I thought it was hysterical when back in 2009 and 2010 there were papers written and conferences held which carried the theme of the “lessons learned from the crisis”. For example, the – 6th ECB Central Banking Conference (November 2010) – had an array of leading mainstream economists and central bankers telling us what it was all about despite these same characters previously representing a body of work that told us the macroeconomic problem (cycles and unemployment) had been solved. There were lots of papers, Op Eds and media commentary (every day on Fox News and its ilk) warning us of the worst unless governments imposed austerity. Even as recently as the last US election, the “skies are about to fall in” message was prominent and dominated the Republican campaign. Millions of people are unemployed as a result of these economists having sway with policy makers. The evidence denying their predictions etc started to slowly trickle in around 2008 and as the years of this madness have passed the evidence is now a dam break. At this point, the mainstream just talk among themselves and continue to bank their high salaries and take on lucrative consultancies. Denial of facts is their ultimate recourse.
There was an interesting Bloomberg Op Ed over the weekend (May 25, 2013) – Conservatives Muzzled by Liberals, and by Themselves.
It recounted the blustering from the American Enterprise Institute about how many graduations in US universities had invited speakers with conservative leanings as opposed to “identifiably liberal speakers”. The ratio over 2012 and 2013 was 15 conservatives to 69 liberals.
But the AEI claim that US liberal arts colleges are “hostile territory” to conservatives.
One could easily assume that as universities are places of learning they prefer not to have manic conservative gospellers who have demonstrated the poverty of their ideas during this extraordinary economic crisis.
But when you consider what gets taught in macroeconomics courses in the majority of these institutions my “hope” is probably far fetched. Damn it!
However, the Bloomberg writer (Francis Wilkinson) considers my view to have some wisdom:
But the overall numbers may be due to another factor … It keeps getting harder to find conservatives worth listening to.
I thought it was apposite when the arch conservative – Bruce Bartlett – wrote last year (November 26, 2012) – Revenge of the Reality-Based Community – which was a testament of his fall out with his fellow conservatives.
He claimed that conservatives have been “living in their own bubble where nonsensical ideas circulate with no contradiction.”
This is a guy who pumped out the Reagan supply-side myths in the 1980s (as an advisor) who says he was banned by Fox News for daring to question the decisions made by George Bush. He was muzzled throughout the Rupert Murdoch empire where he had previously been given good access.
He detailed many “dissident conservatives” like him who were banned from Fox and other News Limited outlets. Bartlett eventually lost his job at the National Center for Policy Analysis for criticising Bush.
Bruce Bartlett relates how in research for his recent books he “came to the annoying conclusion”:
… that Keynes had been 100 percent right in the 1930s. Previously, I had thought the opposite. But facts were facts and there was no denying my conclusion. It didn’t affect the argument in my book, which was only about the rise and fall of ideas. The fact that Keynesian ideas were correct as well as popular simply made my thesis stronger.
His book was published “just as the economy was collapsing in the fall of 2008” and he realised that:
.. it was immediately obvious to me that the economy was suffering from the very same problem, a lack of aggregate demand. We needed Keynesian policies again, which completely ruined my nice rise-and-fall thesis. Keynesian ideas had arisen from the intellectual grave.
With that point obvious in his mind, he assesses that the likes of the American Enterprise Institute and the Heritage Foundation do not present “informed policy analyses” but rather are content “pumping out propaganda” (Source).
The April 27, 2010 New York Times article – ‘Epistemic Closure’? Those Are Fighting Words – noted that when confronted with the view that conservatives have gone into denial of reality, a popular counter was:
I DON’T CARE if every fact and figure is correct … more importantly, the principles were timeless and correct.
This brought back memories of my post-graduate student days when one Monetarist professor told the class that if there is a clash between the data and the theory then the data is wrong. He wasn’t joking. He was a rabid mouthpiece for the movement although they hid behind a veil of respectively.
I recall another time, during a staff workshop (I was a tutor at the time) when I challenged the speaker about his contention that the mass unemployment in the early 1980s recession was obviously due to excessive welfare benefits and excessive trade union power – that a senior professor turned to be in front of everyone and said:
Haven’t you even learned about an downward sloping labour demand curve Bill?
Sniggles all round the room followed. I won’t tell you what I replied but it related to the Professor having his hand on an upward sloping object. I wasn’t popular.
This sort of denial is now going by the trendy term “epistemic closure”, which is now being bandied around the place. In strict terms, the behaviour of conservatives is not what a philosopher would define as epistemic closure. It is more a demonstration of – Confirmation bias.
The Bloomberg Op Ed also uses the term “epistemic closure” on the right which he describes as “the phenomenon of conservative media, politicians and intellectuals forming a closed information loop in which they more or less tell one another what they like to hear.”
That is what confirmation bias is.
But the interesting part of the article was his reference to Jonathan Chait’s excellent New York Magazine article (May 10, 2013) – The Facts Are In and Paul Ryan Is Wrong.
Chait referred to “the collapse of intellectual support for the notion that immediate austerity can boost economic growth” and a “growing consensus that health-care-cost inflation is slowing for deep structural reasons” – both of which “blow to smithereens the intellectual foundations of the Obama-era Republican policy agenda”.
We might add they destroy the substantive neo-liberal policy agenda and its so-called theoretical underpinnings (aka religious doctrine).
I don’t care if someone says that they believe in “god” (whatever). I might think they are mis-guided (I also might not) but that’s fine as long as it doesn’t impact on anyone else.
But when some well-paid, job-secure economist tells us that cutting government spending will increase growth because of A, B and C (all articles of doctrine) then I really care because millions of people become unemployed and children die as a consequence.
Religion can be tolerated if it keeps to itself and doesn’t involve predatory sexual behaviour on minors etc. But religious economic doctrine cannot be tolerated and should be subject to the same laws of malpractice that other professions are forced to operate within.
Imagine the clearing of the academic staff offices at the big American universities if that was the case. Harvard could convert them into apartments for the homeless and the welfare levels in the world would rise.
Jonathan Chait notes that:
The doctrine of expansionary austerity — the premise that we must cut deficits not just eventually but immediately — has suffered a series of disastrous reversals. It has failed repeatedly in Europe, and its most prestigious academic basis, a paper by Harvard’s Carmen Reinhart and Kenneth Rogoff, was exposed for a series of fundamental errors. A New York Times article this week represented a watershed, baldly stating in its headline, as the entire macroeconomic forecasting field has understood all along, that the short-term deficit was too low, no longer a counterintuitive dissent but a clear and barely contested reality.
The “entire macroeconomic forecasting field” has not known this all along. The most influential of these operators, the likes of the IMF, the OECD, etc have actively promoted the fiscal contraction expansion myth and have produced countless technical papers and narratives to support it.
They have lied all along. Only a few economists (proportionally) have stood against the torrent of neo-liberal economic lies. I gave an interview for a radio station today on an upcoming public lecture I am giving entitled – Full employment abandoned – a truiumph of ideology over evidence – and I was reminded that I was considered a heretic by the rest of the economics profession.
That may be so but it is a necessary (though not sufficient) condition for having an understanding. The dominant religion is certainly not correct in the way it construes reality.
Jonathan Chait closed by saying that “Ryan and his party are so certain of these foundations his worldview rests upon that he can’t even be bothered to look down at the rubble all around his feet”.
The millions of unemployed that have materialised since 2008 haven’t just come from nowhere. Welfare rules, tax rules, the number of sunny days on the Costa del Sol, … whatever haven’t changed.
What changed was that in the wake of a massive financial upheaval caused by the application of the failed self-regulating markets doctrine, consumers and investors stopped buying and investing and borrowing and as always is the case in those circumstances real GDP growth falls rapidly and unemployment rises.
We can complicate the analysis by talking about what we might do with the banks, and the new financial regulations, trade imbalances, and all the rest of it but it is very simple – as the arch conservative Bruce Bartlett finally acknowledged after he confronted his religious views with some hard data and had the temerity (and circumspection) to realise that when the data is staring one in the face it is not wrong the theory is wrong.
And none of that makes me a Popperian. There is a point in knowledge determination that one cannot seriously continue advocating a position – and that is once all the complexities of hypothesis delineation and acceptable testing environments and the rest of it are included.
The Bloomberg Op ed concluded that
Chait is one of the smartest liberals writing. His attack on conservative doctrine was direct, empirical and, to my mind, quite devastating. In the two weeks since his piece was published, no smart conservative — Levin is the obvious choice — has answered his challenge.
And they probably won’t. Bruce Bartlett found out that he still had friends (for a while) despite attacking the Bush administration in the New York Times because as he said “Not one person had read it or cared in the slightest what the New York Times had to say about anything. They all viewed it as having as much credibility as Pravda and a similar political philosophy as well.”
I was thinking about this discussion when I read a recent piece by Laurence Ball – The Case for Four Percent Inflation. The full reference is below. You have to subscribe or get sent the paper by a subscriber. But a cut down version of it appeared – The case for 4% inflation .
Laurence Ball is a smart guy and our work has intersected at times (hysteresis and inflation targetting) but he is also wedded to a belief that monetary policy is the best aggregate counter-stabilisation policy option. In this paper, he believes that if central banks didn’t squeeze their economies with low inflation targets and instead lifted their targets to 4 per cent then they would have room to move in the wake of an aggregate demand crisis.
The logic is that nominal interest rates would be higher – providing a wider range for stimulus before the zero rate trap was encountered and that “4% inflation does not harm an economy significantly”.[Reference: Ball, L. (2013) ‘The Case for 4% Inflation’, Central Bank Review, Central Bank of the Republic of Turkey, May]
Laurence Ball says the resistance to such a proposition come from central bankers and mainstream monetary economists (such as Frederick Mishkin).
The latter, who when he is not accepting large sums of money for consulting reports that assessed Iceland was in great shape prior to the crisis, considers 3 per cent inflation to be dangerous. Apparently we learned that from the crisis. In a 2011 paper informing us about these lessons, Mishkin said (quoted by Ball) “when inflation rises above the 3% level, it tends to keep on rising”.
No it doesn’t but then that would be privileging data over the religion wouldn’t it?[Reference: Mishkin, F.S. (2011) ‘Monetary Policy Strategy: Lessons from the Crisis’, NBER Working Paper #16755]
On Mishkin and Iceland – please read this blog – Wrong is still wrong and should be disregarded.
I thought it might be useful to see how Dr Mishkin’s forecasts are actually doing. He was very outspoken in 2009 about the policy settings in the US.
On June 22, 2009 his Wall Street Journal article – How to Get The Fed Out Of Its ‘Box’ – attacked fiscal policy as pushing up long-term interest rates.
Mishkin said at the time:
The bad news is that long-term interest rates are higher because of concerns about the deteriorating fiscal situation, with massive budget deficits expected for the indefinite future. To fund these budget deficits, the Treasury has to sell large quantities of bonds both now and in the future, causing bond prices to fall and interest rates to rise. The increased supply of Treasury debt puts pressure on the Fed to buy it up.
The theoretical flaws in this statement are obvious. The US government – totally sovereign in its own currency – issues debt largely on conditions that it determines. A long history of bid-to-cover ratios tells us that the bond markets suck it all up on the conditions that apply.
But quite apart from the theoretical flaws involved in this conclusion, even the empirical reality is at odds with the projections implicit in this statement.
Ideology reigns supreme.
The following graph, updated from 2009, shows the evolution of the US 10-year bond yields since 1990 (data available from US Department of Treasury).
The yields continued to fall as the budget deficits rose. The demand for US bonds remained strong. Even after the ratings agencies tried to assert their relevance by downgrading US sovereign debt we know what happened – yields fell as demand rose.
In that 2009, WSJ article – Mishkin also rehearsed the usual inflation nonsense – that students are forced to learn if using his textbooks. He was following on the previous claim that the Federal Reserve would have to bail the government out by buying its debt as bond markets would surely revolt.
He said that:
Although an expansion of Treasury bond purchases by the Fed would have the benefit of lowering long-term interest rates temporarily to stimulate the economy, in the current environment it could be dangerous for two reasons. First, it might suggest that the Fed is willing to monetize Treasury debt. The Fed does not, and should not, want to make it easy for the Treasury to sell its debt and thereby be an enabler of fiscal irresponsibility. Second, if the Fed loses its credibility to resist pressures to monetize the debt it could cause inflation expectations to shift upward, thereby leading to a serious problem down the road.
The Federal Reserve has expanded its balance sheet dramatically since that time and inflation has been falling. It is quite clear that the mainstream assessments in this regard have failed to gain empirical traction.
The reason for that is that “time dependent” observations remain as good as the conceptual framework (that is, the “understanding”) that backs them up. Mishkin’s conceptual framework is inapplicable to the monetary system that he claims to be an expert about.
He was wrong about Iceland because his assessment was biased by a flawed mainstream monetary framework plus he was getting paid a lot of cash and I guess he was too blind to see what was about to happen. He operates in his own closed circle – confirmation bias.
Laurence Ball considers these views that inflation is dangerous to be based on “addictive theory of inflation” – “Like an alcoholic’s first drink, 4% inflation may not do great harm by itself, but it is the first step in a dangerous process”.
The other point he makes is that those who argue that such a change in the inflation targetting threshold would be dangerous also argue about credible policy rules – “a central bank should determine its optimal policy, explain this policy to the public, and carry it out”.
There is an obvious inconsistency. Either credibility is what it is all about which means that a central bank could target 20 per cent inflation without expectations breaking out above that or the whole idea is bunk.
I favour the latter approach.
But the other point is that measured inflationary expectations always lag the actual inflation rate. There is no evidence that they break out on their own for any period of time.
So even within the mainstream there is a lot of dispute and the more evidence-based members of that group are starting to come to the fore as the ideologues are revealed, one by one, for their stupid predictions.
The problem though that remains is that a reliance on monetary policy still reflects the neo-liberal consensus that fiscal policy is an inferior counter-stabilising policy option.
Laurence Ball’s recommendation is based on the liquidity trap argument that the likes of Paul Krugman are propagating. I discuss that proposition in this blog – The on-going crisis has nothing to do with a supposed liquidity trap.
In an oft-quoted passage from Chapter 15 (Section III), Keynes argued that:
Thus there are certain limitations on the ability of the monetary authority to establish any given complex of rates of interest for debts of different terms and risks, which can be summed up as follows:
(2) There is the possibility … that, after the rate of interest has fallen to a certain level, liquidity-preference may become virtually absolute in the sense that almost everyone prefers cash to holding a debt which yields so low a rate of interest. In this event the monetary authority would have lost effective control over the rate of interest. But whilst this limiting case might become practically important in future, I know of no example of it hitherto.
This is the liquidity trap – and the intuitive reasoning is that everyone holds cash rather than bonds because they consider interest rates are so low they can only rise which means that purchasing bonds at existing market prices would guarantee a capital loss as their prices fell.
As a result, the central bank then cannot push rates lower and if aggregate demand is deficient at that level of rates they allegedly lose their capacity to increase spending.
This concept was further developed by J.R. Hicks after a 1936 conference at Oxford where various economists attempted to “model” the General Theory. This was the birth of the famous IS-LM model that is standard fare for intermediate macroeconomics students (and which Paul Krugman and others think is a reasonable framework within which to demonstrate macroeconomic propositions).
In this model, the normal state is for monetary policy changes (erroneously considered to be controlled by the central bank) impact on interest rates and, in turn, the real economy (via interest-sensitive components of spending). But when the economy hits a liquidity trap – that is, when everyone forms the view that interest rates can only go up – this capacity is lost and fiscal policy is the only way for government to alter real output.
There are two ways in which the Hicksian approach is now interpreted by the mainstream.
First, in a liquidity trap the central bank can no longer manipulate the interest rate by managing the demand and supply of funds via open market operations because the opportunity cost of holding cash becomes irrelevant to everyone. Monetary authorities lose the capacity to reduce interest rates any further because everyone wants to hold cash rather than bonds – so open market operations fail. In a liquidity trap, people will keep holding extra cash that comes into the economy irrespective of the size of the cash pool.
Second, a more modern approach by mainstream economists suggests that the way monetary policy works is via its influence on the volume of funds available by banks for credit. The modern version of this relates to the debate surrounding quantitative easing.
Whichever version you adopt the notion centres on the view that cash holdings are invariant to interest rates and people will demand an infinity of cash.
The mainstream view – for those who believe that liquidity traps “switch off” monetary policy effectiveness and “turn on” fiscal policy effectiveness is that once the economy recovers there is a massive inflation threat sitting in the system in the form of the build up of the monetary base – if the central bank had acted contrary to their advice and believed that monetary policy could still stimulate demand.
They also argue that in the medium- to long-term budget deficits undermine private spending because they drive up interest rates. But in this special case – they are safe – for a time.
That is the position that economists such as Paul Krugman regularly represents.
As an aside, in a true liquidity trap (a la Keynes) the demand for bonds evaporates because people fear capital losses. So the current situation is not of that ilk because the demand for government debt (among the currency-issuers) is very strong and yields are correspondingly low.
None of this has any traction from the Modern Monetary Theory (MMT) perspective.
First, the narrative that says that monetary policy is effective outside of a liquidity trap and powerless during a trap is highly questionable for reasons explained above – the distributional arguments.
MMT considers that the aggregate demand impact of interest rate changes are unclear and may not even be negative (for a rise) or positive (for a fall) depending on rather complex distributional factors. For example, remember that rising interest rates represent both a cost and a benefit depending on which side of the equation you are on. Interest rate changes also influence aggregate demand – if at all – in an indirect fashion whereas government spending injects spending immediately into the economy.
This is the reason why MMT proponents do not give priority to monetary policy over fiscal policy.
Second, whether there is a liquidity trap or not (and whatever that is) it is moot from the perspective of MMT. The fact is that a recession occurs when spending persistently falls short of the sales expectations of firms, which conditioned their decisions to employ and produce. Not wanting to accumulate inventories, firms reduce production and lay off workers.
The reasons why private spending collapses are many as are the reasons why it might not recover quickly. They can mostly be summarised by the term “lack of confidence” which is exacerbated by rising unemployment and the loss of income that accompanies it.
The early idea of a liquidity trap does not explain why bond markets cannot get enough debt at present even with interest rates low and in some cases negative. There is no capital loss expectation with cash (other than via inflation) whereas bond prices are more likely to fall when interest rates (and yields) as so low than they are to rise.
At any rate, the MMT prognosis is clear. Irrespective of the level of interest rates and the state of private desire to hold cash balances the way forward when private spending collapses is for public spending to take its place.
Third, what about this idea that the liquidity trap occurs when cash and bonds are near substitutes so people are indifferent between them? This is the modern version of the liquidity trap but a perversion of Keynes.
The options for the central bank are simple. If they want a non-zero interest rate and there are excess reserves (perhaps from deficits) they can either pay a return on the reserves or sell bonds to drain the reserves. If they pay a return on reserves (equal to its policy rate) as they are doing now in many nations then cash and bonds remain near substitutes. So what? Nothing!
If they choose not to pay a return on reserves then they have to conduct open market operations to ensure the demand and supply of reserves is at the level commensurate with the policy rate they desire. There are not other options. In that case, if there are excess reserves they have to sell bonds and then cash and bonds become imperfect substitutes (because the latter earn interest). So what? Nothing!
The fact that at times people do not care whether they hold bonds or cash is irrelevant to the main cause of recession. Fiscal policy can always restore aggregate demand irrespective of private portfolio preferences.
The point is that you can get various levels of bank reserves depending on how the central bank pursues its liquidity management in order to hit its target policy rate. None of those levels have any particular operational significance.
The mainstream then argue that if the central bank mops up these reserves it will be less inflationary than if it leaves them in the system. This view is based on the spurious – banks lend reserves argument. The inflation risk associated with government spending is the same whether the government issues debt to match its deficit or not. The inflation risk arises from the impact of the spending on the state of capacity in the economy.
The monetary impacts of the deficit spending – in the form of increased bank reserves – do not add to the inflation risk. They emerge after the transactions have taken place. Bond sales just swap on asset for another (a reserve balance or a deposit).
At any time, a bond holder could cash their bonds in and spend up big. Just about as easily as they could cash in a bank deposit and spend up big. There is no “constraint” on spending involved in the government selling bonds.
Which brings me to some evidence.
Here is my evidence as to why a reliance on monetary policy with a disregard for fiscal policy effectiveness is a failed policy stance. This graph shows real GDP for the Eurozone from 1995Q1 to 2013Q1 (Source: ECB).
That is some output gap. The massive monetary policy shifts of the type already tried in Europe have not stopped that double dip. Only ideology said they would.
Correct assessment of the problem – along the lines of arch conservative Bruce Bartlett – tells us what the problem is – a lack of aggregate demand.
Imagine if the ECB announced that it was going to fund expanding budget deficits in the Eurozone up to the point that the output gap is closed and unemployment drops to its full employment levels (whatever they are).
What do you think would happen? Interest rates wouldn’t rise because the ECB would hold them low. Private borrowing rates would likely fall (closing the gap between the ECB rate and current borrowing rates) because banks would be more confident that loans could be repaid – because firms would be selling more and there would be lower unemployment.
Bond yields in the southern nations would drop because the bond markets would know the ECB was going to buy bonds at a target yield and that if they wanted to get their dose of corporate welfare they better buy up before the debt disappeared from the markets.
Growth would return on Day 1 of the policy. Unemployment would start dropping immediately. There would be a surge of confidence.
Public debt might rise but the debt ratio would fall relatively quickly – but then so what?
Inflation currently low wouldn’t blink.
Imagine that. Then try to tell me that the current Euro crisis is a sovereign debt crisis!
That is enough for today!
(c) Copyright 2013 Bill Mitchell. All Rights Reserved.