Clones galore!

John Quiggin has a post in which he ‘categorizes’ different sorts of ‘Keynesians’. There´s the:

1 Old Old

2. Old New

3. New Old, and

4. New New

Confusing? It gets more so:

There hasn’t been much overt conflict between New New and New Old Keynesians. That’s because nearly all Keynesians are in agreement on the need for more fiscal stimulus in the major economies, and because New Old Keynesians have, in general, confined themselves to policy debate while New New Keynesians have mostly steered clear of those debates. But the need to refound Keynesian macroeconomics on firmer foundations is every bit as clear as in the 1970s.

Which reminded me of Lars conclusion in a recent post:

It is the monetary policy regime stupid!

Show me an economy that has performed “well” and I´ll show you that it didn´t let aggregate demand (or nominal spending) crash. Evidence from three “anglos”

The three “anglos” in question are the US, UK and Australia.

The first chart shows how real growth performed over the last 20 years.

Three anglos_1

Mean growth for the US was 2.6%, for the UK, 2.4% and for Australia 3.4%. The standard deviation (volatility) of growth were, respectively, 1.9, 2.4 and 1.1.

The next charts shows how nominal spending behaved in the same three economies. Which one did not allow spending to crash?

Three anglos_2


“Looping down”?

Just as it seemed that expectations were acquiring an optimistic slant, the markets tumbled worldwide in the past couple of days!

In the US there is the looming change in the Fed´s Commander-in Chief and questions about how the taper will progress.

In the UK, Mark Carney´s “guidance threshold” reached the “way station” much sooner than expected. And to some:

“The guidance framework hasn´t just failed to offer the clarity the MPC was seeking, but has created unnecessary confusion and volatility in rate expectations”

In the Eurozone the ECB is being urged to act on inflation. Not because it risks going up but because it is too low! Unfortunately the ECB does not appear to be too concerned. (Nor does the Fed for that matter).

All this certainly places strong headwinds in Japan´s recovery program.

And in emerging markets, even if you don´t consider Argentina, the rout in stock, foreign exchange and bond markets continued, as there is mounting concern over how those markets will cope with the withdrawal of global stimulus.

But the feed-back effects on developed country markets of eventually slower growth in emerging markets, and how that could affect ‘tapering’, should not be forgotten.

It could be that the world economy is getting into a negative loop!

What was Mark Carney´s view in December 2012?

From his December 11 speech after being chosen as the next head of the BoE:

From our perspective, thresholds exhaust the guidance options available to a central bank operating under flexible inflation targeting.

If yet further stimulus were required, the policy framework itself would likely have to be changed.19 For example, adopting a nominal GDP (NGDP)-level target could in many respects be more powerful than employing thresholds under flexible inflation targeting. This is because doing so would add “history dependence” to monetary policy. Under NGDP targeting, bygones are not bygones and the central bank is compelled to make up for past misses on the path of nominal GDP

From The Guardian Economics blog: “RIP forward guidance? Not even Mark Carney knows” (but from his old views above, he should):

Mark Carney is about to administer the last rites to forward guidance. The major policy initiative introduced by the new governor of the Bank of England six months ago is dead and buried. Forward guidance RIP.

That, broadly, is how the City sees the current state of monetary policy in the UK. The framework set up six months ago is about to be dismantled.

American Economics Becomes Politics in Drag

A guest post by Benjamin Cole

There is much topography to bewail when overlooking the United States landscape of economic thought, but perhaps no sulfur pits and odiferous bogs are more lamentable than those resulting from rank politicization of the profession.

Let’s call a spade a spade: “Economics” has become politics in drag, behind dresses of calculus, skirts of econometric models and bonnets of banal stilted language.

The ongoing professional charade is to feign objectivity while obtaining “results” in studies or observations that always conform to the not-so-hidden agenda of the authors.

Thus we have a John Cochrane or a Paul Krugman executing shrill exquisite contortions in their observations about the impact of QE and monetary expansionism in 2013.

Bottom line, they say QE doesn’t work.

Since September 2012, the Fed has maintained an open-ended, result-dependent QE program, and some forward guidance. This is not yet Market Monetarism (which would include targeting of nominal GDP), but getting closer.

The results of this iteration of QE have been satisfactory if not great. Employment has been rising at nearly 200,000 a month, and the S&P 500 is up more than 25 percent.

The federal deficit has tightened considerably.

The 2013 United States track record strongly suggests sustained, open-ended and result-dependent QE works—and if anything, 2013 further suggests that an even more-aggressive growth-oriented monetary policy would be better. After all, inflation is falling below 1 percent. The Fed has erred on the tight-side.

Japan, as Marcus Nunes so effortlessly pointed out in these pages recently, is another impressive study on the merits of aggressive QE, with the relative success of Abenomics. As the rest of Abenomics has not happened, Japan’s revival can be squarely laid to QE.

So, what then explains Krugman and his easy dismissal of QE? Fiscal stimulus in the USA is rapidly shrinking, but the economy is doing better and better.

So that means QE must work, no? No. We are still in a liquidity trap, insists Krugman, as seen by a still-dull economy.

And John Cochrane? Evidently driven to distraction, he is now entertaining theories that QE is contractionary and deflationary.

Cochrane is even more puzzling than Krugman, on one level. As Cochrane’s twin professional concerns are the dangerous level of federal debt, and inflation, one might assume he is euphoric at the revelation that QE is deflationary.

So, even more QE means we can pay down the national debt while bringing us to zero percent inflation?

That would be the ultimate nirvana for Cochrane.

No matter, he stills dismisses QE.

Right-Wing Dementia

The left-wing is clueless, and so we will dismiss them without further commentary. But the right-wing did offer hope in the not-so-recent past. As early as the 1990s, right-wing economists such as John Taylor, Milton Friedman and Alan Meltzer spoke in favor of QE, as a solution to Japan’s perma-gloom. (As did the left-leaning Krugman and middle-of-the-road Bernanke)

But in the current era of voodoonomics, right-wing economists have become zero-inflation cultists, or even gold nuts.

Did I say zero inflation? That is not the worst; FOMC board member and Philadelphia Fed President Charles Plosser has rhapsodized about deflation.

Think about it: We are still in the Great Depression if you are looking for work, there are fewer people employed today than five years ago, and inflation is at historic lows and at one-half of supposed Fed target levels.

But Plosser thinks deflation is a nice idea.

The upshot: The right-wing has decided not only to lose the battle for economic prosperity, but probably also to lose the political battle—and all to pay homage to the equivalent of a creationist theory of economic growth.

First you get to zero inflation, say the right-wingers. And then you stay there, and all else is cured (or doesn’t really matter, as zero inflation is the theocratic best result).

It is as if Japan sank into the sea 20 years ago.

What modern large industrial nation has had economic growth and deflation? How has deflation affected Japan? What happens to real estate values—and real estate loans—in sustained deflationary environments? And what happens to banks when loans go sour?

Supply Side Arguments Crushed

Market Monetarist solon Scott Sumner recently completely crushed the “supply side improvements are the only answer” argument, by pointing out industrial production has risen 25 percent or so from its recent nadir. And it is still rising. So supply can grow, you just have to have demand.

Complicating this issue: The supply side is now global, compared to mostly domestic 40 years ago. Tough to imagine the supply-side being crimped these days. And since the dollar is an international reserve currency, the United States can simply print money and import goods and services.

But getting back to the supply-side, domestically. I welcome improvements on the supply-side; every sensible economist does, and nearly all Market Monetarists do.

But, just which supply-side constraints are we willing to blast open? And when?

But the big sad ending to this post is this: If the right-wing had embraced Market Monetarism, we might have had much more-robust economic growth since 2008, and very palatable arguments for limiting social welfare programs of all types.

Give to me prosperity, and I happily will say to all, “Get a job.”

But “economics” today is not about prosperity. It is about ideology. It is about politics.

Why did 1999 thinking get lost in the mist of time?

This is an article by Paul Krugman written in March 1999


The Bank of Japan gets radical

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.

The biggest single question now facing the world economy is whether the same magic can work in today’s Japan.

In some important ways, Japan today bears a strong resemblance to the United States in that frightening summer of 1982. Like the United States then, Japan has some serious long-term problems: a slowdown in productivity growth, an ossified management culture, a troubled financial sector (Stein’s article talked at length about the looming problems of the savings and loan industry). But overlaid on these long-term difficulties is a severe recession. Japan’s unemployment statistics notoriously understate the true extent of joblessness, but even so the current 4.4 percent rate is the highest in the 45 years the number has been published. Depending on whose estimates you believe, the economy is operating anywhere from 6 percent to more than 10 percent below its capacity. That means that Japan’s “output gap” is probably comparable to that of the United States 17 years ago. So if Japan can somehow persuade its consumers and business investors to start spending again, there is room for several years of rapid growth–even if the “structural” problems remain unsolved.

There is, however, one big difference between America then and Japan now. Japan can no longer use conventional monetary and fiscal policies to get the economy moving. Whereas U.S. interest rates in early 1982 were in double digits–and could therefore be sharply reduced–Japanese short-term interest rates have been below 1 percent for years, apparently leaving little room for further cuts. And Japan’s government is already deeply in debt, already running huge deficits. The experience of the past few months (in which the prospect that the government would have to sell vast quantities of bonds to finance its deficits temporarily led to a tripling of long-term interest rates) suggests that any attempt to stimulate the economy with even bigger deficit spending will do more harm than good. So it might appear that there are no easy answers, that nothing short of a total restructuring of the Japanese economy can turn it around.

But over the past year a growing chorus of Western economists has argued against this fatalistic view. On one side, they have worried that unless something dramatic is done to increase demand Japan may go into a deflationary tailspin; that the expectation of falling prices will make consumers and businesses even less willing to spend, worsening the slump and driving prices down all the faster. On the other side, they have argued that radical, unconventional monetary policy can still be effective–that even if short-term interest rates are near zero, massive monetary expansion can still push up demand. Some economists–namely, yours truly–have even argued that Japan should try to get out of its deflationary trap by creating expectations of inflation.

Until very recently, these arguments seemed too outlandish to receive support from more than a handful of Japanese officials. But the events of the last few weeks suggest that there has been a sea change of opinion inside the Bank of Japan–a change similar to, but even more striking than, the abandonment of monetarism at the Fed during 1982. After years of warning about the risks of inflation and the importance of sound policy, the BOJ has suddenly begun flooding the market with liquidity. The overnight rate at which banks lend to each other–the equivalent of our “Fed funds” rate–has been driven down literally to zero. Banks now charge each other only for the administrative costs of making the loan. And still the expansion continues. It’s still a bit hard to believe, but it looks as if Japan’s central bank has been radicalized–that is, it has finally seen the light, has finally understood that in Japan’s current state adhering to conventional notions of monetary prudence is actually dangerous folly, and only monetary policy that would normally be regarded as irresponsible can save the economy.

There are, of course, big risks in any such radical policy departure. My own view is that the biggest risk is that the new policy will not be radical enough, for it is a characteristic of deflation-fighting that half-measures get you nowhere. Suppose, for example, that the Bank of Japan were to try to convince the public that the future will bring inflation, not deflation. But that the target inflation rate is too low, so that even if everyone believed that target would be achieved, the Japanese economy would remain seriously depressed. Then deflation would continue–and the policy would ignominiously fail.

But if the BOJ is determined enough–and if people like me have analyzed Japan’s plight correctly–then six months or a year from now Japan may be on the road to an economic recovery more dramatic than anyone would now dare to forecast. By sometime next year, the Land of the Rising Sun may, at least for a while, live up to its billing. You heard it here first.”

What I find interesting is that when talking about Japan people like Krugman, and later that same year Bernanke (“Self-induced paralysis”), had it essentially right. The only suggested modification to their blueprint would be to substitute the I word for a level target for NGDP.

Having the power to do so, Bernanke was very timid in his actions. And Krugman has essentially denied the power, or effectiveness, of monetary policy at the ZLB.

It seems it´s much easier to “judge” others than “judge” yourself!

Sliding towards an alternative target

John Williams, president of the San Francisco Fed presented an interesting paper – Monetary Policy at the Zero Lower Bound – Putting Theory into Practice – at the launch of the Brookings Hutchins Center on Fiscal & Monetary Policy.

From the introduction:

It has been said, “An economist is a man who, when he finds something works in practice, wonders if it works in theory.”

The study of the zero lower bound (ZLB) on nominal interest rates is an example of precisely the opposite: economists first figuring out what works in theory and then seeing if it works in practice. Japan’s experience with price deflation and zero short-term interest rates beginning in the 1990s led to a flurry of economic research on the ZLB and its implications for monetary policy (see, for example, Benhabib, Schmitt-Grohé, and Uribe 2001; Eggertsson and Woodford 2003; Reifschneider and Williams 2000; and references therein). This research came to a number of concrete conclusions and policy prescriptions that influenced policymaking during and after the global financial crisis.

One conclusion from the precrisis research was that the ZLB was a problem that could potentially afflict any economy with a sufficiently low inflation target, but that the episodes at the ZLB would be relatively infrequent and generally short-lived. For example, Reifschneider and Williams (2000) found that under a standard Taylor (1993) monetary policy rule and a 2 percent inflation target, monetary policy would be constrained at the ZLB about 5 percent of the time, and ZLB episodes would typically last just one year. Other research came to even more sanguine conclusions regarding the likely effects of the ZLB, in part because that research was often predicated on an economic environment similar to the tranquil Great Moderation period of the 1980s and 1990s in the United States (see, e.g., Adam and Billi 2006; Coenen, Orphanides, and Wieland 2004; Schmitt-Grohé and Uribe 2007).

Second, this research identified monetary policy strategies that should be effective at reducing most of the adverse effects of the ZLB. Specifically, short-term rates should be cut aggressively when deflation or a severe downturn threatens (Reifschneider and Williams 2000, 2002). That is, do not “keep your powder dry.” In addition, short-term rates should be kept “lower for longer” as the economy recovers (Eggertson and Woodford 2003; Reifschneider and Williams 2000, 2002). In theory, the expectation of a sustained low level of short-term interest rates reduces longer-term yields and eases financial conditions more broadly. In these two ways, the maximal amount of monetary stimulus can be put into place quickly. Indeed, this research found that such strategies should, in most cases, be sufficient to nearly fully offset the effects of the ZLB on the economy.

Third, some researchers argued that unconventional policy actions such as central bank large-scale asset purchases (LSAP) of longer-term securities or foreign exchange can complement conventional policy actions by making financial conditions more favorable for growth even when short rates are constrained by the ZLB (Bernanke and Reinhart 2004; Bernanke, Reinhart, and Sack, 2004; McCallum 2000; Svensson 2001).

Of course, within a few years of this research being written, the ZLB went from being a theoretical concern to a very real practical problem for many central banks across the globe. The Bank of England, the Bank of Japan, the European Central Bank, and the Federal Reserve all brought their policy rates to their respective effective lower bounds in late 2008 or early 2009. Central banks quickly sought to put into practice many of the prescriptions that researchers had identified.

The experiences of the past six years provide a wealth of data on what works and what doesn’t, which theories have proved useful, and which need to be reconsidered. This essay reexamines the three key issues outlined above that research highlighted related to the ZLB, and ends by laying out three still unanswered questions for monetary policy in a world where the ZLB is an ongoing concern.

At the end he covers Unresolved Issues:

The experience of the past six years has demonstrated the valuable contributions of economic theory and research in thinking through abstract economic issues before they became reality. It has also provided a store of new information regarding the incidence and consequences of the ZLB. In particular, we have learned that the ZLB is a serious practical issue that is very likely to constrain policy in the future, and that there are implementable policy actions that can help offset some, if not all, of the deleterious effects from the ZLB.

Looking ahead, there remain a number of key unresolved issues related to the ZLB. Three come immediately to mind.

First, should central banks change their policy frameworks from inflation targeting to one of price-level or nominal-GDP targeting in order to better anchor expectations of future policy actions?

One lesson from the recent past is the difficulty in anchoring policy expectations when the short-rate is at the ZLB. Although quantitative forward guidance has proven a useful tool, it suffers from a number of limitations. Experience has shown that it is impossible to convey the full reach of factors that influence the future course of policy. As a result, forward guidance ends up being overly simplified and prone to misinterpretation. Moreover, forward guidance several years in advance may not be credible, especially in light of the change in policymakers over time. In theory, alternative frameworks such as nominal GDP targeting, if fully understood by the public, could help resolve these communication difficulties.

Finally, and most controversially, in light of the experience of the costs of the ZLB and central banks’ abilities to counter them, does the 2 percent inflation target adopted by many central banks provide a sufficient cushion to allow monetary policy to successfully stabilize the economy and inflation in the future?

On one side of the ledger, recent experience proves that the ZLB is a worse problem than previously imagined; consideration of the implications of the ZLB in the future will need to take this into account. On the other side, forward guidance, large-scale asset purchases, and, in some cases, fiscal policy have proven to be effective partial antidotes for the ZLB. Even if one views the risks from the ZLB to be greater than before, there are alternatives to raising the inflation target. More-effective financial regulation may diminish the potential for a severe crisis for the foreseeable future. And, as noted above, adoption of a price-level or nominal GDP targeting regime could potentially further reduce the costs of the ZLB.

What is needed now, like the surge in research on the ZLB in the decade before the crisis, is a new flurry of research on these issues that takes into account the lessons of the past six years, and helps provide concrete prescriptions for future policymakers.

Australia may constitute a good laboratory for empirical research. The RBA says:

In determining monetary policy, the Bank has a duty to maintain price stability, full employment, and the economic prosperity and welfare of the Australian people. To achieve these statutory objectives, the Bank has an ‘inflation target’ and seeks to keep consumer price inflation in the economy to 2–3 per cent, on average, over the medium term.

(Note: Both the headline and the core measure average 2.6% since IT was implemented, so one can say the RBA has fulfilled its inflation mandate. With no recession it seems economic prosperity and the welfare of the Australian people has not been ignored. And it has remained far away from the ZLB).

The real growth picture:

Australian Paradigm_0

The inflation picture:

Australian Paradigm_1

The unemployment rate picture:

Australian Paradigm_2

The NGDP level targeting picture:

Australian Paradigm_3

The policy rate picture (no ZLB):

Australian Paradigm_4

The “usual idiots suspects”

Paul Krugman thinks he´s been consistently right while others are “usual idiots suspects”:

We are already, however, well into the realm of what I call depression economics. By that I mean a state of affairs like that of the 1930s in which the usual tools of economic policy — above all, the Federal Reserve’s ability to pump up the economy by cutting interest rateshave lost all traction. When depression economics prevails, the usual rules of economic policy no longer apply: virtue becomes vice, caution is risky and prudence is folly.

If the Fed cannot cut interest rates it obviously cannot pump up the economy through that venue. Maybe he thinks monetary policy is interest rate policy. It isn´t, but that has been hammered into everyone´s head so that most believe it is!

Luckily FDR did not think it was. He established a price level target and delinked from gold, in effect depreciating the dollar. This was done in March 1933 and the economy reacted immediately, with nominal spending rising fast! That´s a clear example of monetary policy´s power even at the ZLB!

Usual idiots suspects

‘Abenomics’ one year on

Shinzo Abe was elected in December 2012 on a promise to revive growth and put an end to deflation. How have his promises ‘performed’ one year after taking power?

The ‘performance’ will be illustrated by a set of charts.

The first chart shows the behavior of inflation, both headline and core.

Abenomics 1 year on_1

It appears to be gaining ‘positive traction’ after years of languishing in deflationary territory.

The next chart shows the bounce in aggregate demand (NGDP) and real output (RGDP).

Abenomics 1 year on_2

The next chart depicts what happened with the Nikkei stock index and the exchange rate (yen/USD).

Abenomics 1 year on_3

The strong rise in the stock market is indicative of positive expectations about the effects of the plan. The depreciation of the yen is an important transmission mechanism of the expansionary monetary policy. In this case, the initial negative reaction of competitors, who accused Japan of engaging in ‘beggar-thy-neighbor’ policies, was misplaced. As the next chart shows, imports rose by more than exports, with Japan incurring a trade balance deficit.

Abenomics 1 year on_4

This is indicative that the income effect of the expansionary policy was stronger than the terms of trade effect of the exchange devaluation. In other words, it reflects an increase in domestic demand.

It is also interesting to compare Japan since ‘Abenomics’ with what´s happening in the Eurozone.

The chart shows the growth of broad money (M3). While in Japan, according to the plan, monetary policy is expansionary; in the Eurozone the BCE is tightening monetary policy.

Abenomics 1 year on_5

It is, therefore, not surprising to observe the contrasting behavior of inflation in the two cases. While in Japan inflation is climbing towards the 2% target, in the EZ it is way below target and falling, with several countries in the group experiencing deflation.

Abenomics 1 year on_6

The difference in the behavior of the BoJ and BCE is summarized in the chart below which shows the growth of real output in the two ‘countries’.

Abenomics 1 year on_7

So it seems that ‘Abenomics’ is delivering on its promise. Hopefully it will continue to do so. We may also conclude that the EZ is travelling to “where Japan is coming from”!

The “monetary offset” in action

Monetary OffsetNow imagine if monetary policy had been a bit more purposeful!

Update: Matt Yglesias takes on the subject and concludes:

Now maybe Fed officials are confused or lying or even fooling themselves in an effort to evade accountability. But this is what they say is going on, it’s a view they’ve articulated for years, and it’s a view that they’ve refined as time has gone on.Believers in full offset owe us a clearer account of why we should ignore the Fed’s testimony on this.

The reason to ignore the Fed´s testimony is very straightforward. History is full of examples of the Fed denying responsability for any “less than desirable” outcome.