Knowing and Making

Rising German bond yields over the week since the Irish bailout have been interpreted ( here  and here ) as an increase in default risk to the German government. But surely there is another "risk" much more likely to explain this increase. And that is the simple risk of inflation. The Irish bailout must make inflation more likely - through one of two routes. One : ECB liquidity support, i.e. lending to Irish and other banks, might not be repaid - which will result in an effective increase in money supply unless the ECB then tightens monetary policy to reduce it, which would be politically quite difficult. The ECB lending is secured on bank assets, but we know that those assets might not be worth 100% of their nominal value. So in the case of a bank default, the ECB has printed a billion euros to buy an asset which repays less than a billion euros of principal. Two : monetary policy may be deliberately loosened, either to help reduce the pressure on sovereign borrower...

Two articles this evening lead me to ask the question: how do we predict GDP growth? Before reading on, why not ask yourself this question: what do you expect next quarter's GDP growth figures to be? How about the next 12 months? And why? I'd be interested to see some of your answers in the comments to this post - please also say which particular GDP figures you're predicting (personally I'm most familiar with the UK and US figures, but would be interested in comments from the eurozone and other regions too)*. I'm not going to test you on the accuracy of your forecasts: I'm more interested in the prediction itself, and your reasoning, than whether it turns out to be right. My prompts for thinking about this are: a paper Roger Farmer sent me this evening, introducing the concept of a belief function  describing what people expect next year's growth and inflation figures to be David Smith's blog excerpt of his Sunday Times column today , in which h...

The French MEP and ex-justice minister Rachida Dati has entertained legions of Youtube viewers  with a slip of the tongue - intending to state that "inflation" was close to zero, but instead claiming "fellatio" was close to zero. Fortunately, we hear, the European Central Bank is responding in a timely manner to this problem, with a "moral easing" or ME policy. In contrast to its attitude to inflation, the ECB board - especially its French and Dutch members - are quite concerned about a shortage of fellatio in the economy. They are willing to print as many euros as it takes - and distribute them wherever necessary - to return fellatio to its trend rate. As precedent they have cited Oval Office policy during the Clinton administration. Some economists have claimed that fellatio targeting is not the appropriate measure, and instead the overall level of orgasms in the economy (also known as NGDP, or Number of Groans Derived from Poking) should be the con...

Thank goodness we have economics blogs to explain Ben Bernanke to us. On Wednesday, I read at Scott Sumner's blog that: ...there are lots of simple answers (massive QE...etc.) But...for some reason our monetary authorities don’t see it this way. They view all these ideas as exceedingly risky.... Scott is outraged that the Fed refuses to do more monetary stimulus to reduce unemployment because they are worried about inflation. But it seems that other people live in a different world. On Thursday, I read at FT Alphaville that: The current wisdom appears to be that more quantitative easing (QE) would be a good thing...Bernanke only has one playbook, which he has so far followed almost religiously. The final solution in that playbook involves helicopters and money. So, no, he will not stop printing - it's the only idea he possesses. Alphaville is concerned that the Fed is increasing monetary stimulus to reduce unemployment, and thinks they should worry about inflation. ...

Nick Rowe has come up recently with a couple of nice analogies for monetary policy: the pole balancer and the farmboy . And for those of you not reading the other economics blogs, there's a bit of an uproar right now about Narayana Kocherlakota, president of the Minnesota Federal Reserve, and his claim that long-term  low  interest rates will lead to deflation , when surely every schoolboy knows low rates lead to inflation . I've been trying to work out why Kocherlakota's argument is so intuitively wrong and yet theoretically consistent with standard monetary models. I think I've got it, with a bit of inspiration from Nick, Karl Smith , Andy Harless and Scott Sumner . So here's my contribution to the monetary analogy industry: You're driving a truck, one of those big articulated lorries with a trailer full of goods and services. There are three main variables which determine the truck's acceleration: how much you push the gas pedal (let's call...

A response to Niklas Blanchard's post supporting Scott Sumner 's NGDP level targeting proposal (also posted as a comment on that page). My thoughts on this subject are not complete, but I've been thinking recently about how expectations are formed. I wonder about the following scenario: Let's say the Fed does adopt an NGDP level target with a 5% annual increase, and this becomes accepted as the new orthodoxy. How will future wage negotiations proceed? As an employee, I'd say to management: presumably you are good managers, and you expect to achieve growth in the company's revenues, profits and productivity at least in line with the economy as a whole. (I've yet to meet a manager who'd admit that they are not as good as the national average manager). Therefore, you'd expect your top line revenues to increase by at least 5%, given a fixed amount of labour in your company. What's more, now that the Fed has successfully achieved a 5% NGDP in...

Here's  a little something  on fiscal stimulus. It contains a suggestion I've seen from Tyler Cowen and Scott Sumner, among others: ...while the zero bound does not bind, the Fed might nonetheless be reluctant to engage in the appropriate amount of monetary expansion, and that a fiscal boost is therefore required. A potential response to this is that if the Fed has chosen the unemployment rate with which it is satisfied, it will simply offset any fiscal measures to push unemployment below that level. That's only true if the Fed is assumed to be a simple (rational?) agent acting with just one lever: controlling the money supply in order to choose a balance between inflation and unemployment. However, it's very plausible that the Fed is  not  happy about the current unemployment rate, and recognises that it could and perhaps should increase inflation (or NGDP) to fight it. But it is  also  worried about its long-term credibility (as Ben Bernanke indicates i...

In case you were worried, I have not been intimidated by Kartik Athreya's " Economics is Hard " into closing down my blog. I've just been so busy doing stuff and going to things that I haven't had time to write any of it up. Soon, though. Tomorrow, I hope. Meanwhile, a couple of thoughts here and in the next posting: There's an interesting discussion on nominal wage stickiness  between Scott Sumner and Bryan Caplan. Scott, as usual, has some good insights into the question: are sticky wages the primary cause of recessions? To save you reading it all, the answer is yes. This debate exposes a question of economic modelling which I've considered recently. Is the individual transaction the best level to model economic exchange? As a rational agent with no mental processing costs, it is more economically efficient to treat each single exchange as a new decision and re-optimise your choices. But it's not very realistic. Agents who require time to...

I have posted a couple of detailed comments in response to Scott Sumner's recent items, and as most of my readers probably don't read his blog, I'm cross-posting them here. For background, read this comparison of the performance of the UK and Sweden , and the comment thread; then the following response by Scott . First, I tackle UK monetary policy: As illustrated by the currency discussion, the figures in this debate is strongly influenced by the choice of starting point. For example, nominal GDP in the UK has been growing at an annual rate of 6% for the last nine months. http://www.telegraph.co.uk/finance/economics/7764916/Boost-for-UK-as-GDP-growth-revised-up.html All of the problems in Scott's figures come from a single quarter, Q1 2009. In Q1 of 2009 we were still in recession, with a 3% fall in NGDP in that quarter alone. I believe the CPI was also negative in that quarter (though I can't find quarterly index figures for that, only annual changes). It was ...

Re-reading an old David Beckworth post , I was reminded of that ancient question: is economics a science? On the content of the post, I have no idea if the United States is an optimal currency area. Or the eurozone. But a deeper question is: why ask the question? If this kind of speculation was taking place in a discipline like physics, it would be ignored - if there is no way to test it, there's no point talking about it. But "the US is an OCA" is not a testable proposition. Therefore, is there no value in proposing it? Well, economists don't seem to think so - these things are discussed endlessly, and some of them even get peer reviewed and published. Economic "truth" (or economic arguments), even when not meeting the standard of science, can achieve two things. The first is their value as engineering. Sometimes, with the physics proved to scientific standard, the task is to apply it in a practical design. Nobody can prove that this design is t...

This fascinating analysis from Tino Sanandaji (via Marginal Revolution) reveals an unexpected (to me) fact about the Japanese "lost decade(s)". Japan's growth from 1990 to 2007, adjusting for changes in demographic composition of the population, was exactly the same  as the US and Europe's! So for all the attention on the US technology boom, European integration, Japan's property bust and vast stimulus programmes - none of it mattered. Growth per working-age individual seems to proceed at a steady 1.6% per annum regardless of the different policy regimes, tax rates, interest rates etc etc etc. This sheds interesting light on the claim of Adam Posen (Bank of England monetary policy committee member) that Britain faces a Japan-style decade. So does the surprising fact that the UK was the leader among all rich countries in total factor productivity growth from 1990 to 2007! So is all of economic growth explained by some common underlying factor, unrelated t...

Mervyn King said today that the UK economy might go back into recession and that the recovery is weaker than hoped. So, Mervyn, what possessed you to stop quantitative easing  less than a week ago? Scott must be so disappointed. Unless you can come up with a solid rationale for why QE can't work , this is bizarre and inexplicable. p.s. to be fair, he has also said today it's ' far too soon ' to assume there will be no more QE. David Wighton in The Times points out that this behaviour looks ' downright peculiar '.

Scott Sumner writes : "I understand that China has begun growing briskly again and that at some point they will need to start appreciating the yuan again to prevent overheating....But it is too soon to tighten now. If China slows, our recovery will also be threatened" In other words, even though the Chinese economy is growing fast, they aren't suffering inflation because there's plenty of spare capacity in the rest of the world to help keep prices down. Does that remind you of this article (and ten thousand others) from 2006? ...the increasing integration of national economies contributed heavily to the global decline in inflation. As then-Federal Reserve Chairman Alan Greenspan noted in this May 2004 speech , globalization affords Americans access to goods and services that are produced more cheaply abroad in places where large labor forces work for less money (e.g. China) Funny how things turn around, eh?

Something just struck me when reading Scott Sumner's latest (this often happens - if you're genuinely interested in macroeconomics and not subscribed to Scott's blog yet, you should be). For instance, if wages are sticky it may lead to suboptimal real wage movements. The reason why we think inflation is good for solving recessions is we believe it helps to overcome wage stickiness (NGDP, Scott's preferred target, does the same but also has a useful extra effect on the incentives for, and risks of, investment). In other words, recessions sometimes happen when people are in jobs which are no longer as productive as they used to be (or making products that people don't want so much). In a completely efficient market, their wages would fall, product prices could fall too, some people would move to other jobs and supply and demand would balance at the point of highest output. But in reality it's hard to reduce wages - because of both employment contracts and hab...

In the leader column of City AM today, Allister Heath argues that quantitative easing should be stopped because it will lead to inflation. Set aside for a moment the fact that this is the whole point of it. Is he right that it will actually succeed in causing inflation? Scott Sumner (consistent with mainstream monetary theory) points out that an increase in the money supply is only inflationary if it is expected to be permanent. And is QE a permanent increase? Not necessarily. On the contrary: QE in isolation makes the money supply smaller . Under QE, the Bank of England has issued £200 billion of new currency and used it to buy bonds (mostly gilts) in the private market. (The Federal Reserve has done something similar, with a higher proportion of corporate and mortgage-backed bonds.) So there's now £200 billion more sterling than there used to be - it's fair to say the money supply is bigger. What will happen next year - or in five years time, or thirty years when all the ...

If Scott Sumner and Paul Krugman agree on something, it must be true. I think most of us would accept that as an axiom of economic sociology. Accordingly (see here and here ), we can take as read the idea that expectations of inflation and aggregate demand strongly influence actual inflation and aggregate demand. There's nothing really controversial about this: the idea of multiple equilibria is well established. If people expect deflation and recession, they will try to save more, spend little and invest less - and deflation and recession will result. If people expect inflation or growth, they will spend more quickly and invest in the hope of protecting their assets and capturing a share of that growth; and as a result, the expectation will be fulfilled. Or as it's caricatured by a self-help motto you've probably seen: if you think you can, or if you think you can't, you're right . Presumably we want to have more growth rather than less, and (mild) inflation rat...

I've had this article in draft for about three weeks. Paul Krugman's latest item seemed an opportune moment to finish it. Intriguing article by Sheng and Pomerleano in the Economists' Forum about zero interest rate policy . I don't think I agree with what they are saying (insofar as I can even tell what they're saying) but it stimulates a few thoughts along Scott Sumnerish lines. One bit (from Kevin Warsh, quoted approvingly by the authors) jumped out at me: A complication is the large volume of banking system reserves created by the non-traditional policy responses. There is a risk, of much debated magnitude, that the unusually high level of reserves, along with substantial liquid assets of the banking system, could fuel an unanticipated, excessive surge in lending. Now surely a surge in lending is exactly what we want? Isn't all this monetary activism meant to increase the effective money supply (or counter a fall in velocity) therefore sustaining nominal GD...

I'm going to mention Scott Sumner one more time and then give him a break. For the last six months he's been recommending that central banks (mainly in the US, but presumably worldwide) pay a negative interest rate on commercial bank reserves. (for reference, here's another in a string of recent articles justifying why the Federal Reserve pays positive interest on reserves, without even mentioning the negative interest option. Are they under instruction not to discuss it?) In short, the argument is this. Quantitative easing works by paying banks cash in return for their government bonds. Since they don't earn any interest on cash (unlike on the bonds they were holding previously) they will want to lend out the newly acquired cash into the private sector so that they at least make some money on it. This (depending on your model) will boost the velocity of money, or increase the relevant measures of money supply, or increase inflation expectations, or increase investment...

An chain of favourites is emerging in recent blogs. Let me show you how it works. Chuprevich 's favourite economist is Tyler Cowen (he is a few other people 's favourite too). It follows of course that his favourite monetary economist is also Tyler Cowen*. Tyler Cowen 's favourite monetary economist is Scott Sumner. Scott Sumner 's favourite monetary economist is Bennett McCallum. Bennett McCallum's favourite monetary economist is not currently known. Can this chain of favourite monetary economists be extended in either direction? Perhaps Professor McCallum will leave a comment to assist. If anyone's favourite monetary economist is Chuprevich, do let us know. I am having trouble investigating that as his website makes me dizzy, not to mention the fact that Chuprevich may not be a real person. Can we develop a theory of favouritism among monetary economists? This Google search shows a few more favourites (note the American spelling) and a fair inference is th...

Scott Sumner has got me spotting supply and demand mistakes all over the place. This post combines that theme with the question of ' the price of anarchy ', outlined by Gravity and Levity last week. Niall Ferguson has blended both of them into a particular detail of his FT article on "lucky" Barack Obama . It would take a long time to critique the whole article, but here's the salient point: Iraq is likely to become more unstable as US troop levels are reduced. Now on the surface, that sounds obviously correct. But how about if we turn it around to make the real causality clear: US troop levels are being reduced as Iraq becomes more stable. The thing about supply and demand, like any equilibrium system, is that any change tends to create a pressure to counteract itself. In this case, the reduced "supply" of anarchy has increased its price, thus reducing the production returns on its complementary good, the US Army. Thus the army's supply curve shif...