When the weak are strong

Those who are as old as I am, and who have read The Economist for more than three decades, can recall dozens of economic crises in far-flung places all over the world.  Thailand, Mexico, Turkey, Indonesia, Brazil, Korea, Russia, etc, etc.  And in almost every case the collapsing economy and banking distress are associated with sharply falling currencies.

But every so often you find a peculiar case; a feeble economy associated with a strong, muscular currency.  I posted this right after the Japan post, because I wanted readers to ponder just how unusual it is for a currency to be strong in an economy that is so weak.  Another example occurred in the US during 1929-33, when the trade-weighted dollar rose in value, even as the real economy collapsed.  The same thing occurred in Argentina in the late 1990s and early 2000s.  Let’s consider what these odd cases have in common:

1.  Deflation.

2.  Real economies that had been doing well prior to the crisis.  Japan was the envy of the world in the 1980s.  The economy of the US in the 1920s was one of the most efficient the world has ever seen, in terms of economy policy.  The business press was very optimistic in mid-1929, as we had trade and budget surpluses, low taxes, weak unions, stable prices, free markets, etc, etc.  Argentina did some neoliberal reforms around 1990 and grew rapidly in the 7 years before the crisis hit.

3.  All three crises saw banking problems.

How can we explain these perverse cases—weak economies and strong currencies?  Perhaps the usual direction of causation was reversed.  Perhaps the strong currency caused the weak economy, by causing deflation.  Indeed, it’s now almost conventional wisdom that money was too tight in the US during 1929-33.  Some blame the drop in M2; some blame the ideology of pegging the dollar to a metal that was itself appreciating in real terms.  But most experts see the problem as monetary, broadly defined. The same is true of Argentina, which attached its currency rigidly (through a currency board) to the US dollar during a period when the dollar was appreciating from the tech boom.  And of course many economists such as Paul Krugman criticize the Japanese central bank for being too conservative, for pursuing deflationary policies.

So it seems to me that the profession does have an answer to the mystery of strong currencies in weak economies.  When this phenomenon occurs, the strong currency is itself the cause of the problem.  It seems that deflation can severely damage a formerly quite productive economic machine.

But (like TV detective Colombo asking “just one more question”) here’s what bugs me.  Didn’t the US economy go down the toilet between July and November 2008?  And didn’t the dollar not collapse, but rather soar in value against the euro during that 4 month period?  So why do almost no economists consider tight money to have been the problem during that period?  Why isn’t that like the US in the early 1930s, Argentina in the early 200os, and Japan in the 1990s?

I’d love to put on a rumpled raincoat and ask Mr. Bernanke that “one last question.”



42 Responses to “When the weak are strong”

  1. Gravatar of Chaitanya Chaitanya
    17. October 2010 at 21:05

    Could it be that the dollar holds a “privileged” position in the world economy as the ‘reserve currency’? Thus, when crises take hold – that is to say, world crises – the dollar is considered the safest haven, as it is assumed by investors – perhaps wrongly – that it will always remain valuable as the reserve currency into the future. Also, the stability of the US nation may lend itself to this illusion if one must call it that.

    Or its tight money.

  2. Gravatar of Liberal Roman Liberal Roman
    17. October 2010 at 22:06


    Sigh…I am sorry, but you argument that I have heard many times before lends itself just so easily to the same rebuttal that I can’t help but making it.

    I am sure you are a conservative, free market type and yet you basically just wrote that markets have been systematically wrong for the past two years now.

    Also, it’s not only the dollar that has gained, but the Euro and Yen too.

  3. Gravatar of cassander cassander
    17. October 2010 at 22:55

    Isn’t it likely that the change from inflation to deflation is much more damaging than either on its own? I.E. The US in 1929 and today (not sure about Argentina or Japan) had a small amount of inflation, which rapidly switched into deflation, which meant what otherwise would have been a small crisis became a massive one because everyone had been betting on inflation.

  4. Gravatar of Doc Merlin Doc Merlin
    18. October 2010 at 00:31

    A few things:
    1. Or it could be that the reason you see both is that the currency strength has no effect. This is supported by China’s increasing its currency strength yet seeing growth increase.

    2. Its been almost 3 years now since dec 2007, yet we are still in a hole. I don’t think anyone believes that wages and prices are so sticky they can’t adjust themselves at the margin in 3 years. At this point the economics profession should look for another culprit.

    3. I think the continuing bailouts and regulatory changes are the culprit.

  5. Gravatar of Doc Merlin Doc Merlin
    18. October 2010 at 00:34

    By hole I am referring to per capita non-farm employment which has collapsed. Almost 3 years should be long enough to fix it if the problem was stickiness, it hasn’t gotten any better. So, I don’t think the problem is stickiness.

  6. Gravatar of Richard W Richard W
    18. October 2010 at 03:55

    The 2008 period you refer to certainly did see global scarcity of dollars. See for example this September 18th swap line arrangement. Another thing you might want to research is the literally free money arbitrage opportunities that were left unclosed because there was not the financing available.

    “The Federal Open Market Committee has authorized a $180 billion expansion of its temporary reciprocal currency arrangements (swap lines). This increased capacity will be available to provide dollar funding for both term and overnight liquidity operations by the other central banks.

    The FOMC has authorized increases in the existing swap lines with the ECB and the Swiss National Bank. These larger facilities will now support the provision of U.S. dollar liquidity in amounts of up to $110 billion by the ECB, an increase of $55 billion, and up to $27 billion by the Swiss National Bank, an increase of $15 billion.

    In addition, new swap facilities have been authorized with the Bank of Japan, the Bank of England, and the Bank of Canada. These facilities will support the provision of U.S. dollar liquidity in amounts of up to $60 billion by the Bank of Japan, $40 billion by the Bank of England, and $10 billion by the Bank of Canada.

    All of these reciprocal currency arrangements have been authorized through January 30, 2009.”

  7. Gravatar of scott sumner scott sumner
    18. October 2010 at 04:37

    Chaitanya, It is not an either or situation–both are probably true. When the demand for money rises, it is the Fed’s job to offset that increase with a more expansionary policy. I think almost everyone agrees with that.

    Cassander, Your premise is wrong. The US did not have any inflation in 1929. But I agree with your logic, the sudden switch to lower inflation rates is a shock, which begs the question of why the Fed let this happen in America? In the 12 months to mid-2008 the CPI rose over 5%, in the next two years there was almost no change.

    Doc Merlin, You said;

    A few things:
    1. Or it could be that the reason you see both is that the currency strength has no effect. This is supported by China’s increasing its currency strength yet seeing growth increase.

    You misunderstood my point. I was not arguing that any currency appreciation is harmful, but rather a strong currency that causes falling NGDP is harmful. Obviously NGDP didn’t fall in China. China faces the Balassa-Samuelson effect, the other three cases didn’t.

    You said;

    “2. Its been almost 3 years now since Dec 2007, yet we are still in a hole. I don’t think anyone believes that wages and prices are so sticky they can’t adjust themselves at the margin in 3 years. At this point the economics profession should look for another culprit.”

    Yes, we have adjusted to the nominal shocks of 2007 and 2008, but not to the more recent shocks. That’s not just a hypothesis, look at the data on wages. And don’t compare them to CPI indices (which are worthless), look at NGDP.

    And has the minimum wage law adjusted? Have government salaries?

    And no, bailouts didn’t cause NGDP and RGDP to collapse in late 2008. Nor did regulatory changes. You seem to be arguing that the collapse of NGDP and the collapse of RGDP are unrelated phenomena. Is that really your argument?

    Richard, Good point–they needed to be much more aggressive.

  8. Gravatar of Indy Indy
    18. October 2010 at 04:44

    @Doc Merlin:

    Well, let’s look at the great >a href=”http://calculatedriskimages.blogspot.com/2010/10/job-losses-and-preliminary-benchmark.html”>employment chart from CR. Now, this chart isn’t perfect, it doesn’t “correct” for overall growth trends in the working-population, from general population growth, baby-boomer demographics, women entering the workforce, the period’s trend real-growth rate, etc. but it’s still very revealing.

    The last recession, the one where we could expect general economic-social conditions to be more-or-less closest to what we have now, and what with the tech-bust and 9/11, took almost 4 years to achieve a full employment recovery, a good 18 months longer than the 1990 recession, and two years longer than the average of the previous post-war recessions.

    So let’s step away from this recession and concentrate on the last one. Why did the last recession take so much longer to regenerate those jobs? Structural? Cyclical? NGDP trend departure? Sticky Wages? Austrian Debt-Speculation Excess? Whatever answer you give, why isn’t that answer the same for now, except adjusting for severity?

    Let’s look at that severity. Compared to the labor market weakness, it’s frankly amazing to me that real-GDP hasn’t fallen more than it has.

    The employment-population ratio has never recovered from the all-time peak April 2000 level of 64.7%. Today, we’re at 58.5%.

    In only the last three years, the civilian employed population has fallen by 4.7%, and the non-working supported population has increased by 9.5%. The supported persons-per-employed person” ratio has increased by 15%. Aggregate hours are back where they were in 1998.

    Whatever you think the explanation is, there’s little doubt that it will take an extended, uninterrupted period of healthy growth to achieve a full labor recovery. If, as is predicted, many millions of baby boomers retire during this period, it may take many years.

    My point is that it seems to me that the slowness of recovery alone doesn’t necessarily point to any particular single explanation.

  9. Gravatar of JTapp JTapp
    18. October 2010 at 04:45

    “So it seems to me that the profession does have an answer to the mystery of strong currencies in weak economies. ”
    –Isn’t it called the “monetary approach to exchange rate determination?”

    %change E (Yen/$) = Inflation Japan – Inflation U.S.
    Whichever country has the lowest inflation rate will see their currency appreciate. We know relative PPP holds pretty well in the long-run.

  10. Gravatar of JTapp JTapp
    18. October 2010 at 04:49

    And I would add the the point above the “Cambridge equation” in a 2-country setting–when one country’s demand for money increases, all else constant, its currency appreciates. Hence, a shock that weakens an economy but creates excess money demand causes an appreciation.
    I know you know all that, I just felt it was missing from the post.

  11. Gravatar of q q
    18. October 2010 at 05:46

    i’m not sure why you think that almost no economists think this. a lot of what i read suggests that investors at that time fled risky assets for (dollar) cash and cash equivalents. so there was/is a high demand for these assets compared to their supply. isn’t that the same as ‘tight money’?

  12. Gravatar of Joe C Joe C
    18. October 2010 at 07:29

    I hate to post on something not directly related to this post but did anyone read Charles Evans remarks in the Financial Times article this morning? I actually caught it via CNBC

    “Charles Evans, president of the Chicago Fed, said that “in my opinion, much more policy accommodation is appropriate today” because “the US economy is best described as being in a bona fide liquidity trap”, a point where ultra-low interest rates and high savings rates conspire to make monetary policy ineffective. ”

    I thought that we are NOT in a liquidity trap because there are other measures the Fed can use…QE and IOR.

    If this is true, I question how a person, Charles Evans, well acquainted with monetary policy via his research can make such a mistake…is it merely semantics are are there different definitions of liquidity trap? It also worries me that there appears to be so much discord among the Fed presidents.

  13. Gravatar of Joe C Joe C
    18. October 2010 at 07:32

    Forgot to mention….At least He does talk of temporally targeting NGDP instead of inflation.

  14. Gravatar of David Pearson David Pearson
    18. October 2010 at 07:50


    With regards to your reply to Doc Merlin, I’d be interested in your definition of “shock”. You say the labor market has not had time to react to “recent shocks”. Which ones? A candidate is the crisis in European sovereign debt. Was this a “shock” to the U.S. economy or labor market, or a passing cloud? After all, the European economy has been stronger than expected over the summer, and aside from periphery sovereign spreads, financial conditions remained quite loose (see corporate credit spreads). Yes, inflation expectations fell for a while, but this was due more to a slowdown in the U.S. than one in Europe. Was there a another “shock” to the U.S. economy in 2009 or 2010?

    As the bumper sticker says, “stuff happens”. There is always some negative event brewing in some corner of the world. The stock market doesn’t go up (or down) in a straight line, and 10%-15% corrections are common. Thus, if you define “shock” loosely enough, you can always find something to explain away the inability of wages to adjust over long periods of time.

  15. Gravatar of Stephen Stephen
    18. October 2010 at 08:00

    Seems the root problem is not letting large banks fail–fearing a dramatic fall in money supply. At the same time Bernanke not lowering interest rates enough (by increasing inflation if necessary) that if they did fail, new banks would find it extremely profitable to set up and run (keeping money supply growing).

    We have large zombie banks, sitting on bad loans, hogging market share with a government supported grip– and wonder why the fed has no traction? When they dump their REO and house prices fall, then people will buy houses and the market will be liquid.
    If inflation was 4% wouldn’t a large bank failure would be permitted as it would cool the inflation?

    It would have been politically easier and faster with Paulson/Geithners TARP plan….corrupt, but banks are getting their stealth subsidy anyway with 0% rates and suspension of mark to market, while we sit and wait for them to recapitalize.

  16. Gravatar of Sean Brown Sean Brown
    18. October 2010 at 08:01

    Sorry, but I really don’t think the underlying cause of Argentina’s crisis was the dollar peg. Proximate cause? Obviously, yes. But a continued inability to rein in provincial spending, financed by central-government transfer payments, was the true reason behind the money-printing gradually made it clear to Argentines that the peg was unsustainable (in the end, this widely-held perception among both Argentines and foreigners is what fomented the crisis).

    Paul Blustein’s book on the subject has some great commentary, interviews, and analysis –


    Here’s something from a World Bank paper, written in the late 90s and actually laudatory of Argentina –


    “In 1994, shared revenues accounted for 64 percent of total
    provincial revenues. General revenue sharing (coparticipation) is the largest single transfer, accounting for the bulk of transfers: 72 percent in 1991 and 57 percent in 1997. The importance of revenue sharing varies among provinces, but it has at least some importance to all of them. In Buenos Aires city, it is only 9 percent of total revenue; in large provinces it accounts for about half: Buenos Aires, 46 percent; Córdoba, 51 percent; Santa Fe, 57 percent; and Mendoza, 58 percent. In small provinces, the transfers typically 22 account for more than 75 percent of revenues, reaching 95 percent in La Rioja and Tierra del Fuego. Dependence on federal revenue sharing per se has not weakened provincial power. The provincial share of revenues is theirs by law, and there is little explicit federal discretion in determining the amount or distribution of transferred funds.” (pg. 21)

    The provincial governments kept increasing spending to finance their election campaigns (essentially buying votes through electoral promises). However, post-Tequila crisis they could no longer issue their own debt. So they no longer ran budget deficits, which from this paper’s perspective (late 1990s) made their finances seem great. In reality –

    (http://www.cato.org/pubs/journal/cj23n1/cj23n1-3.pdf , page 2)

    “Throughout the 1991-2001 period, the three levels of government expenditure rose 77 percent in dollar terms, while the Argentine GDP rose 57 percent and dollar-denominated tradable prices fell (Table 1).”

    In truth, the Argentine provinces’ “austerity” of the mid-90s was quickly replaced – not with provincial deficits, but with enhanced transfers from the central government. Since the government couldn’t (or wouldn’t) print the money to finance this, due to the dollar peg, it issued debt abroad, in dollars. This played a key part in making the external shock a true crisis.

    So, I agree to some extent that Argentina’s mid-term “problem” was monetary, in that the peso could not depreciate and thus cushion the export sector in the face of low commodity prices and Asian competition for manufactured goods. However, I think that to a very significant (perhaps dominant) extent, the true failure lay in a continued lack of fiscal discipline, combined with a lack of internal microeconomic and structural reforms (what I would call “neoliberal” such as making it much easier to start and run businesses, ending state-backed monopolies, etc. which Menem did a half-assed job of, and stopped pretty early). I actually think the same thing about Japan.

  17. Gravatar of Benjamin Cole Benjamin Cole
    18. October 2010 at 08:03

    Yes, yes, yes…the “strong dollar” crowd has rocks in their heads. I suspect they mindlessly connect the word “strong” to American strength.

    I try to use other words like a “export-enhancing exchange rate.”

    Another thought: Who wants a strong dollar? Business expanding overseas. I found this out when I bought farmland in Thailand…boy, wouldn’t it be nice if the dollar was worth more. And I could export fine fruits back to the US?

    I see no other reason for the strong dollar sentiments, other than fool’s sense that the word “strong” in connection with the dollar, somehow connotes strength.

    BTW, the 1990s, our best decade ever, we had a “weak dollar.”

  18. Gravatar of Benjamin Cole Benjamin Cole
    18. October 2010 at 08:04

    I gotta say it again: Scott Sumner is far and away the best economic commentator in America…now, if I could just get him to adopt a public-swaying rhetorical style….

  19. Gravatar of Greg Ransom Greg Ransom
    18. October 2010 at 08:09

    Excellent post.

    One question. Why did the U.S. and Japanese bankers think they needed to tighten as their “go-go years” really began to flame — what if they poured more gasoline on the fire, instead of less?

    What is you story about what would happen then?

    If there room in you world Scott for the possibility of an artificial and unsustainable boom fueled by an unsustainable and ever accelerating expansion of credit-leverage-money?

    Isn’t it possible that the set up for a period where the banks have made money and credit and leverage too tight … is a period when the banks have made money and credit and leverage to loose?

    I’m not asking about history, I’m asking about causal mechanisms. A period when money and credit and leverage is too loose creates an artificial and unsustainable boom — setting up its consequence and making a re-trench inevitable.

    Or is such a causal mechanism excluded from your thinking by the fiat of what you model allows to you imagine?

    Scott wrote:

    “money was too tight in the US during 1929-33”

  20. Gravatar of Benjamin Cole Benjamin Cole
    18. October 2010 at 08:56

    Yeah, that was a great character, Columbo. Very effective.

  21. Gravatar of marcus nunes marcus nunes
    18. October 2010 at 09:50

    Funny how QE is always couched in terms of “effect on lowering long term interest rates” and NEVER on “how it much it would affect AD”!
    Then, when interest rates fail to fall (and likely increase), everyone says “it didn´t work”!

  22. Gravatar of JimP JimP
    18. October 2010 at 10:27

    Discussion in Boston of exactly how a price level target would work:


  23. Gravatar of Jeff Jeff
    18. October 2010 at 11:46

    Greg, your comment reminds me of the light-bulb joke: How many Marxist-Leninists does it take to put a light bulb in the ceiling? Answer: None. The bulb contains the seeds of its own revolution.

    But seriously, I’m unclear as to just what boom-bust theory you favor. From the little I’ve read, Hyman Minsky thought that long periods without a financial crisis breeds complacency in the form of lower lending standards and a general underpricing of risk, so that when the inevitable larger-than-expected adverse shock comes along, no one’s ready for it and you get a crisis and a bust.

    Perhaps someone here can correct me on this, but it seems that the Minsky cycle is positing very unrational expectations, which is not going to sit well with many economists.

    Austrians apparently think that booms are only bad to the extent that they are “artificial”. How do you measure the degree of artifice? If it can be measured, why don’t rational agents recognize it and bet on the collapse?

    Another theory is that

  24. Gravatar of Doc Merlin Doc Merlin
    18. October 2010 at 11:55


    “My point is that it seems to me that the slowness of recovery alone doesn’t necessarily point to any particular single explanation.”

    Two obvious similarities are the massive fiscal stimulus.

    Another possibility:
    legal structural changes occurred, they drastically raised the fixed costs for businesses which strongly discourages new entrants. Since new entrants are the main engine of job creation, it took much longer to reach full employment. In this example I am specifically thinking of Sarbane Oxley.

    Anyway I still hold that the slowness suggests its not from stickyness. It could still be from other issues such increased search costs, or something else though.

  25. Gravatar of Keith Keith
    18. October 2010 at 13:25

    “It seems that deflation can severely damage a formerly quite productive economic machine.”

    Yes, yes, but the question is by what mechanisms does monetary deflation damage an economy? making labor more expensive in real terms? shifting the distibution of income between labor and capital? reducing the income available for investment? Lowering real returns?

    It seems that mechanisms via which monetary deflation harm a productive economy are all transcient effects. Doc Merlin may be right in that 2 to 3 years should be enough time for wages to adjust and the transcient effects of monetary deflation to dissipate.

    Perhaps it is a lack of investment that is keeping us in the doldrums and perhaps monetary policy is not what is keeping savings from being translated into productive investments?

    Closing questions: wasn’t the money supply in the U.S. pretty much flat from 1925 to 1930? With a growing economy between 1925 and 1929, wouldn’t a great deal of deflation have built up, perhaps not recognized, prior to the crash in 1929?

  26. Gravatar of Greg Ransom Greg Ransom
    18. October 2010 at 21:13

    Jeff, William White, former chief economist of the BIS, combined Minsky with Hayek in his papers anticipating the bust.

    There are aspects of Minsky and Hayek that are highly compatible.

  27. Gravatar of Greg Ransom Greg Ransom
    18. October 2010 at 21:14

    Jeff, this is something I’m not going to explain here.

    Jeff wrote:

    “Austrians apparently think that booms are only bad to the extent that they are “artificial”. How do you measure the degree of artifice? If it can be measured, why don’t rational agents recognize it and bet on the collapse?”

  28. Gravatar of nyd nyd
    19. October 2010 at 01:24

    Sean Brown — thank you.

  29. Gravatar of scott sumner scott sumner
    19. October 2010 at 05:53

    JTapp, Yes, I was being a little cute by pretending there was some great mystery to be solved. But in many discussions of our financial crisis it is lumped in with all those other crises that were associated with high inflation. Ours is different, and part of a much smaller set of cases. So the Rogoff/Reinhart data isn’t really relevant.

    q, I have read many many discussions of 2008 by economists. They almost all say “the US economy plummeted despite accommodative monetary policy” or despite extreme ease.

    Joe, Thanks for the info. He may be using the term loosely, to mean lower rates can do no more, but there are other things that can be done.

    I couldn’t find him touting NGDP–do you have a link?

    David, Merlin was talking about 2007 and 08. In 2009 NGDP fell at the most rapid rate since 1938. The recovery in 2010 has been far slower (for NGDP) than is normal from a severe recession. (4% vs. 11% in the first 6 quarters of 1983-84) I just don’t think the public understands how big of wage cuts they need to take. And since government workers and minimum wage workers and workers in safe private areas like health care are not going to take draconian wage cuts, then the rest of workers must take far deeper cuts to compensate. It’s just not happening fast enough.

    If you had shown me nothing more than the future path of NGDP back in 2007, I would have predicted a severe recession and a slow recovery—EVEN WITHOUT KNOWING ANYTHING ABOUT FINANCIAL CRISES, STRUCTURAL PROBLEMS, OVERREGULATION, ETC.

    Stephen, A problem, but not the problem.

    Sean, Sure Argentina had other problems like fiscal irresponsiblity. But those don’t cause a depression with 20% unemployment and falling price levels. Argentina’s government policies have been even worse in the last 7 years, and GDP has grown very rapidly. That tells you how important monetary policy is. Even a left wing government can generate fast GDP growth.

    Benjamin, How about “heavy ball and chain dollar.”

    Greg, Good question. I think the 1990s would have been a bad decade, no matter what. I just think the tight money added a bit of “secondary deflation” on top of some excesses and structural problems that you correctly pointed out were there. The real slowdown would have occurred, but in a less destructive fashion.

    Marcus, Good point. And why is fiscal policy never explained as “will it provide the hoped for inflation.” It’s all about growth. Both are attempts to boost P*Y, but money is discussed in the context of P and fiscal stimulus Y.

    JimP, Thanks for the link.

    Keith, What matters is M*V, not M, so the 1920s don’t create any mysteries on that score.

    See my reply above to David on the subject of Merlin’s question.

    I’m willing to keep an open mind, and not assume it’s 100% about sticky wages. There may be other transmission effects for nominal shocks.

  30. Gravatar of Joe C Joe C
    19. October 2010 at 07:55


    Link to Fed’s Evans Article


  31. Gravatar of Keith Keith
    19. October 2010 at 08:08


    I’m not convinced that what matters is M*V, but perhaps. The reason is that V is really a calculated term: M*V = GDP or NI. If NGDP were rising but M is constant, by definition V will rise, but that would not mean that deflationary pressures are not building? I think of V as sort of a rubber band: getting stretched out at times and pulled back at times. It is the buffer for NGDP/M. Expectations of inflation, or deflation, take time to develop; in the mean time, velocity should be changing? Or put another way, by definition, velocity will change faster than prices.

    Agreed with comments to David, just wish your commentary were made explicit in the public debate over “QE”. I think lowering government salaries and pensions would be an appropriate response to the recession but would rather see it done explicitly, and if done by devaluing the $ the reasons made explicit.

  32. Gravatar of Benjamin Cole Benjamin Cole
    19. October 2010 at 08:20

    the “ball-and-chain big dollar”….not bad.

  33. Gravatar of Bob OBrien Bob OBrien
    19. October 2010 at 10:51

    Is the low level of NGDP a result of a low supply of money or a low demand for money? It seems to me there is plenty of supply of money so I am assuming the problem is the lack of demand for money. I do not see how QE2 is going to increase the demand for money so I don’t think it will do any good.

    I am not an economist so I am probably wrong. But I am a small investor and, like many other small investors both here and in Japan, I am not borrowing or investing. I am hoarding. Maybe this is the real (demand?) problem. I don’t see how QE2 is going to motivate me to borrow or invest.

  34. Gravatar of Mark A. Sadowski Mark A. Sadowski
    19. October 2010 at 17:11

    I’ve often felt the predeliction for “strong currencies” was a very Western and oddly testosterone loaded (compensation for a lacking?). In the real world it is often better to use another’s mass and strength to your own advantage. That is the lesson of Judo and part and parcel of Zen philosophy as well.

  35. Gravatar of Morgan Warstler Morgan Warstler
    19. October 2010 at 17:38

    “Austrians apparently think that booms are only bad to the extent that they are “artificial”. How do you measure the degree of artifice? If it can be measured, why don’t rational agents recognize it and bet on the collapse?”

    Jeff, I don’t think Austrians are concerned about the booms, its that the busts have to be able to play out.

    The losers have to lose, the hard assets have to change hands, or “the fear” no longer moderates the game play.

    That is what makes a boom artificial. And frankly, that’s what most here don’t like… they don’t want to see the losers lose.

    They are like the new sports parents – no one has to LOSE, and what kind of fun is that?

  36. Gravatar of scott sumner scott sumner
    21. October 2010 at 04:57

    Joe, Thanks, But I didn’t see any mention of NGDP targeting. Did I miss something?

    Keith, I don’t follow your comment about velocity. You are right that it is the ratio of NGDP to M, but I don’t see why that is important. Deflationary pressure doesn’t build up when the macro economy is doing fine.

    Benjamin, Thanks,

    Bob OBrien, You said;

    “Is the low level of NGDP a result of a low supply of money or a low demand for money? It seems to me there is plenty of supply of money so I am assuming the problem is the lack of demand for money. I do not see how QE2 is going to increase the demand for money so I don’t think it will do any good.”

    Neither, It is due to a very high demand for money right now.

    Mark, Good analogy. It’s pretty immature to think a price movement in one direction is always good. Aren’t prices supposed to be at equilibrium? Not high?

  37. Gravatar of Keith Keith
    21. October 2010 at 18:27


    I’ll spend a moment to try and explain my thinking. No need to reply, this thread is old.

    If in 1880, 10% of the US’s gold supply was shipped from New York to London (quietly), M (the money supply) would drop immediately. NGDP would not. Hence, velocity would go up. Over time, people would come to perceive that the money supply had shrunk and gradually price deflation would develop, as there was less money per unit of production. NGDP might drop over time if the price declines outweighted any increases in production. Eitherway, velocity would gradually return toward its starting place (not necessarily to its starting place).

    Changes in money, prices and production are not necessarily in phase with each other; there will be lags between their respective peaks and troughs. This is especially true when changes in production are driven by changes in the money supply, as it will take time for these changes to be perceived and expectations to adjust and be reflected in prices and still more time for the effects of price changes to alter production.

    My understanding was that from roughly 1925 to 1929, the money supply in the US was relatively flat. Real production was growing so velocity was rising. It may very well be that technology and banking (and other business) practices were evolving to support more production for a given quantity of money. It could also be that in addition to this it was taking time for people to recognize that the ratio of money to production was changing and that this was creating stresses and strains in the economy.

    Velocity is an agregate variable that tells us how much economic activity we got per unit of money; it doesn’t tell us anything about why. Movements in velocity are likely to be often caused by the movements in money and production being out of phase: one leading or lagging the other.

  38. Gravatar of ssumner ssumner
    22. October 2010 at 18:35

    Keith, I see your example, but the question is whether it supports your claim about the 1920s. I’m not saying you are definitely wrong about velocity bouncing around, but the example you cite depends on secrecy. On the other hand, I do agree that when there is a change in policy, V may offset it for a period of time. So that part I’m OK with. But I still think SOME of the effects of the policy should show up almost right away–if only in the asset markets. But the economy of 1925-29 did not exhibit any signs of money tightness, despite the fact that the monetary data was not held in secret.

  39. Gravatar of Keith Keith
    23. October 2010 at 19:24


    Any time the money supply is not growing with production, I would suspect that fact has the possibility to affect the value of money. Did it in the 20s? I don’t know. When I look at the 20s, I see a time of enormous potential; there were just so many new/young technologies: autos, planes, electricity, radio, TV around the corner. The thirties should have been prosperous.

    How quickly do people assess the movements in the value of money? How quickly do expectations get adjusted and transmitted to prices?

    Because my example was extreme, secrecy is probably critical. But what happens when changes are gradual over many years? Even if data is available within weeks or months, how do you interpret it? Perhaps technology is enabling the economy operate on less money per unit of production. Perhaps not completely, but you interpret the data that way? The real questions is how do expectations get set and over what time frame? Noting that the process of developing expectations probably evolves over time as technology, knowledge and data evolve?

    On the 20s, it is just a question that comes to mind when I look at the data: if the money supply were flat and production where growing, why wouldn’t that eventually constrain growth all by itself? I’m not saying it did; I think there are other arguments for why velocity would trend upward.

  40. Gravatar of Scott Sumner Scott Sumner
    24. October 2010 at 07:34

    Keith, Both money supply and money demand matter. There were no signs of trouble untill late 1929. At that time the Fed adopted a very tight money, and NGDP fell in half over the next 4 years. I don’t see a big mystery to explain.

  41. Gravatar of Doc Merlin Doc Merlin
    30. October 2010 at 05:53

    @ Morgan Warstler

    Yah, its very Schumpterian, the bust is there to clear out the bad choices and allow the destructive part of creative destruction to happen. Without them, you just have eventual massive but glacially slow downward slides, as large corps zombify.

  42. Gravatar of Martin Martin
    3. January 2016 at 18:51

    Scott, It is possible to use NGDP targeting in a partially dollarized country such as Argentina? or because of it the central bank has less “power” to target nominal income?

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