This Fed worship is more religious than scientific. The past 10 years should be enough to convince anyone with an open mind that the Fed’s power over the economy is quite limited and tenuous.
More at the link. Pointer from Scott Sumner, who takes an opposing view. As you know, my views align with Grier’s.
Reviewing Sebastian Mallaby’s biography of Alan Greenspan, Randall Kroszner writes,
The Fed has limited instruments at its disposal—primarily its control over short-term interest rates—and trying to use this tool for “bubble bursting” while still addressing the Fed’s traditional mandates for full employment and low and stable inflation could lead to conflicting prescriptions. Better, Mr. Greenspan believed, to be ready to clean up the debris if a bubble were to burst, as in 1987. Mr. Mallaby argues that the inflation-targeting framework, which focused central banks world-wide on the goal of low and stable inflation in response to their bad behavior in the 1970s when they eased credit in the short run to boost employment, provided an intellectual underpinning for Mr. Greenspan’s approach.
Indeed, it is useful to go back to what economists were thinking back when Olivier Blanchard was writing that “the state of macro is good.” The idea was that the GDP factory slumped when there were inflation “surprises,” in which prices increased more slowly than expected, leading to real wages that were too high. So if the Fed kept the inflation rate predictable (and it might as well shoot for a predictable rate that was low), then everything would be fine.
Some remarks:
1. Now, journalists want to paint Greenspan as a great free-marketeer, as if he spent his career fending off cries for more financial regulation. In fact, there was a consensus in the 1980s that inter-state banking had to arrive and that the Glass-Steagall separation of investment banking from commercial banking was being eroded by innovation. The deregulation that ratified these changes would have happened under any conceivable Fed chairman at that time. Moreover, the deregulation was accompanied by what banking officials were convinced at the time were stronger and more effective regulations regarding safety and soundness. They were particularly proud of risk-based capital regulations, and it was the market-oriented economists of the Shadow Regulatory Committee who warned that those were not adequate to prevent a crisis.
2. The “(dis-)inflation surprise” theory of economic slumps is now gone. The closest thing remaining is Scott Sumner’s slower-nominal-GDP theory of slumps. That one works for the post-financial-crisis recession because real GDP went way down, which (a) meant that nominal GDP growth was slower than previously and (b) tautologically, there was a slump. I am troubled by the tautology aspect.
3. However, the Keynesians who dominate the current macro conversation have different theories. Some like to tell a story about consumer debt. Many like to tell a story about a liquidity trap.
4. Speaking for macroeconomists in general Blanchard is now open to many different ideas. However, the one idea that they will not consider changing is the GDP factory. Thus, the idea that patterns of sustainable specialization and trade matter is not on the radar screen.
One commenter pointed out that RGDP fell by over 12% between 1945 and 1946, and that lots of women left the labor force after WWII. So does a shrinking labor force explain the disconnect between unemployment and GDP? As far as I can tell it does not, which surprised even me. But the data is patchy, so please offer suggestions as to how I could do better.
You could do better by taking the RGDP figure with a tablespoon of salt. The way that the Commerce Department adjusts nominal GDP for price changes is pretty unreliable for that period. Part of the reason is that there was so much shifting between public sector output (who knows how much of that is “real” vs. nominal?) and private sector output, and part of the reason is that as you move away from the base year (either many years ahead or many years behind) the adjustment process gets screwy. 1946 is now many, many years away from the base year that is used to calculate real GDP. I think that if you can find old publications from the Commerce Department, you will see very different patterns of real GDP for 1946, resulting from shifts in the base year from 1958 to 1975 to ….
I think that for 1946 you are safer sticking to nominal GDP numbers.
By the way, here is a piece I wrote on that period.
The is no plausible argument that Hong Kong’s success is in any way a success story for statism, and there is no plausible argument that Greece’s failure has anything to do with neoliberalism. To suggest otherwise is to engage in The Big Lie. So what does this mean?
Read the whole thing.
Let me try, in a somewhat charitable way, to express what I believe is the mindset of the left.
1. Start with the assumption that there is a science of government. I need to credit Jeffrey Friedman with influencing me to articulate this assumption. Note that everyone uses the term “social science,” even though Jeffrey and I would argue vehemently that economics, sociology, et al, are not sciences.
2. If there is a science of government, then there is no reason to tolerate market failure. Since market failure is widespread, government intervention should be widespread.
3. If there is a science of government, then government failure is avoidable. Government failure only results from leaders not heeding the scientists.
4. If there is a science of government, and people on the right believe in markets, then they must believe that markets are perfect. They are clearly wrong about this.
According to this scheme, the key to intellectually overcoming the left is to get people to concede that there is no science of government. And in particular, it means taking economics down a peg. That is what Jeffrey is trying to do with his next book, and it is what I try to do in the book that will be out later this month.
The IS relation remains the key to understanding short-run movements in output. In the short run, the demand for goods determines the level of output. A desire by people to save more leads to a decrease in demand and, in turn, a decrease in output. Except in exceptional circumstances, the same is true of fiscal consolidation.
Pointer from Scott Sumner, who disagrees for different reasons than mine.
In the 1960s, macro was distinct from micro, and few people worried about that. If “spending creates jobs and jobs create spending” was contrary to Walrasian general equilibrium, then so be it. By 1985, the situation (at the graduate level) was totally reversed. Every macro model had to nod in the direction of general equilibrium. It stayed that way until 2008.
Now, the best that MIT economists can do is revert back to 1960s thinking. In my forthcoming book, I offer the alternative of PSST.
Check out this chart, which was linked to by one of Scott Sumner’s commenters.
It shows a large secular increase in the spread between risky corporate bonds and 10-year Treasuries.
To me, this chart provides evidence of the bogosity of the secular stagnation story. That story claims that “the” real interest rate has been declining in recent decades, so that we face a constant threat of too-low “aggregate demand.” But focusing on 10-year Treasuries to tell that story is a swindle. Looking at risky corporate bonds, we see signs of dis-stagnation.
There is no unique real interest rate. It’s not just that risk premia diverge. Prices of various goods and services are rising and falling at different rates. In health care and education, where prices have been rising, real interest rates indeed have been negative (a “stagnation” story). For many types of durable goods, where quality-adjusted prices have been falling, real interest rates are decidedly positive (dis-stagnation).
Talking of “the” real interest rate reflects GDP-factory thinking. I look forward to a day when PSST thinking has replaced GDP-factory thinking. Then economists will stop fooling themselves with notions like secular stagnation.
When newspapers make mistakes or false accusations, they publish corrections. That’s not always the case with bloggers, however. And sometimes it seems the more prominent the blogger, the less likely a correction will be made.
A recent example comes from noted economist Paul Krugman. . .
I think that Adler is wrong to frame this in terms of newspapers vs. blogs. Krugman does not limit his remorseless slander to blogs.
Everything written by, for, or against Krugman over the past 15 years is a waste of time. That includes this post as well as Adler’s. It includes various attempts by Henderson, Cowen, and Sumner to engage with Krugman. They try to treat him as if he had some sense of decency. Instead, he is Joe McCarthy with a Nobel Prize.
economists don’t even know that they don’t know what inflation is. They talk as if it’s some sort of objective fact, like the height of Mt. Everest, which we ascertain with ever more accurate measurements.
I agree, and by the same token, we do not know the rate of productivity growth. The aggregation problems involved in trying to characterize the economy as a GDP factory are just too daunting.
Surely there are other independent, ex ante signs for judging the tightness of monetary policy, rather than waiting for ngdp figures to come in, which again is citing a transform of the real gdp growth rate as a way of explaining real gdp.
He also links to Mike Munger, which led me to this post.
Read both in their entirety. I share their concerns with circularity in market monetarism.
Perhaps the market monetarists would answer that we will have an ex ante sign of the stance of monetary policy when we have an NGDP futures market. But in order to get a non-circular definition of tight money from market monetarists, must we wait for an NGDP futures market? Meanwhile, perhaps a worthwhile exercise for market monetarists would be to spell out the best way of inferring expected future NGDP from existing market indicators.
UPDATE: After I wrote this, but before I posted it, Scott Sumner wrote,
My focus when estimating the stance of monetary policy has generally been NGDP forecasts, not actual NGDP. And NGDP forecasts are available in real time, and hence not subject to the “waiting for ngdp figures to come in” critique above.
But that paragraph turns out to be disingenuous. He proceeds to disparage economists’ forecasts as not being market forecasts. He suggests that the spread between nominal bonds and inflation-indexed bonds is a better indicator of expected inflation than what you will find in a consensus economic forecast.
Overall, Sumner does show that he clearly understands that Tyler and other critics are asking for an actionable, forward-looking statement of the market-monetarist view of current conditions. And he comes close to providing it.
the current ultra-low 5-year spread [between interest rates on nominal bonds and rates on inflation-indexed bonds] suggests money is too tight for the Fed’s 2% inflation target. That doesn’t mean we’ll have a recession, but if the Fed wants to hit their 2% inflation target they need to ease policy. If they don’t, and if they fall short of their inflation target, then MMs will have been right.
That is Scott Sumner’s magnum opus on the Great Depression. I am part way through it. The importance of the book cannot be overstated. Here, I want to mention two problems I am having.
1. The structure of the book. It is difficult to get through. He constantly interrupts his own interpretive narrative to discuss other economists’ narratives. I would have rather seen the discussions of other narratives cordoned off into appendices.
2. Sumner wants to rely on stock market movements as indicators of the effect of monetary policy on the economy. I am never a fan of trying to interpret the stock market, and this time period seems particularly problematic. Robert Shiller’s famous argument against the efficient markets hypothesis is the “excess volatility” that he found in stock prices. The period that Sumner is describing has volatility that goes far beyond even what caused Shiller to reject market efficiency. Reading Sumner’s narrative, there seem to be a lot of days where the market goes up or down by 4 percent, 5 percent, or more. In today’s terms, that would mean the Dow often gaining or losing 700 to 850 points in a day. I am inclined to dismiss 90 percent of these movements as irrational (I would do the same for short-term movements in the market now). I understand that Sumner is looking for indications that the economy is responding to monetary policy, as opposed to some other factor, but I find it more persuasive when he cites medium-term trends in commodity prices than when he cites short-term stock price behavior.