Was it sensible to expect “this” back in 2009?

By “this” I mean sluggish growth, very low inflation, and especially near-zero interest rates.  Paul Krugman has repeatedly said “yes” and mocked people like Martin Feldstein, who expected a more conventional recovery with rising inflation and rising interest rates.  But Brad DeLong says he’s too tough on Feldstein:

Unlike Paul, I get why moderate conservatives like Feldstein didn’t find “all this convincing” back in 2009. I get it because I only reluctantly and hesitantly found it convincing. Feldstein got the Hicksian IS-LM and the Wicksellian S=I diagrams: he just did not believe that they were anything but the shortest of short run equilibria. He could feel in his bones and smell in the air the up-and-to-the-right movement of the IS curve and the upward movement of the S=I curve as investors, speculators, and businesses took look at the size of the monetary base and incorporated into their thinking about the near future the backward induction-unraveling from the long run Omega Point. My difference with Marty in 2009 is that he thought then that the liquidity trap was a 3 month-1 year phenomenon-that that was the duration of the short run-while I was much more pessimistic about the equilibrium-restoring forces of the market: I thought it was a 3 year-5 year phenomenon.

I’m somewhere in between, and also a bit off to the side.  DeLong has by far the best argument, and if you are only going to read one post, stop reading mine and read his instead.  But I’ll put in my 2 cents, FWIW.

I have a very low opinion of the IS-LM model; indeed I blame a lot of our policy failures on that model.  I think it led too many economists to write off monetary policy in late 2008, right when we desperately needed monetary stimulus.  But I reached the same conclusions as Krugman, for somewhat different reasons.

Since late 2008, I’ve consistently wanted more, more and more, but not for IS-LM reasons.  Rather I’m a market monetarist, and in my view the markets have been signaling a need for more, more and more.  I’m also a Lars Svensson-style, “target the forecast” guy, which means I always, at every single moment, want the instruments of monetary policy set at a position where expected NGDP growth equals desired NGDP growth.  Since 2008 we’ve consistently fallen short.

In contrast, Paul Krugman is much more skeptical of the market view:

Kevin O’Rourke has a post, What do markets want, raising the same issues I’ve been discussing about debt, austerity, etc.

But never mind all that: read the comments, specifically this one:

The markets want money for cocaine and prostitutes. I am deadly serious.

Most people don’t realize that “the markets” are in reality 22-27 year old business school graduates, furiously concocting chaotic trading strategies on excel sheets and reporting to bosses perhaps 5 years senior to them. In addition, they generally possess the mentality and probably intelligence of junior cycle secondary school students. Without knowledge of these basic facts, nothing about the markets makes any sense””and with knowledge, everything does.

That’s about as far from my view of markets as it’s possible to get, although I suspect that Krugman himself doesn’t really quite believe it.  Maybe it’s just my imagination, but on occasion I think I see him “peeking” at markets, to confirm his (often excellent) intuition about where things are going.  And when he fails to do so, as in early 2013, he pays a heavy price in lost prestige.

OK, so Krugman and I were right in 2009, but did we just get lucky?  Even now it’s hard to say.  DeLong spends a lot of time explaining why in a traditional macro model, even a traditional Keynesian macro model, you would not expect a recession to lead to 7 years of near-zero interest rates.  Not even a deep recession like 1982, when unemployment peaked at 10.8%.  So what happened this time?

On the other hand Krugman’s right that this isn’t actually unprecedented, we had near-zero rates from 1932 to 1951, and then again in Japan beginning in the late 1990s, and still ongoing.  So (he asks) why is anyone surprised?

In my view we had a perfect storm of shocks that just barely added up to zero rates for 7 years in the US, but not enough for Australia, and more than enough for Japan (and perhaps going forward, Europe.)  These included:

1.  A big negative AD shock.  Both a big NGDP drop in 2008-09, and an unprecedentedly slow recovery.  DeLong might argue that I am assuming the conclusion, that I need to explain this slow NGDP recovery.  I don’t quite agree, but I’ll circle back to this issue later.

2.  Bad supply-side factors.  In the US we have boomers retiring, fewer young people choosing to work, more people going on disability, and a crackdown on immigration. Then we had a 40% rise in the minimum wage right at the onset of the recession, and an unprecedentedly long extension of unemployment benefits (which DeLong correctly predicted (in 2008) would raise unemployment.)  By themselves, these factors weren’t that important, but together they had some impact.  For instance, after unemployment compensation returned to the usual 26 weeks in early 2014, job growth accelerated.

3.  A 30-year downtrend in the Wicksellian equilibrium real interest rate.  And the last step down after 2008 was aided by a structural shift in the US and Europe from investment to consumption, as an after effect of the housing bust and tighter lending standards.

In my view the weak NGDP growth is monetary policy.  Period, end of story.  But DeLong would want something more:

In the long run… when the storm is long past, the ocean is flat again.

At that time-or, rather, in that logical state to which the economy will converge if values of future shocks are set to zero-expected inflation will be constant at about the 2% per year that the Federal Reserve has announced as its target. At that time the short-term safe nominal rate of interest will be equal to that 2% per year of expected inflation, plus the real profits on marginal investments, minus a rate-of-return discount because short-term government bonds are safe and liquid. At that time the money multiplier will be a reasonable and a reasonably stable value. At that time the velocity of money will be a reasonable and a reasonably stable value. Why? Because of the powerful incentive to economize on cash holdings provided by the sacrifice of several percent per year incurred by keeping cash in your wallet rather than in bonds. And at that time the price level will be proportional to the monetary base.

So you can’t explain why the massive QE didn’t lead to a big growth in NGDP unless you can explain how interest rates stayed near zero for 6 years after the recession, holding down velocity.

My response is that, yes, back in 2009 it would have been hard to predict near-zero rates in 2015.  The markets didn’t expect that and neither did I.  We had that perfect storm described above.  But that doesn’t matter.  You take policy one step at a time.  The markets were also telling us that the policies that so many thought “extraordinarily accommodative” were in fact woefully inadequate.  That’s all we knew in 2009, but it’s also all that we needed to know in 2009.

Krugman sees traders as drug-crazed yuppies.  I see economists and Fed officials as stupid bulls that need a ring in their noses.  Then you attach the rings to the markets, and let those 22-27 year old drug-addled traders lead us to a glorious world where expected NGDP growth is always on target and where bailouts and fiscal stimulus aren’t needed.  A world where Say’s Law is true even though it’s not really true (I stole that last one from Brad DeLong.)

HT:  Marcus Nunes



30 Responses to “Was it sensible to expect “this” back in 2009?”

  1. Gravatar of J Mann J Mann
    4. June 2015 at 07:32

    Krugman seems to like markets when they agree with him, but like economists, when markets don’t agree with him, that must mean they’re knaves and/or fools.

    My recollection is that he spent a lot of 2009 explaining how the TIPS and TED numbers indicated we had no serious risk of inflation, right after he caught his breath in 08 from declaring that the real estate crash meant the EMH was dead.

    I guess he can sort of round the circle by saying that he meant that other, more market loving, economists should accept those numbers blindly, but smarter economists such as him know when a market has lost track of fundamentals, but it was still kind of jarring.

    For example,


  2. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    4. June 2015 at 08:14

    Off topic but, it’s sad when the China People’s Daily has economists writing for it who make more sense than the NYT;


    ‘…there is a danger in this well-meaning desire to “do something”. What that “something” ought to be surely depends on the forces that have generated the inequality in the first place. Under normal circumstances – apart from emergencies generated by political upheavals or by war, for example — changes in income inequality are mainly transmitted through market mechanisms. Of course economic mechanisms can be modified and regulated, just as physical mechanisms can be modified or regulated by a clever engineer. But playing with a mechanism that you don’t understand is usually a mistake.’

    That’s from the LSE’s Frank Cowell.

  3. Gravatar of Jerry Brown Jerry Brown
    4. June 2015 at 08:38

    Nice post. As far as the bad supply side factors you list and NGDP- would it be wrong to consider most of them as sort of automatic stabilizers acting to limit the potential drop in NGDP from the big shock to AD?

  4. Gravatar of Jason Smith Jason Smith
    4. June 2015 at 11:12

    The surge in job growth in 2014 primarily shows up in the number of job openings. Now it is possible that employers saw that unemployment insurance was being reduced to 26 weeks, thought that applicants would be more pliant (aka desperate) and therefore put out job listings.

    Or better story: Obamacare goes into effect in January 2014 and hospitals etc have to hire more staff to deal with the surge in newly insured patients. The surge in health care jobs accounts for a sizable chunk of the surge in job openings in 2014 … about a quarter of them.

    And there is no surge in retail job openings — one of the largest job types there is in this country.

    Unemployment insurance didn’t just end for health care workers!


  5. Gravatar of HW HW
    4. June 2015 at 11:16

    Professor Sumner, hypothetically speaking, if a country were to adopt an NGDPLT goal of 4%, and then actual NGDP growth overshoot the target for the year by growing 9%, would you be aiming for -1% NGDP growth the next year?

    Also, since there is no quota on how much of the NGDP growth has to be RGDP, how would you stop the a scenario in which most or all of the NGDP growth is due inflation? This could be the result of a big and sudden supply shock, where RGDP stalls or contracts, inflation rises, and the NGDP target is still reached because of high inflation.

  6. Gravatar of BC BC
    4. June 2015 at 11:44

    The other way we know that Krugman and the commenter don’t truly believe that market participants are drug-crazed yuppies is that Krugman and the commenter are not in the markets themselves taking advantage of all these presumed drug-induced arbitrages.

  7. Gravatar of Njnnja Njnnja
    4. June 2015 at 12:19

    The other way we know that Krugman and the commenter don’t truly believe that market participants are drug-crazed yuppies is that Krugman and the commenter are not in the markets themselves taking advantage of all these presumed drug-induced arbitrages.
    In all fairness, there is nothing in EMH that says that individual market participants can’t be drug-crazed yuppies. In fact the whole argument is that the total is greater than the sum of its parts, and surely much greater than the average of its parts. As long as individual participants prefer more money to less money, and the best way to get more money is to buy low and sell high, then individual investors could be dumb as oafs and you *still* couldn’t beat the market.

  8. Gravatar of ThomasH ThomasH
    4. June 2015 at 12:24

    “I think it [use of NK models] led too many economists to write off monetary policy in late 2008.”

    I think that many economist correctly “wrote off” conventional monetary policy, purchase of ST assets. Their error was to have ignored or underestimated a policy of purchases of longer and longer term assets.

    Now that is somewhat excusable as a policy stance since such purchases were fiercely controversial and they might well have foreseen that the Fed would not (be able to?) buy enough to achieve a rapid recovery and to argue correctly that larger fiscal deficits (used to finance projects with positive NPVs) would be welfare-improving. But their failure to support aggressive QE was still a grievous mistake.

  9. Gravatar of ThomasH ThomasH
    4. June 2015 at 12:36

    I’d make the argument for NGDPL trend targeting as better at dealing with both supply and demand shocks and that the loss function of excess inflation during a supply shock in a NGDPL trend target world is less than the RGDP loss from demand shocks in a PL trend target world and much less than in the inflation rate ceiling target world we’ve had since 2007.

    I’d like to hear Prof Sumner’s answer.

  10. Gravatar of Jose Romeu Robazzi Jose Romeu Robazzi
    4. June 2015 at 12:59

    A lot of people spoke about the fact that everytime there is severe financial stress (banking crisis), the recovery is not so fast, I remember people writing about that as early as late 2008. Also, when Dodd Frank was taking shape, I had the feeling that those very people pushing for government stimuli were the same people speaking against banks, preaching more regulation, and wrongly blaming greed and compensation schemes. I thought very ironic that the same people that wanted more reign on banks were complaining that credit (money) was tight. I call that period “regulatory tightening”. Now it is clear that money was indeed tight and the FED was able to monetize debt at large quantities and still see rates lower after that (meaning its policy stance was actually hawkis). I think that the structural change that took place in the banking sector helps to explain (at least partially) why a lot of macro guys can’t understand why rates are the result, not the cause, of monetary policy stance, and the zero lower bound does not matter.

  11. Gravatar of Justin Justin
    4. June 2015 at 14:02

    It’s all about 2: Bad supply-side factors. Growth may have been sluggish this decade, but it’s really a supply-side story.

    In the 5 years to April 2015, just shy of 12 million private sector jobs were created, an annual growth rate of 2.1%/yr.

    For comparison, in the 5 years to December 2007, 7.1 million private sector jobs were created, a growth rate of 1.3%/yr and in the 5 years to March 2001, 12.3 million private sector jobs were created, a growth rate of 2.4%/yr. So from a job creation perspective, the current expansion is running much hotter than the Bush years, and just a bit slower than during the go-go years of late 1990s.

    What’s the disconnect? Productivity. In the 5 years to 2001Q1, productivity grew 2.7%/yr, and in the 5 years to 2007Q4, productivity grew 2.4%/yr. Over the past 5 years, productivity has grown just 0.6%/yr. If productivity were growing as it had during the past two cycles, we’d be enjoying 4% real GDP growth, not 2%.

    Inflation isn’t terribly slow either. The GDP deflator rose 1.6%/yr in the 5 years to 2015Q1, lower than the 2.7%/yr in the 5 years to 2007Q4 but about the same as the 1.7%/yr in the 5 years to 2001Q1.

    Speaking of mocking people who expected a rapid recovery, the White House back in 2009 expected average real GDP growth of 3.8%/yr during 2010-2014, 1.6%/yr inflation per the GDP deflator (spot on) and unemployment 3.1% lower during 2014 than 2009 (incidentally spot on as well, though the start and end points are both 1.2% above White House predictions). The projected deficit during 2014 was 2.7% of GDP, spot on here as well. Like other optimists, the White House expected 4% short term interest rates in 2014.


    I suppose my point is that we got a good recovery, it just didn’t have the productivity growth to make headline real GDP growth look impressive. The Keynesian story that the recovery was slow because of insufficient demand falls apart when everything about the last 5 years screams strong recovery except for the productivity statistics, which is likely a good part of the reason why real wages haven’t grown that quickly this cycle either.

  12. Gravatar of collin collin
    4. June 2015 at 14:13

    1) You can not underestimate the Japanese experience here in which showed their was a new type economy. In many ways the US followed Japan by 10 years and the post-Stock/Dotcom bubble was longer with the housing bubble. I say Germany who has smartly avoided a housing bubble may still end up like Japan of the next years with such demographics and high excess savings.

    2) In 2009, the other problem with falling US AD is nobody could replace this drop on global scale. The falling of commodities in 2012, Gold in 2013, and oil in 2014 showed

    3) Is AS really falling? Considering modern argiculture and manufacturing have gained such enormous economies of scale where it is impossible to have falling AS.

    4) While you focus on work force drops, I still say the reason why the developed world hit such Keynesian liquidity trap is the Baby Bust which first hits the AD about 10 – 20 years after it starts and then the AS curve then 30 years after the bust. It appears the how awesome the global capabilities are, the less people there are to buy it. (Yes, a variation of Pikety that capital is getting a lot more than labor but in reaction labor/average worker is making less children in response.)

  13. Gravatar of Major_Freedom Major_Freedom
    4. June 2015 at 14:17

    CPI (less food and energy) over the past 12 months according to the latest BLS stats rose 1.8%. Is that what is “very” low?

    The PCE has been rising since 2012 and is now 3% annualized. Is that what is “very” low?

    NGDP since 2010 has been roughly between 3.5% to 4.5% annualized. Is that what is “very” low?

    I think the accuracy of reporting data on this blog is “very” accurate.

  14. Gravatar of Major_Freedom Major_Freedom
    4. June 2015 at 14:29

    Fun fact:

    Interest rates would be higher now if the structural problems caused by prior inflation were corrected, ceteris paribus.

    But because the deep, widespreas structural problems as of 2008 have only been partially corrected, and because even more malinvestment has been generated because of the massive and extraordinarily accommodative monetary policy since that time, the outcomes to consumer prices and NGDP have been quite muted.

    Never reason from a spending change. If the cause for a reduced spending (despite the Fed not destroying money) is structural discoordination which is itself caused by to much prior inflation, which is almost certainly the case, then a reduced spending is not a failure of the Fed to print more, but the outcome of the Fed having printed too much prior, in which case more inflation is exactly the opposite of a cure.

    Socialism fails at all levels. Even if it only takes place in law creation / enforcement, and money. We see the failures of socialist law all around us. Sumner has no good answers for why that is. He must resort to vague, weak references to “culture”.

    For those of us who have taken the time and given the effort in studying the history of thought, both economic and philosophic, I do believe we understand not only what Sumner can’t explain, but what is wrong with his own brand of socialism.

  15. Gravatar of Major_Freedom Major_Freedom
    4. June 2015 at 14:59


    “Now it is clear that money was indeed tight and the FED was able to monetize debt at large quantities and still see rates lower after that (meaning its policy stance was actually hawkis).”

    You do realize you are just stating a definition, right?

  16. Gravatar of Major_Freedom Major_Freedom
    4. June 2015 at 15:08

    “On the other hand Krugman’s right that this isn’t actually unprecedented, we had near-zero rates from 1932 to 1951”

    Interesting how prior to the civil war, rates were stable at around 5-6% since the founding of the country, which has since been followed by a much higher degree of socialism since, and a much more volatile trend in interest rates.

  17. Gravatar of benjamin cole benjamin cole
    4. June 2015 at 16:06

    I have been crying “Japan” forever.
    Print more money and keep printing more until the house is on fire.
    Milton Friedman said that first (in 1992) but dang if I wasn’t second.

  18. Gravatar of Major_Freedom Major_Freedom
    4. June 2015 at 16:10

    Gosh golly gee, print print print more! No costs to it! Free lunch at last! No adverse consequences on net! Woooot!

  19. Gravatar of Michael Byrnes Michael Byrnes
    4. June 2015 at 16:29

    Comrade Freedom wrote:

    “Gosh golly gee, print print print more! No costs to it! Free lunch at last! No adverse consequences on net! Woooot!”

    Perhaps the Fed wanted to print, print, print more than it wanted to raise spending or the price level.

  20. Gravatar of Major_Freedom Major_Freedom
    4. June 2015 at 16:40

    My Calls Burn wrote:

    Perhaps it is the opposite. Perhaps it is in their interests to print more and more without raising some abstract aggregate as if higher or lower levels of it affects everyone equally.

  21. Gravatar of ssumner ssumner
    4. June 2015 at 17:53

    J Mann, Good point.

    Patrick, Unfortunately the People’s Daily often makes more sense than the NYT.

    Jerry, In my view the supply-side problems tend to amplify drops in NGDP.

    Jason. Here’s how I look at it. Krugman said 2014 would be a test. Then the actual increase in jobs is pretty much what previous research suggests you’d expect. Then suddenly Krugman has nothing to say on the issue.

    Sure, you can look for alternative explanations, but why bother when it fits the standard model? Occam’s Razor.

    HW, Yes, you’d try to go back to the trend line, as you say. Monetary policy has no control over the P/Y split, you need supply side reforms to fix that problem.

    Justin, I wrote a post on the same subject, I’ll put it up tomorrow.

    Collin, The main cause of the liquidity trap was tight money, other factors complemented that problem.

  22. Gravatar of Saturos Saturos
    4. June 2015 at 18:05

    It is certainly counterintuitive that “drug crazed yuppies” would end up being a more reliable bellwether than the sober minds at the Federal Reserve. But it appears to be true.

    Wouldn’t Scott normally say that when the market signals that a base expansion is inadequate, it’s probably because it has perceived that it is not really permanent enough? You could say that the permanence was thwarted by the zero bound lasting longer than expected, but we know that the zero bound itself is endogenous to the expected stimulus, and that the Fed was doing everything to “reassure” markets of the temporariness of the injection (going so far as naming it qualitative rather than quantitative easing) and also showing much concern over overshooting the inflation target in any period, but little over its repeated undershoots. No wonder the markets had a different idea to Krugman and DeLong. I say markets: I still have a hard time intuitively grasping how the wisdom of crowds’ selection effect overcomes O’Rourke’s complaint.

  23. Gravatar of Ray Lopez Ray Lopez
    4. June 2015 at 18:43

    Sumner: “DeLong has by far the best argument, and if you are only going to read one post, stop reading mine and read his instead. ” – FINALLY! An honest Scott Sumner! But later: “In my view the weak NGDP growth is monetary policy. Period, end of story.” – ??! A simplistic shaman-istic sham remedy. Back to the old, dishonest Sumner…

  24. Gravatar of J.V. Dubois J.V. Dubois
    5. June 2015 at 02:09

    Good post as usual. But my other takeway is that DeLong and other “sensible left” thinkers are slowly distancing themselves from Krugman. And it is about time, his recession articles lately (last 1 or 2 years even) are borderline unreadable although I force myself to read them because unlike Krigman I want to keep myself informed about the “other side” arguments, weak as they are.

  25. Gravatar of ssumner ssumner
    5. June 2015 at 05:28

    Saturos, Good observations.

    JV. In my view Krugman’s most noticeable shift has been away from neoliberalism and toward the loony left big government solutions, as when he praises the current Greek government’s anti-reform position.

    In contrast, two recent Yglesias post criticize a $15 minimum wage and credit the Texas model with attracting lots of people to the state.

  26. Gravatar of Joel Aaron Freeman Joel Aaron Freeman
    5. June 2015 at 09:20

    Most economists haphazardly switch between the nominal economy and the real economy as it suites them, demonstrating no regard for the classical dichotomy. I was hoping, out of all schools of thought, that Market Monetarists would do better.

    The interest rate is a function of current nominal income, the savings rate, and expected nominal income in the future. There are no real factors involved. Low interest rates should only be explained through nominal mechanics, except where you have a sudden structural change in financial regulations.

    If the Fed had cut the 1-year treasury to -5% back in late 2008, we would have have been at positive 1% in 2010.

  27. Gravatar of ssumner ssumner
    5. June 2015 at 11:34

    Joel, You are mostly right, but are missing a subtle distinction. If the central bank targets inflation at 2%/year, then supply side factors that boost RGDP growth will also, as a side effect, boost NGDP. The classical dichotomy still holds, but real shocks can influence nominal policies.

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