Archive for the 'Robert Waldmann' Category

Wherein I Try to Help Robert Waldmann Calm Down

Brad Delong kindly posted a long extract from my previous post (about Martin Feldstein) on his blog. The post elicited a longish comment from Robert Waldmann who has been annoyed with me for a while, because, well, because he seem to think that I have an unnatural obsession with monetary policy. Now it’s true that I advocate monetary easing, and think monetary policy, properly administered, could help get our economy moving again, but it’s not as if I have said that fiscal policy can’t work or shouldn’t be tried. So I don’t exactly understand why Waldmann keeps insisting that he won’t calm down. Anyway, let’s have a look at Waldmann’s comment.

After making a number of very cogent criticisms of the Feldstein piece that I criticized, Waldman continues:

On the other hand I also disagree with Glasner. This is the usual and I will not calm down.

Well, you maybe you should reconsider.

Then, quoting from my post on Feldstein,

“does he believe the Fed incapable of causing the price level to increase?” Obviously not (it made no sense to type the question) as he fears higher inflation.

That’s true, I started by asking why Feldstein believed a 20% increase in commodity prices was a bubble. I pointed out in my next sentence that if the Fed was causing inflation, then the increase in commodity prices was not a bubble.

I wish for higher inflation, but, unlike Glasner, I don’t hope for it. the Fed has made gigantic efforts to stimulate and inflation is well below the 2% target. What would it take to convince Glasner that the Fed can’t cause higher prices right now ? It seems to me that his faith is completely impervious to data.

OK, fair question. My point is that the Fed is still committed to a 2% inflation target. If the Fed said that it was aiming to increase the price level by 10% within a year and would take whatever steps necessary to raise prices by 10% and failed, that would be a fair test of the theory that the Fed can control the price level. But if the Fed is saying that it’s aiming at a 2% annual increase in the price level, and its undershooting its target, but isn’t even saying that it will do more to increase the rate of inflation, I don’t see that the proposition that the Fed can control the price level has been refuted by the evidence. The gigantic efforts that Waldmann references have all been undertaken in the context of a monetary regime that is committed to not letting the rate of inflation exceed 2%.

Continuing to quote from my post, Waldmann writes:

“Rising asset prices indicate the expectation of QE is inducing investors to shift out of cash into real assets”

Note the clear assumption. QE is the only possible cause of any change in asset prices. Glasner assumes that nothing else changes or that nothing else matters. He basically assumes that there is nothing under the sun but monetary policy.

I think I am being entirely fair to him. I think that, in fact, he assumes not only that monetary policy affects macroeconomic developments but that it is the only thing which affects macroeconomic developments. He has made this very clear when debating me. I think his identifying assumption is indefensible.

Sorry, but where is that clear assumption made? I said that rising asset prices could be attributed to an expectation that QE would increase the rate of inflation. My empirical study showed a strong correlation between inflation expectations and asset values, a correlation not present in the data before 2008. I didn’t say and my empirical study never suggested that asset prices depend on nothing else but inflation expectations, so I am at a loss to understand why Waldmann thinks that that is what I was assuming. What I do say is that monetary policy can affect the price level, not that monetary policy is the only thing that can affect the price level.

Waldmann concludes with a question:

I am curious as to whether there is another possible interpretation of Glasner.

The answer, Professor Waldmann, is yes! Why won’t you take “yes” for an answer? I hope that helps calm you down. It should.

PS I am sorry that I have not responded to comments recently. I have just been too busy. Perhaps over the weekend.

Some Popperian (and Kuhnian!) Responses to Robert Waldmann

Robert Waldmann has been criticizing my arguments for the importance of monetary policy in accounting for both the 2008 downturn and the weakness of the subsequent recovery. He raises interesting issues which I think warrant a response. In my previous response to Waldmann, I closed with the following paragraph:

I think that the way to pick out changes in monetary policy is to look at changes in inflation expectations, and I think that you can find some correlation between changes in monetary policy, so identified, and employment, though it is probably not nearly as striking as the relationship between asset prices and inflation expectations. I also don’t think that operation twist had any positive effect, but QE3 does seem to have had some. I am not familiar with the study by the San Francisco Fed economists, but I will try to find it and see what I can make out of it. In the meantime, even if Waldmann is correct about the relationship between monetary policy and employment since 2008, there are all kinds of good reasons for not rushing to reject a null hypothesis on the basis of a handful of ambiguous observations. That wouldn’t necessarily be the calm and reasonable thing to do.

Waldmann replied as follows on his blog:

Get the null on your side is my motto (I admit it).  You follow this.  You suggest that your hypothesis is the hull hypothesis then abuse Neyman and Person by implying that we can draw interesting conclusions from failure to reject the null.  Basically the sentence which includes the word “null” is the assertion that we should assume you are right and I am wrong until I offer solid proof.  To be briefer, since we are working in social science, you are asking that I assume you are right.  This is not an ideal approach to debate.
I ask you to review your sentence which contains the word “null” and reconsider if you really believe it.  The choice of the null should be harmless (it is an a priori choice without a prior).  How about we make the usual null hypothesis that an effect is zero.  Can you reject the null that monetary policy since 2009 has had no effect ? At what confidence level is the null rejected ?  Did you use a t-test ? an f-test ?  “null” is a technical term and I ask again if you would be willing to retract the sentence including the word “null”.

First, I was careless in identifying my hypothesis that monetary policy is an important factor with the “null” hypothesis. The convention in statistical testing is to identify the null hypothesis as alternative to the hypothesis being tested. What I meant to say was that even if the evidence is not sufficient to reject the null hypothesis that monetary policy is ineffective, there may still be good reason not to reject the alternative or maintained hypothesis that monetary policy is effective. In the real world, there is ambiguity. Evidence is not necessarily conclusive, so we accept for the most part that there really are alternative ways of looking at the world and that, as a practical matter, we don’t have sufficient evidence to reject conclusively either the null or the maintained hypothesis. With the relatively small numbers of observations that we are working with, statistical tests aren’t powerful enough to reject the null with a high level of confidence, so I have trouble accepting the standard statistical model of hypothesis testing in this context.

But even aside from the paucity of observations, there is a deeper problem which is that, as Karl Popper the arch-falsificationist was among the first to point out, observations are not independent of the underlying theory. We use the theory to interpret what we are observing. Think of Galileo, he was confronted with people telling him that the theory that the earth is travelling around a stationary sun is obviously refuted by the clear evidence that the earth is stationary and that it is the sun that is moving in the sky. Galileo therefore had to write a whole book in which he explained, using the Copernican theory, how to interpret the apparent evidence that the earth is stationary and the sun is moving. By doing so, Galileo didn’t prove that the earth-centric model was wrong, he simply was able to show that what his opponents regarded as conclusive empirical validation of their theory was not conclusive, inasmuch as the Copernican theory was able to interpret the supposedly contradictory evidence in a manner that is consistent with the premises of the Copernican theory. As Kuhn showed in the Structure of Scientific Revolutions, the initial astronomical evidence was more supportive of the Ptolomaic hypothesis than of the Copernican hypothesis. It was only because the Copernicans didn’t give up prematurely that they eventually gathered sufficient evidence to overwhelm the opposition.

Waldmann continues:

using expected inflation to identify monetary policy is only a valid statistical procedure if one is willing to assume that nothing else affects expected inflation.  If you think that say OPEC ever had any influence on expected inflation, then you can’t use your identifying assumption.  In particular TIPS breakevens can be fairly well fit (not predicted because not out of sample) using lagged data other than data on what the FOMC did.

again I refer to

[Here is the chart to which Waldmann refers.]


(legend here red is the 5 year TIPS breakeven or expected inflation, Blue is the change over the *past* year of the price of a barrel of oil times 0.1 plus 1.6, green is the geometric mean of the change over the *past year* of the personal consumption deflator and the personal consumption minus food and energy deflator.

Again, I don’t think formal statistical modeling is the issue here, because the data are neither sufficient in quantity nor unambiguous in their interpretation. The data are what they are, and if we cannot parse out what has been caused by OPEC and what has been caused by the Fed, we have to accept the ambiguity and not pretend that it doesn’t exist just so to impose an identifying assumption. I would also make what I would have thought is an obvious observation that since 2007 the causality between the price of oil and the state of the economy has been going in both directions, and any statistical model that takes the price of oil as exogenous is incredible.

I don’t see how anyone could look at this graph and then claim we can identify monetary policy by the TIPS breakeven.  That is only valid if nothing but monetary policy affects inflation expectations.

I don’t understand that. Why, if monetary policy accounts for 50% of the variation in inflation expectations is it not valid to use the TIPS spread to identify monetary policy? We may have to make some plausible assumptions about when there were supply-side disturbances or add some instrumental variables, but I don’t see why we would want to ignore monetary policy just because factors other than monetary policy may be affecting inflation expectations.

Similarly in 1933 monetary policy wasn’t the only thing that changed.  I understand that there was considerable policy reform in the so called “first hundred days.  ” The idea that we can identify the effect of monetary policy by looking at the USA in 1933 is based on the assumption that Roosevelt did nothing else.  This is not reasonable.

Sure he did other things, but you can’t seriously mean that government spending increased in the first 100 days by an amount sufficient to account for the explosion in output from April to July. I would concede that other things that Roosevelt did may have also helped restore confidence, but I don’t see how you can deny that the devaluation of the dollar was at or near the top of the list of economic actions taken in the first 4 months of his Presidency.

But I think we can detect the effect of recent monetary policy on TIPS breakevens if we agree that it (including QE) is working principally through forward guidance.  There should be quick effects on asset prices when surprising shifts are announced.  QE 4 (December 2012) was definitely a surprise.  The TIPS spread barely moved (within the range of normal fluctuations).  I think the question is settled.  I do not think it is optimal to ignore daily data when you have it and treat same quarter as the same instant.  Some prices are sticky and some aren’t.  Bond prices aren’t.

What makes you so sure that QE4 was a surprise. I think that there was considerable disappointment that there was no increase in the inflation target, just a willingness to accept some slight amount of overshooting (2.5%) before applying the brakes as long as unemployment remains over 6.5%. Ambiguity reins supreme.

Robert Waldmann, WADR, Maybe You Really Should Calm Down

Responding to this recent post of mine, Robert Waldmann wrote a post of his own with a title alluding to an earlier post of mine responding to a previous post of his. Just to recapitulate briefly, the point of the post which seems to have provoked Professor Waldmann was to refute the allegation that the Fed and the Bank of Japan are starting a currency war by following a policy of monetary ease in which they are raising (at least temporarily) their inflation target. I focused my attention on a piece written by Irwin Stelzer for the Weekly Standard, entitled not so coincidentally, “Currency Wars.” I also went on to point out that Stelzer, in warning of the supposedly dire consequences of starting a currency war, very misleadingly suggested that Hitler’s rise to power was the result of an inflationary policy followed by Germany in the 1930s.

Here is how Waldmann responds:

I do not find any reference to the zero lower bound in this post.  Your analysis of monetary expansion does not distinguish between the cases when the ZLB holds and when it doesn’t.  You assume that the effect of an expansion of the money supply on domestic demand can be analyzed ignoring that detail. I think it is clear that the association between the money supply and domestic demand has been different in the USA since oh September 2008 than it was before.  This doesn’t seem to me to be a detail which can be entirely overlooked in any discussion of current policy.

Actually, I don’t think that, in principle, I disagree with any of this. I agree that the zero lower bound is relevant to the analysis of the current situation. I prefer to couch the analysis in terms of the Fisher equation making use of the equilibrium condition that the nominal rate of interest must equal the real rate plus expected inflation. If the expected rate of deflation is greater than the real rate, equilibrium is impossible and the result is a crash of asset prices, which is what happened in 2008. But as long as the real rate of interest is negative (presumably because of pessimistic entrepreneurial expectations), the rate of inflation has to be sufficiently above real rate of interest for nominal rates to be comfortably above zero. As long as nominal rates are close to zero and real rates are negative, the economy cannot be operating in the neighborhood of full-employment equilibrium. I developed the basic theory in my paper “The Fisher Effect Under Deflationary Expectations” available on SSRN, and provided some empirical evidence (which I am hoping to update soon) that asset prices (as reflected in the S&P 500) since 2008 have been strongly correlated with expected inflation (as approximated by the TIPS spread) even though there is no strong theoretical reason for asset prices to be correlated with expected inflation, and no evidence of correlation before 2008. Although I think that this is a better way than the Keynesian model to think about why the US economy has been underperforming so badly since 2008, I don’t think that the models are contradictory or inconsistent, so I don’t deny that fiscal policy could have some stimulative effect. But apparently that is not good enough for Professor Waldmann.

Also, I note that prior to his [Stelzer’s] “jejune dismissal of monetary policy,” Stelzer jenunely dismissed fiscal policy.  You don’t mention this at all.  Your omission is striking, since the evidence that Stelzer is wrong to dismiss fiscal policy is overwhelming (not overwhelming enough to overwhelm John Taylor but then mere evidence couldn’t do that).  In contrast, the dismissal of monetary policy when an economy is in a liquidity trap is consistent with the available evidence.

It seems to me that Waldmann is being a tad oversensitive. Stelzer’s line was “stimulus packages don’t work very well, and monetary policy produces lots of fiat money but not very many jobs.” What was jejune was not the conclusion that fiscal policy and monetary policy aren’t effective; it was his formulation that monetary expansion produces lots of fiat money but not many jobs, a formulation which, I believe, was intended to be clever, but struck me as being not clever, but, well, jejune. So I did not mean to deny that fiscal policy could be effective at the zero lower bound, but I disagree that the available evidence is consistent with the proposition that monetary policy is ineffective in a liquidity trap. In 1933, for example, monetary policy triggered the fastest economic expansion in US history, when FDR devalued the dollar shortly after taking office, an expansion unfortunately prematurely terminated by the enactment of FDR’s misguided National Industrial Recovery Act. The strong correlation between inflation expectations and stock prices since 2008, it seems to me, also qualifies as evidence that monetary policy is not ineffective at the zero lower bound. But if Professor Waldmann has a different interpretation of the significance of that correlation, I would be very interested in hearing about it.

Instead of looking at the relationship between inflation expectations and stock prices, Waldmann wants to look at the relationship between job growth and monetary policy:

I hereby challenge you to show data on US “growth”  meaning (I agree with your guess) mostly employment growth since 2007 to someone unfamiliar with the debate and ask that person to find the dates of shifts in monetary policy.  I am willing to bet actual money (not much I don’t have much) that the person will not pick out QEIII or operation twist.    I also guess that this person will not detect forward guidance looking at day to day changes in asset prices.

I claim that the null that nothing special happened the day QEIV was announced or any of the 4 plausible dates of announcement of QE2 (starting with a FOMC meeting, then Bernanke’s Jackson Hole speech then 2 more) can’t be rejected by the data. This is based on analysis by two SF FED economists who look at the sum of changes over three of the days (not including the Jackson Hole day when the sign was wrong) and get a change (of the sign they want) whose square is less than 6 times the variance of daily changes (of the 10 year rate IIRC).  IIRC 4.5 times.  Cherry picking and not rejecting the null one wants to reject is a sign that one’s favored (alternative) hypothesis is not strongly supported by the data.

I think that the way to pick out changes in monetary policy is to look at changes in inflation expectations, and I think that you can find some correlation between changes in monetary policy, so identified, and employment, though it is probably not nearly as striking as the relationship between asset prices and inflation expectations. I also don’t think that operation twist had any positive effect, but QE3 does seem to have had some. I am not familiar with the study by the San Francisco Fed economists, but I will try to find it and see what I can make out of it. In the meantime, even if Waldmann is correct about the relationship between monetary policy and employment since 2008, there are all kinds of good reasons for not rushing to reject a null hypothesis on the basis of a handful of ambiguous observations. That wouldn’t necessarily be the calm and reasonable thing to do.

About Me

David Glasner
Washington, DC

I am an economist in the Washington DC area. My research and writing has been mostly on monetary economics and policy and the history of economics. 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.

My new book Studies in the History of Monetary Theory: Controversies and Clarifications has been published by Palgrave Macmillan

Follow me on Twitter @david_glasner


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