Posts Tagged 'Barack Obama'

Welcome to Uneasy Money, aka the Hawtreyblog

Published July 5, 2021 Frederick Lavington , Keynes , Little Depression , Monetarism , R. G. Hawtrey , Say's Law , Scott Sumner , Uncategorized , Walras's Law 37 Comments
Tags: , , , ,

UPDATE: I’m re-upping my introductory blog post, which I posted ten years ago toady. It’s been a great run for me, and I hope for many of you, whose interest and responses have motivated to keep it going. So thanks to all of you who have read and responded to my posts. I’m adding a few retrospective comments and making some slight revisions along the way. In addition to new posts, I will be re-upping some of my old posts that still seem to have relevance to the current state of our world.

What the world needs now, with apologies to the great Burt Bachrach and Hal David, is, well, another blog.  But inspired by the great Ralph Hawtrey and the near great Scott Sumner, I decided — just in time for Scott’s return to active blogging — to raise another voice on behalf of a monetary policy actively seeking to promote recovery from what I call the Little Depression, instead of the monetary policy we have now:  waiting for recovery to arrive on its own.  Just like the Great Depression, our Little Depression was caused mainly by overly tight money in an environment of over-indebtedness and financial fragility, and was then allowed to deepen and become entrenched by monetary authorities unwilling to commit themselves to a monetary expansion aimed at raising prices enough to make business expansion profitable.

That was the lesson of the Great Depression.  Unfortunately that lesson, for reasons too complicated to go into now, was never properly understood, because neither Keynesians nor Monetarists had a fully coherent understanding of what happened in the Great Depression.  Although Ralph Hawtrey — called by none other than Keynes “his grandparent in the paths of errancy,” and an early, but unacknowledged, progenitor of Chicago School Monetarism — had such an understanding,  Hawtrey’s contributions were overshadowed and largely ignored, because of often irrelevant and misguided polemics between Keynesians and Monetarists and Austrians.  One of my goals for this blog is to bring to light the many insights of this perhaps most underrated — though competition for that title is pretty stiff — economist of the twentieth century.  I have discussed Hawtrey’s contributions in my book on free banking and in a paper published years ago in Encounter and available here.  Patrick Deutscher has written a biography of Hawtrey.

What deters businesses from expanding output and employment in a depression is lack of demand; they fear that if they do expand, they won’t be able to sell the added output at prices high enough to cover their costs, winding up with redundant workers and having to engage in costly layoffs.  Thus, an expectation of low demand tends to be self-fulfilling.  But so is an expectation of rising prices, because the additional output and employment induced by expectations of rising prices will generate the demand that will validate the initial increase in output and employment, creating a virtuous cycle of rising income, expenditure, output, and employment.

The insight that “the inactivity of all is the cause of the inactivity of each” is hardly new.  It was not the discovery of Keynes or Keynesian economics; it is the 1922 formulation of Frederick Lavington, another great, but underrated, pre-Keynesian economist in the Cambridge tradition, who, in his modesty and self-effacement, would have been shocked and embarrassed to be credited with the slightest originality for that statement.  Indeed, Lavington’s dictum might even be understood as a restatement of Say’s Law, the bugbear of Keynes and object of his most withering scorn.  Keynesian economics skillfully repackaged the well-known and long-accepted idea that when an economy is operating with idle capacity and high unemployment, any increase in output tends to be self-reinforcing and cumulative, just as, on the way down, each reduction in output is self-reinforcing and cumulative.

But at least Keynesians get the point that, in a depression or deep recession, individual incentives may not be enough to induce a healthy expansion of output and employment. Aggregate demand can be too low for an expansion to get started on its own. Even though aggregate demand is nothing but the flip side of aggregate supply (as Say’s Law teaches), if resources are idle for whatever reason, perceived effective demand is deficient, diluting incentives to increase production so much that the potential output expansion does not materialize, because expected prices are too low for businesses to want to expand. But if businesses can be induced to expand output, more than likely, they will sell it, because (as Say’s Law teaches) supply usually does create its own demand.

[Comment after 10 years: In a comment, Rowe asked why I wrote that Say’s Law teaches that supply “usually” creates its own demand. At that time, I responded that I was just using “usually” as a weasel word. But I subsequently realized (and showed in a post last year) that the standard proofs of both Walras’s Law and Say’s Law are defective for economies with incomplete forward and state-contingent markets. We actually know less than we once thought we did!] 

Keynesians mistakenly denied that, by creating price-level expectations consistent with full employment, monetary policy could induce an expansion of output even in a depression. But at least they understood that the private economy can reach an impasse with price-level expectations too low to sustain full employment. Fiscal policy may play a role in remedying a mismatch between expectations and full employment, but fiscal policy can only be as effective as monetary policy allows it to be. Unfortunately, since the downturn of December 2007, monetary policy, except possibly during QE1 and QE2, has consistently erred on the side of uneasiness.

With some unfortunate exceptions, however, few Keynesians have actually argued against monetary easing. Rather, with some honorable exceptions, it has been conservatives who, by condemning a monetary policy designed to provide incentives conducive to business expansion, have helped to hobble a recovery led by the private sector rather than the government which  they profess to want. It is not my habit to attribute ill motives or bad faith to people whom I disagree with. One of the finest compliments ever paid to F. A. Hayek was by Joseph Schumpeter in his review of The Road to Serfdom who chided Hayek for “politeness to a fault in hardly ever attributing to his opponents anything but intellectual error.” But it is a challenge to come up with a plausible explanation for right-wing opposition to monetary easing.

[Comment after 10 years: By 2011 when this post was written, right-wing bad faith had already become too obvious to ignore, but who could then have imagined where the willingness to resort to bad faith arguments without the slightest trace of compunction would lead them and lead us.] 

In condemning monetary easing, right-wing opponents claim to be following the good old conservative tradition of supporting sound money and resisting the inflationary proclivities of Democrats and liberals. But how can claims of principled opposition to inflation be taken seriously when inflation, by every measure, is at its lowest ebb since the 1950s and early 1960s? With prices today barely higher than they were three years ago before the crash, scare talk about currency debasement and future hyperinflation reminds me of Ralph Hawtrey’s famous remark that warnings that leaving the gold standard during the Great Depression would cause runaway inflation were like crying “fire, fire” in Noah’s flood.

The groundlessness of right-wing opposition to monetary easing becomes even plainer when one recalls the attacks on Paul Volcker during the first Reagan administration. In that episode President Reagan and Volcker, previously appointed by Jimmy Carter to replace the feckless G. William Miller as Fed Chairman, agreed to make bringing double-digit inflation under control their top priority, whatever the short-term economic and political costs. Reagan, indeed, courageously endured a sharp decline in popularity before the first signs of a recovery became visible late in the summer of 1982, too late to save Reagan and the Republicans from a drubbing in the mid-term elections, despite the drop in inflation to 3-4 percent. By early 1983, with recovery was in full swing, the Fed, having abandoned its earlier attempt to impose strict Monetarist controls on monetary expansion, allowed the monetary aggregates to grow at unusually rapid rates.

However, in 1984 (a Presidential election year) after several consecutive quarters of GDP growth at annual rates above 7 percent, the Fed, fearing a resurgence of inflation, began limiting the rate of growth in the monetary aggregates. Reagan’s secretary of the Treasury, Donald Regan, as well as a variety of outside Administration supporters like Arthur Laffer, Larry Kudlow, and the editorial page of the Wall Street Journal, began to complain bitterly that the Fed, in its preoccupation with fighting inflation, was deliberately sabotaging the recovery. The argument against the Fed’s tightening of monetary policy in 1984 was not without merit. But regardless of the wisdom of the Fed tightening in 1984 (when inflation was significantly higher than it is now), holding up the 1983-84 Reagan recovery as the model for us to follow now, while excoriating Obama and Bernanke for driving inflation all the way up to 1 percent, supposedly leading to currency debauchment and hyperinflation, is just a bit rich. What, I wonder, would Hawtrey have said about that?

In my next posting I will look a little more closely at some recent comparisons between the current non-recovery and recoveries from previous recessions, especially that of 1983-84.

Trying to Make Sense of the Insane Policy of the Bank of France and Other Catastrophes

Published June 18, 2015 Bank of France , Cassel , counter-insurgency , Earl Thompson , gold standard , Great Depression , Hawtrey 18 Comments
Tags: , , , , ,

In the almost four years since I started blogging I have occasionally referred to the insane Bank of France or to the insane policy of the Bank of France, a mental disorder that helped cause the deflation that produced the Great Depression. The insane policy began in 1928 when the Bank of France began converting its rapidly growing stockpile of foreign-exchange reserves (i.e., dollar- or sterling-denominated financial instruments) into gold. The conversion of foreign exchange was precipitated by the enactment of a law restoring the legal convertibility of the franc into gold and requiring the Bank of France to hold gold reserves equal to at least 35% of its outstanding banknotes. The law induced a massive inflow of gold into the Bank of France, and, after the Federal Reserve recklessly tightened its policy in an attempt to stamp out stock speculation on Wall Street, thereby inducing an inflow of gold into the US, the one-two punch knocked the world economy into just the deflationary tailspin that Hawtrey and Cassel, had warned would result if the postwar restoration of the gold standard were not managed so as to minimize the increase in the monetary demand for gold.

In making a new round of revisions to our paper on Hawtrey and Cassel, my co-author Ron Batchelder has just added an interesting footnote pointing out that there may have been a sensible rationale for the French gold policy: to accumulate a sufficient hoard of gold for use in case of another war with Germany. In World War I, belligerents withdrew gold coins from circulation, melted them down, and, over the next few years, exported the gold to neutral countries to pay for food and war supplies. That’s how the US, remaining neutral till 1917, wound up with a staggering 40% of the world’s stock of monetary gold reserves after the war. Obsessed with the military threat a re-armed Germany would pose, France insisted that the Versailles Treaty impose crippling reparations payments. The 1926 stabilization of the franc and enactment of the law restoring the gold standard and imposing a 35% reserve requirement on banknotes issued by the Bank of France occurred during the premiership of the staunchly anti-German Raymond Poincaré, a native of Lorraine (lost to Prussia in the war of 1870-71) and President of France during World War I.

A long time ago I wrote a paper “An Evolutionary Theory of the State Monopoly over Money” (which was reworked as chapter two of my book Free Banking and Monetary Reform and was later published in Money and the Nation State) in which, relying on an argument made by Earl Thompson, I suggested that historically the main reason for the nearly ubiquitous state involvement in supplying money was military not monetary: monopoly control over the supply of money enables the sovereign to quickly gain control over resources in war time, thereby giving states in which the sovereign controls the supply of money a military advantage over states in which the sovereign has no such control. Subsequently, Thompson further developed the idea to explain the rise of the gold standard after the Bank of England was founded in 1694, early in the reign of William and Mary, to finance rebuilding of the English navy, largely destroyed by the French in 1690. As explained by Macaulay in his History of England, the Bank of England, by substantially reducing the borrowing costs of the British government, was critical to the survival of the new monarchs in their battle with the Stuarts and Louis XIV. See Thompson’s article “The Gold Standard: Causes and Consequences” in Business Cycles and Depressions: An Encyclopedia (edited by me).

Thompson’s article is not focused on the holding of gold reserves, but on the confidence that the gold standard gave to those lending to the state, especially during a wartime suspension of convertibility, owing to an implicit commitment to restore the gold standard at the prewar parity. The importance of that implicit commitment is one reason why Churchill’s 1925 decision to restore the gold standard at the prewar parity was not necessarily as foolish as Keynes (The Economic Consequences of Mr. Churchill), along with almost all subsequent commentators, judged it to have been. But the postwar depreciation of the franc was so extreme that restoring the convertibility of the franc at the prewar parity became a practical impossibility, and the new parity at which convertibility was restored was just a fifth of its prewar level. Having thus reneged on its implicit commitment to restore the gold standard at the prewar parity, impairing its ability to borrow, France may have felt it had no alternative but to accumulate a ready gold reserve from which to draw when another war against Germany came. This is just theoretical speculation, but it might provide some clues for historical research into the thinking of French politicians and bankers in the late 1920s as they formulated their strategy for rejoining the gold standard.

However, even if the motivation for France’s gold accumulation was not simply a miserly desire to hold ever larger piles of shiny gold ingots in the vaults of the Banque de France, but was a precautionary measure against the possibility of a future war with Germany – and we know only too well that the fear was not imaginary – it is important to understand that, in the end, it was almost certainly the French policy of gold accumulation that paved the way for Hitler’s rise to power and all that entailed. Without the Great Depression and the collapse of the German economy, Hitler might well have remained an outcast on the margins of German politics.

The existence of a legitimate motivation for the insane policy of the Bank of France cannot excuse the failure to foresee the all too predictable consequences of that policy – consequences laid out plainly by Hawtrey and Cassel already in 1919-20, and reiterated consistently over the ensuing decade. Nor does the approval of that policy by reputable, even eminent, economists, who simply failed to understand how the gold standard worked, absolve those who made the wrong decisions of responsibility for their mistaken decisions. They were warned about the consequences of their actions, and chose to disregard the warnings.

All of this is sadly reminiscent of the 2003 invasion of Iraq. I don’t agree with those who ascribe evil motives to the Bush administration for invading Iraq, though there seems little doubt that the WMD issue was largely pretextual. But that doesn’t mean that Bush et al. didn’t actually believe that Saddam had WMD. More importantly, I think that Bush et al. sincerely thought that invading Iraq and deposing Saddam Hussein would, after the supposed defeat of Al Qaeda and the Taliban in Afghanistan, establish a benign American dominance in the region, as World War II had done in Japan and Western Europe.

The problem is not, as critics like to say, that Bush et al. lied us into war; the problem is that they stupidly fooled themselves into thinking that they could just invade Iraq, unseat Saddam Hussein, and that their job would be over. They fooled themselves even though they had been warned in advance that Iraq was riven by internal ethnic, sectarian, religious and political divisions. Brutally suppressed by Hussein and his Ba’athist regime, those differences were bound to reemerge once the regime was dismantled. When General Eric Shinseki’s testified before Congress that hundreds of thousands of American troops would be needed to maintain peace and order after Hussein was ousted, Paul Wolfowitz and Donald Rumsfeld could only respond with triumphalist ridicule at the idea that more troops would be required to maintain law and order in Iraq after Hussein was deposed than were needed to depose him. The sophomoric shallowness of the response to Shinseki by those that planned the invasion still shocks and appalls.

It’s true that, after the Republican loss in the 2006 Congressional elections, Bush, freeing himself from the influence of Dick Cheney and replacing Donald Rumsfeld with Robert Gates as Secretary of Defense, and Gen. George Casey with Gen. David Petraeus as commander of US forces in Iraq, finally adopted the counter-insurgency strategy (aka the “surge”) so long resisted by Cheney and Rumsfeld, thereby succeeding in putting down the Sunni/Al-Qaeda/Baathist insurgency and in bringing the anti-American Shi’ite militias to heel. I wrote about the success of the surge in December 2007 when that provisional military success was still controversial. But, as General Petraeus conceded, the ultimate success of the counter-insurgency strategy depended on implementing a political strategy to reconcile the different elements of Iraqi society to their government. We now know that even in 2008 Premier Nouri al-Maliki, who had been installed as premier with the backing of the Bush administration, was already reversing the limited steps taken during the surge to achieve accommodation between Iraqi Sunnis and Shi’ites, while consolidating his Shi’ite base by reconciling politically with the pro-Iranian militants he had put down militarily.

The failure of the Iraqi government to consolidate and maintain the gains made in 2007-08 has been blamed on Obama’s decision to withdraw all American forces from Iraq after the status of forces agreement signed by President Bush and Premier al-Maliki in December 2008 expired at the end of 2011. But preserving the gains made in 2007-08 depended on a political strategy to reconcile the opposing ethnic and sectarian factions of Iraqi society. The Bush administration could not implement such a strategy with 130,000 troops still in Iraq at the end of 2008, and the sovereign Iraqi government in place, left to its own devices, had no interest in pursuing such a strategy. Perhaps keeping a larger US presence in Iraq for a longer time would have kept Iraq from falling apart as fast as it has, but the necessary conditions for a successful political outcome were never in place.

So even if the motivation for the catastrophic accumulation of gold by France in the 1928-29 was merely to prepare itself to fight, if need be, another war against Germany, the fact remains that the main accomplishment of the gold-accumulation policy was to bring to power a German regime far more dangerous and threatening than the one that would have otherwise confronted France. And even if the motivation for the catastrophic invasion of Iraq in 2003 was to defeat and discredit Islamic terrorism, the fact remains that the invasion, just as Osama bin Laden had hoped, was to create the conditions in which Islamic terrorism could grow into a worldwide movement, attracting would-be jihadists to a growing number of local conflicts across the world. Although bin Laden was eventually killed in his Pakistani hideout, the invasion of Iraq led to rise of an even more sophisticated, more dangerous, and more threatening opponent than the one the invasion was intended to eradicate. Just as a misunderstanding of the gold standard led to catastrophe in 1928-29, the misconception that the threat of terrorism can be eliminated by military means has been leading us toward catastrophe since 2003. When will we learn?

PS Despite some overlap between what I say above and what David Henderson said in this post, I am not a libertarian or a non-interventionist.

Paul Krugman on Tricky Urban Economics

Published May 29, 2015 intangible infrastructural capital , Jane Jacobs , Paul Krugman , urban renewal 11 Comments
Tags: , ,

Paul Krugman has a post about a New Yorker piece by Tim Wu discussing the surprising and disturbing increase in vacant storefronts in the very prosperous and desirable West Village in Lower Manhattan. I agree with most of what Krugman has to say, but I was struck by what seemed to me to be a misplaced emphasis in his post. My comment is not meant so much as a criticism, as an observation on the complexity of the forces that affect life in the city, which makes it tricky to offer any sort of general ideological prescriptions for policy. Krugman warns against adopting a free-market ideological stance – which is fine – but fails to observe that statist interventionism has had far more devastating effects on urban life. We should be wary of both extremes.

Krugman starts off his discussion with the following statement, with which, in principle, I don’t take issue, but is made so emphatically that it suggests the opposite mistake of the one that Krugman warns against.

First, when it comes to things that make urban life better or worse, there is absolutely no reason to have faith in the invisible hand of the market. External economies are everywhere in an urban environment. After all, external economies — the perceived payoff to being near other people engaged in activities that generate positive spillovers — is the reason cities exist in the first place. And this in turn means that market values can very easily produce destructive incentives. When, say, a bank branch takes over the space formerly occupied by a beloved neighborhood shop, everyone may be maximizing returns, yet the disappearance of that shop may lead to a decline in foot traffic, contribute to the exodus of a few families and their replacement by young bankers who are never home, and so on in a way that reduces the whole neighborhood’s attractiveness.

The basic point is surely correct; urban environments are highly susceptible, owing to their high population density, to both congestion and pollution, on the one hand, and to positive spillovers, on the other, and cities require a host of public services and amenities provided, more or less indiscriminately, to large numbers of people. Market incentives, to the exclusion of various kinds of collective action, cannot be relied upon to cope with congestion and pollution or to provide public services and amenities. But it is equally true that cities cannot function well without ample scope for private initiative and market exchange. The challenge for any city is to find a reasonable balance between allowing individuals to organize their lives, and pursue their own interests, as they see fit, and providing an adequate supply of public services and amenities, while limiting the harmful effects that individuals living in close proximity inevitably have on each other. It is certainly fair to point out that unfettered market forces alone can’t produce good outcomes in dense urban environments, and understandable that Krugman, a leading opponent of free-market dogmatism, would say so, but he curiously misses an opportunity, two paragraphs down, to make an equally cogent point about the dangers of going too far in the other direction.

Curiously, the missed opportunity arises just when, in the spirit of even-handedness and objectivity, Krugman acknowledges that increasing income equality does not necessarily enhance the quality of urban life.

Politically, I’d like to say that inequality is bad for urbanism. That’s far from obvious, however. Jane Jacobs wrote The Death and Life of Great American Cities right in the middle of the great postwar expansion, an era of widely shared economic growth, relatively equal income distribution, empowered labor — and collapsing urban life, as white families fled the cities and a combination of highway building and urban renewal destroyed many neighborhoods.

This just seems strange to me. Krugman focuses on declining income equality, as if that was what was driving the collapse in urban life, while simultaneously seeming to recognize, though with remarkable understatement, that the collapse coincided with white families fleeing cities and neighborhoods being destroyed by highway building and urban renewal, as if the highway building and the urban renewal were exogenous accidents that just then happened to be wreaking havoc on American urban centers. But urban renewal was a deliberate policy adopted by the federal government with the explicit aim of improving urban life, and Jane Jacobs wrote The Death and Life of Great American Cities precisely to show that large-scale redevelopment plans adopted to “renew” urban centers were actually devastating them. And the highway building that Krugman mentions was an integral part of a larger national plan to build the interstate highway system, a system that, to this day, is regarded as one of the great accomplishments of the federal government in the twentieth century, a system that subsidized the flight of white people to the suburbs facilitated the white flight lamented by Krugman. The collapse of urban life did not just happen; it was the direct result of policies adopted by the federal government.

In arguing for his fiscal stimulus package, Barack Obama, who ought to have known better, invoked the memory of the bipartisan consensus supporting the Interstate Highway Act. May God protect us from another such bipartisan consensus. I found the following excerpt from a book by Eric Avila The Folklore of the Freeway: Race and Revolt in the Modernist City, which is worth sharing:

In this age of divided government, we look to the 1950s as a golden age of bipartisan unity. President Barack Obama, a Democrat, often invokes the landmark passage of the 1956 Federal Aid Highway Act to remind the nation that Republicans and Democrats can unite under a shared sense of common purpose. Introduced by President Dwight Eisenhower, a Republican, the Federal Aid Highway Act, originally titled the National Interstate and Defense Highway Act, won unanimous support from Democrats and Republicans alike, uniting the two parties in a shared commitment to building a national highway infrastructure. This was big government at its biggest, the single largest federal expenditure in American history before the advent of the Great Society.

Yet although Congress unified around the construction of a national highway system, the American people did not. Contemporary nostalgia for bipartisan support around the Interstate Highway Act ignores the deep fissures that it inflicted on the American city after World War II: literally, by cleaving the urban built environment into isolated parcels of race and class, and figuratively, by sparking civic wars over the freeway’s threat to specific neighborhoods and communities. This book explores the conflicted legacy of that megaproject: even as the interstate highway program unified a nation around a 42,800-mile highway network, it divided the American people, as it divided their cities, fueling new social tensions that flared during the tumultuous 1960s.

Talk of a “freeway revolt” permeates the annals of American urban history. During the late 1960s and early 1970s, a generation of scholars and journalists introduced this term to describe the groundswell of grassroots opposition to urban highway construction. Their account saluted the urban women and men who stood up to state bulldozers, forging new civic strategies to rally against the highway-building juggernaut and to defeat the powerful interests it represented. It recounted these episodic victories with flair and conviction, doused with righteous invocations of “power to the people.” In the afterglow of the sixties, a narrative of the freeway revolt emerged: a grass- roots uprising of civic-minded people, often neighbors, banding together to defeat the technocrats, the oil companies, the car manufacturers, and ultimately the state itself, saving the city from the onslaught of automobiles, expressways, gas stations, parking lots, and other civic detriments. This story has entered the lore of the sixties, a mythic “shout in the street” that proclaimed the death of the modernist city and its master plans.

By and large, however, the dominant narrative of the freeway revolt is a racialized story, describing the victories of white middle-class or affluent communities that mustered the resources and connections to force concessions from the state. If we look closely at where the freeway revolt found its greatest success—Cambridge, Massachusetts; Lower Manhattan; the French Quarter in New Orleans; Georgetown in Washington D.C.; Beverly Hills, California; Princeton, New Jersey; Fells Point in Baltimore—we discover what this movement was really about and whose interests it served. As bourgeois counterparts to the inner-city uprising, the disparate victories of the freeway revolt illustrate how racial and class privilege structure the metropolitan built environment, demonstrating the skewed geography of power in the postwar American city.

One of my colleagues once told me a joke: if future anthropologists want to find the remains of people of color in a postapocalypse America, they will simply have to find the ruins of the nearest freeway. Yet such collegial jocularity contained a sobering reminder that the victories associated with the freeway revolt usually did not extend to urban communities of color, where highway construction often took a disastrous toll. To greater and lesser degrees, race—racial identity and racial ideology—shaped the geography of highway construction in urban America, fueling new patterns of racial inequality that exacerbated an unfolding “urban crisis” in postwar America. In many southern cities, local city planners took advantage of federal moneys to target black communities point-blank; in other parts of the nation, highway planners found the paths of least resistance, wiping out black commer- cial districts, Mexican barrios, and Chinatowns and desecrating land sacred to indigenous peoples. The bodies and spaces of people of color, historically coded as “blight” in planning discourse, provided an easy target for a federal highway program that usually coordinated its work with private redevelop- ment schemes and public policies like redlining, urban renewal, and slum clearance.

One of my favorite posts in the nearly four years that I’ve been blogging was one with a horrible title: “Intangible Infrastructural Capital.” My main point in that post was that the huge investment in building physical infrastructure during the years of urban renewal and highway building was associated with the mindless destruction of vastly more valuable intangible infrastructure: knowledge, expectations (in both the positive and normative senses of that term), webs of social relationships and hierarchies, authority structures and informal mechanisms of social control that held communities together. I am neither a sociologist nor a social psychologist, but I have no doubt that the tragic dispersal of all those communities took an enormous physical, economic, and psychological toll on the displaced, forced to find new places to live, new environments to adapt to, often in new brand-new dysfunctional communities bereft of the intangible infrastructure needed to preserve social order and peace. But don’t think that it was only cities that suffered. The horrific interstate highway system was also a (slow, but painful) death sentence for hundreds, if not thousands, of small towns, whose economic viability was undermined by the superhighways.

And what about all those vacant storefronts in the West Village? Tim Wu suggests that the owners are keeping the properties off the market in hopes of finding a really lucrative tenant, like maybe a bank branch. Maybe the city should tax properties kept vacant for more than two months by the owner after having terminated a tenant’s lease.

The Internal Contradiction of Quantitative Easing

Published November 18, 2013 Federal Reserve , Fisher equation , Paul Krugman , real interest rates , Scott Sumner 22 Comments
Tags: , ,

Last week I was struggling to cut and paste my 11-part series on Hawtrey’s Good and Bad Trade into the paper on that topic that I am scheduled to present next week at the Southern Economic Association meetings in Tampa Florida, completing the task just before coming down with a cold which has kept me from doing anything useful since last Thursday. But I was at least sufficiently aware of my surroundings to notice another flurry of interest in quantitative easing, presumably coinciding with Janet Yellen’s testimony at the hearings conducted by the Senate Banking Committee about her nomination to succeed Ben Bernanke as Chairman of Federal Reserve Board.

In my cursory reading of the latest discussions, I didn’t find a lot that has not already been said, so I will take that as an opportunity to restate some points that I have previously made on this blog. But before I do that, I can’t help observing (not for the first time either) that the two main arguments made by critics of QE do not exactly coexist harmoniously with each other. First, QE is ineffective; second it is dangerous. To be sure, the tension between these two claims about QE does not prove that both can’t be true, and certainly doesn’t prove that both are wrong. But the tension might at least have given a moment’s pause to those crying that Quantitative Easing, having failed for five years to accomplish anything besides enriching Wall Street and taking bread from the mouths of struggling retirees, is going to cause the sky to fall any minute.

Nor, come to think of it, does the faux populism of the attack on a rising stock market and of the crocodile tears for helpless retirees living off the interest on their CDs coexist harmoniously with the support by many of the same characters opposing QE (e.g., Freedomworks, CATO, the Heritage Foundation, and the Wall Street Journal editorial page) for privatizing social security via private investment accounts to be invested in the stock market, the argument being that the rate of return on investing in stocks has historically been greater than the rate of return on payments into the social security system. I am also waiting for an explanation of why abused pensioners unhappy with the returns on their CDs can’t cash in the CDs and buy dividend-paying-stocks? In which charter of the inalienable rights of Americans, I wonder, does one find it written that a perfectly secure real rate of interest of not less than 2% on any debt instrument issued by the US government shall always be guaranteed?

Now there is no denying that what is characterized as a massive program of asset purchases by the Federal Reserve System has failed to stimulate a recovery comparable in strength to almost every recovery since World War II. However, not even the opponents of QE are suggesting that the recovery has been weak as a direct result of QE — that would be a bridge too far even for the hard money caucus — only that whatever benefits may have been generated by QE are too paltry to justify its supposedly bad side-effects (present or future inflation, reduced real wages, asset bubbles, harm to savers, enabling of deficit-spending, among others). But to draw any conclusion about the effects of QE, you need some kind of a baseline of comparison. QE opponents therefore like to use previous US recoveries, without the benefit of QE, as their baseline.

But that is not the only baseline available for purposes of comparison. There is also the Eurozone, which has avoided QE and until recently kept interest rates higher than in the US, though to be sure not as high as US opponents of QE (and defenders of the natural rights of savers) would have liked. Compared to the Eurozone, where nominal GDP has barely risen since 2010, and real GDP and employment have shrunk, QE, which has been associated with nearly 4% annual growth in US nominal GDP and slightly more than 2% annual growth in US real GDP, has clearly outperformed the eurozone.

Now maybe you don’t like the Eurozone, as it includes all those dysfunctional debt-ridden southern European countries, as a baseline for comparison. OK, then let’s just do a straight, head-to-head matchup between the inflation-addicted US and solid, budget-balancing, inflation-hating Germany. Well that comparison shows (see the chart below) that since 2011 US real GDP has increased by about 5% while German real GDP has increased by less than 2%.

US_Germany_RGDP

So it does seem possible that, after all, QE and low interest rates may well have made things measurably better than they would have otherwise been. But don’t expect to opponents of QE to acknowledge that possibility.

Of course that still leaves the question on the table, why has this recovery been so weak? Well, Paul Krugman, channeling Larry Summers, offered a demographic hypothesis in his column Monday: that with declining population growth, there have been diminishing investment opportunities, which, together with an aging population, trying to save enough to support themselves in their old age, causes the supply of savings to outstrip the available investment opportunities, driving the real interest rate down to zero. As real interest rates fall, the ability of the economy to tolerate deflation — or even very low inflation — declines. That is a straightforward, and inescapable, implication of the Fisher equation (see my paper “The Fisher Effect Under Deflationary Expectations”).

So, if Summers and Krugman are right – and the trend of real interest rates for the past three decades is not inconsistent with their position – then we need to rethink revise upwards our estimates of what rate of inflation is too low. I will note parenthetically, that Samuel Brittan, who has been for decades just about the most sensible economic journalist in the world, needs to figure out that too little inflation may indeed be a bad thing.

But this brings me back to the puzzling question that causes so many people to assume that monetary policy is useless. Why have trillions of dollars of asset purchases not generated the inflation that other monetary expansions have generated? And if all those assets now on the Fed balance sheet haven’t generated inflation, what reason is there to think that the Fed could increase the rate of inflation if that is what is necessary to avoid chronic (secular) stagnation?

The answer, it seems to me is the following. If everyone believes that the Fed is committed to its inflation target — and not even the supposedly dovish Janet Yellen, bless her heart, has given the slightest indication that she favors raising the Fed’s inflation target, a target that, recent experience shows, the Fed is far more willing to undershoot than to overshoot – then Fed purchases of assets with currency are not going to stimulate additional private spending. Private spending, at or near the zero lower bound, are determined largely by expectations of future income and prices. The quantity of money in private hands, being almost costless to hold, is no longer a hot potato. So if there is no desire to reduce excess cash holdings, the only mechanism by which monetary policy can affect private spending is through expectations. But the Fed, having succeeded in anchoring inflation expectations at 2%, has succeeded in unilaterally disarming itself. So economic expansion is constrained by the combination of a zero real interest rate and expected inflation held at or below 2% by a political consensus that the Fed, even if it were inclined to, is effectively powerless to challenge.

Scott Sumner calls this monetary offset. I don’t think that we disagree much on the economic analysis, but it seems to me that he overestimates the amount of discretion that the Fed can actually exercise over monetary policy. Except at the margins, the Fed is completely boxed in by a political consensus it dares not question. FDR came into office in 1933, and was able to effect a revolution in monetary policy within his first month in office, thereby saving the country and Western Civilization. Perhaps Obama had an opportunity to do something similar early in his first term, but not any more. We are stuck at 2%, but it is no solution.

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

Archives

Enter your email address to follow this blog and receive notifications of new posts by email.

Join 3,261 other subscribers
Follow Uneasy Money on WordPress.com