Friday, August 13, 2010

What Can the Fed Do?

In his column today, Paul Krugman excoriates the Federal Reserve System, and especially Ben Bernanke, for "inventing reasons to dither in the face of mass unemployment." Why? Because the Fed is not creating enough inflation, which Krugman claims will give the economy "traction."

Krugman writes:
America’s current economic troubles aren’t exactly identical to those of Japan in 1999-2000: Japan was experiencing outright deflation, while we aren’t — yet. But inflation is well below the Fed’s target of around 2 percent, and it is continuing to slide. And Americans face a level of unemployment, and sheer human misery, far worse than anything Japan went through.

Yet the Fed is doing almost nothing to confront these troubles.
However, Krugman also suggests a "solution," and it is here that I think we need a discussion. He says:
What could the Fed be doing? Back when, Mr. Bernanke suggested, among other things, that the Bank of Japan could get traction by buying large quantities of “nonstandard” assets — that is, assets other than the short-term government debt central banks normally hold. The Fed actually put that idea into practice during the most acute phase of the financial crisis, acquiring, in particular, large amounts of mortgage-backed securities. However, it stopped those purchases in March.

Since then, the economic news has grown steadily worse. And earlier this week, the Fed changed course — but barely. It now says that it will reinvest the proceeds from maturing securities in long-term government bonds. That’s a trivial change, basically the least the Fed could get away with without facing a firestorm of criticism — and far short of the major asset-purchase program the Fed should be undertaking.
So, once again we see the post hoc ergo propter hoc fallacy at work. Why is the economy now in the tank? The Fed isn't buying enough assets, as though the economy was doing well in March.

Not surprisingly, Krugman blames those dastardly regional Fed chairmen for this plight, declaring:
What’s going on here? Has Mr. Bernanke been intellectually assimilated by the Fed Borg? I prefer to believe that he’s being political, unwilling to engage in open confrontation with other Fed officials — especially those regional Fed presidents who fear inflation, even with deflation the clear and present danger, and are evidently unmoved by the plight of the unemployed.

And in fairness to Mr. Bernanke, discord among senior officials also makes it difficult for policy to change expectations: it would be hard to credibly commit to higher inflation if this commitment were constantly being undercut by speeches out of the Richmond or Dallas Feds. In fact, I’d argue that loose talk by some Fed officials is already having a negative economic impact. But while Mr. Bernanke doesn’t have the authority to stop that loose talk, he could make it clear that it doesn’t represent overall Fed policy.
Yeah, its the rhetoric. If only we had all members of the Fed declaring that what this country needs is a good bout of inflation, then everything would be fine and the economy would be gaining "traction" toward recovery. However, there is a problem here, and it is NOT that President Obama waited until recently to fill 16 Fed slots, regardless of what Krugman claims.

No, the problem is that Krugman confuses the paper purchase of assets deemed worthless in the markets with the creation of real wealth. I have said before that Krugman really does confuse paper money with wealth, a fallacy that Adam Smith and others exploded more than two centuries ago, yet lives on in the hallowed halls of Ivy League institutions.

Like the Supply-Siders that claim that the real problem is that the government has not cut tax rates low enough (although that does help), Krugman's answer always is that there is not enough inflation. In Krugman's view, there really is no "real" economy; instead, it is a combination of paper and rhetoric, as though capital and other factors of production are simple putty to be molded in the hands of the "experts" in Washington.

The economy is not tanking because of any alleged "dithering" at the Fed. It is tanking because the government insists upon strangling those firms that still are healthy ("wicked profiteers") and propping up the politically-connected firms (i.e. Government Motors) or forcing taxpayers to ante up to pay for assets that cannot ever be profitable in a real economy (i.e. "Green Energy"). The Keynesian prescription - inflate, inflate, inflate - is what is intellectually and morally bankrupt, and as long as that mentality rules, we will have a moribund and depressed economy.

19 comments:

Bob Roddis said...

Krugman has written

Some of those who consider themselves Keynesians, myself included, agree with what Keynes said in The General Theory, and consider the rejection of Say's Law the core issue. On this view, Keynesian economics is primarily a theory designed to explain how market economies can remain persistently depressed.

Since there is no basis in fact, logic or history to suggest that “market economies can remain persistently depressed” without government interference, Krugman and his minions are trying to solve a “problem” that doesn’t exist. And their “solution” to the non-problem is, in fact, the CAUSE of the problem in the first place.

ICYMI said...

"To fight this recession the Fed needs more than a snapback; it needs soaring household spending to offset moribund business investment. And to do that, as Paul McCulley of Pimco put it, Alan Greenspan needs to create a housing bubble to replace the Nasdaq bubble." - Paul Krugman, NYT, August 2002

Joe the Plummer said...

Krugman was quoting Paul Mccully from PIMCO, an investment company. The point of that article Krugman quoted Mccully from was more or less market prediction because his audience were investors, not a general audience. In this case he was predicting what the FED might do. It wasn't advocacy of a bubble.


This was the quote from Muccully:

"There is room for the Fed to create a bubble in housing prices, if necessary, to sustain American hedonism. And I think the Fed has the will to do so, even though political correctness would demand that Mr. Greenspan deny any such thing (just like he denied belatedly attacking the NASDAQ bubble)"


http://www.pimco.com/LeftNav/Featured+Market+Commentary/FF/1999-2001/FF_07_2001.htm


Take note of "American Hedonism." Does it really sound like he was really supporting hedonism? HURRAY FOR HEDONISM?


Although Mccully did support Greenspan's efforts to lower interest rates because it's simply good macroeconomic policy, he did not advocate a bubble. What Mccully predicted is that Greenspan would see the bubble and let it grow instead of using some micro regulatory tool to curve it, just like he let the tech bubble grow even though he knew about it.


What Mccully and Krugman advocated was keeping interest rates low and using better regulatory tools to take on the bubble. Heck, something as simple as Greenspan using his position as the Fed chairman and declaring there was a bubble would be enough to stop it.


Keeping the interest rates high during the 2001 recession is bad policy, which is why Krugman wanted it lower. As Mcully put it

"If Mr. Greenspan were a bartender with one rowdy drunk:
He would double the price of beer for all, in an effort to bankrupt the drunk more quickly, rather than simply cut off the drunk, letting the decent folk continue to act decently at an unchanged price."

or

"Accordingly, my quarrel with him was that hikes in the Fed funds rate until tech stocks cried uncle was equivalent to "trying to get the attention of gluttons by starving anorexics. It's bad macroeconomic policy, and it's also morally wrong"

http://www.investorsinsight.com/blogs/john_mauldins_outside_the_box/archive/2005/01/24/shades-of-irrational-exuberance.aspx

burkll13 said...

@ Joe-

it certainly does seem like Krugman misrepresented Paul Mccully, but i find it a big stretch to think that Krugman himself wasnt calling for a housing bubble.

Anonymous said...

stop stalking Krugman! He is the most widely-read economist who did important work on international trade- yes he's a liberal and you are a libertarian but get over it.

Anonymous said...

You people are idiots

Joe the Plummer said...

@burkII13

Don't you find it a bigger stretch to think anyone would advocate a housing bubble in the first place? Just think about how ridiculous it sounds for anyone to be advocating a bubble for a second. I think this is more of a case of people's biases misinterpreting what Krugman meant than Krugman misinterpreting what Mucculley meant. Krugman was agreeing with his prediction, not advocating the bubble. I mean Mculley is a fellow Keynesian. Krugman would have no trouble understanding what he meant because they work under a similar framework. It's more likely that an Austrian econ blogger misinterpreted his language than someone who actually speaks the same "Keynesian language." Also, I've seen that quote posted hundreds on times on in random econ blogs and on Mises. Not once has anyone even bothered to looked up the context behind the quote.


In a way, I kind of sympathize with these Austrian bloggers. Sometimes Krugman has a very esoteric and sarcastic writing style, which may be hard to interpret. You have to read inbetween the lines to get what he's getting at specifically. Sometimes if you don't have an intimate understanding of the Keysian framework, you can misinterpret some generalizations and simplifications Krugman makes for the sake of not sounding "wonkish" to his general mainstream readers who have minimal knowledge of economics. For example, Professor Anderson here keeps on repeating the same strawman of KRUGMAN THINKS PRINTING MONEY CREATES WEALTH. As if Krugman means we can print a million dollars and give it to each persona and it would make them all 1 million dollars richer. But no, it's a little more complicated than that. In these specific economic conditions, printing money increases aggregate demand. If you knew for sure the fed would cause 50% inflation by next month, wouldn't you spend more money before inflation lowers the value of your dollar? The same principle applies to krugman wanting the fed to target 3% inflation, but on a smaller scale. Don't you think this is better than direct government deficit spending? It would leave the spending to the market and people would buy what they want. And of course, increasing aggregate demand in this manner doesn't have a burden on our national debt.

Joe the Plummer said...

@burkII13

Don't you find it a bigger stretch to think anyone would advocate a housing bubble in the first place? Just think about how ridiculous it sounds for anyone to be advocating a bubble for a second. I think this is more of a case of people's biases misinterpreting what Krugman meant than Krugman misinterpreting what Mucculley meant. Krugman was agreeing with his prediction, not advocating the bubble. I mean Mculley is a fellow Keynesian. Krugman would have no trouble understanding what he meant because they work under a similar framework. It's more likely that an Austrian econ blogger misinterpreted his language than someone who actually speaks the same "Keynesian language." Also, I've seen that quote posted hundreds on times on in random econ blogs and on Mises. Not once has anyone even bothered to looked up the context behind the quote.


In a way, I kind of sympathize with these Austrian bloggers. Sometimes Krugman has a very esoteric and sarcastic writing style, which may be hard to interpret. You have to read inbetween the lines to get what he's getting at specifically. Sometimes if you don't have an intimate understanding of the Keysian framework, you can misinterpret some generalizations and simplifications Krugman makes for the sake of not sounding "wonkish" to his general mainstream readers who have minimal knowledge of economics. For example, Professor Anderson here keeps on repeating the same strawman of KRUGMAN THINKS PRINTING MONEY CREATES WEALTH. As if Krugman means we can print a million dollars and give it to each persona and it would make them all 1 million dollars richer. But no, it's a little more complicated than that. In these specific economic conditions, printing money increases aggregate demand. If you knew for sure the fed would cause 50% inflation by next month, wouldn't you spend more money before inflation lowers the value of your dollar? The same principle applies to krugman wanting the fed to target 3% inflation, but on a smaller scale. Don't you think this is better than direct government deficit spending? It would leave the spending to the market and people would buy what they want. And of course, increasing aggregate demand in this manner doesn't have a burden on our national debt.

Bob Roddis said...

As I've noted before, Krugman has clearly stated that Greenspan doing a housing bubble was a good thing:

http://tinyurl.com/2as56ep

Joe the Plummer said...

Oops, accidentally posted twice.

Anyway, here some good defenses of Kruman by two libertarian bloggers, who are hardly buddy-buddy by Krugman.

http://www.themoneyillusion.com/?p=1620
http://econlog.econlib.org/archives/2009/06/defending_what.html

James said...

Anonymous said...

stop stalking Krugman! He is the most widely-read economist who did important work on international trade- yes he's a liberal and you are a libertarian but get over it.

August 14, 2010 6:48 PM
Anonymous Anonymous said...

You people are idiots

August 14, 2010 6:59 PM


Nice to see Krugman has time to answer his critics.

Another Anonymous said...

Joe: The same principle applies to krugman wanting the fed to target 3% inflation, but on a smaller scale. Don't you think this is better than direct government deficit spending? It would leave the spending to the market and people would buy what they want. And of course, increasing aggregate demand in this manner doesn't have a burden on our national debt.

The problem is that the Fed doesn't have the power to increase inflation by setting a target rate, or by anything else it can do, other than hidden deficit spending. Monetary policy is much weaker than fiscal policy, although Krugman, along with the trend of the last few decades, when an utterly irrational belief which held the reverse gained sway, doesn't appreciate this. Since the national debt is not a burden - are the dollar bills in your wallet a burden? - increasing it is not a burden. Direct deficit spending could do a lot of good things - like immediate full employment - much quicker than a magically inflationary monetary policy.

Bob Roddis said...

Chartalists Mau-Maued by Von Mises in 1918.

By reading the truly creepy and bizarre article “From Money and Taxes: the Chartalist Approach” by L. Randall Wray, we can finally understand the source of this nonsense of the state theory of money and the truly bizarre idea of “chartal money”, with Wray citing Georg Friedrich Knapp. Von Mises shredded Knapp’s “state theory of money” here.

Anonymous said...

Battle of the fringe schools! Charliton vs Austrain! Who will win??

Another Anon said...

Well, one or the other. These days, the more mainstream and orthodox economics is, the more it is an insult to one's intelligence, an embarassment to human race.

Mises uses the word "Catallactic" but never defines it. I would appreciate enlightement. As far as I can tell, contrary to him, chartalism is a catallactic theory. And I can't find any argument that he makes there, he just says Knapp is wrong - and he seems to completely misunderstand the theory. e.g "[Knapp] was bound—to abandon all attempt at an explanation of the validity of money in commerce." That's the aim of the theory; saying Knapp didn't even try is just silly. So, not shredded.

By the way, Wray was a student of Minsky, and according to wikipedia, http://en.wikipedia.org/wiki/Minsky_moment , his theory is similar to the Austrian Business Cycle theory, which seems to be not terribly far from some ideas of the MMTers / chartalists. The point is that most mainstream economics doesn't take money and credit seriously. About as sensible as if biologists had resolved to only study dead objects, most of which were never alive, or entirely mythical.

Finally, I know of three Austrian blogospheredenizens who have come over to the dark side of chartalism. My plot unfolds ... Bwaahhahhahha.....

Bob Roddis said...

Mises uses the word "Catallactic" but never defines it.

My, we're up on our Austrian theory this morning aren't we?

"Catallactics" is the scientific study of interpersonal money exchanges. Chartalism is acatallactic (and thus primitive and real dumb) because it has no theory and pays no attention to examining the basis of human money exchanges. Or human anything.

Check out Mises’ “Human Action” and Rothbard’s “Man Economy and State” at mises.org. They’re long, but their free.

By the way, Austrian money theory is merely a corollary of the basic axioms of human action. Since Chartalism has no concept of human action and it naively views “the state” as a neutral, mechanical force for good (as opposed to the gang of murderers, bullies, thugs and thieves that it is), I can find no common ground between the two schools of thought whatsoever.

Anonymous said...

"I know of three Austrian blogospheredenizens who have come over to the dark side of chartalism."

So what? I know of four chartalist blogospheredenizens who have come over to the good side of Austrianism. Ha, we win.

Another Anon said...

It really seems to me that Mises did not understand chartalism, where the value of money is determined by the free market - as far as I can tell, "catallacticly." The government controls the initial supply and final demand of base money and regulates banking, which still leaves a lot of room for the market. He may have just thought that Knapp said the state just enforced it by dictate or legal tender laws.

Looked up the word in my OED: Decided I didn't dislike it when I saw: Ruskin's: You may grow for your neighbour, at your liking, grapes or grape-shot; he will also, catallactically, grow grapes or grape-shot for you, and you will each reap what you have sown.

The chartalists don't view the state as good or evil; they just describe try to build up a theory of money, which to describe the real world we see, must include the state.

Thing is, Anonynmous, I wasn't making that up.

burkll13 said...

oh, ok, im convinced now.....