I find this kind of comment intriguing. From ECRI (Economic Cycle Research Institute):

Early last week, ECRI notified clients that the U.S. economy is indeed tipping into a new recession. And there’s nothing that policy makers can do to head it off. 

Maybe it´s because, to start with, it was the policy makers errors that drove the economy to the tipping point. But if they have the power to “tip” it, they must also have the power to “untip” it.

So many wonder why they (the policy makers) have “abandoned ship”.

More evidence on how Cole & Ohanian were deceptive

In a recent post Scott Sumner writes: “And yet I find myself once again to be very irritated by an argument against the demand-side view put forward by Cole and Ohanian”:

The main point of our op-ed, as well as our earlier work, is that most of the increase in per-capita output that occurred after 1933 was due to higher productivity – not higher labor input. The figure [at the link] shows total hours worked per adult for the 1930s. There is little recovery in labor, as hours are about 27 percent down in 1933 relative to 1929, and remain about 21 percent down in 1939. But increasing aggregate demand is supposed to increase output by increasing labor, not by increasing productivity, which is typically considered to be outside the scope of short-run spending/monetary policies.

C&O original figure is this (all data, except NGDP, from C&O):

The sensible interval is 1933-37, not 39 which reflects the 1938 “recession within the depression”. But even there there´s another “fudge”. In their research C&O argue that government employment didn´t change and farm employment dropped only in 1934, so the better measure of hours is to see what happens to manufacturing hours. This is shown below:

While for total hours the change between 1933 and 1937 is from 27% below normal to 17% below normal (the hours data are not detrended), a substantial increase in total hours, in the case of manufacturing hours, the gain in 1933-37 is relatively “immense”: from 47% below normal to “just” 21% below normal!

When C&O look at the picture (not in their article) containing TFP in the private non farm sector compared to total hours they get this:

Leading them to conclude that it wasn´t about increasing AD, but about higher productivity.

The following picture, showing TFP and manufacturing hours would justify the opposite conclusion, with manufacturing hours increasing robustely!

The point is that in either case there is strong support for the AD view of the recovery from the great depression. Note also that productivity flattened in 1936, while hours continued to increase for another year!

The final graph indicates there´s no doubt about the effect of AD with AD rising after 1933 and bringing RGDP up commensurately.

So yes, C&O were very “selective” with their dates and data to further their RBC view of the world. It seems that productivity went up due to an increase in AD, allowing a more efficient deployment of resources.

Forgetting (again) the decisive role of EXPECTATIONS

Martin Wolff is in the right frame of mind:

It is the policy that dare not speak its name: the printing press. The time has come to employ this nuclear option on a grand scale. The alternative is likely to be a lost decade. The waste is more than unnecessary; it is cruel. Sadists seem to revel in that cruelty. Sane people should reject it. It is wrong, intellectually and morally.

But makes the fatal error of falling back on the “size” of needed stimulus instead of on the TARGET to be pursued, which would shape expectations:

It is vital, then, to sustain demand. With fiscal policy set on kamikaze tightening and conventional monetary policy almost exhausted, that leaves “quantitative easing”. Mr Posen recommends a great deal more of it, starting with “a minimum of £50bn in gilt purchases in secondary markets” though he now boldly recommends something closer to £75bn or £100bn, in light of the dire external environment.

For example: Specify a TARGET and “shoot for it”!

The “two faced” credit view

According to Bernanke, keeping short term interest rates low for a period “farther than the eye can see” is the way to go to keep long term rates also low in order to get a recovery “on the road”:

In his first public remarks since the Fed launched a fresh measured aimed at keeping down long-term borrowing costs, Bernanke indicated a willingness to push deeper into the realm of unconventional policy if economic growth remains anemic.

But there´s also the “credit view” espoused by McKinnon:

First, the counter-cyclical effect of reducing interest rates in recessions is dampened. When interest rates dipped in the past, at least part of their immediate expansionary impact came from the belief that interest rates would bounce back to normal levels in the future. Firms would rush to avail themselves of cheap credit before it disappeared. However, if interest rates are expected to stay low indefinitely, this short-term expansionary effect is weakened.

Second, financial intermediation within the banking system is disrupted. Since early 2008, bank credit to firms and households has declined despite the Fed’s huge expansion of the monetary base—almost all going into excess bank reserves. The causes are complex, but an important part of this credit constraint is that banks with surplus reserves are unwilling to put them out in the interbank market for a derisory low yield. This bank credit constraint, particularly on small- and medium-size firms, is a prime cause of the continued stagnation in U.S. output and employment.

Third, a prolonged period of very low interest rates will decapitalize defined-benefit pension funds—both private and public—throughout the country. In California, for example, pension actuaries presume a yield on their asset portfolios of about 7.5% just to break even in meeting their annuity obligations, even if they were fully funded.

Perhaps Fed Chairman Ben Bernanke should think more about how the Fed’s near-zero interest rate policy has undermined fiscal discipline while corrupting the operation of the nation’s financial markets.

Both are wrong. They seem to believe that the Fed determines long term interest rates, and while for one low rates are “expansionary”, for the other low rates can be distortive, in effect blocking the credit expansion needed for recovery.

Remember that when QE2 was launched – with the stated reason of reducing long term rates – long term rates went up! That lasted while it was thought that the Fed was adopting an expansionary MP. When agents understood the “ruse” – that it was just a means to avoid deflation, not promote long lasting economic expansion – long term rates dropped fast, reflecting expectations of continued lackluster spending growth.

A likely “cure”, if the Fed can still be believed to really want to get the economy back on solid footing, is to stop calling monetary policy actions “unconventional”, which is widening the circle of people that get “freaked out” by the term, and adopt the “conventional” policy of stating a nominal target – not an inflation target which is, more than anything, constraining spending expectations – and credibly and transparently pursue it! As Josh Hendrickson has cogently written, DO NOT FORGET EXPECTATIONS!:

[I]n fact, monetary policy can be successful if it partners the monetary injection with an explicit account of expectations. If monetary policy was conducted by announcing that the central bank would increase the monetary base until it met its target for a particular variable — say the price level or nominal income — this would help to shape expectations and help policy to be successful as the increase in the monetary base would have distributional effects.

“No way out”: Commit or die!

St Louis Fed president Bullard is “worried”:

Recent declines in inflation expectations, as measured in government bond markets, are worrisome, James Bullard, president of the Federal Reserve Bank of St. Louis said in an interview with The Wall Street Journal.

But not willing to commit:

Mr. Bullard has pushed internally for the Fed to use asset purchase programs as its main tool for providing an additional boost to the economy if it is needed. Other Fed officials favor different approaches. For instance, Chicago Fed President Charles Evans wants the Fed to promise to keep short-term interest rates near zero until unemployment drops below 7.5% or unless inflation rises to near 3%. Mr. Bullard said he isn’t not for these kinds of commitments.

And Evan´s suggested commitment is far from being the most effective one.


Josh Hendrikson has a very nice post on the symbiotic relation between policy and expectations, in particular that it´s not about the “arithmetic”, or size, of the stimulus (fiscal or monetary), but about the degree of commitment of the policy maker with its stated target, which ultimately will shape expectations.

The Federal Reserve’s focus on the size of its asset purchases represents a grave mistake. There is no model that tells us the precise size increase in the central bank balance sheet will get us to a desired level of nominal income. Those who continue to claim that the magnitude of monetary and fiscal policy haven’t been large enough fail to recognize this point. This is the lesson of the Lucas Critique. Expectations matter.

A pointed turn of phrase

From Ambrose Evans-Pritchard:

Dr Merkel, what we have is the crisis of a foolish monetary union that ought to be shut down but is being kept alive because the priesthood has endowed it with sacred significance. Let stop this absurd quasi-religious charade. The euro is nothing but a currency. It has no intrinsic importance. None.

To claim that Europe fails if the euro fails is hollow rhetoric. The great democracies of Europe will march on serenely.

Plosser: Right for the wrong reason

In a sense Plosser is right. From the WSJ:

“The actions taken in August and September tend to undermine the Fed’s credibility by giving the impression that we think such policies can have a major impact on the speed of the recovery. It is my assessment that they will not,” Federal Reserve Bank of Philadelphia President Charles Plosser said. “We should not take certain actions simply because we can.”

After so many “shots wide off the mark” the Fed is bound to lose credibility. That´s bad because, on the off chance that it makes the right move – an NGDP Target, or even a distant second best Price Level target – it will be hard to inspire “confidence”.

And the views of FOMC members are so diametrically opposed! According to Plosser:

Meanwhile, “we should be cautious and vigilant that our previous accommodative policies do not translate into a steady rise in inflation over the medium term even while the unemployment rate remains elevated.”

While for Bernanke the real danger is deflation:

“If inflation falls too low or inflation expectations fall too low, that would be something we have to respond to because we do not want deflation”.

Update (30/09): But Steven Williamson likes Plosser:

I tend to like Charles Plosser’s speeches, and this recent one is no exception. Plosser has an excellent understanding of why central bank commitment to a policy rule is a good thing, and communicates the idea well to a lay audience.

History and the inevitable comparison

This time the Journal doesn´t sound like the Journal. David Wessel writes about Liaquat (Lords of Finance) Ahamed´s musings:

There is an optimistic scenario for the U.S. economy: Europe gets its act together. The pace of world growth quickens, igniting demand for U.S. exports. American politicians agree to a credible compromise that gives the economy a fiscal boost now and restrains deficits later. The housing market turns up. Relieved businesses hire. Relieved consumers spend.

But there are at least two unpleasant scenarios: One is that Europe becomes the epicenter of a financial earthquake on the scale of the crash of 1929 or Lehman Brothers 2008. The other is that Europe muddles through, but the U.S. stagnates for another five years, mired in slow growth, high unemployment and ugly politics.

No one would intentionally choose the second or third, yet policy makers look more likely to stumble into one of those holes than find a path to the happier ending.

Correction: We´re already inside the “hole” and some seem to like it there!

At the end:

A senior U.S. policy maker, a fan of Mr. Ahamed’s book, called me the other day. “Promise me,” he said, “that if you write a sequel about the Great Depression of 2012 that you’ll note that I was one of the guys really trying to head it off.” It was, in a way, one of the few encouraging things I’ve heard lately. It conveyed a welcome appreciation of how large the stakes are. We’d be better off if more policy makers realized that.

Who could that policy maker be? The only one that comes to my mind is Charles Evans of the Chicago Fed:

Last year about this time economic conditions deteriorated to the point that we undertook discussions on how to provide further monetary accommodation—and we ended up with our second round of large scale asset purchases. Now, one year later, we again find ourselves with a weakened economic outlook and again trying to decide what further accommodation to provide. I’m sure everyone will agree that we seriously don’t want to be in this position again at this time next year. I believe that means we need to take strong action now.

Bernanke´s sole concern: DEFLATION!

We must reevaluate Bernanke´s supposed knowledge about the power of monetary policy. A reread of his (infamous) “A case of self-induced paralysis” on Japanese MP shows he´s almost exclusively concerned with deflation. “Deflation. Making sure “it” doesn´t happen here” in 2002 just after becoming Fed governor is another pointer to his “deflation phobia”. And he was once again very clear about that today in his Cleveland Fed Forum speech:

“If inflation falls too low or inflation expectations fall too low, that would be something we have to respond to because we do not want deflation”.

But that “phobia” should make him have a strong preference for some inflation. But no, he´s “capped” that at 2% tops! And that´s clearly not what the markets want. Just look at the stock market’s reaction to the fall in long term inflation expectations. Man, it´s ALREADY too low!

And the “outside stooge”, Hoenig, made his last speech before retiring this Saturday “shooting from the hip”:

“When you encourage consumption by inhibiting your interest rates from rising to their equilibrium level, you will in fact buy problems, and we have, in fact, bought problems”.

Yes, he must be from Pluto!

“Whoa! Pluto’s dead,” said astronomer Mike Brown, of the California Institute of Technology in Pasadena, as he watched a Webcast of the vote. “There are finally, officially, eight planets in the solar system.”

In a move that’s already generating controversy and will force textbooks to be rewritten, Pluto will now be dubbed a dwarf planet.

But it’s no longer part of an exclusive club, since there are more than 40 of these dwarfs, including the large asteroid Ceres and 2003 UB313, nicknamed Xena—a distant object slightly larger than Pluto discovered by Brown last year.

“We know of 44” dwarf planets so far, Brown said. “We will find hundreds. It’s a very huge category.”

I just hope that the number of “dwarf Stooges” stop coming over to “inhabit” the FOMC! Unfortunately, they’re “multiplying. This year there are already three!

HT Dustin