Previous month:
September 2010
Next month:
November 2010

October 2010

Paul Krugman Smackdown Watch: David Beckworth Says QE Is Effective

David Beckworth says that quantitative easing worked remarkably well in the Great Depression:

Macro and Other Market Musings: QE Has Worked Before: My Reply to Paul Krugman: QE has been done before in the United States and it worked incredibly well.  It was initiated in early 1934 when FDR and his treasury officials decided to (1) devalue the value of the dollar relative to gold and (2) quit sterilizing gold inflows.... [T]hat is exactly what was needed, a big permanent shock to inflation expectations that served to stop the deflationary spiral, end the liquidity trap, and allow a recovery in aggregate demand... backed up with significant and permanent increases in the monetary base over time: it went from about $8 billion right before the policy change to about $24 billion by the end of the 1930s.... FDR's QE was a smashing success when it came to shoring up aggregate spending. So those of us folks who want the Fed to increase and stabilize nominal GDP have a good reason to believe it is possible--it happened before.... QE worked  because it (i) it reshaped inflation expectations and (ii) was backed up with meaningful increases in the monetary base.  

The Fed is more than able to do the same today.  It certainly can reshape inflation expectations. Just look at what has happened to them over the last month or so when Fed officials started talking up QE2. The Fed would be far more effective, though, at shaping inflation expectations by explicitly committing to some nominal target.... The Fed, then, needs to (1) announce an explicit nominal [CPI or mnominal GDP] target and (2) say it will do whatever is necessary to hit it...

There Should Be Resignations in Protest and on Principle from the Washington Post Today...

...but there should be such resignations every day.

Which is worse?

Rosaline Helderman's claim on A-1 that just because having Republican Robert F. McDonnell as governor has not put Virginia into a ditch, President Obama and Democrats are wrong that having Republicans in charge nationally would do that.

Or David Broder's call for Barack Obama to bomb Iran to get the economy moving?

It would be good for the country if this monstrosity shut itself down today.

Why oh why can't we have a better press corps?

Broder is the worst. He is monstrous:

[I]f Obama cannot spur that [economic] growth by 2012, he is unlikely to be reelected.... Can Obama harness the forces that might spur new growth?.... What are those forces?... One is the power of the business cycle.... What else might affect the economy? The answer is obvious, but its implications are frightening. War and peace influence the economy.

Look back at FDR and the Great Depression. What finally resolved that economic crisis? World War II.

Here is where Obama is likely to prevail.... [H]e can spend much of 2011 and 2012 orchestrating a showdown with the mullahs. This will help him politically because the opposition party will be urging him on. And as tensions rise and we accelerate preparations for war, the economy will improve.

I am not suggesting, of course, that the president incite a war to get reelected. But the nation will rally around Obama because Iran is the greatest threat to the world in the young century. If he can confront this threat and contain Iran's nuclear ambitions, he will have made the world safer and may be regarded as one of the most successful presidents in history.

Liveblogging World War II: October 30, 2010

Marshall Petain: "I have chosen the path of collaboration":

1940 Vichy: Pétain spoke on nation-wide rafio broadcast (October 30). Pétain informed the French people that he had met with Reich Chancellor Hitler and had aceppted the principles of the "mew European order".

He insisted that France remained "sovereign" and that imposed the obligation to defend French soil.

To erase divergencies of opinion, to subdue dissesions in her colonies--that is my policy. The Ministers are responsible to me, and to me alobe, and history shll judge.

He continued,

Frenchmen, aew days ago I had a meeting with the Chancellor of the Reich. This meeting raised hopes and caused anxiety. I owe you an explanation on this subject. Such an interview was only possible four months after our military defeat, thanks to the dignity of the French people in the face of their ordeal and thanks to the enormous effort toward regeration which they have made. It was only possible also, thanks to the heroism of our sailors, the energy of our colonial leaders, and the loyalty of the native populations. France has rallied. This first meeting between victor and vanquished signifies the first vindication of our country.

It was my own free will that I accepted the Führer's invittion. I have been under no 'diktat,' no pressure from him. Collaboration between our two countries was considered. I accepted the principle of it. The application will be discussed later....

He who has taken charge of the destiny of France has the duty of creating the nost favourablke atmosphere to safeguard the interests of the country. It is with honour and to maintain French unity, a unity of 10 centuries, within the framework of a constructive activity of the new European order, that I enter to-day the path of collaboration. In the near future the load of suffering of our country may thus be lightened, the lot of our prisoners improved, the burden of occupation expenses be lessened, and thus the line of demarcation may be rendered more flexible, and the administration and provisioning of the territoiry facilitated. This collaboration must be sincere. All thought of aggression must be excluded from it. It must conform to a patient and deliberate effort. An armistice, after all, is not peace. France has numerous obligations toward the victor. Until now I have spoken to you as a father. Today I speak to you as the leader. Follow me. Leep your trust in eternal France...

Duncan Black: Barack Obama Goes Off Message Once Again

Duncan Black:

So What Are We Going To Do About These Problems Then?: [Obama's] answers to [my] housing question were quite disappointing. I don't like the "deserving versus undeserving" rhetoric, especially in the context of the bankster bailout.... Obama:

The biggest challenge is how do you make sure that you are helping those who really deserve help and if they get some temporary help can get back on their feet, make their payments and move forward and stay in their home, versus either people who are speculators, own second homes that they really couldn’t afford because they’d gotten a subprime loan, and people who through no fault of their own just can’t afford their house anymore because of the change in housing values or their incomes don’t support it. And we’re always trying to find that sweet spot to use as much of the money that we have available to us to help those who can be helped, without wasting that money on folks who don’t deserve help. And that’s a tough balance to strike.

The problem is that "foreclose" is the new "issue as many crappy loans as you can for securitization." Foreclosures are how the servicers are making money, and itdoesn't even matter if investors in those mortgages are getting the shaft, at least until there are more lawsuits.... [S]ervicers prefer foreclosures to short sales or sensible principal modifications....

[I]nitially a lot of the problems on the foreclosure front had to do with balloon payments people didn’t see coming, adjustable rate mortgages that people didn’t clearly understand, predatory lending scams that were taking place -- now the biggest driver of foreclosure is unemployment. And so the single most important thing I can do for the housing market is actually improve economic growth.... Yes, turning around the economy faster allow more people to stay in their homes. But we haven't turned around the economy, and it's unclear if Congress will pass any additional legislation, including unemployment extensions. In theory there's a lot that the executive branch can do without Congressional approval. There is still a lot of HAMP money sitting there. We own Fannie and Freddie. I just can't believe there's no way, with improved carrots and sticks, to encourage more widespread principal modifications which would both help more people keep their homes and, you know, help the economy because they'd have additional money to spend on things other than their underwater mortgages.

All of that is even without the fraudclosure mess.

Principal modification, one way or another, was always going to be the only way through this. It still is.

Petrer Dorman: The National Income Identity Is Not Mocked...

Peter Dorman:

EconoSpeak: This Is What Accounting Identities Look Like: I have been periodically raging against the ignorance of those who would slash fiscal deficits without regard to fundamental accounting identities... “serious” people somehow think that public and private debt levels can be lowered simultaneously, without... a current account surplus.... It does not occur to them that one person’s debt is another’s asset.... [I]f the private sector is collectively paying down its debts, and the government tries to pare its deficits at the same time, either there is an increase in net exports to finance all of this, or it just doesn’t happen.

That’s how it is with identities. Unlike other kinds of rules, they are not made to be broken.

Which brings us to this morning’s news about public finances in Europe: despite the earnest efforts of the austerians, fiscal deficits are not declining. Rather, tax receipts are going down, so that the ex post identities remain in force. As long as the private sector continues to deleverage, further efforts to produce “responsible” fiscal deficits will just lead to... a downward spiral of pointless misery.

Kevin O'Rourke Says: Here Comes the European Double-Dip...

Kevin O'Rourke:

What do markets want?: [T]he question of what markets want is beginning to exercise people (see for example here, or here).... [M]arkets understand that governments face political constraints, and take this into account when assessing the credibility of their economic policies. (And, moreover, market participants tend not to believe in tooth fairies or negative fiscal multipliers.)

We’ve known all along that fiscal adjustment here would be contractionary, and that our economy thus needed substantial export growth if it was to avoid falling into the hands of the IMF. That in turn requires a buoyant European economy; hence my alarm regarding austerity measures in countries like the UK and Germany.... Ireland has no choice right now concerning what policies to pursue, but other countries do, and if those with fiscal space (as measured by the interest rates at which they can borrow) choose to embark on contractionary policies now, for what appear to be nothing more than ideological reasons, then that is profoundly irresponsible from the point of view of the fragile system that is the European economy.


What do markets want?: With governments around Europe moving towards fiscal austerity, at a time when over-indebted households are still reluctant to spend, the danger is that Europe will move back into recession.   Why are European governments embarking on such a risky strategy? In peripheral economies such as Greece, Ireland or Spain, the governments have no choice: the markets have made it clear that otherwise they will no longer be willing to continue lending to them. Governments have thus had to cut spending and raise taxes at the worst possible time.... [I]t must have been utterly exasperating for the Spanish government when, late last week, Fitch downgraded Spanish debt on the basis that Spain's adjustment process will lower its medium run growth prospects. It seems a case of damned if you do, damned if you don't.   What, might Spanish politicians well ask, do markets want?   As it happens, the EMS crisis of 1992-1993 taught us a lot about what markets want.... The initial response of politicians was a macho one: get the fundamentals right and the problem would go away. The fundamentals concerned were low inflation, low deficits, and low levels of government debt. But speculation did not stop. The lesson of the EMS crisis is that low inflation, low deficits and low government debt are not, it turns out, enough on their own... if government policies are to be credible.... [F]ar from enhancing credibility, the 'responsible' and deflationary policies which governments thought markets wanted fatally undermined it.... This should not have been a surprise to the governments concerned, since it is a constant theme in 20th century economic history....   Markets want debts to be kept under control, but in the long run they also want tolerable levels of unemployment, since this is what democracy demands of governments. In our current circumstances, this means economic growth. Too much austerity at the wrong time will not make governments more credible, but less so.   Where will this growth come from?... Europe hopes that it will export its way to recovery.... [T]his could lead to US and Asian retaliation.... Those economies with fiscal room to manoeuvre need to use it now, for the good of the European economy. Furthermore, we should be asking whether the European Union as a whole should embark on a growth and investment strategy. Major European investments in new transportation and energy infrastructures are needed in the long run anyway....

If the EU turns itself into a mechanism for imposing asymmetric and deflationary adjustment on the continent, it will be seen, rightly, as one of the causes. And the markets won't like that.

A Response to Justin Fox...

Earlier this month, I wrote "It Does Not Seem to Me That Charles Ferguson Has Gotten It Right..." in response to Charles Ferguson's attempted take-down of Larry Summers because--well, because it did not seem to me that Charles Ferguson had gotten it right.

Now Justin Fox joins the conversation, and I believe that I am the "strangely touchy economist" whom Justin refers to in this:

Economists respond to incentives: Here’s my short take, following on Barbara’s post Wednesday, on economists:

  1. The single most valuable and durable lesson of economics is that incentives matter. Monetary incentives don’t always matter more than other motivations, and sometimes people’s behavior regarding money is a little nutty. But as an organizing principle for a social science, incentives matter is pretty good.

  2. Economists respond to incentives, too. Real and potential financial awards affect what they choose to study, how they go about it, and what conclusions they draw. This doesn’t mean all economists are evil sellouts. It means they’re human beings.

  3. For people who purport to believe that incentives matter, economists can be strangely touchy when anyone brings up point No. 2.

So since I am the strangely touchy economist here, let me reiterate my points.

When Charles Ferguson writes:

Summers rose up from the audience and attacked [Raghu Rajan], calling him a "Luddite," dismissing his concerns, and warning that increased regulation would reduce the productivity of the financial sector...

he has gotten the mood and some of the substance of the discussion wrong.

I know.

I was there--not only for the formal session recorded in the transcript, but for the patio-coffee and the lunchtime and dinnertime conversations that followed.

Larry did not "dismiss" Raghu concerns. He said that in a modern economy with sophisticated financial markets we were likely to have more and bigger financial crises than we had before, just as the worst modern transportation accidents are worse than the worst transportation accidents back in horse-and-buggy days. He said that Raghu's "paper is right to warn us of the possibility of positive feedback and the dangers that it can bring about in financial markets." Indeed, for twenty years one of Larry's conversation openers has been: "You really should write something else good on positive-feedback trading and its dangers for financial markets."

What he complained about was that he thought Raghu was setting forth the wrong cures for the disease. Raghu suggested the job could be done by (a) reform of compensation schemes to give financiers not just skin in the game but vital organs in the game, and (b) by viewing financial innovation with grave suspicion. Larry pointed out that (a) hobbling financial innovation does have serious costs as well, (b) plain-vanilla banking systems do not seem to be any less vulnerable to getting wedged through financial crisis, (c) the LTCM crisis is just the latest episode telling us that reforming financial compensation won't do the job because more often the problems are overleveraged institution or herd groupthink, and (d) transparency and exchanges so that people know what each other's positions are is a better road to pursue.

If you think that the published comment or Larry's other remarks represent a "dismissal" of Raghu's concerns, you do not understand what the word "dismiss" means.

And if you think that Larry pulled his punches in August 2005 on the importance of reforming compensation schemes because fourteen months later he was going to take a job at the hedge fund of D.E. Shaw, you attribute an extraordinarily degree of precognition--back in August 2005 I thought Larry had weathered the storms at Harvard and would be president until 2010 or so.

Liveblogging World War II: October 30, 1940

Nation's Draft Lottery Held, 1940/10/30 : Free Download & Streaming : Internet Archive: Washington, DC: Historic scenes as the first peace-time draft in the U.S. gets underway! Secretary of War Stimson draws out the first number, No. 158, and as Pres. Roosevelt broadcasts a message to the country, America's youth prepares to answer the call to arms!" (2) "Philadelphia, PA: Exclusive pictures of the metal drum used as a draft lottery bowl during the Civil War. It was unearthed along with old recruiting posters." (mostly silent except speech sound) (partial newsreel)

Tim Geithner Needs to Gain Control Over His Building

This is not what should be happening. Not at all.

Zach Carter:

Are Treasury’s Knives Coming Out Against Elizabeth Warren?: On Oct. 12, Politico ran a piece featuring this anonymous nugget (among others):

Some at Treasury grumble that Warren, in her early memos, spent much time detailing what press she was going to do . . . rather than the nuts and bolts of setting up an agency.

Then yesterday, in Politico’s Morning Money column:

NEW PAINT JOB – We also hear that while Warren is out west, her Treasury office is getting a makeover (Warren will have digs both at Treasury and the CFPB’s L Street headquarters). That’s something of a rarity for Treasury officials, who usually leave their offices as-is. There is much internal debate as to exactly what color it is that is going up on Warren’s walls. One person called it “Arizona sunset,” another “terra cotta.”

Both of these represent the kind of meaningless, issue-free pseudo-news that serves as Politico’s bread-and-butter.... [L]ook at the frame Treasury is putting on the stories. In both, Warren is portrayed as an ego-centric fluff-monger, not a serious policymaker. Look at fancy Elizabeth Warren painting her office! Our humble boss Timothy Geithner would never do such a thing! Just days before an election, it’s somewhat astonishing that Treasury officials would be working the media to smear Warren instead of, say, talking about the economy. And it’s certainly counterproductive for Treasury to be creating these distractions for the new, can’t-be-independent-soon-enough agency...

Liveblogging World War II: October 29, 1940

William Shirer:

Twenty-four hours after Italy’s wanton aggression against Greece, the German people are still deprived of news by their rulers. Not a line in the morning papers or the noon papers. But Goebbels is carefully preparing his public for the news. This morning he had the press publish the text of the outrageous Italian ultimatum to the Greek government. It was almost an exact copy of the ultimatum which the Germans sent to Denmark and Norway, and later to Holland and Belgium. But the German public may have wondered what happened after the ultimatum, since it expired yesterday morning. 
 LATER.-The news was finally served the German people in the p.m. editions in the form of the text of today’s Italian war communique. That was all. But there were nauseating editorials in the local press condemning Greece for not having understood the “new order” and for having plotted with the British against Italy. The moral cesspool in which German editors now splash was fairly well illustrated by their offerings today. After several years of it I still find it exasperating.

Also today, the usual Goebbels fakes. For example, one saying that the Greeks disdained even to answer the ultimatum, though the truth is that they did. They rejected it.

>There is certainly no enthusiasm among the people her for the latest gangster step of the Axis.

German military people, always contemptuous of the Italians, tell me Greece will be no walk-way for Mussolini’s legions. The mountainous terrain is difficult for motorized units to operate in and moreover, they say, the Greesk have the best mountain artillery in Europe. General Metaxas, the Premier, and quite a few Greek officers have been trained at Potsdam, the Germans tell me.

This Is Not a Strong GDP Report

Economist_s View_ Real GDP Grows at 2 Percent in the Third Quarter.png

Mark Thoma:

Economist's View: Real GDP Grows at 2 Percent in the Third Quarter: Positive growth is better than negative growth, but this is a loss relative to trend growth, and the fact the inventories are driving growth is of concern. Dean Baker puts it into perspective:

It may not be immediately obvious quite how weakly the economy is growing.... When an economy gets out of a steep recession, it should be soaring.... In the first four quarters following the end of the 1974-75 recession, growth averaged 6.1%. In the four quarters following the end of the 1981-92 recession, growth averaged 7.8%. The growth rate averaged just 3.0% in the four quarters following the end of this recession. But the actual picture is even worse. Most of this growth was driven by the inventory cycle.... If inventory fluctuations are pulled out, growth in demand averaged just 1.1% over the four quarters following the end of the recession. Final demand growth was down to just 0.6% in the most recent quarter.... Inventories grew at the second fastest rate ever in the last quarter. Growth is certain to slow in future quarters, meaning that inventories will be a drag on an already slowing economy. Instead of accelerating, we are likely to see growth just scraping along near zero.

I've been expecting a long, slow, agonizing recovery, in part because there's little chance that fiscal policy authorities will give the economy the boost it needs to recover faster... full recovery by 2013 is looking optimistic now. I wouldn't be surprised if it takes even longer than that.

The San Francisco Fed is also expecting a slow recovery... even that might be optimistic given that they are forecasting an average growth rate for 2010 of 2.5% and today's estimate came in below that.

This is not a strong report. As Calculated Risk notes above, this won't derail quantitative easing. However, I don't expect another round of quantitative easing to have a large impact on the growth rate of GDP. Thus, while this won't derail QEII the problem is that it won't move fiscal policymakers to action, and fiscal policy is, in my opinion, the best way to help the economy recover faster.

Liveblogging World War II: October 29, 2010


ARMY: The Problem - TIME: From Memphis' Beale Street to Harlem's Lenox Avenue, the U. S. Negro press last week suddenly took fire. It blazed up over the Army's No. 1 social problem: what to do with Negro officers and Negro enlisted men. A War Department statement, issued fortnight ago after Franklin D. Roosevelt had talked over The Problem at the White House with Negro leaders, fanned the flames. The policy: that Negroes will get the same kind of military training as whites, but they will get it in separate Negro outfits.

Even Harlem's pro-Roosevelt Amsterdam News joined in the outraged hubbub. Jim Crow Army Hit, ran its page 1 banner over a story denouncing the Army's policy.

Charge White House Trickery, yammered the Republican Pittsburgh Courier. Roosevelt Charged With Trickery in Announcing Jim Crow Army Policy, shrilled the Kansas City Call. Along with the War Department's statement many a paper printed the demands made on President Roosevelt fortnight ago by his White House visitors: Secretary Walter White of the National Association for the Advancement of Colored People; President A. Philip Randolph of the Sleeping Car Porters' union; T. Arnold Hill, an assistant in the N. Y. A. Division for Negro Affairs. For the Army's solution of The Problem had brusquely rejected the pivotal demand in the Negroes' seven-part memo to the President, that "existing units of the Army and units to be established should be required to accept and select officers and enlisted personnel without regard to race."

If U. S. Negroes really expected to see the U. S. Army agree to put black and white in the same outfits on an equality basis, they reckoned on a thumping overturn of precedent. Only four Negroes have ever graduated from West Point (none from Annapolis) and today the Army has only two regular Negro line officers: Colonel Benjamin Oliver Davis, commanding officer of Harlem's 369th Coast Artillery (National Guard), and his West Pointer son, Lieut. B. O. Davis Jr., military instructor at Tuskegee Institute. Before 1940's emergency the Army had only four Negro regiments of regulars (two cavalry, two infantry); all are officered by white men. Since July 1, 17 other Negro outfits have been formed (including a regiment of engineers, one of field artillery, twelve truck companies), and some may be officered by men from the 353 Negro reserve officers now on Army lists.

In World War I, only 10% of the 404,000 Negroes drafted and enlisted for the Army saw service in overseas combat outfits. Except for a few separate regiments (like the 369th 376th 371st and 372nd). their record was undistinguished. Some Army men today think Negroes are as good fighting men as whites, but also think they will never be able to prove it until they go into action led by Negro officers, show once & for all that they do not need white leadership.

But to Negro leaders proof of that point was less important last week than establishing the equality of the races in the U. S.'s new Army. So concerned were they with the Jim Crow issue that they subordinated another point, somewhat less than frank, in the War Department's statement.

Elizabeth Warren Is Giving a Lecture at Berkeley Thursday Night

I highly recommend going. I will be there--unless my calendar attacks me...


Brad DeLong

---------- Forwarded message ----------

From: Valerie Liang
Date: Wed, Oct 27, 2010 at 6:53 PM
Subject: Re: Elizabeth Warren Lecture
To: [email protected]

Mario Savio Memorial Lecture: with Elizabeth Warren

Lecture | October 28 | 8-9:30 p.m. | Martin Luther King Jr. Student Union, Pauley Ballroom

Speaker/Performer: Elizabeth Warren, Harvard Law School

Sponsors: Library, Goldman School of Public Policy, Graduate Assembly, Mario Savio Memorial Lecture

The 14th annual Mario Savio Memorial Lecture & Young Activist Award will feature consumer advocate Elizabeth Warren in a talk entitled "Main Street First: Fixing Broken Markets and Rebuilding the Middle Class."

The inspiration and driving force behind the new Consumer Financial Protection Bureau, Elizabeth Warren has been described as one of the "100 Most Influential People in the World" (Time), "a whipsmart consumer warrior," (S.F. Chronicle), and "a person who will stir up a lot of trouble" (Forbes). She has appeared frequently on The Daily Show with Jon Stewart, Dr. Phil, and the Rachel Maddow Show. An expert on credit and economic stress, Warren is known for her ability to simplify complex financial issues and for her fierce independence and advocacy on behalf of middle-class families. She is the Gottlieb Professor of Law at Harvard University and is the author of nine books, including, with her daughter, the best sellers All Your Worth: the Ultimate Lifetime Money Plan and The Two-Income Trap: Why Middle Class Parents Are Going Broke.

The Memorial lecture honors the memory of the late Mario Savio, a spokesperson for Berkeley's Free Speech Movement (1964), and the spirit of moral courage and vision which he and countless other activists of his generation exemplified. The evening includes a presentation of the Mario Savio Young Activist Award, which recognizes young people engaged in the struggle to build a more humane and just society. It is co-sponsored by the UC Berkeley Library, the Goldman School of Public Policy, the Free Speech Movement Cafe and the Graduate Assembly.

Tickets, which are free and are required for this event, can be obtained in the lobby of the Martin Luther King Student Union after 5 p.m. on October 28. For additional information, email [email protected] or call 707-823-7293.

Liveblogging World War II: October 28, 1940

Mussolini's fascist Italy attacks Greece:

Benito Mussolini:

The Italian Government has repeatedly noted how, in the course of the present conflict, the Greek Government assumed & maintained an attitude which was contrary not only with that of formal, peaceful, good neighborly relations between two nations, but also with the precise duties which were incumbent on the Greek Government in view of its status as a neutral country. On various occasions the Italian Government has found it necessary to urge the Greek Government to observe these duties and to protest against their systematic violation, particularly serious since the Greek Government permitted its territorial water, its coasts and its ports to be used by the British fleet in the course of its war operations, aided in supplying the British air forces and permitted organization of a military information service in the Greek archipelago to Italy's damage.

The Greek Government was perfectly aware of these facts which several times formed the basis of diplomatic representations on the part of Italy to which the Greek Government, which should have taken consideration of the grave consequences of its attitude, failed to respond with any measure for the protection of its own neutrality, but, instead, intensified its activities favoring the British armed forces and its cooperaticn with Italy's enemies.

The Italian Government has proof that this co-operation was foreseen by the Greek Government and was regulated by understandings of a mllitary, naval and aeronautical character.

The Italian Government does not refer only to the British guarantee accepted by Greece as a part of the program of action against Italy's security but also to explicit, precise nengagements undertaken by the Greek Government to put at the disposal of powers at war with Italy important strategic positions on Greek territory, including air bases in Thessaly and Macedonia, designed for attack on Albanian territory.

In this connection the Italian Government must remind the Greek Government of the provocative activities carried out against the Albanian nation, together with the terroristic policy it has adopted toward the people of Ciamuria and the persistent efforts to create disorders beyond its frontiers.

For these reasons, also, the Italian Government has accepted the necessity, even though futilely, of calling the attention of the Greek Government to the inevitable consequences of its policy toward Italy. This no longer can be tolerated by Italy. Greek neutrality has been tending continuously toward a mere shadow. Responsibility for this situation lies primarily on the shoulders of Great Britain and its aim to involve ever more countries in war.

But now it is obvious that the policy of the Greek Government has been and is directed toward transforming Greek territory, or, at least permitting Greek territory to be transformed, into a base for war operations against Italy. This could only lead to armed conflict between Italy and Greece, which the Italian Government has every intention of avoiding.

The Italian Government, therefore, has reached the decision to ask the Greek Government, as a guaranty of Greek neutrality and as a guaranty of Italian security, for permission to occupy with its own armed forces several strategic points in Greek territory for the duration of the present conflict with Great Britain.

The Italian Government asks the Greek Government not to oppose this occupation and not to obstruct the free passage of the troops carrying it out.

These troops do not come as enemies of the Greek people and the Italian Government does rot in any way intend that the temporary occupation of several strategic points, dictated by special necessities of a purely defensive character, should compromise Greek sovereignty and independence.

The Italian Government asks that the Greek Government give immediate orders to military authoritles that this occupation may take place in a peaceful manner. Wherever the Italian troops may meet resistance this resistance will be broken by armed force, and the Greek Government would have the responsibility for the resulting consequences

links for 2010-10-28

Institute for New Economic Thinking

INET Launch:

Department of Economics Calendar: : JOIN the CONVERSATION with the INSTITUTE FOR NEW ECONOMIC THINKING (INET): Changing the Paradigm:The Challenge to the Economics Profession in the Aftermath of the Crisis and the Role of the Institute for New Economic Thinking Panel Discussion | October 28 | 4-6 p.m. | 608-7 Evans Hall

Speakers: Dr. Robert Johnson, Executive Director of the Institute for New Economic Thinking, (INET); Barry Eichengreen, Christina D. Romer, Bradford DeLong.

Sponsors: Economics, Department of, INSTITUTE FOR NEW ECONOMIC THINKING (INET)

The Institute for New Economic Thinking (INET) will join a conversation with students and faculty at the University of California, Berkeley on the importance of new economic thinking in the face of global economic crisis. The session will look specifically at economics in academia, the challenges faced by the economics profession in the aftermath of the crisis, and what must be done to change the prevailing paradigms in economics.

Conversation leaders, Dr. Robert Johnson, Executive Director of INET, and Professor Barry Eichengreen, Professor of Economics and Political Science at U.C. Berkeley, will also introduce the expansion of the Berkeley Economic History Laboratory, which recently received a Task Force Grant from INET’s Inaugural Grant Program.

For more information on the Campus Outreach Program please checkout INET’s website and videos:

Why Oh Why Can't We Have a Better Press Corps? Ed Wyatt of the New York Times FAIL Edition

Mike Konczal on the New York Times's attempted hit on Elizabeth Warren and company:

A Failed Dirt-Finding Expedition on the CFPB « Rortybomb: Today’s New York Times came out with a bizarre hit piece on the Consumer Financial Protection Bureau and the first wave of hires.   They attempted to argue that there are already huge conflicts between those staffing the creation of the Bureau and those that they will be tasked to regulate.... But what’s so surprising about the article is how little they were able to find... the only thing they were able to flag was that Warren advisor Raj Date was, up until recently, a director of Prosper Marketplace Inc.... Having written a paper with Date on Glass-Steagall and the future of financial reform, as well as working with Date when he contributed to Roosevelt’s Make Markets Be Markets financial reform conference on the subject of the GSEs, I was kind of curious to see if he was actually some sort of deranged financial hit man. But if this is all the ‘dirt’, I’m almost worried for the opposite reason: that the agency will be too academic and not take advantage of people involved in the shadier side of the financial world who want to repent.

The Times article relies entirely on the implied assumption that peer-to-peer lending is some sort of shady, fly-by-night operation. In reality, it is simply an over-hyped phenomena of trying to integrate the internet with new financial institutions.... Prosper has been a useful experiment. It’s challenged thinking about information, prices, the “wisdom of crowds” versus institutional information, fringe lending, and started to find creative ways to replace the practice of low-quality high-churn payday-style lending, regardless of whether or not it is going to take off. Either way, wasn’t the problem that the CFPB was going to kill small-scale financial entrepreneurialism? So isn’t it good to include someone in the agency who has experience with it?

Even more striking is that the article fails to mention that Date and his former policy shop, Cambridge Winter, which they summarize as being “active in the Dodd-Frank debate”, were really at the cutting edge of the consumer financial protection debate. I actually wasn’t sure if the auto dealer exemption for consumer protection was something worth fighting until I read Date’s Baseline Scenario post on the topic, Auto Race to the Bottom.

Particularly pertinent was the excellent phrase:

Even by the low analytical standards applied to hastily arranged, crisis-driven corporate welfare initiatives, the exemption of auto dealers from the CFPA appears profoundly ill conceived. Exempting auto dealers would simultaneously be bad for consumers, bad for industry stability, and bad for what remaining sense of free-market integrity we still have.


He was also active in the Volcker Rule debate, bringing sanity to the discussion of the strengths and weaknesses of resolution authority (also here), and a whole ton of other research that created markers for serious financial reform.

The case against him is so weak that even Mark Calabria, director of financial regulation studies at the Cato Institute, who loves hitting a regulatory conflict and capture slowball over the plate, seems kind of bored with it...

Do I Dare Read This?

First Tom Levenson, now Henry Farrell--their tenuous hold on sanity broken, their minds cracked:

A not-so-brief history of violence: Public health warning: much much more McArdle-blogging beneath the fold. But take heart – this may possibly be my last and most definitive statement on the topic. I certainly can’t imagine that I will want to write at length about this any more...

Unfortunately, I do not have the strength of character to refrain:

The fact that she explicitly has mixed motivations for writing the apology... needn’t concern us.... But from here on in, it starts to go downhill.

I have yet to see anyone deploy it against me who could even vaguely be accused of acting in good faith. On the other hand, there are readers in good faith who are surprised by it, and I think I owe them an explanation.

If she really did say something that she has since acknowledged was ‘creepy,’ it is an unusual run of luck indeed that everyone who has criticized her for this post has done so in bad faith....

And now we start to get to the important bits.

I shouldn’t have written it because even if whacking a rioter in the head is necessary to stop the riot, it’s not funny. It’s not funny even when the rioter is a total scumwrangler who is deliberately wreaking mayhem—any more than it is ever funny when a thoroughly repulsive criminal gets raped in prison. To the extent that either the state or private citizens are forced to use violence to prevent violence, it should always be more-in-sorrow-than-in-anger. This is not amusing.

The problem hence, is not that violence against mayhem-wreaking scumwranglers is unwarranted – it is that one shouldn’t laugh at it, but instead treat of it in grave and serious tones.... McArdle apologizes for having written it, explains that she had been in her “mid-twenties” (in fact she had just turned thirty), was exploring the new medium of blogging, and was “more than a tad overemotional at the thought of my city getting another dose of random ideological violence.” She then goes on to tell us that

But the way it’s used in the blogosphere is, for want of a better word, pathetic. Those who link it never, ever mention that it referred to violent protesters, even when they have to do some exceptionally creative editing to avoid that fairly central fact.... What does it say that the people who link it are invariably either outright lying, or deliberately misleading inflicting creative omissions on their readers?...

[S]he apologizes, apparently sincerely, for thinking that violence against mayhem-wreaking scumwranglers was funny, even though they’re scumwranglers (it’s worth drawing attention to the gradual transformation over the years of laughable “little dweebs” that you can’t even be mad at, into mayhem-wreaking “rioters” and “scumwranglers” who are self-evidently a threat to life, property and civilization; they must have been eating all their greens). She does not apologize for her belief back then that “rioters” need to be “restrained” with “violent force, if necessary,” perhaps by “whacking a rioter in the head … to stop the riot.” And she feels hard done by – none of the bloggers who link to the post ever mention that she is only referring to “violent protesters.” And if only we could read Diane E.’s post, we could see that there was “a credible belief” that we were going to see a WTO-style ”dose of random ideological violence.”

I do have good news for Ms. McArdle – the original Diane E. post that she thought was lost to posterity has been located.... There are a couple of general observations worth making. First – that Diane E., whether she was a “war-horse” or not, was clearly and emphatically a rumor-monger, contra McArdle.... Second, that Diane E.s writing in this post reaches Pam-Geller levels of batshit crazy. Myself, I would not be swift to describe a post like this as a justifiable basis for “credible belief.” But then I’m not Megan McArdle....

[W]hat evidence do we have that college student rioters are planning a “can of whup-ass on some Korean vegetable stand,” to use McArdle’s memorable description? Diddly squat. What does this tell us about rioters’ plans to … er … riot? Again. Diddly squat. The protesters plans are explicitly to “transform Feb. 15 into a carnival of peace and resistance.” There are a number of proposed actions – but the only one that can be even faintly thought of as violent, is the proposal to have snowball fights. McArdle’s source of wisdom, the indefatigable Diane E., rants that this isn’t peaceful protest. But it obviously is. All of these actions are taken from the standard repertoire of peaceful disruptive protest. Many of them are certainly massive pains in the arse. None of them would seem to me to be forms of violence that would justify pre-emptive whacks in the head...

Milton Friedman Supports Quantitative Easing 2

David Wessel:

What Would Milton Friedman Do Now?: Enough about John Maynard Keynes.... What would Milton Friedman, the University of Chicago champion of monetary discipline, do now? What would he say—reversing the charges when he returned a reporter's call, as he always did—if asked about Federal Reserve Chairman Ben Bernanke's imminent move to print hundreds of billions of dollars to buy more U.S. Treasury bonds to put more money into the economy?... [T]his seems a ripe moment to contemplate Friedman's views and those of his disciples—though they don't agree among themselves.

Friedman believed in the power of money: the more money, the more income.... Friedman would have scoffed at the notion that the Fed is out of ammunition. He believed in the potency of "quantitative easing," or QE—printing money to buy bonds:

The Bank of Japan can buy government bonds on the open market [e wrote in 1998.]... Most of the proceeds will end up in commercial banks, adding to their reserves and enabling them to expand…loans and open-market purchases. But whether they do so or not, the money supply will increase.... Higher money supply growth would have the same effect as always. After a year or so, the economy will expand more rapidly; output will grow, and after another delay, inflation will increase moderately...

But how would he decide if the Fed should buy bonds now? He would look at the growth of the money supply, though he and his followers always had trouble identifying which measure was the right one.... He would warn, as he often did, about "erratic swings" in the money supply..... He would look at velocity, the number of times a dollar turns over in a given year, to gauge demand for money. "To keep prices stable, the Fed must see to it that the quantity of money changes in such a way to offset movements in velocity and output."... When velocity is stable, the Fed should keep money growth steady. When velocity swings widely, the Fed shouldn't be passive.... He would look at growth in income:

He considered stable nominal [unadjusted for inflation] income growth desirable because sudden swings in it (and thus in spending) cause huge macroeconomic disturbances when wages and prices fail to adjust quickly," says economist David Beckworth of Texas State University. Income is growing well below historical norms. POINT: For QE.

He would look at bond-market inflation expectations.... Markets anticipated low and falling inflation—until Mr. Bernanke began talking about QE2 in late August, a sign that markets believe Fed's bond-buying will boost inflation, as the Fed desires. POINT: For QE....

The Friedman logic, though, makes the case for QE2.

The Oscar for Best Parody in a Comment Section Goes to Nobby Nobs

Let me turn things over to... Nobby Nobbs:

Britain Prepares to Humiliate Itself - Grasping Reality with Both Hands: What a complete NOB!! You must surely be joking with this blatent nonsense...Keynes was a TOOL pure and simple. I'm sure that Wall Street and the Baron's (more arseholes) would be more than willing to keep the UK up to their ears in debt. But guess what, the UK Govt has finally got the message that you don't cut under duress, you cut before you are forced to which opens up choices and greater freedom...

Freedom, that's a word that you clearly don't understand. When you are in debt, you are in servitude, you may prefer that, but I think I speak for all sensible, right-minded people with an ounce of common-sense that you should desist from writing this rubbish when you clearly don't have a Scooby Doo about economics or Good Housekeeping and financial rectitude. Enjoy debt slavery you Keynesian apologist loser...

To understand this comment, you need to know who Nobby Nobbs is. From Wikipedia:

"Nobby" Nobbs is untidy, smelly, and despite being human, about the same height as a dwarf. He therefore carries a certificate signed by the Patrician to prove that he's a human being. The text of this note... states that on the balance of probability, he is a human being. A running joke is the inability of others to believe this, despite—or even because of—the evidence. In fact, in Hogfather, even Death himself was unable to discern Nobby's species....

Sergeant Fred Colon [is] his partner and longterm friend. Together, Nobby and Colon have managed to have many strangely philosophical (or just strange) conversations, including one on whether Death has a first name, or even any friends to call him it. Oddly enough, these conversations hint at Nobby being more intelligent than Colon, with Nobby continually pointing out fatal flaws in Colon's statements and arguments, and Colon mentally scrambling to come up with an answer (this is not unlike some of the byplay in the Laurel and Hardy films). He is fond of folk dancing.

As a child he was a street urchin, that is, small, prickly, and smelling of fish, and a major source of information for various city notables.... The young Nobby sometimes refers to his father as "Number One Suspect", and is afraid of going to prison because his father is currently in there....

He believes he is in a romantic relationship with Verity "Hammerhead" Pushpram, a girl who runs a fish stall and gets her nickname from the fact that her eyes appear to be looking in opposite directions. However, this "relationship" seems to consist solely of her hitting him with a fish and telling him to bugger off. He remains "faithful" to her, however....

According to the Pratchett Portfolio, his typical sayings is: "'tis a lie sir, i never done it" (like all other 'typical sayings' in the Portfolio [except that of the Death of Rats] he has not actually been recorded saying it).

During Nobby's time in Klatch he "got in touch with his feminine side," and is quite fond of wearing women's clothing. This can occasionally be useful, as he dressed up as an old lady as part of a Traffic scam before being stopped by Vimes...

Britain Prepares to Humiliate Itself

Mark Thoma tells me that my Project Syndicate column is out:

The Humiliation of Britain - Project Syndicate: BERKELEY – At the end of 2008, as the financial crisis hit with full force, the countries of the world divided into two groups: those whose leaders decided to muddle through, and China. Only the Chinese took seriously Milton Friedman’s and John Maynard Keynes’s argument that, when faced with the possibility of a depression, the first thing to do is use the government to intervene strategically in product and financial markets to maintain the flow of aggregate demand.

Then, at the start of 2010, the countries that had been muddling through divided into two groups: those where government credit was unimpaired continued to muddle through, while countries like Greece and Ireland, where government credit was impaired, had no choice but to pursue austerity and try to restore fiscal confidence.

Today, another split is occurring, this time between those countries that are continuing to muddle through and Great Britain. Even though the British government’s credit is still solid gold, Prime Minister David Cameron’s administration is about to embark on what may be the largest sustained fiscal contraction ever: a plan to shrink the government budget deficit by 9% of GDP over the next four years.

So far, China is doing the best in dealing with the financial crisis. The mudding-through countries lag behind. And those where confidence in the government’s liabilities has cracked, forcing the government into austerity, are doing worst.

Now the question is: will Britain – where confidence in the government has not cracked and where austerity is not forced but chosen – join the others at the bottom and serve as a horrible warning?

Cameron’s government used to claim that its policies would produce a boom by bringing a visit from the Confidence Fairy that would greatly reduce long-term interest rates and cause a huge surge of private investment spending. Now it appears to have abandoned that claim in favor of the message that failure to cut will produce disaster. As Chancellor of the Exchequer George Osborne put it:

“The emergency Budget in June was the moment when fiscal credibility was restored. Our market interest rates fell to near-record lows. Our country's credit rating was affirmed. And the IMF went from issuing warnings to calling our Budget ‘essential’ Now we must implement some of the key decisions required by that Budget. To back down now and abandon our plans would be the road to economic ruin.”

But if you ask the government’s supporters why there is no alternative to mammoth cuts in government spending and increases in taxes, they sound confused and incoherent. Or perhaps they are merely parroting talking points backed by little thought.

What is so bad about continuing to run large budget deficits until the economic recovery is well established? Yes, the debt will be higher and interest on that debt will have to be paid, but the British government can borrow now at extraordinarily favorable terms. When interest rates are low and you can borrow on favorable terms, the market is telling you to pull government spending forward into the present and push taxes back into the future.

Advocates of austerity counter that confidence in the government’s credit might collapse, and the government might have to roll over its debt on unfavorable terms. Worse, the government might be unable to refinance its debt at all, and then would have to cut spending and raise taxes sharply.

But that is what the British government is doing now. How is the possibility that a government might be forced into radical fiscal consolidation an argument for taking that step immediately, under no duress and before the recovery is well established?

To be sure, back in the 1970’s, confidence in the credit of the British government collapsed, forcing it to borrow from the IMF so that spending could be cut and taxes raised gradually rather than abruptly. But that is why Keynes and Harry Dexter White established the IMF in the first place. An IMF program restores confidence in the fiscal soundness of governments that markets distrust. The lending allows the necessary medium- and long-term spending cuts and tax increases to be undertaken at a more appropriate time.

Borrowing from the IMF may be humiliating for government officials. But businesses establish lines of credit for future contingencies all the time, and they don’t think there is anything humiliating about resorting to them when those contingencies come to pass. And what, really, is so humiliating about borrowing from your own citizens?

Britons, as Osborne knows, are willing to lend to their government on an enormous scale – and on terms that are more generous than those on offer from the IMF. And, if one is worried that the British people might change their minds, well, the princes of Wall Street or the barons of Canary Wharf or US Treasury Secretary Tim Geithner would certainly be willing to sell derivatives contracts to protect Britain against exchange-rate risk for the next several years.

To borrow from your own people is especially non-humiliating when your economy is in depression, when the interest rates at which you can borrow are at near-record lows, and when every economic argument cries out for spending now and taxing later.

What is humiliating is to have a government that cuts a half-million public-sector jobs and causes the loss of another half-million jobs in the private sector. In an economy of 30 million jobs, that translates into an increase in the unemployment rate of 3.5 percentage points – at a time when no sources of expanding private-sector demand exist to pick up the slack. Britain’s finest hour this is not.

Yes, I Am Proud of Obama's PPACA


Health care reform is a very good thing, and something to be really proud of.

Let me outsource this to Aaron Carroll

A reminder of where we are | The Incidental Economist: As the rhetoric heats up before the election, I’d like to give you a quick reminder of why we needed (and still need) health care reform....

That thick red line is the United States.  For the record, we’re beating Mexico, Turkey, and Chile.  But every other OECD country – every single other one listed there – has figured this out.  I’ve been spending a lot of time recently talking about the cost and quality of the health care system, but let’s not forget access.  We’re terrible.  There are so many countries bunched near 100% that you can’t see them all; picking out the very few that aren’t is easy.

Say what you will about the PPACA, but it was designed primarily to get at this issue.  It’s not perfect, and it won’t get us to 100% insured, but it will get us closer.  Our goal at this point should be to keep pushing to get us up with everyone else, not to return us to this.

I Am A Weirdo...

On the BART back from downtown San Francisco yesterday, only 2 of the 60 people in my car got off at Orinda. Only 3 of the 60 people in my car got off at my stop--Lafayette.

The reason is clear as you get off at the Lafayette stop in the median strip of the ten-lane California Scenic Highway 24: the big electronic sign says:


$10 dollars, 40 minutes each way, and you are very likely to have to stand for at least one of the legs as opposed to 22 minutes each way and then having to brave the parking situation downtown.

It simply doesn't make individual sense unless your trips to DWNTWN SF have to be made at the peak commute hours when Teh Bridge is "backed up"...

links for 2010-10-27

Hoisted from the Archives: DeLong (1999), "Should We Fear Deflation?"

Why We Should Fear Deflation

J. Bradford DeLong

University of California at Berkeley, and
National Bureau of Economic Research
[email protected]

April, 1998

For the Brookings Panel on Economic Activity, March 25-26, 1999

Post-meeting draft


After more than sixty years, deflation has reappeared as something to worry about. In the past six months major newspapers printed 438 articles classified under the keyword "deflation"--compared to 36 such in the first half of 1997 and 10 such in the first half of 1990. For sixty years, ever since the middle years of the Great Depression, next to no one had worried about deflation. Next to no one had seen actual falls in the price level as even a remote possibility. Now people do.

The post-Korean War 1950s and the early 1960s saw measured rates of inflation as low as those of today. Yet then people worried not about deflation but about inflation. Only in the late 1990s, not in the 1950s or 1960s, have inflation rates of two percent per year or less called forth fears of deflation.

Source: Bureau of Labor Statistics.

In the past, low inflation did not induce forth fears of deflation because observers believed that the institutions created by the Keynesian revolution had a bias toward inflation. Yet today this belief is gone, or at least greatly attenuated. What happened to the built-in bias toward inflation that past economists believed was inherent in post-WWII institutions? I suspect that the institutional bias toward inflation was never as large as many economists believed, and that it has recently been reduced or eliminated by the growth of countervailing forces.

Given that deflation is back on the agenda, should it be feared? Perhaps we should not worry about deflation because the probability that it will come to pass is infinitesimal. Perhaps we should not worry about deflation because it is not especially damaging. If costs of inflation and deflation are roughly equal--if our social loss function is symmetric around zero as a function of the deviation from price stability--then there is more to fear from renewed inflation than from deflation, for the price level is still rising.

I tentatively conclude that there is reason to fear deflation. The probability of serious deflation or of events that do the same kind of damage to the economy that deflation does is low, but it is not zero. There is good reason to fear that our social loss function is asymmetric: that deflation does more macroeconomic damage than an equal and opposite amount of inflation.

The root reason to fear deflation is that the nominal interest rate is bounded below at zero. Significant deflation--even completely anticipated deflation--thus generates high real interest rates and large transfers of wealth from debtors to creditors. By contrast, significant anticipated inflation does not generate abnormally low real interest rates (although significant unanticipated inflation is associated with large transfers of wealth from creditors to debtors).

Deflation's high real interest rates depress investment, lower demand, and raise unemployment. Deflation's transfers of wealth from debtors to creditors diminish the economy's ability to keep the web of credit and financial intermediation functioning. Such disruption of the financial system puts additional downward pressure on investment, demand, and unemployment.

Thus it seems to me to be hard to argue that our social loss function is symmetric, and that deflation is not to be especially feared. It is easier to argue that the chances of deflation coming to pass are very low. Yet I suspect that they are not as low as we would like to believe, for the Federal Reserve's power to offset surprise downward shocks to the price level is low.


Inflationary Bias

From its beginning the Keynesian Revolution brought fears of inflation. Before the ink was dry on the copies of Keynes's General Theory, Jacob Viner already warned that:

    ...[i]n a world organized in accordance with Keynes' specifications there would be a constant race between the printing press and the business agents of the trade unions, with the problem of unemployment solved if the printing press could maintain a constant lead...

A quarter century later in his AEA presidential address Arthur Burns argued that Viner's fears had come true: that the post-World War II world was one of constant wage-push inflation.

Viner's and Burns's fears have been developed and sharpened by Finn Kydland and Edward Prescott, who pointed out that a benevolent central bank possessing discretion and the ability to induce unanticipated shifts in aggregate demand will be under great temptation to try to take advantage of any short-run Phillips curve boost employment and production. The rational expectations equilibrium will be dissipative: workers and managers will expect such actions from the central bank, and in equilibrium production and unemployment will be unaffected but inflation will be higher than desirable.

This Kydland-Prescott framework suggests two ways to counter this institutional bias towards inflation created by central bank possession of discretion and concern over high unemployment. First-- Kydland and Prescott's preference--make sure central banks are bound by rules and do not possess discretion. Second--a line of thought associated with Ken Rogoff--appoint central bankers who are unconcerned high unemployment.

The pattern of economic policymaking in the 1990s suggests that both of these ways of modifying institutions to diminish inflationary bias have been adopted. The U.S.'s central bank today appears to follow the rule (in the sense of Blinder (1998) although perhaps not in the sense of Kydland and Prescott (1977)) of giving first and highest priority to attaining near price stability. The past decade has seen the flowering of a common culture of central banking in which control of inflation comes first, and always taking the long view is applauded. And some central bankers at least appear to have been appointed with an eye toward their relative lack of concern with--or disbelief in their power to affect--the level of unemployment. The result is a situation in which long-time inflation hawks criticize the European Central Bank for pursuing overly-tight monetary policy, and in which the ECB president announces--with euro-zone inflation approaching one percent per year and euro-zone unemployment approaching ten percent per year-- that the ECB "will act, should the need arise, to prevent either inflationary or deflationary pressures..."

Thus it appears that attempts to reform institutions to eliminate inflationary bias have been successful, or perhaps that the bias toward inflation seen in the 1960s and 1970s was not so much the result (as Kydland and Prescott theorized) of the game-theoretic structure of the interaction between central bankers and the economy or (as Burns theorized) of the absence of fear of high cyclical unemployment, but instead the result of painful misjudgments about the structure of the economy and the slope of long-run Phillips curves that were corrected after the 1970s.


Why We Should Fear Deflation: Economic History

In the early 1920s most economists treated "inflation" and "deflation" as symmetric

    ...evils to be shunned. The individualistic capitalism of today, precisely because it entrusts savings to the individual investor and production to the individual employer, presumes a stable measuring rod of value, and cannot be efficient--perhaps cannot survive--without one.

Deflation was dangerous because entrepreneurs were necessarily long real and short nominal assets:

    ...the business world as a whole must always be in a position where it stands to gain by a rise... and to lose by a fall in prices.... [The] regime of money-contract forces the world always to carry a big speculative position [long real assets], and if it is reluctant to carry this position the productive process must be slackened.... The fact of falling prices injures entrepreneurs; consequently the fear of falling prices causes them to protect themselves by curtailing their operations; yet it is upon the aggregate of their individual estimations of the risk, and their willingness to run the risk, that the activity of production and of employment mainly depends...

The fact of falling prices bankrupted entrepreneurs. The fear of falling prices led them to unwind their positions, close down productive operations, and reduce output and employment.

The coming of the Great Depression, however, shifted economists' focus away from balanced fears of inflation and deflation and to the conclusion that deflation was deeply dangerous, and to be avoided at all costs. Economists' analyses of the root causes of the Great Depression were (and continue to be) widely divergent. Nevertheless, alomost every analyst of the Great Depression placed general deflation--and the chain of financial and real bankruptcies that it caused--at or near the heart of the worst macroeconomic disaster the world has ever seen.

Each analysis focused on a different channel. Irving Fisher stressed that past deflation meant bankruptcy or near-bankruptcy for leveraged operating companies and nearly all financial institutions. Friedman and Schwartz stressed the harm inflicted by deflation on banks' balance sheets by reducing the nominal value of collateral and diminishing debtors' ability to service loans: resulting financial-sector bankruptcies led to sharp rises in reserves-to-deposits and currency-to-deposits ratios, lowering the money stock and aggregate demand in the absence of adequate Federal Reserve response. Peter Temin focused on rising risk premia on corporate debt over 1929-1933: deflation-driven corporate balance sheet deterioration increased risk and drove a wedge between low short-term interest rates on safe assets like government bonds and high long-term interest rates on corporate debt.

Barry Eichengreen wrote of the fear that countries would depreciate their currencies, and how this fear forced country after country to adopt deflationary policies to reduce the price level and shrink the money supply. Charles Kindleberger wrote of how currency depreciation exerted deflationary pressures: a small country that reduced the value of its currency discovered that its businesses and banks had borrowed abroad in gold, and could no longer service their debts. Christina Romer argued that even those who were not heavily long equities found it advisable to cut back on spending and increase liquidity margins in the aftermath of the 1929 stock market crash.

All of these channels share common features. First is that nominal interest rates cannot fall below zero. Hence banks could not respond to anticipated deflation by paying negative interest on deposits: if they could, then the key banking-crisis channel that Friedman and Schwartz see as the principal cause of the Great Depression would have been much weaker. Businesses could not rewrite their debt contracts ex post to diminish the effect of falling demand and prices on their balance sheets: if they could, then the wedge between Treasury and corporate interest rates that Peter Temin focuses on would have been much smaller. Exchange rate depreciation did not, in 1931 any more than in 1997, carry with it a writing-down of the hard money or hard currency debts that domestic firms owed to foreign nationals: if it had, then the channel that Kindleberger notes would have been much weaker. The increases in uncertainty and falls in consumer wealth that Romer focuses on would have had only trivial effects on purchases of durable commodities had not consumers feared that in the future they might want to have very liquid balance sheets of their own.

Second is a common focus on financial fragility: the belief that the interruption of the chain of financial intermediation has disastrous consequences for production and employment, whether the disruption occurs at the level of bank creditors (as in Friedman and Schwartz, in which it is increases in currency-to-deposits and reserves-to-deposits ratios that does the work), of operating companies (as in Keynes's or Fisher's stories of entrepreneurs unhedged against price level declines), of banks themselves (as in Temin, in which the deterioration of bank debtors' balance sheets does the work), of companies with foreign liabilities (as in Kindleberger), or of consumers who no longer dare to be short in nominal terms to finance their purchases of durable assets (as in Romer).

In all of these channels sharp deterioration in debtor balance sheets leads to desires on the part of both debtors and creditors to unwind their positions and boost their liquidity, and to sharp reductions in business investment and consumer spending.

Economists do not have satisfactory theories of why borrowers choose to borrow and lenders choose to lend in unstable units of account, or of why demand is so sensitive to credit-market disruptions. Economic theory tells us that debt contracts are good ways to reduce the principal-agent problems that arise when investors confront entrepreneurs and managers who have vastly greater knowledge of a firm's circumstances and opportunities. Economic theory tells us that when borrowers' balance sheets are impaired such debt contracts no longer work. But there is no theoretical reason why such contracts should be written in potentially unstable units of account, or why they should not condition on observed macroeconomic variables.

Nevertheless, debtors borrow and creditors lend in nominal terms--whether consumers financing purchases of durables, banks taking deposits from households, real estate developers pledging land and property as collateral, or companies borrowing from banks. Such debt contracts interpret nominal deflation and the consequent difficulty in servicing or repaying the loan as a signal that the debtor has failed to properly manage their enterprises, and hence that the enterprise needs to be restructured or liquidated.

This confusion of nominal deflation with entrepreneurial failure is what makes a deflation such a dangerous exercise.

How dangerous? We do not know. We do not know how financially-fragile the U.S. economy is today, either in the sense of how vulnerable financial-sector and non-financial-sector entrepreneurial net worth is to deflation or how much reduction in aggregate demand would be caused by impaired financial-sector and non-financial-sector balance sheets. The U.S. economy has not experienced deflation since World War II. We know that economic historians blame debt-deflation and financial-fragility channels for the greatness of the Great Depression. We have no reliable evidence on the strength of these channels today.

The (relatively poor) data on aggregate movements in production and prices before World War II can be used to support the claim that the association of price changes and output changes is non-linear, with larger falls in prices associated with proportionately greater falls in output. A simple regression of peacetime annual changes in industrial production on the change and the squared change in the wholesale price index is certainly not inconsistent with the existence of a powerful non-linear deflation channel--as long as the World War I years are excluded, and as long as 1920-1921 is excluded as well.

Source: NBER Macro History database.


There is sound reason for the exclusion of the 1920-21 data point as an outlier. Coming immediately after the World War I inflation, the 1920-21 deflation came before businesses and financial institutions had had sufficient opportunity to rebalance their portfolios and readjust their degrees of leverage. Thus financial and non-financial balance sheets were unusually strong, and financial and non-financial net worth were unusually high in 1920-1921. The economy was thus less vulnerable to the channels through which deflation reduces production: the fact that 1920-1921 does not fit the correlations found in the rest of the data can be read as evidence for, not evidence against, the importance of debt-deflation channels back before World War II.

But an economist willing to try hard enough can always find sound reason for excluding an influential and inconvenient observation.

Moreover, these (relatively poor) pre-World War II data on industrial production and wholesale price index changes are of doutbful relevance for the U.S. economy today. And we lack data and convincing theory needed to identify how much of the correlation between changes in prices and changes in industrial production back before World War II reflects movements along an aggregate supply curve and not any destructive consequences of deflation.


Why We Should Fear Deflation: Present Vulnerability

Alternative Channels that Impair Balance Sheets

If the danger of deflation springs from its effect on net worth and depends on the degree of financial fragility in the economy, then economies may well have more to fear than declines in broad goods-and-services price indices alone. If securities and real estate holdings have been pledged as collateral for debt contracts, then large-scale asset price declines also trigger the confusion of macroeconomic events with entrepreneurial failure that makes deflation feared.

Is the United States today potentially vulnerable to large-scale asset price declines in this way? In real estate no. In the stock market yes. Perhaps fundamental patterns of equity valuation have truly changed, as investors have recognized that the equity premium over the past century was much too large--in which case stock prices have reached a permanent and high plateau. But it seems more likely that there are substantial risks of stock market declines on the order of fifty percent back to Campbell-Shiller fundamentals.

Source: Robert Shiller (1987), Market Volatility.

A second source of potential deflation-like pressure--seen during Sweden's exchange rate crisis of 1992, during Mexico's exchange rate crisis of 1994-5, during the East Asian crises of 1997, as well as in Great Depression-era events like the Austrian financial crises of 1931--arises out of large-scale foreign-currency borrowing by banks, companies, and governments in countries whose exchange rates then sharply depreciate.

Exchange rate depreciation is a standard reaction to a sudden fall in foreign demand for a country's goods and services exports (on the current account) or property (on the capital account). When demand for a private business's products falls, the business cuts its prices. When demand for a country's products falls, a natural reaction is for the country to cut its prices, and the most way to accomplish this is through exchange rate depreciation.

But if governments, banks, and non-financial corporations have borrowed abroad in hard currencies, depreciation writes up the home-currency value of their debts and impairs their balance sheets in the same fashion as conventional goods-and-services price index deflation.

We know that other countries certainly have been vulnerable to this form of financial market disruption. Is the U.S. vulnerable? Not today. U.S. gross external obligations of $7 trillion or so are overwhelmingly equity or dollar-denominated investments. But will they still be dollar-denominated come the end of the year 2000, when they will amount to perhaps $9 trillion, and when these gross obligations are part of a net investment position of more than -$2 trillion?


The Limits of Monetary Policy

Moreover, even a pure commodity price deflation may not be as unlikely as we hope.

How adept is monetary policy at controlling the price level? The answer has always been--or at least since Milton Friedman stated that monetary policy works with "long and variable lags"--"not very." Power and precision are two different things.

Modern estimates of the impact of monetary policy shocks on production, employment, and the price level continue bear out this assessment. Authors like Christiano, Eichenbaum, and Evans are very pleased that they find substantial agreement on the qualitative impact of changes in monetary policy (as measured by the short-term interest rates that the Federal Reserve actually controls) "in the sense that inference is robust across a large subset of the identification schemes that have been considered in the literature." But the confidence intervals surrounding their point estimates are large. Moreover the time delay in the effect of a change in monetary policy is large as well: not until some eight quarters after the initial interest rate shock has the impact of a change in interest rates had anything near its long-run effect on the rate of inflation (or deflation). According to Christiano, Eichenbaum, and Evans, a one percentage point upward shift in the federal funds rate is associated with a less than one tenth of one percent decrease in the annual rate of inflation even ten quarters out.

Monetary policy remains the tool of choice for stabilization policy. The lags associated with Presidential and Congressional changes in spending plans and tax rates are even longer and more variable than the lags associated with monetary policy. But in the UnitedStates today monetary policy has no appreciable effect on the rate of price change for a year and a half after its implementation, and has nothing close to its full long-run effect on the rate of price change until two and a half years have passed. Moreover, there are important policy recognition and policy formulation lags as well in the making of monetary policy. The FOMC's reliable information flow is at least one quarter in the past. The FOMC is a committee that moves by consensus guided by its chair, and committees that move by consensus rarely act quickly.


How Large Are Price Level Shocks?

If we today could reliably and precisely forecast what the price level would be two and a half years hence, the long and variable lags associated with monetary policy would not be worrisome. But we cannot do so. In the years since 1950 the standard deviation of the price level two and a half years hence is 6.6%. A little of this variation can be attributed to systematic policy. Conditioning on the level of CPI inflation today accounts for less than a third of the two and a half-year-ahead variance in the price level, and reduces the standard error of the price level two and a half years out to only 5.5%. Conditioning on both inflation and unemployment reduces the standard error of the price to only 5.4%. And conditioning on inflation, unemployment, and current nominal interest rates reduces the standard error only to 4.8%.

The most significant improvement in forecasting comes from conditioning on the identity of the Federal Reserve Chair, which reduces the standard error to 3.8%. But fitting a step function to any process will improve the fit. I see little in the views and characters of Arthur Burns and Alan Greenspan that would lead the replacement of the first by the second to generate an immediate nine percent fall in one's estimate of the price level two and a half years out. It strains credulity to believe in a +26 percent effect on the price level from any chair, even G. William Miller.



Standard Deviation and Conditioning Variables

6.6%: --None--

5.5%: 12-mo inflation rate

5.4%: 12-mo inflation rate, capacity utilization rate

5.3%: 12-mo inflation rate, unemployment rate

4.8%: 12-mo inflation rate, unemployment rate, federal funds rate

4.8%: 12-mo inflation rate, unemployment rate, federal funds rate, 10-yr Treasury rate

3.8%: 12-mo inflation rate, unemployment rate, identity of Federal Reserve chair



Nevertheless, even a 3.8% standard deviation tells us that--if the normal distribution applies appropriate--that there is once chance in twenty that the price level two and a half years hence will be more than seven and a half percent higher or lower than we forecast. At current rates of inflation, an unanticipated fall in the price level of more than five percent before the Federal Reserve can react seems to be an event that would happen once every forty years. Is this a high risk of a serious deflation? No, but it is large enough to be worrisome.


Reasons for Confidence

Is such instability enough to make a debt-deflation spiral set in motion by unanctipated commodity price declines a serious threat? Probably not.

First, it may well be that it takes a bigger economic shock to induce a certain amount of deflation than it takes to induce the same amount of accelerating inflation or of disinflation. If so, calculations of price-level variability from an era of accelerating inflation and disinflation are unreliable guides to the potential for deflation. It takes a much greater contractionary impulse to cause deflation than to cause disinflation.

Second, a large chunk of the post-1960 variance in changes in the rate of inflation comes from the relatively narrow period of the turbulent 1970s. The years between 1971 and 1983 inclusive--one third of the sample--account for ninety percent of the squared deviations of CPI inflation around its mean. Since 1984 the standard deviation of two-and-a-half year ahead changes in CPI inflation is only a third the full-sample standard deviation. Perhaps episodes of variability like the 1970s oil shocks and the breakdown of confidence in the Federal Reserve's commitment to price stability will not happen again because of increasing levels of knowledge about how to make monetary policy.

It is easy to make such arguments in the United States, where monetary policy makers have been skillful and astonishingly lucky over the past decade. It is, however, harder to make this argument from policy making competence elsewhere in the world. In Japan producer prices are 5% lower than they were a year ago, and over the past three months have fallen at a rate of 10% per year. Estimates of the output gap relative to potential in Japan today range between 8 and 25 percent of current GDP. In the euro zone inflation is less than one percent per year, and unemployment approaches ten percent. These macroeconomic problems are different from those of the 1970s. They are not less serious. And they do not appear to be consistent with greatly increased skill in the making of monetary policy.



Our ability to forecast and control the price level at a time horizon that corresponds to the effective range of monetary policy is low. Our policy instruments are powerful, but they are imprecise and are subject to long and variable lags. Moreover, other sets of circumstances than general goods-and-services price declines alone could set in motion the economic processes that we fear from deflation.

Thus there seems to be reason to fear deflation.

But there is no reason-at least not yet--to be very afraid. The institutional structures of our labor market provide us with insurance against debt-deflation as in the argument of Akerlof, Dickens, and Perry (1996)--although note that this insurance comes at a substantial price: in their model the natural rate of unemployment rises substantially as the inflation rate hits zero. The relatively high price level variability of the 1970s may truly be a thing of the past, not a thing to fear in the future.

But if the volatility of the 1970s does come again, and if deflation is not much harder to cause than disinflation, and given that monetary policy is an imprecise instrument that works with long and variable lags, what then? If your loss function is asymmetric--if moderate deflation is much more damaging than moderate inflation--and if the variance of outcomes around targets is large, then the conclusion is obvious: good monetary policy should aim for a rate of price level change consistently on the high side of zero.

After all, in a still-impoverished world, it is worse to provoke unemployment than to disappoint the rentier.



George Akerlof, William Dickens, and George Perry, "The Macroeconomics of Low Inflation," Brookings Papers on Economic Activity Vol. 1996, No. 1 (Spring 1996), pp. 1-59.

Ben Bernanke, "Nonmonetary Effects of the Financial Crisis in the Propagation of the Great Depression," American Economic Review Vol. 73, No. 2 (June 1983), pp. 257-76.

Ben Bernanke and Mark Gertler, "Agency Costs, Net Worth, and Business Fluctuations," American Economic Review Vo. 79, No. 1 (March 1989), pp. 14-31.

Ben Bernanke and Mark Gertler, "Financial Fragility and Economic Performance," Quarterly Journal of Economics Vol. 105, No. 1 (February, 1990), pp. 87-114.

Mauro Boianovsky, "Wicksell on Deflation in the Early 1920s," History of Political Economy Vol. 30, No. 2 (Spring 1998).

Ricardo Caballero and Mohamad Hammour, "The Cleansing Effect of Recessions ," American Economic Review Vol. 84, No. 5 (December 1994), pp. 1350-68.

Lawrence Christiano, Martin Eichenbaum, and Charles Evans, "The Effects of Monetary Policy Shocks: Evidence from the Flow of Funds," Review of Economics and Statistics, Vol 78, No. 1 (February 1996), pages 16-34.

Lawrence Christiano, Martin Eichenbaum, and Charles Evans, "Monetary Policy Shocks: What Have We Learned and to What End?" NBER Working Paper No. 6400 (February 1998).

J. Bradford DeLong, "American Fiscal Policy in the Shadow of the Great Depression", in Michael Bordo, Claudia Goldin, and Eugene White, eds., The Defining Moment: The Great Depression and the American Economy in the Twentieth Century (Chicago: University of Chicago Press, 1997).

J. Bradford DeLong and Lawrence H. Summers, "The Changing Cyclical Variability of Economic Activity in the United States," in Robert Gordon, ed., The American Business Cycle: Continuity and Change (Chicago: University of Chicago Press for the NBER, 1986).

Barry Eichengreen, Golden Fetters: The Gold Standard and the Great Depression (New York: Oxford University Press, ).

Irving Fisher, "The Debt-Deflation Theory of Great Depressions," Econometrica Vol. 1, No. 4 (October, 1933), pp. 337-57.

Douglas Gale and Martin Hellwig, "Incentive-Compatible Debt Contracts I: The One-period Problem," Review of Economic Studies Vo. 52, No. 5 (Octobert, 1985), pp. 647-63.

Friedrich Hayek, "The System of Intertemporal Price Equilibrium and Movements in the 'Value of Money'," in Israel Kirzner, ed., Classics in Austrian Economics: A Sampling in the History of a Tradition. Volume 3. The Age of Mises and Hayek. (London: Pickering and Chatto, 1994 [orig. pub. 1928), pp. 160-98.

Friedrich Hayek, The Road to Serfdom (London, 1944).

Walter Heller, New Dimensions of Political Economy (Cambridge: Harvard University Press, 1965).

John Maynard Keynes, A Tract on Monetary Reform (London: Macmillan, 1924).

John Maynard Keynes, The General Theory of Employment, Interest and Money (London: Macmillan, 1936).

Charles Kindleberger, The World in Depression

Finn Kydland and Edward Prescott, "Rules Rather than Discretion: The Inconsistency of Optimal Plans," Journal of Political Economy Vol. 87, No. 3 (June, 1977), pp. 473-492.

George Perry (1998), "Is Deflation the Worry?" (Washington D.C.: Brookings Institution, Policy Brief #41).

Christina Romer, "Is the U.S. Economy More Stable?" Journal of Economic Perspectives (forthcoming).

Christina Romer, "The Great Crash and the Onset of the Great Depression," Quarterly Journal of Economics Vol 105, No. 3 (August 1990), pp. 597-624.

Robert Shiller (1987), Market Volatility (Cambridge: MIT Press).

John Taylor, "Is There a Role for Fiscal Policy in Macroeconomic Stabilization?" Journal of Economic Perspectives (forthcoming).

Robert Townsend, "Optimal Contracts and Competitive Markets with Costly State Verification," Journal of Economic Theory Vol. 21, No. 5 (October, 1979), pp. 265-93.

Jacob Viner, "Mr. Keynes on the Causes of Unemployment," The Quarterly Journal of Economics, Vol. 51, No. 1. (Nov., 1936), pp. 147-167.

Your Father Was a Hamster! And Your Mother Smells of Elderberries!

David Frum taunts:

Reversing Brad DeLong’s Question: During the Bush years, Berkeley economist and uber-blogger Bradford DeLong taunted Bush supporters.... As voters head to the voting booths in November , they might reverse that question:

Give me one single example of something with the following three characteristics:

  1. It is a policy initiative of the current Obama administration [ie, no continuations of pre-existing successful Bush policies: TARP, surge in Iraq, etc.]

  2. It was significant enough in scale that I’d have heard of it (at a pinch, that I should have heard of it)

  3. It has not utterly failed to produce the results promised.


Well, first of all it is Daniel Davies's question and not mine: he gets the credit...

Second, the ARRA--which would have been a McCain initiative had he won, by the way, or so his advisors say, even though opposed by every single Republican office-holder today--looks very much like it has achieved the results promised--even though it was done at only about 5/8 of the scale Obama proposed (the necessity of getting Voinovich, Snowe, and Collins on board to do pretty much anything weakened it) and what was proposed was only about 2/3 of what was appropriate.

Third, the bank stress tests--opposed by every single Republican office-holder today, by the way--appear to have performed much better than I at least expected (although HAMP and PPIP do not look like successes).

Fourth, the auto rescue--opposed by every single Republican office-holder today, by the way--has also performed much better than I at least expected.

Fifth, health care reform--also a Romney initiative, by the way, even though opposed by every single Republican office-holder today--appears to be performing, so far, as expected: providers are gearing up to deal with an inflow of more patients able to get insurance and insurance companies are thinking hard about how to handle themselves in the new market structure that will emerge after 2014--although, of course, health care reform was also weak tea relative to what ought to have been done, as the necessity of lining up sixty senators including a bunch of DINOs made itself felt.

Sixth, financial reform--also a McCain initiative, by the way, even though opposed by every single Republican office-holder today--appears to be performing as expected. At least, shady mortgage and other companies that function by making borrowers bear risks they don't understand appear to be scared of Elizabeth Warren.

Seventh, the TARP--also a McCain and a Romney and a Giuliana and a Paulson initiative, by the way, even though opposed by every single Republican office-holder today--has performed as well as expected. And it is important to note that the Republican legislators of Washington DC appear now, to a man, to be opposed to it.

Eighth, the focus on Afghanistan appears to be performing as well as focuses on Afghanistan ever do.

Ninth, the carbon tax--a Republican initiative pushed hard by Republican economists like Dick Schmalensee, Jim Poterba, Greg Mankiw, etc., even though opposed by every single Republican office-holder today--well, it did not pass because Republicans blocked it.

Tenth, cap-and-trade--also a McCain and a Romney and a Giuliani initiative, by the way, even though opposed by every single Republican office-holder today--well, it did not pass because Republicans blocked it.

Consider what the world would look like if the current crop of Republican candidates had been in control over the past two years: no TARP, no auto rescue, no financial reform, no stress tests, no ARRA. It would look much bleaker than the current picture looks.

Now I don't doubt that David Frum and his friends could have done a better job of governing America over the past two years if they had had total power over the U.S. government and if they had had omniscient prescient 20/20 hindsight about everything--and if they somehow could be convinced not to have launched a war on Iran in early 2009. But if they had lacked hindsight? I think that they would have done worse than Obama, even if they could have been restrained from launching a war on Iran in early 2009.

And, of course, David Frum and his friends are not the current Republican Party seeking office this November. They are a despised and exiled remnant, wandering through the desert of Sinai, longing for the fleshpots of Egypt with no manna in sight...

W00T!! W00T!! W00T!!!

Something I never in my wildest dreams thought I would see in my lifetime.

Aline van Duyn, Michael Mackenzie and Nicole Bullock:

Debt sales highlight abnormal conditions: The abnormal state of the credit markets came into focus as the US Treasury sold bonds with negative interest rates for the first time and Goldman Sachs prepared to issue its first 50-year debt deal. Both developments on Monday highlighted the difficult choices facing investors at a time when interest rates are at historical lows and the Federal Reserve is moving towards more asset purchases aimed at boosting the economy and staving off deflation. Investors who believe the Fed will succeed in its efforts – which would lead to higher inflation – accepted a yield of minus 0.55 per cent on $10bn of Treasury Inflation Protected Securities – or Tips – which compensate holders if the consumer price index rises. At the same time, retail investors looking for higher yields in the current low interest-rate environment were targeted by Goldman, which prepared to sell $250m of 50-year bonds that are expected to pay interest of up to 6.25 per cent.

“The Fed has been sending the message that its cheque book is ready and it will do what it takes to reflate the economy,” said Jan Loeys, head of global asset allocation at JPMorgan Chase. “What no one knows is whether inflation will start to show in two weeks or two years.” Mr Loeys added: “We are seeing longer-term thinking clients becoming increasingly wary of bonds and hedging against inflation. Shorter-term thinkers are still willing to still buy bonds, on the presumption that they are nimble enough to get out when inflation comes to push yields up.” Long-term institutional buyers purchased 39 per cent of the $10bn Tips sale, up from an average share of 30 per cent for the prior six Tips sales....

Expectations for inflation over the next five years – based on comparing Treasury yields and those for Tips – have risen as high as 1.75 per cent this month, up from 1.13 per cent in August...

Let Me Say That Gideon Rachman--or at Least His Headline Writer--Is Wrong


China can no longer plead poverty: Of course, the city has pockets of poverty. And Shanghai is not China, where 150m people (out of a total Chinese population of more than 1.3bn) still live on less than $2 a day. Even so, China’s insistence that it is a poor, developing nation is beginning to wear a little thin. This, after all, is a country that is sitting on more than $2,500bn worth of foreign reserves. In important ways, China is now a rich nation. But its insistence that it is still a “developing country” has become a shield to protect itself against vital political and economic changes that matter profoundly to the rest of the world...

China can still plead poverty. What China cannot do is ignore that it is now a great economic power, and as a great economic power it can no longer make its own internal policy decisions without any consideration of their consequences for the world at large.

Can Alan Blinder Read Ben Bernanke's Mind

Matthew Yglesis does not think so:

Yglesias » Does Ben Bernanke Secretly Want Fiscal Expansion?: Don’t get me wrong, I liked this Alan Blinder column qua economic policy commentary, but I don’t find his mind-reading speculations very plausible:

The two main thoughts that are probably going through Mr. Bernanke’s head today are, first, “I sure wish I could get some help from fiscal policy,” and second, “I probably can’t, so I’d better do whatever I can.” He’s right on both counts.

The Fed Chairman’s not locked up in the Tower of London. He’s not mute. He’s not even unwilling to comment on fiscal issues. But when he gave a big speech on fiscal policy on October 4, he focused entirely on the need for long-term deficit reductions. And I agree with him that such reductions are desirable. But I also think, just like Alan Blinder, that in the short term a bigger deficit would be helpful. If Bernanke wanted to say that, he had a great opportunity. But he didn’t. Presumably for the same reason that he’s consistently acted like a conservative Republican in other regards over the past two years—he’s a conservative Republican.

I think people tend to overestimate the number of mistakes Barack Obama has made in his presidency. But the flipside of that is that they underestimate the severity of the mistakes that are real. Giving the most important economic policy job in the country to someone who doesn’t share his values, ideology, and partisan loyalty was a big big big mistake and it’s reflected in Bernanke’s conduct around questions like this one.

As an Anxious Observer, I Recommend that Henry Farrell Stop Reading Megan McArdle...

A mind, after all, is a terrible thing to waste.

That is all.

Henry Farrell

Rhetorical violence — Crooked Timber: Megan McArdle 2010 vintage

I thought it was pretty creepy when Jon Chait described another liberal journalist, Michael Kinsley, another journalist, as “curb stomping” economist Greg Mankiw for, yes, daring to suggest that higher marginal tax rates might have incentive effects. Woo-hoo! But why stop with curb-stomping? Wouldn’t it be fun to pile ten-thousand gleaming skulls of supply-siders outside the Heritage Offices? We could mount Art Laffer’s head on a rotating musical pike that plays The Stars and Stripes Forever! Then, in the most hilarious surprise ending of all, the mob could turn on Jon Chait, douse him with gasoline and set him on fire, and then sack the offices of the New Republic!

Megan McArdle 2003 vintage

So I was chatting about this with a friend of mine, a propos of the fact that everyone I know in New York is a) more frightened than they’ve been since mid-September 2001 and b) madly working on keeping up the who-the-hell-caresif -Iget-hit-by-a-truck? insouciance that New Yorkers feel is their sole civic obligation. Said friend was, two short years ago, an avowed pacifist and also a little bit to the left of Ho Chi Minh. And do you know what he said? “Bring it on.”

I can’t be mad at these little dweebs. I’m too busy laughing. And I think some in New York are going to laugh even harder when they try to unleash some civil disobedience, Lenin style, and some New Yorker who understands the horrors of war all too well picks up a two-by-four and teaches them how very effective violence can be when it’s applied in a firm, pre-emptive manner.

I’m afraid I’m not quite bright enough to understand why kerb-stomping-as-a-metaphor for-argumentative-victory is creepy and unfunny, while actually beating up war-protesters with bits of lumber is hee-LAIRIUS. Perhaps someone can tease out the nuances for me in comments.

Department of "Huh?!": John Cochrane Edition

You read the start of John Cochrane's Wall Street Journal op-ed:

John Cochrane: Tim Geithner's Global Central Planning: The Chinese government's accumulation of U.S. debt represents a tragic investment decision, not a currency-manipulation effort...

And the only thing you can say is: "HUH?!?!?!?!?!?!?!?!?!"

Has Cochrane talked to anybody in China?

If you ask anybody--anybody--anybody at all--in China why the Chinese government has invested so much money in dollar-denominated assets, nobody will say:

  • "because we expect a high rate of return on those assets," or
  • "because we believe that they are negative-beta assets that have a use as insurance."

Instead, anybody--anybody--anybody at all--in China, when asked why the Chinese government has invested so much money in dollar denominated assets, will say something like this:

Look. China has 900 million rural dwellers who are still living at a standard of living not that far above subsistence. The pressure to migrate from the countryside to the coastal cities is enormous. China needs to grow at more than 8% per year in order to avoid mass unemployment in the coastal cities. And mass unemployment in the coastal cities is likely to be followed by political collapse and turmoil on a gigantic scale.

Part of growing at 8% per year is to continue to rapidly expand exports to the North Atlantic core of the world economy. But in order to expand exports Chinese-produced goods must look like good values. And if demand for dollar-denominated assets falls and the value of the dollar falls, Chinese-produced goods will no longer look like good values. We know very well that when we unwind these purchases of dollar-denominated assets a generation from now the financial rate of return on our investments will be lousy. But in the meantime we get something much more important to us--export growth, full employment in Shanghai, and societal stability.

So what does Cochrane think he is doing? Who does he think will believe him?

When Cochrane writes:

Economists are full of bad ideas.... Mr. Geithner starts with a dramatic proposal: "G-20 countries should commit to undertake policies consistent with reducing external imbalances below a specified share of GDP [later reported to be 4%] over the next few years." Since when is every trade surplus or deficit an "external imbalance" in need of correction? It makes sense for a country that has good investment prospects to import a lot of goods, run trade deficits, and borrow money. Years later, the country puts the resulting products on boats to pay the lenders back. The U.S. borrowed abroad to finance our railroads in the 19th century and ran surpluses when Europe was rebuilding after World War II. Were these "imbalances"?

does he genuinely not understand that China's investment in the United States does not reflect a belief on the part of China's savers that the U.S. offers high rates of return? Does he genuinely not understand that this is a government-run foreign-exchange intervention program--the largest one in history?

Did nobody bother to tell him? Does he have no friends?

He denounces:

the army of economists in the basements of the International Monetary Fund (IMF) has no clue exactly how much each country should be saving, or where the best untapped global investment opportunities are around the world—including whether trade patterns are "normal" or "imbalanced."... The economists hidden away in the sub-basements of the IMF may try to decide what currencies "should be" worth across vastly different countries.... [I]t is a pipe dream that busybodies at the IMF can find "imbalances," properly diagnose "overvalued" exchange rates, then "coordinate" structural, fiscal and exchange rate policies...

But any one of the members of this army of economist, these economists hidden away in the sub-basements, the busybodies at the IMF could have told him--if he had asked--what organizations in China are responsible for asset accumulation.

But he did not ask.

Now I do not think that the United States should pressure China--much--to more rapidly appreciate the yuan. The United States ought to help China become richer as fast as possible--and allowing them to run an undervalued currency and a big export surplus for a while is a good way to do that. The United States, as the hegemon of the world economy, ought to be able to manage the level of its own and of global demand without pushing for demand-shifting policies. A little pressure on China to figure out how to shift more rapidly to internal demand-driven growth is good for them and good for us. But too much pressure--I don't think so.

Nevertheless, that an economics professor is pretending that China's dollar asset-purchase policy is "a tragic investment decision, not a currency-manipulation effort" makes me want to hide my head in shame.

Another Reason That the New York Times Should Die... (It Employs Amanda Fortini Edition)

Why oh why can't we have a better press corps?

Matthew Yglesias:

Yglesias » Bloggers Are People Too!: Writing about Bravo’s Millionaire Matchmaker, Amanda Fortini and the NYT manage to pull the classic MSM stunt of quoting a blogger without naming her:

Last April’s finale garnered a series high of almost 1.6 million viewers. Even those who generally consider themselves too refined for reality TV — the microwave dinner of the entertainment world — are closet fans. “Watching Patti rather savagely describe what’s wrong with these guys and why they have trouble getting/keeping themselves in real relationships is strangely invigorating,” wrote a blogger for the feminist magazine Bitch before fretting: “Can I continue to watch this show and write for Bitch in good conscience?”

I put the quote into Google, and swiftly unearthed the post in question by Anna Breshears. Would it be so hard to use her name? To include a link to her post in the online version of the article?

Liveblogging World War II: October 25, 1940

United Mine Workers and Congress of Industrial Organizations President John L. Lewis endorses Wendell Willkie for President as the not-Roosevelt:

Through the years of struggle you have been content that I should be in the forefront of your battles I am still the same man. Sustain me now, or repudiate me.... You who may be about to die in a foreign war, created at the whim of an international meddler, should you salute your Caesar?... [Mothers,] may I hope that on election day... with the sacred ballot, [you] lead the revolt against the candidate who plays at the game that may make cannon fodder of your sons.

Melvyn Dubofsky reports that Herbert Hoover telegraphed Lewis that "that speech will resound over years to come," and that Willkie wrote that it was "the most eloquent address I have ever heard."

Department of "Huh?!": Where Is Joe Stiglitz Coming From? Edition

Joe Stiglitz joins... the Austrians, I think:

Joseph Stiglitz: Why Easier Money Won't Work: The Federal Reserve, having done so much to create the problems in which the economy is now mired... now wants to make a contribution to preventing the economy from sinking into a Japanese-style malaise... through large-scale purchases of U.S. Treasurys—called quantitative easing, or QE....

The problem is that, with interest rates already near zero, there is little the Fed can do to restart the economy—and doing the wrong thing can do considerable damage. In 2001, (then) record-low interest rates didn't reignite investment in plant and equipment. They did, however, replace the tech bubble with an even more dangerous housing bubble....

Large businesses are flush with cash, and small changes in interest rates—short-term or long—will affect them little. A banker rightly asks if such a business comes asking for money, "What's wrong with it?" But it is SMEs that are the source of job creation in most economies, including the U.S. Many of these enterprises are starved for cash.... They borrow from banks, and many of the smaller local and community banks on which they depend are in dire straits.... Yet even if the banks were willing and able to lend, lending to SMEs is typically collateral-based, and the value of the most common form of collateral, real estate, has fallen 30% to 40%. No wonder then that credit availability is so constrained. But QE in the form of buying U.S. Treasurys is not likely to affect this much....

QE may not even succeed in lowering interest rates, or lowering them very much. Given the magnitude of excess capacity, there is little risk of inflation today. But if the inflation hawks come to believe that the risk of future inflation is real, then... long-term interest rates, even now, may actually rise....

QE poses a third risk: The bursting of the bond market bubble that the Fed is seeking to develop—the sequel to the tech and housing bubbles—will clearly have adverse effects on the economy....

The advocates of QE point to another channel through which it will strengthen the economy: Lower interest rates may also lead to a weaker dollar, and the weaker dollar to more exports.... But this policy only works if other countries don't respond. They will and have, through every instrument at their disposal.... [A]s the U.S. lets forth a flood of liquidity... money is supposed to reignite the American economy... instead goes around the world looking for economies that actually seem to be functioning well and wreaking havoc there.

The upside of QE is limited. The money simply won't go to where it's needed, and the wealth effects are too small. The downside is a risk of global volatility, a currency war, and a global financial market that is increasingly fragmented and distorted. If the U.S. wins the battle of competitive devaluation, it may prove to be a pyrrhic victory, as our gains come at the expense of others—including those to whom we hope to export.

As I understand it, Joe Stiglitz adopts his standard segmented-capital-markets view and makes three claims:

  1. The problem is one of impaired capital on the part of small banks and impaired collateral on the part os small enterprises--a credit channel problem--and quantitative easing in Treasuries will not help that problem.

  2. Quantitative easing will raise expectations of inflation on the part of financiers--and so will raise long-term nominal interest rates--without raising expectations of inflation on the part of industrialists, and so it will raise the perceived cost of capital to businesses and so diminish investment.

  3. Quantitative easing will unleash a process of combined and uneven quantitative easing across the globe that will create dangerous exchange rate and trade volatility.

Therefore we should not do it.

I, by contrast, would say that to the extent that quantitative easing raises expected price levels ten years hence, it will raise the value of collateral. I would say that quantitative easing gives small banks a chance to sell assets to the Federal Reserve and so improve their capital. I would say that even a bond bubble--a topic I have a very hard time wrapping my mind around--is dangerous only if leverage means that the losses from its end are concentrated in key financial institutions. I would agree that quantitative easing is like the scene from Monty Python where they are trying to catch fish in the river by hitting them with a log.

But when you need fish, and when all you have is a log, you try to catch the fish by hitting it with a log.

Don't you?

links for 2010-10-25

Rich Clarida Says: "We Ought to Have Knowed"

Somebody whose name I forget--was it Jim Hamilton?--sends me to a nice paper by Rich Clarida

Rich Clarida: This Jackson Hole consensus as summarized well by Bean et al. (2010) embraced the following seven pillars

  1. Discretionary fiscal policy was seen as generally an unreliable tool for macroeconomic stabilization.
  2. Monetary policy, conducted via setting a path for the expected short term interest rate, was therefore to be assigned the primary role for macroeconomic stabilization.
  3. Because the transmission mechanism for monetary policy was presumed to operate mainly through longer-term interest rates. expectations of future policy rates were central and credibility of policy was essential to anchor these expectations.
  4. Central bank instrument – if not goal - independence of the political process was important to supporting central bank credibility.
  5. Setting targets for intermediate monetary aggregates... fell out of or never gained favor.... as historical velocity relationships between these aggregates , nominal GDP >growth, and inflation appeared to break down....
  6. The efficient markets paradigm was seen as a working approximation to the functioning of real world equity and especially credit markets....
  7. Price stability and financial stability were seen as complementary....

As noted above, pre-crisis discussions of monetary policy took financial stability for granted, and workhorse models used for teaching (Clarida, Gali, Gertler 1999, 2002; Woodford 2003) and even the much larger models used for policy analysis routinely assumed financial frictions were irrelevant for policy design...


Financial history suggests “never again” eventually becomes “this time it is different” and as Rogoff and Reinhart (2009) remind us, throughout history “this time it is different” eventually sets the stage for the next financial crisis. This is especially true when, as emphasized by Minsky (1982) , the “this time it is different” wisdom supports and encourages greater and greater use of leverage.... [I]mportantly, this channel is missing in the justly celebrated and influential Bernanke – Gertler model (1999) presented at Jackson Hole in 1999. In that model, the bubble affects real activity... a wealth effect on consumption... the quality of firms’ balance sheets depends on the market values of their assets rather than the fundamental values.... B and G assume that—conditional on the cost of capital—firms make investments based on fundamental considerations.... This assumption rules out the arbitrage of building new capital and selling it at the market price cum bubble - the Ponzi finance stage of a bubble in the Minsky nomenclature

In the case of the current crisis, the this time it was supposed to be different because securitization and the expertise of the ratings agencies in assessing default risk correlations across various tranches of structured products was in theory supposed to make the financial system more stable and reduce systemic risk.... Of course it was recognized that originate and distribute business model of the ‘shadow banking system’ had its flaws.... But the cost of poor security selection would be spread, it was thought, among millions of investors around the world who bought these securities.... It was supposed to be the brave new world of ‘originate and distribute’ financial intermediation and for twenty years it was – until in July 2007 when it was no longer...


With the benefit of hindsight (excepting rare examples such Rajan (2005) and McCulley (2007) two of very few to foresee the essential contours of the growing systemic instability being created by the shadow banking system) and authoritative, post- mortem research such as that in the Pozsar et. al., it seems clear – at least to this author - that the financial crisis and the credit and securitization bubble that preceded it resulted not only from spectacular failures in securities markets - to allocate capital and price default risk - but serious failures also as well by policymakers to adequately understand, regulate, and supervise these markets. Policymakers, academics, and market participants simply didn’t know what they didn’t know...


[A] central bank can everywhere and always put a floor on any nominal asset price (or set of nominal asset prices) for as long as it wants regardless of 1) how ‘credible’ it’s commitment is 2) how expectations are formed or 3) how term or default premia are determined.... [T]he central bank simply needs to stand ready to buy government bonds with maturities at that point on the curve whose yields it wants to cap by posting a bid each day at the minimum nominal prices it stands ready to support.... The central bank can, if it so desires, robustly put a ceiling on the yield of any bond, public or private, it chooses to target...


According to monetary theory, central banks have at least two powerful – and complementary – tools to reflate a depressed economy: printing money and supporting the nominal price of public and private debt. As discussed above, a determined central bank can deploy both tools for as long as it wants regardless of 1) how ‘credible’ it’s commitment is 2) how expectations are formed or 3) how term or default premia are determined. There are two fundamental questions. First, can these tools, aggressively deployed, eventually generate sufficient expectations of inflation so that they lower real interest rates? Forward looking models generally predict that the answer is yes.... A second question relates to the monetary transmission mechanism itself. In a neoclassical world that abstracts from financial frictions, a sufficiently low , potentially negative real interest rate can trigger a large enough intertemporal shift in consumption and investment to close even a large output gap. But in a world where financial intermediation is essential, an impairment in intermediation – a credit crunch – can dilute or even negate the impact of real interest rates on aggregate demand.... Deleveraging and the collapse of the shadow banking system that intermediated so much credit before the crisis continue to represent a significant headwind that presents a challenge to policy effectiveness.

Belle Waring "Congratulates" Megan McArdle

Belle Waring:

Odds — Crooked Timber: I congratulate journalist Megan McArdle for having the good fortune to encounter such a talkative fellow passenger on the D.C. bus the other day.

Yesterday, I rode the bus for the first time from the stop near my house, and ended up chatting with a lifelong neighborhood resident who has just moved to Arizona, and was back visiting family. We talked about the vagaries of the city bus system, and then after a pause, he said, “You know, you may have heard us talking about you people, how we don’t want you here. A lot of people are saying you all are taking the city from us. Way I feel is, you don’t own a city.” He paused and looked around the admittedly somewhat seedy street corner. “Besides, look what we did with it. We had it for forty years, and look what we did with it!”

He’s a little off, because I think black control of Washington D.C. officially occurred only in 1975 when Parliament’s “Chocolate City” was released.

DeLong Smackdown Watch: Against Money-Financed Fiscal Expansion, For Open Market Operations in Equity Indexes

Hoisted from comments: Nick Rowe writes:

Why Quantitative Easing Needs to Involve Securities Other than Government Securities: OK. Start with the Fed buying bridges. That will work. Now, wouldn't it be nice if the Fed could also sell those bridges again later, if it needs to, as it probably will. Bridges aren't very liquid. And, the Fed is good at clipping coupons on bonds, but perhaps not very experienced at collecting tolls on bridges. Hmmm. Maybe if the Fed just bought shares in bridges instead, that would be as good as bridges, but even better from the practical point of view. Hmmm. Why stop at bridges? Why not buy shares in everything? Why not just buy the Wilshire 5000, or some such index?

links for 2010-10-24