critical of this observation by Krugman:

But why are long-term interest rates so low? As I argued in my last column, the answer is basically weakness in investment spending, despite low short-term interest rates, which suggests that those rates will have to stay low for a long time.

Here’s how David responded:

Again, this seems inexactly worded. Weakness in investment spending is a symptom not a cause, so we are back to where we started from. At the margin, there are no attractive investment opportunities.

First let’s be clear about what Krugman means by “investment spending” in the quote above.  He clearly does not mean the dollar volume of investment spending, in equilibrium, because equilibrium quantities cannot “cause” anything, including low interest rates.  Instead he means the investment schedule has shifted to the left, and that this decline in the investment schedule (on a savings/investment diagram) has caused the lower interest rates.  And that seems correct.

Unfortunately, Krugman adds the phrase “despite low short-term interest rates”, which only serves to confuse things. Changes in interest rates have no impact on the investment schedule.  There is nothing at all surprising about low investment during a time of low interest rates, that’s normally the relationship we see.  (Recall 1932, 1938, and 2009).

David is certainly right that Krugman’s statement is “inexactly worded”, but I’m also a bit confused by his criticism. Certainly “weakness in investment spending” is not a “symptom” of low interest rates, which is how his comment reads in context.  Rather I think David meant that the shift in the investment schedule is a symptom of a low level of AD, which is a very reasonable argument, and one he develops later in the post.  But that’s just a quibble about wording.  More substantively, I’m persuaded by Krugman’s argument that weak investment is about more than just AD; the modern information economy (with, I would add, a slow growing working age population) just doesn’t generate as much investment spending as before, even at full employment.

I’d also like to respond to David’s criticism of the EMH:

The efficient market hypothesis (EMH) is at best misleading in positing that market prices are determined by solid fundamentals. What does it mean for fundamentals to be solid? It means that the fundamentals remain what they are independent of what people think they are. But if fundamentals themselves depend on opinions, the idea that values are determined by fundamentals is a snare and a delusion.

I don’t think it’s correct to say the EMH is based on “solid fundamentals”.  Rather, AFAIK, the EMH says that asset prices are based on rational expectations of future fundamentals, what David calls “opinions”.  Thus when David tries to replace the EMH view of fundamentals with something more reasonable, he ends up with the actual EMH, as envisioned by people like Eugene Fama.  Or am I missing something?

In fairness, David also rejects rational expectations, so he would not accept even my version of the EMH, but I think he’s too quick to dismiss the EMH as being obviously wrong. Lots of people who are much smarter than me believe in the EMH, and if there was an obvious flaw I think it would have been discovered by now.

David concludes his post as follows:

Thus, an increasing share of total investment has become capital-deepening and a declining share capital-widening. But for the economy as a whole, this self-fulfilling pessimism implies that total investment declines. The question is whether monetary (or fiscal) policy could now do anything to increase expectations of future demand sufficiently to induce an self-fulfilling increase in optimism and in capital-widening investment.

I would add that the answer to the question that David poses is clearly “yes”, as the Zimbabweans have so clearly demonstrated.  I would rather avoid terms like “self-fulfilling pessimism”, as AD depends on monetary policy, or combined monetary/fiscal policy is you are a Keynesian.  Either way it don’t think it’s useful to view AD as depending on the expectations of investors, pessimistic or not.  Those expectations merely respond to what the policymakers are doing, or not doing, with NGDP.

PS.  Yes, I do understand that under certain monetary policy stances, such as a money supply or interest rate peg, exogenous expectations impact AD.  I just don’t think it’s useful to view those pegs as a baseline policy.

PPS.  Let me repeat what I said earlier, we are going to have an interesting test of the impact of uncertainty on (British) GDP, over the next few months.  Not a definitive test (which would require observations with and without NGDP targeting, to tease out AD vs. AS channels), but certainly a suggestive test.  I have an open mind at this point, and am eager to learn.