Failed I Have
I have been warning you guys for a long time now that Scott Sumner was the real guy to watch. Now Christina Romer writes in the NYT–the NYT for crying out loud!–that Ben Bernanke needs to get his Volcker on:
Today, inflation is still low, but unemployment is stuck at a painfully high level. And, as in 1979, the methods the Fed has used so far aren’t solving the problem.
Mr. Bernanke needs to steal a page from the Volcker playbook. To forcefully tackle the unemployment problem, he needs to set a new policy framework — in this case, to begin targeting the path of nominal gross domestic product.
There is only one being who knows how I now feel.
A Video Trying to Make Nominal GDP Targeting the New Normal
This is pretty good, and has the endorsement of lots of market monetarists (see the comments here).
If I were going to make a video to introduce a newcomer to Scott Sumner’s ideas, it would look something like this.
John Carney Smells a Rat, Too
Seeing that I criticized Sumner lo these many years and have lived to tell the (boring) tale, John Carney has lately been launching broadsides against the Brawler from Bentley, here and here. We’ll see if Scott plays bad blogger, good blogger with Carney like he did with Kelly Evans.
Evans & Carney, some Free Advice: This guy is dangerous. You don’t know what you’re dealing with. He is no standard inflationist, he is an evil genius. You can’t just go in, thinking you’ll take him down by saying people will fear soaring prices. That’s exactly what Scott wants them to think (assuming the term “soaring prices” had operational meaning, which Scott denies). You talk like that, you end up like this guy.
How Are Sujatha Reddy and Scott Sumner Alike?
Well, neither has been in my living room. But beyond that, they both have far more expertise in their respective fields than I do, and yet I confidently claim that they are being very misleading when they “debunk” conventional wisdom.
I’ve already complained about how Scott says that inflation poses no problem at all (or words to that effect). In a recent post he gave a hint as to what he could possibly mean:
Supply shocks aren’t bad because they cause “inflation,” they are bad because they reduce resources available to our society (often oil and food) and hence reduce real GDP, real living standards. Let’s start with a perfectly flexible wage price model, then add sticky prices. With complete flexibility, a supply shock that reduces real output by 3% might lead to 5% inflation and 0% RGDP growth (assuming a 5% NGDP target.) That’s unpleasant. But exactly the same reduction in real output and living standards would occur with any inflation rate, including the normal 2%, or even 0%. With perfect wage and price flexibility, the supply shock will immediately reduce real wages, so whatever the inflation rate is, wage growth will be even lower (relative to trend.) It makes no sense (in that case) to talk about supply shocks being bad because the cause “inflation;” they are bad because the are real shocks, they reduce real output.
I said in the comments:
OK Scott if you have time try this one: Let’s say we get a new Fed policy function. Every January 2, a computer randomly picks a number x, between 1 and 5. Then, the Fed raises NGDP that year by a factor of 2^x. (So some years NGDP doubles, some years it quadruples, etc.)
I claim that real GDP growth over a 25-year period will be lower for that economy, than under (say) a Taylor Rule. Now my questions:
(1) Do you agree?
(2) Would you say that technically, even here the problem wouldn’t be due to inflation or monetary shocks, but (by definition) the problem would be the lower standard of living implied by stagnant RGDP growth, which in turn was caused by shorter-term business planning etc.?
(3) If you answered “yes” to the above two questions, can you understand why I now want to take a hostage?
Now on to Sujatha Reddy, who says it’s a myth that cold weather causes you to catch a cold:
Well no kidding, I didn’t think that slower random molecular movement per se made your nose start running. What is at issue here is the policy rule–implemented by the chairwoman of the household, Mom–that says, “Don’t go outside without your hat and gloves, or you’ll get sick.” Is Reddy challenging that? If she has kids, does she say to them, “Don’t go outside without your hat and gloves, or else your skin will sting?”
There have been several times in my life when I was quite sure I got sick because I had foolishly been outside for an extended period without being properly dressed. I suppose that could be a string of coincidences, and that I’m not remembering all the times when I should have had a hat and didn’t get sick, but I don’t think so. I think there are various reasons that your body is more susceptible to being infected with a virus when it’s cold outside, and that you can help protect yourself by dressing appropriately.
I tried finding something definitive on this, and apparently
Douglas, R.G.J., K.M. Lindgren, and R.B. Couch. 1968. Exposure to cold environment and rhinovirus common cold. Failure to demonstrate effect. New Engl. J. Med. 279:743.
is a seminal paper in this area. But if I can’t get the paper on Google, it doesn’t exist.
Sigh, I Think the Blog Is Working Again
I am now starting to suspect that when I’ve been spending too much time blogging, a failsafe kicks in and locks everything up. Sort of a cooling off period, like when the stock market crashes and the exchange shuts down for an hour.
Anyway, I think you should be able to comment now.
Should Central Banks Worry About Asset Bubbles?
A long long time ago, from an ISP far far away, the indefatigable von Pepe was beating me over the head about my reckless CPI “calls,” telling me that loose monetary policy would show up all over the place. He sent me all kinds of academic papers.
Well I finally took the time to write up some of the big-picture results, since Bernanke gave me a good news hook. Here’s the result. From the intro:
In the present article, I’ll summarize some of the key mainstream literature on the theoretical and practical case for including asset prices in a measurement of “inflation” (by which these economists mean “rising prices”). As we’ll see, this isn’t some obscure, crankish Austrian obsession, but actually is quite defensible on even neoclassical grounds.
People Draw Different Lessons From History
Paul Krugman talking about the Europeans’ amazing reluctance to print as much money as he thinks they should:
The point here is that we have a couple of centuries’ experience with central banking, and that experience clearly shows that the lender of last resort function is crucial. The Federal Reserve basically was created after America had to rely on J.P. Morgan to fill that role in the panic of 1907, and it was recognized that one couldn’t always count on having a J.P. Morgan on hand when you needed one. (The Fed went on to fail to do its job in 1930-31, but that’s another story.)
I’m not even going to spoil that by coming up with analogies.
When the Facts Change, I Silently Curse–What Do You Do, Sir?
Dangit, I realized there is yet another complication to the income vs. consumption tax saga. I don’t know about you guys, but this debate is like the first season of 24. In the beginning I thought it was incredibly interesting, I was hooked, I couldn’t get enough. But after 20 hours of it, there were so many plot twists and incredible assumptions that it bordered on absurd.
So yesterday two things happened that made me realize I have been an omitting something important from my repeated assurances that there is a legitimate sense in which the income tax dings you worse than the consumption tax. First, I gave a fairly rigorous “proof” that an individual really is worse off under an income tax, but I had to assume an individual’s lifetime consumption equals his lifetime income. (It doesn’t mean that’s true every period, just over the lifetime. E.g. you save a lot during your working years, and then you draw down yours savings during retirement, so that upon death you have no assets.)
So at the time, I thought I was bending over backwards to be fair to those who were arguing, “Hey I ultimately save in order to consume, so why aren’t the two taxes equivalent?”
But then I read Alex Tabarrok’s paper (from when he was a grad student) talking about the standard mainstream case for the superiority of an income tax versus an excise tax. If you’ve never seen a graphical presentation of these types of arguments, go look at his paper–it’s short. He doesn’t use indifference curves, he just draws a budget set and shows through a revealed preference argument that you are better off if the government takes (say) $1000 out of your income through a percentage tax, rather than $1000 out of your spending on a particular product through a percentage tax.
So at this point warning bells are going off: If Tabarrok is right that this type of “standard” analysis shows an income tax is better than an excise tax on a particular product, what changes to make an excise tax (as it were) on all products better than an income tax?
Well, there are two different things going on here. In Tabarrok’s demonstration, you assume the person’s pre-tax income is a fixed number. And since the person can shift out of the taxed good (when an excise tax is imposed), the government has to jack up the percentage, taking into account your response, in order to extract the same amount of revenue from you.
In contrast, when I was warning of the income tax’s distortionary effects, I focused on the fact that your income itself (over time) isn’t a fixed number, but depends on your saving and investment decisions which in turn are muted by an income tax. If you assume that a person will always consume 100% of his income (which I did in the “proof” linked above), then the only moving part is the person’s income, which will be affected by an income tax but not by a consumption tax (unless it makes you take more leisure).
In conclusion, my sophisticated, PhD answer to which tax hurts an individual more is, “It depends on your assumptions.” I think you can basically say that to any economic question, and you’ll be able to hobknob with the best of us.
Last point, in all seriousness: I want to stress that this is counterintuitive. I think a lot of you are going to say, “OK, I knew there was something fishy here. A consumption tax is just as bad as an income tax, because after all you save in order to consume in the future.” And I’m still saying no, that isn’t what’s driving my addendum above. In fact it’s the opposite (assuming I am now thinking about everything the right way). If you are only saving in order to consume in the future, then my original point holds up; see the “proof” linked above.
But the screwy thing occurs if you don’t consume all of your lifetime income. If you bequeath wealth to your kids, or donate to charities along the way, then your lifetime income is higher than your lifetime consumption. And now we’re back in the realm where a consumption tax can mess up your allocation decisions, this time between consumption and donations to others. So a consumption tax (if calibrated to extract the same amount of tax revenue) will cause you to consume less and donate more, relative to your original tradeoff. Just like an income tax will cause you to save less and consume more in the present. Without giving specific numbers and preferences, I don’t think we can say which effect is worse.
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