Great-grandmother's slump

Krugman in 2002:

The key point is that this isn't your father's recession -- it's your grandfather's recession. That is, it isn't your standard postwar recession, engineered by the Federal Reserve to fight inflation, and easily reversed when the Fed loosens the reins. It's a classic overinvestment slump, of a kind that was normal before World War II. And such slumps have always been hard to fight simply by cutting interest rates.

Now there's no question that the Fed's rapid rate reductions last year helped avert a much bigger slump. But a hard look at monetary policy suggests that the Fed hasn't done enough -- and possibly can't do enough. Although the Fed funds rate, the usual measure of monetary policy, is at its lowest level in generations, the real Fed funds rate -- the interest rate minus the inflation rate, which is what matters for investment decisions -- is actually about the same as it was at the bottom of the last recession, in the early 1990's, because inflation is considerably lower.

The link is found in this blog post from February 2009:

So, how does this all end?

I’ve been saying for a long time that this isn’t your father’s recession — it’s your grandfather’s recession. (I actually used the phrase about the last recession, too.) That is, it isn’t something like the 1981-82 recession, which was brought on by the Fed to control inflation, and ended when the Fed decided that we had suffered enough. Instead, it’s like the 1929-33 recession — or the recession of 1873-1879 — a slump brought on by the collapse of an investment and credit bubble. And monetary policy, at least in its conventional form, has already reached its limits.

Now, the Great Depression was ended by massive fiscal expansion, in the form of World War II. Maybe that will happen again; but so far policy seems inadequate to the task, and the political environment raises concerns about whether we’ll be able to do much more.

So we may end up waiting for the economy’s ills to go into spontaneous remission. Which raises the question, how does that happen?

And it turns out that this is a question our grandfathers thought about quite a lot. Maybe it’s time to dust off Keynesian business cycle theory.

Keynes himself actually didn’t have much to do with this theory. In fact, one of the key moves in his development of the General Theory was the decision to focus on how economies stay stuck in depression for extended periods, rather than on the more complex question of explaining the economy’s ups and downs. But he did devote a brief chapter at the end to the subject, and Hicks elaborated on this quite a lot.

What’s notable about this theory is that it made no use of the self-correcting mechanism expounded in every principles textbook, mine included — the mechanism in which falling prices lead to a rising real money supply, which shifts the aggregate demand curve out moves the economy down the aggregate demand curve. Why? Well, as we’ve now learned the hard way, a sufficiently severe bubble-bursting pushes you into the liquidity trap, and makes the aggregate demand curve more or less vertical.

Instead, recovery comes because low investment eventually produces a backlog of desired capital stock, through use, delay, and obsolescence. And eventually this leads to an investment recovery, which is self-reinforcing.

And what do we mean by use, delay, etc.? Calculated Risk had a nice piece on auto sales, which I find helps me to think about this concretely. As CR pointed out, at current rates of sale it would take 23.9 years to replace the existing vehicle stock. Obviously, that won’t happen. Even if the desired number of vehicles doesn’t rise, people will start replacing vehicles that wear out (use), rust away (decay), or just are so much worse than newer models that they’re worth replacing to get the spiffy new features (obsolescence).

As autos go, so goes the capital stock. In the long run, we will have a spontaneous economic recovery, even if all current policy initiatives fail. On the other hand, in the long run …

How is Japan's lost decade different? Deflation?

Winter Work Done on the Farm by Robert J. Shiller (October 15, 2011)

Winter Work Done on the Farm by Mark Thoma (December 8, 2010)

Pehaps it's a common analogy used in Economics?

What Really Caused the Eurozone Crisis? by Kash Mansori

From a recent speech by Narayana Kocherlakota

But this connection between bank reserves and inflation is simply not operative right now. Banks have few good lending opportunities, and so they’re not trying to attract deposits. As a result, they are keeping nearly $1.6 trillion of reserves at the Fed in excess of what they need to back their deposits. In other words, banks have the licenses to create money, but are choosing not to do so.

Endless Stagnation is Bad for Banks by Yglesias

Dallas Fed Board of Directors

Minneapolis Fed Board of Directors

Philadelphia Fed Board of Directors

From Greider's Secrets of the Temple: How the Federal Reserve Runs the Country:

The ideological implications of the money system had to be understood on two different planes. The idea of money created through new debt offended many conservatives because, in essence, it was a forward-looking process, a social commitment to the future. Bankers were not ordinarily thought of as a progressive element in American politics, yet banking itself functioned on the premise of progress, on a working belief that reliable gambles could be made in the future. On this faith rested the process of economic growth, the financing of new ideas and ventures, of change and innovation. The folk wisdom feared debt, yet future prosperity depended on it.

The folk fears were correct in only one sense: if a society contracted too many claims against the future, if it amassed debts that the future economic effort could not possibly pay off, sooner or later it would pay the consequences.... Bankers as a consequence dwelt between two conflicting commandments: one was to be generous with the future, to take risks and make loans that businesses needed to expand and consumers needed to buy: the other was to be always prudent in the risk taking...

interview with Frances Fox Piven

Arrested Development film in the works

The Demands of Occupy Wall Street

Yglesias relays that Rush Limbaugh endorses The Lord's Resistance Army.

Hitchens article from 2006.

On the Fed (from Doug Henwood's book Wall Street, downloadable here)

"Fantastic fears of inflation were expressed. That was to cry, Fire, Fire in Noah's Flood."

Overcoming America's Debt Overhang: The Case for Inflation by Christopher Hayes (Sept. 9, 2009 two years ago)

(via Rortybomb)

Also from Rortybomb:

First, also from Ezra’s article, Joe Stiglitz gets the core of it:

Yet even among economists who admire Reinhart and Rogoff’s work, there is skepticism.  One source comes in how Reinhart and Rogoff find the economic phenomena they’re trying to study. “There’s an identification problem,” Stiglitz says. “When you have underlying problems that are deep, they will cause a financial crisis, and the crisis itself is a symptom of underlying problems.”

Next Ben Bernanke, transcript:

CHAIRMAN BERNANKE: …I thought [This Time It's Different] was informative and as you say, it makes the point that as a historical matter, recoveries following a financial crisis tend to be slow.

What the book didn’t do is give a full explanation of why that’s the case. Part of it has to do with the problems in credit markets. My own research when I was in academia focused a good deal on the problems in credit markets on recoveries…

That said, another possible explanation for the slow recovery from financial crises might be that policy responses were not adequate. That the recapitalization of the banking system, the restoration of credit flows and the monetary fiscal policies were not sufficient to get as quick a recovery as might otherwise have been possible.

Here is Joe Gagnon:

Some have argued that economies take longer than normal to return to full employment after financial crises (Reinhart and Rogoff 2009). However, there is a wide range of growth outcomes after financial crises, and the worst outcomes tended to be associated with the poorest policy responses.

The goal of policymakers should be to learn from the past and achieve a better outcome than simply the average of past outcomes. In the current crisis, the zero bound on interest rates has been a major factor preventing monetary policymakers from doing as much as they otherwise would to speed recoveries. But, as discussed below, the zero bound is not a limit on what monetary policy can do. There is plenty of scope for further monetary stimulus.

DeLong sends us to Miguel Almunia, Augustin S. Bénétrix, Barry Eichengreen, Kevin H. O’Rourke, and Gisela Rua: 18 November 2009:

The effectiveness of fiscal and monetary stimulus:

There is one important source of information on the effectiveness of monetary and fiscal stimulus in an environment of near-zero interest rates, dysfunctional banking systems and heightened risk aversion that has not been fully exploited: the 1930s.... [W]here fiscal policy was tried, it was effective.

...
Cross-country comparisons can thus help us untie the Gordian Knot and move the debate from the realm of ideology to that of evidence. Our project therefore focuses on assembling annual data on growth, budgets and central bank policy rates, mainly from League of Nations sources, for 27 countries covering the period 1925-39....

The details of the results differ, but the overall conclusions do not. They show that where fiscal policy was tried, it was effective. Our estimates of its short-run effects are at the upper end of those estimated recently with modern data; the multiplier is as large as 2 in the first year, before declining significantly in subsequent years....

The results for monetary policy are less robust but point in the same direction. A positive shock to the central bank discount rate leads to a fall in GDP... [that] just misses statistical significance at conventional levels.... This result is notable, given the presumption, widespread in the literature, that monetary policy is ineffective in near-zero-interest-rate (liquidity trap) conditions. On the contrary, in the 1930s it appears that accommodating monetary policy helped, by transforming deflationary expectations (Temin and Wigmore 1990) and by helping to mend broken banking systems (Bernanke and James 1991). Given the prevalence of both problems circa 2008, we suspect that the results carry over...

So ... fiscal policy gives more bang for the buck with a multiplier of 2 and monetary policy is less robust but pointing in the same direction. "Accomodating monetary policy helped, by transforming deflationary expectations and by helping to mend broken banking systems."

The Beatings Will Continue*

Who'll Stop the Pain? by Krugman (February 19, 2009)

So will our slump go on forever? No. In fact, the seeds of eventual recovery are already being planted.

Consider housing starts, which have fallen to their lowest level in 50 years. That’s bad news for the near term. It means that spending on construction will fall even more. But it also means that the supply of houses is lagging behind population growth, which will eventually prompt a housing revival.

Or consider the plunge in auto sales. Again, that’s bad news for the near term. But at current sales rates, as the finance blog Calculated Risk points out, it would take about 27 years to replace the existing stock of vehicles. Most cars will be junked long before that, either because they’ve worn out or because they’ve become obsolete, so we’re building up a pent-up demand for cars.

The same story can be told for durable goods and assets throughout the economy: given time, the current slump will end itself, the way slumps did in the 19th century. As I said, this may be your great-great-grandfather’s recession. But recovery may be a long time coming.

The closest 19th-century parallel I can find to the current slump is the recession that followed the Panic of 1873.** That recession did eventually end without any government intervention, but it lasted more than five years, and another prolonged recession followed just three years later.

You can see, then, why some Fed officials are so pessimistic.

Let’s be clear: the Obama administration’s policy initiatives will help in this difficult period — especially if the administration bites the bullet and takes over weak banks. But still I wonder: Who’ll stop the pain?

Krugman is prescient again as usual.

I've been rereading William Greider's Secrets of the Temple: How the Federal Reserve Runs the Country. He argues that Arthur Burns - Fed Chairman from 1970-78 - is the original History's Greatest Monster. An economics professor at Columbia, Burns was appointed by Nixon (thanks tricky Dick!) and had a reputation as a real hardass inflation hawk. However he was accused of priming the pump to help Nixon win the 1972 election. Nixon's Federal budget was already highly stimulative and the Fed added rapid money growth which approached 11 percent three months before the election. The following year had runaway inflation followed by the Fed tightening and a painful recession. Greider reports that some governors said Burns and the Fed had made an "honest mistake" and there was no conscious political manipulation of the economy. Later the Bush clan would blame Greenspan for causing Poppy to lose his re-election campaign to Clinton.***

Carter replaced Burns with G. William Miller and as Greider writes:

In Wall Street circles Miller was blamed for the surging inflation of 1978 and 1979, but Fed insiders understood that Miller had inherited errors made earlier by Burns - excessive monetary growth in late 1976 and 1977. One Fed official who worked closely with Burns attributed the mistakes to Burns's deep desire to win appointment to another term as chairman from the new Democratic administration elected in 1976. Money growth accelerated in the months right after Carters election - and Burns began a private campaign to ingratiate himself with the Carter White House. His campaign for reappointment ultimately failed, but monetary economists attributed the subsequent surge in inflation to Burns's overly generous money policy in the opening months of the Carter Adminstration.

There was also the oil shocks of the 1970s and unions could negotiate price hikes into contracts.
-----------------------------
* Until Morale Improves ... or Not.

** Wikipedia entry on the "Long Depression."

Monetary responses

In 1874, a year after the 1873 crash, the United States Congress passed legislation called the Inflation Bill of 1874 designed to confront the issue of falling prices by injecting fresh greenbacks into the money supply.[34] Under pressure from business interests, President Grant vetoed the measure.[34] In 1878, Congress overrode President Hayes's veto to pass the Silver Purchase Act, in a similar but more successful attempt to promote "easy money."[21]

Labor unrest
The United States endured its first nationwide strike in 1877, the Great Railroad Strike of 1877.

*** According to the Wikipedia entry on Burns:

When Vice President Richard M. Nixon was running for President in 1959–1960, the Fed, under the Truman-appointed William McChesney Martin, Jr., was undertaking a monetary tightening policy that resulted in a recession in April 1960. ^{[further explanation needed]} In his book Six Crises, Nixon later blamed his defeat in 1960 in part on Fed policy and the resulting tight credit conditions and slow growth. After finally winning the presidential election of 1968, Nixon named Burns to the Fed Chairmanship in 1970 with instructions to ensure easy access to credit when Nixon was running for reelection in 1972. 

They told me not to smoke drugs but I wouldn't listen,
Never thought I'd get caught and wind up in prison,
Chalk it up to youth, but young age I ain't dissin',
I guess I just had to get it out of my system,
out of my system, out of my system,
Although I'd never do it now - I know what I ain't missin', 
That I went and got it all out of my system,

...

They told me not to steal cars, said I'd wind up in prison,
Thought I knew it all, yeah I wouldn't listen,
Chalk it up to being young, but youth I ain't dissin',
I guess I just had to get it out of my system,
out of my system, out of my system,
Glad I did it all then now I know what I ain't missin', 
That I went and got it all out of my system,

Jeff Madrick on "A Zucotti Park Education"

There was no need at all to worry. Joe Stiglitz, the Nobel laureate economist, and I did a “teach-in” together at Zuccotti Park. It was two Sundays ago now...

...The press, almost uniformly derisive during the initial weeks, shows signs of understanding that the group touches a deep-seated anger and confusion in America. President Obama had to respond to a question about it last week, and said he understood the concerns. Occupy Wall Street is truly national—indeed international. Journalists in Australia and Switzerland have called me for interviews. I am sure others are receiving many such calls.

How could this have happened? Two reasons. The mostly young people who are driving the movement are very well-intentioned. They are almost all well-behaved. Many are highly-educated. They want to learn. And they perceive profound injustice in the land. The crisis they see is not just economic. It is about fairness and democracy. How could one blame those in their twenties for frustration when they can’t get a job with youth unemployment rates so high while Wall Street doles out enormous bonuses?

And the Cold War has long been over.

Doug Henwood on Occupy Wall Street and the Fed

Divisions Grow on Federal Reserve’s Policy Committee by Binyamin Applebaum

WASHINGTON — The Federal Reserve’s policy-making committee is increasingly divided between advocates for stronger steps to bolster the economy and dissenters who see little benefit and considerable risk in such efforts, according to minutes of the committee’s most recent meeting.

The Federal Open Market Committee voted at the end of a two-day meeting in September to begin an effort to reduce long-term interest rates, allowing businesses and consumers to borrow more cheaply.

The Fed disclosed at the time that three members of the 10-person board had voted against the decision. The minutes released Wednesday record that on the other side, two members wanted the Fed to take even stronger action.

...

The minutes do not disclose the names of the two members who favored stronger action, although one obvious candidate is Charles L. Evans, president of the Federal Reserve Bank of Chicago, who has argued publicly that the Fed should move more aggressively to stimulate the flagging economy. 

The names of the three dissenters, however, are public: Richard W. Fisher, president of the Federal Reserve Bank of Dallas; Narayana Kocherlakota, president of the Federal Reserve Bank of Minneapolis; and Charles I. Plosser, president of the Federal Reserve Bank of Philadelphia. They argued that the Fed’s actions were unlikely to help the economy and would increase the chances of a faster pace of inflation.

All three were appointed by the banks in their respective regions. All five members of the committee appointed by the President and approved by Congress voted for more action.

The Fed iPad App

Matt Taibbi on OWS

E.J. Dionne on Elizabeth Warren and George Will

(via DeLong)

MMT or Chartalism

In Krugman's blogpost on the quasi-monetarists he links to Mike Konczal who mentions MMTers alongside Richard Koo, i.e. those who are skeptical of monetary policy. From Wikipedia:

"Austrian economist Robert P. Murphy states that "the MMT worldview doesn't live up to its promises" and that it seems to be "dead wrong".^[18] Daniel Kuehn of the Urban Institute has voiced his agreement with Murphy, stating "it's bad economics to confuse accounting identities with behavioral laws [...] economics is not accounting.""

"New Keynesian Brad DeLong has suggested MMT is not a theory but rather a tautology"

Proponents:
"Bill Mitchell, from the Centre of Full Employment and Equity (CofFEE), at the University of Newcastle, Australia, refers to modern Chartalism as Modern Monetary Theory in the body of work he has developed in the field."

"Cullen Roche, a California based investment manager, published one of the most widely read pieces on MMT titled "Understanding The Modern Monetary System." ^[28] Roche has become one of MMT's most vocal proponents and has engaged Paul Krugman in several debates on the subject of MMT."

"Hyman Minsky seems to favor a Chartalist approach to understanding money creation in his Stabilizing an Unstable Economy^[32], while Basil Moore, in his book Horizontalists and Verticalists^[33], delineates the differences between bank money and state money."

"James K. Galbraith supports Chartalism and wrote the foreword for Mosler's book Seven Frauds in 2010."

The DeLong quote is linked to blogpost titled "Is "Modern Monetary Theory" Modern or Monetary or a Theory?" which is a reaction to a blog post by Steve Randy Waldmann.

I really enjoyed these comments by Waldmann:

In general, the MMT community would be well served by adopting a more civil and patient tone when communicating its ideas. I’ve had several conversations with people who have proved quite open to the substance, but who cringe at the name MMT, having been attacked and ridiculed by MMT proponents after making some ordinary and conventional point. Much of what is great about MMT is that it persuasively challenges a lot of ordinary and conventional views. But people who cling to those views, even famous economists who perhaps “ought to” know better, are mostly smart people who simply have not yet been persuaded. Neither ridicule nor patronizing lectures are likely to help.

My complaint is a bit unfair. The MMT community has been sinned against far more than it has sinned, especially within the economics profession. Whether you ultimately agree with them or not, the MMT-ers have developed a compelling perspective and have done a lot of quality work that has pretty much been ignored by the high-prestige mainstream. But a sense of grievance may be legitimate and still be counterproductive.

The internet is a fractious place. Many MMT-ers are civil and patient, and devote enormous energy to carefully and respectfully explaining their views. There’s no way to police other peoples’ manners. Still, even by the standards of the blogosphere, MMT-ers have a reputation as an unusually prickly bunch. That might not be helpful in terms of gaining broader acceptance of the ideas.

Sometimes I tend to get abusive on the Internet in response to perceived abuse.

Krugman on MMT

Jonathan Chait on Republicans' rank dishonesty and galling hypocrisy

... Rather, it’s that a McCain presidency would, for purely political reasons, offer the possibility of greater Keynesian demand-side response.

Douglas Holz-Eakin, the chief economic advisor to John McCain in 2008 and the president of American Action Forum, a Republican agitprop group, offers a few tantalizing clues. First, he concedes that economic stimulus does in fact boost economic growth:

“The argument that the stimulus had zero impact and we shouldn’t have done it is intellectually dishonest or wrong,” he says. “If you throw a trillion dollars at the economy, it has an impact. I would have preferred to do it differently, but they needed to do something.”

Holz-Eakin, like most economists, but unlike the entire elected wing of the Republican Party since 2009, understands that economic stimulus does in fact stimulate the economy and is the proper response to a disaster like the one we’re experiencing.

The one truly large-scale response to the crisis that exceeded Obama’s response may have been an attempt to shore up the housing market. This bit, from Holz-Eakin, is also tantalizing:

In late 2008, when the economy was cratering, Holtz-Eakin convinced McCain that the way out of a housing crisis was to tackle housing debt directly. “What we proposed at the time was to buy up the troubled mortgages, pay them off and let people refinance at the lower rates,” he recalls. “That would have filled up the negative equity and healed bank balance sheets.” To this day, Holtz-Eakin thinks the proposal made sense. There was one problem. “No one liked that plan,” he says. “In fact, they hated it. The politics on housing are hideous.”

The politics were, indeed, hideous. But they were horrible in a way deeply aggravated by the political circumstances of the moment. You had an all-Democratic government, led by a charismatic, young, black president. Any measures to alleviate the crisis struck millions of conservatives as a terrifying redistribution of wealth, a frightful and permanent unmooring of the nation from its tradition of liberty. This helped encourage the hyper-partisan response of Republican leaders, who abandoned the belief in Keynesian stimulus that they had previously endorsed in 2001 and 2008. (Yes, Republicans passed a stimulus bill in 2008. Their turnabout against stimulus was rapid and total.)

(via Mark Thoma)

Holz-Eakin is advising Romney, as is Mankiw.

(Mankiw on the IS-LM model)

Krugman on the quasi-monetarists (QMs?):

And the diatribes against unorthodox monetary policy seem to me to come completely out of left field, not derived in any way I understand from Koo’s basic analysis. They have the feeling of arguments half-baked on the spot out of annoyance that people aren’t totally buying Koo’s insistence that fiscal policy is the answer; as you can see, I’m for fiscal policy myself, but see monetary policy as a useful supplement.

The queasy quasi-monetarists are, in a way, the mirror image of this position, so focused on the monetary solution that they rail against any suggestion that fiscal policy might play a useful role.

I would submit, by the way, that the quasi-monetarists — QMs? — have actually backed up quite a bit on their claims. They used to say that the Fed can easily and simply achieve whatever nominal GDP it wants. Now they’re more or less conceding that the Fed has relatively little direct traction on the economy, but can nonetheless achieve great things by changing expectations. That’s pretty close to my original view on Japan.

But changing expectations in the way needed is hard, especially when the Fed (a) faces massive sniping from the right and (b) has a number of hard-money obsessives among its own officials.

So my view is that we need to use everything we can — fiscal and monetary policy. And we shouldn’t let a desire to promote our pet solutions block other things that might help.

Well the Senate is blocking Obama's American Jobs Act. Bernanke needs to pull a Volcker.