Opinion

For new commenters — there are a couple of rules around here.

One is that comments should be comments — not long diatribes. If you want to paste in whole chapters of Friedrich Hayek or Glenn Beck, start your own blog and see if you can attract any readers. I’m using a rough rule of three inches on my screen.

Second, Times rules require that comments containing obscenities be rejected; yes, I know it seems archaic, but gee whiz and by golly, try to do without cuss words.

As it happens, the moderating software identifies potential not-alloweds, highlighting them in red. Many of these are, of course, false positives.

Which brings me to the mystery of the day: why does “horses” get highlighted? Did I miss something when I learned about the birds and bees?

I’m finding it hard to read about politics these days. I still don’t think people in the administration understand the magnitude of the catastrophe their excessive caution has created. I keep waiting for Obama to do something, something, to shake things up; but it never seems to happen.

Here’s what I wrote in February 2009. It’s pretty rich that now the usual suspects are accusing me of having shared the administration’s optimism. But that’s a trivial point; the important thing is that all signs are that the next few years will be a combination of economic stagnation and political witch-hunt.

This is going to be almost inconceivably ugly.

Via Mark Thoma, Dean Baker points out that real government consumption of goods and services — that’s government buying things, as opposed to cutting taxes or handing out checks — has risen more in “austerity” Germany than in the United States. Dean starts from 2008III, which is somewhat unorthodox; but his result is not, in fact, sensitive to the start date. I can’t post a figure right now, due to an outage on the Princeton servers, but here’s a table, with 4th quarter 2007 as the baseline:

Quarter Gemany US
2007Q4 100.0 100.0
2008Q1 100.4 100.6
2008Q2 101.5 100.8
2008Q3 101.7 102.2
2008Q4 102.5 102.9
2009Q1 103.6 102.5
2009Q2 104.2 103.8
2009Q3 105.1 104.0
2009Q4 104.8 103.9
2010Q1 106.9 103.8
2010Q2 107.3 104.5

What’s going on here? It’s basically the Fifty Herbert Hoovers problem. Because state and local governments can’t run persistent deficits, and because aid to those government was shortchanged, cutbacks at lower levels of government have undermined expansion at the federal level. Overall government purchases have actually grown more slowly than the economy’s potential output.

So when people talk about Germany versus the US as austerity versus stimulus, you should ask, What austerity? What stimulus?

Update: I meant to say that these are purchases by all levels of government in both countries.

One point I haven’t seen made about the troubles of the US economy is that the timing of recent growth tells you a lot about what was — and what wasn’t — wrong with economic policy.

After all, we had more or less a consensus view about when the stimulus would kick in, and how much effect it would have. Here, for example, was Mark Zandi’s estimate:

Why did the peak impact of growth come in 2009, even though only part of the money had been spent? I explained all that a while back.

And how did things actually turn out? Like this:

It’s not a perfect correspondence, nor would you expect one — other factors, especially inventory swings, were bound to make the timing of actual growth different from that of stimulus. Still, the two pictures support the view that stimulus worked as long as it lasted, boosting the economy — which is the same conclusion Adam Posen drew from Japan’s experience in the 1990s (pdf): Fiscal policy works when it is tried.

But the stimulus wasn’t nearly big enough to restore full employment — as I warned from the beginning. And it was set up to fade out in the second half of 2010.

So what was supposed to happen? The invisible cavalry were supposed to ride to the rescue.

I never understood why the Obama administration thought this would happen so soon; history tells us that the effects of a financial crisis on private spending are normally protracted. And sure enough, the cavalry has not arrived.

I’ve written a lot about the invisible bond vigilantes who have terrorized policy makers, even though there’s no actual evidence for their existence. But after Ben Bernanke’s speech this morning, it seems to be that I should also start writing about the invisible cavalry, which is always about to come to our rescue, but somehow never arrives.

Bernanke more or less admitted that the economic situation has developed not necessarily to America’s advantage, nothing like the growth he was predicting six months ago. But he argued that 2011 will be better, because … well, it was hard to see exactly why. He offered no major drivers of growth, just a general argument that businesses will invest more despite huge excess capacity, and consumers spend more despite still-huge debts and home prices that are likely to resume their decline.

Oh, and sure enough, he declared that inflation expectations are well-anchored, although the market says otherwise.

So: I guess this speech marked a small step toward QE2 and all that. But mainly the message was that just around the corner, there’s a rainbow in the sky.

So I’m going to have another cup of coffee, but skip the pie (in the sky).

Brad DeLong and Mark Thoma continue to suffer from dropped-jaw syndrome over the fact that (1) a Federal Reserve bank president believes that low interest rates lead to deflation (2) economists who think they’re being sophisticated are actually defending him.

I don’t really believe that a clearer explanation of what’s wrong with the Kocherlakota view will change anyone’s mind — my experience is that nobody ever admits that they were wrong about anything, and that this is especially true of economists who thought they were being sophisticated when they were actually failing Econ 101. But let’s give it a try, anyway.

So let’s look at it this way: instead of thinking of the Fed as setting the interest rate forever — which we’ve known since Wicksell it can’t do — think of it as following some kind of Taylor rule, in which the short-term interest rate depends positively on inflation and, maybe, negatively on the unemployment rate. This is feasible, as long as the coefficient on inflation is bigger than one.

Now suppose that it changes the rule, so as to set either a higher or a lower interest rate at any given level of inflation. What will happen to inflation and interest rates over time?

Suppose it shifts the Taylor rule up — that is, it tightens monetary policy, raising interest rates for any given set of economic conditions. This will, in fact, raise interest rates in the short run. However, over time inflation will fall, and in the long run lower inflation will be reflected in lower interest rates. This isn’t just theory: it’s what happened, with a few bumps along the way, in the great Volcker disinflation:

Conversely, a looser monetary policy will lead to lower rates in the short run, but higher rates in the long run.

What Kocherlakota and his defenders are doing is getting all of this backward: imagining that because in the long run low rates and low inflation go together, that loosening monetary policy — which reduces rates in the short run — actually causes disinflation and deflation. That is, as Brad says, cargo-cult economics; or to put it another way, it’s as if the Williamson family, noticing that families with high spending tend to have high net worth, assumed that it could raise its net worth by spending more.

Does this make things any clearer?

Slight edit for clarity.

For tomorrow’s column.

A couple of months back I asked, does fiscal austerity actually reassure markets? I noted there the curious case of Ireland, which embraced savage austerity early on; quite a few press reports declared that this had gained it the confidence of markets, but the actual numbers said otherwise. And I noted the contrast with Spain, which has been relatively slow and reluctant to embrace austerity, but has been treated no worse by investors.

Since then, the contrast has grown even more striking. Here’s the 10-year bond yield for Ireland:

And here’s the same for Spain:

Now, this isn’t a clean experiment: Ireland had an even bigger bubble than Spain did, so you could say that’s the issue. But since austerians were claiming bond market approval as a sign of its policy success, it is worth pointing out that dutiful Ireland looks as if it’s entering a runaway debt spiral, while malingering Spain is looking considerably better.

Something I wanted to put up before the Jackson Hole extravaganza: let’s watch and see how many Fed officials declare that expectations of future inflation are “well-anchored” (which is the favorite formulation). Because, you know, they’re not.

Here’s a quick measure: the zero-coupon 5-year inflation swap, explained here. It looks like this:

Bloomberg

Some anchor.

Update: Yes, I know that the second word is spelled differently in the song. It’s deliberate on my part. No weigh would I get confused.

On behalf of the great state of New Jersey, I’m insulted: Trenton didn’t make this list of America’s 10 dying cities. OK, Atlantic City was on the list, but still.

This morning Bloomberg has a story about how business investment — which was one of the few sources of strength lately — is flagging. Why? Because of concerns about overall economic growth.

This should serve as a reminder that we’re still very much in a paradox of thrift world.

In normal times, we believe that more saving, private or public, leads to more investment, because it frees up funds. But for that story to work, you have to have some channel through which higher savings increase the incentive to invest. And the way it works in practice, in good times, is that higher savings allow the Fed to cut interest rates, making capital cheaper, and hence on to investment.

But right now we’re up against the zero lower bound — yes, I’ll get the usual complaints about how long-term rates aren’t zero, but the Fed doesn’t have direct control over those rates — so this normal channel doesn’t work.

And what that means is that if people — or the government — try to save more, they only end up depressing the economy. And the weaker economy leads to lower, not higher investment. And this in turn means that attempts to save more don’t help our future prospects. On the contrary, they reduce the economy’s future growth.

That’s why fiscal austerity is such a terrible idea: no only does it raise unemployment, it actually makes us poorer in the long run.

And good for him.

He has a piece about the Kocherlakota claim that a policy of keeping interest rates low will lead to deflation, and is shocked to find “new monetarist” Stephen Williamson agreeing. The fun stuff is in the comments (all items from Rowe):

W (as quoted by Marcus):

“In this case, I agree with Kocherlakota, that the market has it wrong. As Kocherlakota argued, most of our monetary models tell us that, if the Fed maintains a constant nominal interest rate target forever, that will essentially determine the inflation rate, by way of the Fisher relation.”

Oh Christ. Oh Christ. Oh Christ.

SW interprets Kocherlakota the same way I do, and thinks he’s right. Oh Christ.

…

Oh Christ.

Central banks can’t keep the price level and inflation rate determinate by pegging the nominal (or even real) rate of interest forever. We’ve known that was wrong at least since Wicksell’s cumulative process. I assumed that everyone (except a few hopeless lefties and funny money guys) knew that was wrong. *Nobody’s* monetary model tells us that (except a few hopeless Post Keynesian types, who are at least logically consistent, because they assume very sticky prices that don’t respond to AD at all).

Oh Christ.

…

This is much worse than Cochrane getting Say’s Law wrong. Say’s Law is very nearly right, and very few people understand precisely why say’s Law is wrong, and that it’s money, and only money, and not any other asset, that makes Say’s Law wrong.

I give up.

This isn’t New Monetarism. It’s got nothing to do with Monetarism at all. It’s the exact opposite of Monetarism. Somebody resurrect Milton Friedman.

Yup.

I always thought that the deficit commission was a bad idea; it has only looked worse over time, as the buzz is that Democrats are caving in to Republicans, leaning ever further toward an all-cuts, no taxes solution, including a sharp rise in the retirement age.

I’ve also had my eye on Alan Simpson, the supposedly grown-up Republican co-chair, who has been talking nonsense about Social Security from the get-go.

At this point, though, Obama is on the spot: he has to fire Simpson, or turn the whole thing into a combination of farce and tragedy — the farce being the nature of the co-chair, the tragedy being that Democrats are so afraid of Republicans that nothing, absolutely nothing, will get them sanctioned.

When you have a commission dedicated to the common good, and the co-chair dismisses Social Security as a “milk cow with 310 million tits,” you either have to get rid of him or admit that you’re completely, um, cowed by the right wing, that IOKIYAR rules completely.

And no, an apology won’t suffice. Simpson was completely in character here; it was perfectly consistent with everything else he’s said, and with his previous behavior. He has to go.

Sorry, can’t resist. That was the title of this Business Week article a few months ago. The tone made it pretty clear that if you had any sense, you’d ignore the bearded academic and go with the market wizard:

If [Krugman] makes you want to head for the hills with your shotgun and turnip seeds, consider another view, expressed the week prior at the London School of Economics. The speaker was not a decorated academic with visions of 1873, he was a profit seeker, pure and simple: John Paulson, the hedge-fund manager on whose behalf Goldman Sachs (GS) cooked up those killer collateralized debt obligations designed to pay off handsomely in the event of a housing crash. He was right about that one, you’ll recall.

“We’re in the middle of a sustained recovery in the U.S.,” Paulson declared in London. “The risk of a double dip is less than 10 percent.” The housing market is now, he says, an attractive buying opportunity. “It’s the best time to buy a house in America,” he said. “California has been a leading indicator of the housing market, and it turned positive seven months ago. I think we’re about to turn a corner.”

No mention of a third depression.

So, how’s it going? I’m sure that if Paulson had proved right, there would be a followup article mocking yours truly. Wanna bet that there won’t be a piece saying that maybe professors know something that traders don’t?