Grasping Reality with Both Hands

Ben Bernanke's Tenure

Jon Hilsenrath, Sudeep Reddy, and David Wessel write:

White House Ponders Bernanke's Future: As the White House begins to ponder whether to reappoint or replace Ben Bernanke when his term expires in January, the Federal Reserve chairman's standing on Wall Street is on the rise while attacks on him from Congress mount. Treasury Secretary Timothy Geithner is expected to play a key role in advising President Barack Obama on whether to reappoint Mr. Bernanke. Mr. Geithner has worked closely both with Mr. Bernanke and with the leading alternative for the powerful post -- Lawrence Summers, the former Treasury secretary, who is currently the president's top economic adviser.

Before making a decision later this year, the White House also is expected to look at other economists, including Roger Ferguson and Alan Blinder, former Fed vice chairmen; Janet Yellen, president of the San Francisco Federal Reserve Bank; and Christina Romer, chairman of Mr. Obama's Council of Economic Advisers.

Mr. Bernanke's reputation on Wall Street has ebbed and flowed. But a Wall Street Journal survey conducted this week of 46 private-sector economists found that 43 endorsed his reappointment. "Bernanke's leadership during this financial crisis was outstanding, but not flawless," said Scott Anderson of Wells Fargo & Co., one of those surveyed. "But given human limitations and the limitations of economic and financial knowledge he deserves another tour of duty." Some saw benefits to continuity. "Don't change horses in midstream," said David Wyss of Standard & Poor's. Others cited the alternatives: "Stated differently: Don't appoint Summers," said Nicholas Perna of Perna Associates.

The White House isn't rushing to decide on reappointing Mr. Bernanke, who hasn't sent any signal that he wants to leave the post. The Intrade online wagering Web site puts 60% odds on reappointment. But a bad turn in the economy could prompt Mr. Obama to seek a new helmsman of his own choosing, or new embarrassing revelations about Mr. Bernanke's handling of the financial crisis could alter the picture before the president makes a decision. For now, the White House is concentrating on finding new members for the Fed board. Two of the seven seats are vacant. Two sitting governors -- Kevin Warsh, 39 years old, and Donald Kohn, 66 -- are widely believed to be eyeing the exits. The White House is seeking at least one candidate with financial-market experience, a tough task at a time when likely choices are tainted by Wall Street ties....

Mr. Bernanke has come under tough questioning on Capitol Hill, and new powers that the Obama administration proposes to give the Fed have intensified congressional scrutiny of the central bank. "If these new powers are going to be granted to the Fed, then maybe a professor of economics will never again be the best choice for the Fed chairman," said Darrell Issa (R., Calif.). Rep. Brad Sherman (D., Calif.) accuses the Fed of "a Wall Street mentality." Regarding Mr. Bernanke, he said, "Of those who are infected... better than average," but he said he would prefer a Fed chairman with "populist Democratic values."

Still, Mr. Bernanke has influential admirers -- including Rep. Barney Frank (D., Mass.), chairman of the House Financial Services Committee, and Rep. Carolyn Maloney (D., N.Y.), chairman of the Joint Economic Committee. Ms. Maloney, who backs Mr. Bernanke's reappointment, said, "He's basically an academic working in a nonpartisan way to save the economy." Mr. Bernanke would need to be confirmed by the Senate if reappointed for a second four-year term. Both the chairman of the Senate Banking Committee, Christopher Dodd (D., Conn.), and the panel's senior Republican, Richard Shelby of Alabama, have been critical of the Bernanke Fed...

A year ago I would have said that Ben Bernanke was almost certain to be a one-term Fed chair. The financial crisis was bad enough and enough decisions had to be made quickly enough that it was certain that he would make some big mistakes, and in the aftermath too many people would remember and he would be too damaged to be the right choice moving forward.

But given the quality of the opposition to a Bernanke reappointment that Hilsenrath and company have been able to dig up, it seems that I was wrong. The complaints about Bernanke seem... incoherent. And the consensus judgment appears to be the correct "outstanding but not flawless."

And, yes, Larry (or Janet, or Roger, or Allen, or Christy) would in all likelihood be very, very good at the job as well.

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.

Arthur Burns in the 1970s...

Sounding a little bit like the fish in The Cat in the Hat: "'This is not a good game!' said the fish to the cat...":

Each temporary surge in inflation was quickly followed by--or in the case of the mid-1970s oil shock inflation cycle roughly coincident with--an increase in unemployment. Each cycle in the late 1960s and 1970s was larger than the one before: unemployment peaked at around 6 percent in 1971, at about 8.5 percent in 1975, and at nearly 10 percent in 1982-83. Congress attempted to legislate full employment. Federal Reserve chair Arthur Burns pushed back: “[The] Humphrey-Hawkins [proposal]... continues the old game of setting a target for the unemployment rate. You set one figure. I set another figure. If your figure is low, you are a friend of mankind; if mine is high, I am a servant of Wall Street.... I think that is not a profitable game...” (Wells (1994))

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.

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.

---

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

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.

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

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.

This Is Getting Damned Annoying: Will I Ever Be Allowed to Disagree with Paul Krugman Again About Anything? (Niall Ferguson Edition)

There have been two annoying things about the past decade. The first is that I feel like I have been living in a Ken Macleod novel--and one of the more dystopic ones too, at least up until January 21, 2009 (I am glad he has stopped: Ken: please don't get cranky again). The second is that the best way to understand the world is through these two rules:

1. Paul Krugman's analysis is correct.
2. If you think that Paul Krugman's analysis is incorrect, see rule number 1.

Most recently, I thought that Paul Krugman must be being too harsh on Niall Ferguson. Ferguson could not really have forgotten so much economics as to believe that when interest rates are zero deficit spending is inherently contractionary, could he? But Paul said he did:

Liquidity preference, loanable funds, and Niall Ferguson (wonkish) - Paul Krugman Blog - NYTimes.com: Joe Nocera... fails to mention... the most depressing aspect... further confirmation that we’re living in a Dark Age of macroeconomics, in which hard-won knowledge has simply been forgotten. What’s the evidence? Niall Ferguson “explaining” that fiscal expansion will actually be contractionary, because it will drive up interest rates. At least that’s what I think he said....

[I]t might be useful to re-explain why [in] our current predicament... fiscal deficits won’t drive up interest rates unless they also expand the economy.... I imagine Niall Ferguson was thinking... of... the “loanable funds” model.... Keynes pointed out was that this picture is incomplete if... the economy is not at full employment.... [S]upply and demand for [loanable] funds... tells you what the interest rate would be conditional on the level of GDP... defines a relationship between the interest rate and GDP....

So what determines the level of GDP, and hence also ties down the interest rate?... [A]dd “liquidity preference”, the supply and demand for money. In the modern world... the central bank adjusts the money supply so as to [try to] achieve a target interest rate.... [But r]ight now the interest rate that the Fed chooses is essentially zero [and cannot go any lower], but that’s not enough to achieve full employment... the interest rate the Fed would like to have is negative... the Fed’s own economists estimate the desired Fed funds rate at -5 percent....

So what does government borrowing do? It gives some of those excess savings a place to go — and in the process expands overall demand, and hence GDP. It does NOT crowd out private spending... until the excess supply of savings has been sopped up... [and the interest rate consistent with full employment rises above zero].

Now, there are real problems with large-scale government borrowing — mainly, the effect on the government debt burden. I don’t want to minimize those problems; some countries, such as Ireland, are being forced into fiscal contraction even in the face of severe recession. But the fact remains that our current problem is, in effect, a problem of excess worldwide savings, looking for someplace to go.

And Krugman reiterated his judgment:

China and the liquidity trap - Paul Krugman Blog - NYTimes.com: By the way, I’ve had a chance to see the transcript of the PEN/ NY Review event, and I don’t think I was misrepresenting Niall Ferguson’s position...

Sure enough, now that I have taken a look at the transcript, I have to once again agree that Paul Krugman's analysis is correct. This is annoying. This is damned annoying. In fact, this is beyond annoying:

Niall Ferguson: Now we are in the therapy phase, and what therapy ar we using? Well, it is very interesting because we are using two quite contradictory courses of therapy. One is the prescription of Dr. Friedman, Milton Friedman, that is, that is being administered by the Federal Reserve: massive injections of liquidity to avert the kind of banking crisis that caused the Great Depression of the 1930s. I am fine with that. That is the right thing to do. But thre is qnother course of therapy that is simultaneously being administered, which is the therapy prescribed by Dr. Keynes, John Maynard Keynes, and that therapy involves the running of massive fiscal deficits in excess of 12 percent of gross domestic product this year and the issuance therefore of vast quantities of freshly-minted bonds.

There is a clear contradiction between these two policies, and we are trying to have it both ways. You cannot be a Keynesian and a monetarist simultaneously, at least I cannot see how you can, because if the aim of the monetarist policy is to keep interest rates down to keep liquidity high, the effect of the Keynesian policy must be to drive interest rates up.... [T]here is going to be... a very painful tug-of-war between our monetary policy and our fiscal policy...

A real monetarist--like Milton Friedman's teacher Jacob Viner, say--would argue (in fact, did argue during the Great Depression) that when the interest rate is near zero monetary expansion and deficit spending do not offset but reinforce each other, for essentially the reasons set out by Krugman. As Paul said in rebuttal to Ferguson: "There is... no contradiction between the Federal Reserve's actions and... fiscal stimulus. It is very much necessary to do both..."

Normally the banking system buys bonds from corporations which then spend the money investing in plant and equipment. Right now that process has broken down, and until the banking system gets fixed the second-best is to have the government step into the role. As Krugman writes:

By buying a lot of private securities, the Federal Reserve is... playing the role the private banking system is no longer playing properly... debt-financed spending on infrastructure by the Obama administraiton is filling the hole left by the collapse in business investment....

Conclusion? Once again:

There is not an excess demand for savings that is going to drive up interest rates...

Niall Ferguson does indeed know a lot less than economists knew in the 1920s. Back then when R.G. Hawtrey was laying out the Treasury View he claimed that fiscal policy was ineffective--and was wrong. Niall Ferguson's belief that fiscal policy is destructive shows that he has not even got that far.

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UPDATE: As a "friend" points out, Ferguson spent considerable time trying to bait Krugman into losing his cool:

• As d² points out, the references to "Dr. Keynes" appear for some reason to work like a red flag to a bull on status-conscious Englishmen--for Keynes never got a Ph.D.--but it doesn't work on Dr. Krugman.
• "I rather fear that, at the risk of provoking the man sitting on the other side of me, that it says 1936 on the bottle of Dr. Keynes’ medicine..."
• "[I]if you listened carefully to what Paul Krumgan said, he actually agreed with me [laughter]..."
• "So, I hate to teach arithmetic to a Nobel laureate, it doesn’t quite add up..."
• Madrick: "Let’s let Paul speak..." Krugman: "Oh, Dear..." Ferguson: "Oh Dear indeed..." Krugman: "Let’s talk national income accounting offstage..."
*

Are They or Aren't They?

Put me on record as saying that the Federal Reserve is making a bad mistake if Treasury ten-year bond yields rise far above 3% while the unemployment rate is still rising.

Jon Hilsenrath:

Fed’s Not Targeting Long Bond Rates: Bond investors have spent a lot of time in recent weeks wondering whether the Federal Reserve would increase its purchases of long term Treasurys now that yields on 10 year notes have pushed up beyond 3%. Fed Chairman Ben Bernanke offered some insight into his thinking on the issue at a hearing of the Joint Economic Committee.

The move above 3% isn’t fundamentally important, he suggested. “We are not targeting a particular interest rate” with the long term Treasury note purchase program, he said. That’s not to say the Fed won’t decide later to buy more Treasury bonds than already announced. Mr. Bernanke said he believed the program was helping to bring down private sector interest rates, many of which are benchmarked off of Treasury bonds. But it does suggest bond investors shouldn’t be so hung up on the 3% rate.

Notes and Handouts for Berkeley Physics Colloquium, May 11, 2009

Audio: http://www.j-bradford-delong.net/2009_mov/20090511_physics.m4a

• The fall in the adult employment-population ratio
• The increase in risk and the collapse in risk tolerance
• The fall in monetary velocity
• What determines monetary velocity?
• Policy to fix it 1: dump money into the economy
  • Unjust enrichment
  • Inflationary overhang
  • Might not work when i<<1
• Policy to fix it 2: raise Treasury bond interest rates
  • By making Treasury bonds less attractive to hold--flood the zone
    • But then you have to spend the money you have earned by selling the Treasury bonds
  • By making corporate bonds more attractive to hold
    • Guarantees
    • Asset repurchases
    • Bank recapitalizations
• How did we get here?
  • Herd behavior
  • Short horizons
  • Limits to arbitrage
• What do we do for the long term?

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What is happening to employment?...

Increasing risk and collapsing risk tolerance...

Are the banks about to fail?...

Increasing risk and collapsing risk tolerance affect all asset prices...

Why asymmetry? The fall in monetary velocity...

Asymmetry arising from deflation...

Flight to safety produces a collapse in monetary velocity...

Normally we deal with collapsing velocity via monetary policy...

But may not work if interest rates are very low...

Guess where we are now?

Time to try alternative policies to try to raise the short-term interest rate on Treasury bonds...

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How did we get here?

What do we do to improve the system?

Obama's First 100 Days

And the four timescales on which he must act:

• The three-year time-scale: the economic crisis.
• The fifteen-year time scale: the health cost crisis.
• The seventy-five-year time scale: the global power crisis.
• The 375-year time scale: the global climate crisis.

http://www.j-bradford-delong.net/2009_mov/20090507_100_days.m4a

DeLong: Econ 202b Lecture May 7, 2009: Trying (and Failing) to Understand the "Modern Chicago" View of the Financial Crisis

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• Audio

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Cryptic Note to Self: I Will Never Understand Chicago Today...

"But monetary policy can still be very effective: you just have to buy things other than Treasury bonds in your open-market operations..."

So you grow the money stock: what does that do? Unless your expansionary monetary policy raises short-term interest rates--in which case it is not what I at least think of as expansionary monetary policy--it moves you by the little red line--and it creates a huge excess demand-inflation problem whenever interest rates return to their normal (black) levels as shown by the big black arrow.

By contrast, fiscal policy--or perhaps flow-of-funds policy: fiscal and banking policy--that sops up the flow of savings and raises short-term safe nominal interest rates gets you quickly to the blue arrow--with no long-run monetary-overhang problem to produce a big burst of inflation later.

More to follow...

The Effects of Fiscal Policy in 2009 and Beyond: A Discussion of Cogan-Cwik-Taylor-Wieland

STANFORD INSTITUTE FOR ECONOMIC POLICY RESEARCH ANNUAL POLICY FORUM 2009

The Effects of Fiscal Policy in 2009 and Beyond:

A Discussion of Cogan-Cwik-Taylor-Wieland

J. Bradford DeLong

University of California at Berkeley and NBER

brad.delong@gmail.com; http://delong.typepad.com/; +1 925 708 0467

May 1, 2009

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Last March I got a note from Ward Hanson asking me to come down today and talk about:

the impact of the Stimulus Bill on jobs creation… the contrast between the Romer/Bernstein estimates of the benefits of the stimulus plan versus… Cogan, Taylor et. al. that estimate/argue that there will be very little benefit…. I've got agreement from the "Taylor group" to present, as well as Martin Giles of the Economist Magazine to serve as a moderator…

So I said yes. And Tuesday afternoon I sat down to reread Romer and Bernstein (2009), which I had read before, and Cogan, Cwik, Taylor, and Wieland (2009), which I had not, and I ran into a problem.

On page 2 Cogan et al. write that their Figure 1 shows how Romer and Bernstein think government spending affects the economy alongside:

exactly the same policy change… in another study… by one of us [John Taylor]… the results are vastly different…. [T]he Romer-Bernstein estimates apparently fail a simple robustness test, being far different from existing published results of another model…

Source: Cogan et al. (2009).

This surprised me. I had talked to Christy. I had talked to Jared. I knew that their intention had been to pull standard models off the shelf and use them--not to push the envelope in economic modeling in any way.

So I dug--and found that Cogan et al.’s claim of “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. Expanding the money supply on the one hand, contracting it on the other.

“Geez,” my first thought was, “this is embarrassing—none of four coauthors of Cogan actually read Romer-Bernstein. Sloppy.” Then I got to page 5 of Cogan: “Romer and Bernstein assume that the Federal Reserve pegs the interest rate—the federal funds rate—at the current level of zero…” 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.

Cogan is simply not what it is being sold as--a critique of the argument of Romer-Bernstein. It should not be taken as such.

I could stop here.

But I have extra time.

I think the best way for me to spend the rest of my time is to lay out why right now at this moment someone like Christy Romer--fundamentally a monetarist, a believer in monetary policy, author of papers on how it was monetary expansion that substantially alleviated the Great Depression in the late 1930s--is now a believer in, a designer of, and an advocate for Barack Obama’s plan to give the U.S. economy a fiscal boost to try to cushion the current fall in employment.

The analysis I am going to give is essentially that carried out nearly eighty years ago by one of Milton Friedman’s teachers, Jacob Viner, in his analysis of the Great Depression when he called for “large and continuous deficit budgets to combat the mass unemployment and deflation of the times.” Friedman applauded Viner’s analysis and saw it as superior to those of others like John Maynard Keynes: “so far as policy was concerned,” Friedman wrote in the early 1970s, “Keynes had nothing to offer those of us who had sat at the feet of [Henry] Simons, [Lloyd] Mints, [Frank] Knight, and [Jacob] Viner…”

Start with Robert Lucas’s observation that in a modern economy you cannot deflate--you cannot have the total nominal volume of spending fall--without having production, sales, and employment falls as well.

And also start with the quantity theory of money:

PY = MV

The total flow of spending in the economy--the amount produced and sold Y times the prices at which goods and services are sold P--is equal to the stock of money in the economy M--bank reserves, cash, checking-account balances, other liquid assets--times the velocity of money V. If PY threatens to fall--threatening a fall in production and sales and a rise in unemployment—then the standard policy Jacob Viner, Milton Friedman, and Christy Romer would recommend would be to boost M. Provided that V does not move in the opposite direction to offset the increase in M, nominal spending will stabilize and deflation and depression and high unemployment will be averted.

The loose end is V--how fast households and businesses spend their cash balances. Milton Friedman in Studies in the Quantity Theory of Money maintained that the key determinant of velocity is the (nominal) interest rate: the higher are nominal interest rates, the higher is velocity because the faster you want to spend your money. Holding purchasing power in cash rather than in bonds is expensive when interest rates are high: you would rather either spend it and buy something or move it back into bonds that pay interest rather than keep it around idle. The velocity of money of money is low when interest rates are low because delaying purchases while you comparison shop is not costly: you lose little in foregone interest that you could have been earning.

This dependence of velocity on the interest rate puts a limit on the effectiveness of monetary expansion. When you expand the money stock you increase the ratio of money to bonds. By simple supply and demand raise the price of bonds in terms of money—and the price of bonds in terms of money is the inverse of the interest rate. So when you raise the money stock, you lower velocity.

This matters when interest rates on assets like Treasury Bills get very low, like zero, like they are now. If you hold your money in a six-month Treasury Bill you get essentially no interest--0.3% per year Monday afternoon--and you run the small risk that interest rates might rise over the next month and your Bill might lose a little value. If you hold your money in cash you get exactly no interest and it is safe--FDIC insured. Thus there is no economic incentive pushing you to spend your cash when interest rates are very low. And so there is no economic reason for the velocity of money to be any particular value. When the central bank tries to boost nominal spending through standard monetary expansion it might prove ineffective: interest rates will drop even closer to zero as the ratio of money to bonds rises, and the velocity of money might well drop to offset the boost to the money stock.

Guess where we are now? The Federal Reserve is boosting the money supply with extraordinary force, and the velocity of money is dropping like a stone.

In order to ensure that monetary expansion is effective, you need to do something to boost interest rates. What can you? Here is where “large and continuous deficit budgets” comes in. When the government runs a deficit it floods the market with bonds. Once again by simple supply and demand more bonds means a lower price of bonds which is the same thing as higher interest rates. The government cannot hold on to the money it gets from selling bonds for that would reduce the money stock, and the whole point of the exercise is to make the increase in the money stock effective. It has to return the money to the private sector by spending it. And it can spend it in four ways:

• By buying up assets like mortgage-backed securities.
• By buying up companies like Fannie Mae, Freddie Mac, AIG, GM, Citigroup, and more to come.
• By refunding the money to taxpayers by cutting taxes.
• By spending the money directly--boosting government purchases.

Which of these ways would be most effective at keeping the velocity of money from falling further to offset expansionary monetary policy? The answer is that we really do not know which of the ways would be most effective--and that is the reason that we are trying them all right now, with Tim Geithner buying GM and mortgage-backed securities with the government’s money and Peter Orszag directing the flow of spending and tax cuts that is the American Recovery and Reinvestment Plan.

Will it work? It is hard to see how it could not work. Nobody disputes that in normal times monetary expansion boosts spending, demand, production, and employment. But the worry is that these times right now appear to be not-normal. Nobody disputes that in not-normal times when interest rates are very low--as they are now--there are no strong incentives to spend cash working to keep monetary velocity from falling to offset increases in the money supply. Purchasing insurance against this eventuality--which appears to be a reality outside the building--seems a reasonable thing to do.

Is this a good use of the government’s money? It does, after all, saddle us with additional government debt. If we did not spend money on the stimulus program now, we could use that debt capacity for some other, different purpose in the future. But as of 4 PM EDT on Monday, the U.S. government could borrow for seven years at a real interest rate I estimate at –0.5% per year. Government expenditures on national security, on Medicare, on the Center for Disease Control, on the Interstate Highway System, on research and development into green energy technologies would have to be extraordinarily and uniquely inefficient right now for them not to be worth doing right now when they come with the extra bonus of making monetary policy effective in the current situation.

Will it be big enough, or will in two years we wish we had done more? I think the odds are one-in-three that in two years we wish we would have done more, and that the odds are close to zero that in two years we wish we would have done less.

Thus my analysis of the stimulus program is quite positive. And this analysis, remember, is not mine alone. It is modeled on the analysis of Milton Friedman’s teachers at the University of Chicago in the 1930s--men of whom he highly approved as having left him nothing to learn at the feet of John Maynard Keynes, men who called for a two-handed approach to the Great Depression:

• “the Federal Reserve banks systematically pursue open-market operations with the double aim of facilitating necessary government financing and increasing the liquidity of the banking structure…”
• “the use of large and continuous deficit budgets to combat the mass unemployment and deflation of the times…”

That two-handed strategy is the approach we are pursuing now, in a situation that in its level of short-term interest rates has considerable similarities to the Great Depression.

It seems a wise and prudent bet.

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References

John Cogan, Tobias Cwik, John Taylor, and Volker Wieland (2009), “Old Keynesian versus New Keynesian Government Spending Multipliers” < http://www.volkerwieland.com/docs/CCTW%20Mar%202.pdf>.

Milton Friedman (1972), “Comment on the Critics of ‘Milton Friedman’s Monetary Framework’,” Journal of Political Economy.

Milton Friedman, ed. (1956), Studies in the Quantity Theory of Money.

Christina Romer and Jared Bernstein (2009), “The Job Impact of the American Recovery and Reinvestment Plan” http://otrans.3cdn.net/45593e8ecbd339d074_l3m6bt1te.pdf.

John Taylor (1993), Macroeconomic Policy in a World Economy: From Econometric Design to Practical Operation.

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Bad Banks Are Not an Adverse Supply Shock

Nick Rowe asks a question:

Worthwhile Canadian Initiative: Banks, Aggregate Demand, and Aggregate Supply: can understand how bad banks could affect the AS curve. Long-run growth comes from the Long Run Aggregate Supply curve moving slowly rightward over time as savings create investment that adds to the stock of capital and increases productivity. A good banking and financial system will encourage savings and investment, make sure the investments are the most productive ones, and make the LRAS curve move rightwards more quickly over time.

Even in the short run a good banking and financial system will be important in re-allocating capital between growing and declining sectors, if there are shifts in relative demand. If people want fewer cars and more restaurant meals, but banks cannot shift loans from car manufacturers to restaurants, the Short Run Aggregate Supply curve may shift left, because the restaurants won't be able to expand to meet demand, and car manufacturers' prices or wages may be sticky downwards. If you see the financial crisis as causing the recession by shifting the SRAS curve left, then monetary and fiscal policies, which shift the AD curve right, are not the appropriate cure...

But if bad banks have shifted the AS curve inward, then right now we should have stagflation: depression and inflation, as output falls and prices rise. We don't. The argument that fiscal and monetary policies won't reduce unemployment to normal levels because we have a supply side problem is completely incoherent in an AS-AD framework.

DeLong: The Current Situation (as of April 24, 2009): Econ 196 Lecture

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http://www.j-bradford-delong.net/2009_mov/20090426_196_lecture/

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Posted via email from http://braddelong.posterous.com/delong-the-current-situation-as-of-april-24-2 at Brad DeLong's Scrapbook

Britain Is Off the Euro

And Paul Krugman thinks that is a very good thing:

A quick note on Britain: Paul Krugman Blog: The Darling budget is basically a confession that Britain doesn’t dare do any significant discretionary fiscal stimulus. But it should be pointed out that Britain is getting a serious monetary expansion — much more than other troubled European economies.... Britain has, despite worries about its budget, managed to cut rates significantly vis-a-vis the core eurozone countries... the fall in the pound has made British products a lot more competitive.

I think the Spanish comparison is instructive. Like Britain, it’s had a major housing bust. But Spain has basically had nothing happen to offset that shock.

So I’m actually fairly hopeful about Britain; right now, the fact that it’s not on the euro is serving it well.

Silvio Gesell and Stamped Money: Another Thing Fisher and Wicksell Knew that Modern Economists Have Forgotten

Greg Mankiw in 2009, in the New York Times:

It May Be Time for the Fed to Go Negative : The problem with negative interest rates... is... it would be better to stick the cash in your mattress. Because holding money promises a return of exactly zero, lenders cannot offer less. Unless, that is, we figure out a way to make holding money less attractive.

At one of my recent Harvard seminars, a graduate student proposed a clever scheme to do exactly that.... Imagine that the Fed were to announce that, a year from today, it would pick a digit from zero to 9 out of a hat. All currency with a serial number ending in that digit would no longer be legal tender.... That move would free the Fed to cut interest rates below zero. People would be delighted to lend money at negative 3 percent, since losing 3 percent is better than losing 10....

The idea of making money earn a negative return is not entirely new. In the late 19th century, the German economist Silvio Gesell argued for a tax on holding money. He was concerned that during times of financial stress, people hoard money rather than lend it. John Maynard Keynes approvingly cited the idea...

Ummm... Greg... You make it sound as though Keynes noted it in an obscure footnote somewhere. But Silvio Gesell is the topic of part VI of chapter 23 of Keynes's flagship work, The General Theory of Employment, Interest and Money. And it's not just Keynes in his flagship work. There are 55,000 google hits for "Silvio Gesell." Patinkin (1993) reports that Irving Fisher advocated Gesell-based "velocity control" in his 1932 Booms and Depressions. Nobel prize-winning Maurice Allais was an advocate as well. Gerardo della Paolera and Alan Taylor are Gesell's biggest boosters today in their book Straining at the Anchor: The Argentine Currency Board and the Search for Macroeconomic Stability, 1880-1935, a University of Chicago Press book that is part of the NBER's series on "long term factors in economic development." Willem H. Buiter and Nikolaos Panigirtzoglou writing in the Economic Journal in 2003: "Overcoming the Zero Bound on Nominal Interest Rates with Negative Interest on Currency: Gesell's Solution."

This is, I think, yet another example of how much economics has lost by cutting itself off from its moral philosophical and historical roots. Something that Keynes and Fisher and the other founders of monetary economics seriously wrestled with is today seen as something unknown and new to be thought of by clever graduate students. Once again the answer to Olivier Blanchard's question "What Do We Know that Fisher and Wicksell Did Not?" is that Olivier is asking the wrong question: what did they know that we have forgotten?

Here is John Maynard Keynes writing in 1936, summarizing Silvio Gesell writing in 1916:

J.M. Keynes, General Theory of Employment, Interest and Money, chapter 23: It is convenient to mention at this point the strange, unduly neglected prophet Silvio Gesell (1862-1930), whose work contains flashes of deep insight.... [T]he English version (translated by Mr Philip Pye) being called "The Natural Economic Order". In April 1919 Gesell joined the short-lived Soviet cabinet of Bavaria as their Minister of Finance, being subsequently tried by court-martial.... Professor Irving Fisher, alone amongst academic economists, has recognised its significance. In spite of the prophetic trappings with which his devotees have decorated him, Gesell's main book is written in cool, scientific language; though it is suffused throughout by a more passionate, a more emotional devotion to social justice than some think decent in a scientist.... I believe that the future will learn more from the spirit of Gesell than from that of Marx.... Gesell's specific contribution to the theory of money and interest is... that the peculiarity of money, from which flows the significance of the money rate of interest, lies in the fact that its ownership as a means of storing wealth involves the holder in negligible carrying charges.... [H]e had carried his theory far enough to lead him to a practical recommendation, which may carry with it the essence of what is needed... the prime necessity is to reduce the money-rate of interest, and this, he pointed out, can be effected by causing money to incur carrying-costs just like other stocks of barren goods. This led him to the famous prescription of 'stamped' money, with which his name is chiefly associated and which has received the blessing of Professor Irving Fisher.... [C]urrency...would only retain their value by being stamped each month, like an insurance card, with stamps purchased at a post office. The cost of the stamps... should be roughly equal to the excess of the money-rate of interest (apart from the stamps) over the marginal efficiency of capital corresponding to a rate of new investment compatible with full employment. The actual charge suggested by Gesell was 1 per mil. per week, equivalent to 5.2 per cent per annum.... The idea behind stamped money is sound...

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UPDATE: Ah. Here's the original draft of Greg's New York Times column http://gregmankiw.blogspot.com/2009/03/reloading-weapons-of-monetary-policy.html, with Alan Taylor weighing in. And here is Bruce Champ of the Cleveland Fed writing about this a year ago http://www.clevelandfed.org/Research/commentary/2008/0408.cfm.

Economics 202b, Part II: Relevant Macroeconomics Reading List

TTh 11-12:30

PROLOGUE:

April 2: THE QUANTITY THEORY OF MONEY:

• Hawtrey, "Public Expenditure and the Demand for Labour" http://tinyurl.com/dl20090311f
• Hicks, "Mr. Keynes and the 'Classics': A Suggested Interpretation" http://www.jstor.org/stable/pdfplus/1907242.pdf;

Sections: Week of April 6: Review Problem Set 1

April 7: FROM THE QUANTITY THEORY TO IS-LM AND BEYOND:

• Samuelson and Solow, "Analytical Aspects of Anti-Inflation Policy" http://tinyurl.com/dl20090311a
• Friedman, "The Role of Monetary Policy" http://www.jstor.org/stable/pdfplus/1831652.pdf
• Friedman, "Comment on the Critics" http://tinyurl.com/dl20090311d

April 9: THE ORIGINS OF FINANCIAL CRISES

• Kindleberger, ch. 15 "Financial Crises" of A Financial History of Western Europe

Sections: Week of April 13: Review Problem Set 2

THE CURRENT CRISIS: BACKGROUND:

April 14: LIQUIDITY, DURATION, RISK, AND BANK RUNS:

• Douglas Diamond and Philip Dybvig (1983), "Bank Runs, Deposit Insurance, and Liquidity", Journal of Political Economy http://www.jstor.org/stable/1837095.

April 16: CREDIT CRUNCHES AND ECONOMIC ACTIVITY:

• Ben Bernanke and Mark Gertler (1989), “Agency Costs, Net Worth, and Business Fluctuations,” American Economic Review http://links.jstor.org/sici?sici=0002-8282(198903)79:1%3C14:ACNWAB%3E2.0.CO;2-U&origin=repec.

Sections: Week of April 20:

• Carmen Reinhart and Kenneth Rogoff (2008a), "Banking Crises: An Equal Opportunity Menace," NBER Working Paper no. 14587 (December) http://www.nber.org/papers/w14587.pdf
• Carmen Reinhart and Kenneth Rogoff (2008b), "Is the 2007 U.S. Subprime Financial Crisis so Different? An International Historical Comparison," American Economic Review 98 (May) http://www.economics.harvard.edu/faculty/rogoff/files/Is_The_US_Subprime_Crisis_So_Different.pdf

April 21: BUBBLES, CRISES, AND MONETARY POLICY:

• Franklin Allen and Douglas Gale (2000), "Bubbles and Crises," Economic Journal 110:460 (Jan.) http://www.jstor.org/stable/pdfplus/2565656.pdf
• Michael Bordo and Olivier Jeanne (2002), "Monetary Policy And Asset Prices: Does 'Benign Neglect' Make Sense?," International Finance http://www.nber.org/papers/w8966.pdf

April 23: THE EAST ASIAN FINANCIAL CRISIS OF A DECADE AGO:

• Morris Goldstein (1998), "The Asian Financial Crisis: Causes, Cures and Systemic Implications" (Online reading only; printing not permitted) http://bookstore.petersoninstitute.org/book-store/22.html
• Paul Krugman (1999), "Analytical Afterthoughts on the Asian Crisis" http://www.sfu.ca/~kkasa/krugman1.pdf
• Paul Krugman (1998), "What Happened to Asia?" http://web.mit.edu/krugman/www/DISINTER.html

Sections: Week of April 27: Review Problem Set 3

THE CURRENT CRISIS: ORIGINS AND DEVELOPMENT:

April 28: THE SUBPRIME CRISIS:

• Martin Baily, Robert Litan and Matthew Johnson (2008), "The Origins of the Financial Crisis" http://www.brookings.edu/~/media/Files/rc/papers/2008/11_origins_crisis_baily_litan/11_origins_crisis_baily_litan.pdf
• Claudio Borio (2008), "The Financial Turmoil of 2007-?" http://www.bis.org/publ/work251.pdf?noframes=1

April 30: THE CREDIT CRUNCH:

• Markus Brunnermeier (2009), "Deciphering the Liquidity and Credit Crunch 2007-2008," Journal of Economic Perspectives http://www.princeton.edu/~markus/research/papers/liquidity_credit_crunch.pdf

Sections: Week of May 4: Review Problem Set 4

May 5: THE EFFECT OF LEVERAGE:

• David Greenlaw, Jan Hatzius, Anil Kashyap, and Hyun Song Shin (2008), "Leveraged Losses: Lessons from the Mortgage Meltdown" http://faculty.chicagogsb.edu/anil.kashyap/research/MPFReport-final.pdf.

THE CRISIS: CURES:

May 7: THE SCANDINAVIAN MODEL AND OTHERS:

• Lars Jonung, Jaako Kiander and Pentti Vartia, "The Great Financial Crisis in Finland and Sweden: The Dynamics of Boom, Bust and Recovery" http://ec.europa.eu/economy_finance/publications/publication13551_en.pdf.
• Gauti Eggertson and Michael Woodford (2003), "The Zero Bound on Interest Rates and Optimal Monetary Policy"

May 12: THE GREAT DEPRESSION:

• James Butkiewicz (1995), "The Impact of a Lender of Last Resort in the Great Depression: The Case of the Reconstruction Finance Corporation," Explorations in Economic History http://www.sciencedirect.com/science?_ob=PublicationURL&_tockey=%23TOC%236796%231995%23999679997%23311437%23FLT%23&_cdi=6796&_pubType=J&_auth=y&_acct=C000059607&_version=1&_urlVersion=0&_userid=4420&md5=35aaa48a79aa575b3c81ba53bec39b8e
• William Keeton (1992), "The Reconstruction Finance Corporation: Would it Work Today?" http://www.kansascityfed.org/PUBLICAT/ECONREV/EconRevArchive/1992/1q92keet.pdf.

May 14: SUMMING UP:

May 19: 8-11 AM: FINAL EXAM

The Panic of 1825: We Are Live at The Week

The Panic of 1825 - THE WEEK: If you’re not satisfied with Paul Krugman or Nouriel Roubini as your guide to the current turmoil, you can always rely on E.M. Forster. It was Forster who grasped the essential drawback of the Internet long before anyone else, depicting, in his 1909 story "The Machine Stops" a world in which individuals communicate in isolation via machine. It turns out he’s pretty good on 21st-century financial crises, too, mostly because the underlying processes remain so similar to those of a financial crisis he studied. Only the scale has changed.

Forster’s great-aunt Marianne Thornton helped raise him after his father's death, leaving him 8,000 pounds upon her death, when Forster was 8. That legacy gave him the financial cushion to become a writer. So he wrote Marianne Thornton: A Domestic Biography 1797-1887, stringing her voluminous letters together with scene-setting prose. As it happens, the fortunes of the Thornton family turn on history’s first episode of successful central banking: the Bank of England's intervention in the 1825 financial crisis.

Marianne’s younger brother, Henry Thornton, was 25 in 1825. Though the Thornton ancestors had built a successful bank, it had passed out of family control a decade earlier. But in the middle of 1825 young Henry was invited to join it as the most junior of six partners. Marianne writes of profits of 40,000 pounds a year, which is quite a lot when you reflect that Jane Austen's creation, Fitzwilliam Darcy, the richest commoner in early 19th-century England—other than Nathan Meyer Rothschild—receives (I refuse to write "earns") only 20,000 pounds a year from his estate of Pemberly. Forty thousand pounds a year in income corresponds to a market capital value of 1 million pounds, which bears the same proportion to the size of the British economy then as $10 billion would bear today.

The bank—renamed Pole, Thornton upon Henry's joining—was not small change. To join it as one of the profit-splitting partners was one hell of a 25th birthday present. But, then, these were the kind of people whose house had not an address but a name: "Battersea Rise."

And now let me turn the microphone over to 28-year-old Marianne Thornton. Writing in December 1825 to her friend Hannah More, she said: "There is just now a great pressure in the mercantile world, in the consequence of the breaking of so many of these scheming stock company bubbles."

Sound familiar? These were not bubbles in high-tech stocks or in mortgage lending and house prices, however, but bubbles in shipping lines, canals, and textile-spinning factories. And, of course, the bank of which young Henry had been a partner for only four months had gotten itself badly undercapitalized. The managing partner "had been inexcusably imprudent in not keeping more cash in the House, but relying on [the bank's] credit ... which would enable them to borrow whenever they pleased."

Except, of course, that in 1825 just as in 2009, no bank can borrow cash on the one day it really needs to, for every other bank really needs it on that same day. Which is why there came a “dreadful Saturday I shall never forget,” when a run on the bank was made, with “one old steady customer” withdrawing, without warning, his entire 30,000 pounds, leaving the bank vault “literally empty."

According to Marianne, the other bank partners fell apart: The managing partner "insisted on proclaiming themselves bankrupts at once, and raved and self-accused himself." Senior partner Scott "cried like a child of 5 years old." Partner Pole was away at his country estate. Another was on a business trip. It fell to 25-year-old Henry to deal with the fact that in the last business hour of Saturday, "they would have to pay 33,000 [pounds], and they should receive only 12,000 [pounds]. This was certain destruction."

Henry Thornton frantically searched the City of London looking to borrow money. He found banker John Smith, who always has been “particularly kind to Henry." He told Smith he could hardly expect him to lend the bank funds, but asked if Smith could at least tide them over until the 5 p.m. closing time. Smith asked if the bank was solvent and Henry gave his word. Well, then, Smith said, Pole, Thornton would have all he could spare.

“Never, [Henry] says, shall he forget watching the clock to see when 5 would strike, and end their immediate terror. ... The clock did strike ... as Henry heard the door locked, and the shutters put up, he felt [Pole, Thornton] would not open again but would be forcibly liquidated Monday morning."

There were, however, other characters in motion. Robert Banks Jenkinson, Second Earl of Liverpool, first lord of the Treasury and prime minister of His Majesty George IV, had been having whispered conversations with Bank of England Gov. Cornelius Buller and his deputy John Baker Richards. Liverpool said that it was of vital importance that the banking system of London not collapse under the weight of speculation and the popping of all those stock company bubbles.

Liverpool claimed he could not get Parliament to appopriate money to save the banks or to prop up asset prices: Parliament was populated by tax-paying landlords who did not especially trust the stock-jobbing financiers of London. Liverpool had spent much of the past year warning bankers that if their "overtrading" were followed by "revulsion" and "discredit," that he would not spend Treasury money to rescue them.

However, Liverpool told Buller, the Bank of England might. The Bank of England had a peculiar semi-private status with enormous autonomy. And everyone knew it was too big to fail—it was, after all, the bank for the entire British Empire, and the empire would stand behind it. So the Bank of England could save the situation even if the government could not. Moreover, it seems Lord Liverpool said to Buller, if it becomes necessary I want you to print up banknotes in excess of the legal limit, and to lend out your gold reserves even though the bank’s charter requires you to keep them in your vaults.

Banker John Smith had gotten wind of these conversations between Liverpool and Buller. And that Saturday evening, after the banks had closed, John Smith told Henry Thornton that if Henry truly believed that Pole, Thornton was solvent he, John Smith, would undertake to get it cash from the Bank of England. This was a shock. "[T]he Bank [of England]," Marianne Thornton wrote, "had never been known to do such a thing in the annals of banking," and so "Henry had little hope from this."

Nevertheless, the following morning, Sunday, at 8 o'clock, Bank of England Gov. Buller and Deputy Gov. John Baker Richards, along with every member of the Court of the Bank of England who was in London, were assembled to meet John Smith and Henry Thornton.

Marianne Thornton picks up the story: "John Smith began by saying that the failure of [Pole, Thornton] would occasion so much ruin that he should really regard it as a national misfortune," and he also praised Henry Thornton beyond all reason, saying "what he had seen of the conduct of one of the partners ... had convinced him that could [the bank] be saved for the moment," the crisis would pass. Smith "then turned to Henry and said, 'I think you give your word the House is solvent?' Henry said he could ... [and] had brought the books.

“'Well then', said the governor and the deputy governor of the Bank, 'you shall have 400,000 pounds by 8 tomorrow morning, which will I think float you'. Henry said he could scarcely believe what he had heard.”

I can scarcely believe it myself, even now. Blowing that number up to account for the difference between the British economy then and the British economy now, that's a $4 billion commitment secured on the word of a 25-year-old. Amazing—although there was a joke making the rounds last April that JPMorgan Chase CEO Jamie Dimond could have borrowed an extra $2 billion from the Federal Reserve if he had been willing to pledge his dog as collateral.

Monday morning, in the pre-dawn dark, Henry Thornton was at the Bank of England with Gov. Buller and Deputy Gov. Richards. For security reasons, they were alone. Buller and Richards counted out 400,000 pounds in bank notes. "I hope this won't overset you, my young man," Marianne Thornton claims one of the two said to Henry, “to see the governor and deputy governor of the Bank [of England] acting as your two clerks."

Henry Thornton arrived at his own bank before opening with 400,000 pounds in cash. The run on bank funds then recommenced. But "rumors that the Bank of England had taken them under its wing soon spread, and people brought back money [on Monday] as fast as they had taken it out on Saturday."

This was the birth of central banking as we know it.

The Bank of England had accepted the role of maintaining orderly markets and financial stability in a crisis. Why? Because the prices of financial assets are too important to be left to the market when it is panicked and when letting prices reach market levels will mean unemployment for hundreds of thousands in 1825, or tens of millions today.

Ben Bernanke's Public Private Investment Partnerships—the vehicles for purchasing banks’ toxic assets—are a natural development, even a Burkean development, of policy that has been pursued for 184 years now.

When politicians wash their hands of a financial system in crisis and fail to intervene on a large scale, things do not turn out well. The most notable example was 1929–1933, when, at least according to Herbert Hoover, Treasury Secretary Andrew Mellon persuaded Hoover that "even a panic is not altogether a bad thing” because "it will purge the rottenness out of the system.”

Did 1825 turn out better? We think so. George IV was not executed on Tower Green. Lord Liverpool's head was not carried about London on a pike. The spinning of cotton into thread in Britain in 1826 was 11 percent lower than in 1825—the first serious industrial recession—but it bounced back and grew 30 percent from 1826 to 1827.

And the bank of Pole, Thornton? Alas, Henry Thornton was irrationally exuberant when he swore that the bank was solvent. The bank was eventually closed. The partners lost their capital shares. The Bank of England had to wait years before getting its emergency loan back. (They did not care much; they were too big to fail, and Lord Liverpool thought they had done well.) Henry’s career prospered thereafter. Even though the financial ship that he had seized command of as a junior partner foundered, the consensus was that he had displayed great energy, good judgment, a cool head, and a facility with figures that made him worth backing in the future.

IS-LM

Scott Sumner writes:

The Money Illusion:More Reverse Causation: I have to confess that I don’t understand the IS-LM model very well, as I never us it in teaching...

Hmmm... My first reaction is "what's to understand?" If you use the quantity theory of money--well, that is the LM curve. Even if you deny that money demand is interest elastic, well, that is still the LM curve--it is merely a vertical LM curve. If you use the real flow-of-funds balance through financial markets or the income-expenditure framework with exports and investment depending on the real interest rate--well, that's the IS curve. You then have to stitch them together, which requires a model of (a) expected inflation, (b) term premia, (c) default premia, (d) information premia, and (e) risk premia. But I have not yet seen a theory of nominal spending or real output determination that does not have an IS-LM representation...

The Coming of the Industrial-Financial Business Cycle: Economics 202b: April 9, 2009 Lecture

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Simple Keynesianism for Monetarists: A Primer

Tyler Cowen's Email to Brad DeLong is in response to this piece in progress. I'm still not sure whether it is a work of genius, a useful exercise in cross-community communication, a weird exercise like trying to run the 50-yard dash on your hands, or just a mistake:

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DeLong: Thinking About Macroeconomic Issues 1925-2006: Economics 202b Lecture (April 7, 2009)

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An Appeal for Help: Recent History of Economic Thought

Somewhere, somehow, without as far as I know leaving any paper trail, Chicago-School economists became convinced of two false things:

1. Ricardian equivalence means not just that deficit-financed tax cuts have no short-term stimulative effects but also that deficit-financed spending increases have no short-term stimulative effects on nominal spending.

2. There are no issues worth discussing at the zero nominal interest rate bound: monetary expansion via open market operations retains its full potency and power to affect the level of nominal spending spending even when open market operations are just the swap of one zero-yielding government liability for another.

If anyone can help me understand the process by which these strange doctrines of economics became Holy Writ among the Monsters of the Midway, I would be very grateful...

The latest to show up in these camps is Robert Lucas:

Why a Second Look Matters: [1929-1932] added up to four years of negative [nominal income] growth averaging minus-8 percent a year.... [T]he Federal Reserve didn't cause this decline.... My guess is it was... people seeking safety in liquidity after the stock market crash... people... wanted to build up their cash holdings. [T]he Fed could have responded to that situation by... creating... reserves... to supply the added liquidity.... But the Fed didn't do anything to relieve this liquidity. They... cut interest rates to zero. They were, I guess, the believers that the only thing... monetary policy can do is fix interest rates. And once interest rates get to zero, you're over.

Friedman and Schwartz... [argued] that this passive response by the Fed must bear the ultimate responsibility for the severity of the contraction.... So even today, many people think of the Depression as evidence that monetary stimulus is ineffective when the real problem was that it wasn't used....

[T]his is one policy mistake that's not going to be repeated in the current situation.  The Fed, under Bernanke's leadership, had added something -- I never know quite know what number to say, I'll say 600 billion (dollars) in bank reserves... [to] a system that operated with $50 billion in reserves last August... just a mountain of new reserves.... I think this is the right thing to do.... It is not possible to pull a modern economy through a neutral or painless deflation.  Economic theory doesn't really tell us why -- what's hard about it.  But, the evidence, I mean, it just doesn't work....

[W]ould a fiscal stimulus somehow get us out of this bind, or add another weapon that would help in this problem? I've already said I think what the Fed is now doing is going to be enough to get a reasonably quick recovery committed. But,could we do even better with fiscal stimulus? I just don't see this at all. If the government builds a bridge, and then the Fed prints up some money to pay the bridge builders, that's just a monetary policy. We don't need the bridge to do that. We can print up the same amount of money and buy anything with it....

But if we do build the 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.) You apply a multiplier to the bridge builders, then you've got to apply the same multiplier with a minus sign to the people you taxed to build the bridge... taxing them later isn't going to help, we know that...

DeLong: The State of the Economy, Early April 2009

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

From RJW:

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

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

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

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

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

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

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

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

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

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

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

The Coming of the Great Depression

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

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

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

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

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

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

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

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

DeLong: Thinking About Macroeconomic Issues 1890-1935—Plus What Is Going on Today: Economics 202b Lecture (April 2, 2009)

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Future Inflation: The Least of Our Worries

Ryan Avent:

The Bellows » Inflation: Bring It On: We need not worry about hyperinflation. Or rather, in a world where hyperinflation is a real possibility, hyperinflation is the last thing we’d be worrying about. There are certainly circumstances under which America could face uncomfortably high inflation down the road, the result of which would most likely be Fed tightening and a painful double-dip recession. But there are two key points to be made about this.

One is that “uncomfortably high” given present conditions is pretty darn high. In the midst of deep recession, inflation isn’t nearly as nasty as it might otherwise be. For one thing, when dollars are getting weaker people don’t want to hold dollars, and so they spend them, which is a good way to make a dent in the shortfall in demand. For another, inflation will help housing markets clear. And for another, a weaker dollar should goose American exports.

The second, and related, point is that inflation is one of many concerns that we face at the moment. Fed independence is a big issue, and 20% annual inflation is something we’d prefer to avoid, but so is, say, a 6% contraction in output. I’d love for Congress to allocate all the necessary funds and then turn around and take the necessary steps to rein in the deficit, but given actual political constraints I’m extremely glad the Fed has done what it’s done — I prefer to see some action appropriate to the scale of the downturn taken and roll the dice with inflation. As Yglesias wrote earlier today:

Talking about a different issue last week, I heard Tyler Cowen forcefully make the point that you have to think of the political constraints as a real policy consideration.

Another way to think about this is that maybe all the folks worried about inflation should instead focus their ire on the supermajoritarian rules constraining Senate action.

Tyler Cowen: Timeo Stimulus Dona Ferentes

Tyler Cowen fears fiscal stimulus:

Marginal Revolution: Fiscal stimulus and German unification: For all the talk about the Great Depression, we are missing one historical analogy for a program of large fiscal stimulus, namely Germany after the Berlin Wall came down.  The two countries united, lots of money was spent and lots of money was borrowed.  West Germany had a modern economy with both manufacturing and services.  At the time Germany had unemployed resources, especially if you count the labor moving from East Germany to West Germany as grossly underemployed and available for higher-return projects.  The results were less than wonderful. The higher demand boosted measured gdp growth in the short run (bananas and porn, plus reconstruction) but Germany fell into economic stagnation.... The higher taxes and debt then kept the German economy down for many years. Few Germans were happy with the economic fallout from this "stimulus." And that was with a relatively well-functioning financial system and a reasonable amount of initial optimism. You can list many dissimilarities between German unification and the current U.S. situation...

The big difference, of course, is that the German central bank did not play ball with the program. The Bundesbank upset the applecart by offsetting expansionary fiscal policy with extremely contractionary monetary policy.

I don't know anybody who thinks fiscal policy boosts output if the monetary authority doesn't play ball. But right now Ben Bernanke is not only playing ball, he is funding the construction of an entire new stadium...

DeLong: The Financial Crisis

My talk to the California Budget Project on The California Channel.

AIG: We Did Our Best, and Need Better Tools

Ben Bernanke and Tim Geithner try to use the AIG bonus scandal to argue that they should be trusted more and not less.

Andrew Ward and Tom Braithwaite of the FT:

Treasury urges new powers to intervene: The Obama administration joined forces with Ben Bernanke on Tuesday to press Congress for powers that would enable regulators to seize control of troubled financial groups including “non-banks” such as insurer AIG. In a rare joint appearance before the House financial services committee, the Federal Reserve chairman and Tim Geithner, Treasury secretary, also called for an oversight body to monitor big financial institutions that pose systemic risks.

Mr Bernanke said if such tools were available when the government moved to rescue AIG in September “they could have been used to put AIG into conservatorship or receivership, unwind it slowly, protect policyholders and impose haircuts on creditors and counterparties as appropriate”. The Fed chairman said the AIG case highlighted the “urgent need” for a new resolution authority modelled on the Federal Deposit Insurance Corporation, which protects depositors when banks fail. Such an authority would be able to seize non-banks as well as the holding companies that control big banks.

Responding to questions about $165m in bonuses paid to AIG executives after the insurer was bailed out, Mr Bernanke said he had wanted to sue to block the payments but was advised this move could be successfully challenged in court. Mr Bernanke and Mr Geithner defended their handling of the AIG bail-out but said the government needed stronger tools to prevent similar turmoil in future...

A Note on Paul Krugman's Reflections on Fiscal Aspects of Quantitative Easing (with Gratuitous Toy Story Reference)

Paul Krugman thinks about monetary policy:

Fiscal aspects of quantitative easing: The big policy news this week has been the Fed’s decision to buy $1 trillion of long-term bonds, going beyond the normal policy of buying only short-term debt. Good move — but it’s probably worth pointing out that yes, this does expose the Fed, and indirectly the taxpayer, to some risks. And in so doing, it blurs the line between fiscal and monetary policy.... The Fed is... printing $1 trillion of money, and using those funds to buy bonds. Is this inflationary? We hope so! The whole reason for quantitative easing is that normal monetary expansion, printing money to buy short-term debt, has no traction thanks to near-zero rates. Gaining some traction — in effect, having some inflationary effect — is what the policy is all about. The problem may come when the economy recovers... there will come a time when the Fed wants to withdraw that extra $1 trillion of money it created. It will presumably do this by selling the bonds it bought back to the private sector....

[W]hen the economy recovers... long-term interest rates will rise.... Suppose that the Fed has bought a bunch of 10-year bonds at 2.5% interest, and that by the time the Fed wants to shrink the money supply again the interest rate has risen to 5 or 6 percent.... Then the price of those bonds will have dropped.... My back of the envelope calculation looks like this: if the Fed buys $1 trillion of 10-year bonds at 2.5%, and has to sell those bonds in an environment where the market demands a yield to maturity of more than 5%, it will take around a $200 billion loss. I’m not complaining.... But we should go into it with our eyes open.

Paul thinks (correctly, I believe) that the prices of Treasury bonds are higher than they will be in the long run, and thus that the Fed is buying high and will be selling low. But, as I understand it, Paul also thinks (correctly, I believe) that the prices of private-sector bonds are too low--that is our problem: that firms that ought from a social-welfare point of view to be expanding can't expand because they cannot get financing on any but usurious terms. If true, then in the long run the prices of private-sector bonds will go up.

Since buying Treasury bonds and buying private bonds for cash should have similar effects on the overall structure of asset prices, this raises a natural question: why not have the Federal Reserve buy those assets that are undervalued (private bonds, because the risk discount right now is too high) rather than those assets that are overvalued (Treasury bonds, because the duration discount right now is too low)? In that case the Fed would be buying low and selling high--and making, not losing money for the Treasury in the long run.

The answer in normal times is that open-market operations in Treasuries do not play favorites among corporations (although they do play favorites among sectors, either penalizing or rewarding sectors whose capital or output is of long duration), just as revenge is not a concept believed in on Buzz Lightyear's planet. However, then Buzz Lightyear grabs Woody by the throat and says: "But we are not on my planet, are we?"

We are not in normal times right now, are we?

Greg Ip on Alan Greenspan

From the Economist:

He had the power | Free exchange: ALAN GREENSPAN’s defence of the Federal Reserve in the formation of the housing bubble restates a familiar argument—it raised short-term interest rates but long-term interest rates did not follow, and housing is most sensitive to long-term rates.... Mr Greenspan asserted on a number of occasions that while America might have local housing bubbles, there was no national housing bubble. Yet he now asserts there was a global housing bubble. It has always puzzled me how he could go from seeing local bubbles to a global bubble without at some point diagnosing a national bubble. By failing to diagnose a national housing bubble until it was already well inflated, the Fed under Mr Greenspan escaped the obligation to do anything about it.

But had the Fed recognised it, should, or could, it have done anything about it? Mr Greenspan argues that irrespective of whether it should, it could not, because it did not control long-term interest rates. I disagree.... Yes, the linkage between the short- and long-term rates weakened. But at some point, it probably would have reappeared. The Fed could have gotten the long-term rate up had it raised the short-term rate enough. And even if the long-term rate remained stable, the economy, and housing demand, would eventually have wilted as other components of financial conditions tightened.

How much is enough? It’s hard to say, but perhaps 8% or 10%. The problem is that this would have been so draconian, that the entire economy would have tanked.... This is a legitimate defence of the Fed's actions. But saying the Fed had the power to stop the bubble but chose not to exercise it is different from saying it was powerless.... There was, of course, an alternative between letting the bubble inflate and inviting recession. Had Mr Greenspan and his colleagues concluded housing prices were too high and there was value in taming them, they could have used regulatory tools instead of monetary policy. They could have insisted on a margin requirement for home purchases—no one could put down less than 20% unless they obtained mortgage insurance. (At the peak of the bubble, the widespread use of second liens made 100% loan-to-value mortgages without insurance commonplace.) This would have been politically difficult since it would have deprived lots of people the opportunity to own a home.... It would have also contradicted Mr Greenspan’s own deregulatory impulses...

Government-Run Financial Stabilization Programs on a Pan-Galactic Scale

God! Don't let British editors choose your headlines. Just saying. Chris Carroll:

Punter of last resort : The financial meltdown that shifted into high gear last September has flushed into public view many surprising facts. One of the strangest is the existence, in the economics profession, of a bizarre religious cult. This cult adheres to the dogma that the “price of risk” is the Holy of Holies that can properly be set only by the immaculate invisible hand of the financial marketplace; and cult members seem to believe, to paraphrase President Lincoln from a rather different context, that “If the Market wills that the economic crisis continue until every dollar of economic activity created by the taking of risk shall be repaid by another dollar destroyed by a newfound fear of risk, so it still must be said that the judgments of the Market are true and righteous altogether.”...

This game brings to mind Joan Robinson’s comment that “utility maximization is a metaphysical concept of impregnable circularity,” and Larry Summers’s remark (quoted by Robert Waldmann) that the day when economists first started to think that asset prices should be explained by the characteristics of a representative agent’s utility function was not a particularly good day for economic science.... As DeLong (2008) has recently reminded those of us who are susceptible to the lessons of history (see also Kindleberger (2005)), the “lender of last resort” role of the central bank has always been, during a panic, to short-circuit the catastrophic economic effects of a collapse of financial confidence (in today’s terminology, ‘an increase in the price of risk’). Some economists, of course, view narrative history in the DeLong and Kindleberger mode as irrelevant.... For the numerically inclined, however... controlling a market price of risk is something the Federal Reserve has done since it first opened up shop... the shortest-term interbank lending rate for which data are available (on a consistent basis) from before and after the founding of the Fed. Figure 1b shows the month-to-month changes in this interest rate. The only reason this rate is now viewed as ‘risk-free’ is that the Fed takes away the risk:

  Do the advocates of the risk-is-holy view really believe that we were better off in a real free-market era when interbank rates could move from 4 percent to 60 percent from one month to the next (as happened in 1873)? And how long do they think such a system would last?... A less extreme version of essentially the same dogma states that while it is acceptable for the central bank to suppress the aggregate risk that would otherwise roil short-term interest rates, the Fed should ignore all other manifestations of financial risk. It is, if anything, harder to construct a coherent economic justification of this point of view than of the strict destructionist view that says the Fed should not exist at all.... [T]here is, at least, a perception that this way of operating is hallowed by time and practice.... But... Robert Barbera, Charles Weise, and David Krisch show... that... the Federal Reserve’s choice of the short run interest rate has been powerfully correlated to market-based measures of risk....

Given the Fed’s pattern of past responses to risk and economic conditions (as embodied in risk-augmented Taylor rules), the implied value of the short term interest rate right now should be somewhere below negative 3.3 percent (actually even lower, since these projections do not reflect the dire recent news). Since interest rates cannot go below zero, the Fed must do something else to boost the economy. The obvious answer is to do everything possible to rekindle the appetite for risk – even if that means taking some of that risk onto the Fed’s balance sheet....

Let’s put it this way: Simple calculations show that the current price of risk as measured by corporate bond spreads amounts to a forecast that about 40 percent of corporate America will be in bond default in the near future. The only circumstance under which this is remotely plausible is if government officials turn these dire forecasts into a self-fulfilling prophecy....

Back when the financial system was almost entirely based on banks, the solution to such a problem was that the Federal Reserve would act as the ‘lender of last resort’ to quell the panic. In the new financial system where banks are a much smaller share of the financial marketplace than they once were, the Fed’s appropriate new role seems clear: It needs to intervene more broadly than before, in public markets (as has already been done for the commercial paper market) as well as for banks...

How large a scale are we talking about here? I can't help but think that we are calling for a $4 trillion operation--$4 trillion of bank reserves and Treasury debt created, $4 trillion (at current market values) or risky assets pulled onto the government's balance sheet.

Can the U.S. government do this without cracking the U.S. Treasury bond's status as safe asset in the world economy? I think so. But we will see...

Chris Carroll: Change in the Interbank Lending Rate

via voxeu.org

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Posted via web from http://braddelong.posterous.com/chris-carroll-change-in-the-interbank-lending at Brad DeLong's Scrapbook

Justin Fox: Helicopter Ben

Here we go. Finally action on a scale that might be a third as big as will ultimateby be needed.

Justin Fox:

Helicopter Ben finally hauls out the helicopter: The Federal Open Market Committee, that group whose interest rate decisions we used to care about back before the Federal funds rate settled down around 0.15%, moved markets this afternoon with its announcement that it was going to buy lots more mortgage securities (up to $750 billion more) and start buying long-term Treasuries (up to $300 billion worth) for the first time in a very long time.... [T]hr Fed's move into the long-term Treasury market is a momentous and somewhat unsettling one. As the federal government issues trillions in new debt to finance stimulus spending and the daily operations of government, the quasi-governmental Fed will now be buying hundreds of billions of it, in the process creating new money.... It's a very weird, somewhat circular transaction, and it was last done in a big way during World War II.... Milton Friedman described this kind of transaction as the functional equivalent of a "helicopter drop" of money, and after Ben Bernanke mentioned this in a speech in 2002 he became known as Helicopter Ben. Now he's finally living up to the name.

Will it work?...

I say yes--but needs to be done on a larger scale.

Richard Clarida Is Not an Optimist

Richard:

A lot of bucks, but how much bang?: Because of the severe damage to the system of credit intermediation through banks and securitisation, policy multipliers are likely to be disappointingly small.... Policy multipliers are greater than 1 to the extent the direct impact of the policy on GDP is multiplied as households and companies increase their spending from the increased income flow they earn.... Historically, multipliers on government spending are estimated to be in the range of 1.5 to 2, while multipliers for tax cuts can be much smaller, say 0.5 to 1. But these estimates are from periods when households could – and did – use tax cuts as a down payment on a car or to cover the closing costs on a mortgage refinance....

So where does this leave us? A LOT is riding on the efforts of the Fed and other central banks to stabilise the financial system and restore the flow of credit. Officials recognising these challenges are now seriously considering “non-traditional” policies that combine monetary and fiscal elements. Cutting rates to (near) zero has not been a mistake, but it has been ineffective – really the most striking example of ‘pushing on a string’ I have witnessed in my lifetime. The reason, again, is the impaired credit intermediation system....

Altogether, between the MBS, CPFF, and TALF programs, the Fed is committing nearly 2 trillion dollars of financing to the private sector. While these sums may be necessary to prevent an outright economic collapse that extends and deepens into 2011 and beyond, it is not clear to me that they are sufficient to turn the economy around so that it returns to robust growth. Moreover, based on the Fed’s just released economic forecast and Chairman Bernanke’s recent testimony to the Senate Banking committee, the Fed is also not convinced that these policies are sufficient to turn the economy around...

I'm Picking Up Economics 202b Next Week...

... and I still have not decided what to do. The subject I have been given is "macroeconomic policy"--but repeating any macroeconomic policy syllabus from any year in the past seems like a really stupid thing to do right now.[1]

So let me send out a list of first week's readings--ancient history and culture--to tide the students over...

Week 1: March 17 & 19: In the Shadow of Milton Friedman

• DeLong, "America's Only Peacetime Inflation: the 1970s" http://tinyurl.com/dl20090311h
• DeLong, "Keynesianism, Pennsylvania Avenue-Style" http://tinyurl.com/dl20090311i
• Hicks, "Mr. Keynes and the 'Classics': A Suggested Interpretation" http://www.jstor.org/stable/pdfplus/1907242.pdf
• Samuelson and Solow, "Analytical Aspects of Anti-Inflation Policy" http://tinyurl.com/dl20090311a
• Friedman, "The Effects of a Full-Employment Policy on Economic Stability: A Theoretical Analysis," in Milton Friedman, Essays in Positive Economics (Chicago: Univerity of Chicago Press), p. 117 ff http://tinyurl.com/dl20090311e
• Friedman, "The Role of Monetary Policy" http://www.jstor.org/stable/pdfplus/1831652.pdf
• Tobin, "Friedman's Theoretical Framework" http://tinyurl.com/dl20090311b
• Friedman, "Comment on the Critics" http://tinyurl.com/dl20090311d
  • Friedman, "A Theoretical Framework for Monetary Analysis" http://tinyurl.com/dl20090311c
  • Hawtrey, "Public Expenditure and the Demand for Labour" http://tinyurl.com/dl20090311f
  • Kahn, "The Relation of Home Investment to Unemployment" http://tinyurl.com/dl20090311g
• Romer, Advanced Macroeconomics, ch. 5: 5.1 Aggregate Demand. 5.2 The Open Economy. 5.3 Alternative Assumptions About Wage and Price Rigidity. 5.4 Output-Inflation Tradeoffs. 5.5 Money and Output. 5.6 The Cyclicality of the Real Wage

Problem Set Out: Romer 5.1, 5.3, 5.4, 5.9, 5.14, 5.15, due 30 Mar

On the Economy, Obama and Company Are Now Batting 2 Out of 5...

Paul Krugman is unhappy:

Feelings of despair: There’s so much to like about where Obama is going — health care, transparency in government, ending the war in Iraq. And the stimulus bill is OK, though not big enough. But on the question of fixing the banks, many of us are feeling a growing sense of despair. Obama and Geithner say the right things. But Simon Johnson nails it:

How long can you say, “we are being bold” when in fact you are not?

Obama and Geithner say things like,

If you underestimate the problem; if you do too little, too late; if you don’t move aggressively enough; if you are not open and honest in trying to assess the true cost of this; then you will face a deeper, long lasting crisis.

But what they’re actually doing is underestimating the problem, doing too little too late, and not being open and honest in trying to assess the true cost. The actual plan seems to be to keep the banks semi-alive by implicitly guaranteeing their liabilities and dribbling in money as necessary, all the while proclaiming that they’re adequately capitalized — and hope that things turn up. It’s Japan all over again. And the result will probably be a deeper, long-lasting crisis.

Back last November, I said that the Obama administration needed to do five things:

1. Expansionary monetary policy at an appropriate scale.
2. Expansionary fiscal policy at an appropriate scale.
3. Massive bank recapitalization--or nationalization--so that banks believe that they can be banks that start lending again rather than being zombies that think they have to hunker down and minimize risk in order to keep the next negative shock from destroying the institution.
4. Massive buy-ups of mortgages by Fannie and Freddie so that (a) mortgage deals could be reworked, and (b) the supply of risky assets on financial markets that the private sector could be reduced in consonance with the banking system's reduced risk tolerance.
5. Design the regulatory system for financial markets going forward.

Bernanke has done (1). Summers and company have done (2) at perhaps half-scale--but thanks to the Republicans and Senator Nelson that was the biggest fiscal boost progrtam that could get through congress. Geithner and his skeleton staff are doing about half of (3)--or perhaps less. And I see no signs of (4) or (5).

This is much, much better than the Bush administration. But it is not reassuring. We might still get out of this "OK," where "OK" means a headline unemployment rate that stays below 10%. But we might not...

Scrapbook: Tobin: Friedman's Theoretical Framework

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DeLong: Very Conventional Short-Run Stabilization Policy

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