Potpourri
I’ve got to really buckle down in the office, so you won’t be seeing much from me in the next few weeks. Here are some links to keep you from losing it.
==> My flights got screwed up so I missed this live, but Lew Rockwell gave a great antiwar talk on Saturday for the Ron Paul Institute.
==> My reflections on 9/11 and the political uses of crisis.
==> A really interesting Sowell column on income inequality statistics. I didn’t know some of these.
==> Tom and I talk about lead poisoning and Republicans on the latest Contra Krugman.
==> I sure hope Scott Adams wasn’t one of my students:
One of the the most important things I learned while getting my degree in economics is that economies are driven by psychology. If people expect tomorrow to be better than today, they make investments. If they think things are in decline, they wait it out, and that lack of investment makes things decline further. Psychology rules. Almost everything else is just scenery.
==> I know some might regard this as nitpicking, but the following from Scott Sumner really frustrates me:
For several years the Fed has been tightening monetary policy. This started with tapering, then with signals of an increase in interest rates, then an actual increase in interest on reserves. Now Fed officials are signaling that more rate increases are likely to occur. The Fed does this for one reason, and one reason only, to prevent overshooting of their target. If they were in fact “struggling” to hit their inflation target, it’s not clear how they would respond. But one thing that is 100% clear is that if they were truly “struggling”, THEY WOULD NOT BE RAISING THEIR FED FUNDS TARGET INTEREST RATE. This is a really basic point, which is taught in every single EC101 textbook. The Fed raises rates to prevent high inflation, not when it is struggling to achieve it. If you don’t believe me, look at the monetary policy chapter of any recent econ text. No central bank that is raising rates is also struggling to hit its inflation target. They may be failing to hit it (I agree with that claim) but they are not “struggling” to hit it.
OK, I have no problem with the above, *except* for the fact that if I wrote the following, or if (say) someone in Bloomberg wrote the following, Scott would go ballistic and wonder why he and Milton Friedman are the only decent economists since Hume.
[HYPOTHETICAL COMMENTARY THAT WOULD MAKE SUMNER FLIP OUT, WRITTEN CIRCA 2013]: “For several years the Fed has been loosening monetary policy. This started with signals of rate cuts, then rate cuts, then massive expansions of the monetary base. Now Fed officials are signaling that more asset purchases and possible rate cuts (negative rates) could occur. The Fed does this for one reason, and one reason only, to prevent undershooting of their target…This is a really basic point, which is taught in every single EC101 textbook. The Fed cuts rates to stimulate a weak economy, not when it is trying to stifle growth. If you don’t believe me, look at the monetary policy chapter of any recent econ text. No central bank that is cutting rates is also causing a recession. They may be failing to prevent it (I agree with that claim) but they are not causing the economy to tank.”
“No central bank that is raising rates is also struggling to hit its inflation target” is always true.. There are no circumstances where raising rates could (other things equal) cause more short-run inflation than no rate increase.
“No central bank that is cutting rates is also causing a recession” could be false. There are circumstances where (other things equal) a CB fails to cut rates sufficiently, and so does cause a recession (or fails to prevent one, which I think is the same in Sumner’s view).
“There are no circumstances where raising rates could (other things equal) cause more short-run inflation than no rate increase.”
“other things equal” assumes all circumstances away. There are plenty of circumstances where rising rates happens at the same time as accelerating inflation.
Even in times of raising inflation there are no (obvious) circumstances where raising rates could cause more short-run inflation than no rate increase.
Very misleading to switch between speaking of counterfactuals-as you are-and different realized outcomes at different times-as Sumner is.
Even in times of falling GDP growth there are no (obvious) circumstances where cutting rates could cause less GDP growth than no rate cut.
yes, that is true – but that doesn’t mean that cutting rates necessarily leads to easy money, only easier money !
Not if the cutting of rates is due to a reduction in the inflation premium with no change to the liquidity effect!
Hmmm, there’s strong feedback happening with the market playing the “double guess the Fed” game instead of searching for genuine investments. Thus the reaction of all the Fed watching crowd could conceivably be greater than the direct effect of the Fed itself.
Consider this: right now they have been talking about another quarter percent rate rise, which in the scheme of things is not much. There’s expectation out there that the economy is improving and rate rises are in the pipeline. However, clearly the Fed are nervous to trigger anything right in front of a significant election. Yellen wants to maintain a hairy-chested rising rates posture… but suppose she suddenly just dropped those rates out of the blue? Suppose sometime this week Yellen dropped rates by a quarter point unannounced, what would the reaction look like?
I suggest the reaction would be bad. People would be coming up with theories about why she did that, what’s going on? Anyone thinking about investment would freeze and go back to double check everything. Even the short term stimulus potential would be lost because such a large market is now ready to react to the slightest Fed move.
Of course, this is not “all things equal” but that’s the whole idea of having a market… absorb and process new information.
Inflation that takes the form not of increased funds in the loan market, but of increased spending on goods, with no reduction anywhere else, could raise rates by virtue of the inflation premium outweighing the liquid effect.
That is an obvious circumstance.
Stephen Williamson disagrees.
Transformer:
“There are no circumstances where raising rates could (other things equal) cause more short-run inflation than no rate increase.”
Actually there are. It depends on HOW the central bank raises interest rates.
Imagine two different worlds, exactly equal with the exception of one thing: psychology.
If in both worlds “everything else were equal”, then the world with inflationary psychology X could have the central bank inflating in order to raise rates, while in the other world with inflationary psychology Y could have the central bank deflating in order to raise rates.
And our world today could be either one.
Not that I’m a Scott Adams fan but what he says is approximately equivalent to a clumsy way of explaining time preferences.
If the individual time preference is (let’s say) 3% and they see the economy is growing, many new products popping up, their investments might get 5% or 10% so investment seems like an attractive option. Also, in a generally growing environment risk is perhaps lower or at least perceived to be lower.
OK, same individual has same time preference at 3%, but the type of investment available is either very low return (bank deposits) or higher risk and still low return (most of the stock market right now). Thus, estimated return is lower than individual time preference and therefore no incentive to invest money. Not a lot of incentive to work harder than necessary to keep up with short term consumption either.
Now the thing about time preference is that no individual can compare their personal preference against the real return on investment… we all compare against our estimated prediction of return as adjusted for risk. Since many people follow the herd, there’s elements of positive feedback at work (Scott Adams certainly isn’t the first to point that out).
Oh wait, that would be the “confidence fairy”, Krugman already killed her if I remember correctly. Strange to see people trying to wake her up again after all these years. Now we have zombie fairies running round the back garden. Egat!
“”If they think things are in decline, they wait it out, and that lack of investment makes things decline further. Psychology rules. Almost everything else is just scenery.” …”
“… Since many people follow the herd, there’s elements of positive feedback at work …”
“… Oh wait, that would be the “confidence fairy”, Krugman already killed her if I remember correctly.”
No response, here; Just making an observation.
The Confidence Fairy is true as far as it goes, but what the Keynesians miss is that people can only push back their time preferences for so long since all the confidence in the world can’t change the fact that people are taking losses in real, subjective terms.
This is why the market always wins.
In my opinion, the “magic” of Keynesian stimulus does not work by adjusting individual time preferences, instead it is an attempt to fool each individual into believing that their chosen time preference is likely to be fulfilled. This makes those individuals more inclined to save and invest than they might have otherwise been.
If you think about an inflationary environment, it gives the appearance that returns are good, at least in the nominal sense. Probably if the economy has had a recent downturn, people’s expectations of inflation are low so when they see the nominal figures going up, it puts them into a positive mindset. Same thing with nominal wage rises… the workers feel wealthier. It’s a trick though, it depends on sneaking in ahead of expectations, so once everyone starts to see price inflation and gets into the habit of automatically discounting for inflation, then once again they are disappointed with their returns.
So, potentially you might have this collective action problem where every individual is waiting for every other individual to move… no one wants to be first. In that narrowly defined scenario you could find that Keynesian trickery can be self fulfilling because it gets the herd underway. That’s the whole “pump priming” scenario, and you are creating a kind of artificial confidence to tide the situation over the worse of the depression. That’s what I mean by positive feedback.
Trouble is that Keynesians want to believe their stimulus works as a general purpose tool. They don’t want to limit themselves to the occasional narrowly defined scenario, their motto is “Saving yesterday, saving tomorrow, but always spending today.” Krugman will never openly admit the whole thing is an elaborate Jedi mind trick… he will come up with any and every alternative explanation and he will grouse on anyone who starts talking like Scott Adams about overall investor confidence.
We have been doing economic “pump priming” for more than 50 years, you would think the pump might start working as a pump at some point.
Then once we do start talking about confidence, perhaps we should also talk about all of the other things that affect confidence. You know sovereign risk might discourage investment. Could be weak an unreliable property rights act as a disincentive. Dare I say it, Obamacare is increasing costs (both for individuals and business) without any obvious improvement in service, and people can get bummed out by that. Speaking for myself I find comments like “You didn’t build that!” to be deeply offensive and I’m pretty sure that was the intention.
Scott Adams wants to talk about “psychology” but I would point out that human brains are fairly good at what they do. I’ve yet to see someone turn up with a viable replacement for a human brain, so if there’s a lot of people lacking confidence I would tend to go looking for a sensible reason.
“but I would point out that human brains are fairly good at what they do. I’ve yet to see someone turn up with a viable replacement for a human brain”
Fairly good possibly, but that leaves a lot of room for improvement. We know they are fairly bad at many things also. One thing they are bad at is weighing evidence accurately. Presentation, peer pressure and previous beliefs are given far too much weight.
“No central bank that is cutting rates is also causing a recession. They may be failing to prevent it (I agree with that claim) but they are not causing the economy to tank,” except, of course, when they start paying interest on reserves, as they never did before, to make sure banks do not make loans with the new increased money supply and lower rates (making them irrelevant) and in so doing they cause a demand side recession.
Why 2013?