Brad DeLong

Nick Crafts: George Osborne Badly Needs to Study the Macroeconomic Leadership Secrets of Neville Chamberlain…

Nick Crafts:

Escaping liquidity traps: Lessons from the UK’s 1930s escape: The UK escaped a liquidity trap in the 1930s and enjoyed a strong economic recovery. This column argues that what drove this recovery was ‘unconventional’ monetary policy implemented not by the Bank of England but by the Treasury. Thus, Neville Chamberlain was an early proponent of ‘Abenomics’. This raises the question: is inflation targeting by an independent central bank appropriate at a time of very low nominal-interest rates?

My John Maynard Keynes Lecture

Little more than quotes from Skidelsky's three-volume Keynes biography strung together, with a little commentary and occasional quibbling…

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John Maynard Keynes

J. Bradford DeLong Professor of Economics, U.C. Berkeley

Econ 115 Lecture

September 29, 2009

http://delong.typepad.com/files/20090929-115-lecture-9.pdf

5,562 words: September 29, 2009

"This Is a Nightmare"

John Maynard Keynes:

The Great Slump of 1930: This is a nightmare, which will pass away with the morning. For the resources of nature and men's devices are just as fertile and productive as they were. The rate of our progress towards solving the material problems of life is not less rapid. We are as capable as before of affording for everyone a high standard of life… and will soon learn to afford a standard higher still. We were not previously deceived.

But to-day we have involved ourselves in a colossal muddle, having blundered in the control of a delicate machine, the working of which we do not understand. The result is that our possibilities of wealth may run to waste for a time — perhaps for a long time…

The Hoover Administration Was "Liquidationist"; Hoover Himself Was Merely Anti-Keynesian

It is very important to note that Herbert Hoover in his Memoirs is an unreliable narrator, magnifying his differences with those upon whom he seeks to cast blame--not only their fair share of blame but his share as well--for the disaster of the Great Depression.

LK:

Social Democracy for the 21st Century: A Post Keynesian Perspective: Herbert Hoover Rejected Keynesianism: And he tells us explicitly that he did so in a speech in October 1936, when describing his time as president, recently cited by Daniel Kuehn in a really excellent post here. I cite the full quotation below:

During my four years powerful groups thundered at the White House with these same ideas [i.e., the ideas of Roosevelt’s New Deal – LK]. Some were honest, some promising votes, most of them threatening reprisals, and all of them yelling ‘reactionary’ at us.

Did Stan Lebergott Implicitly Compare U.S. WPA Workers with Nazi German Labor Camp Inmates?

Sure looks like it…

Wow!

Eric Rauchway:

Louis Menand and New Deal Denialism in The New Yorker — Crooked Timber: Tyler, if you’d follow the link, you’d see, or possibly remember, that it’s Darby with whom I agree. It’s Lebergott to whose usage I object. I’ll quote him again here:

These estimates for the years prior to 1940 are intended to measure the number of persons who are totally unemployed, having no work at all. For the 1930′s this concept, however, does include one large group of persons who had both work and income from work—those on emergency work. In the United States we are concerned with measuring lack of regular work and do not minimize the total by excluding persons with made work or emergency jobs. This contrasts sharply, for example, with the German practice during the 1930′s when persons in the labor-force camps were classed as employed, and Soviet practice which includes employment in labor camps, if it includes it at all, as employment.

Paul Krugman: The Intellectual Triumph of Old Keynesianism

Paul Krugman--The Intellectual Triumph of Old Keynesianism

Preview of Joshua Hausman's Economics Job Market Paper, Courtesy of Miles Kimball: Effective Expansionary Fiscal Policy in the Great Depression

Joshua Hausman on Historical Evidence for What Federal Lines of Credit Would Do:

Perhaps the best historical analogies to Miles’s Federal Lines of Credit Proposal are 1931 and 1936 policy changes that gave World War I veterans early access to a promised 1945 bonus payment. In 1924, Congress passed a bill promising veterans large payments in 1945.

When the depression came, veterans’ groups lobbied congress for immediate payment. Congress partially acquiesced in 1931, giving veterans the ability to borrow up to 50 percent of the value of their promised bonus beginning on February 27. (Prior to this, veterans could take loans of roughly 22.5 percent of their bonus.) For the typical veteran, this meant being able to borrow about $500. For comparison, in 1931 per capita personal income was $517. The loans carried an interest rate of 4.5 percent, but interest did not have to be paid annually. Rather, the amount of the loan plus interest would be deducted from what was due the veteran in 1945. In fact, the interest rate was lowered to 3.5 percent in 1932, and then forgiven entirely in 1936. But there is no reason to think that this was expected at the time.

Despite their ability to take loans, veterans continued to demand immediate cash payment of the entire, non-discounted, value of their bonus. Tens of thousands of veterans camped in Washington, DC from May to July 1932 to lobby for immediate payment. Finally, in 1936, congress granted their wish, giving veterans the choice of taking their bonus in cash or leaving it with the government where it would earn 3 percent interest until 1945.

Department of "Huh!?!?": Knut Wicksell Rules OK! Edition

In the neo-Wicksellian framework that Krugman likes to use when the economy is at its zero nominal interest rate bound, the central immediate problem with the economy is that because private households want to deleverage--planned saving at full employment is high--and because private businesses do not want to leverage--planned investment at full employment is low--planned spending is less than expected income and the economy spirals downward.

So why in the Holy Name of the One Who Is does Steven Keen write:

The Crisis in 1000 words—or less: Rising aggregate private debt adds to demand, and falling debt subtracts from it. This point is vehemently denied on conventional theoretical grounds by economists like Paul Krugman…

?

The neo-Wicksellian framework is not a denial that times of falling debt are times of depression. The neo-Wicksellian framework is an explanation of why times of falling debt are times of depression.

"Explanation" ≠ "denial"…

David Glasner: Hawtrey, Cassel, Hayek and the Great Depression

David Glasner:

Keynes v. Hayek: Enough Already: Ralph Hawtrey and Gustav Cassel had explained what was happening ten years before the downturn started in the summer of 1929. Both… understood that restoring the gold standard after the demonetization of gold that took place during World War I would have hugely deflationary implications if, when the gold standard was reinstated, the world’s monetary demand for gold would increase back to the pre-World War I level…. That is why both… called for measures to limit the world’s monetary demand for gold (measures agreed upon in the international monetary conference in Genoa in 1922 of which Hawtrey was the guiding spirit). The measures agreed upon at the Genoa Conference prevented the monetary demand for gold from increasing faster than the stock of gold was increasing so that the world price level in terms of gold was roughly stable from about 1922 through 1928.

But in 1928, French demand for gold started to increase rapidly just as the Federal Reserve started to tighten monetary policy in a tragically misguided effort to squelch a supposed stock-price bubble on Wall Street, causing an inflow of gold into the US while the French embarked on a frenzied drive to add to their gold holdings and other countries rejoining the gold standard were increasing their gold holdings as well, though with a less fanatical determination than the French. The Great Depression was therefore entirely the product of monetary causes, a world-wide increase in gold demand causing its value to increase, an increase manifesting itself, under the gold standard, in deflation.

Hayek, along with his mentor Ludwig von Mises, could claim to have predicted the 1929 downturn as well, having criticized the Fed in 1927 for reducing interest rates to 3.5%, by historical standards far from a dangerously expansionary rate…. But it has never been even remotely plausible that a 3.5% discount rate at the Fed for a little over a year was the trigger for the worst economic catastrophe since the Black Death of the 14th century. Nor could Keynes offer a persuasive explanation for why the world suddenly went into a catastrophic downward spiral in late 1929. References to animal spirits and the inherent instability of entrepreneurial expectations are all well and good, but they provide not so much an explanation of the downturn as a way of talking about it or describing it. Beyond that, the Hawtrey-Cassel account of the Great Depression also accounts for the relative severity of the Depression and for the sequence of recovery in different countries, there being an almost exact correlation between the severity of the Depression in a country and the existence and duration of the gold standard in the country. In no country did recovery start until after the gold standard was abandoned, and in no country was there a substantial lag between leaving the gold standard and the start of the recovery.

So not only did Hawtrey and Cassel predict the Great Depression, specifying in advance the conditions that would, and did, bring it about, they identified the unerring prescription – something provided by no other explanation — for a country to start recovering from the Great Depression.

Hayek, on the other hand, along with von Mises, not only advocated precisely the wrong policy, namely, tightening money, in effect increasing the monetary demand for gold, he accepted, if not welcomed, deflation as the necessary price for maintaining the gold standard…. Faced with a conflict between maintaining the gold standard and following his own criterion for neutral money, Hayek along with his friend and colleague Lionel Robbins, in his patently Austrian book The Great Depression, both opted for maintaining the gold standard.)

Not only did Hayek make the wrong call about the gold standard, he actually defended the insane French policy of gold accumulation in his lament for the gold standard after Britain wisely disregarded his advice and left the gold standard in 1931. In his paper “The Fate of the Gold Standard” (originally Das Schicksal der Goldwahrung) reprinted in The Collected Works of F. A. Hayek: Good Money, Part 1, Hayek offered a lament for impending demise of the gold standard after Britain tardily did the right thing. The tone of Hayek’s lament is struck in his opening paragraph (p. 153).

There has been much talk about the breakdown of the gold standard, particularly in Britain where, to the astonishment of every foreign observer, the abandonment of the gold standard was very widely welcomed as a release from an irksome constraint. However, it can scarcely be doubted that the renewed monetary problems of almost the whole world have nothing to do with the tendencies inherent in the gold standard, but on the contrary stem from the persistent and continuous attempts from many sides over a number of years to prevent the gold standard from functioning whenever it began to reveal tendencies which were not desired by the country in question. Hence it was by no means the economically strong countries such as America and France whose measures rendered the gold standard inoperative, as is frequently assumed, but the countries in a relatively weak position, at the head of which was Britain, who eventually paid for their transgression of the “rules of the game” by the breakdown of their gold standard…

I have only three relatively minor quibbles with what Glasner has to say:

1. He seems to want to have it both ways. He says both (a) the decision to return to the gold standard with an inadequate gold cover caused the Depression, and (b) French and American refusals to actually use their (gold) reserves for their proper purpose (shades of the ECB today) caused the Depression. It's hard to make both arguments at once. If the Bank of France and the Federal Reserve acting in a non-insane way could have prevented the Great Depression, you can't say that the gold cover was inadequate. If you say the gold cover was inadequate, then it is hard to see how Bank of France and Federal Reserve spending their gold could have rescued the situation.

2. The experience of the past four years leads me to think that perhaps Glasner should rethink elements of his position. The Federal Reserve and the ECB and the Bank of England have flooded the North Atlantic economy with liquidity over the past four years. Yet it has not been enough to produce a healthy recovery. Cassel and Hawtrey took it for granted that enough monetary ease--buying enough short-term bonds for gold or other forms of rock-solid cash--would do the job. But today it looks as though balance-sheet depressions are more stubborn beasts, that simple liquidity-provision by the government is not enough, and that proper handling may require banking and fiscal policy to provide the market with duration and safety as well.

3. Related to (2), I think that Cassel and Hawtrey are not enough. I think that their exclusive focus on monetary liquidity misses large aspects of the picture. You need to think along Bagehot-Minsky-Kindleberger lines about safety and risk and along Wicksellian lines about the savings-investment balance as well. And, historically, the traditional road from the quantity theory of money to those concerns has been the Keynes-Hicks-Tobin road.

Econ 1: U.C. Berkeley: Spring 2012: Why We Read Milton Friedman and Rose Director Friedman, "Free to Choose"

My Obituary for Milton Friedman:

"Lord, enlighten thou our enemies," prayed nineteenth-century British economist and moral philosopher John Stuart Mill in his "Essay on Coleridge" http://olldownload.libertyfund.org/Texts/MillJS0172/Works/Vol10/PDFs/Mill_1277.pdf. "Sharpen their wits, give acuteness to their perceptions, and consecutiveness and clearness to their reasoning powers: we are in danger from their folly, not from their wisdom; their weakness is what fills us with apprehension, not their strength."

For every left-of-center American economist in the second half of the twentieth century, Milton Friedman (1912-2006) was the incarnate answer to John Stuart Mill's prayer. His wits were smart, his perceptions acute, his arguments strong, his reasoning powers clear, coherent, and terrifyingly quick. You tangled with him at your peril. And you left not necessarily convinced, but well aware of the weak points in your own argument.

General William Westmoreland, testifying before President Nixon's Commission on an All-Volunteer [Military] Force, denounced the idea, saying that he did not want to command an army of mercenaries. Milton Friedman interrupted him:

General, would you rather command an army of slaves?

Westmoreland got angry:

I don't like to hear our patriotic draftees referred to as slaves.

And Friedman got rolling:

I don't like to hear our patriotic volunteers referred to as mercenaries. If they are mercenaries, then I, sir, am a mercenary professor, and you, sir, are a mercenary general.

And he did not stop:

We are served by mercenary physicians, we use a mercenary lawyer, and we get our meat from a mercenary butcher http://www.davidrhenderson.com/articles/0199_thankyou.html.

As George Shultz likes to say:

Everybody loves to argue with Milton, particularly when he isn't there.

Thinking as hard as he could until he got to the root of the issues was his most powerful skill. "Even at 94," Chicago economist and Freakonomics http://www.amazon.com/exec/obidos/ASIN/006073132x/ author Steve Levitt wrote on his website yesterday, "he would teach me something about economics whenever we talked" http://www.freakonomics.com/blog/2006/11/16/sad-news-milton-friedman-has-died/. In this morning's New York Times http://www.nytimes.com/2006/11/17/business/17milton.html, Chicago economist Austen Goolsbee quotes from Milton Friedman's Nobel autobiography:

Friedman said that when he arrived [at the University of Chicago] in the 1930s, he encountered a "vibrant intellectual atmosphere of a kind that I had never dreamed existed."

"I have never recovered."

His world-view began with a bedrock faith in people, in their ability to make judgments for themselves, and thus an imperative to maximize individual freedom. On top of that was layered a deep faith and conviction that free markets were almost always the best and most magical way of coordinating every conceivable task. On top of that was layered a powerful conviction that a look at the empirical facts--a marking-to-market of your beliefs to reality--would generate the right conclusions. And on top of that was layered a fear and suspicion of government as an easily-captured tool for the enrichment of cynical and selfish interests that sought to grab whatever they could. Suffusing all was a faith in the power of argument and the utility of reason. He was an optimist: people could be taught the truths of economics, and if they were properly taught then institutions could be built to protect all against the corruption and overreach of the government.

And he did fear the government. He hated government's and society's sticking their nose into people's private business. And he interpreted "people's private business" extremely widely. He hated the War on Drugs, which he saw as a cruel and destructive breeder of crime and violence. He scorned government licensing of professions--especially doctors, who heard over and over again about how their incomes were boosted by restrictions on the number of doctors that made Americans sicker. He feared deficit spending: cynical politicians could pretend that the costs of government were less than they were by pushing the raising of taxes to pay for spending off into the future. He sought to innoculate citizens against such political games of three-card-monte: "Remember," he would say, "to spend is to tax."

This did not mean that government had no role to play. Enforcement of property rights, adjudication of contract disputes--the standard powerful rule-of-law underpinnings of the market--plus a host of other government interventions when empirical circumstances made them appropriate: Mayor Ken Livingstone's congestion tax on cars in central London is Milton Friedman's. Friedman's negative income tax is one of the parents of what is now America's largest anti-poverty program: the Earned Income Tax Credit. And, most important, government had a very powerful and necessary role to play in keeping the monetary system working smoothly through proper control of the money stock. If there was always sufficient liquidity in the economy--enough but not too much--then you could trust the market system to do its job. If not, you got the Great Depression, or hyperinflation.

In his belief that the government was required to undertake relatively narrow but crucially important strategic interventions in order to stabilize the macroeconomy--keep production, employment, and prices on an even keel--Milton Friedman was in the same chapter if not on the same page as John Maynard Keynes, the economic giant of the previous generation whose doctrines and influence Friedman worked tirelessly to supplant and minimize. The Great Depression had convinced Keynes that central bankers alone could not rescue and stabilize the market economy. In Keynes's view, stronger and more drastic strategic interventions were needed to boost or curb demand directly.

Friedman and his coauthor Anna J. Schwartz argued in their Monetary History of the United States that this was a misreading of the lessons of the Great Depression, which in Friedman's view was caused by monetary mismanagement--or perhaps could have been rapidly alleviated by skillful monetary management--alone.

Over the course of forty years, Friedman's position carried the day. Federal Reserve Chair Ben Bernanke right now holds Milton Friedman's view, not John Maynard Keynes's, of what kind of strategic interventions in the economy are necessary to provide for maximum production, employment, and purchasing power, and stable prices.

Milton Friedman's thought is, I believe, best seen as the fusion of two strongly American currents: libertarianism and pragmatism. Friedman was a pragmatic libertarian. He believed that--as an empirical matter--giving individuals freedom and letting them coordinate their actions by buying and selling on markets would produce the best results. It was not that he thought this was natural law--that markets always worked best. It was, rather, that he believed that places where markets failed were atypical; that where markets did fail there were almost always enormous profit opportunities from entrepreneurial redesign of institutions; that the market system would create now opportunities for trade that would route around market failures; and that government failure was pervasive--that any expansion of government beyond the classical liberal state would be highly likely to cause more trouble than it could solve.

For right-of-center American libertarian economists, Milton Friedman was a powerful leader. For left-of-center American liberal economists, Milton Friedman was an enlightened adversary. We are all the stronger for his work. We will miss him.

It's Maynard Keynes's World...

Paul Krugman:

Keynesophobia:

1. There has been no crowding out; interest rates outside the euro area have remained low despite massive government borrowing, which is what you’d expect in a liquidity trap.

2. Inflation has been quiescent despite huge increases in the monetary base, again what you’d expect in a liquidity trap.

3. Fiscal austerity has deepened the economic downturn everywhere it has been put in place.

Were these predictions different from what non-Keynesians were saying? And how. Go back to Niall Ferguson, or Brian Riedl, etc., and you’ll find confident assertions that all that government borrowing would send interest rates soaring. Go back to the likes of Allan Meltzer or the Austrians, and you’ll find confident predictions that all that money printing would cause an explosion of inflation. And just about everyone on the right bought into some version of the doctrine of expansionary austerity.

But, but, the Obama stimulus didn’t bring unemployment way down! Indeed — and those of us who took our Keynes seriously warned of just that.

So what the anti-Keynesians are left with are the sovereign debt troubles in the euro area. But as many of us have tried to explain, these are really balance of payments crises exacerbated by the refusal of the ECB to act as lender of last resort.

And bear this in mind: no country has driven itself into a debt crisis with stimulus — nor has any country with significant debt regained investor confidence through austerity.

Look, I know that many people can’t bring themselves to even consider the possibility that Keynes was right — or, for that matter, that I personally might have gotten anything right. But reality has been really clear here.

http://krugman.blogs.nytimes.com/2011/12/19/keynesophobia/?pagewanted=all#

The truly puzzling questions are: Why is the world right now so "Keynesian"? And what might make it stop being so Keynesian?

A "Keynesian" world is a world in which three things are true:

1. Spending is held down not because of a shortage of liquidity but because people's portfolios don't have enough or the right kind of savings vehicles to make them happy.

2. Investors are eager to hold the nominal liabilities of governments that can print money at will and so turn those liabilities into cash with certainty--never mind any long-term political-economic inconsistency between spending plans and tax rates.

3. Private-sector leverage is sufficiently high that adjustments to reduced spending via lowering the path of the price level are perverse--that they create enough bankruptcies and moral-hazard credit-channel problems that they such adjustments push the pace of production not up but down.

That these things are true right now seems to me to be indisputable. I think I understand why (1) and (3) are true. But I don't think I have a good understanding of why (2) is true. The Princes of Canary Wharf and Midtown I talk to say that at this conjuncture they think that if they take on risk and then have a bad year that they are then out of the game--lose their existing clients whose money they manage and cannot attract new ones. Thus, they say, their only option is to hunker down and try to hold as low risk a portfolio as possible so that they will still be in the game when the return to normalcy comes about.

I then say: I understand that in that case you would like to be holding cash. But why the #$$&*@^! would you be eager to hold 30-Year U.S. Treasuries at a nominal yield of 2.79%/year? 30-Year TIPS at a real yield of 0.68%/year? Houses in Elmwood are selling at a price-annual rental ratio of 12, for Jeebus' sake! The earnings yield on the S&P Composite is 6%/year. Those are extraordinary return gaps in expected returns. Why not sell some of your long-duration U.S. Treasury and Agency assets and try to take advantage of them?

And the answer to that is: we will, but we won't start selling our long-duration Treasury and Agency assets until the market turns and Treasury bonds start to fall in price.

And I say: What if you are not first? At the moment, you are earning 2%/year on your 10-Year Treasuries relative to zero on your cash, but if the 10-Year interest rate normalized to its 2007 level tonight you would have lost 23% of your principal... by dawn

"The Fault, Dear Brutus, Lies Not in the Stars But in Ourselves…" Inadequate Fiscal, Monetary, and Banking Policy Response to the Lesser Depression

Mark Thoma sends us to Christy Romer:

A Financial Crisis Needn’t Be a Noose: RECESSIONS after financial crises are long and severe, and the subsequent recoveries are protracted…. But while there are strong patterns in the authors’ mountains of data, this simple summary misses an important fact: There’s dramatic variation in the aftermaths of crises, and much of it is caused by how policy makers respond….

Reinhart-Rogoff… emphasizes common patterns across crises…. [T]he averages are stunning. For 14 major crises since 1929, the associated decline in real per capita gross domestic product averaged 9.3 percent….

But… Norway had only a slight decline in per capita G.D.P. — around 1 percent — after its 1987 crisis…. The Depression… G.D.P. fell nearly 30 percent in the United States, and didn’t return to its pre-crisis level for a decade. But in Spain, it fell only 9 percent in the Depression as a whole, and actually rose in the year after its 1931 banking crisis….

What explains the variations?… [C]rises that happen along with currency crises tend to be followed by much more severe recessions…. [B]ig declines in house and stock prices… have damaging effects on their own…. BUT an even larger determining factor is the policy response. Why was the Great Depression so much worse here than in Spain?… Spain benefited from not being on the gold standard. Its central bank was able to lend freely and increase the money supply after the panic. By contrast, in 1931 the Federal Reserve in the United States raised interest rates to defend its gold reserves and stay on the gold standard…. [P]olicy response largely explains why output fell after the American banking panics in 1930 and 1931, but rose after the final wave in early 1933. After the first waves, the Fed did little, and President Herbert Hoover signed a big tax increase to replenish revenue. After the final wave, President Franklin D. Roosevelt abandoned the gold standard, increased the money supply and began a program of New Deal spending….

The Reinhart-Rogoff study points out that policy makers’ ability to take strong fiscal action depends on whether they start with high levels of debt. In the current episode, China and South Korea have recovered faster, partly because they have taken more aggressive fiscal stimulus measures. They could do that because they entered the crisis in good fiscal health…. After its banking panic in 1991, Sweden aggressively restored its banks to health. They were nationalized, recapitalized with public funds, and then returned to private control. After three rough years, Sweden grew rapidly, soon returning to its pre-crisis trend. Japan, by contrast, put off cleaning up its banks after its 1992 crisis….

[W]here does this… leave us?… [P]olicy makers need to make the financial system less prone to crises, and to fight panics aggressively when they arise…. A country as creditworthy as the United States can continue to use fiscal stimulus to help return the economy to full employment. And… there’s much more the Fed could be doing. Whether we continue to fester or finally embark on a robust recovery depends on whether we choose to use the tools available.

Finally, governments around the world, including our own, should remember that it helps to be in sound fiscal shape before a crisis hits…. Being careful in good times gives policy makers the ability to fight crises in bad ones.

A Stray Thought on Herbert Hoover: At Least He Was Trying

You know, for most of my life I have been viciously contemptuous of Herbert Hoover as president over 1929-1933. His major policy thrust was to cut spending and raise taxes in order to maintain and then restore confidence in the long-term fiscal stability of the U.S. government, and even a brief look at bond interest rates ought to have convinced him that that was exactly the wrong tack to take.

But even though that was the major thrust, he was doing other things to try to fight the gathering Great Depression--the Young Plan and the international debt moratorium to ease bond-market pressure on overleveraged sovereigns, the HOLC to deal with the mortgage crisis, the RTC to get capital to businesses that found that private finance's appetite for taking on risk had dried up. These were all, in the great scheme of things, merely rearranging the deck chairs on the Titanic.

But at least Hoover was moving the chairs around...

Quote of the Day: November 21, 2011

"This fall in [stock market] value[s] immediately afflicted only a few Americans. But so closely had the others watched the market and regarded it as an index of their fates that they suddenly stopped much of their economic activity."

--Eric Rauchway, The Great Depression and the New Deal

Neville Chamberlain as Superior to David Cameron (or Barack Obama): Macroeconomic Policy in a Depression Blogging

Nick Crafts:

Fiscal stimulus is not our only option: Economic historians describe the policy as one of “cheap money”. This entailed a commitment to raising prices back to the 1929 level, announced by the chancellor of the exchequer, Neville Chamberlain, at the British Empire Economic Conference in July 1932. It was underpinned by Treasury bill rates at 0.6 per cent and by an exchange rate target that locked in a 25 per cent devaluation compared with the gold standard parity that Britain had been forced to abandon in 1931. This target was enforced by intervention through the Exchange Equalisation Account.

The policy was credible because it was clearly in the Treasury’s interests and it, rather than the Bank of England, was in charge. People therefore expected prices to rise and monetary policy was able to offset the deflationary impact of fiscal retrenchment.

This worked through reducing real interest rates as the expected rate of inflation rose relative to nominal interest rates. Real interest rates were falling from 1932 to 1936, first as prices stopped falling and then as inflation picked up. One channel by which stimulus was transmitted to the real economy was private housebuilding, which increased from 63,000 per half year in September 1932 to 154,000 in March 1935. This was possible because of the absence of strict planning regulations.

The key lesson is that there is scope for monetary policy to stimulate the economy, even though nominal interest rates cannot be cut because they are already at zero. This means that there is an alternative to fiscal stimulus if the economy falls back into recession in 2012. Implementing a “cheap money policy” would, however, mean abandoning the current inflation targeting regime. Today’s equivalent of 1930s policy would imply formally adopting a price level target. The target could be to increase the price level by 15 per cent over four years and to convince the private sector that this will happen while interest rates are held down.

Although inflation has been high recently, the monetary policy committee stresses that it will soon return to and probably undershoot the 2 per cent target, implying that real interest rates remain higher than is desirable at present. The policy would not work if people thought that it would be reversed at the first sign of sustained recovery; the key to success in the 1930s was embedding the belief that prices would rise. The MPC would therefore need a new target that everyone expected to be achieved.

If we recognise that a price-level target worked in the 1930s, could it be equally successful today?

Circumstances may be less favourable now. Politicians would have to choose macroeconomic policy reform, whereas it was forced upon them in the 1930s. Consumers are burdened by debt and struggling to cope with falls in real disposable income, which is a notable contrast with the early 1930s. The eurozone crisis may deliver a bigger adverse shock than anything Britain faced after 1931. The output gap, whose magnitude is highly uncertain, may be much smaller than it was then, so that there is less scope for expansionary policies to raise real output. The chances of success would be greater if planning regulations were relaxed and we could once again envisage building 300,000 houses in a year, but that is politically too difficult...

Fiscal and Monetary Policy in a Liquidity Trap Now and Then

Paul Krugman:

Why Believe In Keynesian Models?: [W]hat evidence makes me believe that Keynesian economics is broadly right, given the relative absence of experience with large fiscal stimulus programs?...

First, we’re talking about a model.... So you can ask about the ancillary predictions of that model as opposed to rival models. Anti-Keynesians assured us that budget deficits would send interest rates soaring; Keynesian analysis said they’d stay low as long as the economy remained far from full employment. Guess who was right?... Keynesianism isn’t just about sticky prices, but it does generally assume sticky prices — and there is overwhelming evidence, from a variety of sources, that prices are indeed sticky. Also: there’s plenty of evidence that monetary policy can move output and employment — and it’s very hard to devise a model in which that is true that doesn’t also say that fiscal policy can be effective, especially when you’re up against the zero lower bound.

Second, while we don’t have a lot of postwar experience with fiscal stimulus, we do have a lot of experience with anti-stimulus, that is, austerity — and that turns out to be reliably contractionary. Again, it’s hard to think of a model in which austerity is contractionary but stimulus isn’t expansionary.

Finally, there is evidence from fiscal expansions in the 1930s, which actually did lead to economic expansion too.

Mainly I’d stress the first point. We have a model... an implication of that model is that fiscal stimulus will work under conditions like those we face now. If interest rates had soared, if the rise in base money had led to rising GDP and/or soaring prices despite the zero lower bound, I would have sat down to reconsider what I thought I knew about macroeconomics. In fact, however, my preferred model has passed the test of events with flying colors, while the other guys’ models have been totally wrong.

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Miguel Almunia, Augustin S. Bénétrix, Barry Eichengreen, Kevin H. O’Rourke, and Gisela Rua: 18 November 2009:

The effectiveness of fiscal and monetary stimulus: There is one important source of information on the effectiveness of monetary and fiscal stimulus in an environment of near-zero interest rates, dysfunctional banking systems and heightened risk aversion that has not been fully exploited: the 1930s.... [W]here fiscal policy was tried, it was effective.

The Keynesian argument for expansionary fiscal policy – whether right or wrong – was not known in this pre-Keynesian era. Hence there was relatively little variation in fiscal stance, with conservative policies being the default option. The aggressive use of discretionary monetary policy was also relatively unusual, as central banks were wedded to gold-standard ideology. But there were exceptions. Japan’s aggressive use of monetary policy under Takahashi was one, Italy’s large budget deficits under Mussolini another. And there were good – exogenous – reasons for this variation. Fiscal impulses were generally governed by forces other than immediate economic conditions; Italy’s war in present-day Ethiopia, Hitler’s rearmament, the approach of World War II. Who responded to the crisis with monetary stimulus depended heavily on prior monetary experience; counties that had suffered high inflation in the 1920s tended to be reluctant to abandon the gold standard in the 1930s.

Cross-country comparisons can thus help us untie the Gordian Knot and move the debate from the realm of ideology to that of evidence. Our project therefore focuses on assembling annual data on growth, budgets and central bank policy rates, mainly from League of Nations sources, for 27 countries covering the period 1925-39....

We use panel vector autoregressions (VARs) with conventional assumptions about the “ordering” of the variables (whether a variable affects the others contemporaneously or only with a lag). We consider alternative orderings, and also run panel VARs with defence expenditure entering the equations as an exogenous variable. We run panel instrumental variables regressions using defence spending as an instrument for fiscal policy and gold standard membership as an instrument for monetary policy. And we run alternative panel regressions looking at the impact of fiscal and monetary shocks, the latter calculated by running simple autoregressions and extracting the residuals.

The details of the results differ, but the overall conclusions do not. They show that where fiscal policy was tried, it was effective. Our estimates of its short-run effects are at the upper end of those estimated recently with modern data; the multiplier is as large as 2 in the first year, before declining significantly in subsequent years....

The results for monetary policy are less robust but point in the same direction. A positive shock to the central bank discount rate leads to a fall in GDP... [that] just misses statistical significance at conventional levels.... This result is notable, given the presumption, widespread in the literature, that monetary policy is ineffective in near-zero-interest-rate (liquidity trap) conditions. On the contrary, in the 1930s it appears that accommodating monetary policy helped, by transforming deflationary expectations (Temin and Wigmore 1990) and by helping to mend broken banking systems (Bernanke and James 1991). Given the prevalence of both problems circa 2008, we suspect that the results carry over...

"We Must Not Allow Anyone to Put Them Back in the Golden Cage Where THey Have Been Pining Their Hearts Out"

John Maynard Keynes.

Today, of course, the great and good of Europe appear to be working hard to produce a cage of euros…

Cross, cage, fetters… The gold standard is not a PG-rated monetary system, is it?

Franklin D. Roosevelt on Unemployment and Public Policy

Fred Clark sends us to:

Sept. 30, 1934, Fireside Chat, President Franklin D. Roosevelt: those who say that our expenditures for Public Works and other means for recovery are a waste that we cannot afford, I answer that no country, however rich, can afford the waste of its human resources. Demoralization caused by vast unemployment is our greatest extravagance. Morally, it is the greatest menace to our social order. Some people try to tell me that we must make up our minds that for the future we shall permanently have millions of unemployed just as other countries have had them for over a decade. What may be necessary for those countries is not my responsibility to determine. But as for this country, I stand or fall by my refusal to accept as a necessary condition of our future a permanent army of unemployed. On the contrary, we must make it a national principle that we will not tolerate a large army of unemployed and that we will arrange our national economy to end our present unemployment as soon as we can and then to take wise measures against its return. I do not want to think that it is the destiny of any American to remain permanently on relief rolls…

The New Deal Fixed 40% of the Great Depression in Four Years

Matthew Yglesias:

Another Depression Chart: Eric Rauchway sent me another chart that helps illustrate the issue of the puzzling Cole/Ohanian theory that there was no demand-driven recovery from the Great Depression, According to Cole and Ohanian, demand-driven changes in output can be distinguished from productivity-driven ones, because they’re manifested by changes in hours worked. On this chart, it becomes very difficult to miss the Depression-era collapse in the demand for workers, and recovery of demand during the mid-30s and during World War II. You also see that there was a long-term structural transition to more leisure, but that the line tends to squiggle around with the business cycle. But the Depression is no squiggle. It’s there plain as day, as is the recovery.

The Shift Toward More Leisure Between 1929 and 1952

Cole and Ohanian Say: "We Do Not Mention Our Main Point in the First Three Paragraphs of Our Op-Ed"

Cole and Ohanian say:

Cole and Ohanian Reply: Paul Krugman claims our economic history is in "incredibly bad faith" by showing that industrial output is positively correlated with the wholesale price index. The main point of our op-ed, as well as our earlier work, is that most of the increase in per-capita output that occurred after 1933 was due to higher productivity – not higher labor input…

The first three paragraphs of Cole and Ohanian:

HStimulus and the Depression—The Untold Story: About one-half of President Obama's proposed $447 billion American Jobs Act consists of payroll tax holidays designed to boost spending and increase hiring. But these temporary policies will do little to jump-start the economy, much as earlier temporary economic Band-Aids, such as the 2009 stimulus, did little to improve the economy.

Proponents justify stimulus spending in part based on the widely held view that government-fueled increases in "aggregate demand" during FDR's New Deal ended the Great Depression and brought recovery. Christina Romer, former chairwoman of Obama's Council of Economic Advisers, has argued in op-eds that government should continue to spend for this reason. And in a 2002 speech as a Federal Reserve governor, current Fed Chairman Ben Bernanke claimed that monetary expansion and the turnaround from the deflation of 1932 to inflation in 1934 was a key reason that output expanded.

But boosting aggregate demand did not end the Great Depression. After the initial stock market crash of 1929 and subsequent economic plunge, a recovery began in the summer of 1932, well before the New Deal. The Federal Reserve Board's Index of Industrial production rose nearly 50% between the Depression's trough of July 1932 and June 1933. This was a period of significant deflation. Inflation began after June 1933, following the demise of the gold standard. Despite higher aggregate demand, industrial production was roughly flat over the following year...

I defy anybody to read the first three paragraphs of Cole and Ohanian and not believe that Cole and Ohanian's "main point" is that the level of production is unrelated to aggregate demand--that Romer and Bernanke are wrong in claiming a link. We are told that production "rose nearly 50%… [in] a period of significant deflation". We are told that "despite higher aggregate demand, industrial production was roughly flat…"

If Cole and Ohanian want to delete the first three paragraphs from their op-ed, that would be good.

If they want to keep those three paragraphs, it seems to me that Glasner is correct:

Misrepresenting the Recovery from the Great Depression: Though not wrong in every detail, the version of events offered by Cole and Ohanian is still a shocking distortion of what happened before FDR took office in March 1933…. The misrepresentation perpetrated by Cole and Ohanian only gets worse when they describe what happened during the period of true recovery, April through July 1933…

Yes, Recovery in the Great Depression Started with Roosevelt: Stephen Williamson Takes to His Fainting Couch Department

Stephen Williamson: New Monetarist Economics: Hal and Lee have joined the Paul Krugman bad guy club. Writing about Cole and Ohanian's WSJ piece, Krugman says:

This goes beyond holding views I disagree with (as does much of what happens in this debate). This is a deliberate attempt to fool readers, demonstrating that there is no good faith here.

Hal and Lee are two thoughtful and careful economists. I don't agree with everything they have ever said, but to call them liars is appalling.

Williamson should be much more unhappy at Cole and Ohanian's claim that July 1932-June 1933 was "a period of significant deflation". The PPI in July 1932 is 11.1. The PPI in June 1933 is 11.2. Cole and Ohanian may be the only people who have ever managed to call a period during which the price level rose as "one of significant deflation".

Cole and Ohanian:

Harold Cole and Lee Ohanian: Stimulus and the Depression—The Untold Story: Fed Chairman Ben Bernanke claimed that monetary expansion and the turnaround from the deflation of 1932 to inflation in 1934 was a key reason that output expanded.

But boosting aggregate demand did not end the Great Depression. After the initial stock market crash of 1929 and subsequent economic plunge, a recovery began in the summer of 1932, well before the New Deal. The Federal Reserve Board's Index of Industrial production rose nearly 50% between the Depression's trough of July 1932 and June 1933. This was a period of significant deflation. Inflation began after June 1933, following the demise of the gold standard. Despite higher aggregate demand, industrial production was roughly flat over the following year…

I think David Glasner says what ought to be said:

Misrepresenting the Recovery from the Great Depression: [T]he version of events offered by Cole and Ohanian is still a shocking distortion of what happened before FDR took office in March 1933.  In particular, although Cole and Ohanian are correct that the trough of the Great Depression was reached in July 1932, when the Industrial Production Index stood at 3.67, rising to 4.15 in October, an increase of about 13%, they conveniently leave out the fact that there was a double dip; industrial production was flat in November and started falling in December, the Industrial Production Index dropping to 3.78 in March 1933, barely above its level the previous July.  And their assertion that deflation continued during the recovery is even farther from the truth than their description of what happened to industrial production.  When industrial production started to rise, the Producer Price Index (PPI) increased almost 1% three months in a row, July to September, the only monthly increases since July 1929.  The PPI resumed its downward trend in October, falling about 9% from September 1932 t0 February 1933, at the same time that industrial production peaked and started falling again.

That is why most observers date the trough of the Great Depression in the US not in July 1932, but in March 1933 when FDR took office in the midst of a banking crisis that threatened to drive the US economy even deeper into deflation and depression than it had been in July 1932. So when Cole and Ohanian assert that recovery from the Great Depression started in July 1932, and go on to say that the recovery took place during a period of significant deflation, it is hard to avoid the conclusion that they are twisting the facts to suit their own ideological predilection.

The misrepresentation perpetrated by Cole and Ohanian only gets worse when they describe what happened during the period of true recovery, April through July 1933.  Contrary to their assertion, deflation stopped in February 1933, the PPI hitting its low point of 10.3.  Prices began to rise as soon as FDR suspended the gold standard shortly after taking office in March (not June as Cole and Ohanian mistakenly assert) 1933, the PPI rising to 11.9 in July (an increase of about 14% over February) when industrial production hit a peak of 5.95, 57% above the March low point…. To assert that the rapid price increases from March to July, a proxy for increased aggregate demand, played no role in what was then (and remains) the fastest increase in industrial production in any four-month period in American history is a gross misrepresentation of the facts.  What is perhaps even more shocking is that Cole and Ohanian would misrepresent facts so easily ascertainable….

Another point overlooked by Cole and Ohanian, presumably because it doesn’t exactly fit the ideological message that they want to propagate, is that the timing of the recovery — immediately after the monetary stimulus resulting from suspension of the gold standard – shows that monetary policy can be effective with little or no fiscal stimulus [even in a liquidity trap].  It is hard to see how any fiscal stimulus could have taken effect by April 1933 when the recovery had already begun.  Moreover, Roosevelt campaigned as a fiscal conservative, so it would not be easy to argue that anticipated fiscal stimulus was being felt in advance of its actual implementation.

The real lesson the Great Depression is that monetary policy works — for good or ill.

And Cole and Ohanian Drive Paul Krugman into Shrillness This Morning

PK:

Bad Faith Economic History - NYTimes.com: "Via Mark Thoma, Uneasy Money catches Cole and Ohanian — whose blame-FDR interpretation of the Great Depression has become dogma among conservatives — arguing in spectacularly bad faith.

Though not wrong in every detail, the version of events offered by Cole and Ohanian is still a shocking distortion of what happened before FDR took office in March 1933. In particular, although Cole and Ohanian are correct that the trough of the Great Depression was reached in July 1932, when the Industrial Production Index stood at 3.67, rising to 4.15 in October, an increase of about 13%, they conveniently leave out the fact that there was a double dip; industrial production was flat in November and started falling in December, the Industrial Production Index dropping to 3.78 in March 1933, barely above its level the previous July. And their assertion that deflation continued during the recovery is even farther from the truth than their description of what happened to industrial production. Putting the facts in one graph:

You might think that this looks pretty straightforward: output shrank when prices were falling, grew when they were rising, which is what a demand-side story would predict. But Cole and Ohanian focus on the month-to-month wiggles in 1932-33 — conveniently omitting wiggles that went in an inconvenient direction — to claim that demand had nothing to do with it.

This goes beyond holding views I disagree with (as does much of what happens in this debate). This is a deliberate attempt to fool readers, demonstrating that there is no good faith here.

Something Seems Very Wrong Here: Economic History of the Great Depression Department

A correspondent emails:

Just watched this animation about Sylvia Nasar's new book... but is the following really true??

1931: President Herbert Hoover responds to the Great Depression with tax cuts, easier money, and public works spending…

It seems extremely off…

Herbert Hoover's Budget Message for Fiscal Year 1932 (July 1, 1931-June 30, 19320:

This is not a time when we can afford to embark upon any new or enlarged ventures of Government. It will tax our every resource to expand in directions providing employment during the next few months upon already authorized projects. I realize that, naturally, there will be before the Congress this session many legislative matters involving additions to our estimated expenditures for 1932, and the plea of unemployment will be advanced as reasons for many new ventures, but no reasonable view of the outlook warrants such pleas as apply to expenditures in the 1932 Budget. I have full faith that in acting upon these matters the Congress will give due consideration to our financial outlook. I am satisfied that in the absence of further legislation imposing any considerable burden upon our 1932 finances we can close that year with a balanced Budget. When we stop to consider that we are progressively amortizing our public debt, and that a balanced Budget is being presented for 1932, even after drastic writing down of expected revenue, I believe it will be agreed that our Government finances are in a sound condition...

Herbert Hoover's Budget Message for Fiscal Year 1931 (July 1, 1930-June 30, 1931):

[E]stimates of appropriations payable from the Treasury in this Budget is $145,696,000 less than the appropriations for 1930. The estimates in the Budget, however, contain no amount for the revolving loan fund for the Federal Farm Board, for which $150,000,000 is included in the appropriations for 1930.... Eliminating this item from the 1930 total the estimates of appropriations in the Budget for 1931 exceed the appropriations for 1930 by $4,304,000.... Through nonrecurring items and justified reductions in other items funds have been found to make increases in certain of our activities without enlarging to any appreciable extent the total of the estimates for 1931 over the appropriations for 1930...

Great Depression II Approaches in Europe

Barry Eichengreen:

Eurointelligence: [A]t this point the crisis boils down to just one word: Italy.   Italy’s debt is too big to restructure and too big for the European Financial Stability to finance.  While crises are complicated beasts, there’s no reason to complicate this one.  Sure, Greece may have to restructure again.  France may have to take budgetary measures.  But those are sideshows.  The euro area will not live or die on their basis.  The euro area’s crisis is all about one thing:  that Italy’s debt might be unsustainable....

Italy needs at least 1 per cent growth and 2 per cent inflation to ensure that the growth of nominal GDP exceeds the 3 per cent interest rate that is the best it can hope for. Bad economic news from other parts of the world has rendered 1 per cent growth unattainable.   This, in a nutshell, is what caused the Italian debt market, and European financial markets more generally, to blow up. The budgetary measures that the Italian government has now proposed, moreover, will only diminish the country’s growth prospects.  Raising taxes on financial investments and corporations will not encourage investment.  The €13 billion of spending cuts and pension savings slated for the next 18 months will only depress demand further.

What would help would be radical liberalization of the system of national labor contracts.  While the government is officially backing the idea, the only specifics we have is that any such initiative will be opposed by the country’s powerful trade unions. 

Maybe Italy will shake off the deep structural problems with labor contracts, tax compliance, and company and administrative law as a result of which its economy has been unable to grow.  Maybe 2012 will see the “miracle on the Mediterranean.” 

If not, as seems more likely, and Italian growth slows, European policy makers will have two choices.  One is a higher inflation target for the ECB.... The only other option is Eurobonds.  Serious Eurobonds.  Halfway houses, for example dividing sovereign debts into a first tier up to 60 per cent of each country’s GDP that will be guaranteed by euro area members as a group, and a second tier that will remain each nation’s responsibility, will no longer cut it.... [F]ull pooling of existing debts and having member states contribute to payments on it according to their respective GDPs....

Which distasteful option – inflation or Eurobonds – will be less revolting to German taxpayers?  Your guess is as good as mine.  (For what it’s worth, my guess is Eurobonds.)  But the German taxpayer will have to choose.  He is in a union with Italy.  And there is no way he can get out.

And if the German taxpayer does not choose, then Great Depression II in Europe draws near...

Unemployment of 9%+ for 28 Months Is a National Emergency

And on current policies, current forecasts tell us that unemployment will have stayed above 9% for 48 months before it drops into the 8s.

Christina Romer:

From World War II, Economic Lessons for Today: Could the Great Recession of 2008 drag on for years, just as the Great Depression did in the 1930s? Adding to the despair is the oft-repeated notion that it took World War II to end the economic nightmare of the ’30s.... Look more closely at history and you’ll see that the truth is much more complicated — and less gloomy... the wrenching wartime experience provides a message of hope for our troubled economy today: we have the tools to deal with our problems, if only policy makers will use them.... [T]he war first affected the economy through monetary developments. Starting in the mid-1930s, Hitler’s aggression caused capital flight from Europe. People wanted to invest somewhere safer.... Under the gold standard of that time, the flight to safety caused large gold flows to America. The Treasury Department under President Franklin D. Roosevelt used that inflow to increase the money supply. The result was an aggressive monetary expansion.... From 1933 to 1937, real gross domestic product grew at an annual rate of almost 10 percent, and unemployment fell from 25 percent to 14. To put that in perspective, G.D.P. growth has averaged just 2.5 percent in the current recovery, and unemployment has barely budged.... Monetary expansion was very effective in the mid-1930s, even though nominal interest rates were near zero, as they are today....

One reason the Depression dragged on so long was that the rapid recovery of the mid-1930s was interrupted by a second severe recession in late 1937. Though many factors had a role in the “recession within a recession,” monetary and fiscal policy retrenchment were central.... The lesson here is to beware of withdrawing policy support too soon. A switch to contractionary policy before the economy is fully recovered can cause the economy to decline again....

[F]iscal stimulus can help a depressed economy recover — an idea supported by new studies of the 2009 stimulus package. Additional short-run tax cuts or increases in government investment would help deal with our unemployment crisis.

What of the idea that monetary and fiscal policy can do little if unemployment is caused by structural factors, like a mismatch between workers’ skills and available jobs?... [S]ich factors are probably small today. But World War II has something to tell us here, too. Because nearly 10 million men of prime working age were drafted into the military, there was a huge skills gap between the jobs that needed to be done on the home front and the remaining work force. Yet businesses and workers found a way to get the job done.... Here the lesson is that demand is crucial — and that jobs don’t go unfilled for long....

Finally, what about the national debt?... Well, at the end of World War II, that ratio hit 109 percent — one and a half times as high as it is now. Yet this had no obvious adverse consequences for growth or our ability to borrow....

In place of the tepid budget agreement now in place, we could pass a bold plan with more short-run spending increases and tax cuts, coupled with much more serious, phased-in deficit reduction.... Equally important, someone needs to explain to the nation and to world markets just why we must increase the debt in the short run. Unemployment of roughly 9 percent for 28 months and counting is a national emergency...

The Politics of Big Downturns

Mark Thoma:

Economist's View: Kevin O'Rourke: Lessons from the Great Depression: Kevin O'Rourke describes how the emergence of extremism during the Great Depression led to the post WWII consensus that produced social democracies. As he notes, one reflection of this consensus was evident in the Atlantic Charter signed by Winston Churchill Franklin D. Roosevelt in 1941. The Charter was mostly a statement of war aims, but it included a provision stating that the two leaders desired "to bring about the fullest collaboration between all nations in the economic field, with the object of securing for all improved labor standards, economic advancement, and social security."

Have we forgotten the lessons that caused the democracies of the postwar period to transform themselves into the social democracies that provided security for citizens and protection against extremism?:

Monetary Easing Achieved Through "Competitive Devaluation" Is Better than No Monetary Easing

Mark Thoma three hundred miles north along The Five informs me that Barry Eichengreen five feet north through the office wall has written yet another good column:

Barry Eichengreen: Competitive devalution to the rescue: In the 1930s, it is true, with one country after another depreciating its currency, no one ended up gaining competitiveness relative to anyone else. And no country succeeded in exporting its way out of the depression, since there was no one to sell additional exports to. But this was not what mattered. What mattered was that one country after another moved to loosen monetary policy because it no longer had to worry about defending the exchange rate. And this monetary stimulus, felt worldwide, was probably the single most important factor initiating and sustaining economic recovery.

It is true that the process was disorderly and disruptive. Better would have been for the countries concerned to co-ordinate their moves to a more stimulative monetary policy without sending exchange rates on a roller-coaster ride. But, not for the first time, they failed to agree. Those in the most precarious positions had no choice but to pursue the new policy unilaterally.

In any case, monetary easing achieved through a process of "competitive devaluation" was better than no monetary easing. Those countries that shifted in this direction first were also first to recover. But in the end – the end coming after an excruciating five years – they had all moved in the requisite direction, and they all began to recover.

This, in a nutshell, is our situation again today. Sterling's weakness reflects, in part, the exceptional severity of the British slump. But it also reflects the fact that the Bank of England has moved further and faster in the direction of quantitative easing than any other central bank. With the Old Lady buying up British Treasury bonds hand over fist as a way of bringing interest rates down, it is no surprise that sterling should fall. It is no surprise, that is, given the failure of the ECB and the Fed to move as quickly to quantitative easing. And, in the event, this aggressive quantitative easing is precisely the medicine needed by a British economy on life support.

Now the Swiss National Bank has followed suit, announcing a shift to quantitative easing in response to mounting fears of deflation. It implemented that policy last week by buying foreign exchange and corporate bonds, rather than government debt as in Britain, but the net result was the same. It was a sharp fall in the exchange rate, by 3%, on the first day of the new regime.

So sterling and the franc are falling because their central banks are administering precisely the treatment that their economies require. Will other central banks, seeing their own currencies strengthen, conclude that the threat of deflation has grown more immediate and also now move quickly to quantitative easing? If so, exchange rates against sterling and the franc will revert to more normal levels. And, with quantitative easing all around, the world will receive the additional dose of monetary stimulus that it desperately needs.

Better of course would be for the major countries to agree to co-ordinate their monetary policy actions. Then exchange rates will not move by large amounts in one direction today and the opposite direction tomorrow. There will not be further disruptions to the global trading system. There will not be international recriminations over beggar-thy-neighbour policy. The G20 countries could even make such co-ordination part of their agreement at the 2 April summit in London. Or not.

Ryan Avent Reads Greg Mankiw

I am not sure that "interesting" is the word, Ryan.

Ryan Avent:

Fiscal policy: When does fiscal stimulus work?: Greg Mankiw has produced an interesting assessment of fiscal policy in National Affairs. He is perhaps a little unkind toward last year's stimulus package. Contra his assertion, tax cuts played a significant role in the stimulus package, and the models used by administration economists called for a larger bill than subsequently passed. It also seems odd to knock the Obama Administration for not taking into consideration the negative effects of stimulus on long-term interest rates, when long-term interest rates remain at rock bottom levels...

"But," Ryan goes on to say:

his broader point is one worth thinking about...

Mankiw's broader point is that since we have seen nothing like this before except for the Great Depression, we should be humble and risk averse--and hence have the government stand back and wash its hands of the situation.

However, even a minor and hasty acquaintance with the Great Depression teaches that the belief that the government should stand back and wash its hands because the self-regulating market quickly returns to full-employment equilibrium is the most arrogant belief possible.

And even a minor and hasty acquaintance with the Great Depression teaches that having the government stand back and wash its hands is the most risky strategy conceivable.

Mellon Pulled the Whistle...

Hoisted from Comments: Ronald Buck:

Ronald Buck wrote: The ditty form the Great Depression:

Mellon pulled the whistle
Hoover rang the bell
Wall Street gave the signal
And the country went to hell.

Can be adapted to this situation:

Trichet pulled the whistle
Merkel rang the bell
The G20 gave the signal
And Europe went to hell

And We Are Live at the Financial Times...

It is far too soon to end expansion...

---

My original draft:

In 1829 the then-young economist John Stuart Mill put his finger on how it could be that there could be excess supply of everything in the economy--of pretty much all currently produced goods and services and pretty much all kinds of workers. Previous economists had asserted a "metaphysical necessity" that excess supply of one commodity be matched by excess demand for another: that if there were unemployed cobblers then there were desperate consumers frantically looking for more seamstresses, and thus that the economy's problems were never those of a general shortage of demand but of structural adjustment instead. These previous economists, John Stuart Mill was the first to point out, had forgotten about the financial sector. If there was an excess demand for some set of financial assets, then there could be an excess supply of everything else--what they used to call a "general glut," and what we now call a depression.

But what is the financial excess demand, exactly? Friedmanite monetarist dogma says that the key financial excess demand is always and everywhere for money--and you can always cure depression by bringing the money supply up so that there would no longer be excess demand for money. Hicksian doctrine says the key financial excess demand is almost invariably a demand for bonds--for vehicles to transport purchasing power in the form of savings from the present into the future--and you can almost invariably cure the depression by (i) raising business confidence so that they would issue more bonds and build capacity or (ii) getting the government to borrow and spend and so boost the supply of bonds.

The Minskyites have a different take. The Minskyites say that the monetarists and the Hicksians (usually called Keynesians, much to the distress of many who actually knew Keynes) are sometimes right but definitely wrong when the chips are down and a big depression is the result of a financial crisis. Then the key financial excess demand is for high-quality assets: safe financial places in which you could park your wealth and still be confident it would be there when you returned.

After a panic, Hyman Minsky and his (few) allies argued, boosting the money stock would fail. Cash is a high-quality asset, true, but even big proportional boosts to the economy's cash supply are small potatoes in the total stock of assets and would not do much to satisfy the key financial excess demand. Trying to boost investment would not work either, for there was no excess demand for the risky claims to future wealth that are private bonds. The right cure, Minsky and his allies argued, was the government as "lender of last resort": increase the supply of safe high-quality assets that the private sector can hold by every means possible: printing cash, creating reserve deposits, printing up safe high-quality government bonds and using the proceeds to buy goods and services, printing up safe high-quality government bonds and then swapping them out into the private market in return for risky assets.

When the government prints up cash and swaps it out for government bonds, we call that expansionary monetary policy. When the government prints up bonds and uses them to buy goods and services, we call that expansionary fiscal policy. When it prints up cash and bonds and swaps them for risky private financial assets or guarantees private assets we call that banking policy. All of these, the Minskyites say, have their place and should be pursued now--not as Friedmanite monetarism or Hicksian fiscalism, but instead as ways to boost the supply of high-quality financial assets that are in such extraordinary demand now.

But what happens should a government's printing press print more bonds than investors think it will dare to raise future taxes to pay off? What happens when a government's debts are no longer regarded as safe? Then policies of monetary or fiscal expansion or of banking sector asset swaps and guarantees do not boost but reduce the supply of safe high-quality assets: they move government paper out of the "safe" and into the "risky" category. We saw this in Austria in 1931 and in East Asia in 1997-8 and in Greece right now. Then not expansion but rather austerity to restore confidence in the safety and quality of government liabilities is the best a government can do to attempt to relieve depression--that and cry for help from outside.

Here we have the crux: Right now Greece and Ireland and Spain and Portugal and Italy need to be austere. But Germany and Britain and America and Japan do not. With their debts valued by the market at heights I had never thought to see in my lifetime, the best thing that they can do to relieve the global depression is to engage in coordinated global expansion: expansionary fiscal policy, expansionary monetary policy, and expansionary banking policy are all called for on a titanic scale.

But, the members of the Pain Caucus say, how will we know when we have reached the limits of expansion? How will we know when we need to stop because the next hundred billion tranche of debt will permanently and irreversibly crack market confidence in dollar or sterling or deutschmark or yen assets? Will shrink rather than increase the supply of high-quality financial assets the world market today so desperately wants? And send us spiraling down?

Trust me, we will know when the time comes to stop expansion.

Financial markets will tell us.

And not by whispering in a still, small voice.

Trust me, we will know, and right now we are still very, very far from that point indeed.

940 words: July 15, 2010

Department of "Huh!?": Raghu Rajan Is a Member of the Pain Caucus, and I Don't Understand Why...

Raghu Rajan:

But this recession is not a “usual” recession. It followed a period of ultra-low interest rates when interest sensitive segments of the economy got a tremendous boost. The United States had far too much productive capacity devoted to durable goods and houses, because consumers could obtain financing for them easily. With households recovering slowly from the overhang of debt resulting from the binge, and with lenders extremely risk averse, it is unrealistic to expect households to spend beyond their means again, and unwise to try to tempt them to do so.

If households are going to want fewer houses, industries such as construction will have to shrink (as should the financial sector that channeled the easy credit). A significant number of jobs will disappear permanently, and workers who know how to build houses or to sell them will have to learn new skills if they can. Put differently, the productive capacity of the economy has shrunk. Resources have to be reallocated into new sectors so that any recovery is robust, and not simply a resumption of the old unsustainable binge.  The United States economy has to find new pathways for growth. And this will not necessarily be facilitated by ultra-low interest rates...

But... but... but... construction already shrank!

As of the end of 2010, the construction sector will have shrunk in nominal terms to its size in 1999, when the economy as a whole was only 57% as large as it is today...

As of the end of 2010, the summed deviations of residential construction spending from their long-term trend will be zero: we will have underbuilt relative to trend in late 2007, 2008, 2009, and 2010 by about half again as much as we overbuilt relative to trend in 2003, 2004, 2005, 2006, and early 2007.

Yet the depression will still be going on.

Resources have already been allocated out of construction. To speak of the fall in the size of the bubble sector construction as something ongoing in the future--"will have to shrink... jobs will disappear..."--is to commit an elementary factual error. The sector has already shrunk. And it has shrunk by moving its excess workers and a huge honking number of other workers into the most unproductive activity possible: unemployment.

And to claim that the process by which resources are "reallocated into new sectors so that any recovery is robust..." so that "the United States economy... [can] find new pathways to growth" is in any way aided by 10% unemployment would be simply insane.

John Maynard Keynes had something to say about people who looked with approval on high unemployment and low demand and claimed that they were aids rather than obstacles to restructuring and growth:

While some part of the investment which was going on in the world at large was doubtless ill judged and unfruitful, there can, I think, be no doubt that the world was enormously enriched by the constructions of the quinquennium from 1925 to 1929; its wealth increased in these five years by as much as in any other ten or twenty years of its history....

Doubtless, as was inevitable in a period of such rapid changes, the rate of growth of some individual commodities could not always be in just the appropriate relation to that of others. But, on the whole, I see little sign of any serious want of balance such as is alleged by some authorities. The rates of growth [of different sectors]... seem to me, looking back, to have been in as good a balance as one could have expected them to be. A few more quinquennia of equal activity might, indeed, have brought us near to the economic Eldorado where all our reasonable economic needs would be satisfied....

It seems an extraordinary imbecility that this wonderful outburst of productive energy [over 1924–29] should be the prelude to impoverishment and depression. Some austere and puritanical souls regard it both as an inevitable and a desirable nemesis on so much overexpansion, as they call it; a nemesis on man’s speculative spirit. It would, they feel, be a victory for the mammon of unrighteousness if so much prosperity was not subsequently balanced by universal bankruptcy. We need, they say, what they politely call a ‘prolonged liquidation’ to put us right. The liquidation, they tell us, is not yet complete. But in time it will be. And when sufficient time has elapsed for the completion of the liquidation, all will be well with us again.

I do not take this view. I find the explanantion of the current business losses, of the reduction in output, and of the unemployment which necessarily ensues on this not in the high level of investment which was proceeding up to the spring of 1929, but in the subsequent cessation of this investment. I see no hope of a recovery except in a revival of the high level of investment. And I do not understand how universal bankruptcy can do any good or bring us nearer to prosperity...

Slides for Great Depression Class (March 17, 2010)

210 March 17 2010.pdf

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

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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

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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"...

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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.