My National Review article

I don’t have much time today, so a few quick comments.

In the National Review I try to show why conservatives should embrace NGDP targeting.

Here’s a recent article on higher interest rates:

With the U.S. housing sector still mired in a prolonged rut, higher rates are certain to do more damage, curtailing refinancing activity and worsening a logjam in foreclosures linked to faulty documentation.

Against that backdrop, it is somewhat baffling to see forecasters frantically raising projections for economic growth. Berner at Morgan Stanley says the tax agreement could push growth up by as much 1.2 percentage points in 2011, putting it above 4 percent.

I’ll let David Beckworth explain, although I imagine you already see the problem.

Here’s another quotation worth pondering:

The central bank’s $600 billion stimulus plan was supposed to lower interest rates. But President Barack Obama’s tax deal with Republicans, by rekindling fears of budget deficits in the bond market, has pushed them higher.

As the Fed meets this coming week, the surprise shot in the arm from the fiscal authorities might strengthen the case of hawks at the central bank, who think the economy is already growing of its own momentum. They could argue to scale down the $600 billion in bond purchases announced in November.

“The shift to fiscal stimulus implies that officials would be less inclined to extend the current program beyond the second quarter of 2011,” said Richard Berner, an economist at Morgan Stanley.

Suggestion to grad students who want to embarrass their Keynesian professors:  Ask them how the Fed reaction function is modelled in their estimates of the fiscal multiplier.  Ten to one they won’t be able to answer your question.

I replied to Arnold Kling in the comment section of this post.

David Henderson pointed out that I misused the term ‘conspiracy’ in my previous post.   I should add that my slightly mocking style probably led you to think I have a negative view of Mishkin.  I was actually just trying to be funny—I agree with his rebuttal of Inside Job (linked to in the final postscript.)   BTW, David is my favorite critic of the National Security State.

Have conservatives always been this anti-intellectual?

Yes, I know about the famous JS Mill quotation.  But when I was younger I thought the right had a lot of intellectual momentum.  The world was moving away from statism and toward neoliberalism, and it seemed like conservatives had most of the good economic ideas.

Of course there has always been a anti-intellectual strain to populist conservatism, as when the right romanticizes the “Golden Age” of the 1950s, before all those evil liberation movements of the 60s gave rights to blacks, women, and gays.  But at least on economics I used to think of conservatives as being relatively hard-headed.  So what is one to make of this appalling column in Forbes magazine:

Amid the very reasonable handwringing about the Fed’s charitably naive attempts to stimulate the economy through “quantitative easing”, there’s an understandable drive among some Fed critics to severely reduce its mandate. Specifically, the Fed can’t create jobs as its defenders inside and outside the central bank presume, so better it would be limit its role to that of inflation watchdog.

All that is fine on its face, but in seeking to redefine the Fed’s doings, naysayers have happened upon the false notion of “price stability.” A recent editorial argued in favor of repealing the Fed’s dual mandate so that it can concentrate “on the single task of stable prices”, and then politicians such as Reps. Paul Ryan and Mike Pence have similarly called for price stability in working to redefine the activities of the world’s foremost central bank.

Sadly, handing the alleged wise men at the Fed control over prices is every bit as mistaken as allowing the central bank to manage unemployment.

Indeed, it is through prices that the market economy is organized. In that certain sense, prices rise and fall with great regularity as consumers tell producers what they want less and more of. Assuming the Fed could do what it cannot; as in fine tune economic activity on the way to stable prices, we would be much worse off if Bernanke et al were to actually succeed.

To see why, it has to be remembered that the cure for high prices is in fact high prices. Or better yet, high prices foretell low prices.

If producers create a consumer product that fulfills unmet needs on the way to high prices, the latter is the signal to other producers to enter the market for the same good on the way to lowering its cost. Gyrating prices are the necessary market signal telling businesses what we need.

Taking this further, if price stability were policy, it would still be the case that a phone call from Houston to Dallas would cost $15 for a half hour of conversation. It would similarly mean that we’d be paying thousands of dollars for flat-screen televisions, not to mention even more for computers that perform very few functions.

I’m not going to insult my readers’ intelligence by describing what’s wrong with the last paragraph.  If you don’t know, go read someone elses blog.  At first I thought this might be an innocent slip up.  Nobody’s perfect.  Editors are very busy people, they can’t spot all mistakes.  But the rest of the piece is equally bewildering:

In that case, rather than price stability, the sole goal of monetary policy should be dollar-price stability. Fed officials would credibly argue that the latter is the preserve of the U.S. Treasury, and they would have a point. Be it Treasury, or Treasury working with the Fed, the mandate should be in favor of stabilizing the dollar’s value.

Um, isn’t the entire point of price stability (which I don’t favor, BTW) stabilizing the value of the dollar?  Indeed isn’t true that, by definition, a stable value of money means a stable purchasing power?  Not to John Tamny.  He seems to define a stable value of money as a stable price of gold.  Why gold?  Why not a stable price of bricks, or toothpicks, or zinc?  He doesn’t say.  Nor does he seem to have the slightest intellectual curiosity about periods in history when the dollar price of gold was stable, like 1929-33, when we had severe deflation (which provided falling prices of electronic goods like radios!), and 25% unemployment, and so discredited capitalism that we elected exactly the sort of politician that Forbes magazine would despise.

Oddly enough, Marx once again had the answer there. Marx, much like the classical economic thinkers of his era, knew that for money values to be stable, they would have to be defined in terms of gold. Marx referred to gold as “money, par excellence.”

Looked at through the prism of today, the dollar lacks a golden anchor, and the result is a money illusion that distorts the real price of everything. Worse, with consumer prices sticky in concert with commodity prices that are most sensitive to dollar-price movements, the beneficiaries of the money illusion tend to be the hard, unproductive assets of yesterday (think housing, art, rare stamps, and oil) that are least vulnerable to currency weakness, and which in fact do best when the unit of account is devalued.

Well if Marx says money must be good as gold, who am I to argue?  Reading this column I can’t help but wonder why all this talk about currency depreciation is occurring when inflation is at the lowest point of my lifetime, indeed lower than during 1896-1914, the so-called Golden Age of the gold standard.

The answer to all of this is very basic. Price stability is a utopian concept on its best day that would hamper innovation on the way to reduced living standards.

The greater, more obvious answer is dollar price stability of the gold kind that would allow investors to rate ideas on their actual merits, as opposed to how they’ll perform amid dollar policy since 2001 that has erred in an economically crippling way in favor of weakness. Fix the dollar, and you fix the U.S. economy. Simple as that.

Isn’t that wonderful!  No need to worry about messy real world issues like macroeconomics.  No need to worry about how nominal shocks can have devastating real effects.  Gold is like a magic wand that will fix the US economy.  But there is one huge flaw with this argument; there are two types of gold standards, and neither produces anything like satisfactory macroeconomic outcomes:

1.  One type is a managed standard, such as we had in the US between 1879-33, and in a weaker form under Bretton Woods.  In that standard the nominal price of gold is fixed (just as Tamny wants) but its real value is highly unstable, as the economy would often suffer from deflation.  The most devastating example was 1929-33.  It’s true that the supply of gold rises at a fairly steady rate, but central bank real demand for gold was highly unstable, and thus the price level was unstable.  Of course you could argue that the central banks should have done a better job of stabilizing gold demand, but by that logic why not just have fiat money and then have them do a better job of stabilizing monetary policy.  Even worse, if we returned to the gold standard almost no other country would be nutty enough to follow.  In that case when people in places like China and India hoarded gold out of fear of inflation, America would suffer deflation.  And from history we know that deflation in America would lead to fears of devaluation, which would cause gold hoarding in America as well, and even more deflation.  Tamny doesn’t even think about those issues, but why should he when he considers deflation to be a good thing?

2.  Some have advocated a laissez-faire gold standard.  In this case the government simply pegs the price of gold, but doesn’t hold large stocks of gold.   This would be even worse than a managed standard, as the relative price of gold would then be determined exactly as the relative price of any other metal is determined, by “industrial demand.”   Rapid economic growth in Asia has been boosting the relative prices of other metals such as silver, copper and iron.  If gold was just an industrial commodity, then its relative price would also be quite volatile.

So either way the gold standard offers no advantages.  At best, a highly managed international gold standard might lead to rough price stability.  But if central banks were really able to manage gold that well, they’d also be able to mange fiat money.

I suppose I am wasting my time with this post.  If the right now believes that deflation doesn’t matter, that 1929-33 is like some bad dream that never really happened, then nothing I say will make any difference.

HT:  Bruce Bartlett

Do the QE opponents have ANY good arguments?

I hope this is my last attack on conservative opposition to QE2, as I am getting sick of the topic.  I’ll try to summarize all their arguments here, to see if any are even slightly defensible:

1.  Inflation only seems low because the Fed ignores food and energy.

The core rate is only 0.6%, but even the overall CPI is only running 1.2%.  So that argument is flat out wrong.  Yet it doesn’t stop some people from making it.

2.  History shows that when central banks print lots of money, high inflation results.

Actually no.  History shows that when central banks print lots of money at the zero rate bound, one generally doesn’t get much inflation.  Japan has been printing lots of money for years, and has also run big budget deficits—thus they’ve been monetizing the debt.  And their price level is lower than in 1994.

3.  Japan is different.  When the Fed has printed lots of money we’ve had high inflation.

Actually no.  Again, when at the zero rate bound, printing money is not necessarily inflationary.  The Fed printed lots of money in the 1930s, indeed the monetary base nearly tripled.  Yet the price level fell during the 1930s.

4.  The gold market shows that high inflation is just around the corner.

Actually no, for reasons discussed in this earlier post.  Every direct indicator we have of inflation expectations shows very low inflation in the years ahead.  CPI futures markets, 5-year TIPS spreads, the consensus economic forecast, they all point to low inflation.

5.  OK, in the past printing money didn’t produce high inflation at the zero rate bound, and we don’t have high inflation now, and both forecasters and markets tell us not to expect high inflation in the future.  But I just can’t believe we can print that much money without eventually suffering from high inflation.  Monetarist theory tells us . . .

Monetarist theory has nothing to do with the current policy environment.  Monetarist theory is all about the impact of printing non-interest bearing money–aka “high-powered money.”  The reason it’s called high-powered is because it lacks interest, and thus is a sort of “hot potato,” an asset that everyone tries to get rid of, and the in process drives up prices.  Milton Friedman and Karl Brunner would be rolling over in their graves if they knew people were claiming monetarist theory meant than the issuance of reserves paying interest at rates higher than earned on T-bills was some sort of “high-powered money.”

6.  If the policy does raise NGDP, interest rates will also rise, causing the Fed to suffer capital losses on its large bond portfolio.

Conservatives presumably believe in efficient markets, and thus the expected loss is approximately zero.  The term structure of interest rates has already priced in the expected increase in rates that will occur as the economy recovers.  Yes, there is some risk, but far less than people think.  The Fed is mostly buying medium terms bonds, for which the price risk is rather low.  And if the recovery is much stronger than expected, the gains to the Treasury would far exceed the losses to the Fed.  This is NOT an argument for leaving millions of workers unemployed.  Especially given that the Fed took far greater risks to save the big banks.

7.  Yes, they are paying interest in reserves, and that prevents inflation right now, but when the economy recovers there will be tremendous pressure on the Fed to avoid raising the interest rate on reserves, and they will spill out into the economy. 

Even distinguished economists such as Becker and Posner are making this argument, but I find it the most perplexing and feeblest argument of all.

Right now the Fed is under tremendous pressure not to do more monetary stimulus, despite 9.8% unemployment and below target inflation.  There is little pressure on the Fed to do more.  Yet somehow we are to believe that when the economy recovers somewhat and inflation is much higher, and unemployment is lower than today, there will be tremendous pressure on the Fed to not raise rates?  And all this despite the fact that the Fed is almost universally blamed for holding rates too low for too long, and inflating the housing bubble?  That makes no sense.

Even worse, we need easier money to reduce that part of unemployment that is not structural; almost certainly a substantial share of the 8 million jobs lost in the recent recession was cyclical.  NGDP is not now growing fast enough to rapidly reduce unemployment.  I don’t expect the 11% NGDP growth we saw in the first 6 quarters of the (low inflation) Volcker recovery of 1983-84, but surely we can at least raise NGDP growth a bit higher than the current path?  How can we in good conscience tell the Fed not to do the right thing, and ease the enormous suffering caused by unemployment, solely because we fear they might do the wrong thing in the future?  Especially given that there is little political pressure on them to inflate now, when you’d think the political benefit of easy money would be greatest?  Obama didn’t even nominate three people for empty Fed seats for 15 months, which shows how little the liberal establishment cares about monetary policy.  And we are to believe that in the near future when the need for monetary stimulus is far less, Obama will suddenly morph into a latter day William Jennings Bryan and start pressuring the Fed?

So there you are.  The conservatives do not have a single good argument against QE2.  Every argument is based on bad logic, bad economics, a lack of understanding of history, or a lack of understanding of our political system.   There must be some reason why the conservative establishment hardly raised a peep when the Fed would cut rates when inflation was running 3% or 4% when Reagan was president, or when Bush was president, and yet are now up in arms over monetary stimulus when we have 1% inflation and 17 million people out of work.  There must be some reason.  But for the life of me, I can’t figure out what it is.

OK, I’ll get off this topic, and wait for conservatives to explain to me what’s going on.

And when we figure that out, then we can work on the even more bizarre opposition from certain voices on the left.  But perhaps I should leave it to Krugman to figure out what’s going on in the mind of that other outspoken, prickly, left-wing pundit and Nobel laureate.  Joe Stiglitz.

Where was the outrage in 2007?

One reason I like Matt Yglesias’s blog is because he is much less “tribal” than most other bloggers of the left and the right.  Here he takes a shot at liberals who insist it’s obvious that we need more government spending during the current recession, but somehow forgot to call for less government spending during the preceding boom:

Or at the state and local level, anyone who’s thinking seriously about the issue ought to see that the middle of a recession is a terrible time to implement major cutbacks in public spending. But at the same time, people who believe in good faith that state and local spending is above the optimal level will understandably agree with Rahm Emannuel that you don’t want to let a good crisis go to waste. After all, were center-left Keynesian economics bloggers issuing table-thumping condemnations of state and local spending increases in 2004-2007? Bemoaning the fact that we’d entered a new “dark age” of macroeconomic understanding where policymakers didn’t realize that under the circumstances states and municipalities ought to be trimming its workforce and accumulating huge surpluses? I think I missed that.

Like Yglesias, I don’t particularly care whether people on my side are offended by my opinions.  So I’ll keep attacking my friends and allies on the right whenever I don’t agree with their views on monetary policy.

Update 12/4/10:  When I woke up this morning I realized the preceding paragraph is all wrong.  It suggests I’m more courageous than other bloggers, which is both incorrect and kind of insulting.  My apologies.]

Here’s a question that puzzles me.  We know the right is up in arms over the Fed’s recent move toward monetary stimulus.  Yes, inflation is only 1.2% and core inflation is only 0.6%.  And yes, unemployment is 9.8% and rising.  But despite these dreary numbers it is viewed as an outrage that the Fed is trying to boost the growth rate of aggregate demand to a more normal level.

So this got me wondering about the right’s reaction to the Fed’s policy of easing during 2007.  As you may recall, the Fed cut rates several times during 2007.   I checked and found that the inflation rate during 2007 was 4.1%, more than double the Fed’s target.  Unemployment was below 5%.   So if the right was angry about monetary easing when inflation is half the Fed’s target and unemployment is double the natural rate, they must have been absolutely apoplectic about Fed easing when inflation was more than double the Fed’s target, and unemployment was below the natural rate.  After all we’re constantly being told that the Fed’s job is to produce price stability.  Period.  End of story.

Now I can imagine some apologist for the right arguing that the Fed needed to cut interest rates in 2007 because there was a banking crisis.  But haven’t we been told over and over again that the Fed should focus on targeting inflation, that it has no business targeting other variables?  So clearly that can’t be the explanation.

So what is the explanation?  Maybe there were a lot of complaints back in 2007 and I have just forgotten.  Were conservatives complaining that monetary stimulus would merely bail out the failed Bush administration fiscal policies, and allow him to put off the tax increases necessary to balance the budget?  I don’t recall reading that argument, but perhaps I forgot.

I’m not good at searching out old editorials; perhaps some commenters can help me.  But here is the Fed press release from the September 2007 rate cut:

Release Date: September 18, 2007

For immediate release

The Federal Open Market Committee decided today to lower its target for the federal funds rate 50 basis points to 4-3/4 percent.

Economic growth was moderate during the first half of the year, but the tightening of credit conditions has the potential to intensify the housing correction and to restrain economic growth more generally.  Today’s action is intended to help forestall some of the adverse effects on the broader economy that might otherwise arise from the disruptions in financial markets and to promote moderate growth over time.

Readings on core inflation have improved modestly this year.  However, the Committee judges that some inflation risks remain, and it will continue to monitor inflation developments carefully.

Developments in financial markets since the Committee’s last regular meeting have increased the uncertainty surrounding the economic outlook.  The Committee will continue to assess the effects of these and other developments on economic prospects and will act as needed to foster price stability and sustainable economic growth.

Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; Timothy F. Geithner, Vice Chairman; Charles L. Evans; Thomas M. Hoenig; Donald L. Kohn; Randall S. Kroszner; Frederic S. Mishkin; William Poole; Eric Rosengren; and Kevin M. Warsh.

Not one vote against?  Thomas Hoenig could have voted against any rate cut.  He could have supported a quarter point rate cut and voted against the half point cut.  But he decided to vote for the full 50 basis point cut, which was more than markets expected and which set the stock market soaring.  And he did this at a time when unemployment was 4.7% and inflation was running at double the Fed’s target.  Interesting.

Another possibility is that conservatives think that right now money is really easy because the base has ballooned and rates are near zero.  Of course the same was true during the 1930s.  Come to think of it, conservatives also thought money was really easy during the 1930s, indeed they thought it was too easy.  Later Friedman and Schwartz showed conservatives how tragically mistaken they had been.  But perhaps they forgot.

There’s no going back

When I was young I thought I was experiencing a series of events.   Now I understand that I was experiencing the feeling of being young.  Sure you can go back and revisited a bunch of European countries, but it won’t seen the same as when you first tramped around Europe with a backpack, and the world seemed charged with mystery and meaning.

I think of public policy in similar terms.  Obviously there are cases where we can literally go back—the 21st Amendment restored the status quo ante of before the 18th Amendment.  But it’s never quite the same.  Indeed in just the last 10 years we’ve lost the ability to drink alcohol at our Bentley holiday party (I suppose due to fear of lawsuits.)

How I think about the past often depends on whether my mood is that of an ornery reactionary or a hopeful progressive.  Whether listening to talk radio or NPR.  Sometimes I think both the left and right miss something important when they visualize the past.  The right tends to romanticize a golden age that was ruined by statism, whereas the left sees a period of misery, which progressive legislation has lifted us above.  I believe the right has lots of blind spots, and the left often attributes change to legislation that actually reflects the fact that we are vastly richer than 100 years ago.

As a macroeconomist I often think of the spring of 1929 as a sort of golden age of policy, when there didn’t seem to be any significant macro problems and we had a pretty efficient policy regime.  But how should a pragmatic libertarian like me think about 1929 vs. today?  It’s not quite as obvious as you might think.  In some ways things have certainly got worse; Federal spending has grown from 3% to over 20% of GDP.  We have an alphabet soup of regulatory agencies that do more harm than good.  But there are also many changes for the better.  The rights of blacks, women, and gays are much better protected than in 1929.  And even many of the changes that would be vigorously opposed by more dogmatic libertarians, are somewhat ambiguous to a pragmatist like me:

1.  Social Security and Medicare really do help older people, but the systems were set up in a way that discourages saving.

2.  Some environmental regulations really do improve our lives, but they are often implemented in an inefficient way.

3.  We have lower tariffs, but many more non-tariff barriers.

4.  We’ve gained the right to drink alcohol, but also suffer from a new reign of paternalism

5.  We are more willing to tolerate immigration from non-European countries, but must suffer under the abominable TSA and INS.

6.  There is less regulation of transport pricing and entry, but more rent controls and minimum wages

7.  We have unlimited bank branching, but much more moral hazard in the system.

8.  There is more annoying paperwork today, but also less governmental corruption

I suppose for a dogmatic libertarian things are clearly worse, but for a pragmatist like me that’s not so clear.  Which finally brings me to monetary policy.  Are we better off today than in 1929?  How about compared to 1912?  I pick those dates because our monetary system has undergone two revolutionary changes in the past century; we’ve added a central bank and dropped the gold standard.  There’s only one thing I am really sure of; it’s a really, really bad idea to have both a central bank and a gold standard.  If you don’t believe me, check out the macro performance of the US between 1913 and 1941.  Both inflation and output were extraordinarily unstable.

In my view we are better off without the gold standard.  We can’t afford to leave the price level and NGDP to chance, where an increase in the demand for gold could cause severe deflation and depression.  Admittedly the worst example of this occurred under a gold standard that was far from pure (1929-33) but there are two strong arguments that cut the other way:

1.  The gold standard was also far from pure during the so-called classical period (up to 1914.)

2.  The whole point of the gold standard is that it’s supposed to work automatically, to protect you against foolish governmental decisions—indeed to prevent governments from printing too much or too little money.  If we need sensible government to make the gold standard work, then why not just attach the sensible government to a fiat regime, that will work even better (and did between 1983-2007.)

So far I’ve been emphasizing my progressive side, but now I’m going to do a 180 degree pivot.  I think a very strong case can be made that we’d be better off if the Fed had never been created.  Indeed a recent paper by George Selgin, William D. Lastrapes, and Lawrence H. White makes exactly that case.  It’s a very long paper and it marshals an impressive array of evidence against the Fed.  The focus in on two areas; whether the Fed has actually made the economy more stable (unlikely), and the effects of its regulatory actions,particularly in the recent crisis.  As far as I am concerned, their new paper becomes the definitive critique of the Federal Reserve System, which any academic researching the issue will have to address.

If you are a pragmatist like me, don’t write off the paper as a hopelessly utopian attempt to re-create a mythical gold age.  Their arguments are much more subtle and nuanced:

“Coming up with alternatives to the Fed today takes more imagination. Assuming that there is no political prospect of replacing the fiat dollar with a return to the gold standard or other commodity money system, for the dollar to retain its value some public institution must keep fiat base money sufficiently scarce. [..] [T]he Fed’s poor record calls for seriously contemplating a genuine change of regime. In particular it strengthens the case for pre-commitment to a policy rule that would constrain the discretionary powers that the Fed has used so ineffectively. Whether implementing such a new regime should be called “ending the Fed” is an unimportant question about labels.”

That’s exactly where I am on the issue.  It’s not a question of going back or staying where we are, it’s about moving forward.  Here’s an analogy.  The left and right have been debating whether we need a government-run postal service for decades.  Long before that debate is resolved technology will have eliminated the need for snail mail (except packages, which can be easily delivered by Fedex or UPS.)  It’s likely that long before we solve the problem of whether to use interest rate or money supply control, we will go to a cashless society with all electronic money.  That will make possible Robert Hall’s (1983) visionary scheme to index interest on reserves in such a way as to automatically stabilize the expected future price level (or NGDP.)  No Fed discretion is required.  Even Woodford once had nice things to say about the idea.

The debate over “ending the Fed” is pointless.  There will always be something called “the Fed.”  What we need to do is not to end it, but emasculate it.  Take away its discretion and simply give it a nominal mandate, and let the market implement the mandate.

I see the human race as like that runaway train in the new Hollywood film.   Technology is hurtling us rapidly toward a future that we can’t envision, and which would both horrify and dazzle us if we could.  (Just as the ancient Greeks would be both horrified and dazzled by our current culture.)  We don’t study the past to try to recreate the past, but rather to learn lessons that we hope will make the ride on this runaway train a bit smoother.

PS.  Thanks to William for sending me the quotation.  I’ll try to have more to say about other issues raised in the Selgin/Lastrapes/White paper when I have more time.  David BeckworthTyler Cowen, Alex Tabarrok, Bryan Caplan, and Arnold Kling also make comments.  I agree with some of the points made by Cowen, although I’d point out that while it’s true that if we’d had no Fed in 2008 there might have been a Great Depression, it’s also true that if we had no Fed in 2002 there would have been no sub-prime fiasco.  Banks don’t do that sort of thing without a safety net.  I will be at another conference this weekend, so blogging will again slow to a crawl.