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Tim Duy body-slams St. Louis FRB President James Bullard:

Estimates of potential GDP are not simple extrapolations of actual GDP from the peak of the last business cycles. They are estimates of the maximum sustainable output given fully employed resources. The backbone of the CBO’s estimates is a Solow Growth model. So I don’t think that Noah Smith is quite accurate when he says:

So, basically, what we have here is Bullard saying that the neoclassical (Solow) growth model – and all models like it – are wrong. He’s saying that a change in asset prices can cause a permanent change in the equilibrium capital/labor ratio.

Bullard can’t be saying the Solow growth model is wrong because he doesn’t realize that such a model is the basis for the estimates he is criticizing. [first and last link in the original; Noah Smith link copied from elsewhere in the original post]

Go Read the Whole Thing. For those of you too lazy to do that without incentive, here’s the conclusion:

Bottom Line: Bullard really went down an intellectual dead end last week. He criticized the focus on potential output, but revealed that he doesn’t really understand the concept of potential output either empirically or theoretically. He then compounds that error by arguing against the current stance of monetary policy, but fails to provide an alternative policy path. And the presumed policy path, tighter policy, looks likely to only worsen the distortions he argues the Fed is creating. I just don’t see where Bullard thinks he is taking us.

It’s Worse Than You Think.

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Deja Vu All Over Again, or On the Whole…

The President of the Federal Reserve Bank of Philadelphia:

We have been putting out credit in a period of depression, when it is not wanted and could not be used, and will have to withdraw credit when it is wanted and can be used.

But this is not Charles I. Plosser, no matter how similar the sound. It’s from September of 1930,* presumably George W. Norris (PDF; see page 4).**

Indeed, reviewing the Calmoris and Wheelock article from which I pulled that quote, we find the same mistakes being made: excess reserves confused with circulating money and therefore treated as harbingers of inflation, squealing for austerity,*** sterilization of shifts in reserves in a desperate attempt to avoid non-visible inflation.

As Owen Wilson’s Gil says in Midnight in Paris, we have antibiotics; the people in Fin de siècle Paris didn’t. It’s just one of our other “sciences” that appears not to have advanced.

*Michael D. Bordo;Claudia Goldin;Eugene N. White. The Defining Moment: The Great Depression and the American Economy in the Twentieth Century (National Bureau of Economic Research Project Report) (p. 36). Kindle Edition.

**Not to be confused with George W. Norris, the Nebraska Senator discussed in Profiles in Courage

***The Norris quote above begins:

We believe that the correction must come about through reduced production, reduced inventories, the gradual reduction of consumer credit, the liquidation of security loans, and the accumulation of savings through the exercise of thrift. These are slow and simple remedies, but just as there is no “royal road to knowledge,” we believe there is no short cut or panacea for the rectification of existing conditions.

Chancellor of the Exchequer George Osborne, not to mention EC President Herman von Rompuy, would be proud.

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Texas Again: Which Rick Does More Harm?

That Rick Perry is a clueless candidate and skilled campaigner is something for Barack Obama’s minions to suffer.* That Perry’s curiosity goes no further than “Where’s My Next Corndog?” cannot be held against him; he only became what they made him, just as his predecessor did, though with a poorer transcript and lack of his father’s Rolodex. A real Horatio Alger story.

So we need to pay attention to who tells him things. And that appears to be people such as Richard Fisher, who recently went to W’s “home town” and bragged about the local economy. He starts by making any sane human being worry:

I, along with the 11 other Federal Reserve Bank presidents, operate the business of the Federal Reserve as efficiently as any bank in the private sector.

I’m certain that is true. Then he spreads the Usual Lie:

[W]e make money for the U.S. taxpayer: We returned over $125 billion to the U.S. Treasury in 2009 and 2010. You are looking at one of the few public servants that make money from its operations, rather than just spending taxpayer money.

English translation: We took money from the Treasury, and our Accounting looks nice because we don’t count the overpaying for “assets” or the free money on “excess reserves” as part of our losses. We can even make a fool out of Allan Sloan.

Oh, and by the way, we don’t “just spend taxpayer money,” like those evil people who run police departments, fire departments, and schools; or make roads, or ensure food and water safety; or do fundamental scientific research, to name a few, do.

Then he tries to tell his constituents that Texas is great, and that he will put “a heavy focus on the data,” which is supposed to explain (“connect the dots”) on why he “dissented from the consensus at the last meeting of the Federal Open Market Committee (FOMC).”

So the data should, at least, show an “I got mine, Jack” aspect, no? Let’s see below the fold if it does.

First he presents a graphic showing non-Agricultural Employment Growth baselined at 1990. Now, I might consider this a bit of cheating: in 1990, Texas was in the midst of its self-created S&L crisis. If it didn’t recover from them compared to the rest of the United States, I would assume (contra Brad DeLong [link updated]) that people realised there was no water table and therefore no opportunity for long-term growth (as opposed to the already-well-developed Greater NYC area and the San Francisco Fed areas** to which he contrasts Dallas).

Suffice it to say, you don’t get quite so dominant a picture if you start in mid-1992.

But let’s ignore that it’s easier to build if there’s Nothing There, and easier to expand if there are natural resources even if the rest of the area is a Vast Wasteland or Lubbock (but I repeat myself***). And let’s just look at what good all those jobs have done, with a heavy focus on, well, FRB Dallas data (from the start of their data):

Hmmm, not exactly consistent manufacturing productivity, even before the (recent) recession. Indeed, I might suspect that Texas since around early 2006 has been dependent on moving Services jobs there, not growth in the local economy. But I’m not a Fed Governor:

Now, let’s look at job creation in Texas since June 2009, the date that the National Bureau of Economic Research (or NBER, the body that “officially” dates when a recession starts and ends) declared the recent economic recession to have ended….[I]t is reasonable to assume Texas has accounted for a significant amount of the nation’s employment growth both over the past 20 years and since the recession officially ended.

Let us give him credit for admitting that the 49.9% number is major b*llsh*t. And half-credit for admitting that, if you drop the states that are still heavily negative, the number is below 30%. So things must be looking up in Texas, right?

Hmmm, a nice recovery—rather similar to the 1991-1992 gain—followed by some drop-off, water-treading, and another peak early this year that suggests seasonality, even though the data is Seasonally Adjusted.**** Difficult to argue an upward trend (see most recent footnote), but maybe stable.

Then again, I’m still not a Fed Governor. But let’s give him some credit for admitting this self-inconsistent point:

The most jobs have been created in the educational and health services sector, which accounts for 13.5 percent of Texas’ employment.

The education sector? Really? Can you say “stimulus monies“? People in Dallas sure can. Who is “just spending taxpayer money” now?

And credit Fisher for being fair enough to note the elephant in the Texas room:

I should point out that in 2010, 9.5 percent of hourly workers in Texas earned at or below the federal minimum wage, a share that exceeds the national average of 6 percent. California’s share was 2 percent and New York’s was 6.5 percent.

And for not thinking that the Fed’s dual mandate needs to prioritize nonexistent “inflation threats.”

It might be noted by the press here today that although I am constantly preoccupied with price stability―in the aviary of central bankers, I am known as a “hawk” on inflation―I did not voice concern for the prospect of inflationary pressures in the foreseeable future….My concern is not with immediate inflationary pressures.

Well, that’s good. And since the other half of the dual mandate is full employment, you’ll be expecting something positive from businesses, then, eh?

Importantly, from a business operator’s perspective, nothing was clarified, except that there will be undefined change in taxes, spending and subsidies and other fiscal incentives or disincentives. The message was simply that some combination of revenue enhancement and spending growth cutbacks will take place. The particulars are left to one’s imagination and the outcome of deliberations among 12 members of the Legislature.

Ma nishta ha-laili ha-zeh? But Fisher digs deeper:

On the revenue side, you have yet to see a robust recovery in demand; growing your top-line revenue is vexing. You have been driving profits or just maintaining your margins through cost reduction and achieving maximum operating efficiency. You have money in your pocket or a banker increasingly willing to give you credit if and when you decide to expand. But you have no idea where the government will be cutting back on spending, what measures will be taken on the taxation front and how all this will affect your cost structure or customer base.

Huh? I thought government was mean and evil and just spends taxpayer money. Shows what I know; I listened to a Fed Governor, one who tells me that businesses “have been driving profits or just maintaining your margins through cost reduction and achieving maximum operating efficiency.” Really should see some nice Production numbers in the past six months, then, no?

No. So when Richard Fisher later says:

[The business owner] might now say to yourself, “I understand from the Federal Reserve that I don’t have to worry about the cost of borrowing for another two years. Given that I don’t know how I am going to be hit by whatever new initiatives the Congress will come up with, but I do know that credit will remain cheap through the next election, what incentive do I have to invest and expand now? Why shouldn’t I wait until the sky is clear?”

There are two answers. The first is the obvious: the Fed only controls short-term rates for risk-free investment. They don’t control lending rates, and they don’t control long-term rates, which are what I’m interested in if I’m “going to hire new workers or build a new plant.” Now, QE2 made it marginally easier for me to borrow in the long-term, but that’s gone now. So unless I’m stupid enough to pretend I’m a bank—if I borrow short-term and create long-term liabilities, I better be damned sure someone will refinance me until the project is finished—the Fed guaranteeing that the short-term Government borrowing rate is going to stay low for a while doesn’t mean much to me.

The second is more interesting: if I believe in competitive advantage, I want my new products on the shelf before my competitor has hers there. I cannot sell what you cannot see. So I want my plant started now—while I can still get the best available workers before my competitor does, while I can still pick a prime location (less of an issue in a Vast Wasteland, but not insignificant if you’re Dallas- or Houston-area), and while I can negotiate a deal with someone who needs me in their space more than I need to be there.

But that is only true if Richard Fisher has been telling the truth about how well I’m running my Texas-based business. And that, not to put too fine a point on it, appears to be—to coin a Texas phrase—bullshit.

I know the reality of Rick Pery: it’s a hermetic, incurious one in which women are property, you read what they tell you, and you get to take credit for a win, even if it’s your handlers doing all the work, including telling you what to do later. It’s not a world of which I approve, but my lack of approval doesn’t mean I believe it doesn’t exist.

I don’t know what reality Richard Fisher inhabits; it is certainly not one in which there is “a heavy focus on the data.” At least not data that is related to the Fed’s dual mandate, or how nonfinancial businesses make long-term decisions, or how to attain a competitive advantage.

Rick Perry speaks to his true believers. Richard Fisher expects you to believe him. Currently, only one of them is trying to do national harm to the economy, and it’s not the (soon-to-be) 45th President of the United States.

*And the rest of the United States when Bachmann-Perry Overdrive starts on 20 January 2013, but that’s tangential.

**Fairness requires me to note that much of the state of California is a desert, though not so bad a one as most of West Texas. Accordingly, growth in those areas would, pari passu be similar to that of Texas, save that there is no not enough***** oil in Central California. But never let it be said that we would expect an FRB official to understand geography.

***And let us always remember that Lubbock gave us the greatest white rock musician of all time.

****Good thing I left out the pre-2006 data, so we don’t have to note that the peaks post-Great Recession are close to the ca. 2006 troughs.

*****Correction by dilbert dogbert in comments noted.

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The Monetary Policy Debates

This article by David Leonhardt in the New York Times is getting a lot of attention.

Leonhardt argues that there is an active debate in the economics profession between inflation hawks, moderates and doves and that only the position of hawks and moderates are represented on the Fed open market committee (FOMC). He guesses that Perry’s equating dovishness with treason (now for monetary policy too) might be part of the problem.

I personally have a strong objection to Leonhardt’s article. He lumps together people who think that the Fed should not cause higher inflation with people who think that the Fed can’t cause higher inflation.

IF you were to conduct a survey of the country’s top economists, you would find a fair number who did not believe that the Federal Reserve should be taking more aggressive steps to help the economy. Some would worry that injecting more money into the economy might unnerve global investors or set off uncontrollable inflation. Others would wonder whether, with interest rates already so low, the Fed even had much power to lift economic growth.

But you would also find a sizable group of economists who thought the Fed could and should do far more than it was doing. This group, known as doves, tilts liberal, though it includes conservatives as well. If anything, it can probably claim a larger number of big-name economists — J. Bradford DeLong, Paul Krugman (an Op-Ed columnist for The New York Times), Christina D. Romer, Scott Sumner and Mark Thoma, among others — than the camp that believes the Fed has done too much.

Note that the group that think that the Fed doesn’t have much power to lift economic growth are lost somewhere between the two paragraphs. Leonhardt goes on to present the debate between DeLong et al on one side and FOMC hawks “Richard W. Fisher of Dallas, Narayana R. Kocherlakota of Minneapolis and Charles I. Plosser of Philadelphia.” with the moderates such as Bernanke in the mushy middle.

The hawks and those who doubt that the Fed can cause higher inflation absolutely disagree. The hawks say there is a risk of higher inflation. DeLong says higher inflation is possible and would be good. They agree on the first question and then disagree about the effects of inflation and the relative importance of economic catastrophe and whatever costs 4% inflation would have (small to minimal according to top conservative academics like uh Kocherlakota).

It is just not true that no prominent FOMC nominee Nobel Laureate has expressed doubt as to whether the Fed can cause higher inflation. Leonhardt seems to have decided that Peter Diamond just doesn’t exist (or to agree with Sen Shelby that he doesn’t know about money — I might add that top academic N. Kocherlakota’s research on money is all based on Peter Diamond’s search model).

I don’t have the sense that Romer and Krugman firmly disagree with those who think the Fed can’t do much more. They call for more more more, but don’t IIRC express confidence that anything the Fed might do would have a really big effect. Conflating the questions of should the Fed try to cause higher inflation and can the Fed achieve it makes them definitely doves. That’s why I object to the conflation.

Before the jump I note (again) that I think the Fed could do more which would be useful — buy risky assets (via Maiden Lane III if necessary). But that means I absolutely don’t agree with people who call for QEIII and look at the quantity and not the quality or who think that saying more inflation would be nice would have much effect or who call for targeting nominal GDP (why not jut “target” real GDP and cut out the middle man ?).

By the way Leonhardt forgets about Diamond also when making the obligatory claim that both parties share blame “The Obama administration has also been slow to fill some Fed openings. At least one of the 12 seats has been vacant since Mr. Obama took office, and two are now.” as Leonhardt knows perfectly well, the Obama administration can’t fill Fed openings if Republican senators filibuster votes on nominees. Obama is not the reason that there are two vacancies, Shelby is. Hat tip Tom Levenson

On the other hand the article does contain news for anyone who thinks that Scott Sumner is reality based.

Mr. Sumner has become so dispirited by the Fed that, before leaving on a trip for Italy last week, he left a post on his well-read blog, The Money Illusion, under the headline, “Not enough.” The headline, he wrote, “refers to my reaction if the Fed does something while I’m gone.”

Sumner just wrote that he doesn’t bother to wait to learn the facts, because he already knows the answer. I knew that was true of him (in general) but you aren’t supposed to say so.

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