The left is right for the wrong reason, the right is wrong for the right reason

One of the things I find most frustrating about this crisis is the way my intellectual allies on the right keep shooting themselves in the foot, and thus unwittingly tend to discredit their otherwise defensible ideologies.  More specifically they continue to warn of high inflation, which is about the last thing we need to worry about right now.  In my previous post I tried to provide a psychological theory for these bad forecasts.  But whatever the reason, when these predictions don’t come true it will (unjustly) tend to discredit both the good and bad parts of their theoretical apparatus.

A few weeks ago it was Allan Meltzer, now it is Arthur Laffer.  I’ll start by severely criticizing Laffer, but in part 2 will atone for this criticism by arguing that he was one of the most important economists of the 20th century (but alas, not of the 21st.)

I should start off by saying that Laffer is too good an economist to say anything blatantly false, but the entire tone of his WSJ piece is that high inflation is just around the corner:

But as bad as the fiscal picture is, panic-driven monetary policies portend to have even more dire consequences. We can expect rapidly rising prices and much, much higher interest rates over the next four or five years, and a concomitant deleterious impact on output and employment not unlike the late 1970s.

One reason that I was so discouraged by this piece is that Laffer was one of the “new monetary economists” of the early 1980s who understood that traditional monetarism had important defects.  Rather than focusing on the money supply, Laffer suggested that we needed to look at forward-looking market indicators such as the price of gold.  Today we have an even better forward-looking indicator—TIPS spreads.  And it is very clear that investors are not worried about high inflation.  Not now, not in 10 years, and not in 20 years.

I immediately knew that Krugman was likely to drag out the same arguments against Laffer that he had used against Meltzer.  Sure enough, Krugman had a short post with some graphs showing that large increases in the monetary base in the US during the 1930s, and again during recent years in Japan, had failed to boost prices.  (Thanks to Dilip for sending me this post.)

When I refer to the “left” in the post title, I mean not so much Krugman himself, but rather Krugman’s followers.  Many Keynesians assume that monetary stimulus is ineffective during a liquidity trap.  Krugman definitely does not believe that, indeed he specifically argues that only conventional monetary policy tools are ineffective in a liquidity trap.  He acknowledges that unconventional tools (such as an inflation target) might be highly effective, but also that they might be politically unacceptable.

I hope the reader will take a look at the two graphs in Krugman’s post.  I believe that the best way of understanding these graphs is by drawing a distinction between a monetary regime where the monetary base is endogenous, and one where it is exogenous.

Laffer is right that a large, exogenous increase in the monetary base will be highly inflationary, even in a liquidity trap.  But note how the Japanese GDP deflator declines at a very stable rate of just over 1% per year from 1997-2007, despite a sharp increase in the Japanese monetary base.  So why didn’t Japan suffer from high inflation in recent years?  Because the MB in Japan is obviously highly endogenous.

On closer examination you will also see a small decline in the base during 2000 and a huge drop in 2006.  What can explain these tightenings?  In both years the BOJ raised rates (which had been at 0%) in order to prevent a threatened outbreak of price stability.  By doing so they insured that prices continued to fall at 1% per year, which seems to be the BOJ’s implicit target (regardless of what they say.)  Thus the BOJ simply adjusts the monetary base to whatever level is required to maintain 1% deflation.  Why did the base tend to rise over this period?  Because there is more base demand during periods of deflation, than during periods of inflation.  And the BOJ simply accommodated that demand.

The experience in the US during the 1930s is very similar.  Under the international gold standard the price level (and hence the monetary base) is endogenous.  The US was big enough to have some impact on world demand for gold, and hence the world price level, but its monetary policy was deflationary in the early years of the Depression, a policy of gold hoarding.  Later they eased somewhat, but by this time the banking panics were increasing the demand for gold.  During the one year where the US left the gold standard (1933-34) prices rose strongly despite near zero rates.  So once again the real problem was endogenous money under the gold standard, not zero rates.

And of course the same thing is true today.  Once the Fed started paying interest on reserves at a rate higher than banks earned on T-bills, the MB became endogenous.  Thus the Fed removed its most effective unconventional tool (QE) at the very moment when conventional monetary tools (interest rates) became completely ineffective.

[Update 6/15/09, Bill Woolsey pointed out that I made a misleading statement.  The monetary base is always endogenous under interest rate targeting.  Under real world Taylor Rules the Fed can indirectly adjust the base if inflation is rising or falling.  They do this by adjusting the interest rate target, which leads to a change in the base.  I should have said that once they started paying interest on reserves there was a massive increase in base demand, and hence the monetary base became a much less effective policy tool for stimulating AD.  I saw most of Krugman’s LSE lectures last night, and now think I may have overstated things in the next sentence.  I will do a commentary soon.]

At a certain level Krugman would agree with much of what I have said.  He also thinks the conservative attitude of the BOJ is a big factor limiting the effectiveness of base expansion.  But the way he interprets these facts is very different.  As I read Krugman, his attitude seems to be something like the following (which is my interpretation, not his words):

“Ah, what a pity it is that these conservative central banks aren’t willing to commit to a modest amount of inflation.  That would be the easiest way to boost AD, and the least costly.  But as they aren’t willing to adopt effective policies, we can assume that monetary policy is ineffective.  Now let’s move right along and look at fiscal policy.”

At this point Krugman directs his moral outrage at the conservative knuckleheads in Congress who won’t accept anything bigger than a measly $800,000,000,000 stimulus package, which he thinks is woefully inadequate.

In my view Krugman is mixing science and advocacy in a very misleading and inappropriate way.  When he evaluates central banks, he seems to take a deterministic, scientific, and clinical attitude, as if studying a colony of ants.  (I assume that for entomologists there is no “should.” The only question is how ants behave.)  Central banks are assumed to be impervious to public pressure.  On the other hand his stance toward fiscal policy is much more normative.  Now he is an advocate, he’s part of the game, passionately calling for more stimulus.  But I don’t see how this makes any sense.  If we are going to take a deterministic view of things, it seems likely that Congress is also far too conservative to implement the sort of spending that Krugman advocates.  Indeed, hasn’t that already been shown?   Couldn’t one just as reasonably say: “Since Congress clearly won’t do what it takes, we must fall back on the Fed as our only hope for the sort of stimulus that the economy needs.”

I view my own role as that of an advocate; I am trying to change the consensus view of economists about the causes of this crisis, and the most effective solutions.  I want to describe the most effective solutions, not those I think are politically feasible.  We need to change the political climate, if that is the problem.  Indeed if policy is deterministic, then all hope is lost.  I hope that my ideas will eventually filter down to policymakers.

Krugman is 100 times more influential than I am.  With his NYT column, and his ideological allies in the White House, he is arguably the most influential economic pundit in the world.  And he is also known (for better or worse) for his moral outrage over perceived injustices.  In many cases I think he goes a bit over the top.  But here it is just the opposite.  I am outraged over Krugman’s lack of outrage over current monetary policy.

Part 2:  Why Laffer is underrated.

When I was at the University of Chicago during the late 1970s most economists seemed to think Laffer was a bit of a crackpot.  I recall one famous macroeconomist disproving the Laffer curve using a Keynesian model.  I can only imagine the contempt in which he was held at salt water universities.  But guess what happened next.  To find out, you might want to take a look at the table in page 432 of this report.  Every single developed economy adopted Laffer’s ideas.  They all cut marginal tax rates for the rich.  Most cut rates very sharply.  Even Sweden cut its top rate from 87% in 1980 to 50% in 1995, before bouncing back up to 56%.  Did Laffer get any credit?  No, and I think this shows how the economics profession as a whole is still in deep denial about what occurred.

I’m sure some economists are thinking “of course those extremely high MTRs were counterproductive, but Laffer was making some much more extreme arguments, such that tax cuts could lead to more revenue.” (Actually, Laffer said revenue might go up, not that it always would rise.)

I don’t buy the previous explanation.  I think many economists still don’t understand why high MTRs are so counterproductive, and thus I think we might repeat the same mistakes in the near future.  If you believe the anti-supplysiders who scoff at the notion that high MTRs discourage work, saving and investment, then why would you favor cutting taxes on the rich? Indeed shouldn’t the rich pay much higher tax rates?  After all, most economists are utilitarians, and utilitarians generally believe (correctly in my view) that an extra dollar is worth more to a poor person than a rich person.  So what’s wrong with the 90% tax rates of the Eisenhower years, or the 70% rates that followed the Kennedy tax cuts?

In fact, high MTRs have a much more powerful effect on efficiency than most economists imagine, but the supply-siders are up against three problems:

1.  Tax cuts for the rich seem unfair.

2.  The supply-side effects are counter-intuitive (most people with 40 hour/week jobs can’t envision changing their hours worked because of tax rates.)  Another counter-intuitive (and long run) effect of high MTRs is to make our health care system much more costly.

3.  Many of the most important incentive effects are very long term (such as the impact on the incentive to acquire more human capital.)

What has so amazed me about the worldwide supply-side revolution is the way that it has been dismissed by the left in the US, even the moderate left.  The Reagan/Thatcher tax cuts were viewed as a sort of right wing plot to help the rich.  I don’t know if liberals are even aware of the fact that all countries, including Sweden, were doing the same thing at the same time.  This revolution would have occurred even if Reagan and Thatcher had never been elected.  Rather they reflected a change in the intellectual atmosphere surrounding public policy formation.  A change in what you might call the zeitgeist.   Pragmatic policymakers all over the world (on both the left and right) looked at the evidence and reached a consensus that high tax rates for the rich were counterproductive.  That they didn’t meet the utilitarian criterion.  (BTW, a similar worldwide change is now occurring vis-a-vis corporate MTRs, and once again many American economists seem rather oblivious to what is going on elsewhere.)

And who provided the intellectual ammunition for that policy revolution?  It wasn’t economists at elite Ivy League schools, and it wasn’t even monetarists at the University of Chicago.  In the late 1970s it was the supply-siders, of whom Arther Laffer was the most influential.

Obama advisor Austan Goolsbee is too politically savvy to call for a return of the pre-Reagan tax rates of 70-80%.  But the clear implication of this editorial is that cutting those rates was merely a windfall to the rich, and hence that we’d be better off returning to those rates.  Of course that won’t happen, but I’d feel better about the future course of policy if there was some sign that Obama’s economic advisers understood why even the Swedes and Danes would recoil at that prospect.  Alas, it’s pretty clear they still don’t get it.

[BTW, if you want me to respond to the anti-supplyside “evidence” offered by Mr. Goolsbee, I’d say that cherry-picking one 4-year period following a MTR increase, when we were emerging from recession, and when the top capital gains tax rate was cut sharply, is hardly a convincing counterargument.]



36 Responses to “The left is right for the wrong reason, the right is wrong for the right reason”

  1. Gravatar of Bill Stepp Bill Stepp
    14. June 2009 at 15:38

    Stefan Karlsson on the bond market and inflation. It seems that looking at the TIPs spreads have underestimated inflation.

    I think betting against PK is a sound position; he will be right right up to the minute he’s wrong.

  2. Gravatar of Alan Alan
    14. June 2009 at 15:45


    To me, the debate about generating positive inflation expectations seems to be to be an exercise in sacrifice ratios…in reverse.

    This is probably a dumb question, but isn’t it possible, under a RE framework, to generate positive inflation expectations without necessarily boosting output (at least RGDP)? (This is probably why you favour targeting NGDP rather than RGDP right?) But then, if this is possible, don’t we need RDGP to rise in order for us to claim that it’s a bonafide recovery?

    Chances are you’ve probably addressed this, so feel free to refer me on the relevant blog post (I haven’t had a chance to take a look at all your earlier posts). Thanks

  3. Gravatar of Jon Jon
    14. June 2009 at 16:21

    Its precisely because marginal dollars offer less marginal utility that high-earners generate more investment–they have a longer time preference than the rest of society because that’s what it takes to restore the present value of income today.

    Prosperity (bigger pie for everyone) depends on shifting the natural real-rate up, short of direct investment by the government, the best way of doing that is by increasing the after-tax share-of-income of high-earners.

  4. Gravatar of Pedro Bento Pedro Bento
    14. June 2009 at 18:18

    Scott: There is an utilitarian argument against lump-sum taxes (MU of a dollar is lower for the rich), but there is no utilitarian argument for higher tax rates for the rich.

    Assuming the same utility function for rich and poor, an x% tax rate will result in an equal %-change in utility for both rich and poor.

  5. Gravatar of TGGP TGGP
    14. June 2009 at 18:34

    I recall a Post Keynesian claiming that the money supply is endogenous even now without the gold standard. You seem to be saying that their description of the behavior of central banks is sometimes accurate. So would you say that “Within a century there are a few occasions when the monetary cranks are right, and that is always when the money supply is endogenous”?

  6. Gravatar of John Swanson John Swanson
    14. June 2009 at 18:40

    Hi Scott,

    Thanks so much for publishing this fascinating, insightful, fresh, and convincing blog. It’s one of the few that I check every day.

    But I think Paul Krugman’s deterministic/advocacy position on the Fed vs. fiscal policy might be less arbitrary than you think. As a blogger and columnist, he has the ability to influence politicians and voters. His abilities to convince central bank economists are probably more limited. And since the Fed is more insulated from politics, even convincing a huge number of voters and politicians that monetary policy is the best option for dealing with the crisis probably won’t make a difference in monetary policy. Convincing voters that fiscal policy is a good option, on the other hand, could potentially make a difference.

    So, PK’s preferences might be ranked as follows: monetary stimulus, fiscal stimulus, no stimulus. If he views his efforts to change monetary policy as wasted, but views his efforts to change fiscal policy as more effective, doesn’t it make sense for him to take a deterministic view of monetary policy and turn to political advocacy when it comes to fiscal policy?


  7. Gravatar of Bill Woolsey Bill Woolsey
    15. June 2009 at 01:57

    Base money is always endogenous with interest rate targeting.

    The point of quantitative easing is that when the target nominal interest rate hits zero and needs to go lower, then interest rate targeting must go, and the monetary base should become exogeneous. Of course, with nominal GDP targetting, base money is still endogenous. It is at the level consistent with nominal income being on target. (Of course, there are issues related to instruments, intermediate targets, and goals. Endogenous at what level of analysis?

    If the demand to hold base money rises more than the quantity of base money, that is deflationary regardless of whether or not base money is “endogenous” or not.

    I don’t think “exogenous” means “a ceteris paribus change starting from equilibrium.”

    In particular, the statement that when the interest rate on reserves rose above the interest rate on T-bills, then base money became endogenous, is false. The demand for base money increased. The increase in the quantity of base money (actually aimed at targetting loans to troubled sectors of the credit market) was less than the increase in demand.

    As best I can tell, Laffer appears to be assuming that the demand for base money/M1/M2/M3 is constant with random fluctuations.

  8. Gravatar of ssumner ssumner
    15. June 2009 at 03:52

    Bill Stepp, That’s just a single observation! And the error wasn’t that large. So if anything it supports my argument that we are not likely to get double digit inflation anytime soon. Just to be clear, the Ratex model say forecasts should be unbiased, not perfect.

    Alan, Yes it is possible (though very unlikely in the short run) to get inflation expectations w/o RGDP expectations, if you had a very pessimistic view of the supply side of the economy. But this is even more true of fiscal policy than monetary policy, as fiscal policy does more damage to the supply side. Let me emphasize, however, that almost all economists believe that we need more AD, so I take that as a given. Where my views diverge from other economists is that I think that monetary policy can do much more.

    Jon, I also think that supply side tax cuts (on cap gains, or the top MTR) would do more to boost recovery than the current stimulus package. So I think we agree.

    Pedro, There are two errors in your assumption. First you assume that with equal utility functions and an equal tax rate, that the foregone utility would be the same for the poor as for the rich. That’s only true in a very special type of utility function. Second, you assume that utilitarianism calls for equal utility sacrifice from each person, but that is not so. It calls for maximizing total utility. Suppose there was a 25% flat tax. Even after the tax was imposed, a dollar would be worth much less to Bill Gates than to a poor person, so utilitarianism might call for more redistribution. Indeed, if not for “supply side effects,” we might need complete equality of income. Needless to say, I think supply side effects are very important.

    TGGP, Good question, but the answer is no. If the Fed has a 2% inflation target, the money supply is also endogenous, but I don’t think the monetary cranks are right. Post Keynesians (like Keynes) don’t have a very good understanding of NGDP determination, last time I checked. Perhaps things have changed. Also, see my response to Bill below

    John, very good question, but I have a somewhat counterintuitive answer. Elsewhere I have argued that economists don’t directly try to influence policymakers, but rather indirectly do so through changes in the Zeitgeist, or spirit of the times. Both Krugman and I want to get other economists to see things our way, so that it becomes conventional wisdom.

    Now who responds more strongly to conventional wisdom? I have argued the Fed does, i.e. the Fed seems to do pretty much what the conventional wisdom of economists says they should do. On the other hand Congress responds to a mixture of idealistic motives and special interest politics. People like Krugman can only influence the idealistic part, they can’t convince politicians to stop ethanol subsidies and bridges to nowhere.

    BTW, To the vast majority of readers, even economists, Krugman gives the impression that the Fed couldn’t do much even if it wanted to. That’s my other problem with his argument.

    Bill, you are right, I will update the post.

  9. Gravatar of Thruth Thruth
    15. June 2009 at 06:29

    on inflation, in some sense both sides are right. the second moment of monetary shocks is very high right now. that means large probability of “errors” in both directions.

  10. Gravatar of Joe Calhoun Joe Calhoun
    15. June 2009 at 10:30

    If the Fed was wrong to introduce interest payments on excess reserves (and I don’t disagree with that) that implies they didn’t understand the effect of the policy. What makes you think they will understand any better in the future? What happens when the demand for base money falls? What happens when T bill rates rise above the Fed’s reserve rate? Do you really believe that they’ll recognize that as a problem when you obviously believe they didn’t get it the first time around? That’s what has Laffer and others (me included) convinced that inflation is the most likely outcome. We just don’t believe the Fed will get it right. And given your criticism of them, I don’t see how you can believe they will either.

  11. Gravatar of Tom F Tom F
    15. June 2009 at 14:23

    Speaking as a non-economist I find this statement a bit off:

    “And it is very clear that investors are not worried about high inflation. Not now, not in 10 years, and not in 20 years.”

    Much like they weren’t worried about the potential for a credit crunch over the last ten years?

    Seriously though if the liquidity that you’ve pumped into the system is now tied up in supporting unpriced and/or unpricable bad debt there’s no way of removing that liquidity from the system until those values are resolved.

    And with interest rates being as low as they are there’s not much room for cutting them to fight inflationary pressures.

    So, if inflation does start to rise for whatever reason what can be done about it?

  12. Gravatar of Current Current
    16. June 2009 at 02:02

    On tax reductions…

    Governments do not generally act for the benefit of their electorates. Folks around here need to read some public choice theory. Whatever the merits of Laffer’s arguments I’ve seen little evidence that governments adopted lower tax rates because they found them persuasive.

    I think the more reasonable view is the governments reduced tax rates because doing so was beneficial to interest groups, including legislators themselves.

  13. Gravatar of Personal Money Management » Blog Archive » Sumner: An Embarassment of Riches, by Bryan Caplan Personal Money Management » Blog Archive » Sumner: An Embarassment of Riches, by Bryan Caplan
    16. June 2009 at 05:59

    […] could devote a dozen posts to Scott Sumner’s latest essay-length entry.  But I’ll limit myself to the highlights:Stop worrying about inflation….Laffer is too good […]

  14. Gravatar of Current Current
    16. June 2009 at 05:59

    Since the state has to pay the coupon on TIPs the question arises of the honesty of the CPI/RPI. In Argentina the government have lied about it to prevent them from having to payout. Why shouldn’t other governments do the same?

    Perhaps bond markets are only calculating that they are not politically important if there were inflation.

  15. Gravatar of Greg Ransom Greg Ransom
    16. June 2009 at 06:46

    In the 30s the U.S. was on a gold standard.

    In Japan the Yen was not the reserve currency of the world.

    Today the dollar is a fiat currency and the reserve currency of world, a completely different situation from the 30s or from Japan.

    We’ve got Keynesians and monetarists using closed economy models to make sense of an open system and international monetary problem.

  16. Gravatar of Greg Ransom Greg Ransom
    16. June 2009 at 06:52

    If the demand for U.S. currency collapses outside the U.S., then the currency supply within the U.S. will massively explode.

    If America destroys the dollar as the preferred reserve currency of the world, this is exactly what will happen.

    Money issues don’t arise in a closed economy bubble.

  17. Gravatar of Greg Ransom Greg Ransom
    16. June 2009 at 06:57

    “they insured that prices continued to fall at 1% per year”

    If Japan was experiencing significant productivity gains during these years — greateroutput per input cost — then prices SHOULD have been falling. Say prices should have been falling 5 or 6 percent a year, but expansion of the money supple blocked this natural price decline. Then an “observed” fall of 1% per year in the wake of money expansion and productivity gains would mean that Japan WAS experiencing inflation, even with this “fall” in prices.

  18. Gravatar of Alex Golubev Alex Golubev
    16. June 2009 at 08:04

    Scott, i’m gonna have to side with Greg’s arguments above and i’ll go for a long shot here. You say:

    “Today we have an even better forward-looking indicator””TIPS spreads. And it is very clear that investors are not worried about high inflation”.

    EMH – “markets are unpredictable”. Of course. What theory says that we SHOULD look to markets as best PREDICTORS of the future? I mean i know that we all do, but can’t we overlay the market predictions over reality after the fact to show how … “sh1tty” (the technical term) the predictions were. I know we cannot use the gov’t or an inteligent superbeing like Krugman to predict, but what claim do we have that markets are a GOOD ENOUGH predictor? The “broken clock on an island” theory? I think there’s a very good argument that markets ALWAYS reflect the ASSYMETRIC risk/return profiles of most money managers, executives, and politicians. Just because a process is always unpredictable, doesn’t mean that it’s own product was the best prediction of it’s unpredictability or that such allocations are in any way FAIR (assymetry leads to that). SO once again, we should focus on creating FAIRNESS in the markets, for better (mroe fair) resource allocation, instead of focusing on emergency services of the Fed. what do you think? (and the whole spiel about taking advantage of inefficiencies in markets is BS. “markets can stay irrational longer than one can stay solvent/sober”. That’s precisely why modeling selfreinforcing processes is critical)

  19. Gravatar of Scott Sumner Scott Sumner
    16. June 2009 at 08:43

    Thruth, I should do a post on this soon, but for now I’ll say that if you are targeting TIPS spreads, a major inflation problem is almost impossible. Stable TIPS spreads means stable inflation expectations, stable inflation expectations means stable wages, stable wages means stable core inflation. So the only inflation breakout would be the non-core inflation (energy, food etc.) But that inflation is transitory. Because it hasn’t yet worked into wages, it can be brought down w/o Phillips curve problems. Does this make sense? I really need a longer explanation but am short of time today. I’ll try to do a post soon.

    Joe, This is also a good question. As in my answer to thruth, I assume the Fed can observe inflation expectations in real time, minute by minute. Also, there is an asymmetry in monetary policy, nominal rates can’t go below zero, but there is no “liquidity trap” on the upside. So there is always some target rate that will get inflation expectations back in line.

    With the preceeding in mind, let me answer your question. I think the Fed did know it was way off course last fall. They might have been a few weeks late, but they basically understood NGDP growth was too low. The problem is that they (claim they) didn’t know what to do about it. I think they do know how to stop excessively high inflation.

    Tom F, The Fed can raise rates on ERs if necessary so that banks continue to hold this unusually large liquidity. It’s not necessarily the best option (open market sales are another) but it does address your question of what to do if inflation threatens but the extra liquidity is still needed by a fragile banking system.

    On interest rates, you need to distinguish between short an long rates. I want to see long rates go up because that will indicate recovery. But the Fed uses short rates as a tool. Thus if the Fed wants to reduce inflation it raises short rates. If this is credible it lowers inflation expectations and makes long rates fall. Nick Rowe uses a pole analogy in his blog. If you are balancing a pole with your hand, want the top to go one way, you move your hand the other way.

  20. Gravatar of Scott Sumner Scott Sumner
    16. June 2009 at 08:58

    Current, Why would all governments, even left wing governments, decide to favor the rich at the same time? And why do the Dems now want to raise MTRs? I still think this partly reflects utilitarian judgements, which change as new information comes in. Of course special interests do play some role, but I think there is more at work.

    Current#2, Is it PC to say “this isn’t Argentina?” Seriously, the CPI numbers are done by non-partisan civil servants, unless I am mistaken. I’ve known people in the BLS, I don’t sense the numbers are cooked for political reasons. Also, the lowest rates reported are often in the easiest to check categories (non-services.)

    Greg, If foreigners no longer want our currency the Fed will remove it from circulation via open market sales. There would be no price level impact if supply reductions accommodated a reduction in foreign demand.

    Greg#3, I don’t think there was much productivity growth. The deflator fell about 1% per year, and RGDP rose a similar amount, leaving NGDP little changed. In any case, I think Austrians should drop their definition of inflation. Use a different term like “wage inflation.” Everyone else in the world defines inflation as the change in the price level. No price rise=no inflation, even if this is due to higher productivity offsetting higher money supply.

    BTW, I think their definition might be a very useful concept, and I’d rather stablize their definition than the CPI. So I’m not saying it’s not useful, I’d just like something like “NGDP growth,” or “wage inflation,” or whatever, used instead. But these were also well bahaved in Japan.

    Alex, There is one big flaw in your argument. If we trust expert opinion more than markets, and look for other inflation indicators, then the natural second choice is the consensus of economic forecasters. And that consensus also shows low inflation. So Laffer can’t used the non-EMH argument either. He’d have to say both markets and the consensus of economists is wrong. Maybe, but what else do you have?

  21. Gravatar of Tom F Tom F
    16. June 2009 at 09:21

    No need to publish this one Scott just a quick note to say thanks for answering my question. That’ll give me a place to start on some more reading/research.

    Love the blog as well.


  22. Gravatar of Current Current
    16. June 2009 at 09:54

    Scott: “Why would all governments, even left wing governments, decide to favor the rich at the same time? And why do the Dems now want to raise MTRs? I still think this partly reflects utilitarian judgements, which change as new information comes in. Of course special interests do play some role, but I think there is more at work.”

    Even left-wing governments are mostly made up of taxpayers who pay the higher rate. Many who contribute to left-wing parties are too. I think that the reason that the marginal tax rate reductions occurred was connected with Laffer. He provided a justification to do what many politicians wanted to do anyway. I think that is one of the main reasons that Keynesian deficit spending has been so prevalent in the last seventy years too.

    Scott: “Is it PC to say ‘this isn’t Argentina?’ Seriously, the CPI numbers are done by non-partisan civil servants, unless I am mistaken. I’ve known people in the BLS, I don’t sense the numbers are cooked for political reasons. Also, the lowest rates reported are often in the easiest to check categories (non-services.)”

    Perhaps. The question isn’t though if they are cooking the books now. The question is if they will cook them in the future. In Britain and Ireland it is fairly well accepted that the state fiddles with statistics frequently. It’s the sort of thing you read in broadsheet newspapers not just on the web.

    I think your government is better than ours, but not that much better.

  23. Gravatar of Greg Ransom Greg Ransom
    16. June 2009 at 10:23

    “To fight this recession the Fed needs more than a snapback; it needs soaring household spending to offset moribund business investment. And to do that, as Paul McCulley of Pimco put it, Alan Greenspan needs to create a housing bubble to replace the Nasdaq bubble.”

    — Paul Krugman in 2002 …

  24. Gravatar of Current Current
    16. June 2009 at 10:39

    From the Daily Telegraph in the UK:

    “Last week’s revelation that the Bank of England had switched 70pc of its own pension fund into index-linked gilts has raised the question of whether these government IOUs could be the answer to savers’ inflation worries.

    The bank’s pension fund is the nearest thing to a legal insider trader, because the bank also sets the interest rates that control inflation. If the pension fund thinks inflation will rise, maybe we should all sit up and take notice”

    I, for one, am suspicious.

  25. Gravatar of On praising Laffer at catallaxyfiles On praising Laffer at catallaxyfiles
    16. June 2009 at 21:49

    […] first half of this essay is critical of Arthur Laffer, while the second part praises him. Read the whole thing, but read […]

  26. Gravatar of Jethro Jethro
    17. June 2009 at 03:47

    Hi, Scott,
    I’m interested in your comment that the MTR can affect health care costs, where could I find out more on that?

  27. Gravatar of ssumner ssumner
    17. June 2009 at 04:58

    Current, At least we agree that Laffer was influential. Maybe I am too idealistic.

    You are right that the British government is more centralized, and has more control over the whole governance system. We have lots of checks and balances.

    Greg, I actually think Greenspan was right to cut rates in 2002, it prevented a Depression. The flaw was our banking system. It was appropriate that there was some expansion of housing after business investment tanked, but the subprime lending made it overshoot. I have an earlier post on the Canadian system, which isn’t so much more regulated as it is better regulated. They didn’t have the subprime fiasco to nearly the same extent. Canadians have to put more money down on mortgages, and banks can go after any of the homeowners assets.

    Current#2, That’s a great article. Maybe I will link to it.

  28. Gravatar of d kite d kite
    17. June 2009 at 20:42

    Current: The reason governments reduced mtr’s is because raising taxes produced less revenue.

    Very counter intuitive.


  29. Gravatar of ssumner ssumner
    18. June 2009 at 06:01

    Derek, There were cases where that occurred. But it should also be mentioned that even if there is slightly more revenue from higher rates, there may be a big “deadweight cost” to the economy, in terms of lower efficiency. That’s a point many supply-side critics overlook.

  30. Gravatar of Current Current
    18. June 2009 at 06:16

    d kite: “The reason governments reduced mtr’s is because raising taxes produced less revenue.”

    I understand the point. However at the time these cuts were done it was very difficult to say if that would be the effect. Historic evidence does not necessarily apply to the present.

    Governments have ignored historic evidence time after time in their other actions. I don’t think they were guided by it here. I think they thought “it may work, we’ll get rich anyway”.

  31. Gravatar of Uncertainty Cat Uncertainty Cat
    1. July 2009 at 18:19

    Completely off-topic; but I love the term “Saltwater Universities” what does it mean?

  32. Gravatar of Current Current
    2. July 2009 at 02:08

    Saltwater universities means those near to oceans. The freshwater universities those near to lakes – like Chicago.

  33. Gravatar of ssumner ssumner
    2. July 2009 at 06:26

    Current, Thanks, and I’d add the salt water schools are considered more liberal (or centrist) and the fresh water schools (notably Chicago) are more right wing.

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