The Keynesian model continues to unravel

After everything that has happened since the beginning of 2013, it feels kind of pointless to continue beating the dead horse of Keynesian economics.  But it’s also kind of hard to resist given the arrogance “confidence” of some of its most famous proponents.

Today two more things happened that the Keynesian model says are impossible:

1.  The ECB cut rates from negative 0.1% to 0.2%.

2.  The euro fell on the news.

So much for the zero bound, and the theory of monetary policy ineffectiveness.

Oh, and US stock futures rose on the news.  So much for “beggar-thy-neighbor” theories, which have already been shot down 100 times.

Update: Vaidas Urba sent me an interesting observation from Gavyn Davies:

Unlike the example of Japan under Mr Kuroda, or QE3 in the US under Ben Bernanke, there is no suggestion that this is “open ended” action from the ECB, and no attempt to influence the foreign exchange market or inflation expectations by aggressive use of language. If the programme works, it will be because monetary conditions have genuinely been eased by the measures, not because of fanfares or smoke and mirrors.




72 Responses to “The Keynesian model continues to unravel”

  1. Gravatar of foosion foosion
    4. September 2014 at 06:16

    Just to be a bit more technically accurate:

    The ECB cut rates from 0.15% t0 0.05%
    It cut IOR from -0.1% to -0.2%
    It also announced a bond buying program

  2. Gravatar of foosion foosion
    4. September 2014 at 06:18

    Also, Draghi said “Now we are at the lower bound.”

  3. Gravatar of benjamin cole benjamin cole
    4. September 2014 at 06:20

    Can Europe or Japan escape stagdeflation? And what is the Fed concerned about? That inflation might approach 2 percent? Is that looking the wrong way down the railroad tracks?

  4. Gravatar of James in London James in London
    4. September 2014 at 06:28

    Those ECB-sceptics over at MarketMonetarist.Com must be eating their hats 😉

    And you know what, 30 yeaer bond yields in ECB-land are going up!

  5. Gravatar of Nick Nick
    4. September 2014 at 06:55

    I watched a little too much of CNBCs coverage of the ECB this morning and lt looks to me like all these dead horses still need a lot more beating. Everyone is surprised by how the yield curve moved. Rick Santelli, who I hope knows better deep down, says the fact that long yields moved up proves QE is self defeating.

  6. Gravatar of bill bill
    4. September 2014 at 07:17

    And at the same time, Krugman continues to try to have it both ways. See: Money in Zero Time
    He says with a straight face that the Fed did more than the ECB yet somehow maintains that the Fed couldn’t haven’t done even more than that. And his commenters talk about the “ideological blinders” of anyone that disagrees with Lord K.

  7. Gravatar of Brian Donohue Brian Donohue
    4. September 2014 at 07:38

    Wow, Kruggie really doubling down here:

    “It’s true that we’re living in a time of monetary impotence, where central banks trying to reflate economies are not having much success gaining traction.”

    I applaud the man for taking a clear position.

  8. Gravatar of Kenneth Duda Kenneth Duda
    4. September 2014 at 09:09

    For what it’s worth, I don’t think many of you are accurately portray Krugman’s position(s). I’ve read pretty much everything he’s blogged in the last five years, and his position has been consistent:

    1. Conventional monetary policy (by which he means interest rate targeting + Taylor rule) becomes impotent at the zero lower bound. (This is pretty indisputable, isn’t it? If you have the wrong target, you do get stuck.)

    2. Central banks have not effectively reflated the world economy. (This also appears true, as inflation is still running below target, employment rates below historic norms, NGDP running under potential GDP, etc., in the US and Eurozone)

    3. Governments should undertake more monetary and fiscal stimulus immediately, because the social benefits outweigh the costs. (Krugman consistently argues for more monetary stimulus — I have never seen him write anything negative about additional monetary expansion) (I believe MM’s would agree that fiscal stimulus would be better than nothing, but will usually be less efficient than monetary stimulus; this seems right to me.)

    4. Unconventional monetary policy (which seems to mean everything besides the Taylor rule, including MM) is unproven and the problem is urgent; therefore, we should not rely on monetary stimulus alone, because it might not work, and the human cost of the current mess is too high to risk that.

    It annoys me that Krugman neither embraces nor argues against MM. However, he does not take the inconsistent positions that various commenters here imply. For example, I have never heard him argue (as Bill claims) that the Fed has done all it can. He is always careful to say that conventional monetary policy has done all it can, which is tautologically true at the ZLB by the definition of “conventional monetary policy”. His biggest “take-down” of MM is to point out that it is “unproven”, and that neither political party establishment is pushing for it, implying that it is therefore irrelevant. The facts are true, but the conclusion is rather unhelpful; if neither Democrats nor Republicans were pushing for use of fire, would we therefore ignore its potential? The biggest intellectual crime I’ve seen Krugman commit is indicating that 2013 would be a test for market monetarism versus Keynes, and then never following up on that. I would like him to explain how he thinks MM faired in his “test” because it looks like it did pretty well.

    Kenneth Duda
    Menlo Park, CA

  9. Gravatar of Joel Aaron Freeman Joel Aaron Freeman
    4. September 2014 at 09:30

    Kenneth Duda, your point is well stated. Thank you for the explanation.

  10. Gravatar of Brian Donohue Brian Donohue
    4. September 2014 at 09:52


    What part of ‘monetary impotence’ is unclear?

    1. Tautology.

    2. But what about all the austerity and fiscal consolidation that was gonna thwart the recovery? Only Europe (tight money) seems to have suffered thus.

    3. Fiscal stimulus?

    4. If economists are restricted to what’s proven, they can all go home.

  11. Gravatar of Lars Christensen Lars Christensen
    4. September 2014 at 10:27

    Scott, no reason to be too optimistic here.

    Euro zone breakeven inflation expectations basically didn’t move on the news. Furthermore, Draghi was eager to stress that the ECB was now at the “lower bound”.

    The ECB is still failing…

  12. Gravatar of Don Geddis Don Geddis
    4. September 2014 at 10:42

    @Kenneth Duda: You’re being overly generous to Krugman. Yes, he’s very clever, and not an idiot. He (usually) technically escapes being pinned down having been quoted saying anything false.

    That’s a very low bar. We should expect more from a Nobel laureate with such a large soapbox. He needs to advocate for the best, not merely avoid being wrong. Moreover, Krugman deliberately misleads the vast majority of his readers, allowing them to come away with the wrong impression (“monetary policy is impotent”), while at the same time offering plausible deniability to those few (like you) who actually understand the technical details (only “conventional” policy is impotent, but “unconventional” might still work).

    Krugman pushes fiscal policy over and over again. He never responds to the Sumner critique (monetary offset) — he just ignores it. He’ll write five paragraphs on the importance of fiscal stimulus, mention over and over again how “conventional” monetary policy is out of ammunition … and then at the end, have a brief throwaway sentence about how unconventional policy “might” work, might as well try it too.

    That’s damning with faint praise, and Krugman doesn’t get a pass for such deliberate misleading of his readers.

  13. Gravatar of James in London James in London
    4. September 2014 at 10:59

    Don’t be a curmudgeon. What about the currency? And the Italian stock market?

  14. Gravatar of W. Peden W. Peden
    4. September 2014 at 11:14

    “Unconventional monetary policy (which seems to mean everything besides the Taylor rule, including MM) is unproven”

    Take that, FDR. 1933-1934? Never even happened.

  15. Gravatar of Doug M Doug M
    4. September 2014 at 11:25

    Don Geddis,

    I don’t understand why people read Krugman. He has one point of view that never changes. The democrats are always right. The republicans are always wrong. Keynesian forces drive the macro economy. Monetarism is impotent.

    As new information comes in, he will spin it to suit his view. In the last 10 years he has said absolutely nothing new. The only reason to read the man is if you are a staunch democrat and you want to read something to make you feel good about what you already think.

    Of course, he is not the only pundit in this mold, but I don’t listen to Rush Limbaugh, either.

  16. Gravatar of Vaidas Urba Vaidas Urba
    4. September 2014 at 12:10

    As usual, interesting analysis from Gavyn Davies.

  17. Gravatar of Vaidas Urba Vaidas Urba
    4. September 2014 at 12:11

  18. Gravatar of Chase Chase
    4. September 2014 at 14:00

    Vaidas Urba, thanks for the link. Scott claims two things: “so much for the zero bound and monetary policy ineffectiveness”. yet, the very person responsible for what he claims is his justification (Draghi) doesn’t believe his claims as shown by his statements of “Now we are at the lower bound” (maybe the lower bound is -0.2%?) and, according to Gavyn Davies, ‘the ECB would not be able to meet its objectives on growth and inflation without the help of more expansionary fiscal policy’. I believe unconventional monetary policy can be effective in the current environment, but what happened today wouldn’t sell me on it if I didn’t.

  19. Gravatar of Jason Smith Jason Smith
    4. September 2014 at 15:06


    I’m not sure exchange rates are a good indicator of monetary policy effectiveness …

    Interpreting a fall in the exchange rate as an expected increase in the supply of base Euros (ceteris paribus) isn’t a good model of the exchange rate — in fact an decrease in the exchange rate (dollar price of euros) seems to work better as an indicator of a fall in the supply of base money.

  20. Gravatar of CA CA
    4. September 2014 at 15:35

    Someone on Twitter said Scott Sumner and Alan Meltzer got into an argument (I’m assuming debate) yesterday at the Mont Pelerin Society. I’d have loved to be a fly on that wall.

  21. Gravatar of ssumner ssumner
    4. September 2014 at 16:23

    Everyone, lots of good comments.

    Foosion, So IOR can be cut to minus 0.2, but not minus 0.25? Is there a model for that claim?

    Kenneth, Good comment, but you are far too kind:

    1. Krugman hasn’t merely claimed rates cannot fall below zero, he’s claimed QE is ineffective.

    2. He’s also claimed that monetary stimulus does not depreciate a currency at the zero bound, or at least that it’s very difficult to do. But it isn’t difficult.

    3. I don’t recall him saying that IOR cannot go below zero, but that’s certainly an implication of his model.

    Lars, I am not optimistic about the euro zone.

    Jason, An increase in the base is not a good indicator of monetary stimulus.

    CA, He called me an Austrian, twice. 🙂

  22. Gravatar of TravisV TravisV
    4. September 2014 at 16:31

    Dear Commenters,

    Kenneth Rogoff wrote a new essay. What is the Market Monetarist take? This feels wrong to me:

    “In the years preceding the financial crisis, increasing globalization and technological advances made it much easier for central banks to deliver both solid growth and low inflation. This was not the case in the 1970s, when stagnating productivity and rising commodity prices turned central bankers into scapegoats, not heroes.


    As it turned out, the euro was not quite the free lunch that it seemed to be. The gain in inflation credibility was offset by weak debt credibility. If the European periphery countries had their own currencies, it is likely that debt problems would morph right back into elevated inflation.”

  23. Gravatar of TravisV TravisV
    4. September 2014 at 16:33

    I would LOVE to know what the substantive disagreement is between Meltzer and Sumner…..

  24. Gravatar of Tom Brown Tom Brown
    4. September 2014 at 18:11

    Scott & Jason:

    Jason: Did you mean “base” or the currency component of the base? I noticed your plots are labeled “M0” which is usually what you use for “currency component of base.”

  25. Gravatar of Major.Freedom Major.Freedom
    4. September 2014 at 20:34

    I’m no Keynesian supporter by any stretch, but…

    Sumner, your assessment of Keynesian theory is wrong. The ECB setting “negative rates” is in fact just the ECB setting a negative IOR. A negative IOR is just a tax on reserves.

    There is nothing in Keynesian theory that implies, suggests, or explicitly states that governments cannot institute a tax on money held by banks. In fact, governments taxing money is a Keynesian inspired idea! Think about it. What are Keynesians most concerned about? Cash hoarding and falling aggregate demand. And what is the intention of governments taxing money balances they believe would otherwise be hoarded? To increase “spending” of course!

    I usually like your critiques of Keynesianism, but this one misses the mark.

  26. Gravatar of Vivian Darkbloom Vivian Darkbloom
    4. September 2014 at 23:28

    It’s funny. The WSJ editorial board today said just the opposite about Keynesians:

    “The problem comes from believing that QE is some magic growth elixir. The world’s Keynesians have convinced themselves that the U.S. is now growing faster than Europe simply because the Federal Reserve implemented QE while Europe hasn’t.”

    While I agree that Europe needs to adopt labor and other reforms to help spur growth (a point cited obliquely by Draghi and directly by the WSJ), I’m struggling to think of which “other” reforms the United States has adopted that would distinguish it from Europe over the past 5 years. In fact, as far as such “other” reforms are concerned, the trend might well be in the opposite direction.

  27. Gravatar of foosion foosion
    5. September 2014 at 02:23

    Scott, I’m just reporting what the ECB did and Draghi said. I saw the quote in yesterday’s WSJ.

    BTW, in today’s column Krugman writes: “You can argue, and I would, that the Fed should have done even more. But Fed officials have faced fierce attacks all the way. Pundits, politicians and plutocrats have accused them, over and over again, of “debasing” the dollar, and warned that soaring inflation is just around the corner.”

  28. Gravatar of foosion foosion
    5. September 2014 at 02:31

    “So IOR can be cut to minus 0.2, but not minus 0.25? Is there a model for that claim?”

    Interest on reserves can be set at whatever level the ECB (or Fed) want it to be. How could there be a model that says otherwise?

    Here’s the NY Fed’s spin: You might especially like “7. Is paying interest on excess balances inflationary?”

  29. Gravatar of A A
    5. September 2014 at 02:41

    The WSJ editorial board is a conspiracy of chiropractors seeking to induce chronic neck pains due to excessive nodding. 30 nods every morning, and a workday of intensely matching the S&P 500, taxes the spine over time.

  30. Gravatar of Luis Pedro Coelho Luis Pedro Coelho
    5. September 2014 at 03:24

    Some of the comments inside the eurozone (by a Professor of Economics writing in a serious newspaper, google translated with minor edits by me):

    “‘[T]heory’ predicts that the decrease in interest rates will increase loans by the banking sector allowing greater access to credit for purchase of housing and other goods and services (by families) and investment (by businesses) ensuring in this way the economic recovery. However, this has not happened!


    How to explain this?

    On the one hand, although the ‘official’ interest rates are lower, other increased costs on loans, reflected in increasingly higher spreads imposed by banks on companies and individuals. On the other hand, the extremely low interest rates act as a ‘tax’ on savers and pensioners, reducing yields. This ‘contractionary policy’ has transferred income from savers to banks. It is as if the government announced a “massive” increase of taxes on older pensioners […]

    It is not therefore surprising our low and declining savings rates.”

  31. Gravatar of Brian Donohue Brian Donohue
    5. September 2014 at 06:49

    @Vivian, I think this underscores the weird politics here.

    1. Keynesians aren’t unified, but there’s definitely a strain of ‘monetary skeptics’ (e.g. Krugman). The general logic seems to be: we want (effective and going to the right people) fiscal stimulus, not (less effective and going to the wrong people) monetary stimulus. It’s interesting, because Scott’s idea of ‘monetary offset’ seems embedded in this view.

    2. The majority on the right is gut-level Austrian and suspicious of QE generally. That’s the WSJ audience. Ironically, though, the people who actually work on Wall Street cheered QE on, and have been more tepid this year despite economic and jobs growth precisely because of Fed forward guidance/tapering.

    Politically, monetary policy is a scrambled mess.

  32. Gravatar of Brian Donohue Brian Donohue
    5. September 2014 at 06:53

    @Vivian, in fact, in 2014, at this point in the cycle, strong economic news generally translates to stock market sell-offs, because investors anticipate this means the Fed will maintain/accelerate tapering. Expectations of Fed policy are huge.

  33. Gravatar of Mike Sax Mike Sax
    5. September 2014 at 07:51

    “After everything that has happened since the beginning of 2013, it feels kind of pointless to continue beating the dead horse of Keynesian economics. But it’s also kind of hard to resist given the arrogance “confidence” of some of its most famous proponents.”

    So allegedly you won the war but are stabbing the dead body furiously just for gratuity’s sake?

    Or is the real dead horse this tired claim that no one believes except you and maybe a couple of MM wishful thinkers. Keynesians never said IOR can’t be negative. The ZLB means that nominal rates obviously can’t be negative so that the traditional monetary instrument will be spent.

  34. Gravatar of Mike Sax Mike Sax
    5. September 2014 at 07:57

    Nick you know Santelli’s not a Keynesian right? He’s one of those conservative inflationistas Krugman always mocks who predict Treasury bubbles. If that weren’t bad enough, he’s also the one given credit for firing the opening salvo of the Tea Party.

    One CNBC analyst who makes a lot of sense is Jim Cramer. He likened Draghi yesterday to FDR coming up with a back door way to get in more fiscal stimulus. He actually used the words New Deal in a nondergotary sense on CNBC for God’s Sake.

  35. Gravatar of Saturos Saturos
    5. September 2014 at 08:44

    COMPLETELY OFF TOPIC: this blog post explains a lot of things that Scott has always wondered about liberalism vs. conservatism. Perhaps it could also explain macroeconomics?

  36. Gravatar of Mike Sax Mike Sax
    5. September 2014 at 08:58

    For more on Cramer on Draghi and FDR see here

  37. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    5. September 2014 at 09:13

    ‘One CNBC analyst who makes a lot of sense is Jim Cramer.’

    I’m sure he does to you, Mike. What do you make of the Fed’s latest three-year Survey of Consumer Finances?

    ‘Families at the bottom of the income distribution saw continued substantial declines in average real incomes between 2010 and 2013, continuing the trend observed between the 2007 and 2010 surveys.’

    Barack been too busy concentrating on Foreign Policy?

  38. Gravatar of Brian Donohue Brian Donohue
    5. September 2014 at 09:23


    I think today’s disappointing jobs report and market reaction are supportive of this view (initially negative, then a dawning awareness of Janet Yellen’s existence turns it into a bit of a rally.)

  39. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    5. September 2014 at 09:25

    Casey Mulligan’s ‘pre-sponse’ to Noah Smith will cost you $2.99;

    ‘The competing characterizations of the ACA’s economic impact are essentially arguments about changes in tax rates (or labor market distortions with many of the economic characteristics of taxes), with one side saying that the law is a net increase in tax rates, and the other side saying that it is a net decrease. The first half of the book carefully documents the positive and negative tax effects, with special attention to the distinction between employment taxes and income taxes. The second half of the book looks at the economic consequences of all of the new taxes, with attention to distinguishing small effects from large ones. It offers predictions for work hours and national income through 2017, and explains why forecasters have yet to acknowledge many of the economic forces put in motion by the ACA.

    ‘Anyone interested in economic performance over the next several years has to understand the contents of the Affordable Care Act from a labor market perspective, and this book is so far the only comprehensive and user-friendly introduction to the topic.’

  40. Gravatar of Vivian Darkbloom Vivian Darkbloom
    5. September 2014 at 09:26

    @Brian Donohue

    Not sure what “this view” refers to; but, we seem to agree that the Fed is driving the markets.

  41. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    5. September 2014 at 09:27

    Mulligan also has a comment on the employment report today;

    ‘The payroll report shows +142k (change from July to Aug), which seems low, but note that it excludes self-employed and agricultural workers. If you add those, it’s +299k primarily because (seasonally adjusted) agricultural employment increased so much.’

  42. Gravatar of Jason Jason
    5. September 2014 at 09:34

    Tom — I should have said currency component of the base.

    Scott — I was talking about sustained increases or decreases in currency (temporary changes in MB including reserves makes for a bad model of exchange rates). The key point is that increases in Euro currency are correlated with Eurozone inflation and also are correlated with the dollar price of Euro *rising*, not falling.

    That is to say that a (persistent) decrease in the dollar price of a Euro seems to indicate a fall in forex demand rather than a rise in the supply of Euros.

    In any case, changes in currency supply or demand have little bearing on inflation in a liquidity trap — and so this doesn’t actually refute the Keynesian view in some kind of model-independent way.

  43. Gravatar of Nick Nick
    5. September 2014 at 10:12

    Mike Sax,
    Yeah, obviously, Rick is no Keynesian. I was trying to say that we have more than one dead horses still waking around. I didn’t really want to pile on the Keynesians and get into what Steve Liesman said, which also made no sense to me.
    As to Cramer, I find him more entertaining than I should, but I can’t support taking him seriously.

  44. Gravatar of Bob Murphy Bob Murphy
    5. September 2014 at 13:13


    I’m not trying to be funny here, I really want to understand your overall worldview. I also realize that sometimes you can make an “immanent critique” by showing that the Keynesian approach doesn’t work even on its own terms, without thereby endorsing the approach.

    With those caveats in mind, there is a superficial problem with your post here. You repeatedly tell us “never reason from a price change” and that you are frustrated that so many people–even economists who should know better–think that the Fed and ECB have instituted “loose money” because they’ve cut interest rates so much.

    So then in that context, it’s odd that when the ECB cuts interest rates, you matter of factly interpret that as looser money, and when the ECB raises interest rates, you matter of factly interpret that as tighter money.

    Again, I realize you’re firing off quick blog posts here, and can’t be expected to exposit your whole worldview every time. But, if you could explain somewhere the conditions under which it’s OK to reason from a price change, and when it’s not, that would help.

  45. Gravatar of Kevin A Kevin A
    5. September 2014 at 13:24

    Off topic, but an interesting read from the economist:

    The criminalisation of American business

  46. Gravatar of Major.Freedom Major.Freedom
    5. September 2014 at 16:30

    Speaking of matter of factly interpreting higher interest rates as tighter money:

    “Over the years Krugman and I have both bashed the ECB for their almost unbelievable incompetence. The ECB that has repeatedly raised interest rates in the midst of the biggest recession since the 1930s.”

  47. Gravatar of Scott Sumner Scott Sumner
    5. September 2014 at 18:37

    Vivian, Well the WSJ sure has a sense of humor. Keynesians believe QE works? What will they come up with next?

    Foosion, Yes, I wasn’t criticizing you, just the views of others you reported.

    Jason, Eurozone inflation makes the dollar price of euros fall, not rise.

    Bob, It’s ok to reason from a price change if you know why prices changed. If a hurricane wipes out the orange crop and orange prices rise, you can expect less consumption. IOR is more like a tax than a price. Just as higher taxes on cigarettes will reduce cigarette consumption, a negative IOR will discourage banks from holding reserves.

  48. Gravatar of ChrisA ChrisA
    5. September 2014 at 18:49

    Slightly off-topic but we have the new GDP revisions in on the UK, and as predicted UK growth has been revised substantially upwards ahead of Germany since 2010, and only now behind US and Canada in the G7. Details here;

    So the “austerity is bad” meme not looking too good right now and monetary expansion (QE) looking better.

  49. Gravatar of Scott Sumner Scott Sumner
    5. September 2014 at 18:54

    Saturos, Thanks. Very entertaining post.

    ChrisA, Thanks, that revision certainly seems more plausible than the original figures, given that UK employment is hitting records.

  50. Gravatar of Saturos Saturos
    5. September 2014 at 19:38

    Also, pleased to note that this blog has made it on to Scott Alexander’s “Map of the Rationalist Community” (riffing off several previous “Maps of the Internet”)

  51. Gravatar of Saturos Saturos
    5. September 2014 at 20:31

    Kocherlakota fighting the good fight:

  52. Gravatar of Maurizio Maurizio
    6. September 2014 at 02:36

    Kenneth Duda, thanks for the explanation!

  53. Gravatar of Major.Freedom Major.Freedom
    6. September 2014 at 07:26

    Sumner, IOR is set directly by central banks. They can give banks money out of thin air (positive IOR) or they can take reserves away as tax (negative IOR).

    You said the ECB “cut rates from negative 0.1% to negative 0.2%”, which you said is “impossible in the Keynesian model.”

    I think it is about time you said you incorrectly assumed in the original blog post that this “rate cutting” was the fed funds rate, or the rate at which banks lend to each other, or the rate on short term treasuries, and not the tax rate on reserves.

    Tax rates on reserves are not the rates that Keynesians believe can hit a lower bound.

    You should add an update and make the whole world reject the whole of NGDPLT because of that minor, inconsequential misreading of the news that could have happened to anyone.

  54. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    6. September 2014 at 08:08

    Casey has an even more pointed response to Noah Smith (and Krugman) up now;

    ‘… if it were true that labor demand explained the majority of the change in labor quantity, then employer costs (properly measured) would have fallen dramatically.

    ‘Despite all of these lessons from labor economics, blogosphere economists attempt to dissect the hourly cash earnings data to perhaps find a small and probably ill-timed reduction and jump to the conclusion that labor supply shifts have made a trivial contribution to the change in labor quantity.’

  55. Gravatar of Jason Jason
    6. September 2014 at 09:04

    Scott, you said:

    “Eurozone inflation makes the dollar price of euros fall, not rise.”

    This is not empirically true — we have Xeu,us ∝ M0eu and P ∝ M0eu (where M0eu is the number of Euros in circulation and Xeu,us is dollar price of Euros). And the reason it doesn’t seem to be true is that both supply and demand matter, not just supply.

    (This model also works for the Dollar-Yen exchange rate. Graphs at link.)

  56. Gravatar of maxk maxk
    6. September 2014 at 11:20

    I agree with Kenneth Duda: Scott and many commenters are being too hard on Krugman. I feel sure that Krugman would agree that a central bank (with complete control of the printing press and unconstrained by other political forces) could generate any desired degree of inflation (or NGDP growth) even when up against the ZLB. What I think he doubts is whether the US Fed can (or maybe will) in fact do it.

    I’d make a similar argument about monetary offset. An unconstrained Fed can presumably offset both fiscal expansion and contraction. But this Fed seems willing to offset contraction (and did so successfully in early 2013). But I’d like to think that they would not have offset expansion at the same time, at least to a degree that would have got us to the same point. The Fed feels political pressure from the right and is unwilling to loosen too much. They don’t have the same pressure from the left, and are more able to resist tightening.

    It seems a bit odd to me that Scott so much rails against Krugman as though he and like-minded people were the principal opposition to his proposed monetary solutions. If Yellen were to announce tomorrow that the Fed was committed to NGDP catch-up of X amount and would take whatever steps necessary to make it happen, does Scott imagine that Krugman would be the leader of the opposition? I think he would say that he approved, but doubted she would be able to hold her course. The loud opposition would come from the hard money side. And Scott seems to complain much less about them.

  57. Gravatar of Tom Brown Tom Brown
    6. September 2014 at 17:09

    Bob Murphy, I’m curious: are you satisfied with Scott’s response?

  58. Gravatar of Chris Mahoney Chris Mahoney
    6. September 2014 at 17:11

    It is much easier to prevent deflation than to reverse it because expectations become “anchored”, and because of the liquidity trap. For the ECB to successfully reflate the eurozone will require shock and awe on a scale that is quite beyond even Draghi’s imagination. A little QE will do absolutely nothing, and its failure will only reinforce deflationary psychology. Also, its failure will allow the Austrians to say “See–it doesn’t work!” The eurozone is simply not fixable without a complete intellectual revolution, which is impossible.

  59. Gravatar of ssumner ssumner
    6. September 2014 at 18:15

    Jason, Does that model also apply to Zimbabwe?

    maxk, All I can do is respond to what Krugman says. So I claim the BOJ never tried to create inflation before 2010. He disagrees with me, claiming they tried and failed.

    I don’t follow your second paragraph. If the right has more power, and is trying to stop monetary stimulus, how was the Fed able to offset fiscal austerity in 2013?

    Regarding your last point, the entire Board of Governors is Obama appointees. He didn’t pick people who favored monetary stimulus because he thought the Fed was out of ammo. From which school of thought did he get that idea?

  60. Gravatar of maxk maxk
    6. September 2014 at 21:09

    Sorry, I wasn’t very clear. I think Bernanke would at multiple times have preferred a more aggressive monetary policy to support demand than was implemented, much more consistent with his academic prescriptions for Japan. However, he understood that such actions would have been seen as extreme and would have been strongly resisted, in the media and in Congress, from the right, from the WSJ editorial page, etc.

    In a hypothetical sense, the Fed has the power. But in a practical sense, the Fed is unwilling to go too far beyond what it is usual, what it has done in the past, and what general opinion accepts.

    So, I think the Fed has usually wanted more loosening that it has provided, but has settled for less. We haven’t been getting the economy that the Fed wants.

    In 2013, when there was fiscal contraction, the Fed was able to use that as an excuse and provided some loosening, which kept the economy from contracting. However, that was still not the economy that the Fed wanted. If conversely we had had fiscal expansion to the same degree, the Fed would not have tightened. They would have taken no action and hoped that the economy grew. This is the sense in which I don’t believe in monetary offset.

    Ten years from now, when Bernanke feels that enough time has passed that he can speak publicly, I predict that he’ll say that of course he understood that more aggressive monetary policy would have been an improvement. He will say that he did not forget anything that he wrote about Japan. He will say that he pushed as far as he could but was unwilling to take the Fed to a position that would have raised vehement opposition by a substantial political minority. Perhaps he will say that he was worried such a clash might have led to legislation that threatened the Fed’s independence. But he won’t complain about Krugman.

    I think you simply refuse to see what has always been the principal opposition to monetary solutions to the Great Recession. It is the voices that have been warning that the Fed has already taken us into dangerous territory, debasing the dollar, monetizing the deficit, etc. Amusingly, Krugman complains much more about those nuts than you do.

  61. Gravatar of Tom Brown Tom Brown
    6. September 2014 at 23:35

    Scott, you asked Jason:

    “Jason, Does that model also apply to Zimbabwe?”

    I don’t know if he’s ever looked at Zimbabwe, but his formulation includes two different solutions to his fundamental equations:

    1. The CB pays attention to market indications. It’s in a feedback loop essentially. That’s the normal solution he uses to analyze most economies.

    2. The CB pays no attention to the market, i.e. a truly exogenous CB, not in any kind of feedback loop. The solution in this case can include hyperinflation, even for an economy stuck in an “information trap.”

    Jason has likened these two solutions to the dynamic and static solutions, respectively, to the fundamental electromagnetic equations. Not because macro is anything like electromagnetism, but because it’s similar in that two very different solutions fall out of the same underlying equations.

    Here’s a couple of posts he did on the 2nd type of solution, which would probably be applicable to Zimbabwe:

    OK, I did my best. Jason should be along any minute now to clean up my mess.

    BTW, if you’d really wanted to be a smart-ass I think I outdid you there: I asked him what his model had to say about Democratic Kampuchea from Spring 1975 to early 1979. 😀

  62. Gravatar of TravisV TravisV
    7. September 2014 at 03:53

    Oh, the things left-wingers will say…..

    Dean Baker: “The Pent-Up Wage Growth Story: Why Does Janet Yellen Say These Things?”

  63. Gravatar of TravisV TravisV
    7. September 2014 at 04:52


    Here’s Bryan Caplan on the same topic:

  64. Gravatar of ssumner ssumner
    7. September 2014 at 07:37

    Tom, I like Jason, but he needs to learn how to explain his ideas to economists, using intuition. 100% of economists believe that inflation leads to currency depreciation. If you are going to argue the opposite you need a STORY, not just a model, or an empirical study.

    maxk, I don’t think that what Bernanke will say in a few years is a very good way of understanding how monetary policy works. I certainly accept the fact that he doesn’t agree with my model, but that doesn’t mean the model is wrong.

    In 2013 we had what Krugman called a “test” of monetary offset. The theory passed with flying colors. Now the fallback is that monetary offset is asymmetrical? Anything is possible, but the burden of proof in on those making that claim. In economics, models are almost always assumed to be symmetrical. If more X leads to more Y, then less X leads to less Y.

    You said:

    “I think you simply refuse to see what has always been the principal opposition to monetary solutions to the Great Recession.”

    I’m not looking for “solutions”. Tight money caused the recession. I simply want monetary policy that doesn’t cause problems, not a policy that fixes problems. Because both the left and right don’t understand that fact, both are equally to blame. Of course I’ve criticized both sides 100s of times, indeed just a couple days ago I did a post at Econlog claiming the profession was to blame for not advocating monetary stimulus. Back in 2009 only about 3% of economists favored monetary stimulus. That means both Keynesians (who are the majority) and conservatives are to blame.

    TravisV, See my new Econlog post.

  65. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    7. September 2014 at 08:41

    When he is good, he is very, very good;

    ‘The purpose of the [1961 Friedman] paper, in short, is a Talmudic splitting-of-hairs. The point is to allow von Mises and Rueff and their not-so-deep-thinking latter-day followers (paging Paul Ryan! Paging Benn Steil! Paging Charles Koch! Paging Rand Paul!) to remain in their cloud-cuckoo-land of pledging allegiance to the gold standard as a golden calf while at the same time walling them off from and keeping them calm and supportive as the monetarist central bank does its job of keeping our fiat-money system stable by making Say’s Law true enough in practice.’

    Too bad about all those times he’s horrid.

  66. Gravatar of Tom Brown Tom Brown
    7. September 2014 at 08:59

    Scott, you write:

    “I like Jason, but he needs to learn how to explain his ideas to economists, using intuition. … If you are going to argue the opposite you need a STORY … ”

    I agree that’s a challenge, but he’s trying. He really does have a story… it’s just that a significant part of his story has to do with why stories don’t matter. What I mean by that is two things: In his framework

    1. Typical human-scale-motivations, i.e. “imagining what it would be like” type reasoning probably accounts for no more than 10%… maybe 20% of what’s going on with the set of macro variables he looks at (his estimate).

    2. It’s very hard to distinguish legitimate explanatory stories from just-so stories … they look very much alike!

    Plus, (to torture the analogy a bit), Feynman made statements like this on numerous occasions:

    “Quantum theory is crazy. It doesn’t explain anything. It just gives you numbers.” – R. Feynman

    Of course Feynman wasn’t always right…

    “Imagine how much harder physics would be if electrons had feelings!” – R. Feynman

    Jason, says, … “meh… not much really.”


  67. Gravatar of ssumner ssumner
    7. September 2014 at 18:51

    Patrick, Not bad.

    Tom, I was hoping the Zimbabwe prompt would help him to refine his message. If it doesn’t apply to Zimbabwe (and obviously it doesn’t), why not?

  68. Gravatar of Jason Jason
    8. September 2014 at 09:53

    Hi Scott,

    Regarding Zimbabwe, Tom did a good job of explaining. Zimbabwe — and hyperinflation scenarios in general — represent a different relationship between supply and demand than a “responsible” central bank that monitors the economy. Therefore the model would show a rapidly falling dollar price of the Zimbabwean currency.

    In Zimbabwe we’re riding down the demand curve, while in the EU we are following the equilibrium as both the supply and demand curves move outward — printing Euros generates demand since the central bank isn’t ignoring the economy.

    Overall, that’s a story that can be told with supply and demand curves.

    I’m still working on the story for the information content of money. The information carrying capacity of a dollar depends on the number of dollars and the size of the economy … Inflation is a sign of adding a lot of high information content dollars whereas a lack of inflation is either not adding those dollars or adding a bunch of low information content dollars.

  69. Gravatar of Jason Jason
    8. September 2014 at 09:55

    Tom — thanks for your help! My communication skills sometimes fail me — especially in a new field (for me).

  70. Gravatar of am am
    8. September 2014 at 14:11

    The problem in Zimbabwe was a collapse of exports and so collapse of domestic currency. Speculation and parallel trading just added to the problem. 99 per cent of forex trading took place on the street. If you look at Professor Easterly and the black market premium you will get the idea.

  71. Gravatar of Major.Freedom Major.Freedom
    8. September 2014 at 14:44


    Currencies don’t collapse merely because of export declines. Zimbabwe currency did not have to be inflated.

  72. Gravatar of ssumner ssumner
    9. September 2014 at 07:58

    Jason, The whole discussion started with claims that you made that were causal in nature. You suggested that a fall in the euro (after a move by the ECB) was not an indication of policy easing. I think it is. I agree that correlations during other periods of time may reflect many factors, especially if monetary policy is endogenous. But if the euro falls right after a ECB announcement, that does indicate easing.

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