Don’t underestimate monetarism

A commenter sent me the following:

This slim volume describes a weighty and wonderful event. In 1920, the American economy entered what would presently be diagnosed as a depression. The successive administrations of Woodrow Wilson and Warren G. Harding met the downturn by seeming to ignore it—or by implementing policies that an average 21st century economist would judge disastrous. Confronted with plunging prices, incomes and employment, the government balanced the budget and, through the newly instituted Federal Reserve, raised interest rates. By the lights of Keynesian and monetarist doctrine alike, no more primitive or counterproductive policies could be imagined. Yet by late 1921, a powerful, job-filled recovery was under way. This is the story of America’s last governmentally unmedicated depression.

Sometimes it seems like everyone wants to pick on the monetarists, including to some extent even market monetarists.  Monetarism is ridiculed by Keynesians, Austrians, MMTers, Real Business Cycle supporters, fiscal theory of the price level proponents, etc., etc. It seems out of date, with not many young supporters.  It allegedly “failed” in the 1979-82 monetarist experiment, even though:

1.  That period successfully broke the back of inflation, as the monetarists predicted and others doubted, especially given the Reagan fiscal stimulus.  It led to a severe recession, as the monetarists predicted.  And it was followed by a strong recovery, as the monetarist predicted (but the Keynesians thought unlikely without a rise in inflation.)

2.  Furthermore, the policy of 1979-82 was not truly monetarist (money growth varied), and the monetarists would never have expected velocity to be stable during a period of rapid disinflation. Their argument was that V would stabilize in the long run, if money growth were stable in the long run.  That was never tried.

I find even that weaker claim to be dubious, which is one reason that I am not a traditional monetarist. And of course Friedman made some bad predictions in the 1980s (but since when do bad predictions discredit a model?) Nonetheless, let’s give monetarists their due; contrary to the implication of the quotation above, Friedman and Schwartz’s Monetary History does explain the depression of 1921:

M2 money supply:

May 1920 peak:  $30,304 million.

Sept. 1921 trough:  $27,830 million

December 1922:  $31,920 million

Monetarists would predict a steep recession and fast recovery.  And that’s what happened.

PS:  Rereading the quote, it doesn’t actually say the monetarists failed to predict a fast recovery, but I sort of think that was implied.  Did I misinterpret the quotation? How would the average person interpret the quote?

PPS.  I have not read Grant’s book, but I do believe the 1921 depression is a good example of the natural recuperative powers of a free market economy.  In that sense, it could be viewed as being inconsistent with old Keynesianism, as well as modern variants that say wage cuts will make the depression worse, and that massive fiscal stimulus is needed.  Of course Keynesianism is a slippery critter, which is hard to pin down.  They would probably point to the lack of a zero bound problem. They mention positive interest rates when convenient (1921) but ignore positive interest rates when inconvenient (eurozone 2008-12.)

They Must Be Stopped

Next to mankind and his livestock, is there any animal more dangerous to the global ecosystem than this one:

Screen Shot 2014-12-17 at 9.38.27 AMEager beavers are rampaging across the Canadian wilderness, chomping down trees and creating enormous methane emitting manmade, er, beavermade ponds. The ponds currently emit 800 million tons of methane per year, out of a total global emissions of 6.875 billion tons.

[Update:  Randy pointed out that it was 800 million kg, and the total figure is CO2 equivalent. Two mistakes. Apologies to the beaver population.]

Modest, but not insignificant. But what’s scary is that this total keeps rising:

Researchers at the University of Saskatchewan in Canada have found this methane release from beaver ponds is now 200 times higher than it was a century ago.

.  .  .

Whitfield said: “The dynamic nature of beaver-mediated methane emissions in recent years may portend the potential for future changes in this component of the global methane budget. Continued range expansion, coupled with changes in population and pond densities, may dramatically increase the amount of water impounded by the beaver.

“This, in combination with anticipated increases in surface water temperatures, and likely effects on rates of methanogenesis, suggests that the contribution of beaver activity to global methane emissions may continue to grow.”

And keep in mind that beavers don’t just menace humans, other forms of animal life are also affected by the changes to the environment.

What can be done to stop this threat to the planet? Environmentalists need to encourage people to wear beaver skin coats, a style that was popular in the 19th century, and which resulted in a dramatic reduction in beaver numbers during that period. Hollywood trendsetters need to take the lead—starting with Brad and Angelina. A worthwhile Canadian initiative would be to breed more wolves and set them loose in the beaver infested areas.

A small reserve for beavers should be set aside in northern Canada, but for God’s sake keep them away from civilization.

PS.  This post is not a joke, I’m deadly serious.

PPS.  I don’t have much to say about Russia, other than that they should let the ruble float.

PPPS.  People seem to want more opinions about Russia.  OK, they should ditch the statist model and adopt a neoliberal model.  They should pull out of the Ukraine and Georgia.  They should respect human rights within Russia.  They should stop voting for evil people like Putin.  They should kill beavers.  What other opinions do you want?

Krugman on the limits of monetary policy

Here’s Paul Krugman, in his pessimistic mood:

You might think that it’s a fundamental insight that doubling the money supply will eventually double the price level, but what the models actually say is that doubling the current money supply and all future money supplies will double prices. If the short-term interest rate is currently zero, changing the current money supply without changing future supplies — and hence raising expected inflation — matters not at all.

And as a result, monetary traction is far from obvious. Central banks can change the monetary base now, but can they commit not to undo the expansion in the future, when inflation rises? Not obviously — and certainly “credibly promising to be irresponsible”, to not undo expansion in the face of future inflation, is a much harder thing to achieve than simply acting when the economy is depressed.

Just to be clear, Krugman is not saying the central bank must promise a specific future money supply on a specific date, he’s saying the expected future money supply must be large enough to produce a specific expected future inflation rate (or price level.)

There are several possible solutions to the credibility problem.  One that both Michael Woodford and I have discussed is level targeting.  Suppose the central bank always falls short of its price level or NGDP target by 1%, due to a lack of credibility.  You might argue that this describes the current situation in Japan, for instance.  If the central bank has a level target, that shortfall only has significant macroeconomic effects in the very first year.  After that the level of the target variable continues to fall 1% below target, but the growth rate of the aggregate (which is what really matters) is always on target (after the first year.)

A second solution is to adjust the monetary base as needed to peg the price of CPI futures, or NGDP futures.  That will keep expected future growth in the nominal aggregate right on target.  If that seems “to good to be true,” it’s because it exposes the fact that worry about “liquidity traps” is actually worry about something else—the size of the central bank balance sheet.  But in the long run the central bank balance sheet will be smaller with a more expansionary policy, and perhaps (as the Swiss central bank showed a few years ago) even in the short run. If the central bank balance sheet is too big for comfort when you are hitting your target for expected future inflation, or expected future NGDP growth, then raise the Price level/NGDP target path or lower the rate of interest on reserves.

In my view this is where Krugman goes off course.  He assumes that if the central bank has done a lot, and has still fallen short, it would have had to do even more to succeed—bleeding into fiscal policy. In fact, just the opposite is true.  The central banks that succeed are those (like the Reserve Bank of Australia) that do the least. That’s because faster NGDP growth leads to a much lower desired ratio of base money to GDP, and hence smaller central bank balance sheets.

Krugman continues:

Just to be clear, I have supported QE in both Britain and the US, on the grounds that (a) central bank purchases of longer-term and riskier assets may help and can’t hurt, and (b) given political paralysis in the US and the dominance of bad macroeconomic thinking in the UK, it’s all we’ve got. But the view I used to hold before 1998 — that central banks can always cause inflation if they really want to — just doesn’t hold up, theoretically or empirically.

I seem to recall that Krugman was quite pessimistic about the ability of the BOJ to succeed in producing inflation, at least a few years ago.  But when they raised their inflation target to 2%, they did succeed in moving from deflation to mild inflation (albeit still short of the 2% goal.)  The good news is that we now know that the Japanese government can sharply depreciate the yen anytime it wishes to (something else that Krugman had originally doubted.)  That means the BOJ can inflate–it’s just a matter of how committed they are to make it happen.  In a sense this is also Krugman’s view (when he’s in the more optimistic mood), and he’d undoubtedly argue that the political push from Abe helped the BOJ.  In the past Krugman seemed to think fiscal stimulus was an easier sell politically.  That may be true in a few cases, but in Japan monetary stimulus has turned out to be the easiest part of the three-part reform project.  And monetary policy doesn’t have to worry about fiscal offset, in the way that fiscal policy must worry about monetary offset.

On the other hand, my recent Econlog post on the ECB shows an almost Krugmanian level of pessimism.  I just don’t see the institutional resolve at the ECB to raise inflation up to their 1.9% target. Europe badly needs to rethink everything they are doing, from the ground up.

HT: Ken Duda

The Gabe Newell funded Hypermind NGDP market is up and running

Before discussing the new Hypermind NGDP futures market, let me mention that the donations to iPredict are now coming in.  As I mentioned in earlier, there was a glitch in the process for a few weeks due to the fact that (for tax reasons) donations in the US must go through several layers of bureaucracy.  If you planned to donate and were frustrated a few weeks back, please try again.  All the information including the correct contact address are included in this post.  I plan to complete the donation process in mid-January, and start the program with whatever funding we have received by that time.

Gabe Newell (CEO of Valve) has generously donated $10,000 to Hypermind, and they plan to run 5 markets, 2 of which are now up and running.  The plan is to have 4 quarterly GDP prediction markets, 2014:4, 2015:1, 2015:2, 2015:3, and one annual market; 2014:4 to 2015:4.  The first quarterly market currently trades at 43, which means 4.3% expected (annualized) NGDP growth in Q4.  The annual market began just minutes ago, and is the one I’m most interested in for monetary policy evaluation purposes.  For that reason, the total prize money in the annual market is 4000 euros (about $5000), whereas each quarterly market offers prizes of $1000 euros (about $1250.)

Update:  Actually all five markets are now running.

This is not gambling, as you do not put up your own money.  Thus it is perfectly legal for Americans, but you do need to go through a brief registration process. You can’t get rich doing this, but I’m told the winnings are skewed, with some individuals winning much more than the average.

Here is the way Hypermind describes the payoffs:

Cash rewards are based on a fixed EURO amount and translated in US Dollar according to the current exchange rate.

A contest’s cash reward is split among the participants pro rata of their performance in the contest. For instance, if Jane achieves twice Joe’s performance, then Jane receives a share of the reward that is twice as large as Joe’s. Only the participants who made a profit in the contest can share in the reward. The sharing formula is detailed in Article 7 of the rules.

Your cash earnings are cumulative across contests. You can request a payment at any time in the form of Amazon Gift Certificates. The amount is of your choosing, with a minimum of 20 USD.

So you can win money, but you can’t lose.  And you would be helping to save the world economy by supporting a demonstration project for NGDP futures.  Note that this market is not intended for the general public, but rather for people who are well informed on the issue.  Readers of this blog are some of the most well-informed individuals on NGDP.

PS.  I’d like to thank Emile Servan-Schreiber at Hypermind for helping to create the market.

America’s industrial boom (what is it telling us?)

Over the past few years I’ve done a few posts on an underreported story, the fact that industrial production (IP) has been rising much faster than RGDP during the recovery.  Early on I argued that this was evidence that a cyclical recovery was actually occurring, and that this refuted those who argued otherwise by pointing to the low LFPR.  (It also suggests that tight money, not re-allocation out of housing, caused the recession.) Recently the industrial recovery has gained momentum, so much so that it can no longer be brushed aside.  Before discussing what it means, consider that IP was up 1.3% in November, and is up nearly 6% since August 2013.  By comparison IP only rose by a total of about 9% during the entire period from the 2000 peak to the 2007 peak. The level is still mediocre, but the momentum is undeniable.  The new IP figures seem to confirm the strong November employment data; the economy is now recovering at a faster rate.

Screen Shot 2014-12-15 at 10.34.05 AMSo what does the IP boom tell us?  First let’s recall that IP includes mostly manufacturing, but also mining and utilities.  I prefer the IP aggregate, because when people wring their hands about the loss of “muscular” jobs in manufacturing for men without a college education, it’s clear they are concerned about blue collar jobs in general, including coal mining, oil drilling, etc.  In any case, the manufacturing data are quite similar.

First some international comparisons.  In the US, IP is up more that 73% in the past 25 years. In Japan it fell by 1.5%.  Some of that is population, but not all. After all, Japan’s population is higher than it was 25 years ago, and America’s has risen by roughly 30%, not 73%.  America industrializes as Japan de-industrializes. Germany reunified 25 years ago, which might affect the data, but their IP is up only about 30% since 1991.  France is up only 9% in 25 years. (The 35-hour workweek?).   Britain is similar to Japan, down by about 1%.  (Falling North Sea oil output?) Italy is down 11.2% in 25 years.  (Berlusconi spending too much time at orgies?) It’s the US that stands out as an industrial power, at least if the data is correct. (I suspect it is not—too much hedonics?)

So what’s wrong with American manufacturing?  Jobs, jobs, and jobs.  In recent decades we’ve been losing jobs at a rapid rate.

And why have we been losing jobs at a rapid rate?  Some people point to imports from China.  But the recent IP data suggests that’s not the problem.  We are an industrial juggernaut.  The problem is quite simple:

It’s the PRODUCTIVITY, stupid.

Agriculture went through this in the late 19th century and early 20th century.  And now it’s manufacturing’s turn.

Update:  US capacity utilization pushed above 80% in November, roughly the rate during the 2005-07 boom.  We need more service sector jobs.

Update#2:  I erred in saying the manufacturing numbers were similar.  I was lulled by the fact that they have also been rising rapidly in the past year.  But commenter allen pointed out that manufacturing has only just regained the 2007 peak, and that oil and gas output (part of mining) have grown much faster.

HT:  am