“Everything reminds Paul Krugman of the GOP. Everything reminds me of sex, but I try to keep it out of my papers.”

This is Paul Krugman:

Actually, before I get there, a word about self-styled conservative “market monetarists”: guys, have you noticed who your real policy enemies are? People like me, Brad DeLong, etc. are skeptical about the Fed’s ability to offset the effects of fiscal austerity, but we do want it to try. The furious academic opposition to quantitative easing is instead coming from moderate conservative macroeconomists, notably Taylor and Feldstein. So your problem isn’t just that the GOP’s effective leader on economic issues gets his macro from Francisco D’Anconia; it’s that even the not-so-silly wing of the party is dead set against what you consider reform.

When I read Krugman’s comment I came to think about what Robert Solow once said about Milton Friedman:

“Everything reminds Milton Friedman of the money supply. Everything reminds me of sex, but I try to keep it out of my papers.”

Paul Krugman undoubtedly is an extremely clever economist and when he actually writes about economics – rather than about obsessing about the US Republican party – he can be very interesting to read.

Unfortunately he is no better than the people on the right in US politics he so hates. It seems like every issue he writes about has to involve the Republican Party. Frankly speaking I find that extremely boring and massively counterproductive.

Personally I refuse to participate in the tribalism advocated by Paul Krugman. I do not judge economists and their views on whether they are affiliated with the Republican party or the Democrat party in the US. I find these affiliations utterly irrelevant.

It is of course correct that Market Monetarists tend to agree with Keynesians like Krugman and Brad DeLong that the main economic problem  in the US, Japan and the euro zone right now is weak aggregate demand (we would say weak NGDP growth). None of ever denied that. However, we equally agree with John Taylor that monetary policy should be rule based and we agree with Allan Meltzer (at least the ‘old’ Meltzer) that monetary policy is highly potent. That is as least as important – or maybe even more important – when it comes to policy advocacy.

Furthermore, as particularly Scott Sumner often has argued that Paul Krugman has been extremely inconsistent on his view of monetary policy – sometimes he seems to that there is no role for monetary policy (he seems as obsessed with the imaginary liquidity trap as he is with the GOP) and sometimes he thinks monetary easing is great and will work. Or said in another way – we tend to agree the New Keynesian Krugman, but have no time for the paleo-Keynesian Krugman.

Finally would you all stop calling Market Monetarists “conservative”. As far as I know most of the Market Monetarist bloggers are either apolitical or think of themselves as libertarian or classical liberal. I am certainly no conservative – neither was Hayek nor was Friedman.

PS Josh Barro might be to “blame” to this discussion. It is probably this comment that triggered Krugman’s response:

“But while market monetarism is the shining success of the conservative reform movement, it also points to trouble for the reformists. We have had zero success in convincing Republican elected officials that easy money is ever a good idea. The Republican party has gotten, if anything, more rabidly afraid of inflation and more flirtatious with the idea of returning to a gold standard. The 2012 Republican National Convention adopted a platform calling for a “commission to investigate possible ways to set a fixed value for the dollar.”

PPS I feel that this blog post might have been a complete waste of time writing so I hope that I at least have not wasted your time as well.

PPPS Scott also comments on Krugman as do Dilbert:

186605.strip

 

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BIS is fearful of bubbles, but is not always right (remember the gold standard?)

I think there is a bubble in bubble fears. This is particularly the the case for central bankers and institutional monetary institutions.

Here  in the Telegraph:

The two watchdogs launched broadsides against central bank largess last week. The BIS — the forum of central banks — was particularly blunt, seeming to imply that quantitative easing “does not work”.

Critics say this risks undermining the credibility of radical measures when more may yet be needed. They fear central banks could repeat the mistake made in 1937 when the Federal Reserve lost its nerve and tightened too soon, tipping America back into depression.

And here is my response in the same article:

“The BIS and the IMF are deeply misguided and risk doing the world a grave disservice. The biggest threat right now is irrational fear of bubbles among central banks,” said Lars Christensen 

Particularly the advise of BIS is taken to be very important as the general perception is that the BIS “got it right” prior to the crisis – the fact that it got it mostly wrong over the past five year apparently is less important. Paul Krugman has some not too kind words about BIS – or the Sadomonetarists of Basel as Krugman calls the institution headquartered in Switzerland:

I guess we can check the record here and see just how prescient the BIS was. What I do recall, however … is that the BIS has spent years warning about the dangers of low interest rates. Except that a couple of years back it was telling a completely different story about why we needed to raise rates; you see, the big danger was of imminent inflation…

…In fact, inflation is running below target just about everywhere. You might therefore think that the BIS would step back a bit and reconsider both its policy recommendations and the framework it uses to derive those recommendations.

I can, however, do better than Krugman. BIS’ Sadomonetarist tendencies date back more than five years. This is from BIS’ third annual report publish in May 1933:

“For the Bank for International Settlements, the year has been an eventful one, during which, while the volume of its ordinary banking business has necessarily been curtailed by the general falling off of international financial transactions and the continued departure from gold of more and more currencies, culminating in the defection of the American dollar, nevertheless the scope of its general activities has steadily broadened in sound directions. The widening of activities, aside from normal growth in developing new contacts, has been the consequence, primarily, of a year replete with international conferences, and, also, of the rapid extension of chaotic conditions in the international monetary system. In view of all the events which have occurred, the Bank’s Board of Directors determined to define the position of the Bank on the fundamental currency problems facing the world and it unanimously expressed the opinion, after due deliberation, that in the last analysis “the gold standard remains the best available monetary mechanism” and that it is consequently desirable to prepare all the necessary measures for its international reestablishment.”

And this is what I earlier had to say about that report:

Take a look at the report. The whole thing is outrageous – the world is falling apart and it is written very much as it is all business as usual. More and more countries are leaving the the gold standard and there had been massive bank runs across Europe and a number of countries in Europe had defaulted in 1932 (including Greece and Hungary!) Hitler had just become chancellor in Germany.

And then the report state: ”the gold standard remains the best available monetary mechanism”! It makes you wonder how anybody can reach such a conclusion and in hindsight obviously today’s economic historians will say that it was a collective psychosis – central bankers were suffering from some kind of irrational “gold standard mentality” that led them to insanely damaging conclusions, which brought deflation, depression and war to Europe.

Unfortunately BIS’ view haven’t changed much since 1933. Should we listen to the Sadomonetarists in Basel today?

Paul Krugman warns against fiscal stimulus

This is Paul Krugman on the effectiveness on fiscal policy and why fiscal “stimulus” will in fact not be stimulative:

“The US is currently engaged in the largest peacetime fiscal stimulus in history, with a budget deficit of around 10 percent of GDP. And this stimulus is working in the narrow sense that it has headed off the imminent risk of a deflationary spiral, and generated some economic growth. On the other hand, deficits this size cannot be continued over the long haul; USA now has Italian (or Belgian) levels of internal debt, together with large implicit liabilities associated with its awkward demographics. So the current strategy can work in the larger sense only if it succeeds in jump-starting the economy, in eventually generating a self-sustaining recovery that persists even after the stimulus is phased out.

Is this likely? The phrase “self-sustaining recovery” trips lightly off the tongue of economic officials; but it is in fact a remarkably exotic idea. The purpose of this note is to expose this hidden exoticism – to show that anyone who believes that temporary fiscal stimulus will produce sustained recovery is implicitly endorsing a rather fancy economic model, the sort of model that finance ministries would under normal circumstances regard as implausible and disreputable…

…What continues to amaze me is this: USA’s current strategy of massive, unsustainable deficit spending in the hopes that this will somehow generate a self-sustained recovery is currently regarded as the orthodox, sensible thing to do – even though it can be justified only by exotic stories about multiple equilibria, the sort of thing you would imagine only a professor could believe. Meanwhile further steps on monetary policy – the sort of thing you would advocate if you believed in a more conventional, boring model, one in which the problem is simply a question of the savings-investment balance – are rejected as dangerously radical and unbecoming of a dignified economy.”

Wauw! What is this? What happened to the keynesian Krugman? Isn’t he calling for fiscal easing anymore? Well yes, but I am cheating here. This is Paul Krugman, but it is not today’s Paul Krugman. This is Paul Krugman in 1999 – and he is talking about Japan and not the US. I simply replaced “Japan” with “the US” in the Krugman quote above.

Read the entire article here.

HT Tyler Cowen and Vaidas Urba.

Market Monetarism vs Krugmanism

Here is an interesting comment from ‘JJA’ over at Scott Sumner’s blog:

“Scott, I have enjoyed reading your blog. As a practitioner (firm level decisions regarding export related efforts) I find you (and other market monetarists, especially Christensen and Nunes) very understandable and convincing. But… But I find Krugman and DeLong very understandable and convincing also… From my micro-level point of view it seems to be the case that both sides are right, but something is missing in-between.

Well, I am not an economist, but I think that I see NGDP as the ultimate aim in order to manage stable and prosperous economy. At the same time I see the importance of fiscal activity (from the state or whatever public body), and that is at the same time when I think that the monetary policy is the most important part of the situation. But I feel that monetary policy alone is not enough in order to achieve good results in a reasonable time. Therefore fiscal.

From my practical point of view, both market monetarists and old-style keynesians seem to be right at the same time. It may be that I am mad or something vital is missing from our understanding of economics.

But in any case, I just make decisions in practice. By the way, I am from the Eurozone (unfortunately).”

I think JJA raises a number of interesting questions about the similarities between Market Monetarism and “Krugmanism”. Yes, Krugman has endorsed NGDP level targeting as do Market Monetarists. However, just because we share the policy recommendation (and I am not sure we really do…) that does not mean that our theoretical thinking is close.

I do fundamentally think that Keynesians (including Krugman) and Market Monetarists (and old style Monetarists) are quite far away from each other theoretically.

I have three earlier posts that might clarify this:

On our macro/micro foundation: How I would like to teach Econ 101

On why we don’t think fiscal policy is effective. There is no such thing as fiscal policy

On why we favour a RULES based monetary policy: NGDP targeting is not a Keynesian business cycle policy

These three posts should make it clear what the key theoretical differences between Market Monetarists and Keynesians are.

That said, for the US and the euro zone Market Monetarists and New Keynesians (at least Krugman, DeLong and Romer) agree that monetary easing is warranted and that this could be done within the framework of NGDP level targeting. That said, Market Monetarists do not want to “fix” the economy and unlike keynesians we do not think that the problems are real, but rather nominal. The crisis is a result of a monetary policy mistakes rather than a “market failure”.

In regard to fiscal policy I might add that Market Monetarists probably are less concerned about the general fiscal troubles in the US and the euro zone than many “establishment” economists (and particularly European policy makers). David Beckworth have a number of good posts on this issue (See for example here). We agree that the present fiscal path is unsound in both the US and the euro zone, but if we get monetary policy right (target the NGDP level of the pre-crisis trend) then that would reduce the fiscal stress very significantly – not to speaking of reducing banking problems. Get monetary policy right and then the European and US banking problems and the fiscal policy problems will become manageable (on an overall level).

That said, Market Monetarists do in general not think that fiscal policy on its own can increase nominal spending in the economy so even though we think that fiscal policy should not be a major concern if monetary policy is “right” we also don’t think it is useful to spend a lot of time trying to “stimulate” the economy with fiscal measures. The only role we see for fiscal policy is to ensure long-term productivity growth and growth in the labour supply, but that is certainly not what Paul Krugman has in mind.

There is no such thing as fiscal policy – and that goes for Japan as well

Scott Sumner has a comment on Japan’s ”lost decades” and the importance of fiscal policy in Japan. Scott acknowledges based on comments from Paul Krugman and Tim Duy that in fact Japan has not had two lost decades. Scott also discusses whether fiscal policy has been helpful in reviving growth in the past decade in Japan.

I have written a number of comments on Japan (see here, here and here).

I have two main conclusions in these comments:

1)   Japan only had one “lost decade” and not two. The 1990s obviously was a disaster, but over the past decade Japan has grown in line with other large developed economies when real GDP growth is adjust for population growth. (And yes, 2008 was a disaster in Japan as well).

2)   Monetary policy is at the centre of these developments. Once the Bank of Japan introduced Quantitative Easing Japan pulled out of the slump (Until BoJ once again in 2007 gave up QE and allowed Japan to slip back to deflation). Se especially my post “Japan shows QE works”.

This graph of GDP/capita in the G7 proves the first point.

Second my method of decomposition of demand and supply inflation – the so-called Quasi-Real Price Index - shows that once Bank of Japan in 2001 introduced QE Japanese demand deflation eased and from 2004 to 2007 the deflation in Japan only reflected supply deflation while demand inflation was slightly positive or zero. This coincided with Japanese growth being revived. The graph below illustrates this.

Obviously the Bank of Japan’s policies during the past decades have been far from optimal, but the experience clearly shows that monetary policy is very powerful and even BoJ’s meagre QE program was enough to at least bring back growth to the Japanese economy.

Furthermore, it is clear that Japan’s extremely weak fiscal position to a large extent can be explained by the fact that BoJ de facto has been targeting 0% NGDP growth rather than for example 3% or 5% NGDP growth. I basically don’t think that there is a problem with a 0% NGDP growth path target if you start out with a totally unleveraged economy – one can hardly say Japan did that. The problem is that BoJ changed its de facto NGDP target during the 1990s. As a result public debt ratios exploded. This is similar to what we see in Europe today.

So yes, it is obvious that Japan can’t not afford “fiscal stimulus” – as it today is the case for the euro zone countries. But that discussion in my view is totally irrelevant! As I recently argued, there is no such thing as fiscal policy in the sense Keynesians claim. Only monetary policy can impact nominal spending and I strongly believe that fiscal policy has very little impact on the Japanese growth pattern over the last two decades.

Above I have basically added nothing new to the discussion about Japan’s lost decade (not decades!) and fiscal and monetary policy in Japan, but since Scott brought up the issue I thought it was an opportunity to remind my readers (including Scott) that I think that the Japanese story is pretty simple, but also that it is wrong that we keep on talking about Japan’s lost decades. The Japanese story tells us basically nothing new about fiscal policy (but reminds us that debt ratios explode when NGDP drops), but the experience shows that monetary policy is terribly important.

——–

PS I feel pretty sure that if the Bank of Japan and the ECB tomorrow announced that they would target an increase in NGDP of 10 or 15% over the coming two years and thereafter would target a 4% NGDP growth path then all talk of “lost decades”, the New Normal and fiscal crisis would disappear very fast. Well, the same would of course be true for the US.

Japan shows that QE works

I am getting a bit worried – it has happened again! I agree with Paul Krugman about something or rather this time around it is actually Krugman that agrees with me.

In a couple of posts (see here and here) I have argued that the Japanese deflation story is more complicated than both economists and journalists often assume.

In my latest post (“Did Japan have a productivity norm?”I argued that the deflation over the past decade has been less harmful than the deflation of the 1990s. The reason is that the deflation of the 2000s (prior to 2008) primarily was a result of positive supply shocks, while the deflation of in 1990s primarily was a result of much more damaging demand deflation. I based this conclusion on my decomposition of inflation (or rather deflation) on my Quasi-Real Price Index.

Here is Krugman:

“A number of readers have asked me for an evaluation of Eamonn Fingleton’s article about Japan. Is Japan doing as well as he says?

Well, no — but his point about the overstatement of Japan’s decline is right…

…The real Japan issue is that a lot of its slow growth has to do with demography. According to OECD numbers, in 1990 there were 86 million Japanese between the ages of 15 and 64; by 2007, that was down to 83 million. Meanwhile, the US working-age population rose from 164 million to 202 million.”

This is exactly my view. In terms of GDP per capita growth Japan has basically done as good (or maybe rather as badly) other large industrialised countries such as Germany and the US.

This is pretty simple to illustrate with a graph GDP/capita for the G7 countries since 1980 (Index 2001=100).

(UPDATE: JP Koning has a related graph here)

A clear picture emerges. Japan was a star performer in 1980s. The 1990s clearly was a lost decade, while Japan in the past decade has performed more or less in line with the other G7 countries. In fact there is only one G7 country with a “lost decade” over the paste 10 years and that is Italy.

Quantitative easing ended Japan’s lost decade

Milton Friedman famously blamed the Bank of Japan for the lost decade in 1990s and as my previous post on Japan demonstrated there is no doubt at all that monetary policy was highly deflationary in 1990s and that undoubtedly is the key reason for Japan’s lost decade (See my graph from the previous post).

In 1998 Milton Friedman argued that Japan could pull out of the crisis and deflation by easing monetary policy by expanding the money supply – that is what we today call Quantitative Easing (QE).

Here is Friedman:

“The surest road to a healthy economic recovery is to increase the rate of monetary growth, to shift from tight money to easier money, to a rate of monetary growth closer to that which prevailed in the golden 1980s but without again overdoing it. That would make much-needed financial and economic reforms far easier to achieve.

Defenders of the Bank of Japan will say, “How? The bank has already cut its discount rate to 0.5 percent. What more can it do to increase the quantity of money?”

The answer is straightforward: The Bank of Japan can buy government bonds on the open market, paying for them with either currency or deposits at the Bank of Japan, what economists call high-powered money. Most of the proceeds will end up in commercial banks, adding to their reserves and enabling them to expand their liabilities by loans and open market purchases. But whether they do so or not, the money supply will increase.

There is no limit to the extent to which the Bank of Japan can increase the money supply if it wishes to do so. Higher monetary growth will have the same effect as always. After a year or so, the economy will expand more rapidly; output will grow, and after another delay, inflation will increase moderately. A return to the conditions of the late 1980s would rejuvenate Japan and help shore up the rest of Asia.”

(Yes, it sounds an awful lot like Scott Sumner…or rather Scott learned from Friedman)

In early 2001 the Bank of Japan finally decided to listen to the advise of Milton Friedman and as the graph clearly shows this is when Japan started to emerge from the lost decade and when real GDP/capita started to grow in line with the other G7 (well, Italy was falling behind…).

The actions of the Bank of Japan after 2001 are certainly not perfect and one can clearly question how the BoJ implemented QE, but I think it is pretty clearly that even BoJ’s half-hearted monetary easing did the job and pull Japan out of the depression. In that regard it should be noted that headline inflation remained negative after 2001, but as I have shown in my previous post Bank of Japan managed to end demand deflation (while supply deflation persisted).

And yes, yes the Bank of Japan of course should have introduces much clearer nominal target (preferably a NGDP level target) and yes Japan has once again gone back to demand deflation after the Bank of Japan ended QE in 2007. But that does not change that the little the BoJ actually did was enough to get Japan growing again.

The “New Normal” is a monetary – not a real – phenomenon

I think a very important conclusion can be drawn from the Japanese experience. There is no such thing as the “New Normal” where deleveraging necessitates decades of no growth. Japan only had one and not two lost decades. Once the BoJ acted to end demand deflation the economy recovered.

Unfortunately the Bank of Japan seems to have moved back to the sins of 1990s – as have the Federal Reserve and the ECB. We can avoid a global lost decade if these central banks learn the lesson from Japan – both the good and the bad.

HT JP Koning

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