In summary, the summit has given the ESM some new tasks, but no new money with which to discharge these tasks. And many details are obscure. To quote the lyrics of the great Johnny Nash:
There are more questions than answers
Pictures in my mind that will not show
There are more questions than answers
And the more I find out the less I know
Yeah, the more I find out the less I know.
In “Perils of Prophecy“, DeLong writes:
We economists who are steeped in economic and financial history – and aware of the history of economic thought concerning financial crises and their effects – have reason to be proud of our analyses over the past five years. We understood where we were heading, because we knew where we had been.
In particular, we understood that the rapid run-up of house prices, coupled with the extension of leverage, posed macroeconomic dangers. We recognized that large bubble-driven losses in assets held by leveraged financial institutions would cause a panicked flight to safety, and that preventing a deep depression required active official intervention as a lender of last resort.
Indeed, we understood that monetarist cures were likely to prove insufficient; that sovereigns need to guarantee each others’ solvency; and that withdrawing support too soon implied enormous dangers. We knew that premature attempts to achieve long-term fiscal balance would worsen the short-term crisis – and thus be counterproductive in the long-run. And we understood that we faced the threat of a jobless recovery, owing to cyclical factors, rather than to structural changes.
So the big lesson is simple: trust those who work in the tradition of Walter Bagehot, Hyman Minsky, and Charles Kindleberger. That means trusting economists like Paul Krugman, Paul Romer, Gary Gorton, Carmen Reinhart, Ken Rogoff, Raghuram Rajan, Larry Summers, Barry Eichengreen, Olivier Blanchard, and their peers. Just as they got the recent past right, so they are the ones most likely to get the distribution of possible futures right.
Then, abruptly, he switches gear:
But we – or at least I – have gotten significant components of the last four years wrong. Three things surprised me (and still do). The first is the failure of central banks to adopt a rule like nominal GDP targeting or its equivalent.
The failure of central banks to target nominal GDP growth remains incomprehensible to me, and I will not write about it until I think that I have understood the reasons.
The possible conclusions are stark. One possibility is that those investing in financial markets expect economic policy to be so dysfunctional that the global economy will remain more or less in its current depressed state for perhaps a decade, or more.
Better late than never. If only he (and others) had focused on this last point from the start instead of proselytizing in favor of “self-financing fiscal stimulus” things might have progressed differently.
The “Manifesto for Economic Sense”, signed by hundreds of economists from different countries starts off saying:
More than four years after the financial crisis began; the world’s major advanced economies remain deeply depressed, in a scene all too reminiscent of the 1930s. And the reason is simple: we are relying on the same ideas that governed policy in the 1930s. These ideas, long since disproved, involve profound errors both about the causes of the crisis, its nature, and the appropriate response.
These errors have taken deep root in public consciousness and provide the public support for the excessive austerity of current fiscal policies in many countries. So the time is ripe for a Manifesto in which mainstream economists offer the public a more evidence-based analysis of our problems.
I strongly disagree with this shrug-off of monetary policy:
In the face of a less severe shock, monetary policy could take up the slack. But with interest rates close to zero, monetary policy – while it should do all it can – cannot do the whole job.
Which commits the common error of associating the stance of monetary policy with the level of interest rates. And to all those hundreds of economists’ monetary policy cannot do much! A sad state of affairs indeed.
Towards the end it provides what passes for justification for more “fiscal stimulus”:
In the 1930s the same structural argument was used against proactive spending policies in the U.S. But as spending rose between 1940 and 1942, output rose by 20%. So the problem in the 1930s, as now, was a shortage of demand not of supply.
Interestingly, almost simultaneously with the release of the “Manifesto”, Steven Horwitz and Michael McPhillips released a new paper entitled: The Reality of the Wartime Economy – More Historical Evidence on Whether World War II Ended the Great Depression , which builds on previous work by Robert Higgs, concluding:
Those who credit the war with economic recovery in the form of giant government expenditures and rising GNP must also explain the absence of any economic downturn following disarmament. What should have been the “worst cyclical downturn” in U.S. history was barely noticeable. The lack of a second depression in 1946 has drawn further attention to the limits of aggregate economic statistics, especially during war when government action can heavily distort figures (Vedder and Gallaway 1993: 3-5). For the same reasons that the calculated GNP did not depict reality in describing what occurred in 1946 as the government reduced spending, we should be skeptical of the validity of the growth rates as government-sponsored production increased between 1940 and 1944.
As has been copiously shown, the recovery which began in 1933 was the result of expansionary monetary policy following FDR severing the dollar from gold. And as the chart below indicates, the adjustment following the end of WWII was quick and swift. Why? Answer: nominal spending (NGDP) didn´t crash, or even falter, like it did in 2008!
In today´s Fiscal Times, Bruce Bartlett has a piece with a catchy title: 7 Reasons the Fed Should Raise Interest Rates…
…and Still Keep Easy Money Flowing through the Economy
And after detailing his 7 reasons, he concludes:
So how is it possible to raise interest rates without tightening monetary policy? The answer is surprisingly simple – raise inflationary expectations. According to economic theory, lenders are mainly concerned about the real rate of interest – the market rate minus the expected rate of inflation over the life of a loan. If expectations of inflation rise, then interest rates should rise by the same rate.
The Fed can raise inflationary expectations just by saying that it intends to allow inflation to rise. If markets believe the Fed means it, they will react accordingly because they know that the Fed is the principal cause of inflation.
There are two main problems with instituting this simple policy change. First, there is very fierce resistance to higher inflation among members of the Federal Open Market Committee, the Fed’s policymaking arm. They will make it as difficult as possible for the Fed to explicitly raise its inflation target and sow as much doubt as possible in financial markets that it really means it, which will frustrate the goal of the policy.
Second, some economists have serious doubt as to whether the Fed is capable of raising inflation under current economic conditions even if it wants to. As we have seen over the last several years, even massive, unprecedented increases in the money supply have had no effect on inflation; indeed it has actually fallen. However, Federal Reserve Chairman Ben Bernanke has repeatedly dismissed this argument, saying the Fed has plenty of ammunition left.
In a future column I plan to explain why fears of future inflation are misplaced and why the risk of doing what I have suggested here is very small – well less than a policy of doing nothing and allowing our economic problems to fester.
Back in October 2011 Bruce Bartlett wrote and talked about NGDP targeting. In a CNBC interview at the time he criticized the Fed for “sitting on its hands” and argued it could spur aggregate demand if it adopted a nominal GDP level target.
I have no idea why he switched to talking about inflation expectations and how they have to be raised. The word inflation is a debate stopper and BB will never be able to assuage people´s fears of future inflation. He should have stuck to NGDP targeting, because that´s exactly what he means.
The BIS annual report released last weekend has been ‘dissected’ by many but if you want the best and most detailed critical analysis, Ryan Avent´s ‘ME report’ is the place to go. One quote:
The annual report is a remarkable document, one which might well come to serve as the epitaph for an era of central banking spanning the Volcker disinflation and the Great Recession—the epoch of the central banker as oracle, guru, maestro. If the end of this era is upon us, we can credit a series of revelations: that central bankers learned the lessons of economic history less well than they’d thought, that they displayed an unfortunate tendency to set aside economic rigour in favour of an obsessive focus on price stability, and (perhaps most importantly) that they are in more need of democratic accountability than is often assumed. Above all, the report captures what may be the most critical error of the modern central banker: eschewing a focus on his proper domain—demand stabilisation—in favour of an arena in which he has no business sticking his nose—the economy’s supply side.
The irony is that, considering only the Volcker-Greenspan-Bernanke triumvirate, Bernanke was supposed to know the “lessons of economic history” better than any other but ended up showing the most “obsessive focus on price stability”, to the economy´s loss.
Greenspan has been the most ‘candid’ about the Fed´s ‘power’. In the closing of chapter 20 (The Conundrum) of his “The Age of Turbulence” – an interesting take on the so called “Great Moderation”, Greenspan ‘confesses’ utter surprise with the outcome:
Many economists in fact credit central bank monetary policy as the key factor in the last decade´s reduction in inflation worldwide. I would like to believe that. I do not deny that we adjusted policy to be consistent with global disinflationary trend as they emerged. But I very much doubt that either policy actions or central bank anti-inflationary credibility played the leading role in the fall of long term interest rates in the past one to two decades. The decline (and the conundrum) can be accounted for by forces other than monetary policy. In fact, during my experience since the mid-1990s with the interaction between the policies of the world´s central banks and the financial markets, I was struck by how relatively easy it was to bring inflation down. The inflationary pressures of which I was so acutely aware in the late 1980s were largely absent or, more accurately, dormant. The “conundrum” exposed this point.
And he got nicknamed ‘Maestro’!
This is from Ivan Eland, “The U.S. Should Take Lessons from Mexico,” June 20, 2012.
I found that first paragraph arresting. I realized that I’m one of those average Americans. But Eland goes on:
More important, the bad publicity on the drug death toll has unnecessarily dispirited even Mexicans and eclipsed Mexico’s economic success story. Brazil, billed as an engine for Latin American economic growth, has also overshadowed the equally middle-income Mexico. Yet in 2011, the relatively open Mexican economy, which has increased competitiveness, outgrew its Brazilian counterpart, dominated by large state-owned industries, 3.9% to 2.7% and is expected to maintain that gap in 2012. Whereas Brazil, like the United States, has debt-burdened consumers, Mexico has had manageable debt, low inflation, 17 years of macroeconomic tranquility, and thus investors in the automobile, aerospace, and electronics sectors banging down the door to get into the country.
Mexico’s most-recent annual growth rate (the chart doesn’t make clear, but I think it’s in real terms) is 4.6 percent. Not bad.
Mexico’s rating on the Economic Freedom scale? 75th. That accords with my prior views. Which makes its growth rate somewhat surprising.
And Brazil is ranked 102ond, which makes any growth even more surprising.
But if you look closer, there´s not much growth to be seen over the last 30 years. The charts illustrate. In the first chart, Brazil and Mexico are compared with Korea on the basis of output per employed person.
No contest there. The arrows indicate that in 1980 Mexico´s productivity was higher than Brazil´s, which was about the same as Korea´s. Thirty years on Korea´s productivity is higher than Mexico´s by an amount almost identical to Mexico´s advantage in 1980, while the difference between Mexico and Brazil has remained almost exactly the same, with both having essentially stagnated during that time!
The next chart indicates there are not many lessons the US should take from Mexico. It´s exactly the opposite!
For Stiglitz, the Fed can only do harm:
The Fed has consistently failed to understand the links between inequality and macroeconomic performance. Before the crisis, the Fed paid too little attention to inequality, focusing more on inflation than on employment. Many of the fashionable models in macroeconomics said that the distribution of income didn’t matter. Fed officials’ belief in unfettered markets restrained them from doing anything about the abuses of the banks. Even a former Fed governor, Ed Gramlich, argued in a forceful 2007 book that something should be done, but nothing was. The Fed refused to use the authority to regulate the mortgage market that Congress gave it in 1994. After the crisis, as the Fed lowered interest rates — in a predictably futile attempt to stimulate investment — it ignored the devastating effect that these rates would have on those Americans who had behaved prudently and invested in short-term government bonds, as well as the macroeconomic effects from their reduced consumption. Fed officials hoped that low interest rates would lead to high stock prices, which would in turn induce rich stock owners to consume more. Today, persistent low interest rates encourage firms that do invest to use capital-intensive technologies, such as replacing low-skilled checkout clerks with machines. In this way, the Fed may still be contributing to a jobless recovery, when we finally do recover.
Unsaid, but implied, everything is dependent on fiscal policy.
There definitely must be something in the champaign they serve to toast Nobel recipients!
The BIS annual report was released today. In the section “Limits to Monetary Policy” we read:
The major advanced economies are maintaining extraordinarily accommodative monetary conditions, which are being transmitted to emerging market economies (EMEs) in the form of undesirable exchange rate and capital flow volatility. As a consequence of EME efforts to manage these spillovers, the stance of monetary policy is highly accommodative globally. There is widespread agreement that, during the crisis, decisive central bank action was essential to prevent a financial meltdown and that in the aftermath it has been supporting faltering economies. Central banks have had little choice but to maintain monetary ease because governments have failed to quickly and comprehensively address structural impediments to growth. But the need for prolonged accommodation has to be carefully weighed against the risk of generating distortions that will later produce financial and price instability.
JohnTaylor doesn´t miss the opportunity to advance his namesake rule as THE GUIDE to monetary policy:
At the meeting held today, the BIS issued their Annual Report which addresses key monetary policy issues. BIS analyses often contain useful warnings, including their prescient warning in the years around 2003-2005 that monetary policy was too easy, which turned out to be largely correct, as the boom and the subsequent bust made so clear. So the Annual Report is always worth reading.
This is especially true of the Annual Report released today because it devotes a whole chapter to serious concerns about the harmful “side effects” of the current highly accommodative monetary policies “in the major advanced economies” where “policy rates remain very low and central bank balance sheets continue to expand.” Of course these are the policies now conducted at the Fed, the ECB, the Bank of Japan, and the Bank of England. The Report points out several side effects:
- First, the policies “may delay the return to a self-sustaining recovery.” In other words, rather than stimulating recovery as intended, the policies may be delaying recovery.
- Second, the policies “may create risks for financial and price stability globally.”
- Third, the policies create “longer-term risks to [central banks’] credibility and operational independence.”
- Fourth, the policies “have blurred the line between monetary and fiscal policies” another threat to central bank independence.
- Fifth, the policies “have been fueling credit and asset price booms in some emerging economies,” thereby raising risks that the unwinding of these booms “would have significant negative repercussions” similar to the preceding crisis, which in turn would feed back to the advanced economies
Just go tell that to the ‘people’ in this image Becky Hargrove and I love so much!
For a long time market monetarists have argued that the Fed´s evasive monetary policy is the major force keeping the economy down and out. Keynesians, notably Krugman, argue that the solution requires much more forceful government spending. That´s because, given the extremely low level of interest rates, the economy is in a liquidity trap. That idea follows from a very narrow view of what monetary policy is about (for more on that see this Tim Lee post).
But with regards to the Eurozone, even Krugman acknowledges it´s primary a monetary problem:
So what does ail Europe? The truth is that the story is mostly monetary. By introducing a single currency without the institutions needed to make that currency work, Europe effectively reinvented the defects of the gold standard — defects that played a major role in causing and perpetuating the Great Depression.
In “Silent Movie” I only put up this picture:
It shows a bunch of thirsty people, made so weak that they´re unlikely to make it to the ‘oasis’. And ‘leader Merkel’ appears indifferent to their suffering, indicating that´s the only way to reach ‘nirvana’.
The chart below compares and contrasts two countries, Spain and Sweden. The first is struggling to keep going, despite extreme “thirst”. The other is enjoying the luxury of having plenty of ‘food and water’. One does not enjoy the luxury of having its own ‘reservoir’ from which it can get ‘water’ as needed. The other does.
Some months ago David Beckworth showed a version of the picture below, which I think is the most vivid representation of the cyclical monetary problem (that overlays the structural one associated with single currency flawed monetary system that exists independently).
According to David:
This figure shows that ECB’s failure to stabilize and restore nominal spending to expected levels–as proxied by the 1995-2006 trend–during the crisis as the real culprit behind the Eurozone crisis. This failure to act has been devastating because it means nominal incomes are far lower than were expected when borrowers took out loans fixed in nominal terms. European borrowers, both public and private, are therefore not able to pay back their debt and the result is a fiscal crisis.
And how come ‘leader Merkel’ appears so ‘strong and healthy’? As the next chart shows, Germany is well ‘watered’, enjoying a spending level close to the trend that prevailed during 1992 – 2005.
You shouldn´t ask ‘thirsty’ people to stay away from ‘water’ by way of ‘fiscal austerity’. The solution requires that the ECB ‘placate the thirst’ by restoring nominal spending to a level that allows the most affected countries to ‘get up and walk’!
The Fed said in its official statement Wednesday that it was prepared to take additional action if the job market doesn’t improve. Mr. Bernanke repeated that sentiment over and over again at his press conference. Given how he has behaved in the past, one has to believe he really means it. If he develops more conviction that the recovery is under serious threat, bold follow-up action now looks like a real possibility. And if the recovery miraculously improves, he has lost nothing.
Not only things have NOT been improving, they have been deteriorating. Take a look at the Fed´s real growth forecasts for this year starting in January 2010.
Then take a look at a market based measure of short and long run inflation expectations from the Cleveland Fed over the same period.
Reminds me of the movie, only here it´s “Honey, I´ve shrunk growth and inflation expectations”!