Missing dish on Krugman´s menu

Krugman has an interesting post that fiddles around with Larry Ball´s recent psychoanalysis of Bernanke´s about face, especially if you compare BB today with the BB who 12 years ago wrote on the Japanese “Self-induced paralysis”.

Essentially Krugman sets up two policy menus to reflect BB´s, respectively, pre and post 2003 views.

Menu A comprises:

- Targeting long-term interest rates
– Currency depreciation
– Money financed deficit spending
– A Krugman-style inflation target (note that he doesn´t simply say “higher inflation target”)

Menu B comprises:

- Guidance on future short-term rates (the rates the Fed sets)
– Purchases of long-term bonds and other nonconventional assets
– “Oversupplying reserves”, that is, just pushing up the monetary base

And after a bit of discussion concludes:

You can see where I’m going here. Menu B is, if you like, safer for the Fed than Menu A, because it is defined in terms of actions rather than results; the Fed can point to what it is doing, rather than announce a target for long-term rates or inflation that it might fail to hit. So Menu B serves institutional objectives better. Unfortunately, it doesn’t do the job for the economy. To be fair, we don’t know that Menu A would, in fact, be sufficient. But Benanke the Younger — BB before he was assimilated by the Fedborg — would have said that this was no reason not to try.

But the conclusion is not the exact description of the difference that Krugman discussed. Before, Krugman writes:

Well, here’s my take: Menu A involves the Fed setting targets that can be achieved only if the markets believe that it will persist with unconventional policies even as the economy recovers; ordering from Menu A requires, as I put it lo these many years ago, that the Fed “credibly promise to be irresponsible”. Menu B, on the other hand, involves more or less mechanical actions that the Fed can definitely take.

What if you set a target that defines “exactly” where the Fed will stop, i.e. not become, let alone continue, to be irresponsible?

As Krugman correctly notes, all the “targets” in menu A suffer from a credibility problem and that´s the catch. But that won´t be true if the target is a level target, like a NGDP level target, that could be well defined and credibly established from past data and trend (even if it´s present desired (or attainable) level is deemed a bit different from where it was originally thought it should be).

And even BB himself has expressed this view in 1999:

I do not deny that important structural problems, in the financial system and elsewhere, are helping to constrain Japanese growth. But I also believe that there is compelling evidence that the Japanese economy is also suffering today from an aggregate demand deficiency. If monetary policy could deliver increased nominal spending, some of the difficult structural problems that Japan faces would no longer seem so difficult.

Pity he “chickened out”.

Open letter to Brad DeLong

Brad

I tried to put a comment on your blog but have been repeatedly blocked. I´ve also noticed that at least one comment that suggested you were not being reasonable about this affair “sneaked through” but was later deleted (funny that the comment started with “I know you will not publish this”). So I´ll go public with this open letter.

First you link to my post:

A man for any season: Before it was about “expansionary austerity”. Now it´s convenient to call for “self-financing fiscal stimulus”: In a “Man for all seasons”, we get the story of Thomas More  who stood up to King Henry VIII when the King rejected the Roman Catholic Church to obtain a divorce and remarriage. Now we have a duo – Larry Summers and Brad Delong – that “adapt” to the season at hand. In their just released paper – Fiscal Policy in a Depressed Economy – they say that in the “liquity trap” situation America is in today temporary stimulus “may actually be self-financing”. Interestingly, when he was number two to Rubin (and later top Treasury honcho) during the Clinton Presidency (1993 – 2000), Larry Summers peddled “stimulative austerity”, the idea that to cut deficits would lower interest rates by enough to produce stronger growth…

And then write:

Now this really isn’t fair to Larry.

So I wrote, asking whether Nunes had actually read the paper.

It certainly did not sound like it.

I asked if I(!) understood that we had explicitly argued in our paper that back in 1993 (when Alan Greenspan was very worried about long-term fiscal stability, and promised to make monetary policy easier in order to hold aggregate demand harmless if the Clinton administration undertook deficit reduction) the benefit-cost calculation was very different from what it is today (when Ben Bernanke is saying that he really would like some help from other branches from government).

What the benefit-cost calculation is depends on what the monetary-policy reaction function is, and different monetary-policy reaction functions lead to different appropriate fiscal policies.

Apparently the answer is no. Here’s what I got back, via email:

Mr “DeLong”

Given the quality of your comment I have to assume YOU are the bullshit artist impersonating someone else.

You have been excluded.

Brad, you know that´s not how it went down. You are misrepresenting what happened.

The fact is that I answered your comment in a normal and civil manner. Another commenter – Benjamin Cole – also discussed your comment. But then you came back “swinging the bat” with an answer to my comment, accusing me of implying that Larry Summers was a “bullshit artist” and that I “owed Larry an apology”.

I found the tone and content of the comment very strange and began to have doubts about the real identity of the “Brad DeLong” that was writing. This led me to write the e-mail you mention to the address every commenter is required to supply when posting a comment. I opened the e-mail with “Mr. Brad DeLong”, clearly implying that I didn´t believe the writer was the “real thing”.

As to the substance of your “complaint”, I don´t think I “misrepresented” Larry´s views.

Here´s the Economist of March 24th:

WHEN he was at the Treasury nearly 20 years ago Larry Summers would counsel President Bill Clinton on the merits of “stimulative austerity”: cut deficits, and interest rates will fall by enough to produce stronger economic growth. Now Mr Summers is making the opposite case: stimulate growth through a bigger deficit, and the long-term debt may shrink.

Scott Sumner did a post on your paper with Summers. Being an academic, he knows much better than me how to “roam around the room”, much as diplomats deal with one another. This is a good example of “diplomatic trashing”:

PS. Just to reiterate, this post is not a comment on the core of D&S. I´m not qualified to judge their model, but it looks fine to me. I just don´t buy the assumption that motivates the entire exercise.

Great way to make the other guy feel good – i.e. not get him to charge you with misrepresentation and demand an apology – while subtly implying that what he did was pretty useless.

Scott even did something rare, doing a post on comments. And starts off with: “My commenters are much tougher on Larry Summers than I am”.  A couple of quotes from commenter Jim Glass:

If the Fed was and is unwilling to provide enough stimulus during this recession, the #1 largest identifiable reason is: Larry Summers.

Now he writes:” We presume the central bank is unwilling to provide additional stimulus”. Please. Shame on Larry Summers.

FN: [1] Except write a planning memo to Obama saying there was only $ 300 billion of quality fiscal stimulus available “we do not believe it is feasible to design proposals along these lines that go beyond this total size”, with necessary amounts beyond that amount “not as effective as stimulus”. Now he is writing that deficits as large as one may desire are self-financing?

Anyway, the crux of my argument on the post I wrote is captured in this short paragraph, which even contains a plea for “union”:

You may think Summers got it right by advocating “stimulative austerity”. But his indicator variable – interest rates – moved in the “wrong” direction. Yes, you guessed, monetary policy did it! And it´s monetary policy that can turn things around today. So that´s where the advocates of fiscal stimulus should band together and stop wasting precious time.

One question: Why do you often “swing the bat” on others in defense of “higher-ups”? You certainly do plenty of that in “defense” of Krugman. In any case I don´t think it´s up to you to say that I “owe Larry an apology”. He´s big enough to demand one himself.

Illustrating the story: Same “technique”, different interpretations

David Beckworth and I have for a long time been using a charting technique that purports to show, explicitly, that the economy is “slogging”, not “recovering”. Now I see that Tim Duy is doing the same, but his interpretation is different, influenced by the standard “growth bias”, abstaining from considering the levels difference:

The 0.5% gain in February compensated for some earlier weakness in the numbers, while the overall trend holds – spending is rising about 0.18 percent per month compared to 0.24 percent prior to the recession.  Spending was supported by a drop in the saving rate, down to 3.7% from 4.3% the previous month.  This likely reflects borrowing for new auto purchases – note the stronger trend in durable goods spending:

The acceleration in auto sales is clearly supporting this trend since the middle of last year.  Apparently, what’s good for Detroit is still good for America. The importance of autos in sustaining spending begs the question of what will occur when pent up demand is satisfied?  Obviously, auto sales will stop contributing positively to growth as sales level off at some point in what I would expect to be the not too distant future.

Bernanke is truly amazing!

He “confessed” he knows both the cause and the solution to the “problem”:

“We lack a source of demand to keep the economy growing,” said Federal Reserve Chairman Ben Bernanke at a recent GWU lecture. The economic recovery will be slow and unemployment will remain high as long as consumers are not spending and businesses are not investing. And, businesses will not invest as long as there isn’t enough demand to warrant it. To strengthen the recovery as much as possible, we must first realize that demand is both the cause and solution to the economic crisis. 

And it REALLY is, as depicted in the chart below:

But Bernanke gets into the “in” theme that focuses attention on the 1%:

People often wrongly suggest that the economic problems we face are due to a lack of competitiveness, leading to outsourcing of jobs; they’ll blame taxes (especially corporate income taxes), regulation, education, skills of the workforce, and labor costs, among other things. But, this fails to explain the situation because these things don’t happen overnight to cause such economic problems, nor can they result in a global recession. In addition, the U.S. has been dealing with outsourcing for decades, yet still has been perfectly capable of having full employment for most of that time. Instead, the more obvious cause of the economic malaise is the sudden Great Recession, a severe global reduction in economic output (GDP) due to a loss of demand for goods and services.

So why did demand fall in the first place? People often point to the global financial crisis as the cause of the Great Recession. However, this was only a trigger. The economy was already on an unsustainable path before the financial crisis. The crisis was simply a bubble that delayed the recession, making the recession more severe when it suddenly burst. The real root cause was the insufficient growth of middle and lower class incomes to sustain the levels of demand needed to keep full employment. Income growth went increasingly to the wealthiest among us at disparity levels not seen since the Gilded Age that preceded the Great Depression of the 1930’s. That is no coincidence.

Wealthier people save a greater proportion of their incomes compared to other income groups that spend a greater portion. As more money is shifted to the wealthiest, there is less consumption, but more money available for investment or consumer loans. However, investment opportunities depend on the existence of sufficient consumer demand. This created lots of investment money competing for fewer investment opportunities and at lower rates of return.

And puts part of the “blame” on Wall Street:

Normally, this situation would lead to a recession as businesses downsize due to insufficient demand, and the risk of investment starts to outweigh the returns. Instead, what happened was Wall Street managed to create a new huge investment opportunity in the form of mortgages, using various techniques that hid the real risk from the investors and even themselves. This boom in housing demand propped up consumption in the economy. But of course, this level of consumption wasn’t backed up by enough personal income to be sustainable and would lead to a severe economic crash.

Conveniently forgetting that the Fed has close control of the nominal quantity called NGDP (PY) through its ability to determine MV. In “normal” times the Fed should offset, via M, changes in V. In times like the present it should more than offset the fall in V, getting MV to rise so that PY will get a boost!

Bernanke´s Fantasy

I was just beginning to do a post on Bernanke´s 4th and final Lecture to students at GWU when I came across this just written post by David Beckworth:

The Fed’s failure to stabilize and restore aggregate demand meant it was passively tightening.  This failure to act was epitomized by the Fed’s decision in September, 2008 to not lower the federal funds rate despite the collapsing economy.  This passive tightening is what turned a mild recession into the Great Recession.  Note that the financial crisis was a consequence of this failure, not the cause.   Just like in the Great Depression, the Fed’s failure to stabilize aggregate demand lead to a severe financial panic.  But you will never hear Chairman Bernanke admit it.  For it would not be good PR for the Fed to acknowledge its failure.  And that is why Bernanke did not discuss the passive tightening of monetary policy in his lecture.

So I´ll just put up a version of a chart Bernanke showed. It´s clear we´ve experienced a miniaturized version of the “Great Depression”. Given what Bernanke says in his talk and DB´s arguments, it´s unfortunate that one of Bernanke´s “passport to fame” was his 1983 AER article “Nonmonetary Effects of the Financial Crisis in the Propagation of the Great Depression”. It has become the conventional wisdom (see here) and unfortunately so, because the consequence, as argued by DB, is “passive tightening” in steroids, which leads, as Bernanke concludes, to:

We began by noting the two principal tools and responsibilities of central banks

– serving as lender of last resort to prevent or mitigate financial crises

– using monetary policy to enhance economic stability

The Fed and other central banks used both tools extensively in the crisis and its aftermath. These tools helped prevent a repeat of the Great Depression of the 1930s and set the stage for a slow but continuing economic recovery.

Used BOTH tools? The second one has been used at most parsimoniously. Maybe that´s why I keep thinking of Adele´s (Could have had it all) “Rolling in the deep”!

DeLong & I

The other day I wrote a post which Brad summarizes in his blog:

A man for any season: Before it was about “expansionary austerity”. Now it´s convenient to call for “self-financing fiscal stimulus”: In a “Man for all seasons”, we get the story of Thomas More  who stood up to King Henry VIII when the King rejected the Roman Catholic Church to obtain a divorce and remarriage. Now we have a duo – Larry Summers and Brad Delong – that “adapt” to the season at hand. In their just released paper – Fiscal Policy in a Depressed Economy – they say that in the “liquidity trap” situation America is in today temporary stimulus “may actually be self-financing”. Interestingly, when he was number two to Rubin (and later top Treasury honcho) during the Clinton Presidency (1993 – 2000), Larry Summers peddled “stimulative austerity”, the idea that to cut deficits would lower interest rates by enough to produce stronger growth…

And writes:

Now this really isn’t fair to Larry.

So I wrote, asking whether Nunes had actually read the paper.

It certainly did not sound like it.

I asked if I understood that we had explicitly argued in our paper that back in 1993 (when Alan Greenspan was very worried about long-term fiscal stability, and promised to make monetary policy easier in order to hold aggregate demand harmless if the Clinton administration undertook deficit reduction) the benefit-cost calculation was very different from what it is today (when Ben Bernanke is saying that he really would like some help from other branches from government).

What the benefit-cost calculation is depends on what the monetary-policy reaction function is, and different monetary-policy reaction functions lead to different appropriate fiscal policies.

Apparently the answer is no. Here’s what I got back, via email:

Mr “DeLong”

Given the quality of your comment I have to assume YOU are the bullshit artist impersonating someone else.

You have been excluded

The whole point of weblogging–if it has a point–is to create a more informed public sphere than the journalistic filter allows, not a less informed one.

My side of the story:

I was pleasantly surprised to come back from dinner and find that Brad had put up a comment.

I answered the comment and Benjamin Cole also commented on DeLong´s comment. Everything very civilized. The next day I found DeLong had replied to my comment but found the wording very strange. I was accused of calling Larry Summers a “bullshit artist” and that I “owed Larry an apology”.

I got suspicious, and then remembered that some time ago Scott Sumner had also received a comment from a “Brad DeLong” which had proven to be a fake. I even consulted Scott and he told me it was probably a fake because “The real DeLong wouldn´t say I had to “apologize to Larry”. So I deleted DeLong´s, Benjamin´s and my own comments and sent an e-mail to the apparently fake DeLong saying that he was the “bullshit” artist for impersonating someone else.

Now I find out that the comment had been from the “real thing”.

Who said that blogging cannot have “fun moments”!

Update: I´ve now tried two times to put a comment/explanation about what happened in DeLong´s blog (pasting a link to this post) but haven´t been allowed in!

Like in Ulysses and the Sirens, John Taylor wants to “tie up the Fed”

From Taylor´s op-ed at the WSJ:

Unfortunately the Fed has returned to its discretionary, unpredictable ways, and the results are not good. Starting in 2003-05, it held interest rates too low for too long and thereby encouraged excessive risk-taking and the housing boom. It then overshot the needed increase in interest rates, which worsened the bust. Now, with inflation and the economy picking up, the Fed is again veering into “too low for too long” territory. Policy indicators suggest the need for higher interest rates, while the Fed signals a zero rate through 2014.

For all these reasons, the Federal Reserve should move to a less interventionist and more rules-based policy of the kind that has worked in the past. With due deliberation, it should make plans to raise the interest rate and develop a credible strategy to reduce its outsized portfolio of Treasurys and mortgage-backed securities.

History shows that reform of the Federal Reserve Act is also needed to incentivize rules-based policy and prevent a return to excessive discretion. The Sound Dollar Act of 2012, a subject of hearings at the Joint Economic Committee this week, has a number of useful provisions. It removes the confusing dual mandate of “maximum employment” and “stable prices,” which was put into the Federal Reserve Act during the interventionist wave of the 1970s. Instead it gives the Federal Reserve a single goal of “long-run price stability.”

Coincidentally, Scott Sumner recently wrote a post entitled: “John Taylor on monetary policy in 2008”.

Between 2008 and 2009 NGDP fell at the fastest pace since the Great Depression.  That suggests that monetary policy was probably too tight in 2008.  Oddly, John Taylor seems to think money was too easy…

The Fed “messed up” the moment it let money supply growth reverse while velocity was falling. At the time that happened the Fed was giving excessive attention to oil (and commodity) prices, just as Taylor does in his 2008 piece!

Below is the illustrative picture. Note that Taylor´s rates “too low for too long” period matches exactly the interval during which NGDP was climbing back to trend. So it seems “low rates” was exactly what was required. Under his namesake rule, which indicated a much higher FF rate, it´s unlikely that would have occurred.

This is what happens when the President controls the Central Bank: Good for a big laugh, before Argentina becomes the next Zimbabwe!

From the Merco Press:

The president of Argentina’s Central Bank (BCRA), Mercedes Marcó del Pont, stressed the importance of the recently approved bank’s charter reform and denied that printing currency leads to the creation of an inflationary state “since inflation is rooted in other causes”.

What are these other causes?

The banker added that “it is totally false to say that printing more money generates inflation, price increases are generated by other phenomena like supply and external sector’s behaviour”.

And the best part:

“We discard that financing the public sector is inflationary because according to that statement the increase in prices are caused by an excess of demand, something we do not see in Argentina. In our country the means of payment are adjusted to the growth of demand and tensions with prices must be looked on the supply side and the external sector”.

Professor Sargent. Please go to Argentina and “set them straight”, like when in January 1986 you wrote “An open letter to the Brazilian Finance Minister”, telling him what would happen if he continued with his policies. (Reprinted in Thomas J Sargent “Rational Expectations and Inflation, Second Edition 1993, pps 251-255)

Update: The Economist has a good report:

FOR the past 20 years a plaque has adorned the lobby of Argentina’s Central Bank, proclaiming its “primary and fundamental mission to preserve the value of the currency”. This week the plaque was removed after the country’s Congress approved a government bill that gives the bank a new, wordier mandate: “to promote, to the extent of its ability and in the framework of policies established by the national government, monetary stability, financial stability, jobs and economic growth with social fairness”.

Put more simply, the bank has lost the last shred of its legal independence and become the piggy bank of President Cristina Fernández’s government. It can now be required to transfer to the treasury cash equal to 20% of government revenues plus 12% of the money supply; to use its reserves (of $47 billion) at will to pay government debts; and to play a more active role in regulating banks and in steering credit to favoured industries.

Bernanke misses the “heart of the matter”

Bernanke said of the Great Depression in his third Lecture at GWU:

First, the Fed failed to use monetary policy to prevent deflation and an economic collapse. Second, the Fed did not adequately carry out its responsibility as “lender of last resort,” even as thousands of banks failed. ”The Fed did not fulfill its intended mission” during the Great Depression.

So:

Without the forceful policy response that stabilized the financial system in 2008 and early 2009, we could’ve had a much worse outcome in the economy. Without strong government intervention the financial system could have faced a “total meltdown.”

But

Even as the crisis ebbed, the recession deepened, with gross domestic product shrinking at an 8.9 percent annual rate in the fourth quarter of 2008, the worst quarter in 50 years. The unemployment rate rose to 10 percent in October 2009, the highest since June 1983. The threat of a second Great Depression was very real.

You can see that Bernanke implies that this time “we did it right”, and avoided a catastrophe because our intervention was “forceful and stabilized the financial system”.

He simply won´t recognize the responsibility the Fed had in turning a “normal” recession into a “Lesser Depression”. The economy only plunged after mid-2008. By then the house bubble had popped more than two years before and financial problems had appeared since early 2007 and intensified some months later.

There were two things in his mind. His “creditism” bias geared his “save the financial system” actions, while his inflation target bias geared his monetary policy actions, which in practice, because of the “threat” of rising oil and commodities, turned strongly contractionary in mid-2008. How do we know that?

In words: When the financial crisis became noticeable in early 2007, money demand immediately increased (velocity fell). If money supply had not risen, nominal spending (NGDP) growth would have contracted. But money supply rose to accommodate money demand so nominal spending kept chugging along. Unfortunately, since early 2008 the FOMC became very worried about the possibility of inflation and inflation expectations becoming “unmoored”. And that remained the FOMC´s sentiment all the way through the September FOMC meeting, which took place AFTER the Lehman affair! The practical consequence of that “worry” was that although velocity continued to fall, money growth retrenched. With MV falling PY would also fall, a “no brainer”.

End result: The banks were “saved”, but workers were “doomed”! So no, Bernanke is no “Hero”, as the Atlantic Magazine tries to portray.

“Contingent Commitments”: The new buzzword

Academics and policymakers have been discussing for years about “The conduct of monetary policy in a low inflation environment”. The first conclusion that should have been reached was “ditch IT”. Obviously, given the protracted discussion, IT was not robust.

So now that academics and policymakers had to eat crow, the solution becomes “contingent commitments”, much like after the Asia crisis in 1997 the buzzword became “reform of the international financial architecture”. A lot of good that did!

In the spirit of proposing new “buzzwords, Larry Summers wrote an oped based on his paper with Brad DeLong:

On even a pessimistic reading of the economy’s potential, unemployment remains 2 percentage points above normal levels; employment, 5 million jobs below potential, and GDP, close to $1 trillion short of potential. Even with the economy creating 300,000 jobs a month and growing at 4 percent, it would take several years to re-attain normal conditions. So a lurch back this year toward the kind of policies that are appropriate in normal times would be quite premature.

Indeed, recent research on what economists label hysteresis effects suggests that slowing could have highly adverse consequences. Brad Delong and I argue in a recent paper that it is even possible premature and excessive movements toward fiscal contraction, by shrinking the economy, risk exacerbating long-run budget problems.

How then to respond to valid concerns about fiscal sustainability, excessive credit creation and the eventual return to normality in a world where policy credibility is essential? The right approach is policies that commit to normalizing conditions but only when certain thresholds are crossed. The Federal Reserve might commit to maintain the current Fed funds rate until some threshold with respect to unemployment or expected inflation is crossed. Commitments to fund infrastructure over many years might include a financing mechanism such as a gasoline tax that would be triggered when some level of employment or output growth has been achieved. Tax reform could phase in new rates in pace with the rising economic performance.

Contingent commitments have the virtue of providing clarity to households and businesses as to how policy will play out, and in areas where legislation is necessary, eliminating political uncertainty. They allow policymakers to project a simultaneous commitment to near-term expansion and medium-term prudence — exactly what we require right now. An element of contingency in policy is always there in a volatile world. Recognizing it explicitly is the way to provide confidence and protect credibility in a world whose future no one can gauge with precision.

“Contingent commitments” are vague and instead of “providing clarity”, they sow confusion. The contingencies to which the commitments are tied may just not be credible, and even if they are there can be a combination of “realizations” that leave agents in great doubt about the actions policymakers will deem appropriate.

So instead of appealing to the negative consequences of a protracted economic slowdown and  proposing “voodooesquelike” “self-financing deficits”,  academics should stop bickering about the temporary impotency of monetary policy and the mystic wonders of expansionary fiscal policy and quickly come to a consensus on the most effective way to get the economy “back on track”. Deep down they know how to do it, but “papers have to be written”!