The Pigou Effect

The Pigou Effect (Double-super-special-wonkish) by Krugman

Via Brad DeLong, Robert Waldmann weighs in on the contributions or lack thereof of Milton Friedman, arguing that much of what he said was already there in Samuelson and Solow 1960. Actually, I’d give him more credit than that; the S-S paper — very unusually for both men, and for Bob Solow in particular — is one of those pieces sometimes described as “rich”, with many points alluded to but not many takeaway lines; to the extent that people did take something away, it was the crude notion of a usable downward-sloping Phillips curve, which turned out to be wrong.

Friedman — like Solow, in most of his work — was in the habit of writing crisp papers with very clear morals. So while you can,on a careful read, see from S-S why you should not in fact trust the Phillips curve to be stable, people didn’t actually get that until Friedman and Phelps laid out the point with stark clarity. Credit where credit is due.

Oh, and yes, I modeled my own intellectual style after Bob Solow’s (and Rudi Dornbusch, who was in the same tradition).

What caught me in the Waldmann piece, however, was the brief discussion of the Pigou effect, which supposedly refuted the notion of a liquidity trap. The what effect? Well, Pigou claimed that even if interest rates are up against the zero lower bound, falling prices will be expansionary, because the rising real value of the monetary base will make people wealthier. This is also often taken to mean that expansionary monetary policy also works, because it increases money holdings and thereby increases wealth and hence consumption.

And that’s where I came in (pdf). Looking at Japan in 1998, my gut reaction was similar to those of today’s market monetarists: I was sure that the Bank of Japan could reflate the economy if it were only willing to try. IS-LM said no, but I thought this had to be missing something, basically the Pigou effect: surely if the BoJ just printed enough money, it would burn a hole in peoples’ pockets, and reflation would follow.

But what I did was a little different from what the MMs have done this time around: I set out to prove my instincts right with a little model, a minimal thing that included actual intertemporal decisions instead of using the quasi-static IS-LM framework. [If you have no idea what I'm talking about, you have only yourself to blame -- I warned you in the headline]. And to my considerable surprise, the model told me the opposite of my preconception: there was no Pigou effect. Consumption was tied down in the current period by the Euler equation, so if you couldn’t move the real interest rate, nothing happened.

One way to say this — which Waldmann sort of says — is that even a helicopter drop of money has no effect in a world of Ricardian equivalence, since you know that the government will eventually have to tax the windfall away. Of course, you can invoke various kinds of imperfection to soften this result, but in that case it depends very much who gets the windfall and who pays the taxes, and we’re basically talking about fiscal rather than monetary policy. And it remains true that monetary expansion carried out through open-market operations does nothing at all.

In the simple model, the only channel through which money can operate when you’re against the zero lower bound is by changing expectations of future inflation. And that’s hard to do.

The main point, however, is that we are a very long way from classic monetarism, of the form that says that the central bank can control broad monetary aggregates like M2 at will, and in turn that these broad monetary aggregates determine the course of the economy. That’s not at all true when you’re up against the zero lower bound — which is why Friedman’s analysis of the Great Depression was wrong, and one reason (the other is the madness of the GOP) why modern Friedmanites are a very small group with no real constituency.

So what Bernanke recommended to the Bank of Japan was fiscal policy not monetary policy. So strictly speaking the central bank can do more, it's just that open-market operations do nothing.

KHAAAAAN!

commenter Denim at Economist's View:

Basically the New Deal was slowly bled in order to replace it with fierce dog eat dog competition among us wage slaves and small businesses via deregulation and turning a blind eye toward predatory pricing by the behemoths. That began with Jimmy Carter's Alfred E Kahn inflation and deregulation guru. All Presidents thereafter adopted this meme. All. 

http://en.wikipedia.org/wiki/Alfred_E._Kahn 

http://query.nytimes.com/mem/archive/pdf?res=F70B12FC3C5512728DDDA00894D9415B8084F1D3 

Why do the current crop think they have it right?
http://www.thedailybeast.com/articles/2013/04/26/daniel-kahneman-s-gripe-with-behavioral-economics.html

Pace Yglesias.

 

Obama

Good press conference by Obama yesterday. He stressed the Fed's role in fighting unemployment. He said that Summers's opponents floated his name to attack him pre-emptively, a "Washington trick." 

And he schooled the GOP over the ACA with heavy sarcasm. I was laughing. I thought he was better than Clinton.

the lame recovery

PAUL KRUGMAN: PHONY FEAR FACTOR: NOTED FOR AUGUST 9, 2013 by DeLong

DeLong approvingly quotes Krugman's column where he discusses debt deleveraging and the main thesis of the popular book "This Time It's Different." He also linked to a Krugman blogpost on the subject.

How does this jibe with DeLong's blogposts on the lame recovery? DeLong says the credit channel isn't working while Krugman says it's working fine, it's just that people are paying down debt instead of spending or investing. That's why recoveries from popped asset-bubbles take so much time (and because of poor demand management problems as Bernanke ironically noted when asked about the book by a Democratic member of the House.) Once people are finished deleveraging, they can redirect that demand towards consumption and investment. Five years is a long time. Also part of it is that people are scared. Young people are afraid to invest in a house when they've experienced relatives and friends lose their homes.

Gerson - rogues gallery troll

Michael Gerson Doesn't Like Quantitative Easing and Misrepresents Bernanke's Statements to Make His Case by Dean Baker

Michael Gerson used his column today to warn of the bad effects of quantitative easing, telling readers that it is concealing structural problems. To make his case, he completely misrepresented statements from Federal Reserve Board Chairman Ben Bernanke. 

After referring to comments from Mario Draghi, the President of the European Central Bank, urging governments take steps to increase potential growth, Gerson tells readers 

"Outgoing Fed Chairman Ben Bernanke has been gently suggesting there are limits to what the Fed can accomplish and warning against counterproductive fiscal policies and confidence-shaking political confrontations. Jeffrey Lacker, president of the Richmond Federal Reserve, argues that economic growth is limited 'in large part, by structural factors that monetary policy is not capable of offsetting.'" 

In this context readers would naturally believe that Bernanke was also warning about structural obstacles to growth, which is the theme pushed in the rest of Gerson's column. This is not true. 

Bernanke was very clearly warning about the negative effects of the sequester and ending of the payroll tax cut, both of which reduced demand. Gerson is being dishonest when he is trying to enliist Bernanke as an ally in his assertion that the obstacles to economic growth at the moment are primarily structural. He quite clearly believes the opposite which is what he told Congress in arguing for expansionary fiscal policy and also the reason why he would pursue his quantitative easing policy. 

It is also ironic that Gerson cites Germany as a success story that has effectively dealt with its structural problems. Germany's growth since 2007 has been no better than growth in the United States. (Part of this is explained by its lower population growth, which means that it has lower potential growth.) 

The main reason why Germany has an unemployment rate of just 5.4 percent, compared to 7.5 percent at the start of the downturn, is measures such as work sharing which encourage employers to keep workers on the job but with fewer hours. The average work year in Germany is almost 20 percent shorter than in the United States. This is a huge factor in explaining its high employment levels. Unfortunately Gerson neglected to mention this fact.

Phony Fear Factor by Krugman

The rightwing lies and lies about politics and political economy.

Franz Ferdinand

debt overhang

Doesn't exactly jibe with DeLong's take.

What Janet Yellen — And Everyone Else — Got Wrong by Krugman

Unfortunately, the economy didn’t come roaring back. Why? 

The best explanation, I think, lies in the debt overhang. For the most part, even those who correctly diagnosed a housing bubble failed to notice or at least to acknowledge the importance of the sharp rise in household debt that accompanied the bubble: 

 

Ratio of household debt to personal income 

And I would argue that this debt overhang has held back spending even though financial markets are operating more or less normally again. 

Finally, nobody really anticipated the disastrous response of policy, above all the squeeze on public spending at a time when we needed more government spending to sustain the economy until private balance sheets were repaired. Here’s total (all levels) government spending deflated by the implicit GDP deflator (an overall price index), comparing the last recession and aftermath with the Bush years; if spending had grown this time the way it did in the past, unemployment would probably be close to 6 percent: 

In short, getting the bubble right, while no small thing, wasn’t enough; Yellen (and many other people, myself included) underestimated the fragility of the financial system, but also the importance of household debt, and, above all, the foolishness of policymakers.

How does debt overhang show up in the demand data? Consumer spending? Business investment? Housing?

AV Club reviews "The Beast" from The Bridge

Colbert and friends dancing to Daft Punk

Daft Punk bailed on The Colbert Report last night, but Stephen Colbert emerged victorious

(Read the comment discussion, please.)

I saw on the Program Guide that Daft Punk was scheduled to be on Colbert so figured I'd check it out. Didn't expect to have MY FUCKING MIND BLOWN!!!

Bryan Cranston Roller Disco??? Jon Stewart Skyping from Iran??? War Criminal Kissinger working in his office! "WHISKEY-TANGO-FOXTROT-BANG-QUERY."

The Great C and its aftermath

THE FOUR MAJOR COMPONENTS OF AUTONOMOUS SPENDING ARE STILL 3% POINTS BELOW THEIR BUSINESS-CYCLE PEAK SHARES OF POTENTIAL GDP by DeLong

And that--plus extra drag from reduced consumption from the collapse of housing wealth and the underwater status of many homeowners--is why our GDP is currently 6 percent below the economy's productive potential and we have not had our V-shaped recovery.

[chart] 

Without a stronger economy and thus capacity shortages we are unlikely to get a boom in equipment investment. Without a much lower value of the dollar and a stronger world economy we are unlikely to get much stronger exports. If we are not going to get a much lower value of the economy, then strong short-run growth hinges on: 

a reversal of government-spending austerity and a restoration of government spending to its proper share of potential GDP; 

a housing recovery; or 

both. 

What are the policies that could produce such an outcome? And why isn't the Obama administration proposing them? 

Is it possible to raise the inflation target? by Simon Wren-Lewis

Money*

Money, get away
Get a good job with more pay
And your O.K.

Money, it's a gas
Grab that cash with both hands
And make a stash

New car, caviar, four star daydream
Think I'll buy me a football team

I like Ezra Klein and Wonkblog (Neil Irwin, Sarah Kliff, etc.), Greg Sargent and Harold Meyerson. Steve Callendar is hit or miss.

----------------------
*Pink Floyd tune

MMT

Guest post: Dual mandate — right goals, wrong agency? by Stephanie Kelton

Under the Dumb

AV Club reviews "Imperfect Circles" from Under the Dome

Pediction

Mistermix at the overrated Ballonjuice:

"If I worked at Slate, I’d be polishing my résumé ."

What a dick. The Washington Post Company is no longer losing money on the Post. It just sold Newsweek. Maybe he's right but I wouldn't be so hardcore dick confidant about the prediction. He wants to come off as a hard guy.

That being said, whenever there's a sale of one company to another, it's always bad news for the employees. Companies aren't charitable organizations. 

books and bankers can alter history

What did FDR Write Inside His Copy of the Proto-Keynesian Road to Plenty? by Mike Konczal

...Though Roosevelt didn't buy it at first, he thankfully later evolved on the issue. One lucky reason is because a big fan of the book was a Utah banker who read it intensely starting in 1931, when the Depression seemed like it would never end, much less recover. That man's name was Marriner Stoddard Eccles. The rest, as they say, is history. (Except it's not, because we are currently fighting this all over again.) 

The book* itself is a series of conversations among strangers on a Pullman-car over what is going on in the economy.

So if not for a book and an influential fan, things may have turned out very differently.

Detroit Rock City

Detroit Rock City

Hawk (Edward Furlong), Lex (Giuseppe Andrews), Trip (James DeBello), and Jam (Sam Huntington) are four rebellious teenagers who love rock and roll and idolize KISS. The group are elated to have tickets to see KISS in Detroit the following night. Having discovered a secret cache of KISS albums, Jam's ultra-conservative and religiously hysterical mother, Mrs. Bruce (Lin Shaye), races up to the house where the boys are hanging out and drags Jam home. Jam's mother discovers the tickets the next day and destroys them in front of Jam and the others. She then pulls Jam from his school and has him transferred to a Catholic boarding school.

While in class, the three remaining boys hear a radio contest for tickets to the show. Trip leaves class to call the contest line and ends up winning the tickets. The boys then ditch school to bust Jam out. At the Catholic school, Hawk disguises himself as a pizza delivery guy and delivers a pizza spiked with hallucinogenic psilocybin mushrooms to Father McNulty. The priest gets high, allowing the group to whisk Jam away.

On the freeway, Trip throws a slice of pizza out of the window, where it hits the windshield of a tailgating Trans Am, driven by two Italian-American Disco fanatics, Kenny and Bobby, along with their girlfriends Christine (Natasha Lyonne) and Barbara (Emmanuelle Chriqui). The enraged Kenny forces the station wagon off the road and proceeds to pull Hawk out of the car and rub his face on the cheese-covered windshield. The bullying upsets Christine who leaves, walking down the freeway. Hawk then knees Kenny in the groin and knocks him out, leaving Bobby to contend with all four boys who suddenly pull out weapons (A metal KISS belt buckle, a wallet chain, and Jam's drumsticks). They leave the disco fans tied to the guardrail with KISS makeup on and drive the Trans Am into a ditch. They come upon Christine walking down the freeway and offer a ride to the city.

Upon arrival, the groups discovers that Trip did not stay on the phone long enough to give the radio station his information, forcing the station to give the tickets to the next caller. Back outside, Lex notices that the car has been stolen. They suspect Christine, who they left sleeping in the car. Hawk then suggests that the boys go their separate ways in order to find KISS tickets, and agree to meet in the same place in an hour.

Hawk finds a scalper who suggests that he enter a strip contest to raise money for tickets. He doesn't win, but is offered payment for his company by an older woman (Shannon Tweed). They go to her car and she takes his virginity. Afterwards, Hawk declines the money she offered, but she insists. When Hawk locates the scalper again he runs off, indicating he's all sold out, much to Hawk's dismay.

Trip goes to a local convenience store in the hopes of mugging a younger child to get tickets. He grabs a kid in Ace Frehley makeup, but the kid has an older brother, Chongo; a hulking jock who, with his gang of thugs, threaten to beat him up unless Trip pays them $200.00. Trip plans to rob the convenience store with a fake gun (in reality a Stretch Armstrong toy), but ends up thwarting a real robbery attempt at the store, earning him a $150.00 reward and a passionate kiss from the cashier (Kristin Booth). Trip meets the thugs in an alleyway behind the store. The kid takes Trip's wallet and has Chongo punch Trip in the stomach.

Lex sneaks backstage with the KISS loading crew, but is soon discovered, causing him to flee from arena security. He is eventually caught and tossed over a fence. He is then menaced by a group of vicious dogs, but earns their trust when he plays frisbee with them. In a nearby building he discovers a chained-up Christine and his car in a chop shop with two car thieves. Lex then uses his newly befriended dogs to chase the two thugs into a back office room, saving Christine and his mom's car. Lex and Christine share a passionate kiss.

Jam encounters his mother leading an anti-KISS rally. Mrs. Bruce grabs him and drags him to a church across the street for confession, taking away his drumsticks. He is seen by Beth (Melanie Lynskey), a girl from his school who is in the process of moving with her parents. She rushes into the church and into the confessional booth. There she reveals to Jam that she's been in love with him since freshman year, but never had the courage to tell him. Jam and Beth then make love, losing their virginity to one another. Jam, now imbued with new confidence, goes back to the rally. Jam finally stands up for himself, berating his mother for her domineering ways, her lack of understanding and her hypocrisy at telling other people how to live their lives when she can't even relate to her own son. Jam then demands his drumsticks back and Mrs. Bruce acquiesces, though she's broken one of them.

When the boys meet up again, at Jam's suggestion, they beat each other up in order to say that muggers took their tickets. Upon arrival at the concert the guards are skeptical despite the boys nursing bloody wounds, but suddenly Trip points out the kid and his thugs from the convenience store, who are just entering the concert hall. The guards finds Trip's wallet (with his KISS Army picture ID and the $150.00 he got as reward for thwarting the robbery) on the kid's person. The tickets are taken from the kid and handed to Trip and security escorts the kid and his goons off the premises.

Astonished and elated, the boys enter the concert hall and KISS plays the title song of the movie, "Detroit Rock City". Jam catches a drum stick thrown by drummer Peter Criss as the film ends.

The New New Economy

The United States is doing better than Europe but not better than Germany.

In Germany, Union Culture Clashes With Amazon’s Labor Practices

Jeff Bezos Buys Washington Post—Not The Washington Post Company by Yglesias

post-war Fed

The Fed & Big Banking at the Crossroads by Paul Volcker

I have been struck by parallels between the challenges facing the Federal Reserve today and those when I first entered the Federal Reserve System as a neophyte economist in 1949.

Most striking then, as now, was the commitment of the Federal Reserve, which was and is a formally independent body, to maintaining a pattern of very low interest rates, ranging from near zero to 2.5 percent or less for Treasury bonds. If you feel a bit impatient about the prevailing rates, quite understandably so, recall that the earlier episode lasted fifteen years.

The initial steps taken in the midst of the depression of the 1930s to support the economy by keeping interest rates low were made at the Fed’s initiative. The pattern was held through World War II in explicit agreement with the Treasury. Then it persisted right in the  face of double-digit inflation after the war, increasingly under Treasury and presidential pressure to keep rates low.

The growing restiveness of the Federal Reserve was reflected in testimony by Marriner Eccles in 1948:

"Under the circumstances that now exist the Federal Reserve System is the greatest potential agent of inflation that man could possibly contrive."

This was pretty strong language by a sitting Fed governor and a long-serving board chairman. But it was then a fact that there were many doubts about whether the formality of the independent legal status of the central bank—guaranteed since it was created in 1913—could or should be sustained against Treasury and presidential importuning. At the time, the influential Hoover Commission on government reorganization itself expressed strong doubts about the Fed’s independence. In these years calls for freeing the market and letting the Fed’s interest rates rise met strong resistance from the government.

Treasury debt had enormously increased during World War II, exceeding 100 percent of the GDP, so there was concern about an intolerable impact on the budget if interest rates rose strongly. Moreover, if the Fed permitted higher interest rates this might lead to panicky and speculative reactions. Declines in bond prices, which would fall as interest rates rose, would drain bank capital. Main-line economists, and the Fed itself, worried that a sudden rise in interest rates could put the economy back in recession.

All of those concerns are in play today, some sixty years later, even if few now take the extreme view of the first report of the then new Council of Economic Advisers in 1948: “low interest rates at all times and under all conditions, even during inflation,” it said, would be desirable to promote investment and economic progress. Not exactly a robust defense of the Federal Reserve and independent monetary policy.

Eventually, the Federal Reserve did get restless, and finally in 1951 it rejected overt presidential pressure to maintain a ceiling on long-term Treasury rates. In the event, the ending of that ceiling, called the “peg,” was not dramatic. Interest rates did rise over time, but with markets habituated for years to a low interest rate, the price of long-term bonds remained at moderate levels. Monetary policy, free to act against incipient inflationary tendencies, contributed to fifteen years of stability in prices, accompanied by strong economic growth and high employment. The recessions were short and mild.

(Emphasis added.) "Short and mild" unlike Vocker's recession. His "exit strategy" was overrated.  Didn't the double-digit inflation/financial repression help with deleveraging. Many economists at the time like Paul Samuelson expected the economy to return to Depression after the war.