The dating game

The following is highly speculative, so don’t take it too seriously.

I was surprised to see stocks rise so strongly today; and even more surprised to see the increase being attributed to the Fed’s QE announcement, which occurred a day earlier.  But perhaps stocks were responding to something else.  Consider this quotation from a Bernanke piece published just this morning in the Washington Post:

Although low inflation is generally good, inflation that is too low can pose risks to the economy – especially when the economy is struggling. In the most extreme case, very low inflation can morph into deflation (falling prices and wages), which can contribute to long periods of economic stagnation.

Even absent such risks, low and falling inflation indicate that the economy has considerable spare capacity, implying that there is scope for monetary policy to support further gains in employment without risking economic overheating. The FOMC decided this week that, with unemployment high and inflation very low, further support to the economy is needed. With short-term interest rates already about as low as they can go, the FOMC agreed to deliver that support by purchasing additional longer-term securities, as it did in 2008 and 2009. The FOMC intends to buy an additional $600 billion of longer-term Treasury securities by mid-2011 and will continue to reinvest repayments of principal on its holdings of securities, as it has been doing since August.

This approach eased financial conditions in the past and, so far, looks to be effective again. Stock prices rose and long-term interest rates fell when investors began to anticipate the most recent action. Easier financial conditions will promote economic growth. For example, lower mortgage rates will make housing more affordable and allow more homeowners to refinance. Lower corporate bond rates will encourage investment. And higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending. Increased spending will lead to higher incomes and profits that, in a virtuous circle, will further support economic expansion.

While they have been used successfully in the United States and elsewhere, purchases of longer-term securities are a less familiar monetary policy tool than cutting short-term interest rates. That is one reason the FOMC has been cautious, balancing the costs and benefits before acting. We will review the purchase program regularly to ensure it is working as intended and to assess whether adjustments are needed as economic conditions change.

Although asset purchases are relatively unfamiliar as a tool of monetary policy, some concerns about this approach are overstated. Critics have, for example, worried that it will lead to excessive increases in the money supply and ultimately to significant increases in inflation.

Our earlier use of this policy approach had little effect on the amount of currency in circulation or on other broad measures of the money supply, such as bank deposits. Nor did it result in higher inflation. We have made all necessary preparations, and we are confident that we have the tools to unwind these policies at the appropriate time. The Fed is committed to both parts of its dual mandate and will take all measures necessary to keep inflation low and stable.

That’s not something Hoenig, Fisher, Plosser or Kocherlakota would have written.  It’s pretty clear which side Bernanke’s on.  A commenter named Marcus Nunes pointed out that QE is the new fed funds target, at least as long as rates are near zero.  Note how Bernanke suggested that there had been a fear of the unknown, which initially caused the Fed to hold back.  (Two years ago I told them to come on in, the water’s warm.)  But I think he also hints that as they become more familiar with the policy tool, and find out that it doesn’t lead to explosive growth in the monetary aggregates, they are likely to make further adjustments as needed.  The new normal.  I believe the markets liked that idea.  I also think they liked the part about stocks rising in anticipation of the Fed’s decision, and then the additional comment that higher stock prices can help spur the recovery.  Where have we heard that it’s not just about interest rates; monetary policy also affects all sorts of asset prices.  (Hint: it’s a school of thought that was supposedly discredited when velocity started moving around in the 1980s.)

If I had some literary talent, I’d try a dating analogy for the game that Bernanke and the stock market are playing.  Bernanke sends out some sweet talk, the stock market responds with enthusiasm.  That emboldens Bernanke (a rather shy guy) to send out a bit more sweet talk, with the confidence his ‘policy tools’ are not viewed as being impotent.  I think you can see why I’ll stay away from literature, I couldn’t even write trashy romances.

Paul Krugman seems to think the Fed has a credibility problem; that the markets won’t believe their promises to “inflate.”  I’ve argued that there is no reason why Bernanke would not be believed.  He’ll probably be in charge for a while, why would he trash his reputation by cheating on the markets once he’d sweet talked them into expecting more inflation.  Has there ever been a determined fiat money central bank that tried to inflate, and failed?

The way the stock market responded to rather vague and unimpressive rumors of monetary ease, suggests to me that credibility is the last thing Bernanke needs to worry about.  The stock market seems like a lonely girl who laps up anything she hears from a sweet-talking guy with a very big wallet in his back pocket.  A cheap date.

What do you guys think?  Is Krugman right, or is it easy for the Fed to impress the markets?  No need to even mention marriage (i.e. higher inflation targets), just give her a wink and a nod, and promise you’ll spend $600b on the date.

This post has committed two cardinal sins:

1.  Assuming that if I like Bernanke’s speech, the markets will as well.  What do I know about what turns on lonely girls?

2.  Assuming that it is possible to attribute market movements to specific news, even when we don’t observe an immediate market response in real time.

Still it’s something to think about.  Let’s keep a close eye on everything Casanova Ben Bernanke says to the markets in the next few months, and note how they react to the sweet talk.

HT:  JimP,  Morgan, Marcus Nunes


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38 Responses to “The dating game”

  1. Gravatar of Mark A. Sadowski Mark A. Sadowski
    4. November 2010 at 19:20

    Scott,
    You wrote:
    “The stock market seems like a lonely girl who laps up anything she hears from a sweet-talking guy with a very big wallet in his back pocket. A cheap date.

    What do you guys think? Is Krugman right, or is it easy for the Fed to impress the markets? No need to even mention marriage (i.e. higher inflation targets), just give her a wink and a nod, and promise you’ll spend $600b on the date.”

    I think she’ll settle for a good time. I know I would. I’m a lonely boy (after Maureen left me holding the bill for last winter’s heat) who spends a lot of time tutoring lonely girls.

    The bottom line is that the AS curve is flat as a pancake right now. Any injections of MS are almost 100% good for solid real growth (if it weren’t for that pesky IOER screwing up my calculations).

  2. Gravatar of Mike Sandifer Mike Sandifer
    4. November 2010 at 19:56

    Scott,

    You once said that it wouldn’t have been a good idea for the Fed to have simply guaranteed the solvency of banks and other large financial institutions, say in late ’07 or early ’08, due to moral hazard. How do those concerns trump those of the circumstances we’ve faced since? And what if the Fed followed up by moving in and further regulating lending, etc.?

  3. Gravatar of Doug Doug
    4. November 2010 at 20:14

    I was never very good at the dating scene myself. As such I was always seeking the advice of those who were. The best advice I received was, “Strike while the iron is hot”. I think this would apply in this case. Now that Bernanke knows the market is responsive he should strongly signal his intentions to grow the economy what ever it takes. It he does then, then it could be a cheap date, but if he takes his time and the market thinks he is not serious, the proving that he is serious could be very expensive indeed.

    By the way what is the big deal about overshooting the targets and getting inflation. It seems like we know how to fix inflation. When central bankers get together do the central bankers with the lowest inflation get first crack at the desserts? Wouldn’t a target of 4% be healthier than 2%?

  4. Gravatar of Dustin Dustin
    4. November 2010 at 20:18

    Mark, possibly a dumb question, but how do you know that the AS curve is flat right now?

  5. Gravatar of Doc Merlin Doc Merlin
    4. November 2010 at 20:21

    QE should make stocks rise. Stocks are substitutes for holding cash for savings, QE makes cash even less desirable so stocks will go up.

    Another way of thinking about it: The dollar is expected to fall, but markets are efficient and the corps haven’t actually changed any, so the dollar price of the corp should rise so its still the same non-dollar price as before.

  6. Gravatar of Mark A. Sadowski Mark A. Sadowski
    4. November 2010 at 20:23

    Dustin,
    Vey good question. But rather than me answering it I’ll let Scott (and Taborrak and Cowen) take the heat:

    https://www.themoneyillusion.com/?p=3025

  7. Gravatar of Mark A. Sadowski Mark A. Sadowski
    4. November 2010 at 20:27

    With all due apologies.

    Taborrak=>Tabarrok

    Evidently I have vowel dislexia.

  8. Gravatar of Mark A. Sadowski Mark A. Sadowski
    4. November 2010 at 20:36

    Oh,and in commemoration of John Boehner being Speaker of the House for the next two years I offer the following video (not!):

    http://www.youtube.com/watch?v=mCH3KvcAf9w&feature=player_embedded

  9. Gravatar of Liberal Roman Liberal Roman
    4. November 2010 at 21:37

    Oh what an absolutely dreadful Drudge Front Page right now if you are a monetarist…

    I pray that the Fed continues to just be ignored. I hope against hope that it doesn’t become a political target. I do think we are fine. I think all of the Democrats and a large portion of the GOP would block any intervention into monetary policy. I remember some GOP leadership dared to speak out against the Fed audit during that debate.

    What we need right now are what we have needed for a long time now. Jobs. Jobs. Jobs. Although, I am very skeptical, I hope that Scott is right and that the expiration of extended unemployment benefits (which will almost certainly come with Republicans in office) and other supply-side policies like the extension of tax cuts begin to have some effect.

    I also wish that Bernanke remembers that the Fed is supposed to be politically independent and that he ignores the constant op-eds about rising commodity prices which will fill the paper next year if he is successful in engineering high inflation expectations.

  10. Gravatar of Joe Joe
    4. November 2010 at 21:46

    Professor Sumner,

    Do you adhere to the weak (Whatever information people have, they make optimal use of this information in forming their expectations) or strong (People have access to all available information about the structure of the world in which they live) form of rational expectations theory.

    It seems to me that only the weak form can be right.

    Joe

  11. Gravatar of 123 123
    4. November 2010 at 22:20

    After this Washington Post AD shock, 30y bond yield did not change. Maybe liquidity effect is equal to Fisher effect at 30y maturity, and the main surprise in FOMC announcement was changes in the proportions of maturities.

  12. Gravatar of Doc Merlin Doc Merlin
    4. November 2010 at 23:08

    @Liberal Roman:
    QE2 won’t help do what you think it will wrt jobs. If the reason for the unemployment was wage stickiness, then it should have been over within 2 years. It hasn’t been; this suggests that something else is behind the unemployment problem. I think it was largely bad policies coming down the pipe that made workers too expensive.

  13. Gravatar of Tom Grey Tom Grey
    4. November 2010 at 23:28

    If average American workers are overpaid, on the world labor market scale, then QE II won’t solve this problem for a big reduction in unemployment, although it should be good for some positive growth and some slow employment gains.

    A huge advantage of small inflation now is that house prices can hardly stabilize without some inflation. Once even 1% house price gains are seen and expected in the housing market, buyers will know it’s the bottom and be buying more. The over-built/ over-priced housing market remains a drag against growth.

    Avg. Americans are overpaid, and gov’t workers grossly overpaid.

  14. Gravatar of Edwin A Edwin A
    5. November 2010 at 00:05

    @Liberal Roman
    You know what I found scary?
    http://www.politico.com/blogs/glennthrush/1110/Ron_Paul_in_charge_of_Federal_Reserve_oversight.html

  15. Gravatar of shocking shocking
    5. November 2010 at 00:46

    This is a question I’ve been meaning to pose for a while, especially since the issue has surfaced recently in the econ blogosphere and hasn’t *yet* been addressed on the money illusion.

    As far as I understand, your main argument against fiscal policy being a credible way to stimulate the economy rests on the contention that the effects of any government spending (whether tax cuts or government spending) are completely contingent on the response by the Fed.

    Political realities aside, in the case that the Fed (read Bernanke) communicates a belief that further fiscal stimulus would be beneficial to the economy, we can judge reasonably that the intended response would be an accommodative one.

    Moreover, if the ability of the Fed to implement monetary policy is constrained, either by trepidation at entering uncharted policy waters, limited traction of certain mechanisms (not necessarily a belief I hold-just throwing it out there), or a lack of credibility to influence expectations, wouldn’t the climate be perfect for additional fiscal expansion?

  16. Gravatar of Doc Merlin Doc Merlin
    5. November 2010 at 01:46

    @Edwin A:
    I can only hope, maybe then we will end the fed and allow a free market currency instead of a centrally planed one.

  17. Gravatar of Alejandro Alejandro
    5. November 2010 at 03:36

    Let´s hope it is nothing like a dating game, relationships sometimes don´t end up well. Let´s hope that the markets don´t think that Bernanke is just trying to get them in to bed for the night and dump them the next morning with an “I´ll call you tomorrow”.

  18. Gravatar of DanC DanC
    5. November 2010 at 04:03

    Or perhaps the private sector reacted like a school girl to a new suitor who tells her she is beautiful, after her last boyfriend kept telling her how awful she was.

    More important

    Of course after the devaluation of the dollar, the Fed has imposed an energy tax on the entire economy. Falling dollar means rising energy costs.

    Perhaps oil exploration in this country will increase. Or California will declare independence and become The People’s Commune of The Pacific.

    I don’t know how this will play out. Now other countries react.

  19. Gravatar of scott sumner scott sumner
    5. November 2010 at 04:52

    Mark, Agreed.

    Mike, I think you misunderstood my argument. I said monetary stimulus would have been much better than bank bailouts. Given they weren’t planning monetary stimulus, I’ve always said we might have been better off bailing out Lehman (in retrospect.) I don’t have strong views on that either way–as I’m not sure how much Lehman contributed to the recession. The steep downturn began before Lehman, in July.

    Doug, I agree, just like in the 1930s the overshooting risk is very overrated.

    Doc Merlin, Yes, but that argument requires that the stimulus raises expected inflation (domestic) as well.

    Liberal Roman, Good points. I can’t imagine the top leaders of the GOP calling for tighter money–but stranger things have happened.

    Joe, The weak form.

    123, I don’t follow. The WaPo story contained no new evidence on bond maturities, so why wouldn’t any affect along those lines have occurred on Wednesday (when they did occur) not Thursday (when they didn’t.)

    Tom Grey, I disagree, I think QE2 can reduce real wages.

    shocking, Not necessarily. Suppose Bernanke favored 1.3 trillion in stimulus, because he is shy about using new and risky tools. Instead Congress does 800 billion. Bernanke reacts to this lack of stimulus by doing QE1 in March 2009.

    I’ve always admitted fiscal stimulus might work under certain conditions, but I’m skeptical that it has actually had much impact.

    Alejandro. Bernanke seems sincere to me. But then I’m as gullible as a lonely girl.

    DanC, The net effect of a lower dollar (produced by easy money–“never reason from a price change.”) is more NGDP.

  20. Gravatar of 123 123
    5. November 2010 at 05:02

    OK, so why did stocks rally after Bernanke op-ed, but 30y yield did not change?

  21. Gravatar of DanC DanC
    5. November 2010 at 05:21

    My point is that QE will meet headwinds in international markets plus rising energy prices will work like a tax increase on the economy.

    In addition, without a change in fiscal policy, reform in tax complexity and regulations, long term growth is well below potential.

    Will QE boost the economy? Clearly a bit. A little over two months ago I shifted 90% of my portfolio into stocks and 5% into commodities (not gold). BTW even if Fama says that commodity funds are a poor hedge against inflation, I still bought oil futures.

    Now I have to worry about end of year tax moves that may, depending on what Congress does, create choppy waves for my windfall.

    Fiscal policy will still have more impact in the long run then QE.

  22. Gravatar of Mattias Mattias
    5. November 2010 at 05:23

    I don’t find it that strange that the stock market reacted so well. Probably many investors have been worried about a second deflationary downturn, and now the risk of that seems much smaller. So they get back in the market.

    Personally I think the market will go much higher the next 18 months when the fear of a total collapse subsides until even the gold bugs realize that the armageddon trade is over for this time. But that’s just conjecture of course.

  23. Gravatar of JTapp JTapp
    5. November 2010 at 05:42

    Bill Woolsey has a great post with his response to QE2 today.

  24. Gravatar of Nick Rowe Nick Rowe
    5. November 2010 at 07:07

    What most disappointed me about Ben Bernanke’s piece was how small the role he attributed to stock prices. He said that lower corporate bond rates (i.e. higher corporate bond prices) would encourage investment. Higher stock prices should also encourage investment. but all he said about higher stock prices was that they have a wealth effect on consumption, and boost confidence.

    In other words, he is stuck on thinking in terms of interest rates, but can’t see that the inverse of a stock price is an interest rate.

  25. Gravatar of Mike Sandifer Mike Sandifer
    5. November 2010 at 07:17

    Scott,

    I have misunderstood some of your statements in the past, so I’ll just ask the question again. Would it have been better for the Fed to have simply made a statement that they wouldn’t allow even one major financial institution to fail, say maybe in the fall of ’07? Then, perhaps far less, if any new money would’ve had to have been created and we’d have saved most of this pain we’ve experienced since.

    I originally asked this question months before the ECB promised “unlimited liquidity” to stave off further crisis. I’d been wondering about it since late ’08 or early ’09.

  26. Gravatar of Alejandro Alejandro
    5. November 2010 at 07:31

    Scott,

    Looks like the G-20 leaders don´t read your blog

    From the WSJ
    U.S. Faces G-20 Opposition Over Fed Stimulus

    Brazilian Finance Minister Guido Mantega on Thursday called the Fed’s policy “an error,” and said Brazil will criticize the move at the G-20 meeting in Seoul. “It is doubtful the Fed decision will produce any results,” Mr. Mantega told reporters. “Throwing money out of a helicopter doesn’t do any good.”

  27. Gravatar of 123 123
    5. November 2010 at 07:33

    Nick,

    Bernanke certainly understands that the inverse of a stock price is an interest rate. The problem is that it is a 70 year interest rate, and he thinks that 5 year interest rates are more important for most investment projects. On the other hand, 70 year interest rates are very important for consumption/saving decisions.

  28. Gravatar of Shane Shane
    5. November 2010 at 09:09

    I think you’re leaving another element out of the dating game analogy–the watchful eye of the audience, polite society, and by extension parents and elders who stand guard over cultural mores. Yglesias has a great post (http://yglesias.thinkprogress.org/2010/11/the-mechanics-of-monetary-policy/) answering your question about why central bankers are obsessed with interest rates: it is because it offers a way of getting their message across to the audience they are courting–investors, etc.–while not offending the delicate sensibility of the parental superego. So Bernanke might like to come right out and tell the market all about the size of his QE package, but those whom Krugman calls VSP experience a violent paroxysm of outrage when they hear such blunt language.

    As with courtship, we all know what the bottom line on monetary policy is. Yet we still cannot just come out and talk about it directly, because we need politics to make it sound smoother and more palatable. “Lowering interest rates” was the previously politic way, the pick-up line if you will, for discussing such touchy subjects, but that line becomes unbelievable when interest rates are zero–being “stuck in a liquidity trap” is just shorthand for “got no economic game.” The problem is, no one who actually knows anything about how to get the job done is developing the right lines, so things like “audit the fed!” and “no more bailouts” are filling the gap–or to continue the analogy further, the nice guy is about to lose out to the smooth-talking a@#hole. This is not a policy problem, and hence not something that the autistic approach can solve. It is a political problem, and Barack Obama, like Cyrano de Bergerac, needs to stop feeding his best lines to the air-headed tan-man Boehner and start using his talents to pursue his own goals.

  29. Gravatar of JimP JimP
    5. November 2010 at 10:14

    FT lead editorial more or less predicts price level targeting.

    http://www.ft.com/cms/s/0/5f7070aa-e84b-11df-8995-00144feab49a.html#axzz14QuGHXi1

  30. Gravatar of Stephen Stephen
    5. November 2010 at 10:36

    Why should stock markets rise sharply in response to temporary easy money? The negative rates today will be compensated with above average interest rates tomorrow. If speculators cause stock prices to rise today, they lose when same stock prices fall in the higher interest rate environment a couple of years in the future. (The Fed’s money furnace)
    in other words
    The girl may end up heartbroken with Bernanke because Bernanke is only loaning her the gifts. She’s going to be sad when he wants his gifts back — (the future “money shredder” operations to reduce the money supply as opposed to the printing press for now) it all will balance out to the same roughly 2% inflation target anyway– he’s only her platonic friend. Confidence building, but stock prices should remain stable, his real work is on NGDP growth for the rest of the economy’s sanity.

  31. Gravatar of Morgan Warstler Morgan Warstler
    5. November 2010 at 11:44

    I’m telling ya, Ben is about to become Chief Austerity Cheerleader… CUTGO style. Don’t raise taxes, cut spending. BIG TIME.

    Because of Drudge.

    Dating the stock market does Ben no good if Local Wealth (small business Republicans) decides Wall Street is in their way.

    It takes no time message: DOW hits 14K! Unemployment hits 10%!

    Fortune 1000 companies do not create jobs. The new companies that chew up and undercut Fortune 1000 companies create jobs. Those companies REQUIRE Capital Formation, and need LESS REGULATION.

    So, logically Ben can’t just align with the Stock Market, he has to align with Local Wealth.

    And that means Ben can’t just QE3, he’s got to become anti-Obama.

  32. Gravatar of rob rob
    5. November 2010 at 12:31

    I wrote a long comment yesterday which I ultimately mercifully deleted about how the market is a woman and that trying to rush her to excitement wasn’t likely to work. Whatever the news, the market has its own nature and its own moods. (Volatility is serially correlated.)Is there not reason to suspect that philosophers so far have been very inexpert on women?

    There may not be long and variable lags in response to policy announcements, but I suspect short, variable, unpredictable lags occur.

  33. Gravatar of Mike Sandifer Mike Sandifer
    5. November 2010 at 13:24

    Morgan,

    There is a wealth effect that benefits many invested in stocks and the current prices do reflect higher earnings expectations.

  34. Gravatar of scott sumner scott sumner
    5. November 2010 at 15:58

    123, I don’t know, I’ve always found interest rates to be a rather unreliable indicator—but I would have expected a bit higher 30 year yields. There are always a million possible interpretations. Perhaps the markets saw Bernanke as hinting of QE to come–and assumed the next round would involve longer term bonds. That’s a pretty feeble explanation, but I can’t really think of any explanation that would explain it, even a non-monetary shock usually causes stocks and long term bond yields to move in the same direction.

    DanC, I strongly agree that fiscal policy is much more important than monetary policy in the long run. But in the short run more AD would help.

    Higher oil prices are not a problem as long as NGDP is rising.

    Mattias, I hope you are right.

    JTapp, Thanks, I’ll check it out.

    Nick, That’s a good point. Perhaps I’m too grateful for small favors. What do you think of the Tobin q approach? (Higher stock prices raise market prices relative to book value, encouraging the construction of new corporate assets.)

    Mike, I honestly don’t know. Obviously that’s far from an optimal policy, but given how poorly actual events turned out, it might have been worth a shot.

    Alejandro, I never thought I’d live long enough to see Brazilian officials lecturing the US about the folly of throwing money out of helicopters.

    123, I’m not sure I agree, see the question I asked Nick (above.)

    Shane, That’s a very good comment. I think you could have written a better post on this than me.

    JimP, Yes, that would be the next step (along with a small drop in IOR.)

    Stephen, Because money has important real effects, and these impact everything from regulation to taxes. Tight money causes more regulation and higher taxes–not a good combination.

    Morgan, You make the mistake I mentioned in the post (about myself)–assuming Bernanke thinks like you. He doesn’t.

    Rob, I agree about philosophers. And I’d add myself to the list.

  35. Gravatar of Richard W Richard W
    5. November 2010 at 16:31

    FT Alphaville had a post on the 5s-30s curve.

    http://ftalphaville.ft.com/blog/2010/11/05/395566/unwinding-the-us-treasury-trade/

  36. Gravatar of Mike Sandifer Mike Sandifer
    6. November 2010 at 06:38

    Scott,

    In response to my question about whether the Fed guaranteeing the solvency of the major financial institutions in late ’07 would have been a superior response to what we’ve actually gotten, you reply:

    “Obviously that’s far from an optimal policy,…”

    Why is this?

  37. Gravatar of Morgan Warstler Morgan Warstler
    6. November 2010 at 07:05

    Mike, much Local Capital / Retail Investors has left the stock market.

    Let’s start here: Increase money supply -> increase stock prices != wealth creation.

    You can wish and wish and wish with all the eggheads in the world and it will not make it so.

    I hope you’ll agree, Doc is correct that stocks are basically cash equivalent? Further, 70% of US consumption comes from the top 20% of earners. Whole Foods is going gangbusters!

    Now then….

    Dating the stock market is very much like asking if we’d be better off economically if we just killed the unemployed.

    Is that too esoteric? Our economy runs along just fine, if those that are not productive enough to cover their own feed, don’t get fed. This is not an option.

    There are two options:

    1. Become completely cozy with disparity, accept that the non-productive need only a set amount of feed, and every year it costs less to provide it for them. Aspirin and X-rays get cheaper, after all – as long as we don’t provide them MRIs – no big deal. But we’re not that cozy with disparity.
    So, every year more people become less able to cover their own feed. Eventually we have 60% not worth employing (no profit from their labor), and 40% giving them alms… demanding louder and louder they get cozy with disparity.
    This is our current state.

    2. Or, we focus on creating WEALTH. To create wealth, you MUST have productivity gains, suddenly you are achieving the same X, for less Y. This means you have extra Y to go do something else.

    Invent a machine that lets less skilled people work at McDonalds (pay less per man hour), you have created wealth. Invent a machine that lets a single skilled person run an entire McDonlads with no other employees (less man hours), you have created wealth.

    Notice wealth creation comes from “invent” not just “trade”

    Trade does allow people to focus on their singularly unique skill, it drives human knowledge, it causes inventions… but inventions are what takes your hour and achieves more with it in your speciality… you perform best in the economy as a baker, inventions means you produce more baked goods for less money. trade means you don’t have to grind the wheat, pump the oil, make the oven… etc. Inventions manifest lower cost of production more quickly than trade, so I think we should favor inventors even more than traders.

    Printing money accomplishes very little in this regard. Neither does government.

    But when you buy a stock for $9, and sell it tomorrow for $10 and you have an extra $1, you haven’t created wealth. Instead, someone else brought an extra dollar to the table… it is important we ask where that dollar came from… and if OBVIOUS answer is Ben just printed it… well, the dollar the Baker has to buy wheat, buys less wheat (commodity prices higher)… the dollar you just made buys less bread…. but feeding those 60% unproductive people cost more money. See how this paragraph feels helpless compared to above?

  38. Gravatar of scott sumner scott sumner
    6. November 2010 at 10:49

    Richard, Thanks. My take on the wide gap is that the market thinks were are in the liquidity trap for several more years, but then it’s back to normal in years 5 through 30.

    Mike, It creates massive moral hazard—NGDP targeting would be much better. Of course with NGDP targeting, level targeting, the financial crisis would have been much less serious.

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