"The Collapse of Monetarism and the Irrelevance of the New Monetary Consensus"
It would be safe to say that Jamie Galbraith's view of modern monetary theory differs from mine:
The Collapse of Monetarism and the Irrelevance of the New Monetary Consensus, by James K. Galbraith: Twenty-five years ago, on a brilliant winter day at Alta, I stepped off the top of the Sugarloaf lift and heard a familiar voice asking for directions. It was William F. Buckley, jr. I pulled off my hat and skied over to say hello. Buckley greeted me, then turned to a small man at his side, wrapped in a quilted green parka, matching green stocking cap, and wrap-around sunglasses in the punk style. “Of course,” he said, “you know Milton Friedman.”
Five months ago, I received from Professor Delemeester the invitation to deliver this lecture. My first act was to notify Buckley, already then quite ill. I warned that he couldn’t publish on it or the invitation might be revoked. The email came back instantly, full of exclamation points, block caps and misspellings. “Congratulations! What a wonderful opportunity to REPENT!”
My other close encounter with Milton Friedman came around eighteen years ago, when he invited me to debate the themes of “Free to Choose” for an updated release of that late-seventies television series. Looking at it recently on the Internet after so many years, my main impression is that this format did not show Friedman at his best. Unlike Buckley on television he would simplify and condescend, and this left him vulnerable to easy lines of attack. When I suggested that his program plainly drew no distinctions between the big government of communist China and the big government of the United States, he had no reply. It was true: that’s what he thought. If this were all there was to Friedman, he would not be worth talking about and you would not have endowed this lecture.
Truly I come to bury Milton, not to praise him. But I would like to do so on the terrain that he favored, where he was strong, and over which he ruled for many decades. This is monetary policy, monetarism, the natural rate of unemployment and the priority of fighting inflation over fighting unemployment. It is here that Friedman had his largest practical impact and also his greatest intellectual success. It was on this battleground that he beat out the entire Keynesian establishment of the 1960s, stuck as they were on a stable Phillips Curve. It was here that he set the stage for the counter-revolution that has dominated academic macroeconomics for a generation, and that – far more important – also dominated and continues to influence the way in which most people think about monetary policy and the fight against inflation.
What was monetarism?
Friedman famously defined it as the proposition that “inflation is everywhere and always a monetary phenomenon.” This meant that money and prices were tied together. But more than that, Friedman believed that money was a policy variable – a quantity that the Central Bank could create or destroy at will. Create too much, there would be inflation. Create too little, and the economy might collapse. There followed from this that the right amount would generate the right result: stable prices at what Friedman came to call the natural rate of unemployment.
The intent and effect of this line of reasoning was to defend a core proposition about capitalism: that free and unfettered markets are intrinsically stable. In Friedman’s gospels government is the lone serpent in Eden, while the task of policy is to stay out of the way. Just as this was the vulgar lesson of “Free to Choose” so it turns out it was also the deep lesson of the larger structure of Friedman’s thought. Friedman and Schwartz’s Monetary History for all its facts and statistics carried a simple message: the market did not fail; the government did.
Friedman succeeded because his work was complex enough to lend an aspect of scientific achievement to his ideas, and because the ideas played to the preconceptions of a particular circle. As Keynes wrote of Ricardo: “The completeness of [his] victory is something of a curiosity and a mystery. It must have been due to a complex of suitabilities in the doctrine to the environment into which it was projected. That it reached conclusions quite different from what the ordinary uninstructed person would expect, added, I suppose, to its intellectual prestige. That its teaching, translated into practice, was austere and often unpalatable, lent it virtue. That it was adapted to carry a vast and consistent logical superstructure, gave it beauty. That it could explain much social injustice and apparent cruelty as an inevitable incident in the scheme of progress, and the attempt to change such things as likely... to do more harm than good, commended it to authority. That it afforded a measure of justification to the free activities of the individual capitalist, attracted to it the support of the dominant social force behind authority.”
Friedman’s success was similar to Ricardo’s but not in all respects. Yes he also explained away injustice and supported authority. But the logical superstructure was not vast and consistent. Rather Friedman’s argument was maddeningly simple, yet slippery. He would appeal to short run for some effects and to the long run for others, shifting between them as it suited him. Once at some American Economic Association meetings in San Francisco I encountered him at the end of a camera. “Professor Friedman,” the reporter inquired, “how will the economy do next year?” “Well,” Friedman replied, “because of the slow money growth last year, there will be a terrible recession.” “And what is your outlook for prices?” “Because of the fast money growth over the past several years, there will be a terrible inflation.” “Professor Friedman,” the reporter continued, “will the average American family be better off next year, or worse off than they are today.” “There is no such thing as the average American family. Some American families will be better off, and some will be worse off.” As I said: he could be difficult to pin down. And while the practice resulting from the teachings was indeed austere and unpalatable, Friedman actually denied this. His money growth rules promised stable employment without inflation. Their promise was not austere, but happy. Ricardo was Scrooge. Friedman was more like the Pied Piper.
Friedman’s success was consolidated in the late 1970s by facts: the strength of the monetarist regressions and the failure of the Keynesian Phillips Curve. Stagflation happened. Robert Lucas called this “as clear-cut an experimental discrimination as macroeconomics is ever likely to see.” At the same time, I played a minor role in bringing monetarist ideas to the policy market. My responsibility was to design the Humphrey-Hawkins hearings on monetary policy from 1975 through their enactment into law in 1978. In a practical alliance with monetarists on the committee staff, we insisted that the Federal Reserve develop and report targets for monetary growth a year ahead. The point here was not to stabilize money growth as such: it was to force the Fed to be more candid about its plans. But the process certainly lent weight to monetarism.
It was on the policy battleground, shortly after, that monetarism collapsed. From1979, the Federal Reserve formally went over to short-term monetary targets. The results were a cascading disaster: twenty-percent interest rates, a sixty percent revaluation of the dollar, eleven percent unemployment, recession, deindustrialization through the Midwest including here in Ohio, and in Indiana, Illinois and Wisconsin, and ultimately the debt crisis of the Third World. In August 1982, faced with the Mexican default and also a revolt in Congress – which I engineered from my perch at the Joint Economic Committee – the Federal Reserve dumped monetary targeting and never returned to it.
By the mid-1980s, the rigorous monetarism Friedman had championed also faded from academic life. Money growth became high and variable, but inflation never came back. Perhaps inflation was “always and everywhere a monetary phenomenon.” But monetary phenomena could happen without inflation. This vitiated the use of monetary aggregates as an instrument of policy control. At the Bank of England Charles Goodhart stated his law: when you try to use an econometric relationship for purposes of policy control, it changes. Friedman himself conceded to the Financial Times in 2003: “The use of quantity of money as a target has not been a success. I’m not sure I would as of today push it as hard as I once did.”
What remained in the aftermath was a sequence of doctrines. All were far more vague and imprecise than monetarism but they carried a similar policy message: the Fed should place inflation control at the center of its operations, it should ignore unemployment except if that variable fell too low. Further, there was a sense that instability in the financial sector should be ignored by macroeconomic policymakers except when it could not be ignored any longer. The first of these doctrines, the “natural rate of unemployment” or “Non-Accelerating Inflation Rate of Unemployment,” originated with Friedman and Edmund Phelps in 1968 and had the fatal attraction of incorporating expectations for the first time into a macroeconomic model. Macroeconomists fell for it wholesale. But it proved laughably defective in the late 1990s, Alan Greenspan, bless his heart, allowed unemployment to fall below successive NAIRU barriers – 6 percent, 5.5 percent, 5 percent, 4.5 percent, and finally even 4 percent. Nothing happened. No inflation resulted. This was good news for everyone except economists associated with the NAIRU who were, or ought to have been, embarrassed. Some retreated from Friedman to Knut Wicksell: there was a brief vogue of something called the “natural rate of interest” an idea unsupported by any actual research nor any theory since the demise of the gold standard.
And then we got Ben Bernanke and ostensible doctrine of “inflation targeting.” This idea -- Dr. Bernankenstein’s Monster – rests on something Professor Marvin Goodfriend of Carnegie- Mellon University calls the “new consensus monetary policy.” This is a collection of ideas framed by the experience of the early 1980s but adapted, at least on the surface, to changing conditions since then. These are, first, that “the main monetarist message was vindicated: monetary policy alone...could reduce inflation permanently, at a cost to output and employment that, while substantial, was far less than in common Keynesian scenarios.” Second, a determined independent central bank can acquire credibility for low inflation without an institutional mandate from the government....” and “Third, a well-timed aggressive interest-rate tightening can reduce inflation expectations and preempt a resurgence of inflation without creating a recession.” Let us take up each of these alleged principles in turn.
First, is the proposition that monetary policy can reduce inflation permanently and at reasonable cost the “main monetarist message”? The idea is absurd. The main monetarist message was that the control of inflation was to be effected by the control of money growth. We have not even attempted this for a generation. Money growth has been allowed to do whatever it wanted. The Federal Reserve stopped paying attention, and even stopped publishing some of the statistics. Yet inflation has not returned. The main monetarist message is plainly false. As for the question of cost, no one ever doubted that a harsh recession could stop inflation. But in fact the monetarists’ recession of 1981-82 was by far the deepest on the postwar record. It was far worse than any inflicted under Keynesian policy regimes. In misstating this history, Goodfriend also completely overlooks the catastrophe inflicted by the global debt crisis on the developing world.
Second, is the anti-inflation “credibility” of a “determined central bank” worth anything at all? This idea is often asserted as though it were self-evident: that workers will restrain their wage demands because they recognize that excessive demands will be punished by high interest rates. There is some evidence for such a mechanism in the very specific case of postwar Germany, where a powerful union, the Metallgesellschaft, implicitly bargained with the Bundesbank for a period of some years. But in that case, the Bundesbank held a powerful, targeted weapon: a rise in interest rates would appreciate the D-Mark and kill the export markets for German machinery and metal products. This was a credible threat. Such a situation does not exist in the United States, and there is no evidence whatever that American labor unions think at all about monetary policy in their day-to-day work. It would not be rational for them to do so: in a decentralized system, restraint in one set of wages just creates an advantage for someone else. Moreover, and still more telling, there of course never existed any oil company that ever failed to raise the price of petroleum, when it could, because it feared a rise in interest rates might afflict someone else later on.
Third, can we safely state that a “well-timed aggressive tightening” can avert inflation “without creating a recession”? That statement is surely the lynchpin of the new monetary consensus. It was published in the Journal of Economic Perspectives – a flagship journal of the American Economic Association, in the issue dated Fall 2007. The article, by Professor Goodfriend, is entitled, “How the World Achieved Consensus on Monetary Policy.” It therefore represents a statement of the highest form of expression of economic groupthink we are ever likely to find. Let me quote further, just so the message is clear. Goodfriend writes: “According to this “inflation-targeting principle,” monetary policy that targets inflation makes the best contribution to the stabilization of output. ... [T]argeting inflation thus makes actual output conform to potential output.” Further: “This line of argument implies that inflation targeting yields the best cyclical behavior of employment and output that monetary policy alone can deliver. Thus, and here is the revolutionary point delivered by the modern theoretical consensus–even those who care mainly about the stabilization of the real economy can support a low-inflation objective for monetary policy. ...[M]onetary policy should [therefore] not try to counteract fluctuations in employment and output due to real business cycles.”
This statement was published, hilariously, around August, 2007. It is the economists’ equivalent of the proposition that the road to Baghdad would be strewn with flowers. For as of that moment, the Federal Reserve was at the crest of an “aggressive tightening” underway since late 2004, aimed precisely at “pre-empting inflationary expectations” while “averting recession.” On July 19, 2006, Chairman Bernanke so testified: “The recent rise in inflation is of concern to the FOMC.... The Federal Reserve must guard against the emergence of an inflationary psychology that could impart greater persistence to what would otherwise be a transitory increase in inflation.” On February 14, 2007, he repeated and strengthened the message: “The FOMC again indicated that its predominant policy concern is the risk that inflation will fail to ease as expected.” On July 19, 2007, this is again repeated: “With the level of resource utilization relatively high and with a sustained moderation in inflation pressures yet to be convincingly demonstrated, the FOMC has consistently stated that upside risks to inflation are its predominant policy concern.”
Before the fall, Chairman Bernanke made occasional reference to developments in the financial sector. On May 23, 2006, these were actually enthusiastic. Bernanke testified: “Technological advances have dramatically transformed the provision of financial services in our economy. Notably, increasingly sophisticated information technologies enable lenders to collect and process data necessary to evaluate and price risk much more efficiently than in the past.” And: “Market competition among financial providers for the business of informed consumers is, in my judgment, the best mechanism for promoting the provision of better, lowercost financial products.” As for consumers, education was Bernanke’s recommendation and caveat emptor was his rule: “...one study that analyzed nearly 40,000 affordable mortgage loans targeted to lower-income borrowers found that counseling before the purchase of a home reduced ninety-day delinquency rates by 19 percent on average.”
On February 14, 2007, Bernanke was still optimistic: “Despite the ongoing adjustments in the housing sector, overall economic prospects remain good.” And: “Overall, the U.S. economy seems likely to expand at a moderate pace this year and next, with growth strengthening somewhat as the drag from housing diminishes.” On March 28, 2007, he was less cheerful: “Delinquency rates on variable-interest loans to subprime borrowers, which account for a bit less than 10 percent of all mortgages outstanding, have climbed sharply in recent months.” Still, “At this juncture, however, the impact on the broader economy and financial markets of the problems in the subprime market seems likely to be contained.” Only on July 19, 2007, do we hear that previous assessments were a bit rosy. Only then do we hear that “in recent weeks, we have also seen increased concerns about credit risks on some other types of financial instruments.” That was three weeks before all hell broke loose on August 11, 2007.
What in monetarism, and what in the “new monetary consensus,” led to a correct or even remotely relevant anticipation of the extraordinary financial crisis that broke over the housing sector, the banking system and the world economy in August 2007 and that has continued to preoccupy central bankers ever since? The answer is, of course, absolutely nothing. You will not find a word about financial crises, lender-of-last-resort functions or the nationalization of banks like Britain’s Northern Rock in papers dealing with monetary policy in the monetarist or the “new monetary consensus” traditions. What you will find, if you find anything at all, is a resolute, dogmatic, absolutist belief that monetary policy should not – should never – concern itself with such problems. That is partly why I say that monetarism has collapsed. And that is why I say that the so-called new monetary consensus is an irrelevance. Serious people should not concern themselves with these ideas any more. Meanwhile central bankers caught in the practical realities of a collapsing financial system have had to re-educate themselves quickly. To some degree and to their credit they have done so. What they have not done, is admit it.
What is the relevant economics? Plainly, as many commentators have hastily rediscovered, it is the economics of John Maynard Keynes, of John Kenneth Galbraith and of Hyman Minsky, that is relevant to the current economic crisis. Let say a word on each.
Here is Keynes, who wrote in 1931 that we live “in a community which is so organized that a veil of money is, as I have said, interposed over a wide field between the actual asset and the wealth owner. The ostensible proprietor of the actual asset has financed it by borrowing money from the actual owner of wealth. Furthermore, it is largely through the banking system that all this has been arranged. That is to say, the banks have, for a consideration, interposed their guarantee. They stand between the real borrower and the real lender. ... It is for this reason that a decline in money values so severe as that which we are now experiencing threatens the solidarity of the whole financial structure. Banks and bankers are by nature blind. They have not seen what was coming. Some of them have even welcomed the fall of prices towards what, in their innocence, they have deemed the just and ‘natural’ and inevitable level..., that is to say, to the level of prices to which their minds became accustomed in their formative years. In the United States, some of them employ so-called ‘economists’ who tell us even today that our troubles are due to the fact that the prices of some commodities and some services have not yet fallen enough... A ‘sound banker,’ alas! is not one who foresees danger and avoids it, but one who, when he is ruined, is ruined in a conventional and orthodox way along with his fellows, so that no one can really blame him.”
In The Great Crash, published in 1955, my father rejects the idea, later embraced by Friedman, that bankers and speculators were merely reflecting the previous course of monetary policy. As of summer 1929, “[t]here were no reasons for expecting disaster. No one could foresee that production, prices, incomes and all other indicators would continue to shrink for three long and dismal years. Only after the market crash were there plausible grounds to suppose that things might now for a long while get a lot worse.” And, “There seems little question that in 1929, modifying a famous cliché, the economy was fundamentally unsound. ... Many things were wrong, [including] ...the bad distribution of income... the bad corporate structure... the bad banking structure... the dubious state of the foreign balance...[and] the poor state of economic intelligence.” On the last, he also wrote, “To regard the people of any time as particularly obtuse seems vaguely improper, and it also establishes a precedent which members of this generation might regret. Yet it seems certain that the economists and those who offered economic counsel in the late twenties and early thirties were almost uniquely perverse.” On this point, JKG is now disproved. I refer you back to the “new monetary consensus.”
Finally Hyman Minsky taught that economic stability itself breeds instability. The logic is quite simple: apparently stable times encourage banks and others to take exceptional risks. Soon the internal instability they generate threatens the entire system. Hedge finance becomes speculative, then Ponzi. The system crumbles and must be rebuilt. Governments are not the only source of instability. Markets, typically, are much more unstable, much more destabilizing. This fact that is clear, in history, from the fundamental fact that market instability long predates the growth of government in the New Deal years and after, or even the existence of central banking. We had the crash of 1907 before, not after, we got the Federal Reserve Act.
On November 8, 2002, then-Fed Governor Ben S. Bernanke spoke in Chicago to honor Milton Friedman on his 90th birthday. Bernanke said, “As everyone here knows, in their Monetary History Friedman and Schwartz made the case that the economic collapse of 1929-33 was the product of the nation’s monetary mechanism gone wrong. Contradicting the received wisdom at the time they wrote...Friedman and Schwartz argued that ‘the contraction is in fact a tragic testimonial to the importance of monetary forces.” In that era, Bernanke argued, the Fed tightened to thwart speculation. One would argue that in 2005-7 it tightened to pre-empt inflation. No matter. You can see the difficulty without my help. At the close of his speech, Bernanke stated, “Let me end my talk by slightly abusing my status as an official representative of the Federal Reserve. I would like to say to Milton and Anna: Regarding the Great Depression. You’re right, we did it. We’re very sorry. But thanks to you, we won’t do it again.”
Less than six years later, Chairman Ben Bernanke faces an intellectual dilemma. He can stick with Milton, in which case he must admit that the only possible cause of the present financial crisis and evolving recession is the tightening action of the Federal Reserve, against which, when it started back in 2004 only two voices were heard: that of Jude Wanniski, the original supply-sider, and my own, in a joint Op-Ed piece no one would publish except the Washington Times. Or he can stick with the so-called “new monetary consensus,” which holds that the Fed should now return to its inflation targets, pursue a much tighter policy, and that no recession will result. If Bernanke chooses the first, he must of course assume responsibility for the unfolding disaster. He cannot, logically, stay with Friedman without admitting the error of the late Greenspan years and his own first months in office. If he chooses the second, he must repudiate Friedman, and hope for the best. The two courses are absolutely in conflict.
My own view is that Friedman and Schwartz were right on the broad principle -- monetary forces are powerful -- but wrong in its application. The Federal Reserve alone did not “cause” the Great Depression. Intrinsic flaws in the financial, corporate and social structure, combined with bad policy both before and after the crash, were jointly responsible for the disaster, while the crash itself played a precipitating role. The danger, today, is that something similar could again happen. Thus I do not think that rising interest rates alone caused the present collapse, and I do not think that cutting them alone will cure it. They did so in conjunction with the failure to regulate sub-prime loans, with the permissive attitude to securitization, with the repeal of Glass- Steagall, and with the general calamity of turning the work of government over to bankers.
But if Friedman was wrong, the “new monetary consensus” is even more wrong. That consensus, having nothing to say about abusive mortgage loans, speculative securitization and corporate fraud, is simply irrelevant to the problems faced by monetary policy today. Its prescriptions, were they actually followed, would lead to disaster. Its adherents, who of course never had a consensus on their side to begin with, have made themselves into figures of fun. There is, mercifully, no chance that Ben Bernanke will actually choose to follow their path.
And if both sides of Bernanke’s dilemma are wrong, what is a beleaguered central banker to do? I have an answer to that. Let Ben Bernanke come over to our side. Let him acknowledge what is obvious: the instability of capitalism, the irresponsibility of speculators, the necessity of regulation, the imperative of intervention. Let him admit the intellectual victory of John Maynard Keynes, of John Kenneth Galbraith, of Hyman Minsky. Let him take those dusty tomes off the shelf, and broaden his reading. I could even send him a paper or two.
Thank you very much indeed.
Posted by Mark Thoma on Tuesday, April 29, 2008 at 12:42 AM in Economics, Inflation, Macroeconomics, Monetary Policy, Unemployment Permalink TrackBack (0) Comments (45)
Interesting and valuable economic history indeed!
How do we reconcile monetarism with our current knowledge of poltical economy? In which inflation and its intrinsic impact on employment and rest of the economy is becoming more and more the central focus of policy consideration. May be capitalism, as we knew it under the mantra of *free market* mechanism, is coming to an end.
In our complex world of globalization and its influence on economic stability or instability, policy makers are forced to find alternatives to manage the economic machinery from going sour....
Posted by: hari | Link to comment | Apr 29, 2008 at 02:17 AM
Well, I suppose there is more politics there than economics. But there's not really much there I would disagree with.
What I do disagree with primarily in the discussion of monetary policy is the lack of precision. It is asserted:
"Money growth has been allowed to do whatever it wanted. The Federal Reserve stopped paying attention, and even stopped publishing some of the statistics. Yet inflation has not returned."
However, this depends on how one defines money. Yes, they stopped publishing M3, a broad aggregate. But would M3 growth be expected to track with general inflation? Currency growth for the same period was quite tight.
To really paint a complete picture of what is going on with monetary policy, one needs to look at narrow measures directly impacted by the FOMC (currency, M1), as well as broader economic trends influenced, among other things, by regulatory policy (including aggregates like M2 and M3, consumer credit, mortgage markets, etc.)
Similarly, to really examine inflation, you need to look at all causes of price increases. You have core inflation, which tends to be more strongly related to currency expansion; you have asset prices (including housing and equity markets), which tend to inflate when the currency is strong (and general inflation is low); and you have exchange rate effects, which can lead to price increases in imported goods (including commodities like oil and food) when the currency falls.
If Galbraith's view of monetary policy is too simple here, though, so is that of most of the political acolytes of Friedman whom he is criticizing. Even the criticism of the Bernanke Fed here seems to me mostly on target. Is there any doubt that the Fed was tightening even as we headed into recession? It seems to me also, the Fed's emphasis on targeting generalized inflation, by measures such as core CPI, has been somewhat myopic, with too little attention paid to other factors. Certainly inflation targeting needs to be balanced against employment, stability, and economic growth. And, I would suggest that the levels which have been targeted have been too low; a target in the 3-3.5% range would be more in line with historical norms and less likely to lead to price imbalances in debt and equity markets.
It will be interesting to see if the obviously less monetarist Chinese, who have been holding rates low now despite inflation increasing to over 8%, manage to successfully avoid too much of a slowdown despite the pressure being put on their export sector by the falling dollar. Or if they instead merely cause an inflationary spiral.
Posted by: acerimusdux | Link to comment | Apr 29, 2008 at 05:33 AM
Excellent speech. I'm not sure the source of your disagreement with him Mark. Galbraith merely points out that however monetarism gets redefined, its legacy is incompatible with the belief that "money [is] a policy variable".
It is the politics that flow from that position that he is burying, nothing else.
Posted by: walking_the_line | Link to comment | Apr 29, 2008 at 05:34 AM
Very good article, and good history of the current debacle embedded in it. We've been following the Chicago School on monetary policy, and now look where we are at. Some years ago, I saw a short series, maybe 3 parts, on PBS, that covered some of the modern economists before and up thru WW2, to present, with bits of their lives in it.... seems that a couple were Brits who did patrolling for air raids and discussed their theories. I wish I could have seen the series complete or even see it again. Anyone remember this?
Posted by: Real Person from the Real World | Link to comment | Apr 29, 2008 at 05:35 AM
Mark,
I guess it would be useful if you would clarify what you disagree with here. Is it the argument that the natural rate of unemployment (and NAIRU) are essentially meaningless concepts? Is it that central banks have not used the money supply as a key policy target over the last quarter of a century, and at least until very recently done pretty well? Do you really believe that "inflation is everywhere and always strictly a monetary phenomenon"?
Or maybe you did not like Jamie's characterization of how Uncle Miltie looked in his punk shades.
Posted by: Barkley Rosser | Link to comment | Apr 29, 2008 at 05:49 AM
Or maybe you do not think we should be worrying about "the Minsky moment." Uncle Miltie never did, unless it was brought about by a massive contraction of the money supply.
Posted by: Barkley Rosser | Link to comment | Apr 29, 2008 at 05:50 AM
Do I take it that your refusal to provide a commentary let alone a rebuttal constitutes your acceptance of the points made in the article, Professor Thoma?
Posted by: AllanW | Link to comment | Apr 29, 2008 at 06:00 AM
Good and damning. Seems capitalism and markets are much like fire and nuclear power; they require sophisticated control. Very few absolutes. No simple explanations. The good thing about a model is the lever it provides. The bad thing about a model is the levers it provides.
Posted by: ken melvin | Link to comment | Apr 29, 2008 at 06:20 AM
I would suggest looking into the work of Abba Lerner's functional finance. Monetary policy has been a miserable failure over the last several decades because fiscal policy has been (for the most part) a miserable failure. And fiscal policy is made by 400+ glib idiots whose only economic qualification is getting more votes than the other glib idiot.
Posted by: markg | Link to comment | Apr 29, 2008 at 06:22 AM
I would guess that Mark might have some disagreements on the three points on which Galbraith attempts to refute monetarism.
One, "that monetary policy can reduce inflation permanently and at reasonable cost", he simply argues wasn't the main message. But he seems to be a bit too dismissive of the fact that monetary policy can reduce inflation, and that monetary growth is a significant variable.
On the second point, he seems to argue that anti-inflation credibility has no value at all for a central bank--seemingly casting aside any rational expectations analysis. It may be that controlling expectations alone may not be a magic elixir that cures all economic ills, but does it really have no value whatsoever?
Third, just because the most recent rate increases may not have been well timed, does this really disprove the general idea that a "a well-timed aggressive interest-rate tightening can reduce inflation expectations and preempt a resurgence of inflation without creating a recession"?
Galbraith does a fair job here of ridiculing the notion that "[M]onetary policy should [therefore] not try to counteract fluctuations in employment and output due to real business cycles" but it does not follow that it is impossible under some conditions for monetary policy to preempt inflation without creating recession.
Posted by: acerimusdux | Link to comment | Apr 29, 2008 at 07:04 AM
Certainly Galbraith's attack on the underlying New Keynesian theory of the New Monetary Concensus is is on the mark. David Altig, a top economist at the Federal Reserve and contributor to the theory, has himself voiced
grave doubts about its usefulness and argued it will have to
be abandoned. Since it has no financial intermediation in it (an extraordinary lacuna), it obviously had nothing to say about the brewing crisis.
What is needed, is to integrate the insights
of Minsky into a coherent microfounded monetary model.
Charles Goodhart at the LSE has called for this and has developed some models of financial fragility that meet the high theory standards of today's guardians of the academic macro temple. In the meantime, monetary policy has to be made on the fly, using the school of hard knocks to underpin it, as it has for 200 years.
Posted by: PCLE | Link to comment | Apr 29, 2008 at 07:38 AM
I don't notice any acknowledgment that there is a real world out there. There are two crises going on right now, one real and the other a mathematical construct.
The mathematical construct we understand, it is "monetary" policy, which stripped of all its theory, just means how is wealth going to be redistributed. For example, inflation benefits borrowers who tend to be poorer, while the opposite benefits lenders and the rentier class. Fighting inflation causes unemployment which disfavors the working classes while driving down the cost of labor and thus favoring the capitalist classes.
The real crisis is the neo-Malthusian one: too many people, too few resources. Capitalism dodged the bullet over this for the past several centuries because technological innovation allowed for more efficient exploitation of natural resources and a population explosion. Capitalism and permanent growth can't work in a world of constrained resources. The externalities of depletion and pollution have been ignored and this is what allows capitalistic firms to show a "profit".
Where is the discussion over how to manage in an era of resource insufficiency? Where is the discussion over what to do about population control? Where is the discussion over what happens to the financial and other non-productive sectors when growth has to be replaced by a sustainable social system? Where are the discussions of what replaces capitalism?
Every time anyone even brings the subject up, it quickly gets sidetracked by attacks which associate capitalism with democracy and any other productive organizational schemes with authoritarianism. This is a cheap smear. Capitalism is a way to finance entrepreneurship. How the firms are governed is another issue. Currently there are no democratic, for-profit firms; some would argue that most western governments are barely democratic as well.
We used to have many firms which were not for-profit and were democratically governed, these included mutual banks and insurance companies and co-ops - both of producers and consumers. They have all be replaced by for-profit firms which have raised prices and used the increased income to pay an increasingly wealthy managerial class.
Wake up and smell the coffee: the world is finite, resources are finite and the population continues to increase. You can't grow out of a shortage and fiddling with green pieces of paper won't solve the problems either.
Posted by: robertdfeinman | Link to comment | Apr 29, 2008 at 08:04 AM
"Meanwhile central bankers caught in the practical realities of a collapsing financial system have had to re-educate themselves quickly. To some degree and to their credit they have done so. What they have not done, is admit it. "
Hear! Hear!
I'd add quite a few economists to that list of central bankers.
Posted by: Winslow R. | Link to comment | Apr 29, 2008 at 08:25 AM
"Wake up and smell the coffee: the world is finite, resources are finite and the population continues to increase. You can't grow out of a shortage and fiddling with green pieces of paper won't solve the problems either."
I've not come to this conclusion.........yet.
I do see the recent expansion of consumers based in India and China as a shock to the system. How the system handles the shock is partly determined by how quickly China and India change. Yes they were kept in the stone age for a long time, but do we have to transition their billions so quickly Malthusian constraints become apparent?
Why not slow the transition down a bit? China should increase taxes or sell more yuan denominated long-term bonds.
Posted by: Winslow R. | Link to comment | Apr 29, 2008 at 08:32 AM
Winslow:
Are you going to tell a newly rich person in China that he can't buy a Mercedes and then sit with it in grid-lock in Beijing? How are you going to enforce this?
Why not tell a guy in the US that he can't buy a Hummer instead? Sounds like a bit of cultural chauvinism to me. Telling a society that it has to go slow on development has no appeal for those living now, what do they get out of the sacrifice to their standard of living that you are asking them to make?
The US has 4% of world population and uses 40% of the resources, yet you want China to cut back on consumption?
Posted by: robertdfeinman | Link to comment | Apr 29, 2008 at 08:38 AM
"Wake up and smell the coffee: the world is finite, resources are finite and the population continues to increase. You can't grow out of a shortage and fiddling with green pieces of paper won't solve the problems either."
I agree completely. This whole talk about who's theory or model was right or wrong misses the mark. We are entering an age where *none* of the previous ideas are applicable if they are predicated on growth (as we currently know it) as the solution. Not only do we need to redefine "growth", but we need to redefine the role of our government so that it can take proactive measures that reign in the old-style "growth" and direct economic activity towards resource sustainability. We need to "close the loop", so to speak. Either that, or start working on those mining operations on the moon.
Posted by: OhNoNotAgain | Link to comment | Apr 29, 2008 at 08:38 AM
RF wrote:"Are you going to tell a newly rich person in China that he can't buy a Mercedes and then sit with it in grid-lock in Beijing? How are you going to enforce this?"
Raise taxes or sell long-term bonds. Give the guy an alternative to the Mercedes or tax it out of him.
RF wrote:"Why not tell a guy in the US that he can't buy a Hummer instead? "
This is already happening?
My point, slow the transition so we don't bump into Malthusian constraints. Otherwise here comes WWIII.
Posted by: Winslow R. | Link to comment | Apr 29, 2008 at 08:46 AM
Winslow: I do see the recent expansion of consumers based in India and China as a shock to the system. How the system handles the shock is partly determined by how quickly China and India change. Yes they were kept in the stone age for a long time, but do we have to transition their billions so quickly Malthusian constraints become apparent?
Why not slow the transition down a bit? China should increase taxes or sell more yuan denominated long-term bonds.
The Chinese, at least, are already doing a lot to slow it down. For the past few years they have only been consuming about half of what they produce, which is why they've accumulated more than a trillion dollars in foreign exchange while many of their schools do without heat. The only things that the government has been willing to spend money on are investments that directly help the export economy--things like airports and dams and power plants, which seems to me almost exactly what you are saying they should be doing. How much longer do you think they need to continue doing this?
Posted by: lonesome moderate | Link to comment | Apr 29, 2008 at 09:05 AM
That expectations are not in general rational does not mean the Fed should ignore expectations. They are clearly important, and the Fed should be doing its best to track then, and, if possible, to understand how they will change in light of any policy action the Fed undertakes. Clearly the latter is very hard to do, especially if one is allowing for expectations not to be rational. Ratex was always an easy out.
In that regard, I note that the reigning macro model now underlying most of what finds in the basements of the various Fed banks, and certainly at the BOG, is some variation on the "New Keynesian" Dynamic Stochastic General Equilibrium (DSGE) model. This model is fraught with problems, from assuming ratex to assuming that business cycles are due to price or wage rigidities to assuming there is a natural rate of unemployment to assuming general equilibrium. I realize that there are more sophisticated versions of it being developed, but I am not aware that any of these really get around the bigger problems with DSGE.
Posted by: Barkley Rosser | Link to comment | Apr 29, 2008 at 09:09 AM
Winslow:
Here you are my take on WW III (which I claim is already being seen in preliminary scuffles as happened before WW I and WW II):
Has WWIII already started?
Posted by: robertdfeinman | Link to comment | Apr 29, 2008 at 10:07 AM
Is it possible that there are observable limits on capitalism as an economic construct?
For example, while capitalism has worked well as a generally rising tide to lift much of the world out of poverty, once capitalist innovation gets beyond the point of meeting basic needs, does a continuing rising tide become an unwelcome flood of "goods" that are not really good because the added utility is marginal at best, and at worst might lead to a type of cultural obesity that presages further economic health issues?
Could this be quantified? Likely not without a radical change of perspective on what "counts"...
Posted by: Eric Dewey, Portland OR | Link to comment | Apr 29, 2008 at 10:08 AM
The basic premise of monetarism, that inflation and money supply are reasonably well correlated, seems to me to be broadly correct. It's the unfettered free-markets ideology that was attached to this notion that is clearly dysfunctional in the real financial world. But that's also true for many broadly correct Keynesian observations - they become so slavishly shackled to the greater ideology that their practical value is lost. Unfortunately, that about sums up my experience with the academic economics profession - staying true to one's ideology trumps applying reasonable concepts from both sides of the divide. Unfettered capitalism is unstable, Keynes-inspired socialism is a failed experiment. Why is the middle ground so underpopulated in economics?
Posted by: Turbo | Link to comment | Apr 29, 2008 at 10:44 AM
I don't find Jamie Galbraith's views on the nature of inflation to be at all persuasive, even superficially. acerimusdux has made the kind of points that occur to me. That said, even if Jamie Galbraith does not have much to say in the affirmative, it is a heck of a critique.
Posted by: Bruce Wilder | Link to comment | Apr 29, 2008 at 10:56 AM
Well, If we are going to discuss the legacy of John Kenneth Galbraith, with the direction this thread is going, I suppose we should discuss "The Affluent Society".
From the heavily abridged version above, on monetarism:
"Monetarism may have been effective in 19th Century Britain. Conditions were favourable. It is also plausible that it was not. The prestige of monetarism took a severe hit with its failure to control the 1920s bubble or solve the Great Depression. Since then it has enjoyed a revival, largely because (a) there is strong consensus in the conventional wisdom that inflation is undesirable (b) effective means of dealing with inflation are dangerous – they risk a reduction in output and increases in employment (or, in the case of price controls, such solutions may even be un-American).
Monetarism lacks the magical effects often alluded to. It can only act by reducing aggregate demand by restricting borrowing. Increases in interest rates discourage borrowing, leading to a reduction in demand; a gap between capacity and demand develops which pushes down competitive prices and restrains oligopolistic prices, since an oligopolistic firm with excess capacity has a temptation to gain market share by undercutting opponents. There is, empirically speaking, no inducement for consumers to save rather than spend.
...In effect, the consumer has a very dull perception of changes in the interest rate, and the task of dulling it further is given to advertising. During the active application of monetary policy in the early fifties, increases in interest rates were often followed by large increases in consumer debt."
On production:
"In American society, production is seen as the primary social goal. This is due to the continuing thrall of anachronistic ideas, vested interests in production, the obscurantism of the theory of consumer needs, a mistaken conception of the national security and an unfortunate association under present conditions between production and security for many millions of workers."
"An extremely broad array of policy decisions are cast into doubt by the loss of production as the preeminent concern of the productive system. But more than that, an entire system of morality is at stake. The sin of idleness has been perpetuated by economic reasoning throughout American history. It is difficult to continue to see its danger for the rest of the community when a man's work satisfies artificial wants – or worse, manufactures them. However, joblessness imposes a disagreeably low income, even if there no genuinely productive job can be created. This problem must be solved if the rewards of affluence are to be fully realised."
Posted by: acerimusdux | Link to comment | Apr 29, 2008 at 11:25 AM
"He can stick with Milton, in which case he must admit that the only possible cause of the present financial crisis and evolving recession is the tightening action of the Federal Reserve...,"
Here's a point that seems easy to dispute. The present financial crisis was more likely caused by undue expanionary monetary policy in the period before the tightening. Alan was too much afraid of a slowdown. Ben appears likely to repeat this error.
Posted by: don | Link to comment | Apr 29, 2008 at 11:53 AM
The lack of comments from me simply reflects that it was 3:30am when I posted this (I changed the time to reorder the post) and I had an early session to attend.
I'll add links later to a previous discussion I had with Jamie on this later when I'm at my computer, but if you search the blog for "inflation targeting" you'll find quite a bit on modern monetary policy.
Please excuse spelling, etc - using mobile device.
Posted by: Mark Thoma | Link to comment | Apr 29, 2008 at 12:19 PM
It is difficult to continue to see its danger for the rest of the community when a man's work satisfies artificial wants – or worse, manufactures them.
See the hoopla on GTA IV for confirmation.
Posted by: evagrius | Link to comment | Apr 29, 2008 at 12:28 PM
Real Person from the Real World,
I think the series you are looking for is titled the "Commanding Heights".
Posted by: sgc | Link to comment | Apr 29, 2008 at 12:41 PM
If you look past the political baggage implicit here, this speech illustrates how ridiculously out of touch mainstream economics is. The debate here indicates a fundamental misunderstanding of the major factors that influence the economy today.
The biggest impact in recent years has been the outsize credit bubble generated by the shadow banking system. That dwarfs any monetary aggregate these economists have considered. Second, the impact of deflation exported by China is not even on the radar for these folks. Not to mention the yen carry trade and other distortions in the economy. Any intelligent observer will soon realize the models these folks cling to have been completely discredited. All the action is almost entirely outside their models. How long before everyone recognizes the bankruptcy of their ideas?
Posted by: Spectator | Link to comment | Apr 29, 2008 at 12:44 PM
The problem with RDF's thesis is inherent in Malthusian theory generally, the crisis is always imminent, and yet it time after time gets postponed.
It is obviously true that resources are not infinite, what is not obvious is that we have actually reached the limits. I remember listening to an interview with the Shah of Iran where he insisted that we needed to rapidly shift away from using oil for transportation because it was irreplaceable so many other places. I remember being pretty impressed by the argument expressed in The Population Bomb, I read Garrett Hardin's 'Tragedy of the Common's and went to see him speak in 1974. And of course the Club of Rome's 'Limits of Growth' which sold 30 million copies in 30 languages. All of this mid-seventies discussion was compelling and in the long term probably irrefutable, on the other hand none of them was consistent with the actual world economy as it existed in say early 2003. Thirty years after these theories were widely promulgated we still had reasonably priced oil and few visible limits on food. Now five years later we are trapped in a scenario of intractable war, spiking oil prices associated with peak oil, and a Third World faced with crippling food shortages. Which is to say that the period 2003 to 2008 looks amazingly similar to the period 1968 to 1973- same crises and strikingly with the same apocalyptic language.
I am not at all convinced that we are approaching some limit of growth. Simple Malthusian theory holds that we have a pot of resources here and a growing population there and so clearly we will run short. What I think this ignores is the issues of efficiency and substitution.
I could supply multiple recent examples. But lets take a simple example. When I first went away to college I was given as a graduation president an electric typewriter (with a correcting cartridge-very high tech at the time) and a five or six function calculator. Each of these were relatively expensive items, certainly not every had one or both, the notion that we could supply every kid in Africa with one would have been absurd. Then again in the late fifties very early sixties it was thought absurd that we could supply everyone in America with even a black and white TV and the only person I knew that had a color TV was my uncle. Who owned an appliance store and sold them.
It all goes to defining what makes up the American lifestyle. If you think of that as a McMansion and SUV or Mercedes then of course we can't supply it to everyone in the world and in the long run can't sustain it even here. But in a world where work productivity and the costs of education and entertainment alike are less and less tied to the cost of equipment and more and more to the access to bandwidth we in fact could supply the world with a lifestyle in many respects unimaginable to us who grew up in the seventies.
I carry the Internet in my pocket. I can browse, I can post, I can access video and view it on a nice screen, I can carry around hundreds of songs at a time. I have a map of the world that can even give me directions. I don't wear a watch, I don't need a PDA, or a calculator. I have a nice digital camera I bought for work purposes, but don't carry it now, I have a reasonable substitute. Oh yeah and I can make and receive phone calls. All on a single device,
I don't know what kind of resource footprint my iPhone represents. But in terms of sheer volume of materials certainly a lot less than the combined cost of a 1980's era CRT TV, a watch, a portable electric typewriter, a battery run four function calculator, a two lb. portable phone and a portable cassette player all of which are passably substituted for by a four or so ounce devise that rests comfortably in your front pocket.
We can't supply the world with an SUV in every garage. We can conceivably supply everyone with communication to the Internet. Twenty years from now I am sure as sure can be that there will be villages where people have no running water, insufficient fuel to run the generator more than a few hours a day, and limits on food. On the other hand there is at least a reasonable outlook that every student and teacher in the world will have access to almost every book ever written, and not to be flip YouTube. As a guy that used to work the counter at the UC Berkeley Interlibrary Borrowing unit as well as the on-campus Baker Document Delivery service I can say that is a very, very big development whose long term impacts can hardly be exaggerated. If the real answer to income inequality is the skill premium then much of the answer is just potentially a cell phone away, a World University built into a four ounce device.
Posted by: Bruce Webb | Link to comment | Apr 29, 2008 at 01:07 PM
@ Bruce Webb -
Good to know your old student life in Berkeley (mine was a bit earlier than your's I guess!).
However the points you make are relevant and demand further consideration in light of globalization of world trade and development.
In 1962, when I left Bay Area and arrived in Stockholm, I was made a honorary member of (IKE's) World University...I still keep the lapel button. So the idea is not new...a lot was done during that time to bridge cultural/educational gap.
What would you say if mainland China (instead of America) was likley to implement some of your brilliant ideas and make them real (like they're now in Africa)? SWF???
Recall the concept of *revolution from the bottom*... China and its Maoist Revolution was diametrically different from Soviet Union. They appear to understand the meaning and implication of *under-development* better than EU/US, from my professional (inside EU) perspective.
Posted by: hari | Link to comment | Apr 29, 2008 at 01:36 PM
neo-Malthusian? too few resources, too much demand? Consider that in today's world the "standard of living" of the richest people means that 65% of the global trade in resources is consumed by 5% of the world's population. So repeating Malthusian dictums only reproduces the errors of Malthusian thinking- the lumping of all humanity into an amorphous concept that lacks realism.
On Lumping: The problem with using aggregate statistics to hypothesize on economic concepts of scarcity and abundance is that the statement becomes chaotic in content and form because it has no time, place or person - no history, no geography, no sociology. It's only in the taking apart of aggregate data that the theory can touch the ground and provide the required specificity to make it useful.
Posted by: agricanto | Link to comment | Apr 29, 2008 at 01:42 PM
Bruce Webb:
New Orleans avoided a flood until it didn't. That predictions were wrong in the past is not a scientific argument, you can't argue by historical analogy. History doesn't repeat.
Just like Ipods science has progressed and we have a much better understanding of ecology and population dynamics than we did in the past. There is a global shortage of food, there is global competition for vital resources, this is unprecedented.
Just look at the absolute numbers of population over the past century. We are now at 6.7 billion and expected to go to 8+ billion by 2050. If you think an additional two billion people can be accommodated by as-yet-undiscovered technological breakthroughs that's not a prudent way to approach a crisis.
Try this graphic:
http://wilderdom.com/images/WorldPopulationGraph.jpg
We have no viable plans on how to replace liquid fuels needed for transportation. We have no viable plans for controlling greenhouse gases. We have no viable plans for replacing the internal combustion engine. We have no viable technology which will power an all electric car.
Prudent people put aside money for a rainy day. Those now living should reduce consumption so that our resources will be there for the rainy day that is sure to come. The problem is made more complicated by the fact that those who are consuming the most are also those most unwilling to scale back. We can't even get people out of SUV's.
Wishing won't make it so.
Posted by: robertdfeinman | Link to comment | Apr 29, 2008 at 03:31 PM
"Uneconomic growth in theory and in fact"
Herman E Daly
The First Annual Feasta Lecture
Trinity College, Dublin
26th April, 1999.
[Let me begin then with the question, can growth in GDP - that's usually what we mean by economic growth, growth in GDP - can growth in GDP in fact be uneconomic? Well, I think before answering that we should ask a similar question in micro economics. Can growth in micro-economic activity - that is, an activity in the firm or the household - can that be uneconomic? Of course it can. The whole idea of micro economics is seeking an optimal level of some activity. As the amount of the activity increases, eventually increasing marginal costs will intersect diminishing marginal benefit. If you grow beyond that it's uneconomic. Optimisation is the essence of micro economics and that implies stopping . So the marginal cost equal marginal revenue rule, which you're all to familiar with if you've had the first course in economics, is aptly called in some textbooks the 'when to stop rule'. I like that term, the 'when to stop' rule.
Well you've taken your course in micro economics. Here's the next course in macro economics. No more equating of marginal costs to marginal revenue, no more win {sic} to stop rule, you just aggregate everything into GNP and this is supposed to grow forever. This is a curious thing. At the foundation level of economics, micro economics, the idea of uneconomic growth is fundamental, non controversial really, but when you get to macro economics you just aggregate everything. Oops, all of a sudden there's no longer a when to stop rule, no longer any question of an optimal level of overall economic activity. So, let me try to speculate a little bit on why that's the case and in order to do that, let me go back to that idea of a pre-analytic vision or paradigm that I mentioned.]
Posted by: ideogenetic | Link to comment | Apr 29, 2008 at 04:10 PM
As Mark suggested, I googled "inflation targeting" and found a couple of links where he discussed it:
What is Inflation Targeting and How Does it Stabilize Output?
Explicit Inflation Targeting as a Commitment Device
The latter includes some discussion with James K. Galbraith, where he makes some arguments similar to the above.
As for my take on it, I tend to think inflation targeting seems to do a reasonable job of controlling inflation, the problem is it doesn't seem good for very much else. But I don't know that monetary policy in general is much good for much else.
Posted by: acerimusdux | Link to comment | Apr 29, 2008 at 06:49 PM
As for the neo-Malthusian discussion, one factor to consider here is that strong economic growth may be the most practical way of limiting population growth. So attempting to slow growth alone may not be good enough; in the developing world at least, a certain amount of growth is greatly needed.
As for the need for new frameworks, I wonder is it really necessary to overthrow free markets altogether? I think I saw someone suggest recently that capitalism wasn't equipped to deal with scarcity. But it seems to me that allocating scarce resources is pretty much the very point of free market economics. That's what prices are for, isn't it? So perhaps all we need to do is find better ways to make sure that external costs are included in prices.
But, still, I think there needs to be some improvement of how we deal with this. We need to pay more attention to limiting aggregate resource usage. Is anyone even measuring this, in aggregate? We commonly aggregate total supply and demand; I don't recall that I've every seen this done for natural resource usage. There doesn't seem to be any reason it shouldn't be, or that it shouldn't be regularly reported as an official government statistic (and tracked globally as well).
Likewise, if it is not growth, but resource usage we mean to limit, then there should be some discussion of how to achieve higher growth per unit of resources. That is, there should be a concept of something like labor productivity, but for natural resources. Maybe it's called resource productivity? Or perhaps it could be thought of as a multiplier, something like the velocity of money; every time you recycle you would be increasing the "velocity" of resources, getting higher growth per unit of resource.
I suspect these are not original ideas. Perhaps they are already out there and have better names and are already being measured. But the fact that I have yet to hear of official use of such measures suggests that they aren't being used enough.
Posted by: acerimusdux | Link to comment | Apr 29, 2008 at 07:19 PM
Spectator:
I think you are right on. And I think a fair (if stylized) summary is that Asian lending (China's currency manipulation and the yen carry trade) have led to asset the bubbles and unsustainable U.S. spending and borrowing. Instead of addressing the source of the imbalance, the only response to the current slowdown (by the government and the fed) is to try to keep up U.S. spending. Brad Setser worries about what will happen if Asian countries lose their taste for U.S. debt. But they are interested in growing their economies and industrial bases, not in making a profit on foreign reserves. A Japanese central bank official once responded to U.S. academic economists theorizing on the effects of reserve valuations on currency interventions by saying "Who ever said we were in the business of making a profit on our reserves?"
The economic models are there for proper analysis. But Ben wants to be reappointed, so he is trying to be popular. That's a shame. It subjects him to the same pressures as elected officials - to satisfy short-term wants at the expense of longer term consequences. We would be better served by another Volcker.
Posted by: don | Link to comment | Apr 29, 2008 at 08:23 PM
Spectator:
I think you are right on. And I think a fair (if stylized) summary is that Asian lending (China's currency manipulation and the yen carry trade) have led to asset the bubbles and unsustainable U.S. spending and borrowing. Instead of addressing the source of the imbalance, the only response to the current slowdown (by the government and the fed) is to try to keep up U.S. spending. Brad Setser worries about what will happen if Asian countries lose their taste for U.S. debt. But they are interested in growing their economies and industrial bases, not in making a profit on foreign reserves. A Japanese central bank official once responded to U.S. academic economists theorizing on the effects of reserve valuations on currency interventions by saying "Who ever said we were in the business of making a profit on our reserves?"
The economic models are there for proper analysis. But Ben wants to be reappointed, so he is trying to be popular. That's a shame. It subjects him to the same pressures as elected officials - to satisfy short-term wants at the expense of longer term consequences. We would be better served by another Volcker.
Posted by: don | Link to comment | Apr 29, 2008 at 08:24 PM
Re- The Main Post:
Dean Baker has been shouting for years that NAIRU is a farce. I am inclined to agree with both Baker and Galbraith that virtually every non-empirical aspect of monetary policy is officially bunk. This is not reason, however, to discredit the valuable economic tools which central banking provides. This is a common logical error made in every circle of thought: If theory x is wrong about y, then it is therefore wrong about z as well. Nonsense.
Re- The Burgeoning Malthusian Crisis:
Malthus, Laffer, Hubbert...ect. The problem with these theories is not that they are wrong, it is that you can't place us at any definitive point on the dynamic curve. We simply don't have enough information. Someday, the proponents of each of these theories will be right, but until then we either ignore the doomsayers or prepare for the worst.
It all depends of the consequences of a statistical error (I'm sure most folks here can relate to this). If we accept the null, that Malthus will never be validated, and we are wrong, the consequences could be pretty grim.
What are the consequences of accepting the Malthusian hypothesis if it is false? We make more efficient use of our resources.
In fact, the tacit acceptance of the Malthusian hypothesis has driven the very advances which have proven Malthus wrong. So perhaps folks should not try too hard to discredit Malthus, as his theories may be much responsible for the very innovations which disproved them.
Posted by: Andrew | Link to comment | Apr 29, 2008 at 08:27 PM
Andrew but Malthus is not correct. People do not breed more as they become richer. We discovered an anti-dote by accident. Universal schooling (increasing the cost of having of having children) and increasing the opportunity cost for women of child raising and social security which reduced the benefit (viz. necessity) of having children as insurance against old age.
Yes, resources are limited and it matters, but that is not all there was to Malthus.
Posted by: reason | Link to comment | Apr 30, 2008 at 12:12 AM
I forgot on the previous comment that part of the solution is also medical care reducing child fatalities (so people wanting a number of surviving children don't have to have so many).
Posted by: reason | Link to comment | Apr 30, 2008 at 12:13 AM
And acerimusdux all of the above can be done in poorer societies as well. It is a question of social organisation not wealth.
Posted by: reason | Link to comment | Apr 30, 2008 at 12:16 AM
RDF - Thanks. If it won't extend, it's not valid. Much of our 'progress' is based on unreplacables.
acerimusdux - Thanks for the quotes from JKG
Posted by: ken melvin | Link to comment | Apr 30, 2008 at 06:48 AM
Andrew,
Jamie Galbraith was shouting it before Dean Baker and more publicly, as in the Journal of Economic Perspectives.
Posted by: Barkley Rosser | Link to comment | Apr 30, 2008 at 11:43 AM
The entire economic meltdown revolves around two things: first, Americans living way beyond their means; and second, an industry that has purposely structured itself for, and is screaming for a federal takeover, health care.
If Paulson and Berneke were serious about getting the US out of near economic depression conditions they would have called for massive credit card, student loan, and in certain cases, home mortgage debt forgiveness.
In other words, they want to shore financial institutions but not the people who depend on them. It goes to show the this is normal behavior for abnormal living conditions and thinking.
This is as close to the ghettoization of America as it gets before it actually happens.
Danny L. McDaniel
Lafayette, Indiana
Posted by: Danny L. McDaniel | Link to comment | Nov 27, 2008 at 09:02 PM