Tag Archives: Paul Krugman

The unconscious liberal

Posted on by

Macroeconomic Populism Returns

By Paul Krugman

February 1 (NYT) — Matthew Yglesias says what needs to be said about Argentina: theres no contradiction at all between saying that Argentina was right to follow heterodox policies in 2002, but it is wrong to be rejecting advice to curb deficits and control inflation now. I know some people find this hard to grasp, but the effects of economic policies, and the appropriate policies to follow, depend on circumstances.

Yes, unemployment- source of the greatest economic loss as well as a social tragedy and a crime against humanity, is always the evidence deficit spending is too low. There is no exception as a simple point of logic. The currency is a simple public monopoly, and the excess capacity we call unemployment- people looking to sell their labor in exchange for units of that currency- is necessarily a consequence of the monopolist restricting the supply of net financial assets.

I would add that we know what those circumstances are! Running deficits and printing lots of money are inflationary

Why the undefined ambiguous empty rhetoric?

and bad

What does ‘bad’ mean here? For example, there is no evidence that inflation rates at least up to 40% hurt real growth, and more likely help it. Politically, however, it may be ‘very bad’. But those are two different things.

in economies that are constrained by limited supply;

Limited supply of what? Labor? Hardly! In fact, full employment is even more critical, if that’s possible, when there are limited supplies of other resources. Wasn’t Rome built without electricity, oil, bulldozers, the IMF, etc. etc.? OK, it took more than a day, but it was built. There is always more to do than people to do it. Economically, unemployment is never appropriate policy.

they are good things when the problem is persistently inadequate demand.

Unemployment is the evidence of this ‘inadequate demand’ which is necessarily created by taxation, the ultimate source of all demand for a given currency. In fact, taxation functions first to create unemployment- people looking for work paid in that currency. That’s how govt provisions itself- it creates people looking for jobs with its taxation, then hires those unemployed its tax created. What sense does it make for govt to create more unemployed than it wants to hire??? Either hire the unemployed thus created, or lower the tax!!!!!!!!!!!!

Similarly, unemployment benefits probably lead to lower employment in a supply-constrained economy; they increase employment in a demand-constrained economy; and so on.

With more that needs to be done than there are people to do it, the economy isn’t supply constrained until full employment. And nominal unemployment benefits are about the level of prices, wages, and the distribution of income rather than the level of potential employment, etc.

So sometimes the relationship and money looks like this, from the best economics principles textbook:

This is more about ‘inflation’ causing ‘money’ as defined.

But sometimes it looks like this:

This is more about partially defining ‘money’ as reserve account balances at the Fed but not securities account balances (tsy secs) at the Fed.

And just to repeat a point Ive made many times, those of us who understood IS-LM predicted in advance that the actions of the Bernanke Fed wouldnt be inflationary, while the other side of the debate was screaming debasement.

It’s not about ISLM, which is fixed fx analysis. It’s about recognizing that there is always precious little difference between balances in reserve accounts at the Fed and securities accounts at the Fed.

There’s something else to be said about Argentina and, it seems, Turkey namely, that were seeing a mini-revival of what Rudi Dornbusch and Sebastian Edwards long ago called macroeconomic populism. This involves, you might say, making the symmetrical error to that of people who think that running deficits and printing money always turns you into Zimbabwe; its the belief that the orthodox rules never apply. And its an equally severe mistake.

Unfortunately most of the ‘orthodox rules’ apply to the fixed fx policies in place when they were first stated, and not to today’s floating fx.

Its not a common mistake these days; a few years ago one would have said that only Venezuela was making the old mistakes, and even now its just a handful of countries. But it is a mistake, and we need to say so.

Yes, mistakes are being made by all of the headline economists and the global economy is paying the price.

Share

CNBC’s John Carney on Krugman and MMT

Posted on by

>   
>   (email exchange)
>   
>   On Sat, Nov 12, 2011 at 2:19 PM, Stephanie wrote:
>   
>   John Carney loving on us again

Yes!

Paul Krugman Goes MMT on Italy

By John Carney

November 11 (CNBC) — It seems pretty clear that the school of thought known as Modern Monetary Theory has made a big impact on Paul Krugman’s thinking.

As Cullen Roche at Pragmatic Capitalism points out, just a few months ago the spread between bonds issued by Japan and Italy, which have similar debt and demographic issues, was perplexing Krugman.

“A question (to which I don’t have the full answer): why are the interest rates on Italian and Japanese debt so different? As of right now, 10-year Japanese bonds are yielding 1.09%; 10-year Italian bonds 5.76%.

…I actually don’t have a firm view. But it seems to be an important puzzle to resolve.”

But today’s column is basically right out of MMT.

“What has happened, it turns out, is that by going on the euro, Spain and Italy in effect reduced themselves to the status of Third World countries that have to borrow in someone else’s currency, with all the loss of flexibility that implies. In particular, since euro-area countries can’t print money even in an emergency, they’re subject to funding disruptions in a way that nations that kept their own currencies aren’t — and the result is what you see right now. America, which borrows in dollars, doesn’t have that problem.”

Share

MMT, The Euro And The Greatest Prediction Of The Last 20 Years?

Posted on by

Thanks, Cullen!!!

MMT, The Euro And The Greatest Prediction Of The Last 20 Years?

By Cullen Roche

November 7 (Seeking Alpha) —Being right matters. This isn’t emphasized quite enough in the finance world and in economics in general. Too often, bad theory has led to bad predictions which has helped contribute to bad policy. While MMT remains a heterodox economic school that has been largely shunned by mainstream economists, the modern proponents have an awfully good track record in predicting highly complex economic events.

In the last few years, the Euro crisis has proven a remarkably complex and persistent event. And no school of thought so succinctly predicted the precise cause and effect, as the MMT school did. These predictions were not vague or general in any manner. In reading the research from MMTers at the time of the Euro’s inception, their predictions are almost eerily prescient. They broke down an entire monetary system and described exactly why its construction would lead to financial crisis if the union did not evolve.

In 1992 Wynne Godley described the inherent flaw in the Euro:

If a government does not have its own central bank on which it can draw cheques freely, its expenditures can be financed only by borrowing in the open market in competition with businesses, and this may prove excessively expensive or even impossible, particularly under conditions of extreme emergency….The danger then, is that the budgetary restraint to which governments are individually committed will impart a disinflationary bias that locks Europe as a whole into a depression it is powerless to lift.

In his must read book “Understanding Modern Money” Randall Wray described (in 1998) the same dynamic that led to the crisis in the EMU:

Under the EMU, monetary policy is supposed to be divorced from fiscal policy, with a great degree of monetary policy independencein order to focus on the primary objective of price stability. Fiscal policy, in turn will be tightly constrained by criteria which dictate maximum deficit to GDP and debt to deficit ratios. Most importantly, as Goodhart recognizes, this will be the world’s first modern experiment on a wide scale that would attempt to break the link between a government and its currency.

…As currently designed, the EMU will have a central bank (the ECB) but it will not have any fiscal branch. This would be much like a US which operated with a Fed, but with only individual state treasuries. It will be as if each EMU member country were to attempt to operate fiscal policy in a foreign currency; deficit spending will require borrowing in that foreign currency according to the dictates of private markets.

In 2002, Stephanie Kelton (then Stephanie Bell) was even more specific in describing the funding crisis that would inevitably ensue in the region:

Countries that wish to compete for benchmark status, or to improve the terms on which they borrow, will have an incentive to reduce fiscal deficits or strive for budget surpluses. In countries where this becomes the overriding policy objective, we should not be surprised to find relatively little attention paid to the stabilization of output and employment. In contrast, countries that attempt to eschew the principles of “sound” finance may find that they are unable to run large, counter-cyclical deficits, as lenders refuse to provide sufficient credit on desirable terms. Until something is done to enable member states to avert these financial constraints (e.g. political union and the establishment of a federal (EU) budget or the establishment of a new lending institution, designed to aid member states in pursuing a broad set of policy objectives), the prospects for stabilization in the Eurozone appear grim. (emphasis added)

In 2001 Warren Mosler described the liquidity crisisthat the Euro would lead to:

Water freezes at 0 degrees C. But very still water can be cooled well below that and stay liquid until a catalyst, such as a sudden breeze, causes it to instantly solidify. Likewise, the conditions for a national liquidity crisis that will shut down the euro-12’s monetary system are firmly in place. All that is required is an economic slowdown that threatens either tax revenues or the capital of the banking system.

A prosperous financial future belongs to those who respect the dynamics and are prepared for the day of reckoning. History and logic dictate that the credit sensitive euro-12 national governments and banking system will be tested. The market’s arrows will inflict an initially narrow liquidity crisis, which will immediately infect and rapidly arrest the entire euro payments system. Only the inevitable, currently prohibited, direct intervention of the ECB will be capable of performing the resurrection, and from the ashes of that fallen flaming star an immortal sovereign currency will no doubt emerge.

In a recent article, Paul Krugman referred to some of his predictions as “big stuff”. What the MMT school has accomplished through its understanding and prescience of the European union is not merely “big stuff” – it is nothing short of remarkable. This was not merely saying that the Euro was flawed for this reason or that and that the construct of a united Europe was misguided (a prediction made by many at the time of the Euro’s inception due mainly to political biases). The MMT economists approached the formation of the Euro from a purely operational aspect and predicted with near perfection, exactly why it was flawed and exactly why it would not work as is currently constructed.

Some economists say MMT focuses too much on reality by focusing on the actual operational aspects of the banking system and the monetary system. But as we have seen time and time again, having a poor understanding of the monetary system is not only detrimental to your portfolio, but detrimental to the millions of citizens who are now being subjected to the ignorance of the economists who influence these monetary constructs.

Share

comments on Krugman’s post

Posted on by

Franc Thoughts on Long-Run Fiscal Issues

By Paul Krugman

August 11 (NYT) — Regular readers of comments will notice a continual stream of criticism from MMT (modern monetary theory) types, who insist that deficits are never a problem as long as you have your own currency.

Right, ability to pay is not an issue.

I really don’t want to get into that fight right now, because for the time being the MMT people and yours truly are on the same side of the policy debate. Right now it really doesn’t matter at all whether the United States issues zero-interest short-term debt or simply prints zero-interest dollar bills, and concern about crowding out is just bad economics.

Right.

But we won’t always be in a liquidity trap.

We don’t have one now. It’s a fixed fx concept at best.

But we won’t always be in a liquidity trap.

Someday private demand will be high enough that the Fed will have good reason to raise interest rates above zero, to limit inflation.

Yes, because they ignore the interest income channels.

And when that happens, deficits — and the perceived willingness of the government to raise enough revenue to cover its spending — will matter.

Yes, deficit spending adds to aggregate demand and nominal savings to the penny. Add too much and you get ‘demand pull inflation’

With fixed fx, that can drive up interest rates and threaten reserves. With floating fx it only causes the currency to fluctuate.

I have a specific example that illustrates my point: France in the 1920s, which I wrote about in my dissertation lo these many years ago. Like many nations, France came out of World War I with very large debts, peaking at 240 percent of GDP according to this recent IMF presentation (pdf, slide 17). And France was unable politically to raise enough taxes to cover the cost of servicing that debt. And investors lost confidence in the government’s solvency.

If it was a floating fx policy, interest rates would have been wherever the bank of france set them. If it was a fixed fx policy, rates would be market determined, as the tsy had to compete with the option to convert at the CB.

And taxes falling short of spending is the norm in most nations. Japan for example has one of the largest debts and deficits and one of the strongest currencies. So there’s more to it.

Various expedients were tried, including — late in the game — creation of monetary base, which was advocated by a finance minister on the (very MMT) grounds that the division of government liabilities between currency and short-term bills made no difference. But it turned out that it did: the franc plunged, and the price level soared.

He still hasn’t indicated whether it was a fixed or floating fx policy, and I don’t recall, so I can’t comment.

Now as it turned out this was just what the doctor ordered: because France’s budget problem was overwhelmingly the debt overhang rather than current spending, inflation eroded the real value of that debt and made possible the Poincare stabilization of 1926.

Yes, if a nation goes to a fixed fx policy at the’wrong’ price a further adjustment can address that, though it still doesn’t address the fundamental difficulties of living with a fixed fx policy.

So what does this say about the United States? At a future date, when we’re out of the liquidity trap,

that we aren’t in

public finances will matter — and not just because of their role in raising or reducing aggregate demand. The composition of public liabilities as between debt and monetary base does matter in normal times —

Yes, it determines the term structure of risk free rates.

hey, if it didn’t, the Fed would have no influence, ever.

True, and it doesn’t have much in any case, apart from shifting income between savers and borrowers and altering the interest income of the economy, which is a net saver to the tune of the govt debt, to the penny.

So if we try at that point to finance the deficit by money issue rather than bond sales, it will be inflationary.

Only under a fixed exchange rate policy, which we don’t have.

And unlike France in the 1920s, such a hypothetical US deficit crisis wouldn’t be self-correcting: the biggest source of our long-run deficit isn’t the overhang of debt, it’s the prospective current cost of paying for retirement, health care, and defense. So such a crisis — again, it’s very much hypothetical — could spiral into something very nasty, with very high inflation and, yes, hyperinflation.

Highly unlikely. It would probably take annual deficit of well over 20% to get that kind of inflation from excess demand.

Now, all of this is remote right now. And notice too that France in the 1920s stabilized with debt of 140 percent of GDP — far higher than the numbers that are supposed to terrify us now. So none of this is relevant to the current policy debate.

But since the MMTers seem to have decided to harass those of us who want stronger action now but think there really is a long-run fiscal issue, I needed to put this out there.

MMT explains the difference between fixed and floating fx policy.

Share

1938 in 2010

Posted on by

1938 in 2010

By Paul Krugman

September 5 (Bloomberg) — Here’s the situation: The U.S. economy has been crippled by a financial crisis. The president’s policies have limited the damage, but they were too cautious, and unemployment remains disastrously high. More action is clearly needed. Yet the public has soured on government activism, and seems poised to deal Democrats a severe defeat in the midterm elections.

The president in question is Franklin Delano Roosevelt; the year is 1938. Within a few years, of course, the Great Depression was over. But it’s both instructive and discouraging to look at the state of America circa 1938 — instructive because the nature of the recovery that followed refutes the arguments dominating today’s public debate, discouraging because it’s hard to see anything like the miracle of the 1940s happening again.

Now, we weren’t supposed to find ourselves replaying the late 1930s. President Obama’s economists promised not to repeat the mistakes of 1937, when F.D.R. pulled back fiscal stimulus too soon. But by making his program too small and too short-lived, Mr. Obama did just that: the stimulus raised growth while it lasted, but it made only a small dent in unemployment — and now it’s fading out.

And just as some of us feared, the inadequacy of the administration’s initial economic plan has landed it — and the nation — in a political trap. More stimulus is desperately needed, but in the public’s eyes the failure of the initial program to deliver a convincing recovery has discredited government action to create jobs.

In short, welcome to 1938.

The story of 1937, of F.D.R.’s disastrous decision to heed those who said that it was time to slash the deficit, is well known. What’s less well known is the extent to which the public drew the wrong conclusions from the recession that followed: far from calling for a resumption of New Deal programs, voters lost faith in fiscal expansion.

Consider Gallup polling from March 1938. Asked whether government spending should be increased to fight the slump, 63 percent of those polled said no. Asked whether it would be better to increase spending or to cut business taxes, only 15 percent favored spending; 63 percent favored tax cuts. And the 1938 election was a disaster for the Democrats, who lost 70 seats in the House and seven in the Senate.

Most interesting!

Then came the war.

From an economic point of view World War II was, above all, a burst of deficit-financed government spending, on a scale that would never have been approved otherwise. Over the course of the war the federal government borrowed an amount equal to roughly twice the value of G.D.P. in 1940 — the equivalent of roughly $30 trillion today.

Had anyone proposed spending even a fraction that much before the war, people would have said the same things they’re saying today. They would have warned about crushing debt and runaway inflation. They would also have said, rightly, that the Depression was in large part caused by excess debt — and then have declared that it was impossible to fix this problem by issuing even more debt.

Agreed! The deficit per se was of no consequence. The risks were and remain inflation from excess demand, which is not an easy channel to use to generate what we call inflation in today’s world. Our CPI problems have tended to come in through the cost channel and propagated by govt indexation of one form or another.

But guess what? Deficit spending created an economic boom — and the boom laid the foundation for long-run prosperity.

Agreed. Though the way I say it, for a given size govt. and given set of credit conditions there is a level of taxes that coincides with full employment, and that level is generally well below the level of govt spending.

Overall debt in the economy — public plus private — actually fell as a percentage of G.D.P., thanks to economic growth and, yes, some inflation, which reduced the real value of outstanding debts. And after the war, thanks to the improved financial position of the private sector, the economy was able to thrive without continuing deficits.

What??? Here, sadly, Paul’s implication that the actual level of the govt debt per se matters, and that his bent that lower deficits are somehow ‘better’ shines through, keeping him in the camp of being part of the problem rather than part of the answer.

(Good article for MMT’s to earn some hearts!)

Share

Bernanke Must Raise Benchmark Rate 2 Points, Rajan Says – Bloomberg

Posted on by

If they actually understood how it all works they’d be calling for tax cuts rather than interest rate increases.

>   
>   (email exchange)
>   
>   On Mon, Aug 23, 2010 at 12:18 PM, wrote:
>   
>   Yes, Krugman criticised this today and I put in a kind word
>   for Mr Rajan in the comments section.
>   

I suspect Rajan is looking in part at the deflationary impact of the “fiscal channel” via the current 0% interest rate. Your NY Times colleague, Gretchen Morgenson, had a very good piece on this in the Sunday NY Times. Of course, the impact of this policy would, as you suggest, be ruinous for borrowers and highlights the comparatively diffuse impact of monetary policy, vs fiscal policy in terms of solving the problem of aggregate demand. Overall, this uncertainty points to the problems involved in using monetary policy to stimulate (or contract) the economy. It is a blunt policy instrument with ambiguous impacts.

The major problem facing the economy at present is that there is not a willingness to spend by the private sector and the resulting spending gap, has to, initially, be filled by the government using its fiscal policy capacity. I prefer direct public sector job creation to be the principle fiscal vehicle. But fiscal policy it has to be. Then when the negative sentiment is turned around, private borrowing will recommence and investment spending will grow again. Then the economy moves forward some more and the budget deficit falls.

Bernanke Must Raise Benchmark Rate 2 Points, Rajan Says

By Scott Lanman and Simon Kennedy

Aug. 22 (Bloomberg) — Raghuram Rajan accurately warned central bankers in 2005 of a potential financial crisis if banks lost confidence in each other. Now the International Monetary Fund’s former chief economist says the Federal Reserve should consider raising rates, even as almost 10 percent of the U.S. workforce remains unemployed.

Interest rates near zero risk fanning asset bubbles or propping up inefficient companies, say Rajan and William White, former head of the Bank for International Settlements’ monetary and economic department. After Europe’s debt crisis recedes, Fed Chairman Ben S. Bernanke should start increasing his benchmark rate by as much as 2 percentage points so it’s no longer negative in real terms, Rajan says.

“Low rates are not a free lunch, but people are acting as though they are,” said White, 67, who retired in 2008 from the Basel, Switzerland-based BIS and now chairs the Economic Development and Review Committee at the Paris-based Organization for Economic Cooperation and Development. “There will be pressure on central banks to follow an expansionary monetary policy, and I worry that one can see the benefits, but what people inadequately appreciate are the downsides.”

He and Rajan will have the chance to make their case at the Fed’s annual symposium in Jackson Hole, Wyoming, this week. In 2003, White told attendees central banks might need to raise rates to combat asset-price bubbles. In 2005, Rajan, 47, said risks in the banking system had increased. They were met with skepticism from then-Fed Chairman Alan Greenspan, 84, and Governor Donald Kohn, 67.

Losing Confidence

While the Fed did boost its target rate for overnight loans among banks in quarter-point steps to 5.25 percent by 2006 from 1 percent in 2004, that didn’t prevent a housing bubble, which began to pop in 2006. Banks began losing confidence in August of the same year and started charging other financial institutions higher interest on loans.

A minority of policy makers are increasingly echoing Rajan and White’s current worries, including Kansas City Fed President Thomas Hoenig, who is hosting the Aug. 26-28 symposium, and Andrew Sentance, one of nine members on the Bank of England’s monetary-policy committee.

Hoenig has dissented from all five Fed policy decisions this year, preferring to jettison a pledge to keep rates low for an “extended period.” Sentance was defeated for a third month in August in his bid to withdraw emergency stimulus by increasing the benchmark interest rate.

Few Converts

The naysayers may fail to win many converts any time soon as the recovery slows and U.S. unemployment, at 9.5 percent in July, remains near a 26-year high. The resulting extension of low rates may increase volatility of government bonds, especially in response to any stronger-than-anticipated economic data, said Marc Fovinci, head of fixed income at Ferguson Wellman Capital Management Inc.

Indications that growth will be at least 3 percent “in the coming months” would cause yields on 10-year Treasuries, which were 2.61 percent on Aug. 20, to rise to 3 percent within about a week, said Fovinci, who is based in Portland, Oregon, and helps invest $2.5 billion.

JPMorgan Chase & Co. reduced its forecast last week for growth in this quarter to an annual rate of 1.5 percent from 2.5 percent and in the last three months of 2010 to 2 percent from 3 percent.

“I’m not worried about inflation, because the economy appears to be weak,” Fovinci said. At the same time, the bond market seems to be “tightly coiled up like a spring.”

Rising Yields

Between June 3 and June 8, 2009, yields on 10-year Treasuries rose to 3.88 percent from 3.54 percent after the smallest drop in U.S. payrolls in eight months and European Central Bank President Jean-Claude Trichet’s forecast for economic growth in 2010. Two-year Treasury yields rose to 1.4 percent from 0.91 percent in the same period.

The margin for error is “incredibly thin,” said Derrick Wulf, a portfolio manager at Dwight Asset Management Co. in Burlington, Vermont, which oversees $64.3 billion. “A lot of investors have become complacent about being long” in Treasuries.

Rajan, now a professor at the University of Chicago’s Booth School of Business, says near-zero interest rates are a crisis tool and economists don’t know if the benefits from using them for longer periods outweigh the costs. While inflation isn’t the main threat now, “you can’t be totally comfortable,” he said in an Aug. 18 interview. People think “there is significant unused capacity in the economy” and that assumption may be mistaken.

‘Bad Incentives’

Near-zero rates create “bad incentives” for financial firms, he added.

“Blow the system up, we’ll come back and reward you with very low interest rates that allow you to build up capital, and then you could try it again next time around,” Rajan said.

The Fed also may be “prolonging pain” by propping up the housing market and keeping home prices from falling, he said.

Companies are sending mixed signals.

“Demand is very low across the country” for houses, Richard Dugas, chief executive officer of Bloomfield Hills, Michigan-based Pulte Group Inc., said Aug. 20 on Bloomberg Television’s “In the Loop with Betty Liu.” Meanwhile, Caterpillar Inc., the world’s largest maker of construction equipment, may add as many as 9,000 workers worldwide this year, Doug Oberhelman, chief executive officer of the Peoria, Illinois-based company, said Aug. 19.

Another Bubble

White, a Bank of Canada deputy governor from 1988 to 1994, says the benefits of low rates may already be waning “in a world with so much debt, especially household debt,” which in the U.S. totaled a near-record $11.7 trillion at the end of June. There’s also a danger they might create another bubble, he said.

Another risk is that near-zero rates allow companies to roll over nonviable loans, a practice known as “evergreening” that can create so-called zombie businesses, which happened in Japan, he added.

Rajan and White’s arguments aren’t winning over Keith Hembre, chief economist at U.S. Bancorp’s FAF Advisors Inc. in Minneapolis, where he helps oversee $86 billion.

“There’s little evidence that the very low rates today are inflicting any harm,” said Hembre, a former Fed researcher. While he has “some longer-term sympathy with the argument,” it’s “just off-base today, given the evidence available from both real-time and market indicators.”

Bernanke, 56, and the majority of Fed officials show little inclination to change course. The Fed lowered its benchmark rate to a range of zero to 0.25 percent in December 2008 and said after each policy meeting since March 2009 it will likely stay very low for an “extended period.”

Emergency Measures

The ECB has kept its main refinancing rate at 1 percent since May 2009, and the Bank of England’s key rate has been 0.5 percent since March 2009. Axel Weber, an ECB council member, said in an Aug. 19 Bloomberg Television interview that policy makers should keep emergency liquidity measures in place at least through the end of the year, beyond Trichet’s October guarantee. Bernanke and Trichet will speak at the Fed symposium Aug. 27.

White and Rajan have ruffled central-bank feathers before at Jackson Hole, where policy makers, academics, analysts and money managers from dozens of countries mix hiking and rafting in Grand Teton National Park with debate over monetary policy and bank regulation.

In 2003, White and then-colleague Claudio Borio, who was head of BIS research and policy analysis, told central bankers they might need to raise interest rates to “lean against” asset-price bubbles.

‘Cannot Work’

“The one thing I am sure about is that a mild calibration of monetary policy to address asset-price bubbles does not and cannot work,” Greenspan, who retired in 2006, responded at the conference.

Bernanke, then a Fed governor, told attendees that Japan raised rates in 1989 to prick a bubble, and as a result, “asset prices collapsed and they had a 14-year depression.”

In 2005, Rajan warned that if banks lost confidence in each other, “the interbank market could freeze up, and one could well have a full-blown financial crisis.”

Kohn disagreed in a speech after Rajan’s presentation.

“As a consequence of greater diversification of risks and of sources of funds, problems in the financial sector are less likely to intensify shocks hitting the economy and financial market,” he said.

More Open

Bernanke has since become more open to White’s view. While low interest rates didn’t cause the U.S. housing bubble, he said in a January speech, if the next wave of regulation proves “insufficient to prevent dangerous buildups of financial risks, we must remain open to using monetary policy as a supplementary tool for addressing those risks.”

Kohn, the Fed’s vice chairman from 2006 through June, said in a March speech that “serious deficiencies” with securitization of loans “exposed the banking system to risks that neither participants in financial markets nor regulators fully appreciated.”

Spyros Andreopoulos, a London-based global economist at Morgan Stanley, says he worries about the inflationary implications of extreme monetary accommodation beyond the next two to three years, with policy makers likely to lean toward low rates because of the fear of deflation.

“Imagine a car that’s stuck in the mud,” he said. “When you press on the gas, the car doesn’t emerge smoothly; it jumps up. My fear is when economies pick up after the stimulus, you’ll see inflation faster than was expected.”

Share

Krugman has it right

Posted on by

Lost Decade Looming?

By Paul Krugman

May 20 (NYT) —Despite a chorus of voices claiming otherwise, we aren’t Greece. We are, however, looking more and more like Japan.

For the past few months, much commentary on the economy — some of it posing as reporting — has had one central theme: policy makers are doing too much. Governments need to stop spending, we’re told. Greece is held up as a cautionary tale, and every uptick in the interest rate on U.S. government bonds is treated as an indication that markets are turning on America over its deficits. Meanwhile, there are continual warnings that inflation is just around the corner, and that the Fed needs to pull back from its efforts to support the economy and get started on its “exit strategy,” tightening credit by selling off assets and raising interest rates.

And what about near-record unemployment, with long-term unemployment worse than at any time since the 1930s? What about the fact that the employment gains of the past few months, although welcome, have, so far, brought back fewer than 500,000 of the more than 8 million jobs lost in the wake of the financial crisis? Hey, worrying about the unemployed is just so 2009.

But the truth is that policy makers aren’t doing too much; they’re doing too little. Recent data don’t suggest that America is heading for a Greece-style collapse of investor confidence. Instead, they suggest that we may be heading for a Japan-style lost decade, trapped in a prolonged era of high unemployment and slow growth.

As we discussed, could not agree more!

Let’s talk first about those interest rates. On several occasions over the past year, we’ve been told, after some modest rise in rates, that the bond vigilantes had arrived, that America had better slash its deficit right away or else. Each time, rates soon slid back down. Most recently, in March, there was much ado about the interest rate on U.S. 10-year bonds, which had risen from 3.6 percent to almost 4 percent. “Debt fears send rates up” was the headline at The Wall Street Journal, although there wasn’t actually any evidence that debt fears were responsible.

Correct, it was fears that growth would cause the fed to hike rates to something more ‘normal’

Since then, however, rates have retraced that rise and then some. As of Thursday, the 10-year rate was below 3.3 percent. I wish I could say that falling interest rates reflect a surge of optimism about U.S. federal finances. What they actually reflect, however, is a surge of pessimism about the prospects for economic recovery, pessimism that has sent investors fleeing out of anything that looks risky — hence, the plunge in the stock market — into the perceived safety of U.S. government debt.

Yes, though I would say pessimism that slow growth and negative CPI cause markets to discount ‘low for a lot longer’ rates from the Fed. It’s all about the Fed’s reaction function. Long rates are the sum of short rates, plus or minus a few ‘supply technicals.’

What’s behind this new pessimism? It partly reflects the troubles in Europe, which have less to do with government debt than you’ve heard; the real problem is that by creating the euro, Europe’s leaders imposed a single currency on economies that weren’t ready for such a move.

The euro govt debt is highly problematic as they are all set up like US States and will bounce checks if they don’t have sufficient funds in their accounts. Unlike the US, Japan, UK, etc. the credit risk in the euro zone is real, just like the US States. And that forces them to act pro cyclically, cutting back and tightening up in slowdowns, again like the US States.

But there are also warning signs at home, most recently Wednesday’s report on consumer prices, which showed a key measure of inflation falling below 1 percent, bringing it to a 44-year low.

This isn’t really surprising: you expect inflation to fall in the face of mass unemployment and excess capacity. But it is nonetheless really bad news. Low inflation, or worse yet deflation, tends to perpetuate an economic slump, because it encourages people to hoard cash rather than spend, which keeps the economy depressed, which leads to more deflation. That vicious circle isn’t hypothetical: just ask the Japanese, who entered a deflationary trap in the 1990s and, despite occasional episodes of growth, still can’t get out. And it could happen here.

Banks, too, are necessarily pro cyclical, making matters worse in down turns. Only the Federal government can be counter cyclical, however, unfortunately, our Federal government thinks it’s ‘run out of money’ and ‘dependent on foreign borrowing that our children will have to pay back.’ Complete nonsense, but they believe it, as does the mainstream media and academic community.

So what we should really be asking right now isn’t whether we’re about to turn into Greece. We should, instead, be asking what we’re doing to avoid turning Japanese. And the answer is, nothing.

Agreed!

It’s not that nobody understands the risk. I strongly suspect that some officials at the Fed see the Japan parallels all too clearly and wish they could do more to support the economy. But in practice it’s all they can do to contain the tightening impulses of their colleagues, who (like central bankers in the 1930s) remain desperately afraid of inflation despite the absence of any evidence of rising prices. I also suspect that Obama administration economists would very much like to see another stimulus plan. But they know that such a plan would have no chance of getting through a Congress that has been spooked by the deficit hawks.

Agreed, and because they don’t have a sufficient grasp of monetary operations to support the case for a fiscal adjustment large enough to close the output gap and get us back to full employment.

In short, fear of imaginary threats has prevented any effective response to the real danger facing our economy.

Completely agree! See my ‘7 Deadly Frauds of Economic Policy’

Will the worst happen? Not necessarily. Maybe the economic measures already taken will end up doing the trick, jump-starting a self-sustaining recovery. Certainly, that’s what we’re all hoping. But hope is not a plan.

They seem complacent with the forecast 5 year glide path to 5% unemployment.

Share

Bernanke on lending reserves

Posted on by


[Skip to the end]

>   
>   (email exchange)
>   
>   Yesterday I was rereading Ben Bernanke’s Wall Street Journal piece of July 21 2009.
>   I noticed that the Krugman words quoted in your blog (“The banks don’t need to sell
>    securitized debt to make loans — they could start lending out of all those excess
>   reserves they currently hold. ”) were the same as Bernanke’s (’But as the economy
>   recovers, banks should find more opportunities to lend out their reserves.’).
>   
>   Why would Bernanke say this? Since when do banks need to lend out of reserves?
>   

They don’t. In fact, at the macro level they can’t. Lending does not ‘use up’ reserves.

Both Krugman and Bernanke unfortunately don’t seem to fully understand monetary operations.


[top]

Share

Krugman on monetary creation

Posted on by


[Skip to the end]


Still chasing shadows?

>   
>   (email exchange)
>   
>   On Wed, Oct 7, 2009 at 4:39 PM, Eric wrote:
>   
>   It’s hard to get it more backward than this:
>   

Yes, this is telling:

“The banks don’t need to sell securitized debt to make loans — they could start lending out of all those excess reserves they currently hold. ”

>   
>   He is asking good questions but with all the wrong reasoning.
>   

Agreed, thanks — waiting for the first Nobel prize that’s given to someone who actually understands basic monetary operations!


[top]

Share