George Selgin Relives the Sixties

Just two days before the 50th anniversary of the assassination of John Kennedy, George Selgin offered an ironic endorsement of raising the inflation target, as happened during the Kennedy Administration, in order to reduce unemployment.

[T]his isn’t the first time that we’ve been in a situation like the present one. There was at least one other occasion when the U.S. economy, having been humming along nicely with the inflation rate of 2% and an unemployment rate between 5% and 6%, slid into a recession. Eventually the unemployment rate was 7%, the inflation rate was only 1%, and the federal funds rate was within a percentage point of the zero lower bound. Fortunately for the American public, some well-placed (mostly Keynesian) economists came to the rescue, by arguing that the way to get unemployment back down was to aim for a higher inflation rate: a rate of about 4% a year, they figured, should suffice to get the unemployment rate down to 4%–a much lower rate than anyone dares to hope for today.

I’m puzzled and frustrated because, that time around, the Fed took the experts’ advice and it worked like a charm. The federal funds rate quickly achieved lift-off (within a year it had risen almost 100 basis points, from 1.17% to 2.15%). Before you could say “investment multiplier” the inflation and unemployment numbers were improving steadily. Within a few years inflation had reached 4%, and unemployment had declined to 4%–just as those (mostly Keynesian) experts had predicted.

So why are these crazy inflation hawks trying to prevent us from resorting again to a policy that worked such wonders in the past? Do they just love seeing all those millions of workers without jobs? Or is it simply that they don’t care about job

Oh: I forgot to say what past recession I’ve been referring to. It was the recession of 1960-61. The desired numbers were achieved by 1967. I can’t remember exactly what happened after that, though I’m sure it all went exactly as those clever theorists intended.

George has the general trajectory of the story more or less right, but the details and the timing are a bit off. Unemployment rose to 7% in the first half of 1961, and inflation was 1% or less. So reducing the Fed funds rate certainly worked, real GDP rising at not less than a 6.8% annual rate for four consecutive quarters starting with the second quarter of 1961, unemployment falling to 5.5 in the first quarter of 1962. In the following 11 quarters till the end of 1964, there were only three quarters in which the annual growth of GDP was less than 3.9%. The unemployment rate at the end of 1964 had fallen just below 5 percent and inflation was still well below 2%. It was only in 1965, that we see the beginings of an inflationary boom, real GDP growing at about a 10% annual rate in three of the next five quarters, and 8.4% and 5.6% in the other two quarters, unemployment falling to 3.8% by the second quarter of 1966, and inflation reaching 3% in 1966. Real GDP growth did not exceed 4% in any quarter after the first quarter of 1966, which suggests that the US economy had reached or exceeded its potential output, and unemployment had fallen below its natural rate.

In fact, recognizing the inflationary implications of the situation, the Fed shifted toward tighter money late in 1965, the Fed funds rate rising from 4% in late 1965 to nearly 6% in the summer of 1966. But the combination of tighter money and regulation-Q ceilings on deposit interest rates caused banks to lose deposits, producing a credit crunch in August 1966 and a slowdown in both real GDP growth in the second half of 1966 and the first half of 1967. With the economy already operating at capacity, subsequent increases in aggregate demand were reflected in rising inflation, which reached 5% in the annus horribilis 1968.

Cleverly suggesting that the decision to use monetary expansion, and an implied higher tolerance for inflation, to reduce unemployment from the 7% rate to which it had risen in 1961 was the ultimate cause of the high inflation of the late 1960s and early 1970s, and, presumably, the stagflation of the mid- and late-1970s, George is inviting his readers to conclude that raising the inflation target today would have similarly disastrous results.

Well, that strikes me as quite an overreach. Certainly one should not ignore the history to which George is drawing our attention, but I think it is possible (and plausible) to imagine a far more benign course of events than the one that played itself out in the 1960s and 1970s. The key difference is that the ceilings on deposit interest rates that caused a tightening of monetary policy in 1966 to produce a mini-financial crisis, forcing the 1966 Fed to abandon its sensible monetary tightening to counter inflationary pressure, are no longer in place.

Nor should we forget that some of the inflation of the 1970s was the result of supply-side shocks for which some monetary expansion (and some incremental price inflation) was an optimal policy response. The disastrous long-term consequences of Nixon’s wage and price controls should not be attributed to the expansionary monetary policy of the early 1960s.

As Mark Twain put it so well:

We should be careful to get out of an experience only the wisdom that is in it and stop there lest we be like the cat that sits down on a hot stove lid. She will never sit down on a hot stove lid again and that is well but also she will never sit down on a cold one anymore.

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30 Responses to “George Selgin Relives the Sixties”

  1. 1 Marcus Nunes November 29, 2013 at 9:58 am

    David, I´ve told a version of this story:

    Also, I tend to think that the oil supply shock – the decision to restrict oil output by OPEC – was strongly influenced by the previous rise in inflation!

  2. 2 George Selgin November 29, 2013 at 1:32 pm

    “The key difference is that the ceilings on deposit interest rates that caused a tightening of monetary policy in 1966 to produce a mini-financial crisis, forcing the 1966 Fed to abandon its sensible monetary tightening to counter inflationary pressure, are no longer in place.”

    It seems to me, David, that there is today at least as great a risk than there was in ’66 that the Fed, faced with a need to counter inflationary pressure in the future, will again abandon the “sensible monetary tightening” that would be necessary for the purpose. One only has to consider the likely effects of any of the exit strategies likely to be available to it. Raising the interest rate on bank reserves, for example, would choke off bank lending (again), while eating into the Fed’s net earnings; selling off Treasuries and other long-term assets will raise rates and expose the Fed to major losses. I’m not, in short, at all as confident as you are that the Fed can be counted on to do the right thing when it has to this time around.

    On a more fundamental note, I think the argument that it takes a higher inflation “target” to achieve more complete recovery is deeply flawed. It begs the question if real output improves, does that mean we must have still _more_ spending to achieve the higher inflation goal? Or is it to be understood, as Rogoff suggests (in a foolish golfing analogy), that we must “aim” for 6% in order to “hit” 2%? If so, then just who are the naive persons who are supposed to be taken in by the ruse, and is the attempt not, after all, very “early 60s” in spirit?

    Though sticking to my guns, David, I am as always very glad to have your (typically) thoughtful comments.

  3. 3 lorenzofromoz November 29, 2013 at 6:00 pm

    These sort of debates lead me to conclude that Scott Sumner is correct, “inflation target” is simply the wrong language.

    Central banks essentially set the level of aggregate demand and the only way to hold them responsible for what they actually do is to have them explicitly target that.

  4. 4 Philo November 30, 2013 at 6:10 pm

    I take it that Selgin rejects having the Fed adopt a higher inflation target now because he thinks that, having done so, they would later follow up with policy errors. But nowhere does he reject the recommendation that the Fed adopt-a-higher-inflation-target-now-and-subsequently-follow-good-policies.

    We can divide the situation into two stages: now and later. One possible recommendation concerns what the Fed should do *now*, in which case the recommendation would be based on what they *would actually do later*, in following up. Another possible recommendation concerns what the Fed should do *now and later*; what the Fed will or would actually do is irrelevant for this recommendation.

    Selgin may well be right, that A (higher inflation target) would be bad because the Fed would follow it up with B (bad policy later). But this does not contradict those who call for A *followed by not-B*. (And I think that is what people like Krugman intend, although admittedly they often sound as if they were simply advocating A, by itself.)

    (Of course, Lorenzo/Sumner is right: it would be better to couch the recommendation in terms of NGDP, not mentioning inflation at all.)

  5. 5 Will November 30, 2013 at 9:08 pm

    A Mad Men reference would have fit in nicely.

    I say, take Selgin’s comparison and run with it. The 60s are remembered fondly by most, no? Hippies! Beatles! John Lindsay! Bullwinkle! Moon landing! Also, I reject the implication that the stagflationary 70s were worse than what we’ve had since 2008. The 70s were not all that bad, especially in the US, and people need to stop stressing about them like they were the devil. (Although Milton Friedman did quite well for himself telling people that these years were indeed the devil).

  6. 6 tonidepoli December 1, 2013 at 4:27 am

    Will, I’m guessing that you’re under 50.

  7. 7 Mike Sax December 1, 2013 at 5:06 am

    George the trouble I have with your position is that it seems to suggest that we know the exact costs of inflation and the exact costs of inflation fighting and we know beyond a shadow of a doubt that the costs of inflation fighting are a drop in the bucket to the cost of inflation.

    I just don’t know where you or anyone else gets this confidence. Right now the costs of inflation fighting seem pretty high-a slow subnormal recovery. Weren’t the 70s better than this?

  8. 8 Mike Sax December 1, 2013 at 5:12 am

    I mean, don’t get me wrong, I understand that the 70s were not exactly optimal times to live in but it was still much preferable to the 30s or for that matter today.

  9. 9 George Selgin December 1, 2013 at 6:24 am

    Mike, it isn’t a question of “inflation fighting.” It is one of the appropriateness of _aiming_ for an inflation rate of 4 or even 6 percent. The proposal is as unwise as it is unnecessary. (1) If the goal is merely to get to 2% inflation (as some suggest is the case), then only by twisted logic can one claim that aiming for 4% or 6% will somehow get us there when aiming for 2% itself will not; (2) unless adverse supply changes are responsible for it, even 2% inflation is _ipso-facto_ proof that the economy is not suffering from a real or nominal money shortage, and hence that the source of disappointing employment and output numbers lies elsewhere; (3) higher inflation itself ought not to be regarded as a legitimate monetary policy objective; nor is it properly regarded as a means for achieving higher real output or employment; (4) in the absence of substantial inflation a higher growth rate of NGDP might in contrast properly be regarded as a means for achieving a higher rate of output and employment, perhaps with some increase in inflation as a side effect, but then the argument should be for announcing a suitable NGDP growth target, not for announcing a higher inflation target (for one thing, the latter risks raising inflation expectations, which itself will _hamper_ recovery).

    Whatever the flaws of my comparison with the 60s may be–and all such comparisons are necessarily imperfect–in one respect I’m pretty certain that it isn’t flawed at all. That is in regarding those who argue for a higher inflation target today as subscribing to the same basic fallacy as their early-60s Keynesian progenitors, to whit: that of confusing the inflation rate with the rate of growth of aggregate demand, and thereby falsely treating what are really two contemporaneous consequences of cyclical changes in AD as if one were a consequence of the other.

  10. 10 Mike Sax December 1, 2013 at 6:41 am

    Well George I don’t think anyone is arguing for a 6% rate. As to a 4% rate it might seem a lot but in actuality we had a trend rate of inflation of larger that during the so-called Great Moderation-I believe it was more like 4.7%

    You can make the case that the recent announcement of the 2% target is actually a significant case of tightening as if achieved it would be less than half the rate we had during the GM which is supposed to be the golden age of low inflation.

    In any case we have such low inflation now that it’s tough to see how this remains a valid concern for all but the most fanatical inflation hawks.

    This is why in your ironic post where you wondered if these people are just callous dunderheads I’m tempted to say ‘Yes. Or at least they don’t really worry too much about unemployment. So long as inflation is low that is the important thing.’

    I don’t know whether or not the psychology of those in the 60s are the same as today but the circumstances couldn’t be more different.

  11. 11 tonidepoli December 1, 2013 at 7:06 am

    Ken Rogoff has in fact argued for raising the inflation target to 6%. As for a 2% goal being equivalent to tightening, that doesn’t make sense to me since the current rate is well below 2%. That the inflation rate was higher in the 80s seems to me quite beside the point.

    As for your remarks about not worrying about unemployment, I am unphazed. The suggestion that one who opposes higher inflation must necessarily not be concerned about unemployment is a good example of precisely the sort of force causal inference I complained about in my last comment. It implicitly takes for granted the sort of inflation-unemployment trade-off the unreliability of which was revealed, at such great cost, half a century ago. Finally, the suggestion that those who reject a particular _means_ for attempting to reduce unemployment can do so only because they “don’t worry much” about unemployment, though a stock-in-trade of apologists for higher inflation, is contemptible. Let’s please stick to calling those we disagree with dunderheads–it’s much more generous!

  12. 12 George Selgin December 1, 2013 at 7:07 am

    For “force” in my last, please read “false.”

  13. 13 Mike Sax December 1, 2013 at 7:23 am

    “Ken Rogoff has in fact argued for raising the inflation target to 6%. As for a 2% goal being equivalent to tightening, that doesn’t make sense to me since the current rate is well below 2%. That the inflation rate was higher in the 80s seems to me quite beside the point.”

    Not just the 1980s but the 90s and 2000s up until 2008. I don’t know why a few years that we’ve had subnormal inflation is relevent but the much longer period that most inflationphobes see as a golden age is irrelevant.

    Are you suggesting that you would have supported a 4% inflation rate in the Summer of 2008 when we had a long term trend in inflation closer to 5% than 4 but not now?

    I think ‘unfazed’ is another word for ‘unconcerned.’ At the minimum your position is that maybe unemployment is an evil but inflation is a worse one. For your saying that you will consider only those remedies to unemployment that don’t also raise the inflation rate.

    My point was about the hierarchy of concerns. For example if my daughter is sick and I really want her to get well but then I hear that the cost of her operation is beyond what I want to spend then maybe I still care about my daughter’s health. Just not very much. Or not as much as that extra dollar Id have to pay.

  14. 14 George Selgin December 1, 2013 at 7:38 am

    I was unphazed–that is, not disconcerted–by your arguments, Mike. That you read me as declaring that I don’t care about unemployment, and do so even despite my having objected to that sort of tactic, suggests to me that that you are riding a hobby-horse. In any event, the rest of your remarks suggest that you are not “getting” my points. You continue to simple _assume_ (1) that, with inflation actually at around 1%, _aiming_ for 4% will in fact accomplish more than aiming at 2% could; and (2) that actually _achieving_ 4% will mean having lower unemployment than we’d have with inflation back at 2%; (3) that it is good practice to argue as if there is a stable a causal relationship between the inflation and unemployment rates, instead of one relating both to the rate of NGDP growth (with the split between inflation and employment effects depending on expectations and the economy’s proximity to the natural unemployment rate); and , lastly, (4) that a substantial part of the present unemployment rate can safely be attributed to lack of demand.

    I doubt the validity of all four assumptions, and eagerly await convincing proof that each of them is in fact sound.

  15. 15 Mike Sax December 1, 2013 at 7:56 am

    “You continue to simple _assume_ (1) that, with inflation actually at around 1%, _aiming_ for 4% will in fact accomplish more than aiming at 2% could; and (2) that actually _achieving_ 4% will mean having lower unemployment than we’d have with inflation back at 2%; (3) that it is good practice to argue as if there is a stable a causal relationship between the inflation and unemployment rates, instead of one relating both to the rate of NGDP growth (with the split between inflation and employment effects depending on expectations and the economy’s proximity to the natural unemployment rate); and , lastly, (4) that a substantial part of the present unemployment rate can safely be attributed to lack of demand.”

    George I never said that I necessarily believe raising the inflation target is the best way to improve the recovery, just that I wouldn’t rule it out. I know that NKers think raising the inflation rate will have a major benefit. I’m not sure but I have no problem with trying. In principle I don’t really see why we need an inflation target at all. Still as long term inflation prior to this recession was much higher and it was seen as a golden age the 2% rate is actually monetary tightening

    My point is that I think it’s worth doing virtually anything-obviously we rule out things like forced labor- to get our recovery back to a healthier level. There are a number of what I call inflationphobes who won’t consider doing anything if it might even possibly raise inflation a little bit.

    It might be that it’s not that we need higher inflation but rather doing what’s necessary would raise inflation-that inflation is the effect rather than the cause of good countercyclical policy.

    Right now we have some members of the Fed who perversely still raise inflation concerns when they’re over 50% lower than the implicit 2.5% target Bernanke set last year.

  16. 16 George Selgin December 1, 2013 at 8:19 am

    Mike, I am all for having a monetary policy that doesn’t cause (unnatural) unemployment (the qualifier is to rule out a policy that would boost employment only temporarily, at the cost of further economic waste). But I deny that it’s worth doing ‘anything” that “might” help, and especially that it’s worth doing anything that might hurt rather than help. Raising the inflation target–the only particular policy that my original post addressed–strikes me as a good example of the sort of policy that seems likely to do little good, while it risks doing much harm.

  17. 17 Mike Sax December 1, 2013 at 8:43 am

    Well if we can only go by what we know will happen beyond the shadow of a doubt then we’l never do anything.

    I return to my example of a sick person in need of operation. Are you telling me that in the medical field they do only what they know will work with 100% certainty?

    If someone has cancer and that operation ‘might’ help does that mean you just say ‘well we wont deal wit ‘mights’ lets just not do anything then until we’re 100% certain of the results.’

    By the way I don’t get how you’re original post connects to the 60s-they didn’t raise the inflation target then, they didn’t have one.

    Does your post really lead the reader to anything other than resignation with the status quo?

    We don’t know 100% that NGDP targeting will work. It’s proponents believe it will-others are more skeptical. However, by your criterion we can’t try that either-after all it ‘might’ work it ‘might not.’

    Sometimes the status quo is bad enough that you’re willing to think outside the box. Those who are truly disatisfied with it at least.

  18. 18 David Glasner December 1, 2013 at 9:24 am

    Marcus, Thanks for the link. Your story is obviously told in much greater detail and with a lot more visual aids, but the basic narrative is pretty similar. However, we are clearly not at all in agreement about the origins of the oil price increase. I do not understand how a 400% increase in the price of crude oil can possibly be explained by a 25% increase in the price level.

    George, The Fed is not supposed to conduct monetary policy with an eye on its profit-loss statement. About whether the Fed should pursue its inflation target even if the economy is expanding at low inflation, I think the answer is generally no. That’s why we and the Fed shouldn’t be overly punctilious in following “rules.” Sometimes a dose of common sense is necessary. The problem with recent Fed performance is that the unemployment has been above target and inflation below target at the same time and the Fed has complacently tolerated that intolerable conjunction. Finally, I appreciate your kind words. I think we all benefit from arguing through these issues from our different perspectives. Even if we don’t reach an agreement, we all benefit from understanding better how the other guy is thinking about these issues. We tend to think (see my comment above to Marcus) that the other guy is not making sense, but usually he is, we’re just not understanding how he’s getting to the seemingly strange conclusion he is positing.

    Lorenzo, Good point. The inflation target is a very bad way to think about monetary policy.

    Philo, As of now, I think that NGDP is the best we can do as a target, but that still leaves a lot of issues to be resolved about how to set the target and how to implement policy to achieve the target.

    Will, There’s was a lot of bad stuff going on as well. And, anyway, how did John Lindsay get on your list? The main problem with economic policy was not inflation, it was wage and price controls, and their illegitimate offspring: controls on crude oil and petroleum products prices.

    George, Think of it this way. Suppose we were to set a contingent target of a price level 10% higher than the current price level, which we would aim for until the unemployment rate fell below 6%. That was FDR’s basic strategy in 1933. I understand that you are not likely to be impressed by any argument that uses FDR as a model to be emulated, but devaluing the dollar in 1933 did trigger a very impressive recovery, which FDR himself sabotaged by when he created the NRA thereby raising money wages by 20% later in 1933. At any rate the lesson I draw is that you can raise the price level target and get temporary inflation boost without setting off expectations of permanently higher inflation. I agree that 2% inflation would normally be evidence that aggregate demand is not deficient, but if the real rate of interest is less than negative 2%, the economy is in a trap because the Fisher equation can’t hold. The dynamic process by which the Fisher equation is again satisfied is not at all clear. In those circumstances, raising the inflation rate may be the best way out of the trap.

    Mike, I agree with you that opponents of QE are often complacent about unemployment. That doesn’t not necessarily mean that they are heartless or are insensitive to the suffering of the unemployed, it may just reflect a view of the world in which monetary policy cannot be reliably used to affect real variables. In their view, monetary policy, perhaps in general but certainly at the zero lower bound, cannot even affect the price level. And even if it can affect the price level, real variables are largely independent of the price level changes. So in that view of the world, monetary policy is pretty close to useless, and can only do harm. Therefore the only job of the monetary authority should be to keep the price level constant or as near to constant as is practically possible. Insofar as that view of the world is derived from stagflation in the 1970s, I think it is inferring far more from the evidence than is warranted. The evidence from the 1970s shows that the Phillips curve does shift in response to movements in the price level or the rate of inflation, but the idea is that the long-run Phillips curve is vertical is a purely theoretical construct; there is no empirical evidence that even comes close to establishing that proposition.

  19. 19 Marcus Nunes December 1, 2013 at 10:45 am

    David, the oil price thing is a bit more complicated. OPEC came into existance in 1960 but could never get consensus, until 1973. The Israel-Arab conflict that was the trigger for oil supply restriction was predicated on the fact that between mid 1965 and mid 1973 real oil prices (in U$) fell more than 50%. A loss of 50% (real) in your major source of income is something very significant over a relatively short 8 year period. And that´s not all. The real loss was even greater because after mid 1971 the dollar depreciated significantly relative to major currencies.
    Now the oil producers could not only not buy Cadillacs but the Mercedes also became much more expensive!

  20. 20 George Selgin December 1, 2013 at 1:50 pm

    David, you say, “you can raise the price level target and get temporary inflation boost without setting off expectations of permanently higher inflation.” I agree. But can you raise the inflation rate target without setting off expectations of permanently higher inflation? I think the answer here is generally no: the only in stance I can think of in which the higher target will not lead to higher inflation expectations is that in which the public either doubts the the target is really being aimed at, or in which it doubts the fed’s capacity to achieve it despite really trying. But those cases are also ones in which the higher target is unlikely to accomplish anything at all.

    I agree, by the way, that monetary expansion was called for in ’33. But I don’t agree that a higher price level was called for. Here I think there is some confusion at work. The problem in ’33, and whenever there is cyclical unemployment, was not that P was “too low” but that actual P was above equilibrium P (P*), that is, that P* was in a sense “too low.” Monetary expansion, by eliminating the discrepancy, would also eliminate the excess supply of goods and labor that went hand-in-hand with an excess demand for money. But nothing would have been gained by the fed’s having suggested that it was about to undertake a policy aimed at raising prices further.

    Similarly, today, if indeed some unemployment is properly attributed to a lack of money and spending (and I think it very doubtful, by the way, that this is true of all save 6 percentage points), then the problem is not that the actual price level is too low. It is that the equilibrium level is below the actual one, so that an increase in M and MV can serve to “ratify” the existing level. Again, this is not a question of raising P further. That’s neither necessary nor sufficient to solve the problem.

    All of which takes me back to insisting that we not treat calls for raising the rate of inflation (or price level) as being equivalent to calls for increasing the growth rate (or level) of NGDP. They are fundamentally different things, and whereas I have no serious beef with you or Scott Sumner or others who think NGDP still too low (though i have questioned whether this is indeed true), I think it only weakens the case to associate this view with the views of those who clamor for increasing either the actual or the target rate of inflation.

  21. 21 David Glasner December 2, 2013 at 10:14 am

    Marcus, I am still not following you. US prices did increase by almost 50% from 1965 to 1973, but crude oil prices were not constant, so I don’t know what is the basis for the assertion that real price of crude oil received by exporters fell between 1965 and 1973. OPEC, with an assist from Colonel Ghaddafi and the Shah of Iran, had already imposed large increases in posted prices even before the October 1973 oil embargo. According to data I just found on the BP website, the posted price of Arabian light was $1.80 a barrel on January 1, 1965 and $3.20 a barrel on January 1, 1973, implying an increase in the real price of oil over the 1965 price,10 months before the oil embargo. But even if I give you your 50% reduction in the real price of crude oil plus another 20% reduction in the foreign exchange value of the dollar (and even if don’t pay attention to the double counting issue), you have still accounted for only a 70% increase in the oil price, not a 600% increase (compared to the 1965 benchmark that you have adopted). To say the 600% increase in oil prices imposed at the end of 1973 over the 1965 benchmark was the result of previous US inflation is simply incredible.

    George, I accept your distinction between the implications of raising the inflation target and raising the price level target. I am against inflation targeting as a policy rule, but for purposes of this discussion I was ignoring the distinction, even though they clearly do have very different implications for the long run. So we are not in fact that far apart in our understanding of the implications of raising the inflation target. When I say that I am in favor of doing so, I am implicitly assuming that it is done in the context of a shift to price level targeting (or NGDP level targeting).

    On 1933, however, I think there is a real, but subtle, difference between us. As I understand it, the 1933 devaluation had a direct and immediate effect on prices which had an immediate expansionary effect on output. The subsequent monetary expansion was induced by the price-level effect, not the other way around. So I claim a price-level effect can be expansionary, and similarly the expectation of a price-level effect can also be expansionary. That is not true in general, but in an economy with high unemployment, I think it is true, because profit margins would tend to rise (or be expected to rise) creating an incentive to expand output and employment.

  22. 22 George Selgin December 2, 2013 at 12:54 pm

    I understand the devaluation implied a higher _equilibrium_ price level, consistent with the re-establishment of purchasing power parity, while it also induced gold inflows so long as actual P remained below that new equilibrium level. But it doesn’t follow that such recovery as took place before the ’37 debacle depended on the actual increase in P during that interval rather than on the tendency of monetary expansion (including both the gold inflow effect of devaluation and its more immediate effect on the nominal stock of base money) to close the gap that had opened between actual and equilibrium P prior to devaluation. In my own simple-minded reckoning, the only sort of unemployment that monetary expansion serves to (lastingly) eliminate is the sort related to a prior excess demand for money, which is of course a function not of P* but of the difference P-P*.

    I should add that it is perfectly possible for P to be rising even though it remains above P*, owing to the fact that some prices are relatively flexible. Consequently, at the trough some prices have fallen close to their long-run GE values, while many others have a ways to go. If monetary expansion then occurs, it will raise P* and actual P simultaneously, though the greater effect will be on P*.

    Speaking of gaps, I don’t know whether these remarks help to further close the one between D and G, but I hope they do.

  23. 23 lorenzofromoz December 2, 2013 at 5:20 pm

    This debate also makes clear that level targeting has distinct inter-temporal advantages over rate targeting.

    Regarding unemployment, if the concern is unemployment, then why care about inflation? Because of its impact on income. But why would there be excess demand to hold money? Because of poor income expectations.

    The problem with inflation targeting* is that it allows central banks to evade responsibility for their effects on aggregate income and income expectations. As I read George Selgin, he is against weakening the central bank’s inflation obligations in a temporally untethered way. Quite.

    *The “an inflation rate of 2–3 per cent, on average, over the cycle” target of the RBA effectively incorporates an implicit income target, so is not quite the same.

  24. 24 lorenzofromoz December 2, 2013 at 5:22 pm

    Blogging note: David, I suspect you have various empty paragraph marks at the end of the post, which is why the gap before comments/the next post.

  25. 25 David Glasner December 2, 2013 at 6:50 pm

    George, Thanks for this comment which, I think, helps me identify the point of divergence between us. When you say that devaluation implies a higher equilibrium price level, consistent with the re-establishment of purchasing power parity while inducing gold inflows so long as actual P remained below the new equilibrium level, you are framing the adjustment process in terms of the price-specie-flow mechanism, which is not the way that I think about the adjustment.

    Here is how I think about the adjustment. The change in the exchange rates following devaluation created arbitrage opportunities that forced immediate price adjustments in internationally traded commodities. These price adjustments operated even before there were any gold movements and before money supplies changed. The adjustments in foreign-exchange rates triggered immediate price-level adjustments that had nothing to do with whether the internal price level was above or below its equilibrium level. Gold flows were not the cause of price-level adjustment; they were part of the mechanism by which the quantity of domestic money supplied adjusted to the amount of money demanded. An excess demand for money in the US, given the new higher price level and increasing income and output, lead to an export surplus and an inflow of gold that, absent sterilization, allowed the domestic money supply to expand to match the demand. A disproportionate part of the FDR recovery was concentrated in the four months from April to July 1933 when the value of the dollar fell by about 40%, and wholesale prices rose by more than 10% and industrial output increased by something like 70 or 80%. Unfortunately, the NIRA was passed in July and the recovery more or less flat-lined for two years until the NRA was mercifully terminated by the Supreme Court. So, in my view, monetary expansion was a response to the increase in prices and output following the devaluation, rather than the increase in prices and output being a response to monetary expansion.

    This may or may not help close the gap between us, but it seems to me that this is where the difference between us is coming from.

    Lorenzo, I am not so sure that there is an excess demand for money. I think that I agree with everything else that you are saying.

    I tried unsuccessfully to eliminate the gap. In my initial draft I was going to include a table of inflation rates, real gdp growth rates and unemployment rates for every quarter from 1959 through 1967. But then I decided just to refer to the numbers as needed without including the table. Unfortunately, when I deleted the table, only the numbers disappeared but the space originally occupied remained blank.

  26. 26 George Selgin December 2, 2013 at 8:00 pm

    So many gaps being discussed at once–rather confusing! Nevertheless I do think, David, that the D-G one has indeed shrunk further as a result of your last, for I accept your claim about commodity P (call it P’) responding at once, so long as we can agree that (equilibrium) prices of non-tradeables, including labor, would rise in turn only once domestic spending actually began to increase. As for the big output gains in the months immediately following devaluation, see Eichengreen’s discussion, Golden Fetters 343-4 (and note), which agrees with my own assessment. “Though a higher dollar price of gold meant a depreciated dollar and increased domestic commodity prices,” he observes, “it did not imply increased domestic demand in the absence of the [sic] increased provision of money and credit.” Although producers had responded positively immediately after the holiday, that was largely because they anticipated other steps that would lead to more immediate monetary expansion. However “by the second half of 1933 [they were] disappointed by the absence of evidence of more expansionary policies. Industrial production consequently fell back, and its sustained recovery had to await…growth of commodity exports and capital imports” i.e., gold inflows.

  27. 27 Benjamin Cole December 3, 2013 at 5:53 am

    Okay, some facts: Real per capita incomes in the 1960s rose by more than 30 percent. Okay? It was a great honking decade, economically speaking.

    In 1969, the PCE deflator was 4.5 percent. (Chain type index, see table b-3 Eco Report of the President,

    The CPi was higher, but many have argued the CPI back then overstated inflation,and it was changed later (Boskin).

    BTW, in 1972 the CPI had fallen to 3.2 percent. So, the genie was back in the bottle.

    Second and huge point: The economy today has changed much from then. 1960s: Big Labor, Big Steel (remember announced price hikes), Big Auto. Big retailers with annual catalogs (Sears), regulated rates in trucking airlines, phones, international trade was a small part of the economy. Reg Q. Stockbroker commissions fixed. Top marginal tax rate 90 percent! Venture capitalists are small-timers.

    Today global trade a large part of the economy, unions are dead, rates deregged, no Reg Q. No one has pricing power. Global competition. Huge pots of capital to invest in any business plan that looks promising. Top marginal tax rate 40-something percent. Venture capital everywhere. Capital everywhere, no crowding out.

    Arthur Burns could make a case back in 1960s and 70s that tight money only depressed output. He overstated the case, but there was much truth in what he said.

    Today, a more-expansive monetary policy would likely translate into much higher real growth, and little inflation.

    I don;t think one can connect the dots between the 1960s and higher inflation rates in the 1970s.

    Another fact worth remembering. From 1976 through 1979 (four year period) the USA economy expanded in real terms by 20 percent, after the 1975 recession. Who would not like a recovery like that today?

    Okay, should we credit the rapid 1976-9 expansion to the 1960s as well?

  28. 28 David Glasner December 3, 2013 at 9:09 am

    George, I am happy to reciprocate and agree with you that the prices of non-tradables don’t adjust instantaneously to a devaluation (which helps to account for the boost to profit margins following devaluation). As for the quote from Eichengreen, WADR for both of you, I disagree. The recovery stalled because of the NRA-induce increases in nominal wages with no further dollar depreciation for the rest of 1933. So we may have arrived at the point at which further narrowing of the gap is not easily achieved.

    Benjamin, I largely agree with you. The sixties was a great decade economically. As a quibble, I would observe that measured inflation in 1972 was understated because of Nixonian wage and price controls, while Arthur Burns was busily greasing the skids for Nixon’s reelection. The 1976-79 expansion got out of hand early on because of the incompetence of Carter’s replacement for Arthur Burns, the hapless G. William Miller. It is hard to imagine that that anyone who succeeded Burns could have made Burns look good in comparison, but Miller actually pulled that one off. Inflation should have gradually fallen during the 1976-79 recovery, at least until the next oil shock after the Iranian revolution in 1979. But inflation rose continuously during the expansion (5.8% in 1976 to 7.5% in 1978) before jumping to double digit levels after the oil-price shock later in 1979.

  29. 29 George Selgin December 3, 2013 at 9:38 am

    Well, a little more narrowing, perhaps, for I also very much agree that the NRA stalled recovery, by further widening the gap between actual and equilibrium P, and so (in my view) offset much of the the potential gain from gold inflows and M expansion.

  30. 30 Benjamin Cole December 3, 2013 at 9:16 pm


    Yeah, I forgot about wage-and-price controls, good catch. Still, to say that 1960s-era monetary policy (which, as I say, resulted in a 4.5 percent PCE deflator in 1969) led to double-digit inflation in the 1970s is a stretch.

    And, we are much less inflation-prone today—when was the last time inflation was a problem?

    And I stand by my usually complaint that today economists seem to judge each period not by real growth but by how much inflation there was. This is the Fed-ification, or the Federal Reservization, of the profession.

    Indeed, now we have calls for the Fed to have a single mandate: No inflation. Growth is an interesting numerical curiosity in this world view.

    Gee, and I thought macroeconomics was about prosperity.

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About Me

David Glasner
Washington, DC

I am an economist at the Federal Trade Commission. Nothing that you read on this blog necessarily reflects the views of the FTC or the individual commissioners. Although I work at the FTC as an antitrust economist, most of my research and writing has been on monetary economics and policy and the history of monetary theory. In my book Free Banking and Monetary Reform, I argued for a non-Monetarist non-Keynesian approach to monetary policy, based on a theory of a competitive supply of money. Over the years, I have become increasingly impressed by the similarities between my approach and that of R. G. Hawtrey and hope to bring Hawtrey's unduly neglected contributions to the attention of a wider audience.

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