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September 2, 2012

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'Why Berate Bernanke?'

Posted: 02 Sep 2012 12:18 AM PDT

Via email, Arin Dube dissents:

Why Berate Bernanke?: As months go by and the Fed refuses to "do" anything, some have become upset. I have a different reaction, and one that I think calls into question why people actually do get upset at Ben Bernanke and the Fed.

Let me begin with a simple question: is there any evidence that Ben Bernanke can do much to cure our ailments? I do not think that he can. But more importantly, I am particularly surprised that some self-avowed Keynesians seem to disagree (here and here). I would like to see one example -- one -- that anything like Quantitative Easing (QE) has ever worked. I would like to hear of one example -- one -- that trying to stimulate private demand by convincing folks that a future inflation is right around the corner has ever worked. Yes, I would like to see evidence -- ANY evidence -- that these strategies work, because I certainly cannot find any such evidence. Frankly, if old John Maynard were alive, I'd wager that he would find the idea that a central bank can get capitalists to invest in purchases of durable goods because inflation will be high some years from now to be as foolhardy as the idea that capitalists can be made to invest heavily by summoning the confidence fairy … for example by destroying the public sector.

So, no … I actually don't find it difficult to understand what Ben Bernanke is doing. He refuses to acknowledge the truth that QE or future expectations management is just not an effective strategy. He refuses to do so because acknowledging that fact would clarify that he is utterly useless in determining the welfare of those living the United States, which I happen to think he is … no fault of his own, mind you. It's because he can push on a string (monetary policy in present circumstances) as well as anyone else - which is to say not very well. Of course if he wanted to have a large effect (in magnitude, albeit with the wrong sign), he could follow his European brethren and raise interest rates in the midst of a downturn. And then he could prove to be much more than useless.

What I am less sure about is why self-avowed Keyensians think that this is not obvious. If I had to guess, I think it's because the New Keyenesian claptrap has led reasonable people astray. The dynamic optimization of the New Keynesian models has led even reasonable people to expect fanciful miracles from monetary policy. And sadly this has masked the fact that the expected-inflaiton fairy is just as unreal as the confidence fairy … and they fundamentally exist for the same reason … because someone believes in an Euler equation that is just plain wrong.

So, I respectfully disagree with Paul Krugman and Brad Delong - people who I read every day and generally find to be breaths of fresh air. Buying into New Keynesian machinery is NOT just dotting the i's and crossing the t's … it's buying into policies that work only within unreasonable models. Or perhaps - unreasonable parts of models you may find useful to make reasonable points.

Arindrajit Dube
Assistant Professor
Department of Economics
University of Massachusetts Amherst

Links for 09-02-2012

Posted: 02 Sep 2012 12:06 AM PDT

The Great Divergence between China and Europe

Posted: 01 Sep 2012 06:32 PM PDT

This is from Dan Little:

The great divergence, by Dan Little: It has been ten years since Ken Pomeranz published The Great Divergence: China, Europe, and the Making of the Modern World Economy, a book that forced some real rethinking about the economic history in Europe and China. Along with Bin Wong in China Transformed: Historical Change and the Limits of European Experience, he called for a deep questioning of many of the basic premises of much twentieth century economic history, which was premised on the backwardness and stagnation of China and the dynamism of Western Europe. Industrial revolution and sustained economic growth were unique products of the west, and China was incapable of these transformations at the beginning of the modern epoch -- 1600, let us say.
So the central problematic for "European exceptionalism" was to identify some set of features of western society lacking in China that could account for takeoff. Was it merchant culture? Perhaps Newtonian science? Was it European family and reproductive behavior? Or perhaps it was some feature of Christianity?
Pomeranz doesn't like these theories. More basically, he doesn't accept the premise of European economic superiority in 1600, whether in institutions or ideology. He considers agriculture first and holds that Chinese agriculture was as productive in terms of land and labor as English farming; it was not undergoing involution through population increase; and it supported a rural standard of living that was competitive with that of Europe and England, his primary focus.
Pomeranz doesn't doubt that there were sharp differences in European and Chinese economic development in the 18th century. This is the "great divergence" to which he refers. But he doubts that there are grand socio-cultural explanations for this fact; instead he focuses on contingent conjunctival circumstances that gave England a lead that it maintained for 200 years. These include the fortuitous location of coal in Britain, the fact of New World wealth, and the returns if slave labor in North America. None of these is a deep systemic factor but rather a lucky break for Britain.
Bin Wong adds a different theme to the debate. He recognizes that Europe and China possessed complex political-economic systems that were different from each other. And he agrees that these systems had consequences for development. But he agrees with Pomeranz that neither system is inherently superior. And he calls for an economic history that pays attention to the differences as well as similarities. Each process of development can be illuminated by comparison to the other.
So where is the debate today? This was the focus of a productive conference at Tsinghua University in Beijing last week. Some of the primary contributors to economic history participated, including Robert Allen, Bozhong Li, and James Lee. It isn't possible to summarize the papers, but several themes emerged. The most basic is the need to bring substantially more factual detail to the debate. What we need at this point isn't more theorizing about large causes; it is more fine grained factual discovery across both Europe and China.
Three areas in particular have gotten much more factual in the debate in ten years. the first is agricultural productivity. Historians like Robert Allen and Bozhong Li have substantially sharpened our knowledge of the farm economies of England and China.
Second is the question of the historical standard of living in various places. Essentially this depends on price data, wage data, and a system for comparing consumption across countries. Here too there has been a great refinement of our knowledge. Robert Allen has contributed much of this.
Third is population behavior. The Malthusian theory of the difference between China and Europe is a stumbling block, and of course this theory was created in a fact-free universe. Now comparative historical demography has advanced a long way thanks to researchers like James Lee. The Eurasian Population and Family History Project has now refuted the Malthusian view.
A key idea in the Pomeranz debate is Philip Huang's idea the Chinese agriculture was "involutionary". The work provided by Bozhong Li demonstrates that this theory is simply incorrect when applied to the lower Yangzi River delta. Moreover, China's development after 1970 makes the theory implausible in any case. As Li pointed out at the conference, "It is inconceivable China's modern development could have occurred in the conditions of involution described in the debate." China was clearly not caught in an inescapable involutionary trap.
So there is work to be done still on the origins of the great transformation. And it is valuable for this work to take place with a global and comparative perspective. But most valuable will be detailed factual research that adds significantly to what we know about the past.

The Problem is Lack of Demand

Posted: 01 Sep 2012 11:51 AM PDT

The chair of Bush's Council of Economic Advisors, Ed Lazear, says that the unemployment problem is not structural, it's due to lack of demand:

Jackson Hole Paper: True Cause of High Unemployment Is Basic Economic Weakness, by Michael S. Derby, WSJ: Is the job market weak because of structural changes, or is a lack of demand the true factor keeping unemployment rates high? ...
The answer isn't just academic: If a lack of demand is behind high unemployment, the Federal Reserve can help fix the situation via monetary policy stimulus. Structural problems, however, are beyond the reach of those remedies.
A paper presented Saturday at the Kansas City Fed's annual Jackson Hole, Wyo., research conference argues that what currently ails the economy is indeed a demand problem. That suggests the Fed has room to act if it chooses to do so. The paper was written by Edward Lazear of Stanford Graduate School of Business and James Spletzer of the U.S. Census Bureau. Mr. Lazear was also a chairman of President George W. Bush's Council of Economic Advisers.
"An analysis of labor market data suggests that there are no structural changes that can explain movements in unemployment rates over recent years," the authors write. "Neither industrial nor demographic shifts nor a mismatch of skills with job vacancies is behind the increased rates of unemployment." ...
Meanwhile, some of the trends some have used to support the structural argument—the decline of factory jobs, changing labor participation rates, and the benefits education offer to wage growth—have been in play for a long time, well before the current economic troubles started, the authors write.
The authors discount the idea that the long duration of unemployment seen lately is a sign of structural changes. They tied the extended duration of unemployment to the depth of the downturn, saying "the current recession does not appear fundamentally different from prior ones, except that it is worse."

Some members of the Fed's monetary policy committee sitting in the audience for this paper have used the structural unemployment argument to argue against more help for the economy. If economics was an evidence based science this, and the mountain of other evidence pointing in the same direction, would cause them to change their minds and support more accommodative policy -- the potential benefits of doing more are much higher than they have estimated. Instead, we'll hear the same old arguments from the same people, or they'll search until they find something else that agrees with their priors, and use that to defend them. It's the same with fiscal policy, theory and evidence are ignored in favor of bogus arguments there too, and it's all very frustrating.

Credible Promises about 'Irresponsible' Policy

Posted: 01 Sep 2012 11:49 AM PDT

Paul Krugman discusses Michael Woodford's important paper:

Woodford on Monetary Policy (Sort of Wonkish), by Paul Krugman: I'm not in Jackson Hole... No matter. I can still read the papers — and the most important one was by Mike Woodford (pdf). Woodford's paper is long and really dense... But the bottom line is "Ben, ur doing it wrong".
The topic is what, if anything, monetary policy can do when interest rates are up against the zero lower bound... Under these conditions, conventional monetary policy ... has no traction.
Yet this need not mean that the central bank is without options. I think I was the first to make a point (pdf) that Woodford and Gauti Eggertsson greatly expanded in 2003, namely, that the central bank can still gain traction if it can convince the public that it will pursue a more inflationary policy than previously expected after the economy recovers. As I wrote way back then, the central bank needs to credibly promise to be irresponsible.
But can it really do this? Woodford devotes the first half of the paper to an extended review of the evidence on "forward guidance", in which central banks signal their future intentions — and finds strong evidence that such talk matters. So his answer is yes, the Fed could boost the economy by making a commitment to hold off on raising interest rates when recovery finally kicks in.
But that isn't what the Fed has mainly done... So what should the Fed be doing? Woodford concludes that ... it needs to promulgate a view of its intentions that would lead it to be slower to raise rates following a big slump than it would in other circumstances. And let me repeat the past tense: following a big slump, not just when you're in it.
How to do this? Nominal GDP targeting would be one answer, because it would give the Fed a reason to hold off for a long time on rate hikes. Other schemes might also do the trick.
The point is that this is exactly what the Fed has not done. Bernanke has gone to great lengths to reassure politicians that policy will revert to normal as soon as possible, that the Fed remains as vigilant as ever about inflation; and while Woodford doesn't quite say this, all this amounts to offering forward guidance in exactly the wrong direction.
Important stuff.

As I explained long ago, here's the problem:

[The effectiveness of policy] relies upon changing expectations of future inflation (which changes the real interest rate). People must believe that the Fed will actually be willing to create inflation in the future when it comes time to do so. However, it's unlikely that it will be optimal for the Fed to cause inflation when the time comes. Because of that, the best policy is to promise to create inflation, then renege on the promise when it comes time to follow through. Since people know this, and expect the Fed will not actually carry through and create inflation, it's hard to get them to change their expectations now. All that credibility the Fed has built up and protected concerning their inflation fighting credentials works against them here.

That's why Krugman says repeatedly that the Fed "needs to credibly promise to be irresponsible."

One more note. While everyone has jumped on the statement about nominal GDP targeting, Woodford also says that tying policy to specific goals, e.g. promising to leave interest rates low until unemployment or inflation crosses some threshold, say 4% for inflation or 6.5% for unemployment, "would be an 'important improvement' on what the Fed is doing now, though he said it had flaws." In the short-run, this is probably much more politically viable than moving to a nominal GDP target (Charles Evans, president of the Chicago Fed has been the most vocal proponent of this approach, and I have endorsed it as well).

But let me turn the microphone back to Paul Krugman:

Monetary Versus Fiscal Policy, Revisited, by Paul Krugman: One recurring complaint from commenters on this blog is that they can't figure out where I stand on monetary versus fiscal policy as a response to a deeply depressed economy. Sometimes, they say, I declare that monetary policy is ineffective once you're at the zero lower bound; other times I berate Ben Bernanke for not doing more. Which is it?
But it's not a contradiction. Mike Woodford's latest paper, especially taken in tandem with his paper last year at the Cambridge Keynes conference, actually explains it all.
What Mike demonstrates is the point that liquidity-trap worriers have been making for a long time – actually, ever since my 1998 piece. Current monetary policy is indeed ineffective in a liquidity trap; but there is still scope for central bank action in the form of credible commitments to keep monetary policy easy in the future, when the economy is no longer at the zero lower bound.
The trouble is how to make those credible commitments. ...
What about fiscal policy? As Mike pointed out in his earlier paper, fiscal stimulus in a liquidity trap doesn't require that you convince the market that you're going to behave differently once the crisis is past. It doesn't depend on expectations at all; the government just goes out and creates jobs. So it made a lot of sense to argue for stimulus as the main immediate response to the slump.
But isn't fiscal stimulus also a hard sell politically? Yes, indeed...
So what should well-meaning economists do now, with both fiscal and monetary policy falling short? The answer is, campaign on both fronts...

Which is very much the approach I've pushed -- don't put all our policy eggs in either the monetary or fiscal policy basket. I've worried that there has been too much focus on monetary policy lately, and that has let fiscal policymakers -- who must join the battle to lower our crisis level of unemployment -- off the hook. Fiscal policy has an important role to play: of the points that Eggertsson makes is that government spending does not have the credibility problem that plagues monetary policy. He says:

...Expansionary monetary policy can be difficult if the central bank cannot commit to future policy. The problem is that an inflation promise is not credible for a discretionary policy maker. ...
This credibility problem is what Eggertsson (2006) calls the "deflation bias" of discretionary monetary policy at zero interest rates. Government spending does not have this problem. ... The intuition is that fiscal policy not only requires promises about what the government will do in the future, but also involves direct actions today. And those actions are fully consistent with those the government promises in the future (namely, increasing government spending throughout the recession period). ...

We need to push on both the monetary and fiscal policy fronts. Neither policy alone will be sufficient to get the job done (even without the political hurdles standing in the way), and it's far past the time for both Congress and the Fed to do more about our crisis level unemployment problem.

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