I’m not ready to move on
Karl Smith has an eminently reasonable post on the state of macroeconomics, so naturally I’ll try to poke holes in it:
My growing sense is that the core intellectual struggles surrounding the Great Recession have been practically resolved.
There were three core things that needed to be understood.
1) That the near term future of capitalism could only be secured by hurling huge sums of money at the US banking system in 2008-2009. That was done.
2) That a perhaps not cataclysmic but nonetheless horrific second global financial crisis could only be secured against by hurling huge sums of money at the European banking system in 2011. That was done.
3) That the global downturn is a phenomenon of Aggregate Demand in general and liquidity/collateral constraints in particular. As such it would be alleviated by the easing of credit and the transferring of liabilities from the liquidity constrained to the liquidity free.
. . .
It is time to move to other things.
Here are three that I think are important to get to next.
Hold on there; I don’t really agree with any of that. I believe both the US and European capitalist systems could have been “saved” far more effectively with steady 5% expected NGDP growth, level targeting, rather than throwing lots of money at banks. Indeed if we did the NGDP targeting and combined it with no bailouts at all, I think it’s quite likely the US and European recessions would have been much milder. In fairness to Karl, it’s possible that throwing money was the right thing to do given that we didn’t do NGDP targeting; I’m not really qualified to offer an opinion on that question.
Regarding the third point, I certainly agree that the global downturn was caused by an AD shortfall, but think that the best way to fix it was monetary policy, not credit policy. And yes, they are very different. You can have a monetary policy in an economy with no credit, and you can have a highly sophisticated credit system in an economy with no money. Credit is about loans. Monetary policy is about the medium of account. For instance, imagine gold is money. You can boost both NGDP and RGDP sharply by changing the definition of how many ounces of gold count as one dollar, even if the banking system is flat on its back. Come to think of it, FDR did just that.
I hate to be a killjoy, but I passionately believe that unless we figure out what went wrong, we’ll keep repeating our errors. On a positive note, I agree with Karl here:
This is one reason why I encourage my colleagues to be gentle rather than mean. Another – so that we may be honest – is that I am, obviously, viscerally uncomfortable with meanness.
Karl also made this observation:
Indeed, given the way he talks about the issue I wonder if Scott Sumner might be happier with nominal compensation of employees as his stabilization target:
He’s exactly right. The reason I keep talking about NGDP is that I think it’s an easier sell both politically and academically. And it would do nearly as well, if structured in the form of “targeting the forecast.” Interested readers might want to look at Karl’s graph of employee compensation over time.
BTW, here’s the news out of Japan:
Gross domestic product shrunk by 2.3% during the period from a year earlier, much worse than 1.4% contraction that analysts had forecast.
Analysts said while there is pressure on the Japanese central bank to take measures to boost growth, the BOJ’s options were limited.
. . .
“Money supply is at peak levels already,” said Fujitsu Research Institute’s Mr Schulz.
So has Japan run out of paper? Or are they out of ink?
Tags:
13. February 2012 at 06:09
“eminently reasonable” my results must have been misunderstood
13. February 2012 at 07:36
“So has Japan run out of paper? Or are they out of ink?”
Neither. They’re out of determination. Alternatively, they have an excess of caution. I suspect if they weren’t so touchy with the brakes they wouldn’t need to have “money supply at peak levels” to get far better NGDP results, although -2.3% is a pretty low bar. At what point do firms in Japan just pay their employees in KRW or HKD?
13. February 2012 at 07:41
Suppose a crash occurs, and the central bank has to print and buy up 25% of the economy’s assets.
Since it is the case that a reduction in printing and spending to any degree has a negative multiplier, then how can the “small government” monetarist explain his refusal to reduce the extent of central bank intervention?
13. February 2012 at 07:52
“Regarding the third point, I certainly agree that the global downturn was caused by an AD shortfall, but think that the best way to fix it was monetary policy, not credit policy. And yes, they are very different. You can have a monetary policy in an economy with no credit, and you can have a highly sophisticated credit system in an economy with no money. Credit is about loans. Monetary policy is about the medium of account.”
This is incorrect. Why do you keep invoking this erroneous conception of credit?
Credit is about loans yes, but loans contain two components, the bank side, and the borrower side. The borrower gets money in the form of fiduciary media.
When you go to a bank for a loan, the bank is giving fiduciary media to you which is universally accepted. It is money. You can use that money to purchase goods and services. If a bank extends you a mortgage loan, then the bank is promising to pay the home seller the sum of money for the home seller’s asking price. He can take that money that your bank gave him, and use it in his own exchanges. If the original mortgage loan was created ex nihilo, and not backed by prior real savings, then that credit represents an addition to the aggregate money supply.
Monetary policy enables banks to continue to create credit ex nihilo, by standing by with new reserves in case the banks become liquidity constrained on the basis of granting loans ex nihilo. If the banking system keeps expanding credit out of nothing, and the central bank does nothing, then sooner or later the banking system will no longer be able to expand credit anymore, due to withdrawals and transfers becoming greater than the amount of money they have available. This is why the major banks in the early 20th century wanted, and got, a central bank. To enable the individual banks to inflate together in a coordinated fashion (although they brought on the business cycle in the process).
13. February 2012 at 08:31
How does NGDP targeting prevent the financial system from collapsing? The target just tells people where the economy will end up in the long run. But the long run is irrelevant in a liquidity crisis. Forced liquidation begets forced liquidation.
It’s difficult to imagine that any monetary policy could have prevented a much worse recession if the central banks had passively accepted the total collapse of the system.
13. February 2012 at 08:32
Point #3 had me going “what?”, even before I read the rest of the piece. The “problem” of demand should be addressed by making it easier to obtain credit? Wasn’t too-easy credit part of the problem that led to the financial crisis? That easy credit fuelled an excess of leverage on all sides: home price booms fuelled by mortgages that are both too large and too long; retail banks playing at investment banking, borrowing cheaply to “invest”, as capital requirements were reduced or ignored.
I can see other commenters saying similar things in different ways. Can any of us assume that we will see any real growth, globally, ever again? The whole financial system is founded on the assumption that growth is “normal”, and so it’s back to “business as usual”.
13. February 2012 at 08:46
“Monetary policy is about the medium of account.”
Gold was the medium of account. FDR directly controlled the gold price. Today, the Fed directly controls the monetary base. The base has spiked with little impact on prices. Is the monetary base the medium of account? If not, then what?
13. February 2012 at 08:47
“So has Japan run out of paper? Or are they out of ink?”
Neither. They are limited by their compulsion to carefully and delicately fold every bank note into the shape of a crane.
13. February 2012 at 08:51
Major Freedom:
Most credit has nothing to do with bank loans.
Total debt is about $37 trillion.
Bank credit is about $9 trillion, of which $7 trillion is bank loans.
Most bank loans are not funded by checkable deposits. Banks are obaining about $2.2 trillion from Certificates of Deposits and about $1.2 trillion by checkable deposits.
Most bank funds these days come from savings accounts, which is about $6 trillion.
When Mises wrote the Theory of Money and Credit, maybe banks mostly made loans and funded most of them with checkable deposits (or even banknotes.)
But today, it is quite possible for bank loans to fall, and the total quantity of bank credit to remain the same. Banks buy securities.
It is possible for the quantity of money to rise, and the amount of bank credit to remain the same or fall. Banks fund more of their credit with checkable deposits rather than certificates of deposit, or even savings accounts.
It is very possible for total bank credit (loans and security holding) to rise, but total credit (bank credit plus corporate bonds, government bonds plus commercial paper) to fall.
What market monetarists would like is for businesses to sell off their T-bill holdings and instead purchase capital goods. This would be a decease in lending by those firms and an increase in investment. It would tend to raise interest rates and spending on currently produced output, particularly capital goods.
I don’t mind if those households with low debts borrow more and spend more, but it isn’t something I would like to see or consider necessary.
No one has to borrow more for there to be an increase in the quantity of money and an increase in spending.
Starting with 100% reserve banking, and then following the money multiplier process by which both the quantity of money and banking lending expand is instructive. But don’t confuse the growth of credit in the real world with that simple model.
Most credit does not come from that process.
And, by the way, the quantity of bank reserves aren’t fixed.
13. February 2012 at 09:15
Major_Freedom asks: “[H]ow can the ‘small government’ monetarist explain his refusal to reduce the extent of central bank intervention?” The small-government monetarist does not favor the existence of a central bank. But *assuming a central bank exists, and cannot be eliminated* (an accurate assumption about our present situation), the small-government monetarist has a view about how the bank should operate. (And this view makes no use of the supposed distinction between “intervening” and “not intervening.” The very existence of a central bank is in itself “interventionist.”)
13. February 2012 at 09:21
lol. money supply has peaked? it can do that??
personally I am not ready for the victory lap yet. thats a good way to lose a race- look back to see if your ahead.
13. February 2012 at 09:22
Yes, you can gain price stability. Yes, even mild deflation. You can have a strong currency. They have done that in Japan.
Except industrial production fell by 20 percent, and property values by 80 percent and the stock market by 75 percent, over 20 years and still going down.
The Econo-Shamans never talk about Japan.
13. February 2012 at 09:31
I agree with you that it’s important to learn the right lessons. No doubt there is a good deal of difference among the various schools what the those lessons are.
That’s what’s hard about making counterfactual arguments. As time goes on and we see how this recovery goes-whether it remains weak or picks up steam-the interepretations will necessarily change.
At this point though everyone will claim that it proves their point. You believe had we had NGDP targeting it would have been shorter or maybe avoided.
Keynesians like myslef think we would have been better off with a larger stimulus and more aggressive action in tamping down on the foreclosures-Obama has done some on that lately.
The Real Business Cycle people-Tyler Cowen, et al-are delcaring total victory-trouble with that is that this recovery has been very slow and weak. I’m not sure if I was RBC I use this recession as a talking point.
The GOP is trying to claim there has been no recovery or maybe that there would have been a better one had we had massive austerity, a la Europe and Britain-you and I disagree about what has happened in Britain since Cameron came in to be sure.
Then again, Bulliard thinks we have a permanent loss in output-this is mostly as it gives him a reason to argue for rates being raised sooner rather than later.
The game of counterfactuals is tough, but it is also fun. I look forward to the various arguments.
13. February 2012 at 09:48
I laughed at the name of this post responding to Karl, as I had to restrain the same thought impulse, in order to address his.
13. February 2012 at 09:50
The one counterfactual of yours Scott, that may work for me is the idea that there would not have had to be a huge bailout of the TOO BIG TOO FAIL banks, etc.
If that’s true-I wont even pretend here to try to give a defnitive answer to that here-that would be a major selling point in it’s favor right now. It would also be a political winner. Only question is whether it’s true. To really be convincing maybe someone can write a paper. LOL
13. February 2012 at 12:24
Banks don’t really loan money. When Major_Freedom goes to the bank to apply for a car loan, the bank checks his credit status and, determining him to be credit-worthy, offers to clear the $25,000 payment he is requesting in exchange for a series of smaller payments in the future. Major_Freedom takes the check his bank handed him (rarely happens any more but the principles are the same) to the dealership and drives away with a new car.
The dealer deposits the check at his bank and the teller immediately deposits it, assuming it is good. Major_Freedom’s loan has now created a deposit. At the end of the day the reserves management department at Major_Freedom’s bank tallys up the day’s loans and determines it has insufficient reserves to clear the payment to the car dealer’s bank. It then determines whether it would be less expensive to obtain the necessary reserves from the inter-bank market or from the Fed’s discount window, borrows the reserves it requires and clears the payment.
The point is that the bank’s ability to loan is never determined by its reserve status because it can always obtain whatever it needs, although the interest rates and discount window penalty will affect the bank’s return on its loan to Major_Freedom. The only limiting factors are capital requirements in case the loan goes bad and the bank has to repay the reserves itself, and the number of credit-worthy customers applying for loans. Also as Major_Freedom repays his loan and his bank repays ITS loan, money is subtracted from the money supply and ends up being thrown down a black hole at the Fed from whence it never returns.
13. February 2012 at 12:28
Karl, Try as you might, you can’t avoid being reasonable.
Cthorn, Good point.
Major Freeman, Suppose a asteroid the size of Australia crashes into Earth, how will we be able to maintain a small government? I’d say with 5% NGDP growth, level targeting, we are about that unlikely to see the public demanding to hold 25% of GDP in currency.
Loans may involve money, but they need not do so.
Max, The collapse of the system was CAUSED by plunging NGDP expectations. Current asset values are highly dependent on future expected asset values, and future expected asset values are highly dependent on future expected NGDP.
Brian, Yes, we should not be encouraging more borrowing.
David. FDR set a price level target, and used the price of gold as a tool. If the Fed sets a higher NGDP target they can use the base as a tool. But if they don’t set a target, people will assume base injections are temporary. And of course IOR just drives home that point.
Jason. That’s it!
dwb, Yes, that made me smile too.
Ben, I agree.
Mike Sax, You said;
“Keynesians like myslef think we would have been better off with a larger stimulus”
Yes, a bigger monetary stimulus.
13. February 2012 at 13:21
Barry:
The bank did lend money.
The car seller now has money–a balance in its checkable deposit. The bank has made a loan. It is a promise by the borrower to pay. And the borrower has a debt.
In your scenario, where the bank funded this by interbank borrowing, this particular money held by the car seller at some other bank.
But for the most part each bank is lending out its own deposits. Suppose a bank starts. Customers deposit funds in the bank–checking and savings accounts and CDs. Suppose the bank lends all the money deposited overnight to other banks.
When the bank makes loans, it refrains from relending part of the money that it had lent overnight. Nearly all the banks loans represent are funded by money that it has borrowed from the public, not from other banks or the central bank.
Further, if wants to expand loans, by far the best strategy is to attract more deposits. This can be savings accounts, CD’s, or checkable deposits. As it creates checkable deposits, it is creating money.
Your story would imply that each bank’s balance sheet as loans for assets and liabilities of borrowings from other banks or borrowings from the central bank.
The first is impossible for all banks. As for the second, this would only be possible for the banking system as a whole to the degree some of the currency held by the public, and so lending by the public to the central bank, is used to fund discount lending to the banks, and which in turn make loans funded by discount lending.
Under normal conditions in the U.S., anyway, currency holdings fund government debt and discount lending is trivial but involves one bank lending to the central bank and other bank borrowing from the central bank. Considring the banking system as a whole, all bank credit (loans and security holdings) are funded by deposits and capital. Of the deposits, some are money like checkable depostis, and some are not, like Certificates of Deposit.
Thinking about what is the constraint on a single banks lending (the overnight lending rate or the discount rate) tells little about the nature of banking.
13. February 2012 at 13:26
Cthorm: “At what point do firms in Japan just pay their employees in KRW or HKD?”
Japan is actually unique in the world in the amount of alternative currency systems which have been developed in the last couple decades. If you’re into complementary currencies (which I am), it is a very fascinating place.
13. February 2012 at 16:13
“The collapse of the system was CAUSED by plunging NGDP expectations. Current asset values are highly dependent on future expected asset values, and future expected asset values are highly dependent on future expected NGDP.”
A financial crisis doesn’t need a cause. It is its own cause. Once people realize that half the S&P 500 can go bankrupt overnight, the future recedes in importance. There is no future if you can’t refinance.
It’s very rational to panic when other people are panicing.
13. February 2012 at 17:10
the germans will be happy to take care of japan:
http://en.wikipedia.org/wiki/Giesecke_%26_Devrient#Zimbabwe_involvement
13. February 2012 at 17:16
off topic, the germans were building these 200 (two hundred!) years ago:
http://en.wikipedia.org/wiki/File:Koenig%27s_steam_press_-_1814.png
cue mandel-like innovation and growth history lesson from ss; pretty please?!
13. February 2012 at 17:22
well, the ex-pat germans in england; somewhat a tautology,, england *being* an ex-pat colony of germans; they have a german monarch after all =)
13. February 2012 at 19:50
I thought Smith was referring to things that had actually happened. In that sense, we learned a few things. But your ideas have not actually been instituted, so we haven’t actually seen what would happen if they were. I like your ideas, but I think it’s a mistake not to focus on what actually occurred.
13. February 2012 at 20:41
Bill Woolsey:
Most credit has nothing to do with bank loans.
All credit EXPANSION has to do with bank loans.
Bank credit is about $9 trillion, of which $7 trillion is bank loans.
In the practical sense, credit becomes loans when checks and withdrawals are made off credit accounts. If a bank offers $9 trillion in credit, $7 trillion of which ends up being withdrawn and spent, then the relevant portion for spending is that which goes to bidding up the prices of goods, the loans. In terms of money supply, the credit should also be included. I call those loans granted ex nihilo as “credit expansion,” but yes, in the technical sense, having a credit line doesn’t actually mean money is introduced into “the spending stream.” But it is a part of the money supply because the owner of the credit can make expenditures using it, any time he wants.
Most bank loans are not funded by checkable deposits. Banks are obaining about $2.2 trillion from Certificates of Deposits and about $1.2 trillion by checkable deposits.
If checks can be written on demand off the CDs, i.e. withdrawals can be made on demand, then because money is fungible, there is no distinction in identifying which money or fiduciary media ends up “financing” a loan.
Most bank funds these days come from savings accounts, which is about $6 trillion.
The savings accounts themselves are in large part a product of credit expansion money being redeposited back into the banking system.
When Mises wrote the Theory of Money and Credit, maybe banks mostly made loans and funded most of them with checkable deposits (or even banknotes.)
But today, it is quite possible for bank loans to fall, and the total quantity of bank credit to remain the same. Banks buy securities.
Indeed. But bear in mind that the securities are priced according to how much money exists, which is a product of credit expansion.
It is possible for the quantity of money to rise, and the amount of bank credit to remain the same or fall. Banks fund more of their credit with checkable deposits rather than certificates of deposit, or even savings accounts.
It is very possible for total bank credit (loans and security holding) to rise, but total credit (bank credit plus corporate bonds, government bonds plus commercial paper) to fall.
Yes and yes. But again, bear in mind that the market prices of corporate bonds and government bonds and commercial paper are a function of credit expansion bidding up those prices and would otherwise collapse in price as the amount of circulating credit and thus money in general collapses.
What market monetarists would like is for businesses to sell off their T-bill holdings and instead purchase capital goods. This would be a decease in lending by those firms and an increase in investment. It would tend to raise interest rates and spending on currently produced output, particularly capital goods.
Sell their t-bonds to who? The central bank?
I don’t mind if those households with low debts borrow more and spend more, but it isn’t something I would like to see or consider necessary.
I think all loans should be backed by a prior increase in real savings, rather than bank promises or the central bank.
No one has to borrow more for there to be an increase in the quantity of money and an increase in spending.
Yup. In the monetary system we have however, inflation in large part takes the form of increase in debt.
Starting with 100% reserve banking, and then following the money multiplier process by which both the quantity of money and banking lending expand is instructive. But don’t confuse the growth of credit in the real world with that simple model.
A 100% reserve fiat paper system won’t eliminate the business cycle.
Philo:
The small-government monetarist does not favor the existence of a central bank. But *assuming a central bank exists, and cannot be eliminated* (an accurate assumption about our present situation), the small-government monetarist has a view about how the bank should operate. (And this view makes no use of the supposed distinction between “intervening” and “not intervening.” The very existence of a central bank is in itself “interventionist.”)
That’s a moral and intellectual capitulation / cop-out. By that logic, one should start advising rapists and murderers on the basis that rape and murder probably won’t ever be 100% eradicated. Should an adviser to a criminal be absolved of culpability on the basis that he is just trying to make crime more efficient?
Ben Wolf:
Banks don’t really loan money. When Major_Freedom goes to the bank to apply for a car loan, the bank checks his credit status and, determining him to be credit-worthy, offers to clear the $25,000 payment he is requesting in exchange for a series of smaller payments in the future.
That’s a loan of money. When you say “clear”, that is the same thing as “pay the seller”.
The dealer deposits the check at his bank and the teller immediately deposits it, assuming it is good. Major_Freedom’s loan has now created a deposit. At the end of the day the reserves management department at Major_Freedom’s bank tallys up the day’s loans and determines it has insufficient reserves to clear the payment to the car dealer’s bank. It then determines whether it would be less expensive to obtain the necessary reserves from the inter-bank market or from the Fed’s discount window, borrows the reserves it requires and clears the payment.
Ergo inflation.
The point is that the bank’s ability to loan is never determined by its reserve status because it can always obtain whatever it needs
That means loans are determined by reserves. For if the Fed ceased increasing bank reserves and ceased holding the overnight rate low, then what you’re saying is “always” available, soon won’t be if banks continue to expand credit.
The only limiting factors are capital requirements in case the loan goes bad and the bank has to repay the reserves itself
This is a practical, day to say limitation, not an ultimate limitation. For the prices of capital itself depends on the quantity of money in the economy and that is a function of the money the banks expend ex nihilo when they granted a checking account to the depositor of he who received the loan money that you called a “clearing.”
and the number of credit-worthy customers applying for loans.
There are always the most relatively credit worthy customers applying for loans.
Also as Major_Freedom repays his loan and his bank repays ITS loan, money is subtracted from the money supply and ends up being thrown down a black hole at the Fed from whence it never returns.
This is why credit expansion tends to lead to more credit expansion.
ssumner:
Major Freeman, Suppose a asteroid the size of Australia crashes into Earth, how will we be able to maintain a small government?
I’d first congratulate DeLong on convincing alleged small government monetarists that his hypothetical asteroid scenario is somehow a knock down argument that justifies non-asteroid big government on Earth today, and then I’d ask him why won’t he advocate for a fascist military dictatorship on the basis that aliens might invade Earth someday, and why only the government we have is justified.
Then I’d answer your question and say we won’t need government if an asteroid the size of Australia hits the Earth. We’d need to say our last words before the entire planet’s life goes extinct.
I’d say with 5% NGDP growth, level targeting, we are about that unlikely to see the public demanding to hold 25% of GDP in currency.
What about a gradual increase in the size of government that is consistent with a gradual crowding out of the private sector, but maintaining the magical 5% level targeting? The government can print and spend more and more each year, and constrain the private sector and preventing it from spending more.
The fact that you are running on a “hunch”, what you perceive as “likely”, only shows there is no firm foundation for your advocacy. It is sloppy and based on wishful thinking.
Loans may involve money, but they need not do so.
14. February 2012 at 05:31
Ben and Bill:
This might interest you:
http://blog.mises.org/20997/some-insights-from-my-visit-to-the-ecb/
14. February 2012 at 16:50
Max, Even if you are right, this one did have a cause.
Donald, No he was talking about “the only way” which means he considered all alternative policies.
Major Freedom, Yup, governments can get big under any monetary regime.
15. February 2012 at 11:10
ssumner:
“Major Freedom, Yup, governments can get big under any monetary regime.”
That’s not what I argued. That is agreeing with a straw man.
The context of my argument was clearly an economy with a central bank fiat money production owned by and enforced by the state, not just any monetary “regime.”
Governments get the BIGGEST they can get when they monopolize and enforcing a fiat money central banking system. Central banking both facilitates and encourages bigger government, because it is far easier to print money and take people’s purchasing power that way, than outright taxation that is more easily visible.
Remember the public uproar over the $800 billion fiscal package? Contrast that with the Fed’s multi-trillion inflation spree. I am convinced that the TARP package was insisted by Paulson and the other bankers to divert the public’s attention away from the more secretive multi-trillion inflationary bailouts from the Fed. The designers of the $800 Treasury bailout are on record as saying “We didn’t have a calculated number. It just had to be BIG.”
15. February 2012 at 11:18
Correction:
Remember the public uproar over the $800 billion fiscal package? Contrast that with the Fed’s multi-trillion inflation spree. I am convinced that the ARRA package was insisted by Paulson and the other bankers to divert the public’s attention away from the more secretive multi-trillion inflationary bailouts from the Fed. The designers of the $800 Treasury bailout are on record as saying “We didn’t have a calculated number. It just had to be BIG.”
16. February 2012 at 11:06
Major Freeman, What inflation spree? Inflation has average just over 1% since September 2008.
Government can get big with or without fiat money.
25. February 2012 at 23:11
[…] Dumping China for American job shops – CNN/Money I’m not ready to move on – The Money Illusion Bubbles and Economic Potential – Krugman, NY Times The debate over […]
1. March 2012 at 22:56
ssumner:
<i.Major Freeman, What inflation spree? Inflation has average just over 1% since September 2008.
Inflation of the money supply spree. It’s not hitting consumer goods in its full effect…yet. Just you wait. Consumer price inflation is going to go through the roof.
Government can get big with or without fiat money.
That’s like saying a person can be violent with or without a bazooka.
You’re missing the point. Government has a means to get BIGGER than they otherwise could, with fiat money. Any entity that can print its own money, will have a tendency to grow larger than it otherwise could.