While at the AEA meetings I ran into Ryan Avent, who was covering the event for The Economist.  I found the whole affair so depressing that I wasn’t able to drag myself to many sessions.  Fortunately Ryan is more responsible than me.  Here he reports on something I’ve also noticed, the strange fatalism of the economics profession in the face of the zero bound:

Mr Hall noted that this was an important point because potentially the Fed could have an enormously helpful impact on the economy simply by raising inflation just a little. And here’s where things got topsy-turvy. Mr Hall argued that:

  1. A little more inflation would have a hugely beneficial impact on labour markets,
  2. And a reasonable central bank would therefore generate more inflation,
  3. And the Federal Reserve as currently constituted is, in his estimation, very reasonable; therefore
  4. The Federal Reserve must not be able to influence the inflation rate.

Now, perhaps there was a political economy subtext to this argument; if so, I missed it. Rather, he seemed to be saying (as others, like Peter Diamond, have intimated) that at the zero lower bound it is simply beyond the Fed’s capacity to raise inflation expectations. Now admittedly I haven’t done a rigorous analysis, but it seems clear to me that the Fed has been successful at using unconventional policies to reverse falling inflation expectations. Why is Mr Hall””why are so many economists””willing to conclude that the Fed is helpless rather than just excessively cautious? I don’t get it; it seems to me that very smart economists have all but concluded that the Fed’s unwillingness to allow inflation to rise is the primary cause of sustained, high unemployment. And yet…this is not the message resounding through macro sessions. Instead, there are interesting but perhaps irrelevant attempts to model the funny dynamics of a macro challenge that actually boils down to the political economy constraints (or intellectual constraints) facing the central bank. Let’s focus our attention on that, for heaven’s sake.

Sometimes a reporter can notice things that the best and the brightest miss.   (And Hall is certainly among the best of our macroeconomists.)

Arnold Kling is just as incredulous as Ryan Avent:

Hall is, in effect, saying that his core beliefs about macroeconomics revolve around his view that Ben Bernanke is a nice chap. I side with Duy and Avent, not with Hall. The fact that the Fed has not done more to debase the currency since 2008 says that it does not want to, not that it can’t. It is in a policy-intentions trap, not a liquidity trap

Kling’s right, but I’m afraid it’s even worse than that.  Bernanke has clearly indicated that the Fed has lots of unused ammunition; it just doesn’t see a need to employ it.  Indeed he argues that higher inflation would be a bad idea.  Hall seems to be assuming that Bernanke is both a “nice chap” and a liar.  That Bernanke is unable to produce inflation, but is lying about that impotence.

I feel like I’m in some sort of science fiction movie, like H.G. Wells’ In the Day of the Comet.  Where a mysterious gas has made economists become strangely fatalistic.  I literally have no idea what my colleagues are thinking, or why they hold such strange views.  I have no idea why there aren’t 500 economists picketing out in front of the Fed right now.  The liquidity trap was viewed as a nutty idea when I was in college; why is it now respectable?  Are there facts that someone could point to that would explain its strange new respectability?

I would have expected the profession to react with this sort of outrage to the Fed’s tight money policy of 2008:

Raising the reserve interest rate is a contractionary measure.  A higher interest rate on reserves makes banks more likely to hold reserves rather than increasing lending. The Fed’s decision to raise the reserve rate from zero to 75 basis points just as the economy entered a sharp contraction in activity is utterly inexplicable. Fortunately, the Fed lowered the reserve rate subsequently, but the continuation of a positive reserve rate in today’s economy is equally inexplicable.  Some economists have proposed that the Fed charge banks for holding reserves, an expansionary policy worth considering. With the Fed funds rate at around 15 basis points, it would take a charge to restore the differential that drives banks to lend rather than hold reserves. Were the Fed to charge for reserves, they would become the hot potatoes that they were in the past, when the reserve rate was zero and the Fed funds rate 4 or 5 percent. Banks would expand lending to try not to hold the hot potatoes and the economy would expand. There is no basis for the claim that the Fed has lost its ability to steer the economy.  (Bold print added.)

BTW, this quotation from an 2009 essay by Bob Hall and Susan Woodford, written before the Earth passed through the tail of the comet.

Meanwhile, back in the real world the financial markets respond strongly to even the slightest hints of Fed easing.  We are back in 1933, where most of the Very Serious People insisted that monetary stimulus could do nothing, even as the stock investors knew otherwise.  Maybe that’s why rational expectations and the EMH have fallen into such disrepute.  The economics profession doesn’t feel comfortable with the fact that the markets know more than they do.



19 Responses to “Melancholia”

  1. Gravatar of Nick Rowe Nick Rowe
    9. January 2012 at 17:24

    Bernanke is just one person among many at the Fed. The simplest hypothesis is that he does not in fact control monetary policy.

  2. Gravatar of ssumner ssumner
    9. January 2012 at 17:45

    Nick, That’s right.

  3. Gravatar of T Page T Page
    9. January 2012 at 18:25

    Is that to imply monetary policy is not controlable or that someone/entity other than BB is in control? It would stand to reason that the Fed’s primary concern is the health of the banks. As academically sound as BB’s attempts to move the US economy in a positive direction may be he is still beholden to the interests of the human beings that comprise the heads of the banks, thus his control is limited.
    Concerning the level of control any entity can have on the complex system that is the economy, well, if you have children you’ll realize the folly of that thought.

  4. Gravatar of Scott Wentland Scott Wentland
    9. January 2012 at 18:51

    A year ago at the AEA meetings, I mentioned to you that I thought your analysis of the Great Recession (both the diagnosis and prescription) was the best out there and needs to be published as a book. Given that market monetarism and NGDP targeting has gained a lot more of mainstream traction within the last year and will likely gain even more over time, is there any chance you will undertake this project soon?

    And, you should only be melancholy about current/recent Fed policy and the current state of macroeconomics, but on the bright side, and I think I speak for most of your readers, your blog and ongoing crusade should still make you feel pretty good. Years from now your perspective (and your fellow market monetarists) will have a perception that will be the analogue to Friedman/Schwartz now. A book, where your views are all in one place and more accessible to “mainstream” macroeconomists, could cement your case.

    Let me know when I can pre-order!

  5. Gravatar of Norman Norman
    9. January 2012 at 19:22

    I’ll second Scott Wentland’s request, I would definitely be on the pre-order list! On a more realistic timescale, what are the chances of getting a market monetarism / NGDP targeting panel discussion for the San Diego meetings?

  6. Gravatar of Becky Hargrove Becky Hargrove
    9. January 2012 at 20:12

    Not so long ago you could hardly imagine an honest to goodness book promotion tour, huh. That has all changed.

  7. Gravatar of Chris Marino Chris Marino
    9. January 2012 at 20:29

    When rational people behave irrationally, check your assumptions.

    I’m 100% with Russ Roberts in his belief that the objective here is to save the banking system, not the economy. All you have to do is change your assumption that saving the banks is the objective and suddenly everything makes a lot more sense. It’s right there in their Mission Statement:

    Doing what you suggest would kill one, maybe more TBTF bank.

  8. Gravatar of marcus nunes marcus nunes
    10. January 2012 at 06:07

    I thought you must have been “irritaded” but it was worse, you were “depressed”!

  9. Gravatar of marcus nunes marcus nunes
    10. January 2012 at 06:48

    I wholeheartedly undersign your namesake Westland´s plea!

  10. Gravatar of marcus nunes marcus nunes
    10. January 2012 at 06:49

    Sorry, WENTLAND!

  11. Gravatar of ssumner ssumner
    10. January 2012 at 07:09

    T Page, I don’t understand why Bernanke is beholden to the interests of the banks. Lots of people say that, but it doesn’t make sense to me. These people used to argue that the Fed kept short term rates low to allow banks to profit from the spread between short and long rates. Then the Fed did Operation Twist . . .

    Thanks Scott, I hope to write a book this summer.

    Thanks Norman and Becky.

    Chris, My proposal would help the banks. The Fed tight money policy in late 2008 hurt the banks badly. So the facts don’t fit your argument.

    Marcus—Yes, depressed is the word.

  12. Gravatar of marcus nunes marcus nunes
    10. January 2012 at 10:45

    @ Cris
    Two stages. In stage 1 the Fed hurt the banks.
    In stage 2 the Fed “saved” the banks and hurt the rest of us.
    All in all, a big “screw-up”!

  13. Gravatar of T Page T Page
    10. January 2012 at 15:33

    Bernanke, as the head of the Fed, is beholden to the bankers as the Surgeon General is beholden to docs and health care. He’s the sharp edge of the sword and can act independently, but still has to live in their professional world (yes, he’s an economist 1st)and answer to them in the long run. It’s not conspiratorial it just reflects the position he’s in. There are those with more money and influence than Ben Bernanke that collectively will have a relationship to the head of the money spigot in such a way as to wield influence.

  14. Gravatar of RebelEconomist RebelEconomist
    11. January 2012 at 03:22

    “I would have expected the profession to react with this sort of outrage to the Fed’s tight money policy of 2008: Raising the reserve interest rate is a contractionary measure.”

    Then look at the British experience of introducing interest at 4.5% (previously zero) on reserves on 18 May 2006. Base money supply simply expanded by about 20-fold overnight, without any detectable influence on the exchange rate, inflation, real activity etc. Paying interest on reserves, or even just changing the rate, changes the nature of base money. A lot of wasted time arguing about the relationship between base money and inflation (right wingers) or the lack of it (Krugman) could be saved if this fact was more widely appreciated.

  15. Gravatar of ssumner ssumner
    11. January 2012 at 07:24

    T Page, Wrong, he’s a government bureaucrat. He might be beholden to the bankers, but you need to explain to me why this is so, and also why Fed policy often badly hurts the banks. You’ve simply made the assertion, you haven’t defended it.

    RebelEconomist, That’s not an accurate quotation. The second sentence was written by Hall, not me.

    I certainly agree that paying interest on reserves increases the demand for base money, and is often accompanied by an increase in the supply of base money. That may have some bearing on Hall’s argument (although I doubt it) but it certainly has no bearing on mine.

  16. Gravatar of RebelEconomist RebelEconomist
    11. January 2012 at 08:31

    I know that Scott, but you seem to agree with it. You are so slippery!

    The point is that interest on reserves is more about how interest rates are set (ie applying a lower boundary), rather than being expansionary or contractionary per se. If you hold the money market interest rate you are targeting constant and start paying interest on reserves, base money supply should expand automatically. If anything, the effect should be slightly expansionary, because the small amount of reserves banks need to hold to support their demand deposits gets cheaper to hold. Indeed, the Fed wanted to pay interest on reserves for years before the financial crisis, to remove what was then seen as a distortionary tax on banking.

  17. Gravatar of T Page T Page
    11. January 2012 at 13:08

    1. He’s a presidential appointee.
    2. He serves at the discretion of the president, who in-turn receives guidance from others.
    3. The head of the Fed’s decisions, on the margins, favor those others otherwise they would be seen as anathema to the president’s agenda and he would be replaced with someone more accommodating.
    4. To assume that the head of the Fed operates outside the sphere of political influence is unrealistic.
    5. I understand this is lacking in linear details of Person “A” directly affect a policy decision of Ben Bernanke that would unequivocally defend my assertion. But, my position remains that he is just a guy and wants to be seen in a positive light by his bosses, and we all have at least one, who must include some very wealthy and powerful people.

  18. Gravatar of Mankiw has surpassed Bob Hall | Historinhas Mankiw has surpassed Bob Hall | Historinhas
    11. January 2012 at 16:41

    […] is extremely unfortunate (and depressing) that even the “good guys are abandoning […]

  19. Gravatar of ssumner ssumner
    12. January 2012 at 13:06

    Rebeleconomist, Considered in isolation it is contractionary, obviously in Britain it was accompanied by more base money.

    The Fed could have just increased the base w/o IOR, why wouldn’t that have been better?

    T Page, Fine, but now you need to convince me that Obama is owned by the banks. Do they favor his higher taxes on the rich idea? Higher capital requirements?

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