Grasping Reality with Both Hands

Bad News About Industrial Production. *Sigh*

From the Federal Reserve:

Industrial Production and Capacity Utilization: Industrial production decreased 0.4 percent in June after having fallen 1.2 percent in May. For the second quarter as a whole, output fell at an annual rate of 11.6 percent, a more moderate contraction than in the first quarter, when output fell 19.1 percent. Manufacturing output moved down 0.6 percent in June, with declines at both durable and nondurable goods producers. Outside of manufacturing, the output of mines fell 0.5 percent in June, and the output of utilities increased 0.8 percent. The rate of capacity utilization for total industry declined in June to 68.0 percent, a level 12.9 percentage points below its average for 1972-2008. Prior to the current recession, the low over the history of this series, which begins in 1967, was 70.9 percent in December 1982.

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...

Fiscal Policy: The Obama Administration Is Not Making Much Sense These Days

Tim Geithner is not making sense:

Geithner: Too soon to decide on more stimulus | Reuters: U.S. Treasury Secretary Timothy Geithner said it was too soon to decide whether the U.S. economy would need the help of a second round of government stimulus to recover from recession. "I don't think that's a judgment we need to make now, can't really make it now prudently, responsibly," Geithner said in a taped interview with CNN that will air on Sunday. According to a transcript provided by CNN, Geithner said the "biggest thrust" of the $787 billion package of spending and tax cuts signed into law earlier this year would take effect in the second half of the year...

Let's review the bidding:

Last December the Obama administration to be decided on a fiscal stimulus package which they believed would have minor effects on the economy in the first two quarters of 2009 and major effects--would push unemployment down below what it would other wise have been by more than half a percentage point--starting in the third quarter of 2009. They believed that the economy was not that weak, and that with the fiscal stimulus package taking effect unemployment would be peaking now at a rate of 7.9%.

Instead, unemployment is now probably in the 9.5-9.7% range--and without the stimulus package it would right now have turned out to be above 10%:

The financial crisis of last fall hit the economy's levels of production, spending, and employment much harder than people thought at the time. If we had known then what we know now, it would have been prudent then to propose twice as large a fiscal stimulus program as the Obama administration in fact did propose.

If Tim Geithner is not making much sense, neither is Barack Obama. Keith Hennessy directs us to quotes:

Dan Balz: The Take: Obama Stands to Be Judged on Economic Recovery: Obama, in Moscow yesterday, tried to modulate the impact of the vice president's words that the administration had somehow miscalculated. "No, no, no, no, no," he told NBC's Chuck Todd. "Rather than say 'misread,' we had incomplete information." To ABC's Jake Tapper, he said, "There's nothing that we would have done differently"...

And in Dan Balz's judgment:

Scrambling for a macroeconomic message: It seems hard to square an assessment that the administration underestimated the severity of the recession and the assertion that the White House wouldn’t have done anything differently had it known how bad things really were...

All in all, it looks like the unemployment rate in 2009 is going to average 1.2 percentage points above where the administration last December thought we would be. First quarter real GDP was $11.36 trillion year-2000 dollars--and second-quarter real GDP will be the same. Thus year-2009 real GDP is going to be close to $11.40 trillion--1.2% lower than the administration forecast that real GDP in the four quarters of 2009 would average $11.53 trillion.

It is interesting and important to note that the excess unemployment now forecast over 2009 relative to last December's forecast is of the same magnitude--1.2%--as the deficiency in real GDP. In earlier decades this would not have been the case. In earlier decades the economy was ruled by Okun's Law, and the rule-of-thumb was that the excess unemployment was 2/5 of the magnitude of the deficiency in production, not equal (see "labor hoarding by firms in American recessions, end of"). In earlier decades a 1.2 percentage point rise in unemployment would have meant a $420 billion shortfall in year-2009 nominal GDP, not a $170 billion shortfall.

If I were running the government, I would be trying to make up that GDP shortfall right now: I would be rushing a clean $170 billion--$500 per citizen--aid-to-states-that-maintain-effort package through the congress this week. It would seem the right and the obvious thing to do.

The Changing Nature of the American Business Cycle

Macroeconomic Advisers writes:

Please find "Q2-2009... GDP Tracking 0.2 percent", which has been updated. Exports were stronger than expected, and imports were much weaker than expected, suggesting a large upward revision to our estimate of second quarter net exports. Therefore, we raised our tracking estimate of [the annual] GDP growth [rate] in the second quarter by 1.8 percentage points to +0.2% [growth in GDP per year].

With labor input falling at a rate of 6% per year in the second quarter, that suggests a productivity growth rate in the economy as a whole of some 6.2%--which is really weird. It used to be the case that businesses hoarded labor in recessions because they did not want their skilled workers to wander off and to have to train new ones....

Now it is really beginning to look as though businesses take recessions as opportunities to greatly slim down their workforces without making the workers they retain too angry and depressed. We saw this in 2002-2003. We saw it before in 1992-1993. The fact that productivity is no longer strongly procyclical countercyclical in recessions is good news in the long run--it means that our average long-run rate of productivity growth is higher than we used to think. But it also means that there is more headroom for expansionary policy, and more need.

Thus statements like this one from the very sharp Allan Sinai:

Phil Izzo reports:: "The mother of all jobless recoveries is coming down the pike," said Allen Sinai of Decision Economics. But he doesn't favor more stimulus now, saying "lags in monetary and fiscal policy actions" should be allowed to "work through the system..."

make me pound my head against the wall. If as the policies we have now in train to support the economy work their way through the system we find that we still have "the mother of all jobless recoveries," then we should be acting now to provide additional government support. A jobless recovery is not a good thing. And we should avoid it if we can figure out how in time.

Paul Krugman on the Stimulus Trap

What Paul Krugman wrote:

Paul Krugman: The Stimulus Trap: As soon as the Obama administration-in-waiting announced its stimulus plan — this was before Inauguration Day — some of us worried that the plan would prove inadequate. And we also worried that it might be hard, as a political matter, to come back for another round. Unfortunately, those worries have proved justified.... There’s now a real risk that President Obama will find himself caught in a political-economic trap....

[H]ow [should] concerned citizens... be reacting to the disappointing economic news. Should we be patient and give the Obama plan time to work? Should we call for bigger, bolder actions? Or should we declare the plan a failure?...

When there’s an ordinary, garden-variety recession, the job of fighting that recession is assigned to the Federal Reserve. The Fed responds by cutting interest rates in an incremental fashion [to raise asset prices]. Reducing rates a bit at a time, it keeps cutting until the economy turns around. At times it pauses to assess the effects of its work [on asset prices and thus on private spending by businesses making investments in plant and equipment and on households that feel richer are willing to spend more]; if the economy is still weak, the cutting resumes.

During the last recession, the Fed repeatedly cut rates as the slump deepened — 11 times over the course of 2001. Then, amid early signs of recovery, it paused.... When it became clear that the economy still wasn’t growing fast enough to create jobs, more rate cuts followed. Normally, then, we expect policy makers to respond to bad job numbers with a combination of patience and resolve.... And that’s what the Obama administration should be doing right now with its fiscal stimulus. (It’s important to remember that the stimulus was necessary because the Fed, having cut rates all the way to zero, has run out of ammunition to fight this slump.) That is, policy makers should stay calm in the face of disappointing early results, recognizing that the plan will take time to deliver its full benefit. But they should also be prepared to add to the stimulus now that it’s clear that the first round wasn’t big enough.

Unfortunately, the politics of fiscal policy are very different from the politics of monetary policy. For the past 30 years, we’ve been told that government spending is bad, and conservative opposition to fiscal stimulus (which might make people think better of government) has been bitter and unrelenting even in the face of the worst slump since the Great Depression. Predictably, then, Republicans — and some Democrats — have treated any bad news as evidence of failure, rather than as a reason to make the policy stronger. Hence the danger that the Obama administration will find itself caught in a political-economic trap, in which the very weakness of the economy undermines the administration’s ability to respond effectively....

It’s perfectly O.K. for the administration to defend what it’s done so far.... It’s also reasonable for administration economists to call for patience, and point out, correctly, that the stimulus was never expected to have its full impact this summer, or even this year. But... [i]t was disturbing when President Obama walked back Mr. Biden’s admission that the administration “misread” the economy, declaring that “there’s nothing we would have done differently.” There was a whiff of the Bush infallibility complex in that remark... that’s an attitude neither Mr. Obama nor the country can afford.

What Mr. Obama needs to do is level with the American people. He needs to admit that he may not have done enough on the first try... and that some course adjustments — including, quite possibly, another round of stimulus — may be necessary...

Fiscal Policy and the Possibility of a Jobless Recovery

Greg Ip writes:

AFTER ebbing steadily since the start of the year America’s monthly job losses figure abruptly jumped from 322,000 in May to 467,000 in June, deflating talk of an imminent exit from recession. Hand-wringing in Washington quickly followed. On July 5th the vice-president, Joe Biden, admitted that the White House had “misread how bad the economy was”. In January it had predicted that unemployment would peak at 9% without a fiscal stimulus and 8% with one.... At one level, the hand-wringing is overdone....

The odds are that the economy will begin to grow again in the current quarter for two reasons: the dramatic inventory liquidation, which led manufacturers to slash output and payrolls starting in late 2008, seems to be ending; and the impact of the fiscal stimulus is growing. Other countries, who bore much of the brunt of the inventory liquidation because they provide such a large share of what Americans consume, are already benefiting. Global manufacturing expanded in June for the first time since May 2008....

But... [a] self-sustaining recovery needs more than just replenishing inventory and government stimulus; it requires a virtuous circle of increasing consumer spending and incomes, and there is still no evidence of that.... Jan Hatzius of Goldman Sachs predicts wages will actually start falling next year. If later this year the recovery still looks likely to remain feeble as the maximum impact of the stimulus is felt, pressure for more stimulus will grow....

Mr Obama himself has proposed a budget-balancing rule that he would have to break to inject more stimulus—a formality, perhaps, but one that would further erode his fiscal credibility given the gargantuan deficits his policies will produce even beyond 2010. “We could afford to borrow a bit more over the next year if we had a plausible plan to get the deficit under control thereafter,” says Len Burman of the Urban Institute, a think-tank. “But nobody has articulated such a plan.”

Think: jobless recovery. Now that we have the May trade figures, the modal forecast is (i) an economy that was flat in the second quarter relative to the first quarter, (ii) an economy that starts to grow relatively slowly in the third quarter, and (iii) an unemployment rate that keeps rising for another one and a half to two years--like it did in 1992 and 2002--as the old-fashioned business-cycle productivity-employment pattern is broken once again. Bob Hall's NBER committee is likely to proclaim that recovery began sometime in the second quarter, but it won't feel like a recovery to workers (as opposed to asset owners) for quite some time to come.

A Good Seasonally-Adjusted New Unemployment Claims Number | Reuters

But how good exactly? Reuters:

Jobless claims drop steeply, skewed by autos | Reuters: WASHINGTON (Reuters) - The number of U.S. workers filing new claims for jobless benefits fell sharply last week but the data was distorted by an unusual pattern of layoffs in the automotive industry, which amplified the decline. The Labor Department said on Thursday that initial claims for state unemployment insurance fell 52,000, the largest drop since December, to a much lower-than-expected seasonally adjusted 565,000 in the week ended July 4, from 617,000 the prior week. It was the lowest reading since January. Analysts polled by Reuters had forecast claims to drop to 605,000 from a previously reported 614,000. However, in a sign of ongoing employment weakness, so-called continued claims of people still on jobless aid after an initial week of benefits rose by 159,000 to a record 6.883 million in the week ending June 27, the latest for which data is available.

A Labor Department official said that there had been far fewer automotive and other manufacturing layoffs last week than anticipated on the basis of past experience of claims over July, when many plants are commonly idled. The "seasonal factors" the department uses to adjust the data to provide a better sense of the underlying trend had expected a large increase in claims in the latest week. Actual claims in fact rose by a much smaller amount, which when seasonally adjusted, generated a large fall. A number of states said that auto sector layoffs apparently had already happened, reflecting closures in the battered U.S. automotive industry, while other states said they did not get the layoffs they had anticipated. "I would expect the underlying trend (in claims) is probably diminishing but it's hard to tell from this number how much is noise," said Keith Hembre, chief economist at First American Funds in Minneapolis.

The 4-week moving average for new claims declined by 10,000 to 606,000, the lowest reading since February. This measure is closely watched because it irons out weekly volatility, and it has now declined in four out of the last five weeks.

Looking at graphs like this:

reminds me of how very much in the high-frequency data we typically examine rests on the seasonal adjustment process--and how important it is to get that seasonal adjustment right. Of course, to the extent that the true seasonal adjustment factors are not absolutely invariant to the phase of the business cycle it very quickly becomes impossible to estimate them accurately.

What the standard seasonal adjustment factors for initial unemployment claims tell us is: "don't worry if new claims spike in January or July. But does that mean we should be greatly encouraged if they don't spike in January or July? In January 2008, July 2008, and January 2009 the seasonally-adjusted claims number improved because unadjusted claims did not spike enough. But anyone who took those declines as evidence of an improving economy--well, I have a bridge they might be interested in purchasing...

What, Me Worry?: Few Expected Green Shoots in the Bond Market

Paul Krugman has a chart:

and writes:

Bond panic subsiding?: Over the course of the spring there was a substantial rise in long-term interest rates; it was fed partly by talk of green shoots, but also, I suspect, by all the yelling about deficits and inflation. And, of course, the rise in rates was itself taken as evidence that inflation fears etc. were justified.

But the panic seems to be subsiding. Rates are still well above their post-Lehman lows, when credit markets were completely frozen and everyone was piling into govt. debt. But they’re low by historical standards, and not giving much ammunition to the worriers these days.

On the contrary, they are giving a significant amount of ammunition to the worriers--my brand of worriers, a different kind of worriers. We worry that the next two years are going to bring what happened after the end of the 2001 recession: something like this:

A recovery in which unemployment is higher two years later than when the recovery began is not much of a recovery. And I don't see what is going to keep the probability of such an eventuality low.

The lower are ten-year Treasury interest rates, the more are people trading in the bond market willing to bet their money that the future holds that kind of non-recovery recovery. And so I worry.

Bruce Bartlett Argues Against a Second Stimulus

He writes:

We do not need a second stimulus plan: As the US unemployment rate has risen to 9.5 per cent from 8.1 per cent since the $787bn fiscal stimulus package was enacted in February, many Democrats have become very nervous. They say that another large stimulus may be needed to keep unemployment from rising.... Another stimulus would be a grave mistake. The first one was justified by extraordinary circumstances. But it must be given time to work. People should not allow their impatience to lead to the adoption of policies that will not only fail to reduce unemployment this year, but could stoke inflation in the not-too-distant future....

The forecast also showed the unemployment rate peaking at 8 per cent with the stimulus and 9 per cent without. Obviously this was wrong. Yet it would be incorrect to conclude that the stimulus was doomed to failure, as many Republicans and conservative economists argued.... [T]he Romer-Bernstein document presents reasonable estimates of how quickly different forms of spending would raise gross domestic product. Tax cuts and government transfers are slow to have an effect and have a low multiplier, raising GDP less than $1 for every $1 increase in the deficit even when fully effective after two years. By contrast, government purchases stimulate growth much more quickly and have a higher multiplier, raising GDP by $1.57 for every $1 spent. Unfortunately, the low-impact spending has been the fastest to come online while the high-impact spending is dribbling out very slowly.

In a recent report to the International Monetary Fund, Doug Elmendorf, Congressional Budget Office director, looked at the rates of spending for different components of the stimulus package. He estimates that by the end of fiscal year 2009, which falls on September 30, 32 per cent of the income transfers for things such as food stamps and extended unemployment benefits will have been spent and 31 per cent of the tax cuts will have been disbursed. By the end of fiscal year 2010 virtually all of the money allocated to these programmes will have been spent.

However, just 11 per cent of the discretionary spending on highways, mass transit, energy efficiency and other programmes involving direct government purchases will have been spent by the end of this fiscal year. Even by the end of 2010 less than half the funds will have been disbursed and by the end of 2011 more than a quarter of the money will be unspent. Consequently, it is hardly surprising that five months after the stimulus bill passed it has not yet affected the unemployment rate....

What all this means is that it is foolish to think that any sort of stimulus that is enacted now will have an impact on the economy any time soon. We just have to wait for the medicine we have already taken to work. Pushing ahead with another stimulus will only make it harder to tighten fiscal policy down the road to keep inflation in check.

It's a balance of risks. Any second stimulus package passed this fall would have little impact on the economy until late 2010, that is true. But come late 2010 we might really need more demand to curb unemployment. On balance the inflationary risks of having an extra stimulus hit the economy in late 2010 if it is not needed are outweighed by the deflationary risks of not having an extra stimulus hit the economy in late 2010 if it is needed.

It is like driving a car with its windshield painted black by looking in the rear view mirror.

joe Biden Misses the Point...

If the Obama fiscal boost program has its anticipated impact on the economy as its main effects take hold over the next year, it is still half the size of the program it now looks like we need. Only if it magically turns out to be twice as strong as we think--only with simple Keynesian multipliers of 3 rather than 1.5--is it the right size.

And, of course, if the situation deteriorates further we will need an even bigger stimulus, while if the situation improves having too-big a stimulus is not a problem because we can soak up the demand through monetary policy.

So Vice President Joe Biden completely misses the point when he says:

I think it's premature to make that judgment [that we need a larger stimulus]. This was set up to spend out over 18 months. There are going to be major programs that are going to take effect in September, $7.5 billion for broadband, new money for high-speed rail, the implementation of the grid -- the new electric grid. And so this is just starting, the pace of the ball is now going to increase.

Of course, he is paid to miss the point. Which is one reason why being Vice President is a really lousy job.

Sam Stein reports:

Biden Ignores Warnings Of Krugman, Stiglitz, Roubini And Others: During his interview with ABC's This Week on Sunday, Vice President Joe Biden made what will be a much-discussed admission in the week ahead. The Obama administration, he said, had "misread" the extent of the economic catastrophe it inherited. "The truth is, we and everyone else misread the economy," declared Biden. "The figures we worked off of in January were the consensus figures and most of the blue chip indexes out there. We misread how bad the economy was, but we are now only about 120 days into the recovery package," the vice president said later in the interview. "The truth of the matter was, no one anticipated, no one expected that that recovery package would in fact be in a position at this point of having to distribute the bulk of money."

Certainly, the Obama administration's acknowledgment that it misjudged the crisis it inherited is rife with possibilities for its political opponents. House Minority Leader John Boehner rapped the White House repeatedly on Sunday for presiding over the loss of more than two million jobs since January. Former Bush strategist Matt Dowd, appearing on the ABC panel after Biden, did much the same. For an Obama White House that, two weeks ago, told the public to measure the success of its policies based on jobs they created, it is difficult to decry these critiques as inherently unfair, regardless of what troubles were passed on from the Bush administration.

But equally problematic is Biden's assertion that "everyone" - not just the White House - was off in their prognostications. This is simply untrue. Host George Stephanopoulos pointed out that "a lot of people were saying that you needed to do something bigger and bolder" when it came to the stimulus package. He named New York Times columnist Paul Krugman as one example. There are many others. The prize-winning Columbia University economist Joseph Stiglitz not only warned that the stimulus was too small during its construction, the day after Obama signed it into law he predicted how its shortcomings would make themselves apparent. "I think there is a broad consensus but not universal among economist that the stimulus package that was passed was badly designed and not enough. I know it is not universal but let me try to explain. First of all that it was not enough should be pretty apparent from what I just said: It is trying to offset the deficiency in aggregate demand and it is just too small," Stiglitz said. "The shortfall in state revenue [is] probably in the order of 150 to 200 billion dollars a year. And the states have balanced budget frameworks so if you follow the newspaper you know the drastic problems that California and New York are in, these are really serious problems and because of their balanced budget frameworks they have to reduce their spending... if their income comes down. So that would be a negative stimulus of 150 to 200 billion unless there is federal aid. And the stimulus package there was a little of federal aid but just not enough. So what we will be doing is we will be laying off teachers and laying off people in the health care sector while we are hiring construction workers. It is a little strange for a design of a stimulus package. You ask, why do you want to hire construction workers and fire teachers. I don't know what is the rationale behind that." Stiglitz was joined by a whole host of liberal economists -- from the University of Texas' James Galbraith to Dean Baker of the Center for Economic and Policy Research -- who warned that the stimulus package inexplicably underestimated the size of the crisis.

Several weeks after the stimulus passed, economist Nouriel Roubini, known affectionately as Dr. Doom, made the case that the administration's approach to stabilizing the economy lacked an effective international component. "You have to have a set of concerted, coherent policies done not just by the U.S. but by Europe, Japan, China and everyone else," he said. "The credit crunch is just massive. One thing that's needed is much more aggressive monetary easing. The second dimension is that you need much more fiscal stimulus -- in the countries that can afford it -- that is front-loaded. The U.S. [stimulus package] is $800 billion, but only $200 billion is front-loaded. Of that $200 billion [in stimulus] this year, half of it is tax cuts. That's going to be a waste of money, because people are not going to spend it." In mid-June, weeks before the latest round of poor job numbers came out, U.C. Berkeley professor and former Clinton administration official Brad DeLong was arguing 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," he wrote.

The day that June's job numbers came out, meanwhile, Nassim Taleb, principal of Universa Investments and author of 'The Black Swan,' offered a far more grim interpretation of what was transpiring, though one relatively consistent with what he had said in the past. "We're in the middle of a crash," said Taleb during an appearance on CNBC. "So if I'm going to forecast something, it is that it's going to get worse, not better."

Certainly Krugman himself has aired his share of skepticism. In late June, he reminded his readers that his early concerns had not been misplaced. "[S]ome of us warned about what might happen: if unemployment surpassed the administration's optimistic projections, Republicans wouldn't accept the need for more stimulus," he wrote in the Times. "Instead, they'd declare the whole economic policy a failure. And that's exactly how it's playing out. With the unemployment rate now almost certain to pass 10 percent, there's an overwhelming economic case for more stimulus. But as a political matter it's going to be harder, not easier, to get that extra stimulus now than it would have been to get the plan right in the first place. This past week, meanwhile, he declared once more that the Obama stimulus plan, while "better than nothing" needs to be supplemented with something more.

To be fair, the process of economic forecasting is, as Taleb noted in his CNBC segment, an inherently tricky proposition. In October 2008, for instance, Roubini was arguing that the government needed a $400 billion stimulus package, which ended up being just more than half of what the Obama White House settled on.

But among those who were sounding the loudest alarms about the potential inadequacies of the economic recovery plan, the consensus seems to be emerging that more now needs to be done. Later in his ABC segment, Biden - who is responsible for overseeing the stimulus - was asked if a second package was in the offing. No, he replied, without dismissing the possibility outright. "I think it's premature to make that judgment. This was set up to spend out over 18 months. There are going to be major programs that are going to take effect in September, $7.5 billion for broadband, new money for high-speed rail, the implementation of the grid -- the new electric grid. And so this is just starting, the pace of the ball is now going to increase."

Forensic Table Reading: Bush CEA Forecast Edition

In email, lurkers are questioning my claim that:

Forecasting the Obama Economy: ...what happened to the Mankiw CEA over the winter of 2003-2004, when high politics appears to have reached down into the forecast, changed the table for payroll employment (and only payroll employment: the rest of the forecast is not out of line with contemporary professional forecasts), and produced an estimate for December 2004 (a) inconsistent with the rest of the forecast, and (b) high by 2.3 million in its estimate of payroll employment--all because Karl Rove and company thought it important to avoid headlines like "Bush administration forecasts 2004 payroll employment to be less than when Bush took office." White House Media Affairs would have a much harder time pressuring the forecasters to produce a "rosy scenario" if the pressure has to be kept on month after month [as the Troika forecast is revised, updated, and released at a monthly frequency].

I think that the smoking gun is provided by a little forensic table reading--going through the Bush administration's economic forecasts year-by-year as they were published in the successive versions of the Bush-era CEA's Economic Report of the President, the ERP:

• In the 2002 ERP, Table 1.1 shows 3.2% growth expected for the next two years gives you 2.9 million jobs--for a forecast labor productivity growth rate of about 2.1% per year...
• In the 2003 ERP, Table 1.1 shows 3.5% growth expected for the next two years gives you 4.4 million jobs--for a forecast labor productivity growth rate of about 1.8% per year...
• In the 2004 ERP, Table 3.1 shows 3.7% growth expected for the next two years gives you 6.2 million jobs--for a forecast labor productivity growth rate of about 1.3% per year...
• In the 2005 ERP, Table 1.1 shows 3.4% growth expected for the next two years gives you 4.1 million jobs--for a forecast labor productivity growth rate of about 1.8% per year...
• In the 2006 ERP, Table 1.1 shows 3.3% growth expected for the next two years gives you 3.8 million jobs--for a forecast labor productivity growth rate of about 1.9% per year...
• In the 2007 ERP, Table 1.1 shows 3.0% growth expected for the next two years gives you 3.3 million jobs--for a forecast labor productivity growth rate of about 1.8% per year...

The forecast rate of labor productivity growth over the next two years or so is a relatively stable variable. It starts at an annual rate of 2.1% in the first Glenn Hubbard ERP, and then Glenn and company drop it to 1.8% the next year as they become less optimistic about productivity growth in the aftermath of the collapse of the high tech bubble. Thereafter the Bush CEA forecast assumes a labor productivity growth rate of 1.8% - 1.9% in every year save one: the 2004 ERP, issued at the start of 2004, drops the labor productivity growth rate to 1.3% (and the 2005 ERP raises it back up to 1.8%).

Was there anything in the economic data that would make one much more pessimistic about labor productivity growth in early 2004 and only early 2004? No.

But assuming a 1.8% labor productivity growth rate at the start of 2004 would have meant that the forecast average level of employment in Tqble 3.1 for 2004 would have been lower than the level of employment when Bush took office, and that would have created a point of political vulnerability. There were two ways to fix this that would have satisfied White House Media Affairs: (i) reformat the table so that it no longer reports an annual average payroll employment number, or (ii) push assumed labor productivity growth down because if you keep GDP the same but reduce labor productivity arithmetic forces your forecast to produce higher employment.

Why the Bush CEA didn't pick option (i) is something I have never understood...

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No, It Is Not a Sine Wave

Krishna Guha and Sarah O’Connor in Washington, Michael Mackenzie in New York and Ralph Atkins in Luxembourg write:

Jobs data dash recovery hopes: Published: July 2 2009 13:47 | Last updated: July 2 2009 21:49: Stock markets on both sides of the Atlantic tumbled on Thursday as investors took fright at a bigger-than-expected fall in US jobs last month that dashed hopes the recession was all but over in the world’s biggest economy. The data showed that the number of people in employment fell 467,000 in June and the unemployment rate rose from 9.4 per cent to 9.5 per cent, its highest for 26 years...

But what reason was there to hope that the recession was all but over in the first place? Just that the recent curve looked somewhat like a sine wave?

Krishna Guha: Please Discipline Your Headline Writers!

Krishna Guha to the orange courtesy phone, please.

The headline over your article is:

Romer Upbeat on US Economy

The quotes from the Hon. Christina D. Romer are:

• We do not want to repeat the mistake Japan made in the 1990s, when the moment things started to improve they tightened policy...

• [Stimulus spending is] going to ramp up strongly through the summer and the fall. We always knew we were not going to get all that much fiscal impact during the first five to six months. The big impact starts to hit from about now onwards...

• [Stimulus spending] should make a material contribution to growth in the third quarter...

• I am more optimistic that we are getting close to the bottom...

• I still hold out hope it will be a V-shaped recovery. It might not be the most likely scenario, but it is not as unlikely as many people think. We are going to get some serious oomph from the stimulus, there is the inventory cycle, and I believe there is some pent-up demand by consumers...

If that is what the FT calls "upbeat," what would be "downbeat"? "CEA Chair Romer advised Americans to stockpile bottled water, ammunition, gasoline, and sewing needles; and to start training for the Thunderdome"?

FT.com / US / Economy & Fed - Romer upbeat on US economy: The US economy will feel a substantial boost from the Obama administration’s emergency spending package over the next few months, says Christina Romer, a senior White House official, who has warned against tightening monetary and fiscal policy before recovery is well established. Ms Romer, chairman of the US president’s council of econ omic advisers, told the Financial Times in an interview she was “more optimistic” that the economy was close to stabilisation. But while hopeful that America could yet experience a V-shaped recovery, she said it was much too soon to begin tightening policy: “We do not want to repeat the mistake Japan made in the 1990s, when the moment things started to improve they tightened policy.”

Meanwhile, David Axelrod, a senior White House adviser, told NBC Television on Sunday the administration would be open to further stimulus if needed. “Let’s see in the fall where we are, but right now we believe what we have done is adequate to the task. If more is needed, we’ll have that discussion.”

Ms Romer’s comments come as opposition Republicans step up their attacks on the $787bn fiscal stimulus, pointing out that it has not prevented unemployment from hitting a quarter-century high of 9.4 per cent. Ms Romer said stimulus spending was “going to ramp up strongly through the summer and the fall. We always knew we were not going to get all that much fiscal impact during the first five to six months. The big impact starts to hit from about now onwards,” she said.

Ms Romer said that stimulus money was being disbursed at almost exactly the rate forecast by the Office of Management and Budget. “It should make a material contribution to growth in the third quarter.” But she acknowledged that cutbacks by states facing budget crises would push in the opposite direction. Ms Romer said the latest economic data were encouraging, following a weaker patch a month ago. “I am more optimistic that we are getting close to the bottom,” she said.

The CEA chairman, who has forecast a sharper rebound in 2010 than most economists, said she had lowered her estimates for growth this year “and also for next year, a bit” since the start of the year. She said the consensus forecast that unemployment would continue to rise for the rest of this year and peak early next year was probably accurate. But she added: “I still hold out hope it will be a V-shaped recovery. It might not be the most likely scenario but it is not as unlikely as many people think. We are going to get some serious oomph from the stimulus, there is the inventory cycle and I believe there is some pent-up demand by consumers.”

Fifty Little Herbert Hoovers Watch

The Economist's free exchange:

Fifty little Hoovers, hoovering up stimulus: MATTHEW YGLESIAS makes a good point:

Reading Harold Meyerson’s column on the looming devastation of California public services was yet another reminder of the remarkable extent to which the terrible continuing economic situation has bizarrely dropped off the political agenda. Even the whole “green shoots” debate is really about whether we can expect things to be somewhat better or somewhat worse six months out from now. In either case, things really are really bad right now. And a whole bunch of states—including large ones like California and Pennsylvania—are soon to implement substantial cutbacks in services at just the time when the objective need for social services is going up.

The American economy appears to be nearing the end of contraction. That's good news, particularly when one considers that only about 10% of the funds authorised in this year's stimulus bill has been spent; the plan is only beginning to ramp up and outlays will peak in 2010. We should expect that injection to provide the economy with a nice boost at a critical time.

On the other hand, state budget policies are sharply contractionary at this point. Despite allocations of federal aid to states, services are being cut, state employees are being laid off, and taxes are being raised in order to balance the budgets of local governments constitutionally unable to run deficits. It's not at all clear that the federal stimulus will entirely compensate for state-level fiscal tightening, which means that American fiscal policy could, on net, be contractionary.

Easy money is doing its part, of course, but the bottom line is that the fiscal boost many are expecting may not actually materialise. This will end up causing a lot of human suffering, and it may make for a long and shallow recovery—or worse, a tipping back into contraction.

Nobody thinks that it's time to go back in the water yet. And we do need a bigger stimulus.

I See No Green Shoots Here...

The BLS says:

And David Rosenberg, via Barry Ritholtz:

Getting Ready for a Bad Employment Number Friday Morning...

From Macro Advisers:

Private nonfarm payroll employment declined by 473,000 from May to June on a seasonally adjusted basis, according to the ADP National Employment Report™. Assuming government payrolls expand by 12,000 (the average monthly increase over the last year), this implies an estimated 461,000 decline in total nonfarm payroll employment, roughly 100,000 more of a decline than consensus expectations...

Forecasting the Obama Economy

David Leonhardt writes:

Mistake by Obama’s Advisers in Predicting Job Losses: In the weeks just before President Obama took office, his economic advisers made a mistake. They got a little carried away with hope. To make the case for a big stimulus package, they released their economic forecast for the next few years. Without the stimulus, they saw the unemployment rate — then 7.2 percent — rising above 8 percent in 2009 and peaking at 9 percent next year. With the stimulus, the advisers said, unemployment would probably peak at 8 percent late this year. We now know that this forecast was terribly optimistic.... [T]he difference between the situation that the Obama advisers predicted and the one that has come to pass is about 2.5 million jobs. It’s as if every worker in the city of Los Angeles received an unexpected layoff notice.

There are two possible explanations that the administration was so wrong.... The first... is that the economy has deteriorated because the stimulus package failed.... The... answer is that the economy has deteriorated in spite of the stimulus. In other words, the patient is not as sick as he would have been without the medicine he received. But he is a lot sicker than doctors realized when they prescribed it.

To me, the evidence is fairly compelling that the second answer is the right one. The stimulus package does seem to have helped. But its impact has been minor — so far — compared with the harshness of the Great Recession. Unfortunately, the administration’s rose-colored forecast has muddied this picture.... Worst of all, the economy really may need more help.... There is no ironclad way to judge the stimulus, because we can’t rerun the last six months in an alternate universe. But you can get a pretty good sense by looking at the size of the gap between where the economy is today and where the administration thought it would be: those 2.5 million jobs that would still exist if the forecast had been right.

This gap is just far too large to be explained by the stimulus. The plan that Mr. Obama signed definitely has its flaws. It spends money more slowly than is ideal and spends some of it on projects of little long-term value. But no stimulus package could have come close to preventing 2.5 million job losses over six months.... When private economists began analyzing various stimulus proposals in January, they said that none would have a major effect on the jobless rate until the end of the year. By June, the effect would be only a few tenths of a percentage point, which translates into several hundred thousand jobs.

The stimulus that passed may in fact be having an impact of roughly this scale.... “Early results,” says Mark Zandi, [former McCain advisor and] chief economist of Moody’s Economy.com, “suggest the stimulus is performing close to expectations.” Obviously, though, the economy is not performing close to expectations...

As I understand matters, last December the median private-sector forecast had the unemployment rate topping out at 9% in the second half of 2009. The incoming Obama administration simply adopted that forecast. At the time I thought that was a mistake: (I thought that was a mistake: I thought they should have made a bifurcated forecast with a "good case" 80th-percentile scenario and a "bad case" 20th-percentile scenario; they should then have stressed that in the bad case we would need a large stimulus indeed to prevent high unemployment, and that in the good case we could restrain inflation via monetary policy.) By combining standard estimates of the effects of the fiscal boost package with that forecast, Jared Bernstein, Christie Romer, Steve Braun, Alan Krueger, and company came up with the "unemployment tops out at 8%" projected path for the economy that they put to bed a couple of days after New Year's and released at 6 AM EST Saturday, January 10, 2009.

By the end of January, when the Obama fiscal boost bill started working its way through congress, the situation had deteriorated significantly: things got worse in December as Christmas sales fell significantly below even recent expectations, et cetera. And here the Obama administration made its second mistake. The executive branch of the U.S. government is geared to do budget updates in two cycles six months apart: a January cycle and a July cycle. By the end of January the work on budget forecasting for the January cycle was well-advanced using the forecast as the transition had made it in mid-December. To change the forecast in early or mid-February to reflect the way the situation had changed over year-end would have required that OMB tear up a lot of estimation work and do it over at a time when the people in the NEOB are already working twelve-hour days to cope with all the extra work associated with a change of administration. I thought that they should have (a) changed the forecast and (b) simply not done the extra budget work: that they should simply have put an asterisk on every page of the budget saying that these numbers use the outdated mid-December rather than the current forecast. (In fact, I think the administration Troika should decouple its forecasts from the budget process, update them monthly, release them, and yet still feed them into the budget process only twice a year.) But, I think largely for these bureaucratic process reasons, they did not update their forecast. So by the time the stimulus bill was passed everyone's expectations were already that the 8% unemployment peak was way overoptimistic...

How about it guys? Can we get Steve Braun and company on a monthly forecast public update cycle decoupled from the budget process? It would improve the quality of information.

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Among other things, it would make it extremely difficult for things to happen like what happened to the Mankiw CEA over the winter of 2003-2004, when high politics appears to have reached down into the forecast, changed the table for payroll employment (and only payroll employment: the rest of the forecast is not out of line with contemporary professional forecasts), and produced an estimate for December 2004 (a) inconsistent with the rest of the forecast, and (b) high by 2.3 million in its estimate of payroll employment--all because Karl Rove and company thought it important to avoid headlines like "Bush administration forecasts 2004 payroll employment to be less than when Bush took office."

White House Media Affairs would have a much harder time pressuring the forecasters to produce a "rosy scenario" if the pressure has to be kept on month after month...

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Please Allow Me to Introduce Myself: I'm a Central Banker of Wealth and Taste...

Now other people are weighing in. Here are a bunch of smart reactions to my "Sympathy for Greenspan" piece.

First, some scene-setting:

Knut Wicksell some eighty years ago argued that the purpose of a central bank like the Federal Reserve is to manipulate the money stock so that the "market" rate of interest is equal to the "natural" rate of interest. The natural rate of interest is the rate of interest at which intended savings is equal to intended investment--at which the rewards to saving call forth enough abstinence from consumption on the part of households to equal business desires to try to make additional profits by expanding capacity.

Why have the central bank manipulate the money stock? After all, won't the market eventually get it right? Wicksell said that the key was the "eventually": if the money stock was too low then the market rate of interest would be above the natural rate, and you would have a prolonged period of unanticipated deflation (because demand for consumption and investment goods together would be below the value of production, which is equal to households' incomes) that would cause lots of unemployment until the price level had fallen enough to make desired money holdings low enough to reduce the market rate to the natural rate; if the money stock was too low then the market rate of interest would be below the natural rate, and you would have a prolonged period of inflation (because demand for consumption and investment goods together would exceed the value of production, which is equal to households' incomes) that would cause lots of unjust wealth redistributions until the price level had risen enough to make desired money holdings high enough to increase the market rate to the natural rate. Better to aid the market in its job via activist central-bank monetary policy.

Thus Wicksell gave economists and central bankers:

• a goal for monetary policy: to set the market rate of interest equal to the natural rate.
• a rationale for monetary policy: to quickly carry out the adjustments to the real money stock that the unaided laissez-faire market would carry out only slowly and painfully.
• a way to judge the central bank: it was doing its job of setting the market to the natural rate if there was neither unanticipated inflation--which would mean the market rate was too low--or unanticipated deflation--which would mean the market rate was too high.

You can think of Wicksell's insights this way: In a credit economy the market interest rate would always be equal to the natural interest rate that balances desired saving and desired investment. However, we live not in a credit but in a monetary economy in which the interest rate has to both balance supply and demand for investment and balance desired increases in people's cash holdings to the increase in the money supply. It cannot do both of those--not and keep full employment--unless the increase in the money supply is of exactly the right magnitude. The job of the Federal Reserve is thus to change us back so that even though we live in a monetary policy interest rates are as if we lived in a credit economy.

That was what Alan Greenspan was trying to do in the first half of the 2000s: to set the market rate of interest equal to the natural rate. And he succeeded: there was neither unexpected inflation nor unexpected deflation.

But was it a mistake for Greenspan to have carried out the mission that Knut Wicksell assigned him? Should he have pushed the market rate of interest above the natural rate--pushed investment, production, and employment below their credit-economy laissez-faire levels--in the interest of avoiding the growth of a housing bubble?

I don't know: http://delong.typepad.com/sdj/2009/06/three-or-four-mistakes-in-american-monetary-policy.html. But other people are willing to venture an opinion:

Mark Thoma:

Economist's View: I have argued the Fed's decision to keep interest rates low contributed to the bubble, but was not itself the sole cause of it. As to whether the Fed made a mistake, I'll just note that the tradeoff wasn't quite as stark as Brad implies, i.e. there were other policy instruments that Fed could have used to limit the housing bubble. Regulation is certainly one means the Fed had to that end, but Fed communication could have helped too. If Greenspan had, for example, told people to stay away from mortgages because they were toxic rather than implicitly encouraging them to invest in housing, things might have been different.

Would limiting the bubble through regulation, communication, or other means have limited the employment response, the primary worry? I don't think so, at least not enough to matter. The money would have been invested somewhere, housing had an opportunity cost after all, so the next best alternatives would have been pursued to the extent that they were profitable (and many would have been, just not as profitable - apparently anyway - as investing in housing and mortgages). So people still would have been employed somewhere as the money was invested, just not in housing, and that would have helped to insulate us from the housing crash. (And a lot of them might still have those jobs, unlike the people who depended upon the housing markets for employment.)

So narrowly, keeping interest rates low and employment high was the right thing to do. The mistake was letting all of the action brought about by those low rates, or most of it anyway, occur in a single sector, housing, rather than using regulation and other means to limit the flow of resources into the housing market in pursuit of profits based upon the misperception of risk. Those resources could have been redirected into other sectors and put to productive use rather than wasted building houses nobody wants, and achieving this result did not require the Fed to aggressively raise the target rate, it only needed to use the other tools it already had available.

Unfortunately, however, those tools were not used, and the ideology Greenspan brought to the Fed played a large role in this outcome.

Michael @ Bright Rights:

Bright Rights: The causes of the financial crisis: Brad Delong has a nice post outlining some of the mistakes the government made before or during the crisis. I agree with all of the three points listed at the beginning of his article, but I disagree with his comment on Greenspan's involvement. Brad DeLong states:

On Tuesdays and Thursdays I think that going forward central bankers must now also recognize that it is imprudent to lower interest rates in pursuit of full employment when doing so risks an asset price bubble. On Mondays, Wednesdays, and Fridays I think that even with the extra information about the structure of the economy we have learned in the past two years that Greenspan's decisions in 2001-2004 were prudent and committed us to a favorable and acceptable bet. And I am writing this on a Friday.

I think before explaining my point of view, let me explain something about Alan Greenspan. Alan Greenspan believed (I don't know if he still holds this view) that central bankers should not involve themselves in asset bubbles. According to Mr. Greenspan, it is too difficult to identify when something is actually a bubble, until after it blows up. I think this is an incredibly irresponsible opinion. But I think if you are going to take the view, as Brad DeLong does at the end of his post, that Greenspan's actions were reasonable at the time, you have to take into account how Greenspan would react if he lost this bet. If an asset bubble occurs, in my opinion a central banker needs to step in and try to deflate it before it creates a crisis. However, Greenspan didn't believe in deflating bubbles; he believed in dealing with them after they blew up. Taking this view into account, it seems unreasonable to me to say Greenspan's actions were correct. I think they were only correct if he would have been willing to deflate bubbles. But we know he wasn't.

David Beckworth:

Macro and Other Market Musings: Yes Brad, the Fed's Low Interest Rate Policy Was a Mistake: Brad Delong is wondering whether the Federal Reserves' low interest rate policy in the early-to-mid 2000s was truly a mistake:

There is, however, active debate over whether there was a fourth mistake: whether Alan Greenspan's decision in 2001-2004 to push and keep nominal interest rates on Treasury securities very very low in order to try to keep the economy near full employment was a fourth mistake...I am genuinely not sure which side I come down on in this debate.

Brad's uncertainty is understandable given he invokes the entire 2001-2004 time frame. For during this period there was a time when the U.S. economic recovery was sputtering along (2001-2002) and a time when the recovery began to take hold (2003-2004). It was during this latter period that Fed's low interest rates were a big mistake. But even for that period I think Brad is misreading the data:

People claim that the Greenspan Federal Reserve "aggressively pushed the interest rate below its natural level."... [T]he market interest rate[, however,] was if anything above the natural interest rate in the early 2000s: not accelerating inflation but rather deflation threatened. The natural interest rate was very low because, as Ben Bernanke explained at the time, the world had a global savings glut (or, rather, a global investment deficiency). You can argue--and on Tuesdays and Thursdays I will believe you--that Alan Greenspan's policies in the early 2000s were wrong. But you cannot argue that he aggressively pushed the interest rate below its natural level. The low interest rate was at its natural level.

I think the evidence shows the opposite. The natural interest rate is a function of individual's time preferences, productivity, and the population growth rate. Of these three components, the one that changed the most in 2003-2004 was productivity.... [A] rise in productivity growth should lead to a rise in the natural interest rate and ultimately, a rise in the federal funds rate for monetary policy to stay neutral. However, this latter development did not happen. It seems, then, the Fed did push its policy rate below the natural rate and in the process created a huge Wicksellian-type disequilibria. This interpretation of events has been borne out more rigorously in this ECB paper. One a more practical level, this disequilbria comes through in the Taylor rule which similarly shows the federal funds rate was below the neutral rate during this time.

It is also worth noting that these same rapid productivity gains were the source of the deflationary pressures in 2003 that Brad mentions. Thus, these deflationary pressures did not indicate a weakening economy. In fact, aggregated demand (AD) was growing at at rapid rate in 2003-2004 which, if anything, indicated an overheating economy. The figure below shows a measure of AD, final sales to domestic purchasers, relative to the federal funds rate and has the period 2003-2004 marked off by the dotted lines (click on picture to enlarge):

The productivity gains, apparently, were offsetting the upward pressure on prices being created by the robust growth in AD at this time. There simply was no real deflationary threat in 2003. By way of contrast, this figure shows for 2008-2009 what a real AD-induced deflationary threat looks like. Regarding the saving glut theory I would recommend Menzie Chinn's post here or my previous post here...

Greg Ip:

What the regulators did wrong | Free exchange | Economist.com: BRAD DELONG catalogues the consensus on three mistakes the Fed made leading up to and during this crisis, and also gives a balanced and anguished analysis of a fourth: whether Alan Greenspan erred in keeping interest rates as low as he did.

I agree with almost everything here, in particular that it was almost impossible at the time to believe the Fed was erring in holding rates too low. (If the error was so obvious, surely more people would have pointed it out at the time, even if not a majority of people, right?) That this does not look the right decision in hindsight is because the small risk of a catastrophic financial collapse was in fact realised.

Where I do disagree, however, is his faulting abandoment of principles-based regulation, which he says allowed the shadow banking system to grow as much as it did beyond the reach of regulation. In fact, the decision to let the shadow banking system grow as large as it did was a textbook example of principles-based regulation. In most of the markets that went awry, bank regulators ran the show, and in America bank regulation is principles-based.

Regulators pride themselves on closely monitoring banks' behaviour, often from inside the banks themselves. If they get worried, they quietly tap the bankers on the shoulder and suggest they do something differently. When troubles arise, they are often handled with a nonpublic order. And when an order becomes public it is devoid of useful information, such as what the bank did wrong.

Contrast this with the SEC, which is rules-based and will make an errant broker take a perp walk in front of the TV cameras as a lesson to his peers. This different approach is precisely why, during the 2008 debate about financial modernisation, people like Hal Scott wanted a single financial regulator to adopt the approach of the bank regulators rather than that of the SEC.

This principals-based approach can be very powerful: regulators can bar a merger, ban a banker or do any number of far-reaching things. But the fact of the matter is that the bank regulators choose which principles to live by. They had countless opportunities to rein in the shadow banking system and chose not to because the most important principle guiding their action was to safeguard the depository. The Fed oversaw bank-holding companies and in theory had oversight of the off-balance sheet and non-bank activities that got banks into trouble. It chose not to exercise that oversight as long as the rest of the entity was a “source of strength” to the depository. Regulators also did not force banks to keep full capital on hand for off-balance-sheet vehicles, because to do so would've frustrated the very purpose of them: to legally segregate risky assets from the depository. In both these instances bank regulators used a principals-based approach. They simply deprioritised the principles that would prove most important. They failed to look for potential sources of systemic risk and think creatively about how things that should not have threatened the bank in theory did in practice.

This is a cautionary tale to those who call for principles-based regulation. Just how it works in practice depends on the principles being observed.

Noam Scheiber:

Are We Too Hard On Greenspan? (Hint: Probably Not.) - The Stash: I guess my problem with this analysis is that I don't think it's right to lump the years 2001-2004 together. From early 2001 to early 2003, the economy was indeed very weak, and it's hard to quibble with Greenspan's decision to ease interest rates aggressively and stay easy. But by mid-2003, the economy was growing at a decent clip. It may not have been quite at full employment, but certainly stable. And yet Greenspan lowered the fed funds rate another quarter point to an eye-popping 1 percent in June of 2003, and kept it there through June of 2004. (And though the tightening began at that point, the fed funds rate was still at a mere 2.25 percent through January of 2005.) During the four quarters between June '03 and June '04, the economy grew at a real rate of 7.5 percent, 2.7 percent, 3 percent, and 3.5 percent. So when people talk about a monetary policy mistake, I think they're generally refering to that final year of easing, not the 2001 through mid-2003 period.

The stated reason for this continued easing was that Greenspan wanted to take out an insurance policy against deflation, of which there were some mild hints at the time, though even Greenspan referred to them as remote. In retrospect, this concern was probably unwarranted, as inflation chugged along either at or well-above the Fed's implicit target through all of 2004. Worse, all the easing appears to have resulted in a massive real estate bubble.

But, as DeLong says, the question isn't whether a policymaker is wrong in retrospect. The question is whether he or she made a reasonable bet at the time. DeLong thinks maybe. I lean the other way. Here's why: DeLong's defense of Greenspan hinges on the idea that, if it turned out the Fed was wrong about the necessity of easing--so wrong it created a bubble that later popped and threatened a deflationary spiral--the Fed had enough powerful tools at its disposal to prevent a depression at that point.

Three or Four Mistakes in American Monetary Policy?

http://www.project-syndicate.org/commentary/delong91

In the circles in which I travel, there is near-universal consensus that here in America our monetary philosopher-princes have made three serious mistakes. This consensus is almost always qualified by fervent declarations that we have been very well served by our Federal Reserve chairs and others since at least Paul Volcker's accession to the chair at the end of the table in the Eccles' Building's conference room, and that each of us who has not sat in that chair knows that he or she would have made worse mistakes, but nevertheless there is a consensus that mistakes were made when:

• the Federal Reserve and the Treasury decided to nationalize AIG rather than to support AIG's counterparties last fall, allowing financiers to pretend that their strategies were fundamentally sound rather than things that would have shut down their firms had the Feds not paid AIG's bills.

• the Federal Reserve and the Treasury decided to let Lehman Brothers go into an uncontrolled bankruptcy last fall in order to try to teach financiers that having an ill-capitalized counterparty was not riskless and that people should not expect the government to come to their rescue always.

• the long-ago decision was made to eschew principles-based regulation and allow the shadow banking sector to grow unregulated with respect to its leverage and its compensation schemes in the belief that government regulation of finance should be minimal and that the government's guarantee of the commercial banking system was enough to keep us out of messes like the one we are currently in.

As I said, there is near-universal consensus in the circles in which I travel that these were mistakes and serious mistakes--and it is as certain as it is that the sun will rise in the east tomorrow morning that monetary policymakers will not make these mistakes again.

There is, however, active debate over whether there was a fourth mistake: whether Alan Greenspan's decision in 2001-2004 to push and keep nominal interest rates on Treasury securities very very low in order to try to keep the economy near full employment was a fourth mistake. Should Alan Greenspan have kept interest rates higher and triggered a much bigger recession with much higher unemployment back then in order to head off the growth of a housing bubble? If we push interest rates up, Alan Greenspan thought, millions of extra Americans will be unemployed and without incomes to no benefit--they will not enjoy the prolonged "staycations" they will be taking, and the rest of us won't have the stuff they could make. If we allow interest rates to fall, Alan Greenspan thought, these extra workers will be employed building houses and making things to sell to all the people whose incomes come from the construction sector and making things to sell to the people whose incomes come from making things to sell to people whose incomes come to the construction sector. Full employment is better than high unemployment if both can be accomplished without inflation, Alan Greenspan thought. If a bubble does develop, and if the bubble does not deflate but crashes, and if the crash threatens to cause a depression--well, Greenspan thought, then will be the time to deal with that, and the Federal Reserve is a very powerful institution with policy tools that can short-circuit that chain leading to catastrophe at any point.

With hindsight Alan Greenspan was wrong. Catastrophe does stare us in the face. His policies have crapped out. But not every good policy is certain to have a good outcome. The question is: was the bet that Alan Greenspan made a favorable one? Whenever in the future we find ourselves in a situation like 2003 should we try to keep the economy near full employment even at some risk of a developing bubble?

I am genuinely not sure which side I come down on in this debate. Central bankers have long recognized that it is imprudent to lower interest rates in pursuit of full employment if the consequence is an inflationary spiral in wages, resource prices, or consumer prices. On Tuesdays and Thursdays I think that going forward central bankers must now also recognize that it is imprudent to lower interest rates in pursuit of full employment when doing so risks an asset price bubble. On Mondays, Wednesdays, and Fridays I think that even with the extra information about the structure of the economy we have learned in the past two years that Greenspan's decisions in 2001-2004 were prudent and committed us to a favorable and acceptable bet. And I am writing this on a Friday.

I do, however, know that the way the issue is usually posed is wrong. People claim that the Greenspan Federal Reserve "aggressively pushed the interest rate below its natural level." But what is the natural level of the interest rate? Swedish economist Knut Wicksell defined the natural rate of interest in the 1920s: it is the interest rate at which, economy wide, desired investment is equal to desired savings and hence in which there is neither upward pressure for consumer price, resource price, and wage inflation to accelerate as aggregate demand outruns supply nor downward pressure on those three inflation rates as demand falls short of supply. On Wicksell's definition--which is the best, in fact, to my knowledge the only definition--the market interest rate was if anything above the natural interest rate in the early 2000s: not accelerating inflation but rather deflation threatened. The natural interest rate was very low because, as Ben Bernanke explained at the time, the world had a global savings glut (or, rather, a global investment deficiency).

You can argue--and on Tuesdays and Thursdays I will believe you--that Alan Greenspan's policies in the early 2000s were wrong. But you cannot argue that he aggressively pushed the interest rate below its natural level. The low interest rate was at its natural level. Rather, Greenspan's mistake--if it was a mistake--was his failure to overrule the market and aggressively push the interest rate up above its natural rate, thus deepening and prolonging the recession that started in 2001.

It's Friday, and I don't think Greenspan's failure to push the interest rate up above its natural rate to generate high unemployment and head off the growth of a mortgage-finance bubble was a mistake. There were mistakes--other places where the chain that has generated the catastrophe that faces us should have been interrupted. But today at least I don't think Greenspan's unwillingness to overrule the market's choice of the natural interest rate was one of them.

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Open publication - Free publishing - More wicksell

Can the Federal Reserve Shrink the Money Stock Rapidly Now that It Can Pay Interest on Reserves?

Tyler Cowen asks:

Marginal Revolution: Paying interest on reserves, and why it should be easy to disarm future inflationary pressures. Do I believe it?

The correct answer is "maybe."

If inflationary pressure comes because banks and others regain their confidence and seek to move their excess reserve deposits into higher-yielding dollar denominated assets, then the Federal Reserve can fix that with a flick of its wrist by raising the interest rate on deposits.

If inflationary pressure comes because banks and others fear a large dollar depreciation and seek to move their excess reserve deposits into non-dollar denominated assets, then the Federal Reserve is helpless, and the situation is dire--unless the Federal Reserve has gotten the authority to issue bonds and has preemptively used that authority to mop up the excess liquidity.

Paul McCulley of PIMCO:

PIMCO - Global Central Bank Focus June 2009 Exit Strategy: Most rational investors accept the dual proposition that a Fed funds rate pinned against zero and near-$800 billion of excess reserves sloshing around the banking system are not enduringly sustainable. This is the case despite the fact that most – though a smaller most – applaud the Fed for engineering these outcomes, so as to cut off the fat tail risk of deflationary Armageddon. The consensus overwhelmingly holds that once that fat tail has been cut off and then killed, borrowing from Colin Powell’s famous description of America’s strategy for running Iraq out of Kuwait, it will be necessary for the Fed to exit its extraordinarily accommodative strategy, hiking the Fed funds rate and soaking up all those excess reserves. It’s hard to argue with the basic thrust of this exit thesis. Because it’s basically right!

I must admit, however, that I’m perplexed that so many pundits put so much emphasis on the importance of the Fed soaking up excess reserves, as if it is a necessary condition for hiking the Fed funds rate. It is not. To be sure, it used to be, before the Fed had the legal authority to pay interest on reserves, which Congress granted last fall. Before then, the only way the Fed could achieve a meaningfully positive Fed funds rate target was to constrain the supply of reserves relative to the banking system’s demand for reserves, essentially required reserves. If there were excessive excess reserves, then the Fed funds rate would fall below the Fed’s target, as banks with excess would be willing to lend them out in the Fed funds market below the Fed funds target, given that if they simply left them at the Fed, they would earn nothing. But now, the Fed pays interest on banks’ excess reserves (presently at an interest rate of 0.25%, the top of the Fed’s 0% – 0.25% target band for the Fed funds rate). Thus, logic says that banks with excess reserves will not lend them in the Fed funds market at a rate appreciably lower than the Fed pays, but simply leave them on deposit at the Fed. Accordingly, the rate that the Fed pays on excess reserves should now act as a proximate floor for the Fed funds rate, even if there are huge excess reserves in the system. Thus, by hiking the rate it pays on excess reserves, the Fed now has the ability to enforce a rising Fed funds rate target – even before it “unwinds” its bloated balance sheet....

The Federal Reserve’s approach to supporting credit markets is... credit easing... focuses on the mix of loans and securities that it holds and on how this composition of assets affects credit conditions.... [C]redit spreads are much wider and credit markets more dysfunctional in the United States today than was the case during the Japanese experiment with quantitative easing. To stimulate aggregate demand in the current environment, the Federal Reserve must focus its policies on reducing those spreads and improving the functioning of private credit markets more generally.... When markets are illiquid and private arbitrage is impaired by balance sheet constraints and other factors, as at present, one dollar of longer-term securities purchases is unlikely to have the same impact on financial markets and the economy as a dollar of lending to banks, which has in turn a different effect than a dollar of lending to support the commercial paper market.... [T]he stance of Fed policy in the current regime – in contrast to a QE regime – is not easily summarized by a single number....

Yes, I know that many of your eyes are probably glazing over about now, given my (and Ben’s) wonkishness. I’m sorry about that, but this is really, really important stuff to understand, given the widespread yammering about the need for the Fed to have an exit strategy to de-create all the excess reserves it has created, as if they are intrinsically the kindling for an (eventual) rip-roaring inflationary fire. They are not.... [W]e can categorically say that the near-zero Fed funds rate is not, for the moment, fueling an inflationary pace of aggregate demand growth.... And neither is the Fed’s Credit Easing.... Yes, in the fullness of time, zero Fed funds could conceptually re-ignite borrowers’ and lenders’ mojo. Indeed, that’s precisely the Fed’s objective. And if and when that objective is achieved, the Fed funds rate will need to be hiked.... But right now, the least of my worries, and I think the Fed’s, too, is the prospect for an overheated economy, putting too many idled resources, both labor and industrial capacity, back to work too quickly... it would be delightful if that were our primary worry! But it isn’t....

Chairman Bernanke and a number of his colleagues have talked about all these various tools, stressing they have plenty of potential doors in their exit strategy. And indeed they do, even though simply hiking the rate the Fed pays on excess reserves is the cleanest way to hike the Fed funds rate...

In Which Stanford Economist John Taylor Adopts the False, Exploded "Treasury View" of More than Eighty Years Ago...

You know, it is very odd: When nominal interest rates on short-term Treasury securities are at their normal levels--4% or 3% or even 2% per year--I am among the very first to declare that discretionary fiscal policy has no proper role to play, and that the task of managing the business cycle should be left to the fiscal automatic stabilizers and to the Federal Reserve.

But things are--as we economists have known for nearly a century--different when short-term safe nominal interest rates are at their floor to make safe short-term bonds nearly perfect substitutes for cash, for then the standard mechanisms of monetary policy--flooding the system with cash and relying on the fact that holding wealth in cash is expensive (for it means that you forego interest) to trigger a rise in spending--is not guaranteed to work. And then fiscal policy has a place. To deny that fiscal policy has a place is then, it seems, to me, to fail the most basic test of thinking like an economist. As John Hicks put it back in 1937, we know that the speed at which people spend their cash--the velocity of money--is a function of the short-term safe nominal interest rate. And we know that the velocity of money becomes very elastic as the short-term safe nominal interest rate becomes very low:

On grounds of pure value theory, it is evident that the direct sacrifice made by a person who holds a stock of money is a sacrifice of interest; and it is hard to believe that the marginal principle does not operate at all in this field. As Lavington puts it:

The quntity of resources which (an individual) holds in the form of money will be suh that the unit of money which is just and only just worthwhile holding in this form yields him a return of convenience nad security equal to the... net rate of interest.

The demand for money depends upon the rate of interest!...

It is not only possible to show that a given supply of money determines a certain relation between [national] income and interest... it is also possible to say something about the shape of the cure. It will probably tend to be nearly horizontal on the left.... If is lies to the right, then we can indeed increase employment by increasing the quantity of money; but if IS lies to the left [and short-term safe interest rates are at their minimum], we cannot do so; merely monetary means will not force down the interest rate any further...

and we have to resort to fiscal policy and banking policy--things that affect not the quantity of money but the flow-of-funds through financial markets.

Now, however, we have to add John Taylor to the votaries of the 1920s-era "Treasury View": the claim that fiscal policy must be ineffective. He is thus one of those who, as Olivier Blanchard puts it, does not know things that Irving Fisher and Knut Wicksell (or at least John Hicks) knew.

Why John Taylor believes in the "Treasury View" is not at all clear. Paul Krugman writes:

The virus is spreading: I just taped Fareed Zakaria with John Taylor, who is a fine economist. But if I understood John’s position, it was that fiscal expansion is actually contractionary, because deficits drive up interest rates, unless the fiscal expansion takes the form of permanent tax cuts...

I'm not so sure about Taylor. The last paper of his I cracked... wasn't impressive. It was supposed to show that fiscal policy could not be powerful. And it didn't deliver.

Here's what I had to say about it at a conference at Stanford early in May:

Tuesday afternoon I sat down to... Cogan, Cwik, Taylor, and Wieland (2009).... I dug--and found that Cogan et al.’s claim [that they and the Obama administration had analzyed] “exactly the same policy change” was simply wrong. Romer-Bernstein model an increase in government spending with the Federal Reserve expanding and keeping on expanding the money supply in order to keep the short-term Treasury Bill interest rate the same. Taylor (1993) models an increase in government spending with the Federal Reserve contracting the real money supply to push the short-term Treasury Bill interest rate up over time as unemployment falls and inflation creeps up. There is no “robustness” problem with Romer-Bernstein at all: the results are different because the policy changes are different.

“Geez,” my first thought was, “this is embarrassing--none of four coauthors of Cogan actually read Romer-Bernstein at all carefully. Sloppy.” Then I got to page 5 of Cogan: “Romer and Bernstein assume that the Federal Reserve pegs the interest rate....” Cogan et al. know perfectly well that the policy changes are not “exactly the same.” They just say they are.

I am sorry. In Europe that gets you four red cards. In America that gets you sent to the showers. The first intellectual responsibility of critique is to accurately present what you are critiquing. When Cogan et al. learn that they can come back into the game. But not until then.

What is their explanation for not telling us up front that they are assuming a different monetary policy? They give none. What is their explanation for assuming a different fiscal policy? It is this:

Romer and Bernstein assume that the Federal Reserve pegs the interest rate—the federal funds rate—at the current level of zero.... [S]uch a pure interest rate peg is prohibited in new Keynesian models with forward-looking households and firms because it... lead[s] to instability and non-uniqueness.... Inflation expectations of households and firms become unanchored and unhinged and the price level may explode in an upward spiral….

In short, the monetary policy rule that Romer and Bernstein believe that the Federal Reserve is following makes fiscal policy incredibly powerful: so powerful that the level of nominal spending explodes. So we are going to make a different assumption about monetary policy that makes fiscal policy weak because we assume the Federal Reserve neutralizes the effects of government spending.

Do they provide any reason to justify their monetary policy assumption--any reason to believe that the Federal Reserve is currently engaged in raising short-term interest rates to neutralize the effects of fiscal expansion? No, they do not.

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Open publication - Free publishing - More macroeconomics

Fiscal Policy Watch: Anyone Have a Good Feeling About the Next Employment Report? Anyone? Anyone? Bueller?

I certainly don't.

And once again I am reminded of the two rules for understanding the world:

1. Paul Krugman is right.
2. If you ever think Paul Krugman is wrong, refer to rule #1.

Paul Krugman:

What I was afraid of: Back in March, when I was lamenting the inadequate size of the Obama stimulus, I made this prediction:

Republicans are now firmly committed to the view that we should do nothing to respond to the economic crisis, except cut taxes — which they always want to do regardless of circumstances. If Mr. Obama comes back for a second round of stimulus, they’ll respond not by being helpful, but by claiming that his policies have failed.

And I laid out the following scenario:

So here’s the picture that scares me: It’s September 2009, the unemployment rate has passed 9 percent, and despite the early round of stimulus spending it’s still headed up. Mr. Obama finally concedes that a bigger stimulus is needed. But he can’t get his new plan through Congress because approval for his economic policies has plummeted, partly because his policies are seen to have failed, partly because job-creation policies are conflated in the public mind with deeply unpopular bank bailouts.

It’s only June, but Republicans are already claiming that the Obama economic plan has failed. (Yes, that’s insane — hardly any of the money has flowed to the economy yet — but this was predictable.) Meanwhile, unemployment is already above 9 percent. And the green shoots are looking browner by the week, especially on the jobs front: new claims for unemployment insurance are stubbornly running at more than 600,000 a week, far above the 350,000 or so that would be consistent with a stable unemployment rate.

We really do need a bigger stimulus. But it’s going to be hard slogging.

I understand that last December we thought (wrongly) we had a one-quarter long and not a two-quarter long collapse in the economy and thus that the unemployment rate could be kept from rising above 8%. I understand the (wrong) judgment that Congress would increase and make more effective rather than diminish and make less effective whatever stimulus program bid Obama put on the table. But what I don't understand is the failure to understand that a too-big fiscal boost package could be neutralized by the Federal Reserve's raising interest rates while a too-small package could not be further boosted by the Federal Reserve's lowering interest rates, and hence that prudent policy last December involved at least planning for a fiscal boost package that would then look very large indeed.

Remember: World War II-style deficit spending was needed to get the unemployment rate down from 10% to 3%, suggesting to me at least that a truly effective fiscal boost capable of doing half that would have to be a quarter to a third of large. And we are not there: we are far from there:

Americans Keep Getting Fired...

From the Department of Labor:

ETA Press Release: Unemployment Insurance Weekly Claims Report: In the week ending June 20, the advance figure for seasonally adjusted initial claims was 627,000, an increase of 15,000 from the previous week's revised figure of 612,000. The 4-week moving average was 617,250, an increase of 500 from the previous week's revised average of 616,750...

Unemployment is still going up for quite a while...

The Federal Reserve

It watches and waits:

Full text: Fed statement:

Information received since the Federal Open Market Committee met in April suggests that the pace of economic contraction is slowing. Conditions in financial markets have generally improved in recent months. Household spending has shown further signs of stabilizing but remains constrained by ongoing job losses, lower housing wealth, and tight credit. Businesses are cutting back on fixed investment and staffing but appear to be making progress in bringing inventory stocks into better alignment with sales. Although economic activity is likely to remain weak for a time, the Committee continues to anticipate that policy actions to stabilize financial markets and institutions, fiscal and monetary stimulus, and market forces will contribute to a gradual resumption of sustainable economic growth in a context of price stability.

The prices of energy and other commodities have risen of late. However, substantial resource slack is likely to dampen cost pressures, and the Committee expects that inflation will remain subdued for some time.

In these circumstances, the Federal Reserve will employ all available tools to promote economic recovery and to preserve price stability. The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period. As previously announced, to provide support to mortgage lending and housing markets and to improve overall conditions in private credit markets, the Federal Reserve will purchase a total of up to $1.25 trillion of agency mortgage-backed securities and up to $200 billion of agency debt by the end of the year. In addition, the Federal Reserve will buy up to $300 billion of Treasury securities by autumn. The Committee will continue to evaluate the timing and overall amounts of its purchases of securities in light of the evolving economic outlook and conditions in financial markets. The Federal Reserve is monitoring the size and composition of its balance sheet and will make adjustments to its credit and liquidity programs as warranted.

Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; Elizabeth A. Duke; Charles L. Evans; Donald L. Kohn; Jeffrey M. Lacker; Dennis P. Lockhart; Daniel K. Tarullo; Kevin M. Warsh; and Janet L. Yellen.

In My Inbox: Public Economic Argument

A corresopondent writes:

Dear Professor DeLong:

This fall I am teaching a section of the required freshman writing course at Malefactor of Great Wealth University, a course that emphasizes the analysis of argument and other related rhetorical skills, as well as instruction and practice in academic writing. All sections are organized around a single issue, and I have chosen to focus on public argument on the economy leading up to and following the events of late 2008.

I have been enjoying your blog and the fine array of links. My main question for you is this: can you recommend any good, short primers that can provide my students with enough economic literacy to be able to follow the public arguments made by, say, Alan Greenspan or Paul Krugman?

I would also be curious to know your answer to the following: What would you as an economist say to a member of the public who did not have an extensive economic education but nevertheless was trying to decide, say, what public economic policies to support? Is it a matter of picking the right experts to trust?

Thanks very much for your time and consideration!

Candidate for MA in Rhetoric and Freshman Writing Instructor
Malefactor of Great Wealth University
Sunny City, USA

My answer:

Oyyyy...

The problem is that everything I can think of takes a side (the fact that I think one side is clearly right is not of much help for your purposes)...

I can think of three things to do:

1. Set them to read, as preliminary background, one nineteenth-century book, Walter Bagehot's Lombard Street, and one early twentieth century book, John Maynard Keynes's Tract on Monetary Reform. There is a possibility of some confusion: when people today say "Keynesian" they mean late Keynes, and the Tract is early Keynes. But if that is made clear, it should work well: those two lay out pretty much all the issues and do so in a historical context divorced from today...

2. Set them to read, as preliminary background, the paperback macroeconomics half of Krugman and Wells's introductory economics textbook...

3. Set them to read, as preliminary background, the macroeconomics half of Cowen and Tabarrok's forthcoming introductory economics textbook...

As to your second question, all I can say is that I am trying as hard as I can in lots of different forums, with as best as I can see no success...

Better suggestions, guys?

Yours,

Brad DeLong

More on the Romer Symposium at the Economist

I confess that I think Alan Meltzer's contribution to the Christie Romer symposium at the Economist ill-advised for two reasons. Meltzer writes:

Romer roundtable: Think, plan, and tell us the plan: CHRISTINA ROMER... like generations of policymakers before her... counsels "trust us"... [I]t was they who allowed banks to circumvent the Basel regulations, that permitted Fannie and Freddie to expand beyond any reasonable standard, that brought us too big to fail and, as John Taylor has shown, abandoned a policy that brought us almost 20 years of the Great Moderation....

[L]ike most other defenders of this inflationary, low productivity policy, Christina puts the choice as whether we act against recession now or against inflation now. That leaves out a multitude of options.... [Y]es, stimulate now to reduce unemployment, but avoid creating a big inflation in a year or two. And even announce in advance how you propose to reduce the high money growth rate and the excessive deficits. Don't just say you'll do it, think, plan, and tell us the plan.

The first reason that it is ill-advised is that Meltzer really should not be claiming that Christina Romer is one of the "they" who "allowed banks to circumvent the Basel regulations... permitted Fannie and Freddie to expand... abandoned a policy that brought us almost 20 years of the Great Moderation..." Christie has not been doing any of these things. She has been sitting in her southeast corner office on the sixth floor of Berkeley's Evans Hall lecturing about monetary policy before, during, and since the Great Depression. If Meltzer wants to blame the actions of the American conservative politicians he has consistently voted for and the officials they appointed for our current mess, fine. But to say that Christie Romer = Phil Gramm because both are "policymakers" is simply wrong.

The second reason that it is ill-advised is that Meltzer misleads when he implies that the Obama administration and the Federal Reserve have not "announce[d] in advance how [they] propose to reduce the high money growth rate and the excessive deficits..." The Obama administration wants, as OMB Director Peter Orszag explains every hour on the hour, to balance America's long-run budget by reducing the extraordinary economic inefficiency of the American health-care system via health care reform. The fact that the people staffing the executive branch are in large part those who in the Clinton administration did such great work at bringing America's public sector back toward fiscal balance in the 1990s (but whose work was then largely undone by the American conservative politicians Alan Meltzer has consistently voted for and the officials they appointed) should give observers some confidence that they will at least try to reduce excessive deficits. At the very least Alan Meltzer should not be claiming that they have not told us how they intend to do so.

The same applies to the Federal Reserve, which Meltzer implies needs to "tell us the plan." I have found the Federal Reserve extremely eager and anxious to explain how it intends to unwind the large increase in the money supply when monetary velocity starts to recover. The basic problem, I learned back in my first year of graduate school, is that the central bank's ability to soak up excess liquidity in an economy and reduce the supply of "monnaie" is limited by its balance sheet: it needs to be able to induce banks to part with their cash by offering them something else to hold, and the Fed cannot offer what it does not itself have to trade. The solution the Federal Reserve is proposing is to allow it to create additional kinds of liabilities on its balance sheet. If congress grants the Federal Reserve the power to accept not just interest-free but interest-paying reserve deposits (which it has) and the power to issue and sell its own interest-bearing bonds (which I hope it will), then the Federal Reserve will have no trouble reducing the transactions balances that make up our monetary base when it wishes to do so. Once again, we have already been told the plan--and it is unfair to claim that Bernanke and company have not told us.

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.

1429 words

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Preview on posterous

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Posted via email from http://braddelong.posterous.com/comment-for-the-economist-on-christina-romer at Brad DeLong's Scrapbook

I See No Green Shoots Here...

Macroeconomic Advisers estimates that GDP in the second quarter fell at a 1.3% annual rate:

Now we will get to see whether fiscal contraction by the states will set off another round of cliff-diving in the third quarter...

Had I known last November what I know now, I would then have been pushing federal fiscal stimulus at $800 billion rather than $400 billion per year.

And We Are Not Yet at the Bottom...

Rex Nutting:

Industrial production slumps 1.1% in May: The nation's industrial output tumbled 1.1% in May, led by big drops in motor vehicles, mining and high-technology products, the Federal Reserve reported Tuesday. The decrease was a bit worse than forecasts of a 1% drop. April's output was revised lower, to a decrease of 0.7% from 0.5% reported earlier. See Economic Calendar.

Output fell to the lowest level in 11 years in May, and is down 13.4% in the past year, the largest year-over-year decline since 1946. Output has fallen in 16 of the past 17 months since the recession began in December 2007. Since that month, industrial output is down 14.8%. Read the full report.

Capacity utilization in industry fell to a record-low 68.3% last month, down from 69%. Capacity utilization -- a key measurement of slack in the economy -- stands 12.6 percentage points below its long-term average. In manufacturing alone, capacity utilization fell to a record-low 65%. The government has tracked capacity data since 1948...

Today's "Green Shoots? What Green Shoots?" Lesson...

Cartoon drawn by David Sipress

---

Paul Krugman is... Jeremiah!:

Unemployment claims and employment change - Paul Krugman Blog - NYTimes.com: New claims for unemployment insurance are one of the highest-frequency economic indicators we have — that is, the data come in early and often, giving a quicker read than things like employment numbers and unemployment rates. And there’s been some celebrating over the fact that new claims seem to have peaked.

But the level of new claims is basically an indicator of the rate of change of employment. And we are nowhere near the point at which employment looks ready to expand, or for that matter to stop falling at a terrifying rate.

Here’s a plot of new claims (4-week average) (red, right scale) versus the monthly decline in payroll employment (blue, left scale). What the figure suggests is that to stabilize employment, we’d have to see new claims drop below 400,000 or so. We’re nowhere near that point. In fact, a read of the data remains very, very grim.

The cantor will now lead the congregation in that old standby: "Woe is upon us! For He is trampling the unrighteous with hooves of red-hot iron!"

Warning: Socratic Dialogue

I have never seen this before. From the Economist:

The price of debt, and the cost | Free exchange | Economist.com: This is somewhat curious, as Brad DeLong points out today (warning: Socratic dialogue)...

Is there a standard warning sign that a Socratic Dialogue is ahead? What would it look like?

Department of "Huh?" (Eric Zitzewitz Department)

Justin Wolfers gives the keys to the freakonomicsmobile to Eric Zitzewitz:

Krugman vs. Ferguson: Letting the Data Speak: Why Have Long-Term Interest Rates Risen? There’s no debating that long-term interest rates on government debt have risen. But there’s a pretty fierce debate about what it means. Harvard historian Niall Ferguson interprets this as indicating that the bond market is worried about the U.S. deficit and the prospect of inflation. Princeton economist Paul Krugman thinks it indicates that worries about deflation have eased. It’s a high-stakes debate: Professor Ferguson is arguing that the stimulus package has counterproductively stimulated inflation fears, while Professor Krugman thinks the stimulus has worked as intended by reducing the likelihood of deflation. In fact, Krugman has argued for another dose of fiscal stimulus.

So who is right?... Resolving their debate requires measuring the likelihood of different inflation scenarios. Let’s do it. The graph below plots the probability of different outcomes for the yield on 25-year Treasuries on two different dates — late February and the end of last week.... The blue line shows that there was a lot of uncertainty about future Treasury yields in February, including a very large chance of very low interest rates, as in Krugman’s deflation scenario. But the green line shows that this deflation risk appears to have receded. In fact, the recent increase in Treasury yields is almost entirely due to a reduction in the probability of the deflationary (low nominal interest rates) scenario. Score this round for Krugman...

OK. Zitzewitz is out of the driveway and the car is still running. He has, how ever, run over the mailbox and crushed it into smithereens. The graph should, I think, say not "Option-Implied Probability Distribution" but instead "Risk-Neutral Option Pricing-Implied Probability Distribution." But the car is still rolling down the street because Zitzewitz does say--correctly--that Krugman is right and Ferguson is wrong: rates have risen because the fear of deflation has ebbed and not because the fear of inflation has grown (in fact, he claims the fear of inflation is less than it was in February).

But then Zitzewitz wraps the freakanomicsmobile around a tree:

While Ferguson wrongly diagnosed the cause of the rise in interest rates, he is right that the markets are spooked about the risk of an inflationary breakout. There’s about a 7 percent chance that 25-year interest rates will exceed 10 percent.... This is a fairly extreme scenario: long-term interest rates have not been above 10 percent since inflation was tamed in the mid-1980’s. So there’s a chance that Professor Ferguson may be right about the broader issue: now that deflationary worries seem to have eased, it might be time to start turning the fiscal policy battleship around...

No, no, and no. It is not that the market thinks that there is a 7% chance that the 25-year Treasury nominal rate will exceed 10% in January 2011. Rather, the probability that the 25-year Treasury will exceed 10% in Jaunary 2011 times the scaled marginal utility factor for how much you fear Treasury rates above 10% together equal .07 when you normalize values so that the sum over the entire probability distribution of the scaled marginal utility factors is equal to one. (I know that that is totally incomprehensible, but that does make sense.)

The chance that 25-year Treasury rates will be above 10% in January 2011 is more like 1% or maybe 2%: it is not 7%.

To say that there is a 7% chance that the 25-year Treasury rate will be above 10% in only 19 months is to say something bizarrely misleading.

Someone please call AAA...

We Hicksian Economists Should Be Confident that We Know Something...

Looking at forthcoming U.S. Treasury bond issues:

I do understand why people who think about supply-and-demand expect this tsunami of bonds to push down the prices and push up the interest rates on Treasury bonds a lot.

The argument that it will not do so but will instead boost spending is an old argument--more than three-quarters of a century old--but it is somewhat subtle.

The fact that U.S. Treasury bond prices did not collapse the moment the magnitude of the U.S. government's 2009 and 2010 fiscal deficits became clear is the one thing that gives me substantial confidence that we Hicksian economists do actually know something about how the world really works.

A Sokratic Dialogue: Liquidity Preference, Loanable Funds, and European Hedge Funds that Fear the Collapse of U.S. Treasury Bond Prices

Meno: I haven't seen you since spring classes ended.

Adeimantos: I have been away: Paris. London. Frankfurt.

Meno: Oh. Pleasant? Interesting?

Adeimantos: Not really interesting--too jet-lagged, so I sit in my hotel room in my underwear, read the Economist and Financial Times,, and reflect on how if in my 20s I had been in a fancy hotel in central Paris with someone else paying I would have thought I was in heaven, but that now I am just tired. Thus not too pleasant either.

Meno: Middle age is a shipwreck?

Kephalos: It gets worse...

Adeimantos: However, it was somewhat lucrative: talking to European hedge funds.

Meno: And what do European hedge funds think?

Adeimantos: They look at things like this:

Then they demand that I tell them why U.S. Treasury bond prices have not already collapsed (and Treasury interest rates risen) in anticipation of this forthcoming tsunami of bond issues. Given that Treasury bonds have not yet collapsed they are very very bearish about U.S. Treasury bond prices and interest rates. Supply and demand. The supply of U.S. Treasury bonds is about to become huge, and when supply goes up price should go down.

Sokrates: But if that argument is correct, then rational profit-seeking traders should already have sold U.S. Treasury bonds and already have pushed their prices down in anticipation of the sudden increase in supply...

Meno: Are you Sokrates or Milton Friedman?

Kephalos: There are two supply-and-demand arguments that can be made here. The first is that the supply of U.S. Treasury bonds is about to jump enormously--and so by supply-and-demand the price will be low once the extra bond issues hit the market, and should be low now in anticipation of this low-price Treasury bond market equilibrium. The second is that the inverse of the price of U.S. Treasury bonds--the Treasury nominal interest rate--is the price of liquidity: the amount of interest income you forego by keeping your wealth in cash rather than in securities. According to this second argument, the supply-and-demand is the supply and demand for cash: when the supply of cash is high, the price of liquidity is low, and since the price of liquidity is the short-term Treasury interest rate the short-term Treasury interest rate should be very low.

Adeimantos: Which it is...

Kephalos: And the long-term Treasury interest rate is the average of expected short-term future Treasury interest rates. Since the Federal Reserve has flooded the economy with cash and will keep flooding it with cash for the foreseeable, Treasury interest rates should be low which means Treasury bond prices should be very high--which they are--and stay high.

Adeimantos: Loanable funds vs. liquidity preference.

Sokrates: So, Kephalos, with your impeccable logic and deep wisdom derived from a long career financing expeditions to the shores of the Black Sea, you have presented us with two different supply-and-demand arguments, one saying that Treasury bond prices should be low and hence are about to collapse, and the other saying that Treasury bond prices should be high and are likely to stay more-or-less where they are for some time to come.

Meno: Which argument is right? Is the price of bonds the price that balances the supply and demand for bonds in the bond market? Or is the price of bonds the inverse of the interest rate which balances the supply and demand for cash in the money market? Both cannot be true, can they?

Adeimantos: Ah. But both arguments are true...

Meno: Why do I get the feeling that I am being cast as the dumb straight man in this dialogue?

Sokrates: Because you are a sophist and we are philosophers. We write the dialogues, and we write them to make ourselves look good so that everyone thinks that philosophers are the roxxor and sophists are lame...

Meno: What have I ever done to you?

Glaukon: Tried to take our students and their fees, perhaps?

Sokrates: And we have won. There are now departments of philosophy everywhere. But when was the last time you saw a department of sophistry?

Meno: OK. I will take up my role: Kephalos: Can you explain to me how two perfectly-coherent supply-and-demand arguments lead to opposite conclusions? And if both arguments are coherent, why do European hedge funds all believe the first?

Kephalos: I can answer the second question but not the first: European hedge funds live in the bond market and they see the supply and demand of bonds all day, so that is the market they believe is most important...

Adeimantos: That is true about European hedge funds. But, Meno, the way you have posed the issue is somewhat misleading. It is not which supply-and-demand argument is correct--for both are: the price/interest rate on Treasury bonds clears both the bond and the money market, both loanable funds and liquidity preference. It is how does the economy adjust in order to make the Treasury bond price/interest rate clear both these markets.

Meno: And I have the feeling that you are about to tell me...

Adeimantos: Let's start with an economy in equilibrium--where Treasury bond prices are such as to satisfy both loanable funds and liquidity preference, so that everyone is happy to hold the bonds given their current price and everyone is happy to hold the economy's cash supply given the current interest rate. Now suppose the Treasury issues a huge honking tranche of bonds (and Obama spends the money hiring the unemployed to give people cholesterol screenings on the street and hand out statins). Now the supply of bonds is greater than demand at current bond prices. So what happens?

Kephalos: The prices of Treasury bonds fall--interest rates rise...

Adeimantos: And what happens in the money market as interest rates rise?

Kephalos: People are no longer happy holding the economy's cash--it's too expensive; it's burning a hole in their pocket. So they start spending it faster...

Adeimantos: And as they start spending it faster?

Kephalos: This puts upward pressure on prices and employment, as businesses find that they can charge more and make hire profits and so hire more people...

Adeimantos: Incomes rise, and as incomes rise savings rise because people don't spend all of their increased incomes, do they?

Sokrates: Very true, Adeimantos.

Adeimantos: And what happens as savings rise?

Kephalos: People want to park those savings somewhere. They want to park those savings in Treasury bonds. And so demand for Treasury bonds rises...

Adeimantos: And the economy settles back at its new equilibrium, with (a) somewhat higher interest rates and (b) higher spending and income so that (c) people are happy holding the economy's cash at the current interest rates and rate of spending, and (d) people are happy holding the bonds at the current bond prices and level of income.

Kephalos: So both supply-and-demand arguments are true...

Meno: And the way that they can both be true is that there isn't just one quantity--the bond price--that adjusts to match supply and demand in the bond and the money markets...

Sokrates: But there are two quantities that adjust: the bond price and the level of spending...

Adeimantos: Yes. You have just derived things that were well-known 72 years ago. See John Hicks (1937), "Mr. Keynes and the 'Classics': A Suggested Interpretation."

Sokrates: But which adjusts more?

Adeimantos: Once again back to Hicks (1937). When the unemployment rate is high and the nominal interest rate on Treasury bonds is very very slow, adjustment comes in the form mostly of changes in spending and only slightly in changes in interest rates--the world is then "Keynesian." But when the unemployment rate is normal or low and the nominal interest rate on Treasury bonds is near its normal levels, adjustment comes in the form mostly of changes in interest rates and only slightly in changes in spending--the world is than "Classical." That's why the title of the article is "Mr. Keynes and the 'Classics'."

Meno: So when European hedge funds predict the collapse of U.S. Treasury bond prices as the new issues hit the market and ask where is the extra demand to hold all these new bonds come from, the answer is...?

Adeimantos: That even as the government issues the bonds it is also spending the money, and as the money it spends is parked in the bank accounts of the businesses the government is buying things from, the banks in which the money is parked take it and use it to buy Treasury bonds.

Meno: That sounds like sophistry...

Sokrates: You should talk...

Glaukon: Actually, it's just general equilibrium...

Meno: But is this doctrine--that the government's issuance of a fortune in bonds and spending of a fortune in money will show up primarily not as a collapse in bond prices and a spike in interest rates but as an expansion of spending--true?

Sokrates: We will see. Keynesian--or maybe I should say Hicksian--economists would say that bond prices/interest rates and spending/income levels are the two quantities that together adjust to jointly clear the bond and the money markets, to satisfy both loanable funds and liquidity preference equilibrium; that sometimes the principal movement is in interest rates; that sometimes the principal movement is in spending levels; and that right now it is likely that spending will adjust by much more than interest rates.

Adeimantos: And there is a little bit of empirical evidence that the Hicksian economists are right. Tim Fernholz http://www.prospect.org/csnc/blogs/tapped_archive?month=06&year=2009&base_name=compare_and_contrast_economic sends us to Nelson Schwartz, who writes:

Europe Lags as U.S. Economy Shows Signs of Recovery - NYTimes.com: There was more evidence Thursday that the United States economy might be stabilizing, if not rebounding, even as economic reports in Europe remained gloomy. The American news — showing slight growth in retail sales and a dip in first-time jobless claims, as well as rising stocks — was not enough to end the disagreement between bulls and bears over how soon the economy would improve. But the apparent divergence of fortunes between America and Europe highlighted the different approaches to solving the financial crisis, and why some economists say the more aggressive American strategy may be working better, at least for now. It is a debate that is likely to be one of the issues dominating discussions when finance ministers from the eight largest economies meet in Italy this weekend.

Some private economists are even predicting that the American economy will resume growth in the fourth quarter, while Europe’s economy is expected to remain in recession well into 2010, after contracting an estimated 4.2 percent this year compared with an expected 2.8 percent decline in the United States. “The shock originated in the U.S., but Europe is paying a higher price,” said Jean Pisani-Ferry, a former top financial adviser to the French government who is now director of Bruegel, a research center in Brussels. Almost from the beginning of the crisis, the United States and Europe chose largely different paths to aiding their economies. The most stark was Washington’s willingness to commit hundreds of billions of dollars to stimulus spending — in addition to moving aggressively to shore up banks and keep credit flowing — versus Europe’s worry that similar spending would increase inflation in the future. Just as the policies pursued during the Great Depression have been dissected ever since by economists, the fate of the United States and Europe as the two regions emerge from the global crisis will be analyzed for decades to come.....

One crucial concern about America’s increased deficit spending — that it would lead investors to demand higher interest rates on United States debt, making it far more expensive to borrow and slowing the economy — has been allayed, for now. An auction on Thursday of $11 billion in 30-year Treasury bonds found enthusiastic buyers, helping to push the Standard & Poor’s 500-stock index to a seven-month high...

Meno: And the Chicago School economists who say that government borrow-and-spend logically cannot increase overall spending? The Robert Lucases who say: "[W]ould a fiscal stimulus somehow get us out of this bind...? I just don't see this at all. If the government builds a bridge... by taking tax money away from somebody else, and using that to pay the bridge builder... then it's just a wash.... [T]here's nothing to apply a multiplier to. (Laughs.)... [And] taxing them later isn't going to help, we know that..."? And the John Cochranes who said: "[W]hile Tobin made contributions to investing theory, the idea that spending can spur the economy was discredited decades ago. 'It’s not part of what anybody has taught graduate students since the 1960s. They are fairy tales that have been proved false. It is very comforting in times of stress to go back to the fairy tales we heard as children but it doesn’t make them less false.'" To borrow money to pay for the spending, the government will issue bonds, which means investors will be buying U.S. Treasuries instead of investing in equities or products, negating the stimulative effect, Cochrane said. It also will do nothing to unlock frozen credit..."?

Sokrates: I, at least, find myself unable to understand them. They say they believe in the quantity theory of money--that spending is equal to the economy's cash times its velocity. And they say that they believe that velocity is interest elastic--that people respond to incentives and spend the cash in their pockets more rapidly when nominal interest rates are high. They say that they believe that bond prices/interest rates are such as to balance saving and investment and make people willing to hold the stock of bonds. That's all you need to be a Hicksian. Yet they also claim that Hicks is wrong, somehow--without giving arguments. I can trip up and make foolish anybody who makes an argument, but if they don't make an argument I cannot make them look any more foolish...

Net Treasury Bond Issues to Be Held by the "True' Public, since 1980 and Projected

Bonds held by the Federal Reserve are not part of debt held by the public, no matter what OMB may say.

It's really too bad that I don't have to give a lecture on liquidity preference vs. loanable funds right now...

The U.S. Treasury-Eurodollar Interest Rate Spread (TED) Spread Is Back to Normal

(Small) Interest Rate Increases Are Good News, Not Bad News (Washington Post Crashed-and-Burned-and-Smoking Watch)

Over at the Financial Times, the careful, insightful, and highly intelligent Martin Wolf writes:

FT.com / Columnists / Martin Wolf - Rising government bond rates prove policy works: Is the US... on the road to fiscal Armageddon? Are recent jumps in government bond rates proof that investors are worried about fiscal prospects? My answers to these questions are: No and No.... [T]here are... right now and strong reasons for welcoming recent moves in the bond markets....

The jump in bond rates is a desirable normalisation after a panic. Investors rushed into the dollar and government bonds. Now they are rushing out again. Welcome to the giddy world of financial markets.... What has happened is a sudden return to normality.... [W]hat about the other concern caused by huge bond issuance: crowding out of private borrowers? This would show itself in rising real interest rates. Again, the evidence is overwhelmingly to the contrary.... [A]s confidence has grown, spreads between corporate bonds and Treasuries have fallen (see chart). One can also use estimates of expected inflation derived from government bonds to estimate real rates of interest on corporate bonds. These have also fallen sharply (see chart). While riskier bonds are yielding more than they were two years ago, they are yielding far less than in late 2008. This, too, is very good news indeed.....

[T]he last concern: the fear of inflation.... People need to believe that the extraordinarily aggressive monetary and fiscal policies of today will be reversed. If they do not believe this, there could well be a big upsurge in inflationary expectations long before the world economy has recovered. If that were to happen, policymakers would be caught in a painful squeeze and the world might indeed end up in 1970s-style stagflation. The exceptional policies used to deal with extreme circumstances are working.... It is irresponsible to insist either on immediate tightening or on persistently loose policies. Both the US and the UK now risk the latter. But their critics risk making an equal and opposite mistake. The answer is both clear and tricky: choose sharp tightening, but not yet.

Over at the Washington Post, the , , and _ Neil Irwin writes:

Spike in Interest Rates Could Choke Recovery: Rising long-term interest rates are making it more expensive for home buyers, corporations and the U.S. government to borrow money, threatening to further stifle an already weak economy. In just the past two weeks, the rate on a 30-year, fixed-rate mortgage has risen to 5.6 percent from 4.9 percent, ending a boom in refinancing and working against a budding recovery in the housing market. Rates on corporate borrowing have also risen, making it more expensive for companies to expand. And the government has been forced to pay more to finance its deficit.

Since the beginning of the year, historically low mortgage rates have had a twin benefit for the economy: They have allowed homeowners to refinance about $1.5 trillion worth of mortgages, thus lowering monthly payments and leaving people with more money to spend on goods and services. Low rates have also created greater incentive for people to buy homes, despite continuing troubles in the housing market. The abrupt rise in rates has removed that key stimulant for the economy.

The rise has many causes, some of which reflect good news. As investors have grown more confident about the future, for example, they have become more inclined to put money in risky investments, such as the stock market, rather than lending it to the U.S. government and to government-backed mortgage companies. But other causes give more reason for worry. Investors around the world are increasingly fearful that Congress and the Obama administration will be unwilling to bring taxes and spending in line in the years ahead. That makes the U.S. government appear to be a riskier borrower, leading those who lend to it to demand higher interest payments.

The Federal Reserve now finds itself in a box. It could try to lower rates by buying government debt. It has already said it would buy $1.5 trillion in U.S. Treasuries and mortgage-related securities this year to try to stimulate growth. But doing so would likely only deepen fears that the Fed will print money to fund government deficits in the future. That possibility -- while rejected by Fed officials and many mainstream economists -- means that expanding purchases might not have the intended effect of lowering rates. It could even drive them up further...

General equilibrium. Long-term interest rates have risen because banks expect that four or five years from now the economy will be stronger than they thought two months ago and so they will be able to lend their money out more profitably then--even with higher interest rates. The rise in interest rates is the result of a stronger anticipated recovery, not the cause of a weaker one.

Neil Irwin's economist sources are:

• Scott Anderson, a senior economist at Wells Fargo: "Households really have no capacity to afford higher rates at this point.... It affects the cost of any long-term borrowing a consumer or business might do, whether it's auto loans, mortgages or business credit..."
• Jay Brinkman, chief economist of the MBA, who says "The increase so far has not really been enough to choke off home buying..."

In short, Neil Irwin did not find an economic forecaster who would agree with his headline--"Spike in Interest Rates Could Choke Recovery"--yet he wrote the article anyway.

Think about that.

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

No Upward Pressure on Interest Rates Here. Move Along...

Paul Krugman:

Private borrowing is still negative: Flow of funds data out today. I won’t have time to do a careful analysis for a few days, but a quick check shows that the Setser point — high government borrowing is more than offset by net negative borrowing from the private sector — remains true.

A Pretty Good but Not Excellent Story from David Leonhardt on the Deficit

David writes:

Economic Scene - How the U.S. Surplus Became a Deficit: There are two basic truths about the enormous deficits that the federal government will run in the coming years. The first is that President Obama’s agenda, ambitious as it may be, is responsible for only a sliver of the deficits, despite what many of his Republican critics are saying. The second is that Mr. Obama does not have a realistic plan for eliminating the deficit, despite what his advisers have suggested. The New York Times analyzed Congressional Budget Office reports going back almost a decade, with the aim of understanding how the federal government came to be far deeper in debt than it has been since the years just after World War II. This debt will constrain the country’s choices for years and could end up doing serious economic damage if foreign lenders become unwilling to finance it.

Mr. Obama — responding to recent signs of skittishness among those lenders — met with 40 members of Congress at the White House on Tuesday and called for the re-enactment of pay-as-you-go rules, requiring Congress to pay for any new programs it passes. The story of today’s deficits starts in January 2001, as President Bill Clinton was leaving office. The Congressional Budget Office estimated then that the government would run an average annual surplus of more than $800 billion a year from 2009 to 2012. Today, the government is expected to run a $1.2 trillion annual deficit in those years...

There are two things wrong with the story. First, David doesn't say what part of the $1.2 trillion deficit is a problem. My estimate is that the U.S. could run a $500 billion annual deficit in an average year without incurring any chance of getting into any serious economic problems (although I would wish that the cyclically-adjusted deficit were smaller), and that an additional $400 billion of annual deficit is justified by the recessionary state of the business cycle over Obama's first term. So the serious deficit problem seems to me to be, today, at $300 billion a year.

Of course, it will grow unless taxes are raised by 2012 or health-care costs contained...

Second, this "[the deficit] could end up doing serious economic damage if foreign lenders become unwilling to finance it..." needs to be balanced by the observation that a worry that foreigners will prove unwilling to buy U.S. Treasury bonds at reasonable prices is, like, worry #927 on our list of worries. It's just not up there...

Unemployment Is Going to Keep Rising for Quite a While...

Courtesy of Barry Ritholtz:

Job Openings vs Unemployed:

Somebody Expects a Rapid Recovery...

Chris Flood:

FT.com / MARKETS / Commodities - Oil hits fresh seven-month high above $70: Crude oil prices rose above the $70 a barrel mark on Friday, hitting a fresh seven-month high, propelled by better than expected economic indicators and a bullish view from Goldman Sachs, Wall Street’s largest commodities dealer...

It's Not Clear to Me How This Is Consistent with a -1.1% Second Quarter GDP Number

Kathleen Madigan:

ADP Reports 532,000 Private-Sector Job Losses : Private sector jobs in the U.S. fell by 532,000 slots in May, according to a national employment report published Wednesday by payroll giant Automatic Data Processing Inc. and consultancy Macroeconomic Advisers. The expected loss is less than the 550,000 drop forecast by economists in a Dow Jones Newswires survey.

The ADP survey tallies only private-sector jobs while the U.S. Bureau of Labor Statistics' nonfarm payroll data, to be released Friday, include government workers. Economists surveyed by Dow Jones Newswires expect that the BLS will report May job cuts totaling 525,000, on top of a 539,000 loss in April. The May unemployment rate is projected to rise to 9.2%. "Despite some recent indications that economic activity is stabilizing, employment, which usually trails overall economic activity, is likely to decline for at least several more months, although perhaps not as rapidly as during the last six months," said Joel Prakken, chairman of Macroeconomic Advisers...

Origins of the Present (Financial) Crisis

Mark Thoma sends us to Paul Krugman, who argues that American financial regulation went off on the wrong track with Reagan-Garn-St. Germain:

Economist's View: Paul Krugman: Reagan Did It: Reagan... essentially ended New Deal restrictions on mortgage lending... that, in particular, limited the ability of families to buy homes without putting a significant amount of money down. These restrictions were put in place in the 1930s by political leaders who had just experienced a terrible financial crisis, and were trying to prevent another. But by 1980 the memory of the Depression had faded. Government, declared Reagan, is the problem, not the solution; the magic of the marketplace must be set free. And so the precautionary rules were scrapped.... We weren’t always a nation of big debts and low savings: in the 1970s Americans saved almost 10 percent of their income...

It was only after the Reagan deregulation that thrift gradually disappeared..., culminating in the near-zero savings rate ... on the eve of the great crisis.... All this, we were assured, was a good thing: sure, Americans were piling up debt... but their finances looked fine once you took into account the rising values of their houses and their stock portfolios. Oops. Now, the proximate causes of today’s economic crisis lie in events that took place long after Reagan... — in the global savings glut... and in the giant housing bubble that savings glut helped inflate. But it was the explosion of debt over the previous quarter-century that made the U.S. economy so vulnerable. Overstretched borrowers were bound to start defaulting in large numbers once the housing bubble burst and unemployment began to rise.

These defaults in turn wreaked havoc with a financial system that — also mainly thanks to Reagan-era deregulation — took on too much risk with too little capital. There’s plenty of blame to go around... But the prime villains behind the mess we’re in were Reagan and his circle of advisers — men who forgot the lessons of America’s last great financial crisis, and condemned the rest of us to repeat it...

The "Treasury View" and Fiscal Policy

'I can call spirits from the Vasty Deep!" "Why, so can I, and so can any man. But do they come when you call them?" Felix Salmon calls Alan Beattie of the FT and Justin Fox of Time:

What use economic history? : How relevant is economic history at times like this? I asked. Can studying history prevent us from repeating past mistakes, or does it just end up forcing us into committing new ones? And how much of a good thing is it that an economic historian is chairman of the board of governors of the Federal Reserve?

Successfully:

Beattie replied first:

yes, I think it definitely helps when looking at such once-in-a-century events to have a discipline which focuses on specific similar episodes in the past, not least because the sample size is so small. And that does seem to be having some effect on the policy response now. Despite the best efforts of some, I don’t think the Montagu Norman/Andrew Mellon liquidationist instinct or the 1930s “Treasury view” on deficit spending are getting much serious traction in the US or UK, for example. (Irrelevant trivia: I am very distantly related by marriage to Andrew Mellon - something like a third cousin three times removed. She divorced him in a spectacular case involving all sorts of legal shenanigans and managed to walk off with a sizeable chunk of the Mellon loot, though not a nickel has trickled down to me.)

but of course you need to learn the right lessons and pick the right comparator. the current German reluctance to increase fiscal stimulus, for example, seems to be assuming that this is a 1920s/1970s inflationary situation, not a 1930s deflationary one.

it is good that an economist who is also an economic historian is Fed chairman. Not sure you’d want someone who was reading entirely out of the previous playbooks without also being able to recognise that the monetary transmission mechanism has changed out of all recognition. The General Theory is a bit light on what to do about credit default swaps, for example.

Then Justin weighed in:

My book is basically the story of a bunch of guys who decided to ignore financial market history (the dodgy parts, at least) in order to create more elegant models of financial markets’ future. That didn’t work out so well, so yeah, knowing economic history would seem to be useful. But Alan’s right that there are lots of different lessons that can be drawn from the past, and sometimes people draw the wrong ones. I too am related to a liquidationist, by the way—George Washington Norris, the hard-line president of the Philly Fed in the early 1930s, was my great great uncle.

On Bernanke, I’d certainly rather have somebody with his background in that job than an ahistorical rational expectations type who believes bubbles and panics don’t happen...

And then Felix summons me:

I’d be interested in what Brad DeLong — one of the foremost economic historians of our own time — thinks about whether the “Treasury view” is getting much serious traction — I suspect he might have killed it before it had a chance to spread widely, and it certainly doesn’t seem to have been mentioned much since January 20. And in general I think that economic historians are having something of a day in the sun right now, with lots of people looking back to previous economic crises around the world, and fewer people finding modern theory-based economics particularly helpful from a policymaking perspective. Maybe economic history is a classic countercyclical asset.

I am here:

(I) With respect to the “Treasury View” that Obama's fiscal policy will be ineffective--well, I think it is very common. In the past two months across my desk I have seen it advocated by Robert Barro; Eugene Fama; John Cochrane; Luigi Zingales; Michele Boldrin; Niall Ferguson; Nobel Prize winners Gary Becker, Edward Prescott, and Robert Lucas; John Cogan; John Taylor; and Peter Klenow. Of these, only John Taylor and John Cogan on the one hand and Pete Klenow on the other had even a slightly-coherent argument based on a slightly-recognizable model. And I'm stretching it to call Taylor and Cogan's argument slightly coherent. It was that: (a) Jared Bernstein and Christie Romer say that fiscal expansion is likely to be powerful, (b) they assume a certain reaction by the Federal Reserve to fiscal expansion, (c) a reaction that makes fiscal policy so powerful that we cannot calculate its effects--our model explodes--(d) so we assume a different reaction by the Federal Reserve that makes fiscal policy much less powerful, and so (e) we find that fiscal policy is not very powerful. To which my reaction is: Huh!? Assuming that fiscal policy is not powerful is a reason to think that it is not powerful. That simply will not do.

Klenow said that (a) the Federal Reserve is not powerless to affect spending right now, (b) the Federal Reserve is happy with the projected growth path of spending, so (c) policy moves by Obama that raise the projected path of spending in the future will be offset by the Federal Reserve's raising interest rates to keep the projected growth path of spending the same. This seems to me to be false as a description of what the Federal Reserve is doing. But at least it is coherent--you can at least have a response to it other than "Huh?!"

The assumption of some version of the quantity theory of money plus the recognition that money demand is usually interest elastic create a presumption that fiscal policy is effective. There are then four coherent ways to argue to try to rebut that presumption and arrive at the "Treasury View":

1. Klenow's--that the central bank is happy with the projected growth path of spending and both can and will take action to make sure that fiscal policy is ineffective by offsetting its effects.

2. The goods-crowding out argument: that we are at full employment so workers have so much bargaining power at the moment fiscal policies that increase spending will go 100% into increasing wages and prices and 0% into increasing production and employment. This seems to me to be false.

3. The the interest-crowding out argument: that when the government sells a bond interest rates will rise and induce a private-sector firm not to sell a bond, and thus investment spending falls by as much as government spending increases. This requires that in this particular case the increase in interest rates resulting from a higher government budget deficit have no effect on the velocity of money, which could happen as a limiting case but I see no reason to think that it would happen now.

4. Increases in government spending now lead private individuals to cut back on their spending out of fear of future tax increases by so much that total spending is unchanged. This seems to me to fundamentally misunderstand the permanent income hypothesis.

The interesting thing from my perspective is that Barro, Fama, Cochrane, Zingales, Boldrin, Ferguson, Becker, Prescott, and Lucas don't appear to be making any one or any combination of the four coherent arguments for the "Treasury View." They do believe in the quantity theory of money. But either they don't believe that households and businesses respond to incentives in their money-holdings or they have not tought about the issue. And so they don't recognize that they have to make one or more of the four valid argumentative moves if they are to be coherent.

(II) Nevertheless analytical incoherence seems to be no barrier to influence. Last January I thought that the numbers from the fourth and forecast for the first quarter told us that we should (a) immediately do $1.2T of effective fiscal stimulus, and (b) stand ready--preferably by putting the money into the Budget Resolution--to do another $1.2T of effective fiscal stimulus in October with the Reconciliation Bill if things turned out to be worse than expected. We did about $0.6T of effective fiscal stimulus, nothing got into the Budget Resolution, and there is no legislative prospect for additional fiscal stimulus this year. By my count that is at least a 2/3 victory for the "Treasury View"--we are doing less than we should be doing, and certainly much less than it would be prudent to be doing, and we are doing less than we should be doing because the "Treasury View" advocates have muddied the analytical waters.

(III) As to history--well, yes, of course. Economics does not have solid foundations. We pick episodes from history that seem interesting and informative, and we crystalize these historical episodes into economic theory. But then theorists teach this crystalized history as if it were handed down from Mount Olympus. And so we wind up with a lot of young and many old economists who can manipulate theories but who do not understand what they are good for or where they come from.

Paul Krugman on Inflation Fears: Economists Should Know Better

When markets are scared that governmental finances are broken, the prices of long-term government bonds are low and the interest rates on long-term government bonds are high. While U.S. long-term Treasury bonds have fallen recently, their prices are not low by any standard. Markets are not yet nervous about broken American government finances and the risk of future inflation. Maybe they should be nervous. But they are not yet.

Thus any argument that begins: "financial markets are nervous about the U.S. long-run budget deficit..." needs to be thrown out the window.

Paul Krugman:

The Big Inflation Scare: Suddenly it seems as if everyone is talking about inflation.... But does the big inflation scare make any sense? Basically, no — with one caveat.... It’s important to realize that there’s no hint of inflationary pressures in the economy right now.... So if prices aren’t rising, why the inflation worries? Some claim that the Federal Reserve is printing lots of money, which must be inflationary, while others claim that budget deficits will eventually force the U.S. government to inflate away its debt. The first story is just wrong. The second could be right, but isn’t....

[T]hese aren’t ordinary times. Banks aren’t lending out their extra reserves. They’re just sitting on them — in effect, they’re sending the money right back to the Fed. So the Fed isn’t really "printing money" after all.... [M]uch of the current inflation discussion calls to mind what happened during the early years of the Great Depression when many influential people were warning about inflation even as prices plunged. As the British economist Ralph Hawtrey wrote, “Fantastic fears of inflation were expressed. That was to cry, Fire, Fire in Noah’s Flood.” And he went on, “It is after depression and unemployment have subsided that inflation becomes dangerous.”

Is there a risk that we’ll have inflation after the economy recovers?... Over the past two decades, Belgium, Canada and, of course, Japan have all gone through episodes when debt exceeded 100 percent of G.D.P. And the United States itself emerged from World War II with debt exceeding 120 percent of G.D.P. In none of these cases did governments resort to inflation to resolve their problems.... All of this raises the question: If inflation isn’t a real risk, why all the claims that it is?... But it’s hard to escape the sense that the current inflation fear-mongering is partly political, coming largely from economists who had no problem with deficits caused by tax cuts but suddenly became fiscal scolds when the government started spending money to rescue the economy. And their goal seems to be to bully the Obama administration into abandoning those rescue efforts...

Vicious Circles in the Mortgage Market

The recession is not finished with us yet:

Foreclosure Woes Mount for Those With Good Credit: A record 12 percent of homeowners with a mortgage are behind on their payments or in foreclosure as the housing crisis spreads to borrowers with good credit. And the wave of foreclosures isn't expected to crest until the end of next year, the Mortgage Bankers Association said Thursday. The foreclosure rate on prime fixed-rate loans doubled in the last year, and now represents the largest share of new foreclosures. Nearly 6 percent of fixed-rate mortgages to borrowers with good credit were in the foreclosure process. At the same time, almost half of all adjustable-rate loans made to borrowers with shaky credit were past due or in foreclosure.

The worst of the trouble continues to be centered in California, Nevada, Arizona and Florida, which accounted for 46 percent of new foreclosures in the country. There were no signs of improvement. The pain, however, is spreading throughout the country as job losses take their toll. The number of newly laid off people requesting jobless benefits fell last week, the government said Thursday, but the number of people receiving unemployment benefits was the highest on record. These borrowers are harder for lenders to help with loan modifications. President Barack Obama's recent loan modification and refinancing plan might stem some foreclosures, but not enough to significantly alter the crisis.

"It may be too much to say that numbers will fall because of the plan. It's more correct to say that the numbers won't be as high," said Jay Brinkmann, chief economist for the Mortgage Bankers Association.

Jacob Viner at His Most Arch

Bull, meet red flag:

Jacob Viner (1937), ["Mr. Keynes on the Causes of Unemployment"(http://www.jstor.org/stable/pdfplus/1882505.pdf): Written tho it is by a stylist of the first order, [Keynes's General Theory] is not easy to read, to master, or to appraise. An extremely wide range of problems, none of them simple ones, are dealt with in an unnecessarily small number of pages. Had the book been made longer, the time required for reading it with a fair degree of understanding would have been shorter, for the argument often proceeds at breakneck speed and repeated rereadings are necessary before it can be grasped. The book, moreover, breaks with traditional modes of approach to its problems at a number of points--at the greatest possible number of points, one suspects--and no old term for an old concept is used when a new one can be coined, and if old terms are used new meanings are generally assigned to them...

Jacob Viner (1933), "Balanced Deflation, Inflation, or More Depression"

Perhaps the most important single document with respect to how much the Chicago School of Economics has forgotten over the past seventy-five years--how much less they know now than Irving Fisher or Knut Wicksell did.

As I understand things, Jacob Viner's estate has rights to this document until 2040, and there is at present no way for me to get permission to legally distribute it. So I think it is time to hoist the jolly roger...

Download now or preview on posterous: 20090527_viner_lecture.pdf

Jacob Viner (1933), "Balanced Deflation, Inflation, or More Depression" (Minneapolis: University of Minnesota).

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The Chicago School on Dealing with Depression in 1933 II

Click here to download:

Davis (1968),

J. Ronnie Davis (1968), "Chicago Economists, Deficit Budgets, and the Early 1930s," American Economic Review 58:3,1 (June), pp. 476-481.

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