J. Bradford DeLong's Grasping Reality with All Eight Tentacles

Time to Reread the History of Austria's Creditanstalt in 1931...

Interesting time. In Europe, the Creditanstalt's bankruptcy and what followed was what turned the recession into the European Great Depression...

Roula Khalaf: The emirate has a lot of explaining to do: It came in a short statement about the restructuring of Dubai World, one of the emirate’s biggest and best-known companies, with the big news buried towards the end. But the decision to ask bondholders of the company and its most troubled subsidiary, Nakheel, to extend maturities from December to May 2010 was a bombshell. And the Middle East’s most glamorous and creative emirate will pay the price of its decision for a long time to come.

For months, all indications in Dubai were that the heavily indebted city-state, symbol of the rise of the region as an economic powerhouse as much as of the excesses of the pre-financial crunch days, would meet the obligations of the companies it owns, and that Nakheel’s $4bn debt due in December would be repaid. Only a few weeks ago, bankers in the region were so upbeat that some had suggested that Dubai might not even need to raise more funds to pay debts due this year. It helped of course that the emirate was showing signs of recovery, with fewer expatriates packing their bags than had been expected, retail sales on the rise and the real estate sector, devastated by the economic crisis, beginning to stabilise. The government itself looked confident too, and it went to the markets to raise funds, bringing in $2bn in Islamic bonds last month.

As always, though, the problem in Dubai is that no one had all the facts, and perhaps some in the financial community had all the wrong assumptions. The whole affair, one financial analyst told me on Thursday, was “typical of the way things work in Dubai – top down and in a vacuum, and that makes it very difficult for investors”. True, top officials had indicated repeatedly that Dubai would not default on its debt – and Nakheel, developer of the extravagant Palm real estate project, was too important for Dubai to allow it to default. What officials have not explicitly said, however, was that the repayments would be made on time.

Interestingly, moreover, the prospectus that Dubai recently issued to test market appetite for government bonds said that the government was “not legally obliged” to meet the obligations of related entities – what is commonly referred to as Dubai Inc – but might at its sole discretion decide to extend such support. Most of the funds raised in the past year – including from Abu Dhabi banks on Wednesday, the same day that Dubai said it intended to call a “standstill” until May 30 on all its Nakheel and Dubai World debt due in December – were by the government itself, rather than individual companies.

Chance of Great Depression Now 5%...

For 2 1/4 years now I have been saying that there is no chance of a repeat of the Great Depression or anything like it--that we know what to do and how to do it and will do it if things turn south.

I don't think I can say that anymore. In my estimation the chances of another big downward shock to the U.S. economy--a shock that would carry us from the 1/3-of-a-Great-Depression we have now to 2/3 or more--are about 5%. And it now looks very much as if if such a shock hits the U.S. government will be unable to do a d----- thing about it.

We could cushion the impact of another big downward shock by a lot more deficit spending--unemployment, after all, goes down whenever anybody spends more (even though sometimes falling unemployment comes at too-high a price in rising inflation), and the government's money is as good as anybody else's. But the centrist Democratic legislative caucus has now dug in its heels behind the position that we cannot undertake more deficit spending right now because we have a dire structural health-care financing proble afrer 2030. The Republican legislative causes has now dug in its heels behind the position that the fact that unemployment is 10% shows not that policy earlier this year was too cautious but rather that it was ineffective. And the Obama administration has not been able or has not tried to move either of those groups out of their current entrenchments.

We could cushion the impact of another big downward shock by recapitalizing the banks again. But the failure of the Fed and the Treasury in the aftermath of Lehman to grab a share of the upside from its capital injection and purchase operations for the public in the form of warrants means that there is no coalition anywhere for a repeat or anything like a repeat of propping-up the banking system: the right thinks it is an unwarranted intervention in the free market, the left thinks that it is a giveaway to the undeserving and feckless superrich, and the center is bewildered because it is an enormous and poorly-structured intervention in the market, it is a giveaway to the undeserving and feckless superrich, and the optics are terrible.

So if another big bad shock hits the U.S. economy, what could the Obama administration possibly do?

Hugh Son of Bloomberg:

Fed ‘Severely Limited’ Savings on AIG, Watchdog Says: n American International Group Inc.’s rescue by refusing to compel banks to take concessions, said a Treasury Department watchdog. The Fed didn’t use its “considerable leverage” as regulator of several of AIG’s counterparties to force them to accept so-called haircuts on credit-default swaps, Neil Barofsky, special inspector for the Troubled Asset Relief Program, said today in a report. The regulator gave up efforts to negotiate discounts from the banks after two days and opted to pay them in full for $62.1 billion in swaps, Barofsky said. “These policy decisions came with a cost -- they led directly to a negotiating strategy with the counterparties that even then-New York Fed President Geithner acknowledged had little likelihood of success,” Barofsky said.

Timothy Geithner, now Treasury secretary, was among officials who took over negotiations with the banks from AIG in November 2008. Lawmakers including Representative Darrell Issa have said the September 2008 AIG rescue was a “backdoor bailout” for banks that received billions in payments. The Fed contacted eight of AIG’s biggest counterparties by telephone last year to negotiate discounts, Barofsky said. While UBS AG, the Zurich-based bank, was willing to make a 2 percent concession, the Fed decided that all counterparties would receive full payment, he said.

‘Misuse’ of Power

In a letter to Barofsky included in his report, the Fed said it “would not have been appropriate to use our supervisory authority on behalf of AIG to obtain concessions from domestic counterparties.” Doing so would have been a “misuse” of power that would have given an advantage to non-U.S. banks that the Fed doesn’t regulate, the Fed said. Andrew Williams, a Treasury spokesman, said in an e-mail statement that Barofsky’s report:

overlooks the central lesson learned from the unprecedented steps taken to support AIG. The federal government needs better tools to deal with the impending failure of a large institution in extraordinary circumstances like those facing us last fall,” Williams said. “It is for these reasons that the Obama administration has proposed a regulatory reform agenda that includes giving the government the emergency authority to resolve a significant, interconnected financial institution...

Econ 115 Lecture Notes: October 8, 2009: Great Depression III

20091008 115 climb out.pdf

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Great Depression Problem Set: Econ 115: Fall 2009

Due Friday October 16, 5 PM, in GSI mailboxes:

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Econ 115 Lecture Notes: October 6, 2009: The Great Depression II

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Lecture Audio: Econ 115-11--Great Depression II (10.06.2009 12-47-45 PM)

Why Aren't We Undergoing Another Great Depression?

Paul Krugman's answer:

Averting the Worst: So it seems that we aren’t going to have a second Great Depression after all. What saved us? The answer, basically, is Big Government.... [T]he economic situation remains terrible... we’re... nine million jobs short of where we should be. And the job market still hasn’t turned around....

For all that, however, the latest flurry of economic reports suggests that the economy has backed up... from the... abyss. A few months ago the possibility of falling into the abyss seemed all too real.... [I]n the 1930s the trend lines just kept heading down. This time, the plunge appears to be ending after just one terrible year. So what saved us from a full replay of the Great Depression? The answer, almost surely, lies in the very different role played by government.

Probably the most important aspect of the government’s role in this crisis isn’t what it has done, but what it hasn’t done: unlike the private sector, the federal government hasn’t slashed spending.... All of this has helped support the economy in its time of need, in a way that didn’t happen back in 1930.... In addition to having this “automatic” stabilizing effect, the government has stepped in to rescue the financial sector. You can argue (and I would) that the bailouts of financial firms could and should have been handled better... while acknowledging that without these bailouts things would have been much worse. The point is that this time, unlike in the 1930s, the government didn’t take a hands-off attitude while much of the banking system collapsed. And that’s another reason we’re not living through Great Depression II.

Last and probably least, but by no means trivial, have been the deliberate efforts of the government to pump up the economy... the American Recovery and Reinvestment Act... was too small. Nonetheless, reasonable estimates suggest that around a million more Americans are working now than would have been employed without that plan — a number that will grow.... All in all, then, the government has played a crucial stabilizing role in this economic crisis. Ronald Reagan was wrong: sometimes the private sector is the problem, and government is the solution.

And aren’t you glad that right now the government is being run by people who don’t hate government?...

[W]e appear to have averted the worst: utter catastrophe no longer seems likely.

And Big Government, run by people who understand its virtues, is the reason why.

The loose end in Krugman's article is why there weren't more Great Depressions back in the old days, before big government. The answers, I think, are two:

1. Business cycles are a disease of the post-agricultural economy--of the nonfarm economy. If you look back at the nonfarm unemployment rate before 1930, things look not as bad as the Great Depression but still pretty bad.

2. Most countries had a form of "big government"--a military large in size relative to its nonfarm economy and an activist, interventionist central bank--reaching far back into the past.

3. The U.S. was the only major industrial power without an activist, interventionist central bank before 1913--but the U.S. Treasury did give the baton to run monetary policy to the Morgan-Belmont syndicate in the 1890s and to Morgan in 1907, so we were not always without an activist, interventionist central bank.

4. And the U.S. looks like the worst as far as pre-1930 business cycles are concerned, with 1874 and 1885 matching 1893 in terms of nonfarm unemployment and industrial distress.

For example, this shows the Weir-basis nonfarm unemployment rate back to 1890:

Fun and games in 1921-22, 1914-15m, 1907-08, and 1893-6 as well as 1885 and 1874...

DeLong Smackdown Watch (David Wessel/Marx-Schumpeter-Hoover-Mellon Axis Edition)

On page 46 of David Wessel (2009), In Fed We Trust: Ben Bernanke's War on the Great Panic (New York: Crown: 9780307459688), I read:

This notion of the government's [macroeconomic stabilization] role was not universal in the 1930s. In his memoirs, Herbert Hoover described tension within his own administration, putting words into Treasury Secretary Andrew Mellon's mouth that are routinely reported as something Mellon actually said:

In one camp were the "leave it alone liquidationts" headed by Secretary Mellon, who felt that government must keep its hands off and let the slump liquidate itself. Mr. Mellon had only one formula: "Liquidate labor, liquidate stocks, liquidate the farmers, liquidate real estate." He held that even panic was not altogether a bad thing. He said: "It will purge the rottenness out of the system. High costs of living and high living will come down. People will work harder, live a more moral life. Values will be adjusted, and enterprising people will pick up the wrecks from less competent people"...

Who is it "routinely reports" something like this? Moi!

This is actually a difficult question, which I hope to write up properly someday:

1. Hoover in his memoirs is definitely an unreliable narrator. He sets himself up as opposing Mellon within the administration, when actually when push came to shove he (reluctantly) supported Mellon. As Wessel notes on page 47, he gave himself in the early 1930s excessive vision as to the size of the problem. And he claimed that he had nothing to do with the MacArthur-Eisenhower-Patton military police action against the Bonus Marchers on the Mall.

2. Hoover's unreliability centers around two issues: (a) Hoover insists--no matter what the evidence--that everything was going fine and the depression was licked until the election of THAT COMMUNIST ROOSEVELT; (b) any mistakes made during his administration were the fault of unworthy subordinates--MacArthur, Mellon--who misled Hoover.

I conclude that it is hardly credible to believe that MacArthur pleaded with Hoover to conciliate the Bonus Marchers--instead, Hoover's unreliability is focused on taking decisions that were joint that Hoover is not proud of, and loading them onto others.

Similarly, I conclude that it is hardly credible to believe that Mellon pleaded with Hoover to boost demand. Instead, Mellon called to stay the course--no experiments, and either a program of monetary expansion, a banking recapitalization, a banking nationalization, a deficit spending plan, or government employment of the unemployed would definitely have been experiments:

Conditions today are neither so critical nor so unprecedented as to justify a lack of faith in our ability to deal with them in our accustomed way.... [The middle of the Great Depression was] no time to undertake drastic experiments... surrendering the management of business and industry to government or to any board or group of men...

So Hoover is an unreliable narrator. But odds are that his claims that, internally, Mellon was a liquidationist are sound.

Cracking Christiano, Eichenbaum, and Rebelo's Big Multipliers without Coffee...

Greg Mankiw asks a question:

Greg Mankiw's Blog: Modern macro even Paul Krugman will love: Lately, Paul Krugman has been dissing modern macroeconomics, mainly because many macroeconomists do not agree with his conclusions about fiscal policy. This new paper by Marty Eichenbaum, Larry Christiano, and Sergio Rebelo should, however, make Paul happy. They report large fiscal policy multipliers in a new Keynesian DSGE model when the economy is at the zero interest lower bound.

An open question: How can the results in this paper be reconciled with results by John Cogan, Tobias Cwik, John Taylor, and Volker Wieland, who seem to perform a similar policy simulation in a similar model but reach a very different conclusion? Are there subtle differences in the models? Or subtle differences in the policy experiments? Or did one team simply make a mistake of some sort?

Figuring out why these two prominent teams of researchers come to opposite conclusions about fiscal policy multipliers, and which conclusion is more applicable to actual policy, would be a good paper topic for an ambitious grad student.

As I understand it, the big problem with Cogan, Cwik, Taylor, and Wieland is that there is nothing special going on at the zero nominal interest rate bound. In their model, a fiscal expansion (a) raises expected future inflation, which (b) creates expectations of future interest rate rises by the Federal Reserve to cool off that inflation, which (c) damps present spending, and so (d) shrinks the multiplier. Their model is a model of a small multiplier in an economy away from the zero nominal interest rate bound when central banks are targeting inflation.

Christiano, Eichenbaum, and Rebelo, by contrast, have a model in which:

a shock increases desired savings.... When the shock is small enough, the real interest rate falls and there is a modest decline in output. However, when the shock is large enough, the zero bound becomes binding.... The only force that can induce the fall in saving required to re-establish equilibrium is a large transitory fall in output. The fall in output must be very large because hitting the zero bound creates an economic meltdown. A fall in output lowers marginal cost and generates expected deflation which leads to a rise in the real interest rate. This increase in the real interest rate leads to a rise in desired savings which partially undoes the effect of the fall in output. As a consequence, the total fall in output required to reduce savings to zero is very large. This scenario captures the paradox of thrift originally emphasized by Keynes (1936).... The government spending multiplier is large when the zero bound is binding because an increase in government spending lowers desired national savings and shortcuts the meltdown created by the paradox of thrift...

That said, I think that the CER multipliers are much too large to be applicable to our world today. If I understand CER completely (which I may not: the coffee has not yet hit the brain this morning), their Calvo pricing assumption creates a direct link between output Y and inflation π. Recall the flow -of-funds balance equation:

S(Y, 0-π) = D + I(0-π)

Savings S as an increasing function of income Y and of the real interest rate, which is the nominal interest rate 0 (we are at the lower bound) minus the inflation rate π, is equal to the government deficit D plus investment I which is a decreasing function of the real interest rate, which is the nominal interest rate 0 minus the inflation rate π.

An increase in the deficit thus (a) directly increases saving S necessary to finance the deficit which requires a direct increase in Y. But this direct increase in Y then increases inflation π--there is less deflation. And less deflation means both less savings and more investment. So the direct effect increase in Y does not generate enough savings to close the gap in the flow-of-funds market: savings must increase by more--which requires that Y increase by even more. The government deficit thus genuinely "primes the pump" and the multiplier is very large.

This channel is, I think, the channel pointed to by those who think that the New Deal had an enormous impact, as Roosevelt's deficits in combination with the increase in price rigidity produced by the NIRA and the breaking of deflationary expectations created by the abandonment of the gold standard diminished desired S.

But I don't think we have big expectations of deflation right now. And I don't think fiscal policy moves right now are having a great deal of effect in reducing expected deflation. So I don't think the interaction of output gaps and deflation is playing a big role in boosting the multiplier right now...

I may well, however, assign CER next March when I hit the Great Depression week in Econ 210a as an argument for why Cary Brown's estimates of the fiscal policy effect of the New Deal are too low...

And it is nice to see a model in which J. Bradford DeLong and Lawrence H. Summers (1986), "In Increased Price Flexibility Destabilizing?" American Economic Review makes a reappearence...

The Lessons of 1937

Christie Romer is live at the Economist:

Economics focus: The lessons of 1937.

And myComment for the Economist on Christina Romer (2009), "The Lessons of 1937"? For now it is now not yet live...

http://www.economist.com/blogs/freeexchange/romer_roundtable/

Comment for the Economist on Christina Romer (2009), "The Lessons of 1937"

Five Lessons from 1937 and Otherwhen

J. Bradford DeLong
U.C. Berkeley and NBER
delong@econ.berkeley.edu

June 17, 2009

Comment on Christina Romer (2009), "The Lessons of 1937":

Let me make five points to eliminate or refute or at least to fight against or lay down a marker that there is--well, call it "confusion" about what the right state of American macroeconomy should be.

Last December’s Unemployment-Rate Forecast and Outcome to Date

Source: Romer and Bernstein (2009).

My first point is that over the past six months the economy has been a severe disappointment. Output and employment have fallen much faster than people were projecting last December. Romer and Bernstein (2009) projected at the very start of this year that unemployment in the U.S. would reach a peak of 7.9% in the summer of 2009. But unemployment now in mid-June is about 9.7%, with 10% baked in the cake and the possibility existing that it might go much higher. The signs that the cliff-dive of employment has come to an end are very few. The level of new unemployment claims is still consistent with a rapidly-collapsing labor market nationwide.

New Weekly Unemployment Claims (Red, Right Scale, Four-Week Average) and Monthly Fall in Payroll Employment (Blue, Left Scale, Thousands)

Source: Paul Krugman.

Six months ago a net federal fiscal stimulus of about $1 trillion--$400 billion each year for about 2.5 years--seemed appropriate: that seemed to balance the benefits of filling-in the hole in aggregate demand without running too great a risk of triggering worrisome inflationary fever further down the road. Now the hole in aggregate demand is greater than was thought likely last December--about twice as great--and the likelihood of heightened future inflation is less. Thus if it was appropriate to set a $1 trillion federal fiscal stimulus in motion last December given what we knew then, if we had known then what we know now it would have been appropriate to set a roughly $2.4 trillion fiscal stimulus--$800 billion for 3 years--in motion back then.

My first point is thus that the Obama administration's federal fiscal stimulus programs are on the low side of what is appropriate by a substantial margin: this is the largest economic downturn since the Great Depression and the standard tools of expansionary monetary policy are tapped out and broken right now.

My second--related--point is that the need for federal-level fiscal expansion is reinforced by what state governments are doing right now. The federal government's discretionary actions are expanding aggregate demand by about $400 billion over fiscal year 2010, but state governments are right now cutting their spending and raising their taxes in order to offset this federal fiscal expansion more or less completely. On net, the government sector will be on autopilot as far as discretionary policy moves to stimulate the economy are concerned: federal-level expansion is offset and neutralized by state-level fiscal contraction. This is not an appropriate macroeconomic policy stance: this is the largest economic downturn since the Great Depression.

My third--unrelated--point is that the policy innovations of the past year have created a potentially dangerous weakness in the Federal Reserve system. The Federal Reserve's balance sheet has more than doubled over the past year, as it has acquired an enormous and bizarre menagerie of assets. On the liability side, it has funded this acquisition by expanding the monetary base, and has increased private-sector willingness to hold this monetary base by paying interest on reserves. This has added a fourth motive--profit--to the three traditional motives for holding reserve deposits at the Fed: the transactions demand, the emergency liquidity demand, and the speculative demand.

As long as the dollar remains the safest currency in the world, as long as the dollar remains the linchpin of the global financial system, there is no problem in the Federal Reserve's funding by what is essentially overnight borrowing the expansion of its balance sheet and the purchase of private securities that will vary up or down in market price with an eye toward holding them to maturity.

However, at some future time the dollar will cease to be the linchpin of the world financial system, in which case the Federal Reserve's financing its balance sheet via overnight borrowing will leave it vulnerable to the mother of all bank runs. It would be very good to fix this now: to give the Federal Reserve now the option to borrow not in what are essentially demand but rather in time deposits--to grant the Federal Reserve the power to issue its own bonds. This diminishes the chance of a great financial crisis in 2050 or so, with no downside that I can see.

My fourth point is the obvious one that health care is the only thing tht matters for the long run budget. The other points that the Hon. Dr Christina Romer raises, are--as is almost always the case--accurate and important. America's long-run fiscal problems are caused by health care, and will not be appreciably made worse by this half-decade's federal fiscal stimulus. If restructuring the health care system can bend the curve on the rise in overall (and hence public as well as private) health care costs, then America has ample debt capacity to borrow whatever we wish in this crisis--and to borrow it at extraordinarily favorable rates as well. If the curve of rising health-care costs is not bent, then the government's long-term finances are in trouble and so is the growth of private-sector non-health living standards: health care costs that rise as fast as CBO is projecting in the baseline cause lots of long-run economic problems, of which government fiscal bankruptcy is not the worst. Health care reform to bend the long-run curve of costs is now just what it was back in 1993: the most important issue for the American political system to deal with.

Fifth, I have the sense that the Obama administration's economic policymakers have forgotten one of the most basic lessons taught by Robert Rubin during his stewardship of economic policy during the 1990s. The lesson is to think probabilistically: to project yourself forward into the possible futures, to ask in each one what would be the actions that you would then wish you hd undertaken today, and then to actually take the appropriate action today. Looking forward into the future, (a) I see a 10% chance that something happens to create renewed cliff diving--a recession that bottoms out not with an unemployment rate in the 10-12% range that we currently anticipate but an unemployment rate that blows through 12% and keeps on rising. (b) I see a 30% chance of a rapid recovery as confidence and asset prices recover, and firms take advantage of high unemployment to hire new workers in droves at wage levels that make increasing production very profitable. But (c) I see a 60% chance of the end of the current cliff-dive in employment being followed by what happened in Japan in the 1990s, in the U.S. after 1991, in the U.S. after 2001, and to some extent in the U.S. after 1933--a recovery that does not see the market exert sufficient upward pressure on employment to return the unemployment rate to normal levels in two or three years, but that instead sees a jobless or low-job recovery during which the unemployment rate continues to drift upward for years, or falls only then to rise again.

The Obama administration's policies appear to me to be the ones that would be adopted if we believed that there was a 75% chance of scenario (b) and a 25% chance of scenario (a). But I don't think those are the probabilities. And I wonder what the Hon. Dr. Christina Romer thinks the probabilities are. For she is the one who warns of how:

[t]he 1937 episode provides a cautionary tale. The urge to declare victory and get back to normal policy following an economic crisis is strong. That urge needs to be resisted until the economy is again approaching full employment. Financial crises, in particular, tend to leave scars that make financial institutions, households and firms behave differently [than in normal times]. If the government withdraws support too early, a return to economic decline or even panic could follow...

The blunt fact is that the economic recoveries that have been rapid and seen fast growth in employment are those that ended when a Federal Reserve following strongly restrictionary policies to fight inflation eased off and significantly lowered interest rates. No such lowering of interest rates is possible this time--interest rates are already as low as they can possibly go at the short end. So I can see no reason to anticipate a rapid recovery and employment when the cliff-diving stops. And I do not understand why the Obama administration is following policies that presume such a rapid recovery--a V rather than an L for the shape of the recession--is not just possible but probable.

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John Kay Weighs in, Calling for a Practical Macroeconomics

Me? I think that we ought to be turning out a lot of macroeconomic historians and historians of economic thought, and that only they should be allowed to serve in government or comment on public affairs at least as far as the business cycle is concerned.

John Kay at the FT:

John Kay: How economics lost sight of real world: The past two years have not enhanced the reputation of economists.... Although more economic research has been done in the past 25 years than ever before, the economists whose names are most frequently referenced today, such as Hyman Minsky and John Maynard Keynes, are from earlier generations. Since the 1970s economists have been engaged in a grand project. The project’s objective is that macroeconomics should have microeconomic foundations. In everyday language, that means that what we say about big policy issues – growth and inflation, boom and bust – should be grounded in the study of individual behaviour.... Most economists would claim that the project has been a success... the criteria are the self-referential criteria of modern academic life....

But policymakers and the public at large are, rightly, not interested in whether models are rigorous. They are interested in whether the models are useful and illuminating – and these "rigorous" models do not score well here.... That people respond rationally to incentives, and that market prices incorporate information about the world, are not terrible assumptions. But they are not universal truths either. Much of what creates profit opportunities and causes instability in the global economy results from the failure of these assumptions. Herd behaviour, asset mispricing and grossly imperfect information have led us to where we are today.

There is not, and never will be, an economic theory of everything....

Keynes... explain[ed] that economic understanding required an amalgam of logic and intuition and a wide knowledge of facts, most of which are not precise: “a requirement overwhelmingly difficult for those whose gift mainly consists in the power to imagine and pursue to their furthest points the implications and prior conditions of comparatively simple facts which are known with a high degree of precision”. On this, as on much else, Keynes was right.

Samuel Brittan Worries About Secular Stagnation

He writes:

A long cool look at budget deficits: it would have been much better if the UK could have entered the [current] recession with much lower initial deficit and borrowing ratios – if only because the financial markets do not understand the very good arguments for fiscal deficits in depressed times.... What fundamentally is wrong with a budget deficit? The basic argument is that if borrowing is too high the government can get into a debt trap, having to borrow more and more simply to pay the interest on past borrowings.... Keynes in his General Theory maintained, however, that the propensity to save was much greater than the private propensity to invest, not just at the bottom of a recession but more or less permanently – a state known as secular stagnation.... We could easily have a good few years in which secular stagnation might seem to prevail again, if only because of the near destruction of the world financial system. If we are in such a state then an attempt to adhere rigidly to a fiscal rule could lead to a permanent and unnecessary loss of output outweighing any welfare loss from the debt trap risk itself.

I have sympathy with those economists who favour a mainly monetary approach to sustaining demand. But I fear that the present dangers are great enough to require a belt and braces – monetary and fiscal – approach. I go back to an early suggestion of Milton Friedman... tax rates should be set to balance government spending at a hypothetical level of national income corresponding to “reasonably full employment at a pre-determined price level”... the beauty of the suggestion is that, should the economy go back to a recognisable trend growth rate, then the budget would automatically achieve the target balance. Yet should there really be secular stagnation then deficits would run on as long as necessary...

Maynard Keynes Might Say: Real Wages and the Great Depression

From RJW:

Maynard Keynes comments on Ohanian and Cole

in the short period, falling money-wages and rising real wages are each, for independent reasons, likely to accompany decreasing employment; labour being readier to accept wage-cuts when employment is falling off, yet real wages inevitably rising in the same circumstances on account of the increasing marginal return to a given capital equipment when output is diminished."

General Theory Chapter II section 2.

As you know, one didn't have to wait for Blanchard and Kiyotaki or for New Keynesians or--well read Keynes to find the argument that real wages are determined (certainly were determined in the 20s and 30s anyway) by firms when they set prices and must be high when demand is low.

I personally don't share Keynes' certainty that, in the short run, employment is a decreasing function of real wages and vice versa. However, he expressed no doubt whatsoever on the point and managed to explain the Great Depression without appealing to trade unions. I think that if he had known that a reputable professor at UCLA had the idea that the US had extraordinarily huge unemployment in 33 because it had extraordinary strong unions he would have lowered his opinion of Americans (hard as that is to imagine).

There is an argument that the "Red Scare" Palmer raids of the early 1920s plus the fact that nominal wages had just been boosted by wartime inflation made it easy in the early 1920s to shrink nominal spending during the post-WWI deflation without causing a Great Depression--nonfarm unemployment peaked at only 16%. But to me, at least, the spectacle of a market system that is capable of rapid nominal adjustment only under a police state is not to attractive.

Union Strength, Unemployment, and the Great Depression

UCLA economist Lee Ohanian writes, in "What - or Who - Started the Great Depression?":

The defining characteristic of the Great Depression is a substantial and chronic excess supply of labor, with employment well below normal, and real wages in key industrial sectors well above normal.... President Hoover... offered industrial firms protection from unions in return for paying high wages. Firms deeply feared unions... [and] a sea change in economic policy, including policies advanced and supported by Hoover, that significantly fostered unionization and enhanced their bargaining power.... [T]he Depression is the consequence of government programs and policies, including those of Hoover, that increased labor’s ability to raise wages above their competitive levels. The Depression would have been much less severe in the absence of Hoover’s program.... Presidents Hoover and Roosevelt shared similar goals of fostering industrial collusion and increasing real wages and raising labor’s bargaining power. Hoover accomplished these goals... by inducing industry to maintain nominal wages, and by promoting and signing legislation that facilitated union organization and that increased wages above competitive levels, including the Davis-Bacon Act and the Norris-Lagaurdia Act. Roosevelt accomplished these goals with... the Wagner Act.... The 1930s would have been a better economic decade had government policy promoted competition in product and labor markets...

There are three problems with ascribing a big role to this.

The first is that Herbert Hoover's interventions in the labor market were absolutely tiny. If Hoover's signing of Norris-Laguardia and Davis-Bacon plus his meetings in the White House with business leades were enough to drive unemployment up from 2% to 25%, then Roosevelt's Wagner Act should have driven unemployment from 15% to 75%, and in western Europe--well, in western Europe we should see unemployment rates of 357%. The outcome is radically disproportional to the shocik that Ohanian claims drove it.

The second is that Ohanian's real wage is the inverse of a Blanchard-Kiyotaki markup, which is a consequences of low aggregate demand and high unemployment and not a cause. If you are a monopolistic competition-style New Keynesian, then you look at Ohanian and Cole and say "so"? This pattern is what you would expect to see whether or not union power or deficient aggregate demand is creating high unemployment.

The third, of course, is that Ohanian's measure of whether wages are above market levels is unconnected with the structural factors that he claims drove wages above market levels. Union power in the American economy reached its apogee in the 1950s, when union density reached 35% of non-farm employees and companies were the most frightened and prone to raise to keep unions out. The correlation between union density and unemployment that Ohanian's theory says should be very strong is simply not visible when one looks across decades: it is an hypothesis not borne out by empirical evidence.

As James Galbraith likes to say. Ohanian and Cole believe that high wages "relative to market clearing levels" caused the high unemployment of the 1930s both under FDR and under Hoover, but not not do so under Eisenhower. How do they know this? Because, they say, the labor market cleared--unemployment was low--in the 1950s but not in the 1930s, therefore the strong unions of the 1950s were weak and unable to exert market power while the weak unions of the 1930s were strong and able to choke off labor market competition. This argument seems to be not just a little bit circular.

Price Fishback on Labor Policy in the Great Depression

Price Fishback talks sense about labor policy in the Great Depression:

The Role of Labor Policy - Council on Foreign Relations: PRICE V. FISHBACK:  Sure.  So what I've been doing over the last 10 years of my life is collecting all sorts of statistics about what's going on in all sorts of different parts of the country because the experience of the Great Depression varies quite a bit from different parts of the country.  The amount that they spend varies quite a bit in various parts of the country as well.  So we've been trying to use this variation to try to get a sense of how effective these New Deal policies were.... [T]he way that they dealt with unemployment during this period with 25 percent unemployment was to come up with work relief expenditures. And so what they did was they put people back to work, first under the Federal Emergency Relief Act, and that was from 1933 to '35, done under the WTA. And the typical way they did that was that they paid you about half of the normal hourly wage... 50 cents, somewhere in that neighborhood, and they didn't have you working full time... almost like unemployment insurance.

So what's the effect of this?... [I]t doesn't look like that they had any effect on private employment at all... just... government employment increased.... [W]e found... that... you get quite different effects in different time periods during the New Deal.... [U]p to about half way through 1935... for every eight jobs you create in the public sector with the work relief, you get an additional job in private work because you're stimulating demand and things like this.... [I]n the second half of the decade... when you increase the government jobs or increase work relief by one job, you might lose as much as .3 or .5 private jobs....

Now, there were positive effects from the work relief bill as well.  It turns out that in the course of the decade, say you spend $1 on work relief... retail sales in that small town might go up about 50 cents... very positive effects on things like infant mortality... for about every $2 million you spend in modern dollars... they've saved an infant's life... reduced deaths from diarrhea... from infectious disease, and some suicides as well...

And Eugene White talks sense as well:

QUESTIONER: Eugene White, Rutgers University. And one of the ideas I heard floated was that labor market problems cause financial crises. So I thought I'd take an opportunity to throw some cold water on that idea.... For that actually to be true... [t]here can't be any bubbles. If there was a bubble in 1929, and there's... strong evidence that it's the case, then you get an independent shock coming from the decline in values both on consumption and investment spending.... [Again] for labor markets to cause financial crises, what you have to have happen is that higher wages would have to cause... defaults on industrial loans. Well, that's not the source of bank failures in the early 1930s...

Time to Use the D-Word

Barry Eichengreen and Kevin O'Rourke argue that it is time to use the D-word:

The world economy is tracking or doing worse than during the Great Depression: To sum up, globally we are tracking or doing even worse than the Great Depression, whether the metric is industrial production, exports or equity valuations. Focusing on the US causes one to minimize this alarming fact. The “Great Recession” label may turn out to be too optimistic. This is a Depression-sized event.

That said, we are only one year into the current crisis, whereas after 1929 the world economy continued to shrink for three successive years. What matters now is that policy makers arrest the decline... in both crises there was a lag of five or six months before discount rates responded to the passing of the peak, although in the present crisis rates have been cut more rapidly and from a lower level. There is more at work here than simply the difference between George Harrison and Ben Bernanke. The central bank response has differed globally.... [M]onetary expansion was more rapid in the run-up to the 2008 crisis than during 1925-29.... Moreover, the global money supply continued to grow rapidly in 2008, unlike in 1929 when it levelled off and then underwent a catastrophic decline....

To summarize: the world is currently undergoing an economic shock every bit as big as the Great Depression shock of 1929-30. Looking just at the US leads one to overlook how alarming the current situation is even in comparison with 1929-30. The good news, of course, is that the policy response is very different. The question now is whether that policy response will work. For the answer, stay tuned for our next column.

An Open Letter to Patricia Cohen of the New York Times (with Replies and Updates)

ORIGINAL 5:15 AM April 4:

Dear Ms. Cohen:

Eric Alterman speaks very highly of you indeed. And right now I am trying to resolve a certain... cognitive dissonance. The reports I got of the Council on Foreign Relations's conference last week on the Great Depression portrayed a day that was--frankly--insane.

We had Edward Prescott ranting about how the Depression came about because Herbert Hoover was not free market enough; denouncing "Hoover's anti-market, anti-globalization, anti-immigration, pro-cartelization policies"; and claiming that the economy only "started recovering in 1939, when... Roosevelt... called up the businessmen who had fled to England... and said please come back." I have never heard of a single one of the "businessmen who had fled to England" in the aftermath of Roosevelt's election, stayed there until 1939, and was then called back by Roosevelt.

And unemployment did fall from 23% in 1932 to 11% in 1939.

We had Ellen McGrattan misrepresenting my friend Christina Romer and claiming that because she is "using estimates of spending multipliers of about 1.5," she believes pure socialism in which we "have the government basically do everything." But Christy Romer says that she believes that the fiscal policy multiplier is 1.5 (or larger) now when unemployment is high--and thus that the government should do more right now--but that the multiplier drops to a very small value whenever unemployment is low.

We had Amity Shlaes claiming that "unemployment remained high throughout the decade" of the 1930s--in spite of its fall from 23% to 11%--because "the uncertainty created by Roosevelt’s continual tinkering paralyzed private investors"--in spite of the rise in inflation-adjusted private investment spending from $11 billion in 1932 to $77 billion in 1939.

Yet you seem to write of a quite different conference. I would have thought that Prescott's denunciation of Hoover, McGrattan's claim that the Obama administration seeks socialism (and their denials), and the striking disjunction between Shlaes's claims of little progress in unemployment and falling private investment in the 1930s and the reports of the Bureau of Labor Statistics and the Bureau of Economic Analysis would be... somewhat newsworthy.

Can you shed some light on the difference between the CFR conference as related by, say, James Galbraith and the conference that you attended?

Revisionist Views at a Conference on the Depression and the New Deal: For more than half a century, America’s political leaders — Republican and Democrat — have sought to wrap themselves in the legacy of Franklin Delano Roosevelt, the man credited with replacing fear with hope and ending the Great Depression. But in recent years some writers and economists have been telling a version of this story that is quite different from the one generally taught in school or seen on the History Channel. In this interpretation Roosevelt is a well-meaning but misguided dupe who not only prolonged the Depression but also exacerbated it. For many people, it’s like hearing that Little Red Riding Hood’s grandmother and not the wolf is the rapacious killer.

Since the financial crash this fall, the revisionist look at the Great Depression has attracted new attention; it even recently made its way onto Stephen Colbert’s television show. But more than that, it has become an intellectual banner for Republican opponents of the Obama administration’s ambitious bailout and stimulus proposals. Amity Shlaes, a syndicated columnist who works at the Council on Foreign Relations, helped ignite this latest revisionist spurt with her 2007 book, “The Forgotten Man: A New History of the Great Depression.” “The deepest problem was the intervention, the lack of faith in the marketplace,” she wrote, lumping Herbert Hoover and Roosevelt together as overzealous government meddlers. The current financial crisis, as well as continuing praise from conservatives, helped propel the book back onto the Times best-seller list in November. Jonathan Alter, an editor at Newsweek and the author of “The Defining Moment: FDR’s Hundred Days and the Triumph of Hope” — which has also benefited from the renewed fascination with the 1930s — calls Ms. Shlaes’s book a “taste badge,” flaunted by Republicans looking for a way to oppose the administration.

This week competing theories about the Depression and the New Deal were once again on display at a conference at the Council on Foreign Relations’ New York headquarters, co-hosted by the Leonard N. Stern School of Business at New York University, and partly organized by Ms. Shlaes. She and other critics of the New Deal credit Roosevelt with some important innovations, like restoring confidence in banks and establishing social insurance. Nonetheless, they argue that most of his mucking about in the economy crowded out private investment and antagonized the business world, and thus delayed recovery. Unemployment remained high throughout the decade until World War II, Ms. Shlaes told conference attendees, because the uncertainty created by Roosevelt’s continual tinkering paralyzed private investors. When the federal government keeps changing the rules, it’s like having Darth Vader in control, John H. Cochrane, a professor of finance at the University of Chicago Booth School of Business, said during a panel. “I have changed the deal,” he intoned like Vader, the “Star Wars” villain. “Pray I don’t change it any further.”

Many of the economists who were invited to speak were similarly skeptical of the New Deal, even if they disagreed on the Depression’s causes. “No episode in American history has been so misinterpreted as the Great Depression,” declared Richard K. Vedder, an economist at Ohio University. By artificially keeping prices and wages high, he argued, both Hoover and Roosevelt prevented the economy from adjusting, which is why unemployment remained in double digits until the United States entered the war. Anna Schwartz, who collaborated with Milton Friedman on a classic study of the Depression, and the Nobel Prize winner Robert E. Lucas Jr. argued that the idea of stimulating the economy with federal spending is a fairy tale. Government spending just crowds out private investment, they asserted; the money supply is the only thing that matters...

Sincerely yours,

J. Bradford DeLong

---

UPDATE 6:45 PM April 5: Patricia Cohen replies, and upgrades opinions-on-shape-of-earth-differ journalism to a moral imperative: "It would be completely inappropriate for me to declare one theory correct or incorrect, however, and had I inserted that into the piece, an editor would -- or certainly should -- take it out..."

Patricia Cohen replies:

Thanks for your note about my article. Let me give you a bit of a longwinded reply. Part of my beat is to cover what kind of intellectual currents are making their way through the scholarly world as well as the popular culture, regardless of whether I agree with them or not. I think it is particularly important to cover ideas that are often unpopular or have been dismissed by the mainstream yet are taken seriously by respected scholars or those that are making headway among large swaths of the public despite expert opinion. In 2007, for example, I wrote a story about how heterodox economists (like Jamie Galbraith) complained that they were being marginalized by neo-classical economists who dominated economic departments.

As I say in my first paragraph, FDR has been an idol to generations of Americans. The notion that he helped get the U.S. out of the Depression is taught is pretty much taught in public schools and secondary school textbooks across the country; Reagan continually invoked Roosevelt, recognizing his widespread appeal, etc. etc. So when an idea that has been on the fringe for decades -- that FDR actually made the Depression worse -- starts to make its way into the mainstream, that to me is newsworthy. The fact that the overwhelming weight of opinion continues to think it crazy, and yet it keeps making headway in unlikely places makes it all the more newsworthy. Whether or not one thinks Amity Shlaes' book belongs in the library or in the trash, it has clearly been very influential. The recent crash is one reason, reviving interest in a book that had come out in 2007 and had somewhat faded from public view, but more importantly, because it has been championed for political reasons by Republican opponents of Obama's economic policy (something that is noted very prominently in my article and commented upon by Jonathan Alter). That influence is what prompted Jonathan Chait for example to write a critique of it, which then made its way onto the Colbert show.

Now, the Council of Foreign Relations decides to sponsor a conference on the subject along with New York University's Business School -- not the Heritage Foundation or the American Enterprise Institute -- but the very soul of the traditional establishment and a liberal Eastern academic institution. The majority of people invited to speak, mostly economists, share the view that Roosevelt made things worse (although often for different reasons). Regardless of what one thinks of Ms. Shlaes book and scholarship, many of the economists who agree with her main thesis, are highly respected and hold positions of power -- 2 Nobel prize winners, Robert Lucas and Edward Prescott; Anna Schwartz; Harold Cole, an economist at Univ of Pa. and an advisor to the Fed; Price Fishback, etc. etc. There are knowledgeable people like yourself who may think what they say are rubbish, but I don't think you can argue that none of them deserve any coverage in the New York Times.

I give both sides the opportunity to state their main arguments, but because I am a news reporter and not an opinion writer, I don't take sides. I'm sure Mr. Galbraith articulated his view of the conference very effectively; Robert Rubin would have given a very different opinion on the parts of the conference he saw, as would Anna Schwartz. It would be completely inappropriate for me to declare one theory correct or incorrect, however, and had I inserted that into the piece, an editor would -- or certainly should -- take it out. What I can and should do is give the reader sufficient context -- for example, that most people still consider the idea that FDR made things worse preposterous; that the theory is being used partly for political purposes; that the pro-FDR people felt the panels were one-sided; that opinions about the Depression have become a kind of a litmus test for where people stand on Obama's economic policies.

There are scores of topics and relevant points that I could have discussed in a news story, but in 1,100 words, I clearly can't cover the waterfront. I did not, for instance, make any mention of the first panel on the causes of the Depression at which Edward Prescott spoke -- someone whom you mention in your post. (Even among conservatives, there is significant disagreement on that point.) Nor did I get into the fairly extended discussion of the fiscal multiplier effect, a topic that is interesting and important, but fairly technical and much more appropriate for the business pages than for the culture section, for which I write.

For interested readers, though, we link on the Internet to the entire CFR conference, so they can judge for themselves. In any event, I hope that answers your question to some extent.

Yours,

Patti Cohen

---

UPDATE 2 8:15 PM April 5: Linda Hirshman is displeased by Patti Cohen's claim thqt "because I am a news reporter and not an opinion writer, I don't take sides." She emails:

[T]his “but because I am a news reporter and not an opinion writer, I don't take sides” is pretty outrageous. When Patricia Cohen disagreed with [me]... she attacked me in the first person, broadside, her opinion, no research, no fair and balanced, not even in the FOX sense of the phrase.... http://www.nytimes.com/2006/01/15/weekinreview/15patti.html:

That Ms. Hirshman's views on family life now sound so radical is a testament to how roundly the mainstream has rejected them. While rigid doctrines may have made sense in the early days, they don't now, when major goals have been won and a more diverse group of women are in the picture. Indeed, the common critique of the women's movement in the 60's and 70's was that it was too elitist and dogmatic, that it didn't respect women who wanted to stay home...

and

That is why edicts that order women either to get out of the house or to stay there inevitably resurface. Issuing marching orders is simple. "Viva la revolución!" is a lot catchier than "Muddle Through!" It's just not helpful...

I may be wrong (although of course I don’t think so).... But regardless of whether Linda Hirshman is wrong or right or crazy, Patricia Cohen is the furthest thing from a "news reporter and not an opinion writer"...

---

UPDATE 3: 8:04 AM April 6: Patricia Cohen's email of last night--quoted in full above--contained no request for confidentiality (which I was always taught had to be negotiated in advance). Nevertheless, this morning she writes:

That email was a response to the email you sent me, and I did not realize you were going to ignore my request not to post it on your website.

For the sake of clarity, could you please note in response to Linda Hirshman's post that the article regarding her work ran in the Week in Review, which runs analysis and opinion, and not in the daily news report.

I posted her email because (a) it was a response--which one rarely gets: the New York Times's SOP is "we have the megaphone and you do not"--(b) it was an intelligent and well-written response, and (c) it lays out a point of view--the opinions-of-shape-of-earth-differ journalism response that "yes, I know these people I am covering are very strange, but it would be unethical to do more than quietly hint to my readers what I in fact believe to be the case"--that I think is completely wrong but am always anxious to learn more about.

Thus when Cohen writes:

[B]ecause I am a news reporter and not an opinion writer, I don't take sides.... It would be completely inappropriate for me to declare one theory correct or incorrect...

She immediately follows it with:

What I can and should do is give the reader sufficient context -- for example, that most people still consider the idea that FDR made things worse preposterous; that the theory is being used partly for political purposes; that the pro-FDR people felt the panels were one-sided; that opinions about the Depression have become a kind of a litmus test for where people stand on Obama's economic policies...

Which I can read in no way other than: I have to appear to be impartial, but actually my thumb is on the scale--and on your side.

Yet More New Deal Revisionism Blogging...

A correspondent writes:

The problem with the NYT story is that it reports a "controversy" which is not in any serious sense an intellectual controversy, as opposed to agitprop theater, and amateur agitprop at that. Shlaes's book is engaging in some respects -- a character defense of Samuel Insull! -- but contains no economic analysis to speak of. Nor did her comments at the CFR session. And she's prone to flagrant error. For instance on page 7 of her book she states that industrial production did not increase in the US after 1932. In fact, from 1932 to 1936, it doubled...

I think well of [Patricia] Cohen's work generally, but it would be reasonable to go beyond the "she said, he said" reporting, to ask whether the claims being made have any actual merit. In the final session, which Cohen apparently attended, [Galbraith] pointed out very clearly that by presenting an average value for unemployment in the 1930s Shlaes was grossly misstating the actual history and reality, which is that unemployment peaked in early 1933 and fell sharply and steadily in the first four years of the New Deal. But Cohen didn't pick up on it...

Richard Haass was warned that the program that Sebastian Mallaby and Amity Shlaes had put together should have been cancelled--that it would not educate the public and that it would cost the Council on Foreign Relations substantially in terms of its reputation as an honest broker. Haass seems to have thought that he could rescue the event by parachuting Michael Bordo, Richard Sylla, Peter Temin, and James Galbraith in at the last minute to add economists both with expertise and free of wingnuttery to the event. They acquitted themselves well, as did Price Fishback. (Robert Lucas was interesting... but in the end disappointing, as he ignored all of the issues that come up when one attempts monetary expansion when safe interest rates are at the zero nominal bound.)

Howard comments:

An Open Letter to Patricia Cohen of the New York Times: one of the many problems with contemporary journalism is that it is taught as a craft and presumed to be transferable to any subject. The odds, in short, that patricia cohen has the background to understand what she was hearing are very slim, but a a new york times reporter, she believes that she is capable of grasping and presenting anything in a matter of days. We see this kind of abysmal lack of background at work over and over again in our media discourse...

This from Stephen Seidman is worth promoting:

I'd like to second the preceding comment. You don't see chemists these days making claims for the validity of the phlogiston theory, physicists (at least since the "German Physics" of the Nazi era) trying to discredit relativity and quantum theory, or biologists (since Lysenko) reviving Lamarck. Is economics anything more than a collection of conflicting models and theories, with each under constant attack from the proponents of the others? Is there a generally accepted set of core principles that define the subject? If so, are the arguments just about the correct application of these principles, or is it that some economists are choosing a model to produce a desired answer?

It's actually worse than that. It's not as though Prescott, Shlaes, and McGrattan are promoting the phlogiston theory. It is that they claim to have lit charcoal in fire in the presence of oxygen and produced not water, carbon dioxide, and heat but rather cold and little spheres of silver.

And this, from an anonymous lurker:

Patti Cohen's "beat" is enormous. Anything at a university, foundation, or think tank that might be noteworthy becomes her default responsibility. Stuff that goes on in academia would be part of many reporters' beats rather than cordoned off to just one. The web is going to make this situation better, including Patti Cohen's life -- though she will be paid much less. A list of her assignments is http://topics.nytimes.com/top/reference/timestopics/people/c/patricia_cohen/index.html:

Maynard Keynes Might Say: JMK Comments on Christina Romer's Analysis of the Benefits of Quantitative Easing in the Great Depression

From RJW:

Robert's Stochastic thoughts: C Romer with lots of data in 1992 "What Ended the Great Depression?" The Journal of Economic History vol 52 pp 757-784:

This paper examines the role of aggregate demand stimulus in ending the Great Depression. Plausible estimates of the effects of fiscal and monetary changes indicate that nearly all the observed recovery of the U.S. economy priort to 1942 was due to monetary expansion. A huge gold inflow in the mid- and late 1930s swelled the money stock and stimulated the economy by lowering real interest rates and encouraging investment spending and purchases of durable goods. That monetary developments were crucial to the recovery implies that self-correction played very little role in the growth of real output between 1933 and 1942.

Now, I'm not sure if Obama understands that Romer is saying that the US recovered because of Hitler who scared the gold out of Europe (she is very clear on this point in the text). She makes a strong case, but the party line is that Roosevelt deserves the credit.

Keynes, with almost no data and writing in 1935 (hence before the flight), understood the issue. In The General Theory of Employment Interest and Money, Chapter 23: Notes on Notes on Merchantilism, the Usury Laws, Stamped Money and Theories of Under-consumption, Keynes argued that back in the bad old days, going for the gold was the only feasible approach.

Now, if the wage-unit is somewhat stable and not liable to spontaneous changes of significant magnitude (a condition which is almost always satisfied), if the state of liquidity-preference is somewhat stable, taken as an average of its short-period fluctuations, and if banking conventions are also stable, the rate of interest will tend to be governed by the quantity of the precious metals, measured in terms of the wage-unit, available to satisfy the community’s desire for liquidity.

At the same time, in an age in which substantial foreign loans and the outright ownership of wealth located abroad are scarcely practicable, increases and decreases in the quantity of the precious metals will largely depend on whether the balance of trade is favourable or unfavourable.

Thus, as it happens, a preoccupation on the part of the authorities with a favourable balance of trade served both purposes; and was, furthermore, the only available means of promoting them. At a time when the authorities had no direct control over the domestic rate of interest or the other inducements to home investment, measures to increase the favourable balance of trade were the only direct means at their disposal for increasing foreign investment; and, at the same time, the effect of a favourable balance of trade on the influx of the precious metals was their only indirect means of reducing the domestic rate of interest and so increasing the inducement to home investment.

That does not mean that Keynes was a merchantilist. In particular, one can imagine how delighted he was by a process that enriched the USA at the expense of Europe:

For this and other reasons the reader must not reach a premature conclusion as to the practical policy to which our argument leads up. There are strong presumptions of a general character against trade restrictions unless they can be justified on special grounds. The advantages of the international division of labour are real and substantial, even though the classical school greatly overstressed them. The fact that the advantage which our own country gains from a favourable balance is liable to involve an equal disadvantage to some other country (a point to which the mercantilists were fully alive) means not only that great moderation is necessary, so that a country secures for itself no larger a share of the stock of the precious metals than is fair and reasonable, but also that an immoderate policy may lead to a senseless international competition for a favourable balance which injures all alike.[4] And finally, a policy of trade restrictions is a treacherous instrument even for the attainment of its ostensible object, since private interest, administrative incompetence and the intrinsic difficulty of the task may divert it into producing results directly opposite to those intended.

Thus, the weight of my criticism is directed against the inadequacy of the theoretical foundations of the laissez-faire doctrine upon which I was brought up and which for many years I taught;— against the notion that the rate of interest and the volume of investment are self-adjusting at the optimum level, so that preoccupation with the balance of trade is a waste of time. For we, the faculty of economists, prove to have been guilty of presumptuous error in treating as a puerile obsession what for centuries has been a prime object of practical statecraft...

Basically, Keynes' insight into the results reported by C. Romer is that, given the fools in the Fed and the timidity of Roosevelt, the US might as well have been an early modern country (and US policy was relatively Keynesian compared to say that of France).

The Coming of the Great Depression

Michael Bordo was parachuted at the last minute into the Council on Foreign Relations New Deal Conference last Monday to make it less hopelessly biased--less of an event that, as one senior Bush I economic policy advisor and rock-ribbed Republican quipped, was the Council on Foreign Relations' attempt "to outbid Heritage as the most biased and least educational thinktank:" He did a good job in talking about infrastructure spending during the Great Depression, and why you would never have expected it to curematters: there just wasn't enough of it:

The 1920s: Bubble, Growth, or Gold? - Council on Foreign Relations: BORDO: Okay, my comments are going to in some respect echo what Dick Sylla said and what the others said.  There are sort of -- there are two principal stories on what cause the Great Depression. One is the failure of the Federal Reserve.  And the second is the gold standard.  And I'll just mention each of those two views briefly....

[W]hen the stock-market boom started, about 1926, the Fed became increasingly concerned about this on real bills doctrine lines. In a sense, they thought that the asset price inflation was really going to be inflationary and that policy should be used to  tighten it, to stop that.  And so they tightened progressively starting in '28. This led to a recession, which started in the summer of '29.  And then the Crash followed the recession.  Okay, and the Crash itself, as everyone and the others have all said, was not the cause of the Great Depression.

In fact, the Fed initially -- the New York Fed initially followed very good policies in October and November of '29.  And they flooded the money markets, the New York money markets, to prevent a liquidity crisis. But then they stopped, in late '29.  And they stopped because there was pressure coming from the board on real bills line, which had said, look, if we keep expanding, we're going to refuel the stock market boom.  And so they checked the tight policy, from that point onwards.  And we know that '30 was a disaster.  It was a disaster because there was a series of banking panics which started in October '31 -- October of '30, and the last one was in '33. And these four panics, okay, were disasters because they did two things:  A, they drastically reduced the money supply, and this reduced spending in prices and output.  And secondly, they destroyed the credit -- they destroyed what Bernanke called "credit intermediation."  And this again had a very negative effect.  Okay?  

And the Fed did not -- the reason the Fed did this -- and there's two stories, there's Friedman and Schwartz, and Bernanke and Meltzer. But you know, one is the real bills story that I told you.  Another is the Fed itself, okay, had some serious structural problems.  There was a sort of continuing conflict between the reserve banks -- and specifically, New York -- and the board in Washington.  So there was a paralysis and the Fed couldn't act to deal with the deflation and depression that was taking place.  Okay. And it didn't end until Roosevelt came in and the banking panic -- and imposed the banking holiday in March 1933, which ended up closing one-sixth of the nation's banks, and so in a sense clearing away the serious problem of bank insolvency.  And also, the last thing that happened, thank God, is that -- and it started getting us out of the Depression -- was the Treasury followed expansionary gold purchasing policies, not the Federal Reserve.  That in a sense led to a recovery that started in '33.  

Okay.  I have a minute, and I want to just mention -- I'll mention the gold.  So the gold standard comes in in a number of ways. The one way in specific is that all the countries in the world are tied together with gold.  When the U.S. goes down, the shock is transmitted to the rest of the world.  Okay, and so we transmit -- the Depression starts in the United States; it's transmitted to the rest of the world. Also, the rest of the world, the small countries and even fairly large countries, have a problem, in that because they had not -- they do not credibly adhere to the gold standard, okay, to the gold- exchange standard and the problems of the gold-exchange standard that  Benn Steil talked about, okay, that they could not follow expansionary policies to get us out of the Depression; that when they did, there would be speculative attacks on their currencies.  

And so they were anchored by what's called golden fetters.    

And the only country that could have gotten us out was the United States, because the U.S. had extremely large gold reserves.  And if they had followed expansionary policies starting in 1930, which they could have done, they had the technology to do so, that could have re- flated the world and prevented the Depression from turning great.  

Jeff Madrick on Infrastructure Spending in the Great Depresion

Jeff Madrick was parachuted at the last moment--as he wrote me, he thought he was the wrong person (the right person would have been someone like Alex Field)--into the Council on Foreign Relations New Deal Conference last Monday to make it less hopelessly biased--less of an event that, as one senior Bush I economic policy advisor and rock-ribbed Republican quipped, was the Council on Foreign Relations' attempt "to outbid Heritage as the most biased and least educational thinktank." He did a good job in talking about infrastructure spending during the Great Depression, and why you would never have expected it to curematters: there just wasn't enough of it:

Infrastructure Spending to Grow: JEFF MADRICK: I want to state this very strongly because I don't think it has been stated strongly enough... enough wasn't spent... there was no net stimulus to the economy when you talk about all that spending.  Let me put that in a little bit of perspective, and I want in particular to emphasize Peter Temin's point about what a deep hole we were in. From 1933 to 1937.. [t]he economy grew at 9 percent a year... GDP equaled its 1929 level by 1937, coming out of an enormous hole.... So when we talk about the depression lasting from... 1930 to 1939, we are seriously misstating it.... You have heard already about unlocking the monetary system, the bank holiday, people were borrowing, leaving their money in banks... Federal Reserve policy was loosened, and there was modest deficit spending in those years....

Keynes talked about a deficit, not the size of government, which is a different issue, but a deficit.... That came at most to something like 5 percent in those mid-1930s years. Nothing serious enough to get us out of that very deep hole in the early '30s, which cut GDP by about 30 percent....

I have to say one other thing about high labor costs and unionization.  A simple fact of life -- the golden age of American growth was the 1950s and 1960s.  The golden age of unionization was the 1950s and 1960s.  The golden age of wage growth in America was the 1950s and 1960s.  The golden age of capital investment was the 1950s and 1960s....

[W]e didn't have roads and bridges.  We had to build them.  And when did we build them?  In the 1930s.  And the good work of Alex Field, for example, suggests that the capital stock of roads and bridges in the 1930s increased by 70 percent.... I don't know many economists who think adequate infrastructure for a modern economy since the industrial revolution in the 1700s will be created by General Electric or General Motors or big oil.It has been created by people getting together and deciding, we've got to build roads and bridges, we've got to build turnpikes, we've got to build railroads.... Government has been the source of major infrastructure investment....

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And the smart and well-informed Nick Taylor thinks he has wandered into the wrong discussion:

NICK TAYLOR:  Well, I'm not prepared to argue Henry Morgenthau and whether he was right... as I look over the program this morning I believe I'm the first non-economist on the stage or at least among the panel...

Lessons from the New Deal: Banking Committee Hearing Transcript (March 31, 2009)

Download now or preview on posterous

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Posted via email from http://braddelong.posterous.com/banking-committee-hearing-tran at Brad DeLong's Scrapbook

Maynard Keynes Discusses the Current Crisis, Parts I-III

Hoisted from comments: Robert Waldmann writes:

Grasping Reality with Both Hands: Ex-College Roommates Write Letters: Self referential blog commenting: Uhm, Brad, don't expect to have a monopoly on Keynes Comments on Current Events Blogging. I'm up to III already:

• http://rjwaldmann.blogspot.com/2009/03/music-prince-and-revolution-those-who.html
• http://rjwaldmann.blogspot.com/2009/03/limits-of-monetary-policy-we-have.html
• http://rjwaldmann.blogspot.com/2009/03/maynard-keynes-comments-on-current.html

Ex-College Roommates Write Letters

Robert Waldmann:

Dear Brad,

...Anyway, I really think you ought to have posts of the form: "Maynard Keynes Discusses the Current Crisis part MDCCLXXIV." It seems to me that he is one of the most insightful commentators on current events, in spite of the disadvantage of writing say 70 years ago.

This, despite the mildly embarrassing URL, is searchable and cutandpastable: http://www.marxists.org/reference/subject/economics/keynes/general-theory/...

ciao

Robert

The Earlier You Abandon the Gold Standard and Start Your New Deal, the Better...

Another version:

DeLong: Lessons from the New Deal for Today

Before the United States Senate Committee on Banking, Housing and Urban Affairs: LESSONS FROM THE NEW DEAL: Economic Policy

Tuesday, March 31, 2009. 02:30 PM. 538 Dirksen Senate Office Building:

The witness on Panel I will be The Honorable Christina Romer, Chair, Council of Economic Advisors.

The witnesses on Panel II will be: Dr. James K. Galbraith, Lloyd M. Bentsen Chair, Lyndon B. Johnson School of Public Affairs, University of Texas at Austin; Dr. J. Bradford DeLong, Professor of Economics, University of California Berkeley; and Dr. Allan M. Winkler, Professor of History, Miami (Ohio) University.

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March 25, 2009 DRAFT:

Download now or preview on posterous

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Posted via email from http://braddelong.posterous.com/delong-lessons-from-the-new-de at Brad DeLong's Scrapbook

Lessons from the Great Depression I

A perfect correlation among the G-5: the earlier you abandon the gold standard, the better you are doing in 1937. A 119-1 shot.

FDR Done Did Good

On the Wall Street Journal editorial page, George Bittlingmayer and Thomas Hazlitt remind us that FDR's radical policies--regulating the banking system, abandoning the gold standard, abandoning the goal of balancing the short-term budget, and committing the government to an anti-laissez faire program of interventionist social democracy--were an extraordinary and immediate success:

GEORGE BITTLINGMAYER and THOMAS W. HAZLETT: [Roosevelt's] first step was to stem the banking panic with a national bank holiday (many states had already imposed their own). He closed troubled institutions, injected capital into the healthy ones, and reassured Americans that their deposits would be safe. His approach met with quick success. The New York Stock Exchange, closed during the bank holiday, opened up 15% on March 15. By July 3, the Dow Jones Industrial Average was 93% above its close on March 3, the day before Inauguration Day in 1933...

More New Deal Denialist Truth Squadding from Eric Rauchway

Eric Rauchway on George Bittlingmeyer and Thomas Hazlett:

Just when I thought I was out. « The Edge of the American West: It’s hard to exaggerate the incoherence of the WSJ editorial, “FDR’s Conservative 100 Days”. The authors write... FDR did not launch his New Deal with a program that roiled financial markets.” No: he shut down the banks, and reopened about eighty percent of them with federal assurance that they were sound. This helped restore confidence in the American financial system. And, FDR said, “I hope you can see from this elemental recital of what your government is doing that there is nothing complex, or radical in the process.”

The authors also quote Raymond Moley saying, “It cannot be emphasized too strongly that the policies which vanquished the bank crisis were thoroughly conservative.” And then they add mention of the Economy Act, which cut the budget dramatically. Now, you might note, as Ed Kilgore does, that you want to be careful quoting Moley, who “left the Roosevelt administration midway through 1933, and then devoted much of the rest of his long career to New Deal-bashing, contemporary and revisionist.”

Or you might want to use your common sense. Yes, it is in some sense “conservative” to save the banking system—it helped, as Moley also said, save capitalism. But is it in any sense more conservative than what Obama’s doing? No; Obama’s so far avoided shutting down all the country’s banks for a week, and keeping 20 percent closed for even longer. Which, by the way, is no recommendation of Obama’s policy; with each day it seems a less conservative measure might be a good idea.

But set all that aside: most hilariously, the WSJ authors’ measure of Roosevelt’s conservative success is that “By July 3, the Dow Jones Industrial Average was 93% above its close on March 3, the day before Inauguration Day in 1933.” Yet their account of the hundred days stops with the Economy Act, on March 14. Between March 14 and July 3, you had also (among other measures) the

• Civilian Conservation Corps / Reforestation Relief Act, which employed young men chiefly for the maintenance of public lands;
• Agricultural Adjustment Act, which taxed processors to subsidize reduction of farm crops;
• Federal Emergency Relief Act, which allocated $500m as unemployment relief to the states;
• Tennessee Valley Authority Act, which established federal management of the Tennessee River and its watershed, to generate lower electricity rates (among other purposes);
• Banking Act of 1933, which among other things separated commercial and investment banking;
• National Industrial Recovery Act, which created federally sanctioned industry cartels to set prices and wages and which strengthened the right to unionize.

I look forward to the WSJ editorial explaining how these conservative policies contributed to the market rally evident by July 3, 1933.

Tyler Cowen Wants to Become a Fisherian-Pigovian-Vinerian-Hawtreyan

Tyler writes:

Marginal Revolution: Irving Fisher on the liquidity trap: The very healthy influence of Scott Sumner has induced me to read the Irving Fisher works I had never looked at before.  Wow.  It's Fisher, not Keynes, who is the prophet of our times and the superior analyst of the Great Depression.  Circa 1932, Fisher wrote:

...in the depression of 1929-32, while the volume of deposit currency in member banks was falling 21 per cent, the velocity of it was being reduced by 61 percent....a mere new supply of money, to replace what has been liquidated or hoarded, might fail to raise the price level by failing to get into circulation...a mere increase in M might prove insufficient, unless supplemented by some influence exercised directly on the moods of people to accelerate V -- that is, to convert the public from hoarding.

One wishes that Keynes were so clear. And what is the best way to restore confidence and break the liquidity trap?  Restoring confidence in banks, so that a multiplier, working through credit, may be effective again.  Fisher also suggests negative interest on reserves and he outlines in detail how this might be done. That is all from his Booms and Depressions, First Principles, a very sophisticated work.  Pigou, Hawtrey, and Viner are also all worth reading; they are more advanced in their thinking than Keynes was willing to admit. Hail Irving Fisher, still one of the most underrated economists of the 20th century.  By the way, 1936 - 1932 equals 4.

Here is what Pigou said about Keynes (after Pigou hqd gotten over his snit, of course): his Marshall lectures, Keynes’s General Theory: A Retrospective View:

Nobody before [Keynes], so far as I know, had brought all the relevant factors, real and monetary at once, together in a single formal scheme, through which their interplay could be coherently investigated...

You need the bond market and the goods market

Great Depression Revisionism Blogging: The Council on Foreign Relations Crashes-and-Burns in Real Time...

The speaker's list for the Council on Foreign Relations "A Second Look at the Great Depression" conference on March 30 is out, and it is a doozy--even the Heritage Foundation would never have dared to put forward a speaker's list so partisan, so biased, and with so few speakers with more than an inch-deep knowledge of the Great Depression. Jamie Galbraith, Nick Taylor, and Jonathan Alter are all by themselves holding down the center and the left of the political spectrum. And Jamie and Richard Sylla are the only people holding down the non-Chicago and non-goldbug-wingnut part of the economic spectrum.

In general, when you have a panel at a conference about an issue, you find (a) the smartest and best-informed person who thinks "yes," (b) the smartest and best-informed person who thinks "no," and (c) somebody thoughtful in the middle to hold the balance. That is... not the strategy that the Council on Foreign Relations has followed in this case.

Over the weekend I have gotten two three four copies of the program in the email--all with accompanying commentary that sounds somewhat... panicked:

The CFR Board is aware of the situation...

Who would you recommend as replacement speakers? Preferably not more New Deal-denialists..."

The CFR... is... perhaps belatedly getting worried about a lack of balance...

A perverse part of me wants to watch them go ahead...

They are looking to make the speaker's list less biased...

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A Second Look at the Great Depression and New Deal

Monday, March 30, 2009 — 8:15 AM to 6:00 PM

Welcoming Remarks: Richard N. Haass, President, Council on Foreign Relations

Session One: 1929: Bubble or Growth? Irving Fisher was the Yale economist who argued that market prices were not too high in 1929 and was rewarded with half a century of ridicule. There is evidence that Fisher may not be so far off, and that the more illusionary we deem growth in the 1990s, the more likely we are to demand fiscal, financial, and monetary policy shifts or reform.[1] * Edward C. Prescott * Benn Steil * Richard Sylla

Session Two: Nice Work If You Can Get It: The Role of Labor Policy: Did labor policy under Hoover and Roosevelt make the Depression worse, keep it the same, or actually pave the way to recovery? Labor policy and wages are again an issue today in regard to auto companies’ legacy obligations, new union legislation (“card check”), or public-sector union obligations for state governments. * Price V. Fishback * Lee E. Ohanian * Richard K. Vedder * James F. Hoge Jr.

Session Three: Infrastructure Spending to Grow: What did we learn from the Depression era spending programs of the New Deal? Will spending, especially infrastructure spending, take us to recovery? How political is such spending? * Ellen R. McGrattan * Nick Taylor * Anna J. Schwartz * Simon Constable

Session Four: Keynote: Why a Second Look Matters * Robert E. Lucas Jr. * Carl J. Schramm, President and CEO, Ewing Marion Kauffman Foundation

Session Five: The New Financial Deal: What can we learn about reforming today’s financial markets from those of the 1930s? What does the Depression tell us the new architecture should and should not do? * John Cochrane * Thomas F. Cooley

Session Six: Today’s Path to Growth: What Do the 1930s Tell Us About Now? * James K. Galbraith * Jonathan Alter * Amity Shlaes

at the Harold Pratt House, 58 East 68th Street, New York, New York 10065

This event will be on the record.

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As I see it, Cochrane and Lucas are smart enough to always be worth listening to no matter what they are talking about. Alter and Taylor know stuff about politics in the 1930s. Galbraith knows stuff about politics and economics in the 1930s. Fishback and Sylla know a great deal about the economics of the 1930s. Those six belong in their places on the program. The rest do not--they don't know enough about the issues they are talking about to be on the stage rather than in the audience.

It's not as though people who are qualified to be on the stage--who actually know stuff about the Great Depression--are hard to find. Where is Eugene White? Hugh Rockoff? Michael Bordo? Claudia Goldin? Robert Higgs? Jeremy Atack? Peter Temin? Bill Sundstrom? Charlie Calomiris? Chris Meissner? Chris Haynes? Kris Mitchener? David Wheelock? Lee Alston? Peter Lindert? David Mowery? Robert Whaples? Eric Rauchway? Marc Flandreau? Barry Eichengreen? Christie Romer? Ben Bernanke? Doug Irwin? Tim Hatton? Richard Portes? Ken Rogoff? Gary Walton? Thomas Ferguson? A.P. O'Brien? J.R. Vernon? Robert Shiller? Richard Grossman? Mark Thomas? Robert Gordon? Joseph Mason? Pierre Siklos? Theda Skocpol? Margaret Weir? Gary Libecap? Maggie Levenstein? Naomi Lamoreaux? Michael Bernstein? Dan Raff? Dan Nelson? Sally Clarke? David Hounshell? Louis Johnston? Jeff Miron? Ken Snowden? Jim Hamilton? Susan Carter? Steve Cecchetti? Sanford Jacoby? Josh Rosenbloom? Bob Margo? John Wallis? Farley Grubb? Alex Field? And a host of others from all political and analytic perspectives whose knowledge of the Great Depression swamps those of the Council on Foreign Relation's speakers.

Why oh why can't we have better thinktanks?

It looks as though Richard Haass badly needs to do some house cleaning. And if he won't, then Carla Hills and Robert Rubin need to get involved.

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[1] You may ask what this means. I don't know. It seems ignorant and illiterate. First of all, Irving Fisher was ridiculed not for saying that the market was fairly-valued in 1929 but for saying that the market was not going to go down: that it had reached a plateau that was "permanent"--that investments in stocks were no longer risky. There is no evidence that Fisher was not so far off: the market did go down in 1929, 1930, 1931, and 1932. And then we shift to "the more illusionary we deem growth in the 1990s, the more likely we are to demand fiscal, financial, and monetary policy shifts or reform"--which seems to be neither a coherent thought nor connected to the issue of market valuation in 1929.

Over at the Economist...

I see that Andrew Atkeson has been listening too much to his colleague Lee Ohanian when he should have been rereading his Friedman and Schwartz. And that he has not asked Lee the five key questions that he should have asked: (i) why move the goalposts so far by comparing the New Deal period to 1930-1932 rather than late 1932? (ii) why focus so heavily on hours per adult to the exclusion of other labor market indicators? (iii) why if the NRA was so bad did employment grow so rapidly during the short time it was in effect? (iv) if strong union power was responsible for high unemployment in 1937-1939, why wasn't stronger union power responsible for even higher unemployment in the 1950s and 1960s? (v) why pay no attention at all to Friedman and Schwartz's judgment of the causes of renewed depression in the late 1930s.

If Atkeson had asked those five questions, I think he would have written a very different comment.

So I have a response:

In my view, Andrew Atkeson makes a very bad mistake when he cites Cole and Ohanian's Wall Street Journal op-ed as an authority for the claim that the New Deal did more harm than good.

Cole and Ohanian write thqt under "the New Deal... there was even less work on average... than before FDR took office." It turns out that by "before Roosevelt took office" Ohanian and Cole mean not the months before Roosevelt took office in late 1932 and early 1933 but, instead, an average of 1930-1932. 1929 was a boom year of extremely high un employment. 1930 was an average year. 1931 was a bad year. But it was only after the financial crises of late 1931, say Milton Friedman and Anna Schwartz, that the cratering of the system of financial intermediation and the sudden rise in the reserve-deposit and currency-deposit ratios turned the downturn into the Great Depression. To compare the New Deaql to the average of 1930-1932 is not just to move the goalposts--it is to pick up the goalposts and run as fast as you can out of the stadium. Cole and Ohanian work very hard to try to convince their readers that things got worse after Roosevelt took office. But, as they know well, they didn't: things got better--they just did not get enough better to get employment back to normal until the huge burst of federal deficit spending that was World War II.

And Cole and Ohanian cherry-pick their statistics. Do they tell their readers that unemployment was 22.9% in 1932 and down to 11.3% in 1939? No. They tell their readers that "hours worked per adult in 1939 remained about 21% below their 1929 level, compared to a decline of 27% in 1933" without telling them that in 1949 hours worked per adult were 18% and in 1959 17% below their 1929 level. The 1929-1950 period saw the last sharp decline in the American workweek--a decline that does not mean that the economy was depressed and performing poorly in 1959 or 1949 (or 1939) relative to 1929, but instead that Americans had decided to take a substantial part of their increased technological wealth and use it to buy increased leisure.

Cole and Ohanian do even worse when they try to account for the fact that the Great Depression was not followed by a vigorous recovery. They blame the New Deal, primarily my least favorite government program of all time, the National Recovery Administration. But the years during which the NRA was in effect saw the unemployment rate go from 22.9% down to 14.4%--hardly what you would expect to see if the NRA were doing massive additional macroeconomic damage to the economy. And the NRA comes to an end before the middle of 1935 when it is ruled unconstitutional. So for the period after 1935 Cole and Ohanian blame the National Labor Relations Act and the increase in union power that it enabled. They ignore that fact that unions were far stronger in the late 1940s and 1950s than they were in the late 1930s. And they ignore Milton Friedman and Anna Schwartz's conclusion that the economy became more depressed in the late 1930s than it had been in 1935-1936 because of an extraordinary contractionary mistake of monetary policy: that in early 1937 the Federal Reserve doubled required reserves out of fear of future inflation, and the economy fell off a cliff as a result.

Now there is somewhat more than a grain of truth in the claim that much of the New Deal, especially its structural interventions in the economy, was ineffective and counterproductive--John Maynard Keynes told Roosevelt so in a letter of February 1, 1938. And Keynes went on to argue that the reason the U.S. recovery had stalled out in 1937-1938 was that Roosevelt's policies were not Keynesian enough--that "the present [renewed] slump could have been predicted with absolute certainty" by anybody knowing the year before how Roosevelt was going to try to reduce deficit spending and tighten money. But that the New Deal was not Keynesian enough does not mean that we should be even less Keynesian now than we are being. And the argument that Milton Friedman, Anna Schwartz, and John Maynard Keynes were all wrong when they blamed the renewed 1938 downturn on contractionary macroeconomic policies--well that is an argument that Atkeson is a very brave man indeed to make.

Jonathan Chait on New Deal-Denialism

He misses two important threads.

1. Had John McCain won last November, very few of the New Deal denialists would be out in public--instead, the Republican legislators and their tame intellectuals would be enthusiastially rallying behind McCain's tax cut-based Keynesian fiscal stimulus package right now.

2. Amity Shlaes was fired from the Financial Times for lying about the Bush administration's preparedness to deal with Hurricane Katrina. Surely this deserves a mention?

Jonathan Chait:

Wasting Away in Hooverville: A generation ago, the total dismissal of the New Deal remained a marginal sentiment in American politics. Ronald Reagan boasted of having voted for Franklin Roosevelt. Neoconservatives long maintained that American liberalism had gone wrong only in the 1960s. Now, decades after Democrats grew tired of accusing Republicans of emulating Herbert Hoover, Republicans have begun sounding ... well, exactly like Herbert Hoover.... When Republicans announce that the New Deal failed--as they now do, over and over again, without any reproach from their own side--they usually say that the case has been proven by the conservative columnist Amity Shlaes in her book The Forgotten Man.... Whether or not The Forgotten Man actually persuaded conservatives that the New Deal failed, in the time of their political exile, which is also a time of grave economic crisis, it has become the scripture to which they have flocked.

When they say that the New Deal "didn't work," conservatives almost always mean New Deal fiscal stimulus.... And then, in turn, they confuse New Deal fiscal stimulus with Keynesian economics.... When people worry about losing their jobs, they sensibly cut back on their spending. But that decision, in turn, reduces demand for goods and services, which results in reduced income or lost jobs for other workers.... The recession was therefore a failure of collective action that required government action. Government needed to encourage spending by reducing interest rates or, failing that, to inject spending into the economy directly by deliberately running temporary budget deficits.... [T]he essential framework constructed by Keynes--that recessions are caused by a failure of demand, and that at the very least government should not respond to an economic slowdown by paring back its largesse--is no longer in dispute. Even a right-wing Republican economist such as Gregory Mankiw, a former Bush advisor, writes that "if you were going to turn to only one economist to understand the problems facing the economy, there is little doubt that the economist would be John Maynard Keynes."

[E]verywhere you look, conservative pundits and elected officials have embraced the pre-Keynesian nostrums. Citing The Forgotten Man, they insist that efforts to stimulate the economy are not just insufficient but also counter-productive.... It is 1932 again in the Republican Party....

Now here is the extremely strange thing about The Forgotten Man: it does not really argue that the New Deal failed. In fact, Shlaes does not make any actual argument at all, though she does venture some bold claims, which she both fails to substantiate and contradicts elsewhere. Reviewing her book in The New York Times, David Leonhardt noted that Shlaes makes her arguments "mostly by implication." This is putting it kindly. Shlaes introduces the book by asserting her thesis, but she barely even tries to demonstrate it. Instead she chooses to fill nearly four hundred pages with stories that mostly go nowhere. The experience of reading The Forgotten Man is more like talking to an old person who lived through the Depression than it is like reading an actual history of the Depression.... Having been prepared for a revisionist argument against the New Deal, I kept wondering if I had picked up the wrong book.

Many of Shlaes's stories do have an ideological point, but the point is usually made in a novelistic way rather than a scholarly one. She tends to depict the New Dealers as vain, confused, or otherwise unsympathetic. She depicts business owners as heroic and noble. It is a kind of revival of the old de haut en bas sort of social history, except this time the tycoons from whose perspective the events are narrated appear as the underappreciated victims, the giants at the bottom of the heap....

Shlaes begins every chapter with a date (say, December 1936), an unemployment percentage (15.3) and a Dow Jones Industrial Average. The tick-tick-tick of statistics is meant to show that conditions did not improve throughout the course of Roosevelt's presidency. Yet her statistics are highly selective. As those of us who get our economic information from sources other than the CNBC ticker know, the stock market is not a broad representative of living standards. Meanwhile, as the historian Eric Rauchway has pointed out, her unemployment figures exclude those employed by the Works Progress Administration and other workrelief agencies. Shlaes has explained in an op-ed piece that she did this because "to count a short-term, make-work project as a real job was to mask the anxiety of one who really didn't have regular work with long-term prospects." So, if you worked twelve hours per day in a coal mine hoping not to contract black lung or suffer an injury that would render you useless, you were employed. But if you constructed the Lincoln Tunnel, you had an anxiety-inducing make-work job.

In response to this criticism, Shlaes has retreated to the defense that unemployment was still high anyway. "Even if you add in all the work relief jobs, as some economists do," she has contended, "Roosevelt-era unemployment averages well above 10 percent. That's a level Obama has referred to once or twice--as a nightmare." But Roosevelt inherited unemployment that was over 20 percent! Sure, the level to which it fell was high by absolute standards, but it is certainly pertinent that he cut that level by more than half. By Shlaes's method of reckoning, Thomas Jefferson rates poorly on the scale of territorial acquisition, because on his watch the United States had less than half the square mileage it has today.

Shlaes's actual critique of the New Deal is not easy to pin down. Defining what she believes depends on whether you are reading the book itself or her incessant stream of spin-off journalism. In one article she adopted the classic right-wing line taken up by Andrew Mellon, Hoover's treasury secretary: "Mellon--unlike the Roosevelt administration--understood that American growth would return if you left the economy alone to right itself." This is the conclusion that most excites Shlaes's conservative admirers....

If your understanding of the New Deal is limited to the simple notion that Roosevelt spent a lot of money and tamed unemployment, then this story might sound like a persuasive piece of evidence for Shlaes. Yet there is a tip-off within the story that ought to give even the uninformed reader pause: the part where the Treasury Secretary promises to balance the budget. That doesn't sound very New Deal-ish, does it? And indeed it is not. The historical fact is that Roosevelt's administration contained warring factions with often wildly differing ideas. FDR came into office promising to slash the federal budget, but he moved in fits and starts toward a Keynesian policy of fiscal stimulus. After the elections of 1936, though, his more conservative advisors prevailed upon him to roll back the budget. Liberals, including Keynes, protested that this would jeopardize the fragile recovery. And events vindicated them: after impressive growth, the economy plunged back into a recession within a depression.

That Roosevelt see-sawed between Keynesianism and budget-balancing has been conventional wisdom among mainstream historians and economists for decades. The MIT economist E. Carey Brown wrote this in 1956. Keynes made the same point in a pleading letter to Roosevelt in 1937. Economists disagree about the extent to which Roosevelt's fiscal expansion helped. Many give more credit to his abandonment of the gold standard--which Shlaes, naturally, also decries. The fact that he retreated from Keynes in 1937 and that this retarded the recovery, though, bears little dispute....

[I]ntellectual coherence is not the purpose of Shlaes's project. The real point is to recreate the political mythology of the period. It does not matter that Shlaes heaps scorn on Roosevelt for doing things that liberals also scorn. Anything that tarnishes his legacy, she seems to think, tarnishes liberalism by association.... If the New Deal failed so miserably, one might wonder why voters continued to endorse it. In Shlaes's telling, Roosevelt's first challenger, Alf Landon, lost in 1936 because he "failed to distinguish himself" from Roosevelt. It is certainly true that Landon hailed from the party's moderate wing and shied away from the root-and-branch condemnation of the New Deal favored by, say, Hoover. But as the campaign wore on, Landon's rhetoric grew increasingly harsh. If Roosevelt returned to office, he warned, "business as we know it is to disappear." Voters who opposed the New Deal may not have had a perfect choice, but they did have a clear one. It also takes quite a bit of ideological credulity to believe, as Shlaes apparently does, that Roosevelt's twenty-point victory represented anything other than massive support for his program. Landon himself later remarked that "I don't think that it would have made any difference what kind of a campaign I made as far as stopping this avalanche is concerned."...

The final unanswered question that must nag at the minds of the true believers is how the Depression managed to develop even before Roosevelt assumed office. After all, his bungling caused the economy to stall for years, yet the Depression was already more than three years old before Roosevelt even took office. Shlaes's answer is to implicate Hoover as a New Deal man himself.... This part of Shlaes's argument has generated enormous enthusiasm on the right. At last the cultural baggage of Roosevelt's predecessor--Hoovervilles, Hoover flags, and the like--has been lifted off the shoulders of conservatism and onto the real culprit, which is liberalism. Senator Kyl proclaimed on the Senate floor last fall that "in the excellent history of the Great Depression by Amity Shlaes, The Forgotten Man, we are reminded that Herbert Hoover was an interventionist, a protectionist, and a strong critic of markets."... There is indeed a revisionist scholarship that recasts Hoover as an energetic quasi-progressive rather than a stubborn reactionary. William Leuchtenburg... settles on a more traditional conclusion. Leuchtenburg shows that Hoover's history of activism consistently left him with the belief in the primacy of voluntarism and the private sector, a faith that left him unsuited to handle a catastrophe like the Depression.... Shlaes's attempt to equate Hoover's disdain for short-sellers and Roosevelt's regulation of the market presumes that there is no important difference between expressing disapproval for something and taking public action against it....

[N]ow we have come to a time when leading Republicans and conservatives--not just cranks, but the leadership of the party and the movement--once again sound exactly like Herbert Hoover. "Prosperity cannot be restored by raids upon the public Treasury," said President Hoover in 1930. "Our plan is rooted in the philosophy that we cannot borrow and spend our way back to prosperity," said House Minority Leader Boehner in 2009. They have come to this point by preferring theology to history, by wiping Hoover's record from their memories and replacing it with something very close to its opposite. It is Hoover, truly, who is the Forgotten Man.

I Knew Franklin Delano Roosevelt, Franklin Delano Roosevelt Was a Friend of Mine, and You, Herbert Hoover, Are No Franklin Delano Roosevelt Blogging

UPDATE: Robert Murphy writes:

Free Advice: OK I Will Ignore DeLong, Starting... Now: I misspoke in the previous post when I said I was done nitpicking Brad DeLong's posts. For how could I know that he would then devote an entire post to me?! (What timing.) Regular readers here will see right away the true hilarity in DeLong's response.

Robert. It's not about you. It's about Hoover. So I'm going to edit things down to make that clear.

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In a thumbnail, Herbert Hoover was a Keynesian avant le lettre with his heart but a liquidationist in his head. Hoover wished that he could do something to alleviate the Great Depression, but his head would not. The policies advocated by Mellon were the views that ruled the policies of the Hoover administration. Because Hoover kept Mellon as his Treasury Secretary and followed his led, Hoover did not:

• nationalize any banks.
• rescue any bank depositor businesses whose accounts are now frozen.
• abandon the gold standard to expand the money supply.
• do anything else to expand the money supply.
• abandon the balanced-budget principle as a constraint on relief spending.

Now Hoover did not believe that he had a moral duty to make the little people who were going bankrupt in the Depression suffer. Unlike Ludwig von Mises or Grover Norquist, Hoover did not believe that he had a moral duty to drown government in the bathtub. Hoover was eager to use government's powers to cushion--note not cure--the Great Depression. But as long as he kept Andrew Mellon on as Treasury Secretary, Hoover could do none of the things--nationalizing banks, rescuing depositors whose accounts were frozen, abandoning the gold standard to expand the money supply, other forms of "quantitative easing," deficit-financed relief expenditures, or indeed deficit-financed expenditures of any kind--that might have actually helped enough to matter.

Assessing the Collapse of the American Labor Market: What Should Our Yardstick Be?

While the headline unemployment number is still only 8.1%, the Bureau of Labor Statistics reports inTable A-12: Alternative measures of labor underutilization that "total unemployed, plus all marginally attached workers, plus total employed part time for economic reasons, as a percent of the civilian labor force plus all marginally attached workers"--the underemployment rate--is 14.8%.

In the Great Depression the nationwide unemployment rate according to David Weir reached an annual peak of 22.9% in 1932. Unlike the headline unemployment rate today, Weir's unemployment rate concept makes no allowance for "marginally attached workers" who we today count as out of the labor force when we do our calculations: the Weir labor force grows at a steady 700,000 per annum between 1929 and 1932, while our labor force concept has fallen by 700,000 since last October. "Part time for economic reasons" is simply not a category in Lebergott's or Weir's unemployment series: they are imputing numbers between census benchmarks based on estimates of production and their hunches about cyclical labor productivity measures.

Clearly the Weir 22.9% should be compared to some weighted average of today's 8.1% headline number and today's 14.8% underemployment number. But what are the appropriate weights? if the proper weights are 50-50, underemployment today is fully half the peak value it reached during the Great Depression. If the proper weights are 100-0, unemployment today is only 7/20 of its peak Depression value. If the proper weights are 0-100, unemployment today is fully 13/20 of its peak Depression value.

What are the proper weights? Ah, that is what we call an "open research question." I would loooovvvveee to get an Econ 210a paper this semester taking a shot at it...

Bruce Bartlett: The Real Lesson Of The New Deal: Deficits were too small, not too large...

Bruce Bartlett: The Real Lesson Of The New Deal: Deficits were too small, not too large...

Required Reading

jodsh Marshall asks:

Talking Points Memo: Has anyone else read this book? Many of you must have. Only Yesterday by Frederick L. Allen. The classic first-draft history of the 1920s prosperity up to the 1929 crash, written from the vantage point of 1931.

It is great. Once in Golconda is better.

Memo to Self: Add Eichengreen and Sachs to the 210a Reading List

Early adoption of "new deals"--of expansionary policies--in the Great Depression produces results:

We Are Live at The Week... Reflecting on the Rhetorical Strategy of Milton Friedman

Part of my continuing attempt to think through the Decline of the Chicago School--here I try to argue that Milton Friedman tried too hard to sell a stable nominal money growth rule as a laissez-faire policy, and thus undermined the ability of his students' students to actually say anything coherent about the macroeconomy:

End times for Milton Friedman? - THE WEEK: After World War II, laissez-faire economists had a big intellectual problem: the Great Depression. How could you argue for dismantling the post-WW II social insurance states and returning to the small-government laissez-faire of the past when that past contained the Great Depression? Some argued that the real problem was that the laissez of the past had not been faire enough: that everyone since Lord Salisbury and William McKinley had been too pinko and too interventionist, and thus the Great Depression was in no way the fault of believers in the free-market economy. This was not terribly convincing. So advocates of a smaller government sector needed another, more convincing argument.   It was provided by Milton Friedman.   Friedman proposed that with one minor, technocratic adjustment a largely unregulated free-market would work just fine. That adjustment? The government had to control the "money supply" and keep it growing at a steady, constant rate--no matter what. Since money was what people used to pay for their spending, a smoothly-growing money supply meant a smoothly-growing flow of spending and, hence, no depressions, Great or otherwise. In Friedman's view, if the task of monetary stabilization could be accomplished via technocratic manipulations by a non-political central bank, there would be no need for much of the apparatus of the post-World War II social insurance state.   In the 1950s Friedman's doctrines were considered way out there. But his Keynesian adversaries overreached, and claimed that clever governments could maintain price stability and a high-pressure economy with "full" (rather than merely "normal") employment. By the 1970s, it was clear they were wrong. Since then, advocates of expanded social democracy have been on the retreat more often than on the advance. By the 1990s, even left-of-center politicians had come to respect central bankers' mastery of the money supply, giving them a wide berth.   The power of Friedman’s theory was, in part, rhetorical. "Keep the money supply growing smoothly" sounds like it means to keep the presses in the Bureau of Engraving and Printing rolling at a constant pace, printing out a steady flow of pictures of George Washington. But that is not how "money supply" actually works. In economic reality, "money supply" means not just cash money but also credit entries the Federal Reserve has made in commercial banks' accounts at the Fed; plus all the credit entries commercial banks have made in households' and businesses' checking accounts; plus savings account balances; plus (usually) money market mutual-fund balances; plus (sometimes) trade credit and the ceilings between credit card limits and consumers' current balances.   No central banker controls all these vast and varied sluices of the money supply – at least not in economic reality. When banks and businesses and households get scared and cautious and feel poor, they take steps to shrink the economic reality that is the "money supply." Businesses extend less trade credit. Credit card companies cut off cards and reduce ceilings. Banks call in loans and then take no steps to replace the deposits extinguished by the loan pay-downs. Without a single bureaucrat making a single decision to slow down a single printing press, the money supply shrinks—disastrously in episodes like the Great Depression. Thus in emergencies, to say that all the central bank has to do is to keep the money supply growing smoothly is very like saying that all the captain of the Titanic has to do is to keep the deck of the ship level.   For the past eighteen months the collective central banks of the world have been trying as hard as they can to keep the deck of the ship level. Traditionally, central banks boost the money supply by buying government bonds from the Treasury for cash. Buying government bonds for cash cuts the supply of bonds the private sector can acquire, boosting their price while lowering interest rates, making businesses more eager to spend to expand and making asset holders feel richer and thus more eager to spend to consume.   The central banks and finance ministries of the world have purchased so many government bonds for cash that they have pushed the prices of short-term government bonds up as high as they can possibly go. With interest rates practically zero, there is no extra interest return to be gained in the short run from bonds. Yet it has not been enough.   So increasingly over the past year, the central ministries of the globe have taken extra measures: they have guaranteed debts, they have partially or completely nationalized banks, they have forced weak institutions to merge with stronger ones, they have expanded their balance sheets to an extraordinary extent. And yet this, too, has not been enough.   So now the central bankers have thrown up their hands, and asked for help to stimulate spending through tax cuts and government expenditures. Because they have run out of means to "keep the money supply growing smoothly."   Today, we have reached the end of the line for the Chicago view of financial deregulation. Friedman thought (a) that the central bank could exercise enough influence over the money supply to effectively control it, and (b) that banks and other financial intermediaries would be regulated tightly enough that what is now happening would be impossible. But he never resolved the tension between his view that banks need controls and the Chicago view that business must be unfettered.

Monetarism may well make a comeback -- as a doctrine that is good enough for normal times. For in normal times "keep the money supply growing smoothly" does appear to be a relatively easy task, a minor adjustment to laissez-faire that can be performed by a small number of qualified technocrats. Unfortunately, not all times are normal.

A Guide for the Perplexed Justin Fox on Fiscal Policy

Justin Fox is needlessly worried. He writes:

The uncertainty of stimulus :: The Curious Capitalist - TIME.com: From a Congressional Budget Office estimate released today on the impact of some amendment or other to the Senate stimulus bill:

The macroeconomic impacts of any economic stimulus program are very uncertain. Economic theories differ in their predictions about the effectiveness of stimulus. Furthermore, large fiscal stimulus is rarely attempted, so it is difficult to distinguish among alternative estimates of how large the macroeconomic effects would be. For those reasons, some economists remain skeptical that there would be any significant effects, while others expect very large ones.

It's sort of like that mutual fund boilerplate, "Past performance is no guarantee of future results." Except that we're not even sure of what the past performance was. (And I say this as somebody who thinks the stimulus legislation is on balance a good idea.)

Well, why should we be certain of what past performance was? There haven't been a great many uses of large-scale fiscal policy to try to cure depression. And in those cases in which it has been tried, a lot else has been going on.

But when fiscal boost was tried on a large enough scale, it certainly did the job. And it is reasonable to infer (with all the caveats provided by the CBO) that what is true in the very large will be true in the merely large as well. Eugene Fama says that it is theoretically impossible for fiscal stimulus to boost output: World War II proves him wrong. Robert Barro says that the multiplier is zero: World War II proves him wrong. Benn Steil says that Jacques Rueff in 1947 conclusively proved that fiscal policy could not boost employment: World War II proves him wrong.

The extent to which the Great Depression and World War II changed how economists thought--and how those who know their history still think--cannot be overstated. And even those economists who don't know their history should be forced to come up with a reason why the lessons of the Great Depression do not apply to today.

As I am going to say in class a couple of weeks from now:

The end in the Great Depression of laissez faire--the idea that the government should keep its hands off of the economy--as a doctrine for guiding economic policy did not mean the end of the market economy as a social resource allocation mechanism. "Keynesianism" and the doctrine of the "mixed economy" that it supported emerged in the nick of time, soon became the ruling ideologies in the industrial core of the world economy, and provided North America and western Europe with a Keynesian escape route from what had seemed the insoluble crises of the interwar period.

The Keynesian escape route opened up key ground in the middle between fascist-style regimentation and socialist-style national planning. Keynes argued that the market economy and capitalist order could be salvaged, and salvaged by relatively minor reforms. An activist welfare-state government with a commitment to full employment had the tools to eliminate Great Depressions, and could put economies back onto the road to Utopia. If only governments would reduce interest rates to get private agents or would themselves spend money freely (without raising taxes) in times when total demand was low, and raise interest rates to reduce private spending and themselves raise taxes (without raising spending) in times when total demand was high, then fiuctuations in employment and production could be greatly reduced, and Great Depressions avoided.

Belief in this escape route was strongly reinforced by facts. Those countries that had tried it by accident during the Depression--had infiated early, printed money, ensured low interest rates, and run large budget deficits--managed to survive the Depression much more easily than others. World War II provided final proof, were any necessary--"vindication by Mars," as John Kenneth Galbraith calls it. That component of unemployment, called "structural" or "permanent" during the 1930s, that was seemingly-immune to both the self-adjusting forces of the market and the armament of the New Deal vanished entirely in the 1940s as the federal budget deficit approached and then exceeded the levels that had long been recommended by John Maynard Keynes. And the United States fought World War II without reducing civilian consumption: all of U.S. war production came from new capacity or from capacity that stood idle at the end of the 1930s.

Demand expansion--deliberate attempts by governments to put the unemployed back to work by deficit spending and loose-money low interest rate policies--was successful in the 1930s and 1940s. It put the unemployed back to work. It did not contain within itself the seeds of a renewed Great Depression. It did not explode into hyperinflation. The coming of "stablization policy" enlarged the policy steps that could be undertaken without forcing a definitive break with the market-capitalist order, and without forcing a choice between Hitler's way and Stalin's.

In later years--in the second and third post-World War II generation--tasks of macroeconomic management would prove harder, and the truth of the doctrines of Keynes's disciples if not of the doctrines of Keynes himself would become less clear.

And Eric Rauchway Sets the Scene

Okay, Eric, where's the Friedman quote from? I am not familiar with it:

My View: The New Deal roots in the stimulus debate: When Roosevelt came into the presidency on March 4, 1933, the economy had fallen into a hole of historic depth. The unemployment rate reached nearly 25 percent. As the conservative economist Milton Friedman later said, the situation required action: "Something had to be done; it was intolerable. And it was a case in which, unlike most cases, the short run deserved to dominate"...

But Keynes Is Saved by Walras's Law

Tyler Cowen writes:

Keynes's General Theory, chapter six: in part ii the bombshell comes, unannounced.  Keynes decides that he will declare savings to be a "mere residual."  Consumption and investment alone will determine income and savings is defined as whatever is left over to make the national income equations balance. At the time this was considered by many to be an enormous sleight of hand. The Austrian and Swedish traditions focused on the question of whether planned savings was going to equal planned investment and what happens if not.  Keynes has just banished such questions to the woodshed and he has done so by a terminological maneuver.

Whether or not you think that the Austrian and Swedish traditions lead anywhere fruitful, Keynes is on shaky ground here.  He is using definitions to favor one causal account of macro over another.  That's not right.  You can still make a plausible argument that Keynes is right on empirical grounds that planned savings is not an important force for understanding business cycles.  But so far no such empirical argument has been clinched...

I think it is much more than a terminological maneuver. Walras's law tells us that if one market is out of supply-demand balance, there must be another related market (or markets) that is also out of balance. If planned saving is in excess of planned investment, then planned consumption spending must be less than planned production of consumer goods. You can then follow the inventory adjustment chain--say that as inventories pile up producers cut back on the making of consumption goods. You then try to follow through on what is happening in the money market and you are led to the conclusion that ex ante savings must be destroyed by a process of deleveraging and deflation and... you wind up in the swamp. But you can be rescued from the swamp by recalling Walras's law, and recognizing that if you just follow the process by which equilibrium is restored in the goods market you will then discover that that process has also restored equilibrium in the flow-of-funds through financial markets.

Keynes's "terminological maneuver" would not have succeeded if it were not for the fact that Keynes's theory worked at a level that Wicksell's or Myrdal's or Ohlin's never could.

Blogging Krugman's The Return of Depression Economics Over at TPM Cafe...

TPMCafe | Talking Points Memo | What Is Non-Depression Economics?: This discussion has so far one major lack: it does not tell us what "depression economics" is supposed to replace--it does not tell us what non-depression economics is, or was.

So let me try my hand at a definition of non-depression economics.

Non-depression economics believes that:

• Short-run economic policy should be left to the central bank--the legislature and the executive should focus on the long run and keep their noses out of year-to-year fluctuations in employment and prices.
• The highest priority for central banks should be to maintain their credibility as guardians of price stability.
• Once that highest goal has been achieved, central banks can turn their attention to trying to keep the economy near full employment.
• They should try to keep the economy near full employment by influencing asset prices--pushing asset prices up when unemployment threatens to rise, and pushing them down when an inflationary spiral appears on the horizon.
• Central banks should influence asset prices through normal open-market operations--by buying and selling short-term government securities for cash, thus changing the safe interest rate and the price of longer-duration assets.
• Central banks should stand ready to intervene to prevent bank runs. Otherwise, central banks should let the financial sector run itself with a light regulatory hand--financiers can take care of themselves, and the central bank should view itself not as chaperone or duenna but rather as the designated driver in the case of financial speculative excess.

That is what Paul Krugman is arguing is no longer sufficient doctrine for our age.

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TPMCafe | Talking Points Memo | What Is Going to Be the New Leading Sector?: What is going to be the new leading sector? What is going to allow us to maintain full employment without running huge long-term budget deficits that will, eventually, sap our rate of economic growth somewhat?

If it weren't for the fact that the furshlugginer dollar refuses to fall in value, the answer would be obvious: we will have a boom in import-competing manufacturing (and exports). But then the rest of the world has a long-run problem: if we decide to no longer be the world's importer of last resort, than what serves as a locomotive to keep it near full employment?

But if the dollar doesn't fall, then we have a long-run problem. The only answer I can think of is for the U.S. to then become the world's largest private-equity fund: they lend us their money, and we then invest the money back in their economies--in industries and companies that then have a very high demand for U.S. high-tech goods and for U.S. services exports.

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TPMCafe | Talking Points Memo | What Is to Be Done Now?: Paul Krugman writes:

[M]y main answer to Brad's question is that the events of 1997-1998 were, for me, a wake-up call. Before then I'd taken it for granted that central banks could always pump up demand, but Japan showed that the liquidity trap was a very real danger in a world in which inflation rates were fairly low.... I'd also assumed that bank runs were a thing of the past, but the Asian and LTCM crises showed that events functionally equivalent to bank runs could happen even if depository institutions - the denizens of big marble buildings with "FDIC insured" signs in their windows -- were protected. So I didn't take much comfort in the fact that a makeshift, cobbled-together set of measures managed to contain the crisis; it seemed all too obvious that the next crisis could be too big for improvisation to handle...

So what, in the long run, should the new regulatory and management system consist of?

Back in 1992 Larry Summers and I egged each other on to say that the target rate of inflation should be 5% per year--that anything less leaves you too vulnerable to a liquidity trap, and that as long as inflation is 5% per year it's hard to see any form of debt-deflation-credit-channel taking hold: even minimal principal amortization writes down the real value of debts and hence debt overhang very rapidly. Was this one of the (many) stupid things I have written in my career, or was it a really smart insight?...

We clearly need to extend the lender-of-last-resort umbrella to cover the shadow banking system--which means that someone has to oversee and regulate their portfolio leverage as well...

We clearly need to mandate that the Princes of Wall Street and Canary Wharf be paid not in cash bonuses and option rights but in restricted stock--to bail them into their institutions for a decade or so...

We clearly need to separate capital adequacy regulation from rating agencies that can be gamed in order to eliminate regulatory arbitrage...

But how do we impose capital requirements? Do we require that everybody unwind the derivatives in their portfolios and express them in a stocks-and-bonds-and-currencies basis, and then require monthly capital adequacy checks limiting their functional leverage to less than ten-to-one? I don't understand these issues well enough to have an informed view. And I don't see how I could implement a proper capital adequacy framework even if I were suddenly made head of bank regulation at the Federal Reserve...

And what, in the short run, is to be done with the crisis?

I am swinging around to (a) massive fiscal stimulus, plus (b) profit-making financial intervention: assign Fannie Mae and Freddie Mac to borrow from the Treasury and buy up mortgages at market prices until they have pushed the risky interest rate down to something reasonable. It's time for monetary policy to take on the role not just of managing the risk-free interest rate but managing the risky rate as well.

There is a big question here: is this possible? We know that the Federal Reserve can manage the riskfree rate without breaking a sweat. But I have Ricardian-equivalence worries about whether large scale government financial operations can actually move risky interest rates very far...

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TPMCafe | Talking Points Memo | Japan's Fifteen-Year Long Crisis: Paul Krugman writes:

My first answer is that the 1998 crisis was not, in fact, resolved all that easily. Bear in mind that there were really two crises: the high-speed capital-flight crises of Southeast Asia and the prolonged Japanese slump. The capital-flight crisis did subside quickly -- although even there it left permanent damage (Indonesia, with a bigger population than all the other crisis countries combined, has never recovered to its old growth track.) But Japan's woes went on and on. And Japan was the clearest omen for the United States...

Touche...

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TPMCafe | Talking Points Memo | Dean Baker Talks to His Inner Hayek: Dean Baker wrote:

Several Bush administration officials have suggested reducing mortgage interest rates to 4.0 percent, or possibly lower, with the intention of boosting the housing market. While there are markets in which it would be reasonable for the government to intervene to prevent a downward spiral of house prices, it is difficult to see anything good that would come from delaying a full adjustment in the markets that have still yet to fully deflate.

If extraordinarily low mortgage rates can succeed in preventing prices from falling back to trend levels, then house prices in these markets will presumably plummet when the economy recovers and mortgage interest rates return to more normal levels...

I disagree.

The mortgage interest rate is made up of four things. Compensation for inflation--call it 2% per year. Real time preference--the fact that because we will be richer in the future we value future goods at less than par in terms of present ones--call it 2% per year. The default discount--which in a well-run housing market should be small. And the risk discount--the extra return mortgage lenders demand because they are not sure when their payments are going to come exactly or what they will be worth exactly when they do come--and I am under the spell of Richard Thaler and Matt Rabin who argue that this discount should also be very small.

Thus I think that 4.0% per year is what mortgage interest rates ought to be. There is no higher "normal" that they ought to return to. The fact that they are not at 4.0% on average is a sign of a significant market failure--a failure to appropriately mobilize the collective risk-bearing capacity of the y.

But a 4% mortgage rate would push up housing prices. Wouldn't that tend to make housing less affordable? No--because it would also push down the mortgage payment you would have to make to carry a mortgage of a given principal amount. And the two effects should offset each other.

So I say: unleash Fannie Mae and Freddie Mac. Let them borrow at the Treasury rate and buy and buy up mortgages until the mortgage rate is down to inflation plus 2% per year. That seems to me to be a good use of public money--and in all likelihood a profitable one.

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TPMCafe | Talking Points Memo | 1998 and 2008: What's Different?: Let me ask Paul two related questions:

Paul, you wrote the first version book a decade ago, back when you were worried that the East Asian financial crisis of 1997-8 was a dying canary in a coal mine, a reflection not of faults in the Asian model but rather a sign that the old business cycle malady that we thought was controlled by monetarist eurythromycin was gaining immunity. But the East Asian financial crisis of 1997-1998--although sharp--was quickly cured (i) once the International Monetary Fund realized that the crisis was not one to be cured by administering painful medicine to governments, (ii) once the U.S. Treasury was freed from the fetters that Alfonse D'Amato and Bob Dole had imposed on it, (iii) once the IMF and the U.S. Treasury understood that their role was that of a lender-of-last-resort, and (iv) once Bob Rubin had bailed the big New York banks into Korea. The old monetarist eurythromycin seemed to work pretty well.

So, first, why did you back in 1998 think that the business cycle malady had developed some immunity?

And, second, why now does it seem as though the business cycle malady has developed some immunity?

On Not Making the Same Mistakes We Made in the Great Depression

J. Bradford DeLong (2008), "On Not Making the Same Mistakes We Made in the Great Depression," OKB Roundtable, December 11-12 2008.

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Publish at Scribd or explore others:

Jesse Jones, Head of the Reconstruction Finance Corporation

My brother just gave me a present:

Jesse H. Jones with Edward Angley (1951), Fifty Billion Dollars: My Thirteen Years with the RFC (1932-1945) (New York: Macmillan).

Analyze Like It's 1939

You know, if you thawed out a bunch of macroeconomists who had been cryogenicslly frozen since 1939--they would be cutting edge. Where does Paul Krugman say he kept falling further and further behind the cutting edge until one day he woke up and learned that all along he had been doing state-of-the-art behavioral game theory?

Bruce Bartlett Asks: "What Would Keynes Do?"

Some time ago Ezra Klein asked why we economist types were so happy--well, why all we economist types except those of us with offices on the same hall who will miss her company and must teach her and her husband's courses in the spring--at Barack Obama's decision to choose Great Depression and monetary history expert Christie Romer to chair the President's Council of Economic Advisers:

Ezra Klein: [C]an this really be so useful? It's hard to believe that a complex financial crisis in 2008 is so similar to a complex economic crisis in 1929 that you need an incredibly subtle understanding of the latter to effectively apprehend the former. Presumably most economists know enough not to repeat the basic mistakes of the 1930s, and the question is which economists know enough to avoid the possible mistakes of the 2000s. Is there any real reason to assume otherwise?

The problem is that economic theory is not rocket science. It is not like theoretical physics--conducting a relatively few crucial experiments to decide on basic theories and then working out the consequences of those theories from first principles. Economic theory is, instead, crystalized history. We take a bunch of historical episodes that seem relevant to the problems of interest of today. We boil down what seem to be their salient features. And then from the resulting soup and bones we construct simple stylized models that we think help us understand present and future episodes that fall into the same class.

The problem is that right now we have a financial crisis big enough and strange enough that there is only one past historical episode in the same class: the early stages of the Great Depression. And when there is only one, the value of skill at deriving theoretical lessons from the class is at a steep discount and the value of knowing the history is at a premium: better to take the history raw.

Which is why we (OK, them) are cheering the appointment of Christie Romer, reading copies of John Maynard Keynes, Collected Works vol. XXI: Activities 1931-1939: World Crises and Policies 1931-1939, and casting ourselves back into the Great Depression and asking: "What would John Maynard Keynes do?"

And with that let me turn the mike over to Bruce Bartlett at Forbes:

What Would Keynes Do?: Every day that goes by makes clearer the parallels between the current financial crisis and the one that led to the Great Depression. Then, as now, the core problem was... falling prices... fixing it will require more than just low interest rates. This was the key insight of British economist John Maynard Keynes....

The decline in wealth also reduced spending, and the fall in prices had the effect of magnifying debts.... Both Hoover and Roosevelt tried to stanch the bleeding by buying up bad assets through the Reconstruction Finance Corporation, just as the Treasury is doing today through the Troubled Asset Relief Program. But it was just as unsuccessful as the current Treasury effort....

[M]arket rates cannot fall enough to compensate because no one is going to lend money at a negative nominal rate; they will just hold on to it. When this happens, we have what economists call a liquidity trap, and the Fed cannot inject liquidity into the economy to stop the deflation.... [T]he Fed is unable create liquidity by buying Treasuries with new money. It ends up being an exchange of similar assets with no economic effect. What's the difference between a dollar bill and a Treasury bill with a barely positive interest rate (as is the case today)?...

Unlike in the 1930s, the Fed is not allowing the money supply to diminish. Also, we have programs like federal deposit insurance to prevent bank deposits from shrinking. But velocity is collapsing.... The nation is fortunate to have Ben Bernanke as chairman of the Federal Reserve Board. As an academic economist, he studied the Great Depression in great depth. He also has a keen grasp of the problem of deflation....

What Keynes figured out is that when conditions such as these exist, the federal government must step in to raise spending in the economy and thereby increase velocity. This means running a budget deficit, but that is only part of the solution.... Keynes argued that the only thing that will really work is if the federal government uses its resources to purchase goods and services. It must buy "stuff"--concrete, computers, paper, glass, steel--anything as long as it is tangible. In other words, the government must spend the way households do, by buying things. It must also employ labor, because much of what people spend money on today is in the form of services....

At this point, Federal Reserve policy will become effective again. As prices and interest rates rise, the liquidity trap disappears and money begins circulating more rapidly; i.e., velocity increases. This is what ends an economic crisis. Unfortunately, it was not until World War II that the federal government spent enough on real resources--because they were needed for the war effort--to make Keynes' theory work in practice.

The challenge for Congress and the Obama administration will be to devise a spending program that draws a significant amount of real resources out of the economy fast enough....

For what it's worth, Keynes didn't know what to do in this situation, either. He suggested building pyramids and burying bank notes in deep mine shafts that had been filled in. As people tried to dig up the money, they would be forced to employ labor and purchase equipment that would raise spending and thereby growth. In the end, it took the greatest war in history to make Keynes' theory work.

Hopefully we won't need another world war to get us out of the fix we're in today. Fortunately, we are in the early stages of a crisis, and downward momentum has not yet set in....

[T]here is a limit to what the Fed can do by itself. At some point, government spending must be the engine that pulls the economy out of recession.... But it must be the right kind of spending. It must draw real resources out of the economy--that is the only kind of spending that will work. Buying bad mortgages and sending out more rebate checks won't do any good.

John Maynard Keynes’s Private Letter to Franklin Delano Roosevelt of February 1, 1938

In which Keynes begs Roosevelt to undertake some real stimulative Keynesian policies--rather than merely the macroeconomic weak toast that was the New Deal:

John Maynard Keynes’s Private Letter to Franklin Delano Roosevelt of February 1, 1938

Also: Keynes urges Roosevelt to stop the deck chair-rearranging that was poorly thought-out structural reform--NIRA, PUHCA, anti-business rhetoric, et cetera.

Paul Krugman Sets the Bar Far too Low...

...when he says that Keynes's greatness is illustrated by the fact that he understood things that George F. Will does not. A six year old child could write more intelligent columns about economics than George F. Will. The fact that Fred Hiatt has not yet fired George F. Will and replaced him with a six year old child is yet another piece of the wreckage of the crashed-and-burned Washington Post detritus scattered around the landscape.

Paul:

The greatness of Keynes...: ...is illustrated by the trouble people who consider themselves well informed have, to this day, in understanding the basic principles of how a depressed economy works. The key to Keynes’s contribution was his realization that liquidity preference — the desire of individuals to hold liquid monetary assets — can lead to situations in which effective demand isn’t enough to employ all the economy’s resources. When you don’t understand that principle, you end up writing stuff like this [from George F. Will]:

Obama’s “rescue plan for the middle class” includes a tax credit for businesses “for each new employee they hire” in America over the next two years. The assumption is that businesses will create jobs that would not have been created without the subsidy. If so, the subsidy will suffuse the economy with inefficiencies — labor costs not justified by value added.

That is, if the private sector wouldn’t have created a job on its own, that job shouldn’t have been created... [never mind that] the real choice is between having workers doing something and being uselessly, destructively unemployed....

Why do people still fail to get Keynes, after all these years? Keynes might have said that it’s the inherent difficulty of the concepts: "For—though no one will believe it—economics is a technical and difficult subject." But there’s also the Upton Sinclair theorem:

It is difficult to get a man to understand something, when his salary depends upon his not understanding it.

But George F. Will's salary doesn't depend on his not understanding that we are now for the first time since 1982 faced with the prospect of a depression, or upon his not understanding that if Amity Shlaes disagrees with Ben Bernanke on the Great Depression one would be well-advised to bet on Ben Bernanke.

Why oh why can't we have a better press corps?

The Monetary History of the United States

Paul Krugman notes that we now have an ongoing test of Keynes-Bernanke vs. Friedman-Schwartz accounts of the Great Depression:

Paul Krugman: Has anyone else noticed that the current crisis sheds light on one of the great controversies of economic history? A central theme of Keynes’s General Theory was the impotence of monetary policy in depression-type conditions. But Milton Friedman and Anna Schwartz, in their magisterial monetary history of the United States, claimed that the Fed could have prevented the Great Depression — a claim that in later, popular writings, including those of Friedman himself, was transmuted into the claim that the Fed caused the Depression.

Now, what the Fed really controlled was the monetary base — currency plus bank reserves. As the figure shows, the base actually rose during the great slump, which is why it’s hard to make the case that the Fed caused the Depression. But arguably the Depression could have been prevented if the Fed had done more — if it had expanded the monetary base faster and done more to rescue banks in trouble. So here we are, facing a new crisis reminiscent of the 1930s. And this time the Fed has been spectacularly aggressive about expanding the monetary base: And guess what — it doesn’t seem to be workiing.

I think the thesis of the Monetary History has just taken a hit.