From “hero” to “nemesis” in 2 short years

This is Steven Williamson praising Minneapolis Fed chief Kocherlakota in 2010:

Narayana Kocherlakota, 9th Federal Reserve District President, gave a speech, posted here, which I originally commented onhere. He’s speaking to an audience of Upper Peninsula business people, and he treats them with respect. Narayana uses the opportunity to explain Fed policy to his audience, to teach them some economics, and to say something to the wider community (us) by posting the speech on the Minneapolis Fed website. The speech is quite comprehensive, touching on all the current monetary policy issues and, as it should, it brings to bear all the relevant macroeconomics we know to address the issues. Some of this theory is sophisticated, but Narayana does a good job of bringing this down to a level where a lay audience should be able to get most of it. We have Irving Fisher, search and matching theory of unemployment, New Public Finance, etc., all rolled into a coherent whole. We have come a long way. William McChesney Martin could not have pulled this off, and neither could Alan Greenspan.

Now I think the Invisible Hand got things right when she/he/it made Narayana Kocherlakota, Jim Bullard, and Jeff Lacker (for example) Fed Presidents, and sent Paul Krugman, Brad DeLong, and Mark Thoma off to the blogosphere.

Fast forward to 2012. Kocherlakota has fallen off the pedestal (only Bullard and Lacker remain)

So the Kocherlakota of 2 1/2 years ago had some worries about the potential for inflation. Maybe he changed his mind for good reason? I don’t think so. The new Kocheralakota seems to be a flimsy-excuse guy.

Addendum: Kocherlakota goes on in the same speech I quote from in the last paragraph to say this:

I hasten to say—and I want to stress—that I view this scenario as unlikely. For it to transpire, the country would need a combination of bad monetary policy and poor fiscal management. I do not foresee this combination as likely to occur.

That’s important. We now have bad monetary policy and poor fiscal management (whoever is elected President next week – worse if it’s Romney). The stunning thing here is that the old Kocherlakota didn’t imagine that he would be the source of the bad monetary policy.

And to top it off:

When is it Time to Take a Vacation?

Answer: When Matt Yglesias calls you (Kocherlakota) a “hero of rigor.”

Fortunately for him, Kocherlakota will not be “homeless” for long. Fallen Idol for some, Born Again Hero for others!

Two kinds of money

  1. The good kind;
  2. The bad kind

The good kind is “whole money”. That is, it is both the MoE and MoA. Bad money loses its MoA property, but keeps its MoE property. In that sense you could say, like Scott, that MoA is money´s defining characteristic or “the essence of money”. I would say “that´s good money defining property”

Bad money reflects a “sickness” in the economic fabric. Usually this sickness is manifested in very high, rising AND uncertain inflation. In those situations people search for “something” to play the role of MoA. That “something” could be gold, but in modern times the dollar is the usual stand in for the MoA.

Brazil provides an interesting experiment. For almost two decades inflation was high, rising and uncertain. Not many countries have gone on functioning for so long with that “sickness” hanging about (Argentina, for example, quickly “dollarized”, with the dollar becoming both the MoE and MoA). Brazil managed to create all sorts of palliatives to mask the sickness, and they usually worked for a time. Then, a new set of “anti-aids cocktail” was created and the country marched on. The “palliatives” were even reflected in architectural designs. If you visit apartments built in the 1980s and early 1990s, you will be surprised by the size of the pantries, sometimes just as large as the kid’s bedrooms.

Sometimes we were so “smart” that we managed to have a constant 23% per month inflation for all of twelve months. That actually happened between late 1991 and late 1992. It ended up in smoke when the new president told the nation he was very distraught because his mother could not afford to buy medical drugs. Immediately inflation took off, climbing to 30% and then 35% (that´s per month). Those “kind words” from the new president signaled that once again the country would resort to price-freezes and everyone rushed to get his own price quickly higher.

The chart below shows the last stretch of (hyper)inflation, which followed on the president´s thoughts on medical drug prices.

By February 1994, inflation was 40% (per month). On March 1st future president Cardoso, at the time the Finance Minister, introduced a new “MoA”, the “URV” (“Real Unit of Value”). At that date all prices were converted into URV at a stated “exchange rate”. During the next four months, until June 30, everyday a new “exchange rate” between the MoE (at the time called the Cruzeiro Real (CR$)) and 1 URV was posted. While MoE prices were rising MoA prices were stable.

The URV was the MoA and prices were quoted in URVs. What happened? Now there was a “stable” MoA. Shopkeepers who felt their URV price, which had been determined freely on March 1st , was “too high”, lowered it. Shopkeepers who thought their URV price was “too low” increased it.

On June 30, presuming an “equilibrium” price level in URV had been established (with relative prices having had the time to adjust), the government announced that on July 1st the URV would disappear. The new MoE AND MoA would be called Real and 1 Brazilian Real would equal 1USD. In effect, the exchange rate to the dollar became the anchor of the new currency.

Things worked perfectly, so that by August inflation had fallen from almost 50% in June to “just” 2%. There was no recession and no unemployment. Demand for the new “good money” soared and the Central Bank accommodated.

On January 1999 the foreign exchange anchor was abandoned. The real depreciated by 100% between December 1998 and February 1999. You wouldn´t have guessed something so drastic took place by eyeballing the monthly inflation chart above.

That happened because the MoA property of the real remained “standing”. That it did so was mostly due to the fact that Brazil quickly introduced (with surprisingly “instant credibility”) an inflation targeting regime as the new anchor for the domestic money.

For “money” to have meaning it has to have both properties, otherwise you are in limbo. If the central bank only worries about the MoA property of money it will be concerned only with inflation (because that´s what is able to “destroy” that property). If it is concerned with overall economic stability, it will do better by pursuing an NGDPL target. If it does that, it will be concerned also with the MoE property of money and thus avoid undesirable economic fluctuations.

Other discussions on the “MoE/MoA” properties of money are:

Scott Sumner (who got the ball rolling)

Nick Rowe, and

Bill Woolsey

This chart says more about monetary policy than fiscal policy

Veronique de Rugy and Keith Hall show that the difference in RGDP growth between the second and third quarters was all due to increase in government spending. We know that growth in government spending was almost all attributed to a rise in defense spending; so unless the US ventures into a new war (always possible) there´s not much hope of continued increases in Gov. Purchases (the ‘fiscal cliff’ is just around the corner). Maybe Sandy will have a ‘positive effect’ (!)

So what the chart really tells us, given the behavior of private sector output, is that monetary policy remains ‘pathetically guarded’.

The housing boom, financial crisis & the “Great” Recession

The present crisis has been labeled a “financial crisis”, the conventional wisdom being that its roots can be found in the housing boom and subsequent bust which, on its turn, was the result of lax monetary policy, with the Fed having kept interest rates “too low for too long” during 2002-2005.

I deal with the housing boom. This can be divided in two parts: “Overbuilding” and the “House price bubble”.

The idea that there was a building “frenzy” in the 1990s and 2000s is illustrated in Chart 1. The somewhat cyclical pattern of house starts is broken in 1990, after which starts increase almost continuously for the next fifteen years to 2005.

As Chart 2 indicates, that is consistent with the rise in the rate of population growth, which rose form 1% in the 1965 to 1989 period to 1.2% for the next 10 years. A substantial portion of this rise was due to immigration, with the number of immigrants doubling from an average of 500 hundred thousand prior to 1990 to 1 million thereafter.

Chart 3 shows that the house stock population ratio reached a ‘steady state’ in the late 1980s. It appears, therefore, that the rising trend in house starts was just sufficient to maintain the house stock-population ratio constant.

Interestingly, note from Chart 1 that in 2000 and 2001 house starts dropped somewhat, bringing the house stock-population ratio below the “steady-state” (SS) level. That mostly explains the so-called “crazy” number of house starts in 2002 – 2005 period. But as Chart 3 shows that was just enough to bring the house stock population ratio back to the SS level.

It appears, therefore, that there was nothing  “suspicious” or even “speculative” about the 1991 – 2005 home-building boom. What about the construction bust that followed? Once you see that the house stock population ratio has remained close to the SS level, the construction bust reflects mostly the sharp drop in population growth, which has averaged just 0.89% since 2005. Also, because of the crisis, in 2009 – 2011 the increase in the number of households fell considerably. While household formation averaged 1.1 million in 2006 – 2008, it dropped to just 338 thousand in 2009 – 2011. In 2010 there was an absolute decrease 0f 82 thousand in household formation.

While the data do not indicate that there was house “overbuilding”, what about house prices?

The set of charts below graph the Case-Shiller Home Price Index (HPI) for six different cities in different regions and states of the country. Note that there is little, and frequently none, resemblance at all in the price behavior in different places. The shaded area in each chart represents the period during which  interest rates were deemed “too low for too long”. Contrary to the conventional wisdom, I don´t see this fact having explanatory power for house price behavior.

The set of Charts below show the behavior of house prices for the states in which the cities in the above set are located. These are quarterly house prices from the Federal Housing Finance Agency (FHFA). Again, prices behave very differently in the different states. In addition, I compare house prices in Texas and Nevada and provide an explanation for the differences in price behavior that transpire.

Unlike California and Massachusetts, Nevada, like Texas, did not have aggressive land development and zoning law restrictions. But suddenly, after 2002, prices in Las Vegas (and in Nevada in general) soar. That may be signaling that speculative activity increased (maybe they took their casinos “to the street”). On the other hand, beginning in the early 2000s, environmentalists managed to obtain restrictive legislation on land development. This would have the effect of restricting house (land) supply and thus raising house prices.

Data on house permits (single units)may give some indication of what drove prices to soar in Nevada. In the Charts above observe that in Nevada permits increased significantly after 2002. Would this be related to expectations of increasing land development restrictions over time? The fact is that permit behavior in other areas did not change during the period. The Charts below illustrate the argument showing permit behavior for Nevada and Texas.

If it´s a bubble, it´s a funny one. In some places house prices increased a lot and fell relatively little, such as in Colorado and Massachusetts. In others, such as California, prices rose quite a bit and also fell hard. In Texas prices increased steadily but did not reverse.

In most places, prices peaked in the first half of 2006, more than two years before the “cow stepped into the swamp” (where the “cow” stands for NGDP). By the time NGDP “drowned” in the second half of 2008, house prices and house construction had almost finished the “adjustment”. (Again, Nevada house prices being an exception).

Despite all that, before the spending crash, in the second quarter of 2008 unemployment was still a “healthy” 5.3%. It would soon soar. Financial troubles had flared up in several institutions since early 2007. And by the time Lehmann folded, NGDP had already dropped by about half the final plunge.

A recession was maybe inevitable given the magnitude of the shocks. What was NOT inevitable was the recession becoming “Great”. That´s the Fed´s doing. Just as the Fed is mostly responsible for the sluggish (in fact, almost nonexistent) recovery. But never mind, there´s the ‘blanket excuse’ that this is what´s to be expected from a “financial crisis”.

Krugman´s beliefs at the “Zero Bound” have changed radically!

Taking a cue from Lars Christensen, there´s more on “monetary freak” Krugman. This also from a 1999 piece: “Morning in Japan?” (Click on Japan in the sidebar and than on the article title):

SYNOPSIS: Japan’s considerable problems can still be solved with Monetary policy.

The winter of 1981-82 was a grim one for the U.S. economy. After a nasty recession in 1980, there had been a brief, hopeful period of recovery–but by early 1982 it was clear that a second, even worse recession was underway. By late that year the unemployment rate would rise above 10 percent for the first (and so far only) time since the 1930s. So bleak was the prospect that in February the New York Times Magazine ran a long article (by Benjamin Stein) titled “A Scenario for a Depression?” which suggested that “the nation has arrived at a new spot on the economic map where the old remedies–or what we thought were remedies–have lost their power and the economic wise men have lost their magic.” Stein and many others worried that after nearly a decade of disappointing performance, the U.S. economy might simply fail to respond to monetary and fiscal policies, that a self-reinforcing downward spiral of pessimism and financial collapse might already be out of control.

Fortunately, however, it turned out that the old remedies were just as powerful, the nostrums of the economic wise men just as magical, as always. The Federal Reserve Board, which had been following a strict monetarist rule, reversed course in mid-summer and opened up the monetary taps. Interest rates came down, the stock market rose, and by early 1983 the economy was unmistakably on the mend. Indeed, as the workers and factories left idle by the slump went back to work, output soared: Real GDP grew almost 7 percent during 1983, and in 1984 Ronald Reagan was triumphantly re-elected under the slogan “It’s morning in America.” It wasn’t: Once the slack had been taken up, growth slowed again, and over the ’80s as a whole the economy actually grew a bit less than it had in the ’70s. But the surge in 1983 was a spectacular demonstration of the way that a sufficiently expansionary monetary policy can reverse a depressed economy’s fortunes.

Update: Krugman should have left out the 1980-82 period of “transition from high to low inflation”. Once you do that, average real growth in the 1983-89 span was higher than in the 1970s.

The K-K ‘principle’ should read: It´s all proportional to the depth of the hole dug by the NGDP drop

Krugman defends the Keynesianism-Krugmanism with regards to some popular views on Latvian ‘success’:

OK, the recent Reinhart-Rogoff protest against “gross misinterpretations of the facts” on financial crises doesn’t actually say anything about Latvia. But the points R-R make in taking on the US crisis denialists apply with equal force to the weird phenomenon of Baltic triumphalism.

As R-R say, rapid growth over a short period following a deep slump does not constitute a success story; by that measure, America was a tower of prosperity in the depths of the Great Depression. It’s much more informative to focus on levels, both of output and of unemployment, and compare them with the pre-crisis peak.

So, people keep telling me that Latvia is an economic miracle that refutes Keynesianism and Krugmanism. How’s it doing on the level thing? (All data from Eurostat).

And shows this chart:

The equivalent US chart follows (on the same scale for ease of comparison):

Then there´s the unemployment picture in both countries

And finally, the “digger of misery”, the nominal spending level.

One would think that compared to Latvia, the US is a success story. But that would be misleading. In fact the US is proportionally doing just as bad as Latvia. The US was lucky (or maybe the Fed felt less constrained than Latvia´s CB) to see its spending fall much less than Latvia´s.

The Berkeley View: Fiscal Stimulus Rules

Scott Sumner questions the validity of the majority on fiscal stimulus:

Most economists who talk about fiscal stimulus in the press seem to assume that economic theory predicts it’s effective whether you are at the zero bound or not.  So that’s my question; where do economists get this idea?  I know where I got the idea, I was taught the crude Keynesian fiscal stimulus model in college. But I later unlearned it.  Is it possible that most economists learned the model just as I did, and never unlearned it?

And he links to:

From Laura D´Andrea Tyson:

The table below highlights three of these tax changes — the Reagan tax cut of 1982, the Clinton tax increase of 1993 and the Bush tax cut of 2003 – and subsequent employment growth. Strong employment growth followed the Reagan cut, but the employment growth following the Clinton tax increase exceeded the employment growth following the Bush tax cut, which was comparable in size to the Reagan cut.

Another Berkeley star goes down the same route:

From Christy Romer:

Without knowing where the economy was headed in the absence of the stimulus, it’s impossible to judge what it contributed just from what happened afterward. That’s why empirical economists rely on other approaches.

One is to look at history. The stimulus legislation, technically known as the American Recovery and Reinvestment Act of 2009, was a mixture of tax cuts for families and businesses; increased transfer payments, like unemployment insurance; and increased direct government spending, like infrastructure investment. A growing literature examines the effects of such tax cuts and increases in government spending over history and across countries, and the overwhelming conclusion is that fiscal stimulus raises employment and output in the near term.

It is interesting to note that Christy Romer has at other times endorsed NGDP Targeting:

Mr. Bernanke needs to steal a page from the Volcker playbook. To forcefully tackle the unemployment problem, he needs to set a new policy framework — in this case, to begin targeting the path of nominal gross domestic product.

Nominal G.D.P. is just a technical term for the dollar value of everything we produce. It is total output (real G.D.P.) times the current prices we pay. Adopting this target would mean that the Fed is making a commitment to keep nominal G.D.P. on a sensible path.

The charts below indicate she´s right on that count. So let us forget about ‘fiscal stimulus’, which more hinders than helps, and keep to the premier stabilization tool, Monetary Policy, preferably gearing it to target a level growth path for nominal spending.

And Dean Baker was doing so well…

But at the very end, in his conclusion, he misses out:

The argument that unemployment is due to a skills mismatch leads to very different conclusions about economic policy than the view that the main cause of unemployment is insufficient demand.

The former sees the problem as being with workers while the latter view focuses on the need for economic policy to increase demand.

While many people in national policy debates have been anxious to put forward the skills mismatch argument, it is difficult to find evidence that supports this position. The evidence is overwhelmingly consistent with the simple view that the collapse of the housing bubble has led to a large shortfall in demand. In this context, measures that focus on improving skills will have little effect on overall employment.

The evidence clearly does NOT show that. By the time demand took a big hit, when the Fed let nominal spending (NGDP) tank, the collapse of the housing bubble, which brought residential construction employment down with it, had already run most of its course. The charts illustrate (monthly NGDP from Macroeconomic Advisers).


New York Fed Dudley has conceded that the sluggish recovery is due to monetary policy. Now he only has to acknowledge that the “Great” attached to the recession was also the result of inadequate monetary policy.

A big leap forward: New York Fed Dudley points to monetary policy errors.

I know… but couldn´t resist, not with this about turn by a major figure!

William Dudley, the president of the Federal Reserve Bank of New York, gave a speech on Monday to the National Association for Business Economics, an organization for academic and applied economists. What made the speech particularly remarkable was Dudley did something the Fed almost never does: He disagreed with the consensus opinion of economists.

Dudley said he saw tight money as a major reason for the sluggishness of the economic recovery. “Monetary policy, while highly accommodative by historic standards, may still not have been sufficiently accommodative given the economic circumstances,” Dudley said. In adding it to a roster of conventional explanations — such as the natural consequence of recovering from a financial crisis and fighting global economic headwinds — Dudley stepped out of line with the vast majority of his fellow economists.

In a recent Economist poll of top U.S. economists, a majority said that monetary policy was “not important” to answering the question of why the recovery has been slow. Less than 10 percent of economists saw it as “very important.” Many of the surveyed are members of the NABE, perhaps even in attendance to hear Dudley tell them they’re wrong.

That´s important, but still only half of the necessary recognition because further on we learn that:

Nor was the speech a full mea culpa. Dudley took no responsibility for the downturn itself in the way that Chairman Ben Bernanke famously blamed the Fed for the Great Depression. His other explanations for the weak recovery, moreover, put him safely in agreement with most economists.

At least the ‘current misdeeds’ are being recognized. As history shows it would be too much to expect a full blown mea culpa.