A “Picture war”

Lately Mike Kimel at Angry Bear has been jostling with Scott Sumner about how fiscal policy better explains what got the economy going in 1933. His latest post on the topic says:

While I´m a firm believer in the importance of monetary policy I don´t believe it made much of a difference in the New Deal era. As figure 3 shows, changes in nondefense spending – hiring people to build roads, dams and the like, explain subsequent changes in real GDP growth rates exceptionally well from 1934 to 1938. This simple model explains more than 90% of the change in real GDP growth rates over that period.

OK, he finds a positive relationship among second derivatives (changes in growth rates) of the relevant variables, but in this “picture war” I think my pictures, showing LEVELS of variables and associating their behavior with the monetary policy reversal in March 1933 when FDR took the US off Gold and announced a “price level target”, are much more convincing. (Note: they come from this post from early this year).


Adam Posen is on the BoE Monetary Policy Committee, so he surely can be considered an insider. He has an op-ed in the NYT aptly titled: “Central Bankers: Stop Dithering. Do Something”. That´s very different from Atlanta Fed Lockhart suggestion that “we should “dither with improving communications”!

I don´t agree with all Posen says, especially regarding his concentration on the interest rate transmission mechanism and that monetary stimulus would decrease long rates. If done convincingly, monetary “stimulus” would more likely raise rates!

But in this he is perfectly right:

Independent central bankers tend to become very squeamish about expressing support for any particular government proposal, especially when it involves agreeing to buy government bonds. Tragedies have occurred, however, when independent central banks let worries about the perception that they were too close to the government prevent them from doing something constructive in times of crisis.


Central bank officials have wasted too much time over the last year worrying about how their institutions would appear to markets, to politicians and to the public, were they to undertake more stimulus. Sometimes you have to do the right thing even if the benefits take time to become evident. If we do not undertake the monetary stimulus that the grim outlook calls for, then our economies and our people will suffer avoidable and potentially lasting damage.

“Terrorists all”

Over the last four years, on both sides of the Atlantic, leaders have been acting like seasoned terrorists, impervious to any and all reasoned arguments and even eloquent pleas for some rationality, preferring to “bomb themselves” (resign from the highest posts like Weber and Stark) in protest over “minor concessions” (like the temporary ECB Securities Market Program) or risk jettisoning 250 years of democracy like the US Congress which appears incapable of agreeing on anything (if it´s not “my way”, it´s “the  highway to doomsday”).

I just can´t figure out why one would want to play what appears to be a “lose-lose game”. Maybe some of you can “rationalize” all this.

Far from home

Dennis Lockhart, Atlanta Fed president is in Brazil and gave a talk at Fundação Getúlio Vargas, the premier economics school in the country:

As the U.S. economy points to a “somewhat better performance,” a top Federal Reserve official on Monday said he prefers “enhancing” the communications strategy rather than other options, such as buying bonds.

“In light of the somewhat better performance of the economy, notwithstanding the slow pace of the reduction of unemployment, I would like to see how the economy evolves and therefore if we’re looking at options I would be looking at communications,” Federal Reserve Bank of Atlanta President Dennis Lockhart said Monday.

A few weeks ago I argued that without an explicit Target there´s not much sense in “improving” communications, and ended saying:

And that, folks puts the Fed in a situation akin to the “dog running in circles to grab his own tail”. It´s going nowhere! And where do you see the economy pointing to a “somewhat better performance” Mr. Lockhart?

Christy Romer is a chameleon

Just one week after coming out in favor of NGDP level targeting, she doesn´t recognize the monetary origins of the “Great Recession” and makes a spirited defense of fiscal policy stimulus both past (ARRA) and needed future ones:

Importantly, President Obama was completely right. Though there was, and still is, much more the Fed could do, the recession developing the fall of 2008 was already terrible, and getting worse by the minute. We needed to hit it with every tool we had, especially fiscal policy.


The research I have been discussing this evening suggests that more fiscal stimulus would be very helpful.  Despite all of the claims and protestations, the evidence is that fiscal stimulus does raise output and employment significantly.  Now, it would take another bold move—probably substantially larger than the $450 billion program President Obama has proposed—to really create a lot of jobs. But the evidence says it would work.

Lately Scott Sumner has been very critical of the studies (many of which are favorably reviewed by Christy Romer) that purport to show the effectiveness of fiscal policy stimulus (high multiplier).

From what I gather, a bold move coming from the monetary policy camp would be much easier to implement and much more “cost effective” than a bold move from fiscal policy.

But maybe I´m wrong since lately the monetary policy people have been asking for help from the fiscal guys.

Update: I believe these two older posts (here and here) are relevant to this discussion. Note that in one Christy Romer favors PLT (Price Level Targeting):

The ECB: Credible enough to march the EZ towards the precipice.

This is from ECB President Mario Draghi:

Let me use this occasion to dwell a bit further on monetary policy in the current environment. Three principles are of the essence: continuity, consistency and credibility.

Continuity first and foremost refers to our primary objective of maintaining price stability over the medium term.

Consistency means to act in line with our primary objective and with our strategy both in time and over time.

Credibility implies that our monetary policy is successful in anchoring inflation expectations over the medium and longer term. This is the major contribution we can make in support of sustainable growth, employment creation and financial stability. And we are making this contribution in full independence.

Gaining credibility is a long and laborious process. Maintaining it is a permanent challenge. But losing credibility can happen quickly – and history shows that regaining it has huge economic and social costs.

These three principles – continuity, consistency and credibility – are at the root of the Governing Council’s outstanding record during the past 13 years in terms of price stability and anchoring inflation expectations.

Hurray! We´ll all “die” but our credibility will not be “dishonored”!

John Taylor “strikes back” at NGDPT

After all the hoopla about NGDPT that happened over the last several weeks, with “endorsements” from Christy Romer, Paul Krugman, Goldman Sachs and The Economist, among many others, I wondered when John Taylor would come out to defend his namesake rule.

He just did in this post (my bolds):

One change is that, in comparison with earlier proposals, the recent proposals tend to focus more on the level of NGDP rather than its growth rate. This removes some of the instability of NGDP growth rate targeting caused by the fact that NGDP growth should be higher than its long run target during the catch up period following a recession. But it introduces another problem: if an inflation shock takes the price level and thus NGDP above the target NGDP path, then the Fed will have to take sharp tightening action which would cause real GDP to fall much more than with inflation targeting and most likely result in abandoning the NGDP target.

Rules for the instruments are what monetary policy needs, not excuses for discretionary actions. I welcome more research looking for better instrument rules which are explicit and operational enough to be evaluated with empirical economic models. Even an historical comparison of different rules would be welcome, and Allan Meltzer’s monumental History of the Federal Reserve would be a good foundation to build on. As he summarized in a speech this week, “Economists and central bankers have discussed monetary rules for decades. A common response of those who oppose a rule, or rule-like behavior, is that a central banker’s judgment is better than any rule. The evidence we have disposes of that claim. The longest period of low inflation and relatively stable growth that the Fed has achieved was the 1985-2003 period when it followed a Taylor rule. Discretionary judgments, on the other hand, brought the Great Depression, the Great Inflation, numerous inflations and recessions. The Fed contributed to the current crisis by keeping interest rates too low for too long.”

Since I sent the link to Taylor´s post to Scott Sumner, I believe he´s going to do a post. In that case I´ll be brief, referring my readers to a (long) piece that I wrote in early in 2010 (and posted last May) on the “dangers” associated with interest rate targeting (Taylor Rule), arguing, inter alia, that the Fed did not carry on (as pointed by Taylor) an excessively expansionary MP (“too low for too long interest rates”) after the 2001 recession which, according to Taylor and many others, paved the way for everything bad that happened, from high prices at the pump and at the supermarket all the way to the housing crisis and finally the financial crisis.

Regarding Taylor´s claim that “if an inflation shock takes the price level and thus NGDP above the target NGDP path, then the Fed will have to take sharp tightening action…” that is quite wrong. An inflation shock following, for example, an increase in oil prices would raise prices and reduce real output, keeping nominal spending more or less unchanged. If nominal spending was evolving along the target path before the shock, the Fed shouldn´t react to it. The same would be true for a drop in inflation due to a productivity shock. Prices would fall and real output rise, requiring no reaction from the Fed. Actually, in the examples described, if the Fed reacts to these “inflation shocks” it will cause instability. And if the Fed is following a Taylor Rule to target inflation, that´s exactly what it will do!

Update: Scott obliged!

“The dog didn´t bark”

On Wednesday, November 16, I was away all day and completely forgot it was inflation (CPI) day! At night, checking my e-mail I was reminded of the fact because there was the regular mail from the Cleveland Fed with the latest “inflation expectations curve”, which is released on the same day.

And no “dog barked” about it simply because there was nothing to “bark” about. Even the usual suspects did not show any sign of life!

Below, for your visual information is the inflation and inflation expectations pictures.  So yes, the Fed thinks it needs help from the fiscal policy people because current inflation (core) is dead on “target”, although 1-10 year expectations are well below “target”, and the policy rate is at the ZLB (and unemployment is “way up in the clouds”).

“Help! I need (the government´s) Help…”

They recognize they haven´t done enough and they say they have lots of ammo…

…but still ask for “help”. This from SF Fed president Williams:

The Federal Reserve‘s actions during the past four years have not been enough to deliver a robust recovery so fiscal policy actions are “badly needed,” said a central bank official on Friday.

“What would be especially helpful at this juncture are fiscal policy actions that work in tandem with monetary policy to stimulate the economy,” said John Williams, president of the Federal Reserve Bank of San Francisco, speaking at the Central Bank of Chile in Santiago.

Update: In the comments section of TheMoneyIllusion, Marcelo has this link to a Monetary Policy game. Marcelo says:

Scott, Ezra Klein posted on twitter the above link. It is a video game from the StL fed in which you manage policy. I have messed around with it a bit and if you ZLB during a recession, it says that the govt has to step in to encourage expansion. Perhaps letting us into minds of Fed people?

Fits perfectly with what John Williams said. Just like policemen every once in a while have to go to the shooting range to practice, maybe Fed officials every once in a while have to be “reindoctrinated”. And they do it through some game playing.

Technocrats believe in “fairy tales”

From The Economist:

Indeed, Mr Weidmann’s strong opposition to ECB purchases of government bonds might even be helpful to Mr Draghi, who said at his first press conference that unlimited lending to governments would be outside the ECB’s remit. If the ECB gives the impression that it will do the minimum to abate the bond-market panic, it would increase the pressure on Italy’s politicians to support a reform-minded cabinet and to push through the right policies quickly. The markets may be panicking but Mr Draghi is said to be calm in a crisis. That calm will sit well with the Bundesbank’s view that panics blow themselves out, and that what matters most is long-term stability. The hope is that reform (and high yields) will tempt buyers back into Italian bonds and that markets will calm down.

Sadly, it seems that panic is not abating but is spreading to the heart of the euro zone and is no longer easily explained by deficits or public debts. Public finances in France are not nearly as bad as in Britain. But yields on French ten-year bonds are now far higher than for the equivalent British bonds (see chart). The growing gap between borrowing costs in Germany and those in other euro-zone countries suggests that investors now fear a break-up of the euro zone.

As much as reform in Italy and elsewhere is needed, it seems unlikely that promises to be austere will halt what looks like a run from all euro-zone bonds but German ones. The ECB, despite its misgivings, is the only institution with the power to reverse a self-fulfilling panic. If the pressures become so great that a break-up of the euro seemed likely, could even the Bundesbank really say no?

Unfortunately Mr Weidmann conveniently forgets that it was not the hyperinflation that brought the Nazis to Power, but French insistence that Germany had to “bleed through never ending austerity” in order to satisfy its reparations obligations.