Let’s not hear any whining on Wall Street . . .

. . . when Congress raises the top (combined federal and state) marginal tax rate to Swedish levels.  You guys will have brought this on yourselves.  In the early 1930s the forces of reaction controlled the Fed, and they did the bidding of the conservative bond holders on Wall Street.  Eventually deflation got so bad that the public revolted and the top income tax rate was raised from 25% to 90%.  A new and left-wing President tore up the gold clause in debt contracts.  The dollar was devalued.  Pro-union legislation was passed.  And of course the national debt ballooned. 

And now they are doing it again.  I have always wondered why the Fed wasn’t more aggressive in this crisis.  Everything Bernanke published before he became Fed Chairman suggested that he should have agreed with my position.  He wrote that monetary policy can still be effective at the zero bound, that it was important to avoid deflation at all costs, etc.  A new column at Free Exchange provides the most plausible explanation that I have yet seen for the strange passivity at the Fed:

Based on baseline forecasts alone, more monetary stimulus is easily justified. Based on the tail risks around that forecast, the case is even stronger; such a large output gap could turn low inflation into pernicious deflation. There are risks of inflation and bubbles on the other side, but as Mr Gagnon notes, these are easily dealt with, either by rapidly tightening monetary policy (in the first case) or aggressive regulatory intervention (in the second).

As befits a Fed alumnus, Mr Gagnon’s work is technically elegant. I don’t doubt that many of his former bosses at the Fed, Mr Bernanke included, agree with his premises; they may even find the specific estimates reasonable. But the barriers to further quantitative easing at the Fed aren’t economic, they’re political. The Fed was taken aback by how critics on Wall Street, in foreign central banks, and in Congress screamed that its modest, $300 billion Treasury purchases were monetising the government deficit and paving the path for future inflation. They have added to the atmosphere of hostility now surrounding the Fed. The Fed has essentially decided to pursue a second-best (i.e. insufficiently aggressive) monetary policy because a first best monetary policy could bring political perdition.

I hate to say it, but I suspect Free Exchange is right.

The post at Free Exchange discusses an excellent new paper by Joseph Gagnon, who used to be at the Fed and was a senior advisor to Ben Bernanke.  Gagnon makes a strong argument for additional monetary stimulus at the four key central banks (the Fed, ECB, BOJ, and BOE.)   He concludes with this observation about the choice between fiscal and monetary policy:

Altogether then, either monetary or fiscal stimulus would help to attain more satisfactory outcomes for economic activity, employment, and inflation than those envisaged by the main economic forecasts.  Monetary stimulus has the added advantage of also reducing net public debt, whereas fiscal stimulus increases net debt.  In total, central banks in the four main developed economies should buy an additional $6 trillion in longer-term debt securities, which is expected to reduce 10-year bond yields around 75 basis points.

This is what conservatives just don’t get.  The public won’t put up with high unemployment for year after year.  If the right doesn’t offer any answers, the public will turn to the left.  And that means fiscal stimulus, big deficits, and much higher taxes in the future.  Sometimes after I show that inflation expectations over the next few years are quite low, my commenters will point to the fear that big deficits will lead to higher inflation in the long run.  Yes, but that’s precisely why we need more monetary stimulus today.  Monetary ease will slightly raise inflation over the next few years, which is good, and by reducing the debt/GDP ratio it will also greatly reduces the tail risk of monetizing the debt in the out years, which is also good.  Sound macro policy is a win-win.  Good things happen when NGDP grows at a low but steady rate.

Milton Friedman understood all this, which is why he argued that Fed policy was too tight in the 1930s, despite the massive increase in the monetary base and the ultra-low interest rates.  He understood that his and Anna Schwartz’s account of the Depression was essentially a defense of free markets.  Monetary policy should prevent MV from falling, and let free markets do the rest.  And that’s why Friedman favored additional monetary stimulus in Japan in the late 1990s, despite low rates and a big increase in the base.  Alas, this pragmatic understanding of the role of monetary policy has been almost lost at my beloved University of Chicago.

Mr. Friedman was too good an economist to think that there was any mechanical relationship between changes in the monetary base and changes in the price level.  He would have understood how the new program of interest on reserves was a game changer.  But those who just vaguely recall hearing about the QTM in their econ classes are not able to draw these subtle distinctions.  As Keynes once said:

“ . . . the ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed the world is ruled by little else. Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually the slaves of some defunct economist. Madmen in authority, who hear voices in the air, are distilling their frenzy from some academic scribbler of a few years back. I am sure that the power of vested interests is vastly exaggerated compared with the gradual encroachment of ideas. Not, indeed, immediately, but after a certain interval; for in the field of economic and political philosophy there are not many who are influenced by new theories after they are twenty-five or thirty years of age, so that the ideas which civil servants and politicians and even agitators apply to current events are not likely to be the newest. But, soon or late, it is ideas, not vested interests, which are dangerous for good or evil.”

This simplistic fear that more money means high inflation is a perfect example of Keynes’ observation.  The “vested interest” of Wall Street is for a much higher nominal GDP.  So they are going against their own interests with their constant harping about the Fed monetizing debts.

Sure there is a relationship between the monetary base and the price level.  But lots of other factors matter as well.  One complicating factor is the opportunity cost of holding cash (and now reserves, which is even lower.)  Another is whether the monetary injection is perceived as temporary or permanent.   And as Joseph Gagnon points out in his paper, if aggregate demand starts growing faster than anticipated we have plenty of time to watch the asset markets and adjust policy appropriately.  Inflation doesn’t get embedded in the economy until it starts influencing wages.

Gagnon favors an aggressive policy of QE.  On pure theoretical grounds I would prefer to target NGDP expectations directly.  But let’s face it, that’s not going to happen.  So Gagnon’s proposal might be the best we can get given the natural reluctance of conservative organizations to avoid radical policy experiments.  And actual QE would almost certainly be less than Gagnon asks for.  The Fed would probably bend over backward emphasizing the temporary nature of the injections.  As people like Krugman and Woodford have pointed out, those statements undermine the expansionary impact.  Nevertheless, even with all these caveats, I believe a bold and unexpected announcement of QE would boost NGDP expectations, and provide a boost to real output as well.

Part 2.  Two Cheers for Arnold Kling

When I started reading this Arnold Kling post I was taken aback by the following line:

I mention Scott Sumner a lot on this blog. Why? Because I see him as sticking up for mainstream macroeconomics. I myself have been pushing a non-mainstream idea, sort of a muddle between Leijonhufvud and Hayek that I call the Recalculation Story.

I thought; “What a minute, I’m the contrarian here.  I’m the one saying that what looks like a recession caused by real financial and housing problems, is actually a garden variety nominal shock, just like in the textbooks.  I’m one of a tiny number that blames the recession on tight money.”  But then I read the rest of his post, which ended with this perceptive observation:

I am prepared to offer pushback against the Sumner-Hetzel viewpoint. However, it really deserves the status of the “null hypothesis.” In a more reasonable world, everyone would be starting from the presumption that Sumner and Hetzel are correct. Those of us arguing folk-Minskyism and telling the Recalculation Story should be the ones fighting an uphill battle to bring our ideas into the policy debates. That this is not the case, and that SC [the scholarly consensus] is now on the fringe, is one of the most remarkable stories of this whole macroeconomic episode.

This is exactly what I have been trying to say.  It’s like I’ve been trying to grab economists by the lapel and (figuratively) shake them out of their stupor.  Your own models say that falling NGDP is a failure of monetary policy!

Earlier I used a (SF Fed President) Janet Yellen quotation for a post title; “We should want to do more.”  What does that even mean?  Of course you should want to do more!  And she said this when unemployment was significantly lower than it is today.  OK, if you should want to do more, then why don’t you in fact want to do more?  What’s holding you back?  Why the strange passivity?  Her answer was that the Fed couldn’t do more, rates were already at zero.  That attitude should be an immediate disqualifier for being on the FOMC.   Like a Supreme Court nominee saying they oppose Brown vs. Board of Education at a Congressional hearing.  James Hamilton once said something to the effect of “if they don’t know how to create a bit of inflation, then give me try.”

So at the Fed you have inflation doves who would want to do more but haven’t advanced beyond 1938 Keynesianism, hawks who seem more worried about the possibility that inflation will rise from 1% to 2% then they are about 15 million unemployed, and centrists who are intimidated by criticism of Wall Street.  And so here we are.

Why two cheers for Kling?  This post was one of the funniest that I have read in a long time.  (Also check out Ambrosini.)  Kling is great on almost everything.  Strangely enough he is only weak when he ventures into my money/macro turf–especially when he disagrees with me.  He doesn’t seem autistic enough.  But then he probably thinks I’m too autistic.

HT:  Bill Woolsey.

PS.   Normally I am good about quickly responding to emails and blog comments.  But thing have been very busy lately and I am falling a bit behind.  So I apologize if I overlook something you sent me.

Update:  Right after posting this I ran across some rave reviews of Gagnon from prominent liberal bloggers DeLong and YglesiasTim Duy has a very good post that looks at Gagnon in the context of what other bloggers have been saying, and also the views of Fed officials.  But I think he slightly misinterprets Yellen’s stance.  (Refer to the “we should want to do more” link above after reading Duy, and you will see my response to his Yellen comments.  I hope I didn’t sound too disrespectful of Yellen, but it enrages me when a Fed official says nothing can be done at zero rates.)

HT:  Bob Murphy



24 Responses to “Let’s not hear any whining on Wall Street . . .”

  1. Gravatar of Fredrik Fredrik
    5. December 2009 at 12:19

    Hello and thanks for an awesome blog.

    I think a big problem with the central bankers is simply human nature. People tend to have an irrational fear of bad things that have happened to them in the past. So when oil prices reached record levels and the economy started to show weaknesses, everyone got the big 70s style stagflation scare, instead of paying attention to what was actually going on in the economy.

    We had the same thing here in Sweden, where the Riksbank actually raised interest rates in the fall of 2008, based on some weird backward-looking oil price induced inflation fear.

  2. Gravatar of Joe Calhoun Joe Calhoun
    5. December 2009 at 12:59

    Here’s a speech by Bernanke in Japan 2003 where he advocates price level targeting: http://www.federalreserve.gov/boarddocs/speeches/2003/20030531/default.htm

    “What I have in mind is that the Bank of Japan would announce its intention to restore the price level (as measured by some standard index of prices, such as the consumer price index excluding fresh food) to the value it would have reached if, instead of the deflation of the past five years, a moderate inflation of, say, 1 percent per year had occurred. (I choose 1 percent to allow for the measurement bias issue noted above, and because a slightly positive average rate of inflation reduces the risk of future episodes of sustained deflation.) Note that the proposed price-level target is a moving target, equal in the year 2003 to a value approximately 5 percent above the actual price level in 1998 and rising 1 percent per year thereafter. Because deflation implies falling prices while the target price-level rises, the failure to end deflation in a given year has the effect of increasing what I have called the price-level gap (Bernanke, 2000). The price-level gap is the difference between the actual price level and the price level that would have obtained if deflation had been avoided and the price stability objective achieved in the first place.”


    “A concern that one might have about price-level targeting, as opposed to more conventional inflation targeting, is that it requires a short-term inflation rate that is higher than the long-term inflation objective. Is there not some danger of inflation overshooting, so that a deflation problem is replaced with an inflation problem? No doubt this concern has some basis, and ultimately one has to make a judgment. However, on the other side of the scale, I would put the following points: first, the benefits to the real economy of a more rapid restoration of the pre-deflation price level and second, the fact that the publicly announced price-level targets would help the Bank of Japan manage public expectations and to draw the distinction between a one-time price-level correction and the BOJ’s longer-run inflation objective. If this distinction can be made, the effect of the reflation program on inflation expectations and long-term nominal interest rates should be smaller than if all reflation is interpreted as a permanent increase in inflation.”

    The rest of the speech is a discussion of how to implement a strategy to accomplish the goal. Bernanke advocates a tax cut financed by money creation to offset the Ricardian equivalence effect. Obviously, Bernanke gets it. So why doesn’t he advocate here what he advocated for Japan? He acknowledges in the speech that a good explanation of price level targeting would minimized the effects of higher short term inflation rates. He also states that he believes the ricardian effects can be effectively overcome. So what holds him back now? Well, my guess is reconfirmation hearings but if he still sits on his hands after being reconfirmed, someone needs to ask him why his advice for Japan differs from his actions here.

  3. Gravatar of marcus nunes marcus nunes
    5. December 2009 at 13:01

    The danger is that inflation expectations (tips) are back at 2%, the magic number, based on an average of the 5 and 10 year tips.

  4. Gravatar of happyjuggler0 happyjuggler0
    5. December 2009 at 14:13

    Joe Calhoun,

    So what holds him back now? Well, my guess is reconfirmation hearings but if he still sits on his hands after being reconfirmed, someone needs to ask him why his advice for Japan differs from his actions here

    We can only hope that is the case, although I would add in a multiplying factor. If the grief from conservatives that he has been getting regarding their fears that his policy is too inflationary(!) wasn’t there, he might already have had the courage to pursue the policy that he outlined in your post.

    Again, we can only hope that that is the case, and that once reconfirmed he will do as outlined above.

  5. Gravatar of Mark A. Sadowski Mark A. Sadowski
    5. December 2009 at 15:07

    I really enjoyed reading your autistic macroeconomist post (your blog is still new to me) because I think it describes me to a tee (I spent three undergraduate years at Chicago and am an all but dissertation applied macroeconomist). I spent much of my childhood assembling compendiums of statistics and collecting objects. I tend to take a more intuitive perspective when analyzing information and I am seemingly uninfluenced by framing effects. I love data and pride myself on my memory and my ability to spot numerical relationships.

    In fact I was so sure that my approach to everything was so odd that I spent some time with a psychologist recently. His verdict: obsessive compulsive disorder (shades of Monk), which of course falls into the autistic spectrum. But he assures me that in my case it seems to be something of a blessing (at least so far)rather than a curse.

    P.S. I spent this snowy afternoon reviewing the 5 year T-Bond and TIPS data from last year as evidence of inflation expectations (I remember being stunned by them at the time). I compared it to the FOMC minutes and resulting fed funds targets. Although all of the meetings from late July through October were of course ridiculous, 9/16 and 10/29 seem to be the worst. My God, what were they thinking?

    P.P.S. I was somewhat frustrated by the fact your blog was down for much of the day. I may in a small way be responsible for some of the increased traffic as I’ve been recommending your blog to everyone. (Toady!)

  6. Gravatar of StatsGuy StatsGuy
    5. December 2009 at 19:28

    You presume that the crisis is facilitating a shift to the left… The question is whether the public will blame the free markets, or blame the administration that happens to be in charge (e.g. Obama). Polling data has already shown movement on this, and the last batch of data is from September (3 months ago). If you project the trend, and it seems perfectly plausible to do so given Obama’s overall job approval numbers, my guess is that the general public is rapidly buying into the argument that Obama’s interventions are making the situation worse:

    “How much blame do you think the Bush administration, for inadequate regulation of the financial industry, deserves for the country’s economic situation: a great deal, a good amount, only some or hardly any?”

    A Great A Good Only Some Hardly Any None (vol.)
    Deal Amount
    % % % % %
    9/10-12/09 40 25 23 10 1
    7/15-18/09 42 20 23 11 1
    3/26-29/09 47 23 21 7 1

    “How much blame do you think the Obama administration, for not doing enough to turn the economy around, deserves for the country’s economic situation: a great deal, a good amount, only some or hardly any?”

    A Great A Good Only Some Hardly Any None (vol.)
    Deal Amount
    % % % % %
    9/10-12/09 13 15 33 34 4
    7/15-18/09 14 17 28 34 4
    3/26-29/09 13 13 27 39 6

    From http://www.pollingreport.com/budget.htm

    Even though people don’t blame Obama for the crisis, there is rapidly growing disapproval for Obama’s handling of all aspects of it. Note the AP/GFK polls:

    AP-GfK Poll conducted by GfK Roper Public Affairs & Media. Sept. 3-8, 2009. N=1,001 adults nationwide. MoE ± 3.1.

    AP-GfK Poll conducted by GfK Roper Public Affairs & Media. Sept. 3-8, 2009. N=1,001 adults nationwide. MoE ± 3.1.

    “And please tell me if you approve, disapprove or neither approve nor disapprove of the way Barack Obama is handling each of the following issues. How about [see below]?” If unsure: “If you had to choose, do you lean more toward approving or disapproving of the way Barack Obama is handling [see below]?”

    Approve Disapprove Neither Unsure
    % % % %

    “The economy”
    9/3-8/09 44 52 5 –
    7/16-20/09 50 46 4 –
    4/16-20/09 58 35 6 1

    “Federal budget deficit”
    9/3-8/09 33 56 12 –
    7/16-20/09 39 51 10 –
    4/16-20/09 49 41 8 2

    9/3-8/09 38 50 13 –
    7/16-20/09 46 44 11 –
    4/16-20/09 54 35 11 1

    9/3-8/09 40 49 11 –
    7/16-20/09 49 40 10 –
    4/16-20/09 59 29 12 1

    In any case, your arguments rest on the assumption that the individuals who are most benefiting from this situation are indeed in the same boat as the rest of the country. Among the very top income tiers, income is primarily derived through capital gains – and long term cap gains is currently scheduled to rise to only 20% in 2010, much less than top income brackets. Moreover, capital investments permit many strategies to delay or defer recognition of profit, particularly in international settings with regards to repatriation of funds (not to mention official location of residence). US officials will be loath to raise the cap gains taxes (especially long term) due to a fear of capital flight in a world in which other countries offer lower rates.

    In short… you may not agree with Krugman’s fiscal recos, but he has one sharp point: when the current set of policies fail, many people will blame the Fed/Obama Administration for doing _too much_, rather than _too little_.

  7. Gravatar of StatsGuy StatsGuy
    5. December 2009 at 20:21

    DeLong on the political tussle:

    “But if you did get an explanation for the lack of congressional action it would go something like this: Attempts to move supply and demand in the market for savings in order to boost spending would (a) increase the national debt burden on future taxpayers and (b) lead to a large decline in bond prices and a boost in interest rates. Why? Because businesses would try to increase their liquidity to support higher spending, driving up interest rates, which, in turn, would cause businesses to cut back on investment, thus neutralizing most or all of the stimulative policies.

    Similarly, if you were to ask the Federal Reserve why it isn’t doing more to reduce unemployment and boost spending and income, the answer you would get is this: Spending is in no way constrained by a shortage of liquidity. We have already done all we can do, indeed we have “flooded the zone” with liquidity. As a result, the Fed is disinclined to pursue additional tweaks of supply and demand in the market for liquidity because it fears such efforts would fuel destructive inflation in the future without boosting employment and spending in the present.

    Both of these arguments are comprehensible; each might well be true. But they cannot both be true at the same time.”

  8. Gravatar of Bob Murphy Bob Murphy
    5. December 2009 at 20:43

    I dunno Scott you are getting a bit uppity lately, so I need to check back in and confirm: If we get, say, 5% price inflation in 2010 while unemployment remains above 9%, will you agree you have been wrong?

    If not, please tell me what would have to happen, in order for you to say, “Wow I was wrong and the inflation mongers were right.”

    I am concerned that the longer we get away from fall 2008, the less chance anything could make you admit you have been wrong. For sure I don’t want there to be a dollar crash in 6 months and you say, “That’s because those morons were too tight back in 2008! If they had listened to me this wouldn’t have happened!”

  9. Gravatar of Tim Worstall Tim Worstall
    6. December 2009 at 03:41

    “when Congress raises the top (combined federal and state) marginal tax rate to Swedish levels.”

    Well, actually, for those who work on Wall Street they’re not that far off them now. Average tax rates are at about Swedish levels. (Add Federal to NY State and NYC income taxes…..)

    For the Swedish tax system isn’t in fact all that progressive: high marginal rates on income, yes, but much lower rates on corporations and capital gains (and no inheritance tax!). The big earner in the Swedish tax system is really the highly regressive VAT of 25% on everything….including food.

  10. Gravatar of Fredrik Fredrik
    6. December 2009 at 05:11


    VAT on food in Sweden is 12% and some things (e.g. personal transport) have as little as 6% VAT.

  11. Gravatar of bill woolsey bill woolsey
    6. December 2009 at 06:07

    Great post, Scott.

    I favor zero inflation in the long run, but believe that the Fed shouldn’t worry about inflation directly. If returning nominal expenditure to its long run growth path (adjusted to a 3% growth rate) over the next year results in inflation, so be it. With nominal expenditure growing at 3% in the long run, here is no way that more than modest inflation will be generated in the long run.

    Anyway, think about why the Fed is paying interest on reserves. If they didn’t, the real interest rate on safe and short investments would drop. (OK, forget for a second that this would tend to generate recovery, higher credit demand, and higher interest rates across the board.)

    Think about all the smart money that got out of stocks and are holding bonds. You are going to drive their yields to zero? It is bad enough that the 4 week rates are zero. You want to drop the 3 month, 6 month, 1 year.. what? To maintain our lifestyle, we may have to dip into capital! Protect our yields.

    OK, we will pay interst on reserves and put a floor on short and safe interest rates. We will directly fund risky bank loans. Do fancy pants transactions to encourage asset backed commercial paper. Purchase mortgage backed securities.

    How isn’t this a transfer program for bond investors?

    I think the optimal solution (again, leaving aside the “by your own bootstraps recovery leading to higher interest rates) is negative short term nominal interest rates. As I have said, if people want return, they can take risk. If there is an excess demand for short and safe assets at a zero nominal yield, the nominal yield should be negative to clear the market. If it is necessary to pay people on the market to issue safe and short securities, because real investment pojects are risky and take time, then that is what should happen. This zero interest currency stuff is throwing a money wrench intho the market. Paying interest on reserves just makes it worse. And who benefits? The people who are still earning a nominal yield on safe and short assets.

    Of course, I now undestand that it isn’t just pure finance, some shift in risk premia or the like. A lot of what is happening is expectations of low nominal expenditures. Committing to getting them back up to target will solve much of the problem. Maybe all of it.

    One more thought. Conservative Wall Street bond holders? OK. But what about middle class retirees? From time to time I have seen blog comments that more or less say that low interest rates are bad because they reduce the spending of bond holders. Bad economics, because there are other folks who can spend more, but there are people of modest means who depend on the income they earn from short and safe assets. My Mom and Dad should shift into stocks so they can get a yield? (Really, they are still in the market and don’t depend on investment income much. But do you ever chat with Emeritus Professors?)

    Think about it.

  12. Gravatar of Joe Joe
    6. December 2009 at 07:48

    People who are living on bond yields LIKE the current environment. The coupons are the same, and prices are down. They got a raise. Yield is what traders care about. Retirees care more about the coupon. If you are holding mid 90 vintage bonds, the coupons are quite nice. The real question is who is buying bonds now? Low coupon rates, with an expectation of greater coupons in the future due to an increase in interest rates. But maybe today’s low coupons suggest that rates will stay low for quite a long time.

  13. Gravatar of ssumner ssumner
    6. December 2009 at 08:26

    Fredrik, Thanks. I suspect you are right. Over the last 9 months I have had various posts that try to evaluate things from the perspective of a psychologist.

    Joe, That’s worth a post. I’ll try to do one soon.

    Marcus. Yes, they are back to 2%, or slightly more. but not for the next few years. I agree that inflation will eventually rise back up to 2%, but I am more concerned about the next two years, where expectations are only about 1%. And again, NGDP is the key, not inflation. We are still far below trend on NGDP.

    happyjugglerO, I agree.

    Mark, Thanks for the support. It sounds like you and I think alike. You might enjoy Tyler Cowen’s book.

    I was extremely frustrated by the breakdown of my blog, because I feel things are moving a bit our way right now (in the blogosphere, not Washington) But it is a good problem if it is due to growing traffic (as it seems to be according to tech people at Bentley.

    Statsguy, As usual, all good points. But I think you slightly misunderstood my political views (partly because they weren’t well stated.) In other posts I have argued that Obama will have to move back more to the center, as Clinton did. But I think that much of the damage has already been done, except health care which is coming soon. We have already embarked on massive fiscal stimulus. The health care reform will require more government subsidies. So I think the higher taxes are coming, as a result of the path we (and the Fed) have already taken. But I agree that from here on out policies will gradually move back toward the center. Indeed I said this in some earlier posts.

    The capital gains numbers are accurate, but misleading. Capital gains are “lumpy” while income is smoother. So an executive may earn a million a year for 10 years, then leave the company with a $8,000,000 lump sum capital gain. But even the million a year is taxed at the top rate. You are right that in any given year the very highest incomes are disproportionately from capital gains. But that somewhat distorts the impact of personal income taxes. Of course the lower cap gains rate also causes income shifting to occur, which probably contributes to some of the reckless risk-taking in the financial system that so many on the left (correctly) deplore.

    Statsguy#2, Good point. I might have something more to say about the DeLong post.

    Bob, You said;

    “I dunno Scott you are getting a bit uppity lately, so I need to check back in and confirm: If we get, say, 5% price inflation in 2010 while unemployment remains above 9%, will you agree you have been wrong?”

    I don’t think it is likely, but I don’t think it is fair that you keep lowering the bar. 🙂 I recall that earlier you were saying 8-10% inflation is just around the corner. I felt confident in saying that there is almost no chance of that. And if it happens in 2010 I will have been wrong. I also think 5% is unlikely. But in mid-2008 we had 5% YOY inflation in the headline CPI.

    Because oil is so volatile I’d rather argue that the core rate will remain below 3% for several more years, probably below 2%. Ditto for the GDP deflator. Regarding the headline CPI I’d say less than 10% chance of 5% inflation in 2010, but not impossible if oil prices exploded.

    I suppose that’s all too slippery for you, but what number would make you say you were wrong?

    Tim, Yes, and I knew that. That’s why I was able to make that charge. The top federal rate is scheduled to rise to 39.6%. Then there is the Medicare tax of around 3%. And Congress is considering an additional charge to finance health care. Plus state and local, as you say. Isn’t Sweden in the mid-50s?

    Bill, You make good points, but I wasn’t quite able to figure out your views on what I regard as the “bottom line.” Here’s my argument. I think that in net terms both average Americans and the rich gain from more NGDP through easier money. I argue that both stocks and risky corporate bonds have been greatly hurt by the big fall in NGDP. And those losses greatly exceed the gains to T-bond holders. Does that sound right? It all boils down to the fact that this isn’t a zero sum game. A lot of net wealth has been destroyed.

  14. Gravatar of ssumner ssumner
    6. December 2009 at 08:48

    Joe, But again , investors as a class have lost a lot of money. It is only a subset of investors who have gained.

  15. Gravatar of marcus nunes marcus nunes
    6. December 2009 at 09:01

    The “Sumnerian World” pops up again. From A Kling:

  16. Gravatar of StatsGuy StatsGuy
    6. December 2009 at 13:59

    Bill W:

    “I favor zero inflation in the long run, but believe that the Fed shouldn’t worry about inflation directly.”

    I don’t know that many people really are strongly attached to the 2% inflation rate target. We are mostly objecting to the sudden change in trajectory which effects a huge transfer payment – exactly as you identify. In the ‘long run’, moving to 0% would be fine so long as the ‘long run’ was announced 30 years ahead of time to give those with very long positions the ability to shift very slowly toward the 0% expected path. It would be nice if someone (you?) would explicitly cover this, and describe exactly how this shift _should_ occur.

    Leaving the sudden change in trajectory aside, the primary reason I hear to defend the 2% target is that it gives the Fed the ability to ease monetary policy with conventional tools (dropping interest rates). The argument against 2% seems to be menu costs – though I wonder if there is a behavioral argument too (regarding shifting people to longer time horizons). But for most skeptical folks to accept the gains resulting from elimination of menu cost problems, we would need to see the Fed show us exactly how it can successfully manage monetary easing at the zero bound. So far, not impressed…

  17. Gravatar of malavel malavel
    6. December 2009 at 17:09


    You are right, top marginal tax rate is about 55% in Sweden (it varies depending on where you live). But then we have an employment tax at 31% too.

  18. Gravatar of Bob Murphy Bob Murphy
    6. December 2009 at 22:53

    Scott those remarks are fine. I am worried about the Fed having to choose between clamping down on price inflation or allowing the weak recovery to grow. I think there is a very real possibility that banks start getting higher returns elsewhere and begin lending out the excess reserves, even though unemployment is still 9%. At that point we are screwed.

    I’m not certain it will happen, but I am surprised by the confidence with which you and many others assure us it won’t happen.

    If all of 2010 comes and goes and price inflation remains below 4%, then I will publicly admit I am wrong. I might be willing to make a bolder prediction after I think about it some more, but this very weak pledge will have to do for now since it’s 1 am and I should stop shooting my mouth off.

  19. Gravatar of Bob Murphy Bob Murphy
    6. December 2009 at 22:57

    Oh by the way Scott, you’re right my boldest inflation predictions were wrong. I have already acknowledged my mistake on my blog. (Not going to bother finding it; I hope you believe me.)

    The main thing that happened is Bernanke slammed the brakes on M1 and M2 in March or so. At the end of 2008 not only the monetary base but also M1 and M2 were growing quite quickly, and you had all the politicians saying the banks needed to lend because they just got bailed out etc. So I foolishly thought the politicians were serious. Fool me 182 times, shame on me.

  20. Gravatar of ssumner ssumner
    7. December 2009 at 12:57

    marcus, Thanks. I suppose I should respond.

    malavel, Does the 31% employment tax apply to all wages and salaries? All the way up to infinity?

    Bob, OK, we’ll keep watching. Because I believe in the EMH, and think the economy is hard to forecast, I don’t put much weight in forecasts as validating theories. Either the EMH is true, and economists shouldn’t be able to predict futures that markets don’t predict, or is is false and then it is easy to get rich. I don’t think it is easy to get rich.

    But predictions are fun to talk about.

  21. Gravatar of malavel malavel
    7. December 2009 at 13:35

    Scott, yes it’s the same tax rate from 0 to infinity. The literal translation would be employer fee. Google translate gives general payroll tax. It’s called a fee since it’s directly tied to different welfare insurances, like pensions.

    But if we are to compare top marginal tax rates it seems most fair to include all taxes on salaries and VAT. For Sweden that would be 0.69 * 0.45 * 0.8 => 75% top marginal tax rate.

  22. Gravatar of ssumner ssumner
    7. December 2009 at 18:31

    Thanks malavel, You certainly sound like you know what you are talking about. But here is why I am confused. I just read an article by Mankiw in the JEP that listed Sweden’s marginal income tax rate (excluding payroll taxes) at 25% for people making 250% of average income. In America the tax rate on those people (say making $100,000) is only slightly below the top rate. Sweden is a very odd place of the income tax is that steeply graduated between 250% of average income and infinity. But if what you say is right, I guess it must be.

    Do Mankiw’s numbers sound right for a Swede making about $100,000 a year. That rate is lower than in the US, again ignoring payroll and VAT.

  23. Gravatar of malavel malavel
    7. December 2009 at 23:13

    The income tax is divided between local tax and state tax. The local tax is between 29 and 34 percent. The state tax is 0 to begin with, 20% above $45 000, and 25% above $70 000 (yearly income). So I assume that Mankiw only looked at the State tax. But the common figure mentioned for Sweden is 55% top marginal tax rate.

    But again, it’s kinda pointless not to at least include the payroll tax. Would Sweden be economically more efficient if we moved all local taxes to the payroll tax? I can’t see why it would make any difference (in the long run). The same could be said for moving the local tax to VAT.

    And then you have to add any reduction of grants too. Sweden actually had more than 100% top marginal tax rate in the seventies, if you included those effects. Astrid Lindgren had 102% and was publicly complaining about that.

  24. Gravatar of Scott Sumner Scott Sumner
    8. December 2009 at 18:38

    malavel, Thanks for clearing that up. You are right, Mankiw ignored local taxes, which makes the data very flawed. And yes, payroll taxes also discourage work effort.

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