Relevant and even prescient commentary on news, politics and the economy.

Wages and Steel Tariffs (not painfully wonkish)

Paul Krugman demonstrates just how simple models can and should be. He presented a trade model on the New York Times opinion pages. He also apologised for extreme wonkishness, but I don’t think he had to. His aim is to find an example in which Trump’s tariffs on steel cause lower wages (also for steel workers). Here the trick is to make sure that everyone has the same income “not gonna get into income distribution today”. This means that a reduction in total money metric welfare implies a reduction of each person’s welfare (including workers in the protected industry).

This “itsy-bitsy teeny-weeny model” is a major demonstration of Krugman’s extraordinary ability to make models simple.

Imagine a world of two countries, Home and Foreign. (That’s an old-fashioned trade theory convention.) In both countries, labor is the only factor of production (not gonna get into income distribution today). There are two goods, cars and steel. Cars are a final good, sold to consumers; steel is an input into car production. I’m going to assume that both countries end up producing cars.

To keep down on notation, I’m going to do some sneaky things with choice of units (another old trade theory tradition.) We assume that in each country building a car requires one unit of labor (which amounts to measuring labor in units of how much it takes to build a car.) We also assume, using the same trick, that building a car also requires one unit of steel.

This leaves us with just two parameters to specify: the amount of labor it takes to make one unit of steel in each country. Call this a in Home and a* in Foreign (stars for Foreign is traditional.) And let’s assume that a* < a. That is, Foreign has a comparative advantage in steel production. Under free trade Home will import steel from Foreign. Let w and w* be the wage rates in the two countries, in any common unit. Then the cost of producing a car in Home will be w + w*a* (because we’re importing the steel) while the cost of producing a car in Foreign is w* + w*a* Since both countries will be producing cars, these costs will have to be equal, implying w = w*: wages will be the same. Now suppose Home imposes a tariff sufficiently high to induce car producers to use domestically produced steel instead. Now Home costs of car production are w + wa = w* + w*a* because car production costs must be equal. And this implies w/w* = (1+a*)/(1+a) <1 That is, to offset the higher costs imposed by the tariff, Home’s relative wage has to fall – the opposite of what you expect from a tariff on final goods.

My points (if any) are that it is equally easy to find and example in which tariffs on final goods can be bad for everyone in the protecting country and another model in which tariffs on intermediate goods are bad for workers in the country which doesn’t protect (and do not harm or benefit people in the country which does protect).

So model 2 in both countries, 1 unit of labor is needed to make 1 unit of steel. In the home country, 1 unit of steel and a units of labor are needed to make a car and in the forgeign country 1 of steel and a* of labor are needed with a*a. So with free trade all cars are made domestically. The real wage is 1/(1+a) in both countries. With steel tariffs, foreigners start making cars. Then their wage in cars is 1/(1+a*) < 1/(1+a). So it is about equally easy to get any result one wants.

Comments (1) | |

Candidate Specific Response Bias in Polls

Low response rates are a problem for pollsters. The worst problem is candidate specific response bias in which supporters of one candidate are more likely to respond than supporters of another. This can make polls worthless. It is interested to the other very hard problem of predicting who will actually vote.

I am thinking of something a friend told me about 2012. Obama’s support dropped dramatically after the first debate (and this is clearer with the campaigns gigantic sample polls). You said you talked to one of Obama’s pollsters and she told you that they concluded this was due to changing responce rates to the poll — that people who supported Obama didn’t want to talk about politics.

I have been thinking about how to determine this using the rich data from voter registries which they had. I had a thought. I think it might be possible to get useful information about response rates and bias by polling as well as possible and also badly. It is hard to make the problem smaller, but easy to make it larger.

The idea is that with comparitively weak assumptions, one can figure out response bias by looking at how much larger it is with the worse interview approach. So do both human direct dial and robopoll (machine call) & compare response rates as a function of observed characteristics *and* support for candidates among respondents. Or human calls & either says thank you and hangs up at first resistence, or read a brief script asking people who say they are busy to please participate in a special super brief one minute poll.

Without this I think they had to make strong assumptions about how the disturbance to the participation probit and the support Obama regression are jointly normal. I might be ignorant, but I think this is true.

I think such different interview scripts (and human vs machine) might also be useful for predicting who will actually vote. The first election it is tried, it can only be compared to people claiming they will certainly vote, but with actual turnout data (votes are secret — who voted is not secret) things could be improved.

The point, if any, is that campaigns have huge resources compared to independent pollsters who publish results — just polling a huge sample is not necessarily the best way to use those resources.

Comments (3) | |

Krugman, Mundell, Fleming, Summers, DeLong, and Rogoff

Here I go again, commenting on Krugman. But this time on a 5 year old talk on the risk that investors will lose confidence in the solvency of the US Treasury “CURRENCY REGIMES, CAPITAL FLOWS, ANDCRISES”. I think the talk about the risks of excessive budget deficits and unsustainable debt accumulation is much more relevant today than it was in 2013, since Republicans currently in power (not just Trump) will eliminate confidence that the US Treasury will pay its debts, if that is possible.

Krugman, however, thinks that a country which borrows in its own currency and allows the exchange rate to float can never be insolvent — the government can always monetized deficits and inflate away the value of its debt. He also argues that if investors lost faith in the US Treasury and decided Treasury notes and bonds would be worth little (either because of default or inflation) then the result would be a depreciation of the dollar.

He presents models in which this would stimulate demand for an economy in the liquidity trap (as the USA was in 2013). The counter argument is that this depreciation would cause a financial crisis in the USA. The key point of disagreement is explained by Krugman here:

Several commentators – for example, Rogoff (2013) — have suggested that a sudden stop of capital inflows provoked by concerns over sovereign debt would inevitably lead to a banking crisis, and that thiscrisis would dominate any positive effects from currency depreciation. If correct, this would certainly undermine the optimism I have expressed about how such a scenario would play out.

The question we need to ask here is why, exactly, we should believe that a sudden stop leads to a banking crisis. The argument seems to be that banks would take large losses on their holdings of government bonds. But why, exactly? A country that borrows in its own currency can’t be forced into default, and we’ve just seen that it can’t even be forced to raise interest rates. So there is no reason the domestic-currency value of the country’s bonds should plunge. The foreign-currency value of those bonds may indeed fall sharply thanks to currency depreciation, but this is only a problem for the banks if they have large liabilities denominated in foreign currency, a topic I address below

Here Krugman assumes investors are rational. Loss of confidence in the US Treasury doesn’t logically imply loss of confidence in banks. Larry Summers and Brad DeLong argue that investors are irrational and loss of one kind of confidence spills over to fear itself, which we have to fear. Knowing that economic agents are irrational but modeling rational ones implies that we know more than what is in our models.

I guess that the argument is that irrational fear due to sharp depreciation of the dollar could cause a banking crisis in the USA, even though it shouldn’t because US banks have dollar denominated liabilities. I further guess that it is true that general panic could cause a banking crisis in the USA — this doesn’t even have to be irrational — if there are multiple Nash equilibria assuming even Magic Nash rationality isn’t enough to rule out the possibility — a self fulfilling prophecy is a sunspot equilibrium not irrationality.

However, it does seem possible to rule out bad possibilities with rules. Economies used to have bank runs. Now they don’t because there is deposit insurance and/or a lender of last resort. The crisis of 2008 involved non-depository institutions which were acting as shadow banks transforming maturity so they had long term assets and short term liabilities. They weren’t covered by deposit insurance nor were they regulated much.

The Dodd-Frank act may have vastly reduced this risk. It is clear that the risk of financial crises can be very low — there wasn’t one n the USA during the long period of tight regulation from the 1930s through the 1970s. Nixon’s shift from fixed to floating exchange rates was a dramatic event in which the US government said it couldn’t keep a (non legally binding) promise. There was no banking crisis.

This means that the reasonable response to the concerns of Rogoff, DeLong, and Summers is to make sure regulations are sufficiently tight. Unfortunately, this too is highly relevant now. In addition to slashing taxes and raising spending, Congress also decided to relax regulations on medium sized banks with assets up to $249,999,999,999.99 . The argument is that this time the consequences of deregulation will be different.

It is too bad that a 5 year old discussion of possible problems is so topical. The change is that the possible risks have become probable now when Trump replaced Obama.

Comments (2) | |

Krugman, Heckscher, Ohlin, Samuelson, Autor, Dorn, and Hanson

Paul Krugman has been wondering why stock market indices fell so sharply soon after Trump began trade-war-mongering. (also less wonkily here) He starts by noting that it’s a mugs game to try to explain stock market fluctuations, but then tries all the same.

The puzzle is that according to the very standard Heckscher Ohlin Samuelson model, the effect even of a severe trade war on GDP is fairly small. On the other hand the decline in the Dow (which he pegs at 6%) is large. Also Autor, Dorn and Hanson famously estimated a large effect of “The China Syndrome” on local labor markets (pdf warning).

His argument is basically

there is a reason why stock prices might overshoot the overall economic costs of a trade war. For a trade war that “deglobalized” the U.S. economy would require a big reallocation of resources, including capital. Yet you go to trade war with the capital you have, not the capital you’re eventually going to want – and stocks are claims on the capital we have now, not the capital we’ll need if America goes all in on Trumponomics.

Or to put it another way, a trade war would produce a lot of stranded assets.

For this post, it is even more necessary to click the link and read Krugman. I can’t summarize competently.

This post turned out to be really bad, so I am putting the rest after the jump.

Comments (0) | |

Total Blockchain Blocker Man

This essay is excellent. Just click the link.

Kai Stinchcombe argues

“blockchain is a … technology, not a metaphor”

here’s what blockchain-the-technology is: “Let’s create a very long sequence of small files — each one containing a hash of the previous file, some new data, and the answer to a difficult math problem — and divide up some money every hour among anyone willing to certify and store those files for us on their computers.”

Now, here’s what blockchain-the-metaphor is: “What if everyone keeps their records in a tamper-proof repository not owned by anyone?

He argues that blockchain technology does not eliminate the need for trusted intermediaries. He also argues that trust is good and that societies which rely on trust are better then ones which do without it.

I think he shouldn’t assume everyone knows what a hash is. It’s just a function (hash function) which maps from huge numbers to medium sized numbers (so not a one to one function). Also he shouldn’t assume I know what a smart contract is. It appears to be a program that actually transfers funds as soon as it is digitally signed rather than just telling people to pay other people.

There is an implicit challenge in the essay

There is no single person in existence who had a problem they wanted to solve, discovered that an available blockchain solution was the best way to solve it, and therefore became a blockchain enthusiast.

I am not a blockchain enthusiast & I want to try to meet this challenged here in this post. There is a strong hint here (sadly criminal but it doesn’t have to be).

Same with Silk Road, a cryptocurrency-driven online drug bazaar. The key to Silk Road wasn’t the bitcoins (that was just to evade government detection), it was the reputation scores that allowed people to trust criminals. And the reputation scores weren’t tracked on a tamper-proof blockchain, they were tracked by a trusted middleman!

So the challenge is how to have (relatively) trustworthy reputation scores without a trusted middleman ?

A problem with reputation scores (such as yelp reviews) is that they can be hacked with low ratings given by hostile people who haven’t really bought the good or service being reviewed.

There is (probably in use) a technology related to cryptocurrency blockchains which can eliminate this problem. One key part of say the bitcoin blockchain is the key or digital signifier each user has (meaning everyone who has ever owned bitcoin not just miners). This is just an application of the standard public code/private key system used for safe internet browsing (I just checked and I am at https://angrybear… using such a system). Each person A comes up with a function F_A which is very hard to invert and the inverse F_A_inverse. This serves as a digital signature. A tells the world F_A, then sends signed messages F_A_inverse(something comprehensible in say English o italiano). Only if it is really sent by A does F_A(the coded message) make any sense. Importantly it is very very hard to invert F_A knowing only F_A and hard but not so very hard to come up with new pairs of functions (F_A, F_A_inverse). This is standard technology absolutely key to e-commerce.

But it can be usefully combined with cryptocurrency as follows.

A writes (and encodes with F_inverse) an offer to pay B for some good or service, with payment when the good or service is delivered within some interval of time and is satisfactory, but really payment if the buyer doesn’t file a complaint within a slightly longer interval of time. To do this A must describe bitcoin belonging to A equal to the amount paid, possibly plus a penalty forfeited if A posts a complaint. B then sends a message (coded with F_B_inverse) accepting the offer. The pair of messages is is a draft transaction made of the offer and the acceptance. Then miners check that A really has the cryptocurrency (as they do with bitcoin etc), that the longer interval of time has passed and that A has not complained then put the transaction in a block. Now the cryptocurrency belongs to B. Or A can report that B failed to deliver on time or the good was no good. Then B doesn’t own the cryptocurrency. Also A doesn’t own the cryptocurrency. It belongs to the miner who creates who verifies that A made the offer, that A made the complaint, and that enough time had passed. adds the offer and complaint to a block and solves the proof of work math problem so that it is a valid block.

If B is cautious or paranoid, B can only accept the offer if it consists of A transfers so much to B and so much back to A only if A makes no complaint and the rest back to A even if A complains. So A reserves the right to make a complaint at a cost of giving some cryptocurrency to the miner when the complaint is recorded. Also (and finally I think) The buyer may demand (so written in the orignal offer) that the seller must post some cryptocurrency when accepting the offer, which cryptocurrency is forfeited if the buyer complains

Importantly, the offer and the complaint have the same signature (are mapped into apparent gibberish with the same F_A_inverse). The complaint is only recorded if the complainer pays, in this case to the miner not to B.

The remaining problem is that A and the miner might be the same person so the penalty is a transfer from A to A. But this requires A the malicious miner to solve the proof of work problem before anyone else.

I think this works.

A dishonest merchant might only fill orders from people who promise to pay such a large penalty to complain that they won’t complain even if the good never arrives. Fools will buy from such merchants. Technology can’t eliminate idiocy.

But the option to transfer the wealth to a third party miner means both shoddy goods and services and malicious negative reviews can be punished. The miner doesn’t have to be trusted by anyone as the mining oerations are verified by all other miners just so they can keep their blockchains up to date. The merchant B doesn’t have to worry about his or her reputation — the complaint is costly even if A is the only potential customer B will every have. A doesn’t have to worry about A’s reputation or to have a reputation for honesty. If no one trusts me, I promise to pay them or pay more to complain.

I think it works.

Comments (2) | |

On What We Missed About Globalization

Paul Krugman is characteristically and very admirably willing to discuss in this pdf what he got wrong. In particular, he now thinks that in the 1990s he underestimated the medium costs to the USA of globalization. This is especially striking, because his debate with Bill Clinton et al on this topic was uh rather heated.

Brad DeLong uncharacteristically disagrees with Krugman.

Uncharacteristically, I don’t agree entirely with Paul Krugman. It is almost extraordinary that I found myself disagreeing with Krugman in more or less the opposite direction as Brad. Brad wrote of the globalization revolution and the renegade Krugman — he asserted that Krugman ascribes to globalization the costs of bad management and bad macroeconomic policy.

I object to Krugman’s confidence that 1990s Krugman was right about the long run “It’s possible, and probably even correct, to think of specific factors as representing the short run while Heckscher-Ohlin represents the long run. ” Krugman makes no argument that it is “probably correct” to think of Heckscher-Ohlin representing the long run. He also presents no evidence, and it is hard to get many independent observations on long run effects.

In this he is conventional. Macroeconomists have many disagreements about the short and medium runs, but are almost all willing to assume that a flexible price model describes the long run.

I think it is very alarming that there is the most consensus and the highest confindence in exactly the case where there is the least evidence.

In particular, I note that the word “hysteresis” appeared recently in Brad’s blog. If recessions have permanent negative effects, then why would one not expect sectoral disruption due to shifts in trade patterns to have permanent effects ? The fact that something is not true in the short run doesn’t mean it is true in the long run.

I discuss DeLong discussing Krugman at great length after the jump.

Comments (6) | |

Blue State Red State, Blue State Dead State

Back when he was a conservative (and didn’t just play one on TV) David Brooks specialized in the ecological inference fallacy. He tried to argue that the Democratic party was the elite party, because Democratic “blue” states are wealthier than red states. He wrote as if all people in blue states were upper middle class as he and all the people he knows are.

This is passé. Current conservatives just replace data with prejudice. For example, someone tweeted “Still doesn’t answer why these red states don’t have higher mass shootings and murders.” (picking on a random tweet is called the “nut picking fallacy”). This is hard to answer, since those red states do have higher murder rates.. Some people are sure this must not be true as soft on crime liberalism leads to lots of crime. However, there are tens of thousands of dead people who won’t argue back (being dead).

So I decided to look at maps of murder and church attendence. By Brooksian logic we can conclude that christ

There are two big exceptions — devout but not homicidal Utah and my native, blue, secular, and homicidal Maryland.

Still a pretty impressive state by state correlation of church going and killing no ?

Comments (4) | |

Conner Lamb will represent PA-18

First I stress the great effort I put into avoiding all Lamb puns in the title.
Second, I think the discussion of his recent extremely narrow voctory makes the discussion of the campaign seem almost sane.

Before their humiliating loss, Republican operatives insisted that voters were coming around to support their tax cut bill. In spite of the lack of much movement in public polls, they claimed they had private polls showing increased approval. They neglected to mention the fact that they had shifted from arguing against Lamb on the (accurate) grounds that he denounced the tax cut to arguing on the grounds that the former prosecutor was allegedly soft on crkme.

Then he won. Suddenly, Republicans discover that Lamb won because he supported their tax bill, in spite of the fact that he “opposed the tax cuts as a ‘complete betrayal of the middle class.'” When faced with an inconvenient fact, they just lied claiming he campaigned supporting the tax bill.

I think this is a new form or Republican insanity. For 38 years, they have insisted that the secret to economic growth is tax cuts which will pay for themselves (give or take a trillion). This is an absolute article of faith. Even Sen Susan Collins restated the orthodox fantasy. But now they have a new insane article of faith which is that all tax cuts are popular, and their generally disliked tax bill will save them in November.

In this case too, no evidence can dent their (stated) certainty. Not even the evidence from PA-18, where there was a huge “independent expenditure” campaign telling people that a vote for Lamb was a vote against the tax bill. The total failure of this effort (demonstrated by opinion polls before election day) caused Republicans to shift to racists dog whistles. But then when the actual vote showed their effort had failed, Republicans just declared that a victorious critic of their tax bill was a supporter of their tax bill.

So after the spectacular failure of a campaign centered on the tax bill I read (quoted by Costa in the post see below)

“Everybody will … emphasize the parts of the Trump presidency that have been wins for the whole party — taxes, regulatory reform, those kind of issues …” said former Pennsylvania congressman Bob Walker (R).

This is exactly what Americans for Prosperity tried in PA-18 and it was a spectacular failure. It seems as if the GOP’s insane faith in failed policies has infected their previously healthy judgment about political strategy. I sure hope it has.

Not all reporters have covered themselves with glory either. After the jump, I get back to dumping on the MSM

Comments (39) | |

Public Opinion, Opinion Polls and Political Reporters

It is unfair for me to pick on Paul Kane writing in the Washington Post, but he does seem to me to be a clear example of political reporters who interview operatives and quote them and do not look at relevant publicly available data.

The main point of the article is that Republicans are in trouble, because they might lose a special congressional election in deep red PA-18 (which hasn’t gone Democratic since it was created with roughly its current boundries in 2001).

The headline makes sense “The GOP’s messages don’t seem to be working in Pennsylvania. Is that a warning sign?”

But Kane insists on seeking insight into the GOPs problem by talking to political operatives. Also, as far as I can tell, the only Democrat he interviews is Senator Chris Van Hollen who he mainly asks about how it was to be head of the DCCC in deep trouble in 2010.
Kane doesn’t speak to anyone from the surprisingly successful Conner Lamb for Congress campaign.

Instead he seems to base his views mainly on discussions with “Tim Phillips, president of Americans for Prosperity (AFP), a conservative group funded by the industrialist Koch brothers, which is stumping for Saccone.”

The message which isn’t working is ““This guy would not have voted for tax cuts.”

Republicans cannot believe how much money they’ve spent for such little return, never landing a fatal blow on Lamb, a first-time candidate.”

I’d guess their problem is that tax cuts for business and rich people are unpopular even in red districts. For over two decades poll after poll shows that a solid majority of US adults believe rich people and businesses pay less than their fair share of taxes. The republican tax cuts were unpopular.

But obviously the president of AFP can’t say that if he wants to keep his job. Phillips isn’t a Republican operative — he is a Koch flak and flatterer. He must claim that people in the USA support supply side economics — that’s his job. He can’t question the political usefulness of tax cuts any more than he can question their allegedly wonderful effect on the economy.

In the article, I noticed Republican and Koch operatives asserting that the tax bill is becoming “more”popular based on alleged polls. I didn’t notice any actual data from actual polls. In particular, something which was horrible (as public opinion of the tax bill was) can be getting better without getting anywhere near good.

After about 5 minutes of research I get from

Quinnipiac 34% approve 50% disapprove March 3-5

Monmouth 41% approve 42 % disapprove March 2-5

Gallup 39% approve 48% disapprove Feb 26 March 4

ABC 34% 46% way back in January

That sure doesn’t look like an issue which will save Republicans.

The change is from around minus 12 to around (on average) minus 9. Actual public polls say this is not a good issue for Republicans, and also don’t provide super strong evidence that it is getting less bad for them.

Getting spun by hacks is a job hazard, but 5 minutes of googling would be nice.

The rest of my comment (with some reptition) follows after the jump

update: More evidence of the unpopularity of tax bill is the fact that Republicans stopped running the ads about it in PA-18. (via Oliver Willis)

Note the dates, this was reported *in the Washington Post* before Kane began writing, but he still quotes the president of American for Prosperity without checking his claim that the tax bill is becoming more (nearly) popular.

end update.

Comments (4) | |

A Comment on the Return of “It’s Baaaack”

Twenty years ago, Paul Krugman warned that the liquidity trap was not just an issue in the economic history of the 30s. He noted there was every sign that Japan was in the liquidity trap in the 90s, then argued that a liquidity trap was theoretically possible. I guess one lesson is that economists even including Paul Krugman had more respect for theory back then.

Now he, frankly, boasts about being decades ahead of the rest of the profession. (pdf warning) and I mean frankly “This paper is an exercise in self-indulgence and self-aggrandizement.” It is also extremely excellent and very much worth reading. I will mainly discuss two sections near the end (which are the only weak points I perceive — Krugman’s post is brilliant clear and concise)

First there was a theoretical proof that economies with flexible [prices](thanks PGL) couldn’t be in a liquidity trap. The claim was that if the price level fell enough, the real value of money holdings (real balances) would be a significant part of wealth and this would cause high consumption (this is called the Pigou effect). The argument is neither fish nor fowl. There is no Pigou effect in the IS-LM model. It is also a relephant in optimizing models with Ricardian equivalence, because currency is not net wealth. Krugman notes that formal math says if real balances are huge because of a liquidity trap, people know that their apparent wealth will be consumed by inflation tax (or by taxes needed to retire money if the monetary authority doesn’t accept inflation).

This is Krugman’s number 1 example of why formal models are good (and also a case in which the reduced form treat correlations and causation accidental theory works just as well). It also shows the power of two (also self promotion and I thank Krugman for critiquing “a commenter” without naming me).

“my tendency to do New Keynesian models that say they have infinite horizons, but whose analysis always seems to boil down to just two periods, “now” and “forever after”.” I call this “Two Keynesian economics”.

It made it clear to Krugman that one can’t believe both in Ricardian equivalence and the Pigou effect. I think the power of two is one of Krugman’s most useful and important insights (which is saying a lot). Almost all of the differences between New Keynesian and old Keynesian models can be explained with two periods. The difficult models without closed form solutions are needed. I add that, I think, the (limited) influence of academic macro on policy is based on claims about the long run.

The problem, is that those claims are shared assumptions. Macroeconomics is divided into growth theory and the rest of it, and those who work on the rest of it, all make the same strong simple assumptions about the long run — they aren’t tested (it is hard to test them) and aren’t implied by assumptions with other attractions. Two Keynesian economics makes this very very explicit.

And this brings me (finally) to my first point. It is actually Larry Summers’s point. In 1998, Krugman assumed that Japan would, sooner or later, exit the liquidity trap. In fact, he assumes (the expected value of) everthing will be as it would be in a flexible price new classical model in the long run. 20 years later, it seems that the trap might be permanent. This would invalidate Krugman’s argument that, even if standard monetary policy is ineffective in the liquidity trap, a credible (that is credited — believed) promise to cause high inflation when the economy is out of the liquidity trap will be effective.

So the first problem is what if this is a promise about policy on the 8th of never. I claim a second problem is the abuse of “credible” which is used to mean “sincerely and honestly asserted” and “believed by others, that is credited”. The rational expectations assumption sneaks in and asserts that if people should believe, then they will believe. It makes private agents beliefs seem to be part of the policy.

This brings me to my main point (if I have any). First non-standard monetary policy works by changing expectations, and it is assumed policy makers can do that (or rather the implications of the assumption are studied by people who regularly warn that they don’t know if this will happen & say therefore fiscal stimulus should be used). There is also an equivocation in “regime shift” which is used to refer to a major permanent change in policy and the belief that a change in policy is major and permanent.

With the equivocal definitions, unconventional monetary policy can’t fail, it can only be failed. And (finally) I get to the bith of Krugman’s post with which I disagree. He assesses the effects of unconventional policy (as proposed by Krugman) and says the evidence is mixed. I actually became almost known as a skeptic of unconventional monetary policy and I think the evidence strongly suggests it doesn’t work.

To summarize Krugman — he argues that there wasn’t a regime shift except in Japan, because central bankers stuck to the 2% target. He notes that in Japan Kuroda declared a 2% target.

“Abenomics” was supposed to contain three “arrows” – fiscal stimulus and structural reform as well as monetary expansion. In practice, however, fiscal policy has if anything tightened slightly, while structural reform, as often happens, is in the eye of the beholder. There has, however, been a very visible shift not just in the Bank of Japan’s actions but in its underlying attitude: while it still professes the conventional 2 percent target, it gives every indication of being willing to be far more adventurous than in the past in its efforts to achieve that target

Here I agree that the regime shift (if any) was Kuroda’s promise to do whatever it took to get to 2%. From November 2916 to November 2017 (the most recent 12 month period on FRED) Japanese consumer prices increased 0.5% . I conclude that it can’t be done (I don’t think anyone could be use the communications channel much more vigorously that Kuroda).

OK key dates. We all know about the great recession which became great and worldwide September 2008. Shinzo Abe was elected December 2012 and promptly nominated Kuroda and promised non-standard monetary stimulus. On April 1 2014 the Japanese Value added tax (VAT) was increased by 3% (causing the April fool’s recession).

Krugman noted fiscal policy tightening. He didn’t mention that Abe might have done it again if he hadn’t talked to one Paul Krugman who told him not to (Abe still might in 2019)

Not mentioning this Krugman is focusing on monetary policy (and being modest). But the VAT increase wasn’t just a mistake which triggered a recession. It also was an exogenous 3% increase in the price level. This means that increased expected inflation may have been caused by Abe making it more and more clear that he really was raising VAT — Japanese indexed bonds are indexed to CPI gross of VAT. The expected inflation caused by the fiscal shift has the same effect on decisions as expected inflation caused by nonstandard monetary policy.

Basically Japanese almost certainly moved up their scheduled purchases of durable goods to avoid VAT. This is inter-temporal choice, but even I believe it happened (inflation was 3% a minute at 11:59 PM March 31 2014). This helps explain the recession — I guess the fall in demand was greater than would be caused by a 3% of GDP lump sum tax (the policy analysed with simple old Keynesian models).

But it also means that all evidence on expected inflation *and* its effects on real variables collected from December 2012 through April 2014 is contaminated. By the way, that evidence convinced me that Krugman was right (as almost always) and I was wrong as [no comments on this please].

Krugman looks at nominal GDP which usually makes sense. In this case, it obscures the huge increase in the price level on April 1 2014 (all prices are collected gross of VAT) and the severe recession. Here are nominal GDP and the GDP deflator.

I now think it was mostly fiscal policy. That the threat of the VAT incrase helped during 2013 and the first quarter of 2014. I don’t see evidence in prices or real GDP that there was a shift in the monetary policy regime.

The evidence of monetary regime shifts (as the phrase is used which includes the assumption that people believe the policy has changed and that this matters a lot) is, I think, reduced to countries going off the gold standard in the 1930s. I’m going to focus on 1933 and not just FDR (you know who else went off the gold standard in 1933). Here in two big cases there were other “regime shifts” either a major partisan realignment or, uh you know, a literal regime shift.

I now have returned to thinking that “credibly promising to be irresponsible” that is “achieving a monetery policy regime shift” can’t be done (which doesn’t mean it isn’t worth trying if the economy is in a liquidity trap and fiscal policy makers are austerian).

Comments (5) | |