1. A very good blog by a seven-year-old; can you guess the topic?
2. Is the whole CDS market becoming bogus? Is it now just a slightly crooked game of how to define a “credit event”?
3. Four miles of protestors in Yemen.
4. Macropolicy lessons from Sweden; and see #5 on the role of the Fed in bailing them out.
5. Video footage of cultural icons.
On # 4. Tyler, two comments on your reliance on a WP journalist to draw lessons from Sweden:
1. The journalist makes no attempt to support any of his lessons with serious research from scholars. I’m surprised that you make no attempt to compare, or at least to relate, those lessons with lessons drawn from other crises in the past 25 years. More important, since the Great Recession has affected quite differently your country’s 50 states, most likely you can find states that have been doing not significantly different from Sweden. For example, you could have compared Sweden with Texas.
2. Regarding lesson # 5, at least you should know better –most people make blunders. One has to be too arrogant –or should I say too stupid?– to claim that a particular group of people will always make blunders. What about politicians, journalists and professors? And to make things worse the details of lesson # 5 make clear that Swedish bankers didn’t make a blunder in the years up to 2008 –they bet that some bureaucrat would bail them out and they were right: Bernanke did it (I can hear Swedish bankers: Thanks America for Saving Us from Our Stupidity!).
Upon reading this
http://scienceblogs.com/aetiology/2011/06/epidemiology_and_social_media.php
I wonder what has happened for Tyler, a scholar, to spend time circulating the ideas of Irwin, a journalist. I’m missing the old days, when journalists were making the effort to understand and circulate lessons drawn from scholars’ research.
Was there ever reason to suspect that CDS might not be bogus?
But it was convenient. As long as everybody else pretended to believe in it, it was convenient to pretend along with them.
Why can we buy fire insurance like they sell credit insurance on government bonds? Shouldn’t we be able to bet the government will fail to prevent the spread of wild fires and buy fire insurance on houses in Texas located in the tinder dry forest regions? How about buying flood insurance on homes in the Mississippi watershed betting the government won’t prevent them from being flooded.
And best of all, the decision on whether the fire or flood insurance pays out wouldn’t be based on our actual losses, but based on criteria like the house must be evacuated because it might burn or flood, and then we get a payout based on the difference between the insurance coverage and the market price of the house at the time of the forced evacuation.
We used to have flight insurance where you could bet that any particular person would die on a particular airline trip. But it turned out, if the plane exploded then they arrested you and tried to prove that you did it.
Tyler Cowen,
This may be beside the point. But I think you can explain it in the future. Each day I see more than 5000 readers on MR as reported by the feedburner. But there are less than 900 followers on twitter. What are the reasons for such disparities?
The WaPo article actually contains only one lesson. Points 1 and 2 note that Sweden mostly relied on automatic stabilizers for fiscal policy. In other words fiscal policy doesn’t explain their relative success.
Point 5 notes that they had severe banking problems requiring a bailout from the Fed, and still grew much faster than all Western European countries, even those not suffering from banking crises.
Point three and four discuss monetary stimulus and the flexible exchange rates required to make stimulus possible. That’s the lesson.
Which blogger told us in 2009 that the Fed should be following the Swedish example? That is, who told us about Sweden us BEFORE their high NGDP and RGDP growth rates materialized? Who advocated the Swedish policy of negative interest rates, depreciating the currency, and targeting the forecast?
Is that last bunch of questions rhetorical or is there one correct answer? Is it “Scott Sumner”?
If you could answer these questions I’d appreciate it greatly:
1. How do you explain differences in economic performance across U.S. states during the last 5 years? To what extent your explanation of differences across Euro-countries would be different?
2. What is the evidence about long-term growth experiences of the past 300 years in which one can claim that monetary policy (defined broadly as government’s manipulation of the supply and the demand for currency) has been a significant determinant of such a growth?
3. Since (1) studies of commodity currencies have shown that the need to finance government spending has always been a major cause of their poor performance; (2) studies of hyperinflation episodes have shown that they were triggered by large increases in the supply of fiat currency to finance large increases in government spending; (3) studies of high inflation in Latin America have shown that monetary policy was passive, either because the supply of currency was increased to finance government deficits or to accommodate increases in the demand for currency caused by governments’ price policies; (4) studies of the so-called “transmission mechanisms” of monetary policy as implemented by central banks –when they are not financing government directly– have shown that its economy-wide effects depend largely on how it affects the marginal cost of funding a large number of financial and non-financial enterprises and consumers and that these impacts are hard to quantify (and that in turn it is difficult to assess the effects of changes in marginal costs of funding on investment and consumption); (5) studies of monetary policies during financial crises have shown that their effects depended on how they affected the liquidity and solvency of a large number of financial and non-financial enterprises and consumers; (6) studies of exchange rate regimes (that is, the alternative mechanisms through which the prices of one government currency in terms of other government currencies may be determined) have failed to identify the conditions under which a particular regime would be best for an economy to adjust to a shock (so neither we can say how many currency areas would be optimal for the U.S.A. nor we can say that the world economy is not an optimal currency area); and (7) studies of central banks’ balance sheets have shown that they are conditioned by a number of financial functions they perform and not just by monetary policy; why do you still prefer to analyze central banks as if they were in charge of achieving some policy goal rather than analyzing them as the financial intermediaries they are?
Four tips:
White space
Paragraphs
Humility
Brevity
I think Scott has always said that (real) long term economic growth is based on real rather than nominal factors.
That’s what most economists say when studying growth, but if monetary policy is important it should have an effect on the average growth rate over a long period of time.
I agree that white space and brevity are your friends.
On your question about the last 300 years, though, I can think of a few examples where monetary policy greatly influenced real economic production.
1. Most obvious, the Great Depression. CPI dropped by 25% and unemployment also went up to 25%. In theory, the market would adjust to a much lower equilibrium wage rate, but in reality wages are extremely sticky. Real production goes down immensely while so many people are not working.
2. Volker rates of the early-80′s. Even though the tight policy was needed, the huge effects of monetary policy are also shown here. 10% unemployment again has a huge effect on real economic production.
3. Japan’s lost decade. This is most similar to our present situation. Zero interest rates, but deflation expectations is causing everyone to hold onto money rather than investing or spending it. QE also worked for Japan, but like Bernanke today, there was too much political pressure due to inflation fears to keep up with QE. Therefore, Japan effectively targeted a 0% rate of inflation and it never got out of its rut. I’m afraid that inflation hawks will seal the same fate for the US.
Sorry but my question was not about the role of monetary policy during a crisis. By a long-term growth experience I mean what difference monetary policy made over a period of at least 25 years in which the average growth rate was positive. For example, Argentina since the Perón was elected president in 1946 (or since first agreement with the IMF in December 1958), or Hong Kong since the signing of the Sino-British Joint Declaration in 1984, or Chile since the consolidation of the new economic policies in January 1985, or China since the breakdown of the central bank’s centralization/monopolization of banking services in 1984. In these experiences years of high growth were followed by years of low growth or even years of GDP decreases, but the average rate for each period was positive. The relevant questions are whether different monetary policies could have increased the average growth rates and how significant the increases could have been. In those four examples, only in Argentina I’d argue that a different monetary policy could have increased the average growth rate of 1946-2010 but not in a significant amount (the main problems are how to control and finance public expenditure and how to increase the efficiency of government programs). In Chile, since 2000 and especially since 2004, the flexible exchange rate regime may have lowered the growth rate albeit without any sizable effect on the average for 1985-2010.
The assessment of monetary policy in economic crises is a different issue. For such assessment we have to determine first whether a particular monetary policy could have caused or at least aggravated a crisis and then whether a change in monetary policy could turn the economy around or at least accelerate the recovery. Thus, it would take too much time to tell you what I think about the Great Depression and in particular about Volker’s monetary policy (I know the latter quite well because it had an important effect on my professional career).
Japan’s low growth rate of 1990-2010 most likely has been conditioned by factors other than monetary policy and apparently there is nothing that monetary policy can do to increase the average growth rate for the next 25 years.
I know little about the Japanese economy and I haven’t seen evidence to support the idea that the central bank can do something to increase the growth rate.
Matt Walker fails to address a couple of points that seem to be purposely ignored by those who should know better in his #1: deflation determines the changes only in wages and prices buy supply/demand pressure, but debt changes in these situations only by default, foreclosure, bankruptcy.
In #2, inflation falling can have the same impact on debt if the debt has prepayment penalties, but if prepayment is allowed, or the penalty small, or the terms of the debt are limited, then the burden of debt is limited or reduced by both rising or falling inflation.
Milton Friedman pointed out this problem decades ago and called for indexing everything, bank account balances, debt balances, wages, prices, tax bases, so inflation or deflation had no impact within the monetary zone.
The economists who claim removing Greece or Germany from the Euro will solve the problem of Greece being unable to pay the large debt owed to Germany that keeps getting more impossible to pay as Greece sinks further, and thus the solution is to reduce the value of the Greek labor and goods relative to the German base so Greece will find it easier to repay Germany by working longer to produce enough to pay the debt in a labor market that will be unlikely to increase its demand for labor very much. Why would Greek labor demand increase when Germans find little Greece offers they want to buy?
E. Barandian, I am not a professional in this area, and I cannot back up my opinions by professional research. But see if this makes sense:
Different areas of the USA have done differently for a host of reasons. Some have produced raw materials that foreigners wanted, that they could export even while demand was low in the USA. Some were particularly good at producing military supplies etc that were needed for the wars, which tended to take precedence in the military over issues that will be important in the longer term. Some got sheer government pork. Some were bottlenecks for imports or exports, and could take a cut of everything passing through. Some withered. I expect it was the same in europe, but EU nations are individually more sovereign than US states so that allowed an extra level of complexity to their choices.
Monetary policy has been a significant tool for governments, but usually in each region there was one government that had the most clout. It beat a big drum that others had to march to, and if somebody else beat his own drum in a different rhythm it caused the second drummer grief. When your nation is dominant, monetary policy is a stick you can beat things with, including your own people and foreign nations. When somebody else is dominant, their monetary policy is a stick they can beat you with and your own monetary policy is not so useful. So it’s hard to look at monetary policy over the last 300 years without keeping it straight who had the power.
Hyperinflation has only come when a nation is being beaten by some other nation’s stick, and has no adequate response. When anything they do is bad, they might choose bad hyperinflation instead of one of the other bad choices. I’m not sure it means much, except that it decisively shows who does not actually have power. I’m sure it’s possible for governments to simply mismanage things to the point they have no good choices and choose hyperinflation. But do they have foreign puppet masters because they were incompetent, or because they lost a battle that no more-competent government could have won? How can we know?
Central bankers must wear a lot of hats and perform a variety of jobs, some of them mutually incompatible. Still, their choices are important for their economies. There aren’t many people who appear to have so much free choice. Tell industrialists they should do things which will lose them money for the good of the nation? Tell politicians to do things which lose them votes? Central banks may not really have so much initiative and leverage, but they appear to and so naturally economists want to jog their elbows and tell them what to do.
It might be better to clarify the central bank jobs. Like, get rid of the private banks and run whatever banking we want to have, on a more rational basis. But that cannot happen while bankers are rich and powerful. It took a thousand years to get rid of a hereditary rentier aristocracy, and they had nothing going for them except tradition and the loyalty of the standing army. It took a long time even after the loyalty was gone. It could take another thousand years to reform the bankers.
Of course we can’t find a single best way to handle exchange rates. Which method of defense is best depends on who’s attacking you, which attacks they prefer, and how strong they are. Or maybe you want to attack them. A single best exchange rate mechanism would be like a single all-purpose karate move, the move that’s best both for attacking any foe and defending against any attack. Unlikely.
About currency areas, currency is just another tool. If two economic regions have different currencies, then when they get a trade imbalance one currency can (but might not) depreciate to remind them to import less and export more. An automatic mechanism that can resolve the issue, when it works. But when two economic regions share the same currency, that does not happen. Money flows out of one region into the other. Lacking currency makes problems for trade internal to the region. More and more, the region becomes an economic colony of the richer region. The roads are built for exports, not for internal trade; each producer looks for ways to sell to rich outsiders and not so much to his poor neighbors. It gets increasingly harder for locals to finance their own businesses, and outsiders step in to do that for them. Etc.
Probably the poor region doesn’t have a lot of influence over the government that rules them, or it wouldn’t turn out that way.
If they had their own government and their own money, they might manage a degree of independence — although they would likely be dominated by foreigners anyway.
why do you still prefer to analyze central banks as if they were in charge of achieving some policy goal rather than analyzing them as the financial intermediaries they are?
Because they themselves have talked like they are independent and influential and operating for the good of the nation. Nobody else can take much initiative.
If Superman was here, and he said he would fight for Truth, Justice, and the American Way, people would yell for Superman to save us. He can jump over tall buildings and stop speeding locomotives. Maybe he can save the economy.
But sadly Superman is not here. The closest we have is the Fed. For a long time people depended on Greenspan to save the economy. Experts said that he couldn’t keep interests rates low and money supply increasing, it would have terrible consequences. But Greenspan did it, and the economy boomed, and people thought he was Superman. He saved the economy many times. But now Superman is gone and we face terrible consequences, and the new guy doesn’t know what to do. If only he would be Superman too….
Sweden sounds a lot like Texas.
So, both Texas and Sweden use big government regulation to kill financial innovation that spurs higher growth and wealth creation by dictating debt rules like income and asset verification, and a minimum of 20% down plus significant bank capital requirements.
Clearly, by those rules, from 2001 to 2006 both Texas and Sweden were missing out on significant economic growth and wealth creation from the high profits in banking, rapid wealth creation from house price inflation, and the easy profits from building housing to supply the house speculators who profit from the increase in market price between the beginning of a house construction and the time of delivery. Why Texas and Sweden missed out the economic boom of Nevada!!
So, why does Texas have the big government intervention in the free market of European socialist that Sweden refused to abandon in the past decade or so?
lets not forget high oil prices
I think three is only correct if all others are adhered to well. I think easing when spending is poorly disciplined is decidedly bad.
Well Sweden had very high unemployment from 93 to 98. How come the ‘automatic stabilizers’ were not working back then? And if you tell me they were, how come it took 5 years to get unemployment down?
To me it just looks like they were better prepared for this crisis because they had a huge financial crisis in the 90s so they were still recovering from that.
Hence my “sounds like Texas” comment.
I wouldn’t compare Sweden structurally to Texas. Texas’ economy is based around energy, IT and other services which happen to be in demand. Meanwhile, Michigan’s economy is based around manufacturing. Structural differences help explain the two economies’ divergence.
Sweden, on the other hand, is not based around the energy sector like Texas. They are actually closer to Michigan structurally, with a manufacturing and export-based economy. South Carolina also has suffered tremendously due to a manufacturing-based economy.
The reason Sweden has done well where Michigan and South Carolina have hurt is because of the negative interest rates in Sweden. As interest rates push down the yield curve, more companies and individuals decide to borrow. That increases velocity, which increases inflation expectations. That, in turn, incentivizes people to spend or invest their cash holdings. With long-term inflation expectations at 1% in America, zero rates do not have the same incentive to spend or invest. That’s why Michigan and South Carolina are lagging where Sweden is doing well.
In Argentina, for many years real interest rates have been quite negative and they have been quite ineffective to accelerate growth or the recovery after a crisis. Often they have been evidence of serious problems. You should study what happened in 1973-76 when negative interest rates were an incentive to borrow from banks (credit had to be rationed) and to take capital out of the country.
I haven’t study what has been happening in Sweden. I’m ready to bet, however, that despite the negative interest rates (I assume you are correct that they are negative), this year the stock of currency in relation to GDP is at least as high as the average of 2000-2010 (I know that there could have been important tech innovations that reduced that ratio but I don’t think it was a significant reduction).
My point, as it were, had nothing to do with the economies of Sweden and Texas. It was that both Sweden and Texas suffered massive banking failures in the ’90s. I would be much more comfortable with a Texas banker running the Fed today.
On #1
Carnak the Magnificent says Brad DeLong and Economics.
What explains children’s fascination with Dinosaurs? Dinosaurs are not that interesting. The only interesting things are their size and the fact that they dominated the earth before going mysteriously extinct. Can any of these items account for the disproportionate interest that kids seem to show about this otherwise boring lizards?
It’s because kids are taught so much about dinosaurs, therefore they live in a world of dinosaurs that adults don’t. Kids also live more in the world of animals than most adults. Most adults don’t spend much time thinking about giraffes and hippopotamuses. Visits to natural science museums and zoos probably have a lot to do with it, as well as toys, books and cartoons. So ultimately it’s adults who are making dinosaurs so interesting for children.
Its life before dinosaurs. A very esoteric field for a 7 or a 70 year old. Kinda cool actually. Hope he or she never loses that sense of wonderment and discovery.
Giant creatures that ruled the earth, so to speak, and then mysteriously disappeared. Yeah, what could a child possibly find interesting about that?
Fed dollar swap lines are not bailouts. It is only short-term liquidity to stop dollar funding markets from freezing. The Fed 2008/9 had dollar swap lines with Canada, UK, ECB, Sweden, Switzerland, Japan and Australia.
Responding to a few questions:
1. Yes, the answer was “Scott Sumner”
2. No, money doesn’t affect long run growth.
3. Relative state performance depends on industry mix, size of housing crash, taxes, etc.
4. I believe Sweden has done better than Texas over the past year or two, but am not certain. It’s unemployment rate has come down quickly.
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