Gilded Angst

The traumatic effects of the 1923 hyperinflation linger in the German monetary psyche. This has been manifested in the overly-restrictive policies of the European Central Bank and now, in this:

Long attracted to the safety of solid gold, Germans will soon be able to sate their appetite for the yellow metal as easily as buying a chocolate bar after plans were announced on Tuesday to install gold vending machines in airports and railway stations across the country.

The venture by the TG-Gold-Super-Markt company, based near Stuttgart, aims to build on soaring retail interest in gold purchases after a loss in confidence in a range of other investments as a result of the financial crisis.

That comes to my attention via Yves Smith, who says "you cannot make this stuff up."

Update: More on this from the Times.

Internecine Strife

Someone's been spilling some of the beans about the fights within the Obama economic team. The Times has the scoop, including:

[Council of Economic Advisors Chair Christina] Romer was joking, she said in an interview, adding, “There are only a few times that I felt like smacking Larry.” Yet few laughed in the president’s presence.

"Larry" being National Economic Council chair Lawrence Summers.

Could it be that the other other members of the economic team resent the "brilliant but supercilious" Summers because he got a better office? That's what the graphic accompanying the article seems to imply: Of course, intra-administration battles over economic policy are nothing new... indeed, it would be strange if there wasn't any. TNR has a slideshow of the "Economic Feuds" in administrations going back to FDR.

As Matthew Yglesias notes, the real question is who is leaking and why?

The all-time classic of the economic advisor leak genre remains William Greider's 1981 Atlantic Monthly piece wherein David Stockman reveals the existence of the "magic asterisk."

Time to End the Amenities Arms Race?

In the middle of a rather depressing story about Reed College's financial woes, I did find some encouragement in this:

When he talks about Reed’s short-term response to the recession, [Reed President Colin] Diver concedes that he is torn, wondering whether a broader reassessment would be in order.

Perhaps it would be a good thing, he said, if the recession could refocus college administrators on the quality of higher education, rather than on investments in climbing walls (Reed does not have one) and other “country club” aspects of college life that have fueled an academic arms race reliant on tuition increases and fund-raising.

“The catering to consumer tastes — I keep trying to say, we are in the education business,” Mr. Diver said, describing the pressure to keep up with wealthier colleges and expressing a frustration rarely voiced publicly by college presidents. “The whole principle behind higher education is, we know something that you don’t. Therefore, we shouldn’t cater to them.”

Amen to that!

While I would attribute the increase in the relative price of higher education primarily to Baumol's cost disease, the positional arms race in amenities is no doubt an important secondary factor. Hopefully the recession will finally force a change in priorities.

Of course, I say that secure in the knowledge that the finishing touches are being applied to the new FSB building...

Hydraulic Keynesianism, Indeed

A.W. Phillips, who famously noted the relationship between inflation and employment that became the "Phillips curve," was also mechanically inclined... check out the Phillips machine, which models the stocks and flows of the economy with water circulating through a contraption of tanks, valves, pumps and tubes.


For more, see also this Guardian article.

Shoot Out at the Aid Corral

I think the message is that foreign aid is cool uptown, but not downtown. Development aid booster Jeffrey Sachs (Columbia) and critic William Easterly (NYU) are at it again, and this time it's personal.... (Dambisa Moyo is in on it too; she used to work at Goldman Sachs, which is downtown... coincidence?).

Mark Thoma has rounded up their exchange at Economist's View, and Easterly summarizes at Aid Watch.

Nancy Birdsall sees common ground beneath all the sturm und drang:

I am with the majority of students of aid who agree with both of them, yes both of them, on one thing they actually agree on: that aid has made a difference in improving people’s lives and that there ought to be more of it. You wouldn’t know that what they disagree about is not whether aid “works” but how aid programs should be designed and implemented – a subject that doesn’t get headlines but matters.

The Keynes That Can Be Diagrammed

is not the true Keynes...

When I teach the IS-LM / AS-AD apparatus to my intermediate macro students, I preface it with the caveat that some believe that the "textbook" Keynesian model is not a correct representation of the General Theory. Roger E.A. Farmer is among them. He writes:

In the FT’s Economists’ Forum, Benn Steil wrote a stimulating piece in which he argued that Keynes was wrong. His argument is that interpretations of Keynesian economics are all based on the assumption that wages and prices are sticky. But wages and prices are not sticky. Ergo - Keynes was wrong. Mr. Steil and I are in complete agreement that the Keynesians, interpreted in this way are, to use a technical term, out to lunch. But that does not imply that Keynes was wrong. At least not entirely wrong. Far from it.

My emeritus colleague, Axel Leijonhufvud, made a distinction in his 1966 book, on Keynesian Economics and the Economics of Keynes, between Keynes and the Keynesians. He meant that orthodox Keynesian interpretations of the General Theory, that began with influential papers by John Hicks in England and Alvin Hansen in the US, got it all wrong.

Keynes said three things in the General Theory. First: the labour market is not cleared by demand and supply and, as a consequence, very high unemployment can persist forever. Second: the beliefs of market participants independently influence the unemployment rate. Third: It is the responsibility of government to maintain full employment.

He was right on all three counts. But he was wrong about something else. Keynes thought that consumption depends on income. Two decades of research on the consumption function, following world war two, led to a different conclusion. Consumption, and this is two thirds of the economy, depends not on income but on wealth. This is no small matter: the theory of the multiplier and the implication that fiscal policy can get us out of the current crisis rests on exactly this point.

Whether the "Keynesians" got Keynes right and whether Keynes was right are separable issues. On the former, I am a little more sympathetic to the textbook version - it seems to me a correct, but highly incomplete, representation of what Keynes said in the General Theory. On the latter point, Farmer goes on to argue that because (in his view) consumption is dependent on wealth, not income, fiscal policies intended to raise demand through an increase in disposable income will not be effective. Instead, policy needs to focus on asset prices:

Where does this leave us? Keynes was right about three key points. 1) High unemployment can persist forever because the market is not self-correcting. 2) Confidence matters. 3) Government can and should intervene to fix things. But the orthodox Keynesians are wrong: fiscal policy cannot provide a permanent fix to the problem of high unemployment. We need a new approach that directly attacks a lack of confidence in the asset markets by putting a floor and a ceiling on the value of the stock market through direct central bank intervention.

Offhand, it seems to me that using monetary policy to prop up the stock market is not so radically different from increasing "M" in the textbook model. The transmission mechanism is different: Farmer would have the central bank buy stocks, instead of bonds, as it does in conventional open market operations (or instead of dropping money from helicopters, or burying it in bottles...), but the end result would still be an increase in nominal demand.

I suspect I may be missing something - Farmer had limited space to make his argument and the "textbook" Keynesian framework is pretty engrained in my thinking, so it is hard for me to think of these issues outside of it. I'll look forward to the longer version in his forthcoming books.

Too Low for Zero

The Taylor rule describes how the Fed adjusts monetary policy (by changing the target for the Fed funds rate) in response to output and inflation. The San Francisco Fed's Glenn Rudebusch plugged the Fed's forecasts for inflation and the output gap into the Taylor rule, and found that the Fed funds rate should be headed deep into negative territory:The problem is that nominal interest rates cannot be negative; it is better to hold money and earn no interest than lend it and get less back in the future. Thus, monetary policy is up against the "zero lower bound" (which it reached in Dec. 2008, when the Fed lowered the Fed funds target to a range of 0-0.25%), forcing the Fed to improvise. Rudebusch explains:

Toward the end of 2008, the recession deepened with the prospect of a substantial monetary policy funds rate shortfall. In response, the Fed expanded its balance sheet policies in order to lower the cost and improve the availability of credit to households and businesses. One key element of this expansion involves buying long-term securities in the open market. The idea is that, even if the funds rate and other short-term interest rates fall to the zero lower bound, there may be considerable scope to lower long-term interest rates. The FOMC has approved the purchase of longer-term Treasury securities and the debt and mortgage-backed securities issued by government-sponsored enterprises. These initiatives have helped reduce the cost of long-term borrowing for households and businesses, especially by lowering mortgage rates for home purchases and refinancing.

In terms of overall size, the Fed's balance sheet has more than doubled to just over $2 trillion. However, this increase has likely only partially offset the funds rate shortfall, and the FOMC has committed to further balance sheet expansion by the end of this year. Looking ahead even further over the next few years, the size and persistence of the monetary policy shortfall suggest that the Fed's balance sheet will only slowly return to its pre-crisis level.

That is, the usual adjustments to the Fed funds rate affect the short end of the yield curve (the relationship between interest rates and maturity of debt), but now the Fed is creating money to buy longer-term securities. Because bond prices and yields move in opposite directions, this should reduce rates further along the curve.

Global Warming and Investment Demand

Paul Krugman believes the world economy is stabilizing, but it remains to be seen where the demand necessary to output growing again will come from. On a global scale, Krugman notes, it cannot be exports, but it could be investment associated with tougher rules on carbon emissions:

Speaking in UAE, the world's third-largest oil exporter, Krugman said Japan's solution of export-led growth would not work because the downturn has been global.

"In some sense we may be past the worst but there is a big difference between stabilizing and actually making up the lost ground," he said.

"We have averted utter catastrophe, but how do we get real recovery?

"We can't all export our way to recovery. There's no other planet to trade with. So the road Japan took is not available to us all," Krugman said.

Global recovery could come about through more investment by major corporations, the emergence of a major technological innovation to match the IT revolution of the 1990s or government moves on climate change.

"Legislation that will establish a cap-and-trade system for greenhouse gases' emissions is moving forward," he said, referring to the U.S. Congress.

"When the Europeans probably follow suit, and the Japanese, and negotiations begin with developing countries to work them into the system, that will provide enormous incentive for businesses to start investing and prepare for the new regime on emissions... But that's a hope, that's not a certainty."

That's an important point. Critics of meaningful measures to deal with global warming have focused on the costs of dealing with the problem. These costs are often overstated, and the people making this argument seem to underestimate the ability of market economies to adjust to the changes in relative prices that would be induced by cap-and-trade or carbon tax measures. Part of that adjustment will involve replacing some of the capital stock - from air conditioners to power plants - with more efficient equipment. A policy that credibly commits to raising the relative price of carbon in the future therefore could increase demand today. In the Keynesian model, this would shift the investment demand function, which would also shift aggregate demand, and help close the output gap.

Particularly the midst of a global slump, the need to create jobs provides an argument in favor of taking serious action on global warming now.

As for the actual legislation moving through congress, the Waxman-Markey bill, Krugman sees it as a step in the right direction, but The Economist is disappointed.

(Krugman's reference to Japan is to the export growth which helped get it out of its 1990s slump; as I noted recently, its reliance on foreign demand is getting it in trouble again now).

Keynes 1, Trotsky 0

One reason I frequently return to Brad DeLong's blog is that he occasionally digs up nuggets like Keynes' review of Trotsky's book on England. Both men were capable of writing with cutting wit; this is on display in the passages Keynes quotes from Trotsky and in his response to them.

In response to Trotsky's argument that the British left's desire to work through the parlimentary system stood in the way of revolutionary progress, Keynes wrote:

Granted his assumptions, much of Trotsky’s argument is, I think, unanswerable. Nothing can be sillier than to play at revolution – if that is what he means. But what are his assumptions? He assumes that the moral and intellectual problems of the transformation of Society have been already solved--that a plan exists, and that nothing remains except to put it into operation. He assumes further that Society is divided into two parts – the proletariat who are converted to the plan, and the rest who for purely selfish reasons oppose it. He does not understand that no plan could win until it had first convinced many people, and that, if there really were a plan, it would draw support from many different quarters. He is so much occupied with means that he forgets to tell us what it is all for. If we pressed him, I suppose he would mention Marx. And there we will leave him with an echo of his own words – “together with theological literature, perhaps the most useless, and in any case the most boring form of verbal creation.”

Fortunately, eighty years later, it appears that it was Keynes, not Trotsky, who was right about history (though some might say it is too soon to tell).

Japan's GDP: Yikes!

Just as the various emerging market financial crises of the 1990s demonstrated the dangers of dependence on capital inflows, the present global recession is revealing the risks of relying on exports. The latest news on Japan's GDP is staggering, as the Times reports:

Japan confirmed Wednesday what many had long suspected: that the world’s second-largest economy contracted at a record pace during the quarter that ended March 31, as exports collapsed and companies cut back production.

The Japanese gross domestic product shrank 15.2 percent on an annualized basis. It marked a fourth straight quarter of contraction and the biggest decline since Japan began keeping records in 1955.

It was also a deeper fall than during the last quarter of 2008, when the economy shrank a revised 14.4 percent on an annualized basis.

With shipments overseas down 26 percent from the previous quarter, export-dependent Japan has been harder hit than the United States and Europe as demand evaporated amid the global economic turmoil.

The Japanese contraction in the last quarter from the previous quarter — 4 percent — compares to 1.6 percent shrinkage in the United States and a 2.5 percent fall in the euro zone.

Update (5/22): Germany: -14.4%, Mexico: -21.5% (annual rates).