Then and now

Here’s an excellent post by Matt Yglesias:

The March 2010 Cassidy piece and the October 2011 Klein piece end with the exact same factual reflection, in both cases driven by Obama administration awareness of the exact same stylized fact about the likely prognosis of a country facing an economic crisis. Call it the Reinhardt/Rogoff Fact. But the affect has completely changed. In March 2010, the story from the administration was that they spent 2009 being completely aware of the Reinhardt/Rogoff Fact and thanks to their awareness, political guts, and policy knowledge they were going to overcome it. By October 2011, the affect is totally reversed. Having succumbed to the exact political dilemma that they once swore not to succumb to, they now cite the dilemma as nigh-unfixable.

If you don’t understand the role of monetary policy, then macro problems will seem unfixable.  (Check out the Larry Summers quote in the previous post.)

Marcus Nunes has a very interesting post on the changing views of John Taylor.  First Marcus quotes Taylor from 2006:

In the last three years, the Japanese economy has improved greatly compared to the decade-long period of near zero economic growth and deflation that began in the early 1990s. Once again Japanese economic growth is contributing to world economic growth as the expansion in Japan begins to set records for its durability.

What has been responsible for this recovery?  The banking and other economic reforms of the Koizumi administration have been very important, and such reforms will need to be continued to sustain strong economic growth in the future. However, the key to the recovery, in my view, has been the quantitative easing of monetary policy that began in March 2001, but which really took off in 2003 and 2004 with substantial increases in the rate of growth of the monetary base.

It was also during the 2003-2004 period that the Bank of Japan purchased large amounts of foreign exchange as it intervened in the exchange markets. An important question with lessons learned for the future is whether and how this “great intervention” was connected to the quantitative easing, the increase in the monetary base, and thereby to the ultimate recovery in Japan.

And then he quotes Taylor from 2011:

And this is exactly what conservative are saying now. Stop all the interventions””the short-term discretionary fiscal stimulus packages and the massive quantitative easings and the operation twists of monetary policy. The unpredictability caused by these policies is causing uncertainty and holding the recovery back.

From “the great intervention” to “stop all the interventions” in just 5 years.  Is there a more succinct summary of the recent trajectory of American conservatism?

Part 2:  Friday I had the following lunch conversation with a philosopher:

Him:  So what do you think of the Wall Street protests?

Me:  I think they should be picking outside the major economics departments.

Him:  Oh really, so you think economists are teaching the wrong things?

Me:  No, they’re teaching the right things, but their policy advice doesn’t reflect what the teach.

In the last line I was thinking of Mishkin’s textbook, where he forcefully argues that low interest rates don’t mean easy money, that you must look at other asset prices to determine the stance of monetary policy, and that monetary policy remains highly effective at the zero bound.  I’d guess at least 99% of economists rejected this standard textbook monetary economics in late 2008.  And we are now paying the price.



20 Responses to “Then and now”

  1. Gravatar of Benjamin Cole Benjamin Cole
    10. October 2011 at 07:33

    “However, the key to the recovery, in my view, has been the quantitative easing of monetary policy that began in March 2001, but which really took off in 2003 and 2004 with substantial increases in the rate of growth of the monetary base.”

    That is John Taylor, 2006, discussing Japan.


    Really at this point, what are the risks and potential benefits of nominal GDP targeting, QE and decreased IOR?

    The risk is higher inflation (and we may now be in deflation). The benefit is a enhanced recovery.

    Should not we be willing to take some risks to make some gains?

    Can we really say we will never take any risks that might—might—cause some inflation? Is that a policy, or a religion?

  2. Gravatar of Morgan Warstler Morgan Warstler
    10. October 2011 at 07:56


    Don’t be dense, what conservative economists will support for the country of Japan, is not the same thing as what they will support here.

    So the only point you are making is that when people talk about Japan, they will mentally experiment. Jesus, we dropped nuclear bombs on them, you think we won’t inflate their currency?

    You are not making even .0001% of a point that conservative economists actually believe we should inflate away the power, inflate away the hegemony of conservatives in the US.

    They do not believe it will help conservatives in America, and that’s what it means to help America.

    This is perfectly rational:

    What’s good for conservatives is good for America.

  3. Gravatar of John Thacker John Thacker
    10. October 2011 at 07:57

    From “the great intervention” to “stop all the interventions” in just 5 years. Is there a more succinct summary of the recent trajectory of American conservatism?

    Excellent point, and an understandable condemnation of John Taylor.

    However, isn’t it the case that John Taylor might be confused by looking at M2 now, which is, as you’ve noted, rapidly expanding? Even if that’s the wrong metric, that could be why he fears inflation. Was Japan suffering from rapidly expanding M2 before the monetary expansion Taylor praised?

    Here’s a post from John Taylor’s blog where he specifically cites M2 growth as evidence of a problem with QEI and QEII.

    Hopefully you can “understand where [he is] coming from, but respectfully disagree” with him, like some others who seem to have switched their opinions from 2005 to now, like Paul Krugman’s switch from 2005 to 2011 on China “currency manipulation,” which you discuss here.

  4. Gravatar of John Thacker John Thacker
    10. October 2011 at 08:01

    The presentation of the data I’ve seen on the Web indicates that M2 in Japan did *not* appear to have the same dramatic increase in the US. When Japan did quantitative easing, M1 jumped, but M2 did not. Is there something that I’m missing?

    Perhaps he, like others, is focusing on the wrong thing.

  5. Gravatar of bill woolsey bill woolsey
    10. October 2011 at 08:02


    Think of nominal GDP as the flow of spending on output.

  6. Gravatar of bill woolsey bill woolsey
    10. October 2011 at 08:16

    Stiglitz isn’t so much concerned about the productivity growth in agriculture before the Depression but rather the growth of manufacturing productivity growth.

    If the demand for manufactured goods is inelastic, then nominal expenditure on manufactured goods drop as to the nominal incomes received in those sectors. But those who were buying manufactured goods have more nominal income left to spend on other products, presumably services. Those producing service get more manfactured goods for less expenditure on them, and can spend more on services. Those who work in the maufacturing industries also get more manufactured goods (their prices are lower, but they earn less and purchase fewer services.

    Of course, what usually happens is that labor and other resources would shift out of the manufacturing industries, so that per capita nominal incomes would recover, though aggregate nominal income may continue to be lower. (Though with the assumed inelasticity, they rise as resources shift.)

    Per capital nominal incomes fall, and nominal income rises in the service sector, and the production of services rise more.

    It seems to me that the Stiglitz-Kervick error would be to ignore how those in the service sector have more nominal income to spend on services.

    Now, if your goal is to maintain the nominal income of unionized manufacturing workers, then what good does this do?

    If you think that high school grads in services earn low pay, and that the only way to earn high pay in services is to be highly educated, then what good does it do if employment expands in the service sector?

    In other words, if the union movement has been able to organize heavy industry and raise the income of blue collar workers to something near the median, then maybe improved productivity isn’t so good.

  7. Gravatar of Scott Sumner Scott Sumner
    10. October 2011 at 09:48

    Ben, That’s right.

    Morgan, Pretty sure Taylor wouldn’t like your “defense” of him.

    John, Just to be clear, I’m not criticizing him for saying monetary stimulus was need then but not now. There would be no contradiction in that. Rather the problem is that he praised the philosophy of “interventionism” in one case but not another. That’s much harder to reconcile. So the M2 data is not relevant to the latter problem.

    Bill, Wrong post?

  8. Gravatar of W Peden W Peden
    10. October 2011 at 10:10

    John Thacker,

    M2 stopped being a useful measure of the money supply a long time ago. Insofar as it was useful as an indicator, it was because it was a good measure of deposits. However, since it excludes most of corporations’ deposits (it excludes TDs above $100,000, which are now vast) it mainly tells you about the demand for deposits other than large time deposits.

    M3 isn’t any good either, because there’s too much non-banking financial corporation money in there; repos shouldn’t be in it; and I’m also dubious about including eurodollar deposits. It’s better than M2, but it’s still fundamentally flawed as a measure of the money supply.

    The only really useful measures of the money stock would be (1) reserve balances, (2) M0, (3) M1, and (4) a broad measure of non-OFI deposits i.e. a measure of broad money, in the sense of the public’s holdings of bank deposits*.

    However, the key idea behind market monetarism, as I understand it, is that it is the market’s anticipations of the future money stock that are the key causal factor in monetary policy. The past is useful only as it is a guide to the future.

    * Perhaps including certificates of tax deposit. I still haven’t worked this instrument out and I’m not sure if it’s worth bothering.

  9. Gravatar of MikeDC MikeDC
    10. October 2011 at 10:16

    It’s not hard to reconcile two statements with 5 years of intervening facts. He might have thought intervention would work, but looking at Japan, it clearly didn’t generate the anticipated “ultimate recovery”. There or here.

  10. Gravatar of Staunch Staunch
    10. October 2011 at 13:58


    It didn’t work because it was not tried. The Japanese got exactly what they wanted. It seems as if they were perfectly happy to at least stop the deflation and continue with near zero inflation. Japan has tightened monetary policy several times over the last 20 years.

    Japan’s Lost Decade:

    I know some of the readers of this blog do respect the AEI. There are of course some problems with this paper (I’ve only skimmed it), but..

    “The Bank of Japan was misled about the intensity of monetary tightening by a rapid fall in Japanese interest rates, which created an impression of easy monetary policy–an illustration of the danger of gauging the stance of monetary policy solely from the behavior of nominal interest rates. Actually, the drop in interest rates was a reflection of falling inflation expectations and falling real interest rates that accompanied the collapse in Japanese
    investment spending.

    The Bank of Japan has also tended to look with satisfaction upon a strengthening yen and a rising current account surplus as signs of a sound economy. Actually, the rising current account surplus mirrored a collapse in domestic investment spending coupled with a sustained high level of domestic savings. Japan ran out of investment opportunities at home while its households continued a high level of saving. For a time, consumption spending held up reasonably well while the high level of domestic saving made it easy for the Japanese government to begin a series of public works spending packages financed by the sale of government bonds to Japanese savers.”


    “The important impact of interest rates on the real economy flows from real (inflation-adjusted) interest rates, not nominal market interest rates. With Japan’s ten-year yields now at 1.6 percent and deflation close to 2 percent, real interest rates in Japan at 3.6 percent are well above the long-run average of about 3 percent. In short, monetary policy in 2001 is still tight, as evidenced by the continuing tendency toward a falling price level and the weak stock market. The shift toward a weaker yen that began in December probably reflects more outflows from Japan as foreign investors flee the sinking equity market. Meanwhile, the Bank of Japan insists in 2001 that with its policy interest rate at 25 basis points, there is little additional room for easier monetary policy despite the remarkably low growth rate of the monetary base, accelerating deflation, weakening consumption, and a falling stock market.”

  11. Gravatar of flow5 flow5
    10. October 2011 at 14:28

    (1) Ben S. Bernanke
    Chairman and a member of the Board of Governors of the Federal Reserve System. Chairman of the Federal Open Market Committee, the System’s principal monetary policymaking body.

    At the same time, because economic forecasting is far from a precise science, we have no choice but to regard all our forecasts as provisional and subject to revision as the facts demand. Thus, policy must be flexible and ready to adjust to changes in economic projections.

    2) European Central Bank (ECB) Central Bank for the EURO

    The transmission mechanism is characterised by long, variable and uncertain time lags. Thus it is difficult to predict the precise effect of monetary policy actions on the economy and price level…

    3) Janet L. Yellen, President and CEO of the Federal Reserve Bank of San Francisco

    You will note that I am casting my statements about the stance of policy and the outlook in very conditional terms. I do this because of the great uncertainty that surrounds these issues. Frankly, all approaches to assessing the stance of policy are inherently imprecise. Just as imprecise is our understanding of how long the lags will be between our policy actions and their impacts on the economy and inflation. This uncertainty argues, then, for policy to be responsive to the data as it emerges, especially as we get within range of the especially as we get within range of the desired policy setting.

    (4) Thomas M. Hoenig
    President of Federal Reserve Bank of Kansas City

    Monetary policy must be forward-looking because policy influences inflation with long lags. Generally speaking a change in the Federal funds rate may take an estimated 12-18 months to affect inflation measures….But the course of monetary policy is not entirely certain. & will depend on how the economy evolves in the coming months.

    (5) William Poole*
    President, Federal Reserve Bank of St. Louis

    However inflation is measured, economists agree that monetary policy has at most a minimal influence on the rate of change in the price level over relatively short time periods””months, quarters or perhaps even a year. Central banks are responsible for medium- and long-term inflation””such inflation, as Milton Friedman wrote, is a monetary phenomenon that depends on past, current and expected future monetary policy. As a practical matter, the medium- to long-term likely is a period of two to five years.

    (6) Robert W. Fischer – President Dallas Federal Reserve Bank
    November 2, 2006:

    “In retrospect [because of faulty data] the real funds rate turned out to be lower than what was deemed appropriate at the time and was held lower longer than it should have been. In this case, poor data led to policy action that amplified speculative activity in housing and other markets. The point is that we need to continue to develop and work with better data.”

    (7) Governor Donald L. Kohn

    I think a third lesson is humility–we should always keep in mind how little we know about the economy. Monetary policy operates in an environment of pervasive uncertainty–about the nature of the shocks hitting the economy, about the economy’s structure, and about agents’ reactions. The 1970s provide a sobering lesson in the difficulty of estimating the level and rate of change of potential output; these are quantities we can never observe directly but can only infer from the behavior of other variables.

    (8) James Grant (Grant’s Interest Rate Observer)

    “Both use quantitative methods to build predictive models, but physics deals with matter; economics confronts human beings. And because matter doesn’t talk back or change its mind in the middle of a controlled experiment or buy high with the hope of selling even higher, economists can never match the predictive success of the scientists who wear lab coats.”


    Did you catch the bottom? There is a GOSPEL. It is extremely simple. That’s why Bernanke should be fired.

  12. Gravatar of Morgan Warstler Morgan Warstler
    10. October 2011 at 18:21

    MikeDC / Staunch / Soctt,

    You are all dancing around the point I made.

    YES, Japan didn’t try it.

    YES, he said Japan should try it.

    NO he doesn’t want to try it here.

    And you want a fancy explanation?

    Just because “behind the veil” or anthropological analysis has the “benefit” of being removed from personal bias…

    DOES NOT MEAN that we can EXPECT judgements to be made without bias.

    My god, those guys go Nobel Prizes for basically saying humanity screws up theory.

    WHY can’t you all start with:

    Powerful forces decided not to inflate Japan…

    And those same forces are do so here.

    All your math still works, you just have to start weighting behavior based on power of self interested groups.

    Why does doing economics inside a hegemony not appeal to you people?

  13. Gravatar of MikeDC MikeDC
    10. October 2011 at 18:49

    That AEI article was from 2001! We’re talking about Taylor’s praise of Japanese policy circa 2006. While the ink was still wet on Taylor’s 2006 post, they were pulling the plug on QE.

    My point is that that experience looks depressingly familiar. It’s like when I hear Keynesians say fiscal policy wasn’t really tried. I understand what they mean, and it’s technically accurate that the ARA wasn’t the stimulus advocates really wanted. But in a more practical sense, it’s the sort of fiscal stimulus you can expect to get at the end of a policy process.

    And by the way, how about some Sargent/Sims discussion. They’ve got a lot of interesting stuff to say about this, but I think they’re so sophisticated damn near no one can make any sense out of what they’ve said.

  14. Gravatar of c8to c8to
    11. October 2011 at 06:53

    mikeDC, the sargent and wallace paper scott links elsewhere is pretty good:

    (my takeaway is that if you have a fixed path of deficits, you can pay for it now with loose money or later with even looser money because of interest – thats the whole future inflation is worse under tighter money now)

    –> Peden. my current reading is that its too hard to measure “money” because theres so many different types beyond currency and deposits…what about unused credit card balances. considered money in bad times certainly.

    also, re market monetarism and MV = PY. which way are we saying the causation goes. my current reading is that Velocity dropped massively with M originally constant (or worse, scott’s 2008 tight money), sticky prices (fixed P in the short run, ie now) so Y took a massive hit.

    now heres the thing…M may have tripled (with caveats above) but this M is either not actual M out in circulation or the mere act of tripling M has sent V tumbling further (if we have to do massive interventions something really bad is happening so no-one is spending)

    just thinking aloud about scenarios where M and V are somewhat inversely correlated..

  15. Gravatar of ssumner ssumner
    11. October 2011 at 17:55

    MikeDC, He didn’t say it was likely to work in Japan, he said it worked. Then they reduced the monetary base by 20% in 2006, so that’s why things went downhill. There’s nothing in those facts that should lead Taylor to walk away from his earlier views.

    Flow5, You and me are about the only 2 people on earth who don’t believe in long and variable lags–it’s dogma in the profession.

    Morgan, Yes, I know your views about how the tough guys do things.

  16. Gravatar of grcridlan grcridlan
    12. October 2011 at 15:40

    Long and variable lags my foot. The problem with monetary policy is that its affects are often priced in before the policy change is actually executed!

  17. Gravatar of Scott Sumner Scott Sumner
    13. October 2011 at 05:52

    grcridlan, Exactly.

  18. Gravatar of himaginary himaginary
    15. October 2011 at 08:50

    I’m late on this, but here is what Taylor said about a year ago:
    “My assessment, based on this experience, is that the recent intervention is not, and should not, be a repeat of the Great Intervention. While that intervention was not sterilized and quantitative easing occurred, many at the Bank of Japan did not think it was so successful.”
    It seems that he has already reversed his assessment by then.

    And here is a critique of Taylor at the 2006 conference by the Japanese discussant.
    Maybe this critique contributed to make Taylor rethink his assessment?

  19. Gravatar of ssumner ssumner
    16. October 2011 at 07:08

    himaginary, I hope that evidence didn’t make him rethink his views, because it’s not much evidence. The recovery should begin when the policy is announced, not when the currency injections actually occur.

    And obviously the BOJ thinks it was successful, as they tightened policy sharply in 2006 (by the standard measure of tight money–i.e. they raised rates and sharply reduced the base.)

  20. Gravatar of 99 Percent Movement 99 Percent Movement
    19. October 2011 at 16:13

    99 % Movement…

    […]TheMoneyIllusion » Then and now[…]…

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