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November 28, 2012

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Posted: 01 Nov 2012 12:06 AM PDT

'The Role of Money in New-Keynesian Models'

Posted: 31 Oct 2012 12:56 PM PDT

Should New Keynesian models include a specific role for money (over and above specifying the interest rate as the policy variable)? This is a highly wonkish, but mostly accessible explanation from Bennett McCallum:

The Role of Money in New-Keynesian Models, by Bennett T. McCallum, Carnegie Mellon University, National Bureau of Economic Research, N° 2012-019 Serie de Documentos de Trabajo Working Paper series Octubre 2012

Here's the bottom line:

...we drew several conclusions supportive of the idea that a central bank that ignores money and banking will seriously misjudge the proper interest rate policy action to stabilize inflation in response to a productivity shock in the production function for output. Unfortunately, some readers discovered an error; we made a mistake in linearization that, when corrected, greatly diminished the magnitude of some of the effects of including the banking sector. There seems now to be some interest in developing improved models of this type. Marvin Goodfriend (MG) is working with a PhD student in this topic. At this point I have not been able to give a convincing argument that one needs to include M. ...
There is one respect in which it is nevertheless the case that a rule for the monetary base is superior to a rule for the interbank interest rate. In this context we are clearly discussing the choice of a controllable instrument variable—not one of the "target rules" favored by Svensson and Woodford, which are more correctly called "targets." Suppose that the central bank desires for its rule to be verifiable by the public. Then it will arguably need to be a non-activist rule, one that normally keeps the instrument setting unchanged over long spans of time. In that case we know that in the context of a standard NK model, an interest rate instrument will not be viable. That is, the rule will not satisfy the Taylor Principle, which is necessary for "determinacy." The latter condition is not, I argue, what is crucial for well-designed monetary policy, but LS learnability is, and it is not present when the TP is not satisfied. This is well known from, e.g., Evans and Honkapohja (2001), Bullard and Mitra (2002), McCallum (2003, 2009). ...

'Economic Effects of Hurricane Sandy'

Posted: 31 Oct 2012 12:32 PM PDT

Jim Hamilton on the economic damage from hurricane Sandy:

... One parallel to consider is the devastation from Hurricane Katrina in 2005. In addition to the short-run dislocations, this ended up causing lasting damage to offshore oil-producing infrastructure. An optimist might have thought this would create all kinds of new jobs trying to rebuild. The actual experience was not so cheerful.

Econbrowser-1

Seasonally adjusted nonfarm employment in Louisiana, 2004:M1 - 2007:M12, in thousands of workers. Vertical line marks Hurricane Katrina in August 2005. Data source: BLS.

The Wall Street Journal reports that IHS estimates that Hurricane Sandy could reduce the 2012:Q4 U.S. real GDP growth rate by 0.6 percentage points at an annual rate. I'm not sure how one comes up with that kind of number. But I am persuaded this was not a good thing for the U.S. economy.

No Fear of a Pinocchio Nose: Romney's Welfare Lie

Posted: 31 Oct 2012 11:27 AM PDT

Romney continues to disrespect the mainstream press -- he appears to have no fear that they can expose blatant falsehoods in a way that might cost him votes:

The ignominious return of the welfare lie, by Steve Benen: For much of August, Mitt Romney proudly embraced as obvious a lie as has ever been heard in presidential politics. The Republican insisted -- in speeches, interviews, and ads -- that President Obama had "gutted the work requirement" in welfare law. He was blatantly lying, but didn't care.
Over the last month or so, Romney moved on to different lies, most notably about the auto industry, but in the campaign's closing days, the racially-charged welfare lie has made a comeback. ...
This unannounced attack ad, running in several key states,... argues at the outset that Obama "gutted the work requirement for welfare." This isn't just another lie; it's presidential politics at its most disgusting.
What's more, Romney isn't relying on misleading technicalities, or hiding in some ambiguous gray area between fact and fiction. This is just a demonstrable, racially-inflammatory lie -- and the candidate knows it. ... And yet, Romney keeps repeating it. ...
With this ad, Romney is once again carefully extending his middle finger in reality's face. He doesn't care about getting caught -- his campaign has already said, "[W]e're not going to let our campaign be dictated by fact checkers" -- he just cares about what he can get away with as part of his quest for power.
This is the national political scandal of 2012, whether the political world wants to admit it or not.

The Science of New Monetarist Economics

Posted: 31 Oct 2012 11:08 AM PDT

It's been interesting to watch people like Steven Williamson turn on Narayana Kocherlakota because he no longer agrees with their views on monetary policy. The "economics should be a science" people like Williamson resort to the oh so scientific technique of name-calling, e.g. "goofy," "flimsy-excuse guy," e.g. see Williamson's latest (interesting that he chose to emphasize the name-calling rather than the economics in his title for the post). But to me the most notable thing about this is not Kocherlakota's change of heart. As Yglesias notes today, that's how science should proceed -- if the evidence is against you, change your views. No, the most interesting thing to me begins with statements such as this from Williamson two years ago:

the fact is that reserves are leaving banks in the form of currency as we can see in this chart. ... Note in particular that reserves have recently been leaving banks at a more rapid rate. It's possible that we would get more inflation even without QE2.

Or, around the same time:

I think it is quite possible that we will look back on QE2 as a severe error. In spite of the talk from some quarters about the intervention being too small, this is a very large-scale asset purchase for the Fed, on top of a previous very large purchase of mortgage-backed securities and agency securities. One possibility is that economic growth picks up, of its own accord, reserves become less attractive for the banks, and inflation builds up a head of steam. The Fed may find this difficult to control, or may be unwilling to do so. Even worse is the case where growth remains sluggish, but inflation well in excess of 2% starts to rear its ugly head anyway. Bernanke is telling us that he "has the tools to unwind these policies," but if the inflation rate is at 6% and the unemployment rate is still close to 10%, he will not have the stomach to fight the inflation.

My concern here is that, given the specifics of the QE2 policy that was announced, the FOMC will be reluctant to cut back or stop the asset purchases, even if things start looking bad on the inflation front. Once inflation gets going, we know it is painful to stop it, and we don't need another problem to deal with.

He was worried that economic growth would pick up soon (it didn't -- his model misled him, or he didn't use a model in which case I have to wonder about his "science") and inflation would become a problem. He supported this with charts, etc., and he also said inflation could be aproblem even if economic growth didn't pick up.

Well, it didn't happen. We didn't get the economic growth his model had him worried about, and we didn't get the inflation his model predicted. His argument may be that it just hasn't happened yet, but that was two years ago (Nov. 6, 2010), and whatever model was being used to worry about growth and inflation was wrong. Very wrong. If we listen to Williamson, we forego two years of more aggressive policy based upon a fear of inflation that doesn't materialize. Now, he says more aggressive policy has no real effects so it's useless anyway (so why risk the inflation), but theory and evidence disagree on this point. Most current work shows it did, indeed, have modest effects (another failed prediction of his model).

And this is just funny:

So the Kocherlakota of 2 1/2 years ago had some worries about the potential for inflation. Maybe he changed his mind for good reason? I don't think so. ...

Yes, all that inflation we've had should have validated his fears. Williamson's complaint appears to be that Kocherlakota predicted something two and a half years ago, it didn't happen, and he has the gall to use the fact that his prediction failed to change his mind? He changed his mind based upon evidence? He looked at evidence and did science??? How goofy is that? Doesn't he know -- as Williamson apparently knew years ago -- that inflation is just around the corner (according to his wonderfully scientific model)?

Williamson was wrong then, but right now because higher growth does look likely in the near future, is that the argument? Why should we believe his model of inflation and growth now now if it was wrong before? Or will inflation happen even without higher growth like he said could happen two years ago? What should we believe his model now if it was wrong before?

Look, I'm all for science, but that has to include changing your mind when your model is wrong. After two years of running around telling everyone the sky is about to fall, perhaps Williamson will understand why people are more likely to listen to the evidence based views of Narayana and others than to him.

'The Insurer Of Last Resort'

Posted: 31 Oct 2012 10:17 AM PDT

Paul Krugman:

Disasters and Politics: ...let me just take a moment to flag an issue others have been writing about: the weird Republican obsession with killing FEMA. Kevin Drum has the goods: they just keep doing it. George Bush the elder turned the agency into a dumping ground for hacks, with bad results; Clinton revived the agency; Bush the younger ruined it again; Obama revived it again; and Romney — with everyone still remembering Brownie and Katrina! — said that he wants to block-grant and privatize it. (And as far as I can tell, even TV news isn't letting him Etch-A-Sketch the comment away).
There's something pathological here. It's really hard to think of a public service less likely to be suitable for privatization, and given the massive inequality of impacts by state, it really really isn't block-grantable. Does the right somehow imagine that only Those People need disaster relief? Is the whole idea of helping people as opposed to hurting them just anathema?
It's a bit of a mystery, calling more for psychological inquiry than policy analysis. But something is going on here.

Some history from Tod Kelly (via):

One of the hard lessons one learns in risk management is that no one funds for catastrophic losses unless they are required by an outside agency to do so. In many cases this is because it is not feasible to do so; but even in those cases where it is feasible, no one does.

Were FEMA to be dismantled, for example, there would be no financial resources from which to quickly rebuild from disasters like Hurricane Sandy. Conservatives might argue that private insurers could provide such protection, and this is certainly correct – on paper. However, one of the axioms from my industry is that there is no such thing as an uninsurable risk, there are just risks people aren't willing to pay enough premium for.

This is absolutely true for natural disasters. If your insurance provider offered you or your business coverage that would protect you from disasters like Sandy, you would not be willing to pay the premium required. You might disagree with that statement, but history shows that it is true. In fact, it is almost universally true. Governmental disaster insurance schemes didn't appear magically in a vacuum; they were created because prior no one was willing to pay enough money in premiums to allow insurance companies to properly fund for them, and as a result the inevitable losses were uncovered.

That's true of government social insurance sprograms as well. They appeared for a reason, and generally the reason is the inability of the private market to provide adequate protection due to market failures or other causes. Pretending that those problems no longer exist -- that privatization would somehow be different this time -- is wishful thinking.

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