Two Views of Krugman
[UPDATE at end.]
Daniel Kuehn is upset that Don Boudreaux leads his readers to believe that Milton Friedman and people like him have a monopoly on rule-based monetary policy. Daniel writes:
Don, I think, is trying to pull the wool over his readers eyes here. The consensus for a long time now has been that policy rules are superior to policy discretion. All the major Keynesian voices Don usually complains about, and those who he would associate with Nicholas Wapshott, support policy rules – not discretion. Paul Krugman has specifically cited a Taylor rule to govern monetary policy, and has worked out a Mankiw rule answer in the past as well. Brad DeLong has come out in favor of an NGDP level target, although he’s made points in the past grounded in the Taylor rule. And then of course there’s Mankiw who is presumably pro-Mankiw rule and John Taylor who is presumably pro Taylor rule.
In short, Keynesian policy is rules-based policy. People might just cite the need for stimulus right now, because the shortfall is so egregious. But when you ask Keynesians what is required, a rule of one form or another is invoked.
Man, where do we wacky free-market guys come up with these caricatures? Maybe because Krugman writes stuff like this:
Basically, if you listen to Bernanke’s analytical comments, they make a powerful case for more expansion. Underlying inflation is low; unemployment is disastrously high, and the corrosive effects of long-term unemployment are hurting the future as well as the present. More quantitative easing — QE3 and beyond — might not work, but it’s very much worth trying.
And if you think that doesn’t work, surely Ezra Klein’s recent proposal (HT2 Steve Landsburg) fits the bill. Klein suggested:
I don’t pretend to know what is truly in the heart of our top central banker. But in conversations with Fed watchers and economists, I am convinced that there is something more the Fed can do, and that now is the right time for them to do it. I call it Uncle Ben’s Crazy Housing Sale.
Tomorrow morning, Bernanke could walk in front of a camera and announce that the Federal Reserve intends to begin buying huge numbers of mortgage-backed securities with the simple intention of bringing the interest rate on a 30-year mortgage down to about 2.5 percent and holding it there for one year, and one year only.
The message would be clear: If you have any intention of ever buying a house, the next 12 months is the time to do it. This is Uncle Ben’s Crazy Housing Sale, and you’d be crazy to miss it.
I imagine Daniel can point us to the wild denunciations of Klein’s clearly anti-Keynesian proposal, which flies in the face of everything Krugman has been writing for four years.
UPDATE: I can’t believe I have to point this out, but based on the comments at Daniel’s blog, I think I should: If you have a “rule” that goes out the window when the economy is really bad, then it’s not a rule. That would be like declaring, “We don’t negotiate with terrorists! Unless of course they are holding people hostage.”
But, I sympathize with the idea that different situations can call for different rules. If we assume, for the sake of argument, that a central bank could maintain macroeconomic stability by responding to fluctuations counter-cyclically, it doesn’t make sense for the Fed to use a rule fit for a period of healthy economic growth. In other words, different rules for different stages of the game. If you think macroeconomic instability is called by psychological forces or banking greed — i.e. forces exogenous to the Federal Reserve –, then this kind of way if viewing rules makes sense.
OK, but what is the rule that is being proposed by Krugman or Klein above for this stage of the game? Did they come up with a rule for these kind of situations before the crisis or do the rules get to change on the fly and without being announced beforehand?
Krugman’s “rule,” in particular was developed during the late 90s; i.e. his work on the liquidity trap.
Krugman said this on Sept. 5, 2011,
“Against this you had a stimulus bill of $800 billion — except $100 billion of that was AMT extension that was going to happen anyway, another $200 billion was other tax cuts of dubious effectiveness, so you were left with $500 billion of spending, spread over more than 2 years — maybe 1.5 percent of GDP or less. It just wasn’t big enough to do the job.”
So you’re telling me he had a rule to determine how big the stimulus should have been and now needs to be? It sure seems like his rule for liquidity traps is pretty discretionary.
Dan,
1. Krugman had given a figure for his “ideal” stimulus, and the figure remains pretty consistent. Krugman always claimed that the stimulus actually implemented was inadequate.
2. The “rule” he suggested in his work on Japan and the liquidity trap was a monetary one; i.e. the role involves changing “inflation expectations.” I put rule in quotation marks, because I don’t consider it much of a rule… which leads me to #3.
3. When I write that rules can change according to the game, I didn’t have in mind defending Krugman specifically. In other words, I’m not even sure why discussing Krugman is relevant to the point I’m trying to make.
I think your #1 is important. Fiscal policy rules are a lot tougher than monetary policy rules because of this pesky thing called democracy. They needn’t be. You could have a dictator assign fiscal policy in the same way, and then – as you say – a few very traditional calculations could give you a fiscal policy rule. But that’s not how the world works.
So I think you should still have a rule in mind that you advocate from but then there is also always the question “how much am I willing to give to guarantee that this happens” when it comes to fiscal policy.
Is it optimal? Nope. But it’s what you have to do.
Since nobody else has said it, I will:
Rules based central plans are impossible. All central plans are discretionary.
Take NGDP targeting.
The central bank will still have to decide which people to give money to.
The central bank will still have to decide which assets to buy from those people.
The central bank will still have to decide when to buy those assets.
The central bank will still have to decide just what period time is relevant for determining NGDP growth. Daily? Weekly? Monthly? Yearly? Do they print a whole glob of money just before year end, after a year of NGDP decline, so that the annual NGDP is a net increase? Do they print daily or weekly?
The NGDP targeting “rule” is actually discretionary.
—————-
For fiscal spending, it is also discretionary. Who is the Treasury to give the money to? For what purpose? When? Where?
Further evidence that “rules” are just broad guidelines.
“Anything the state wants to do that has democratic support, they can do”
is also “rules” based.
A broad guideline is not a rule. Even if the applicable rule changes to fit the situation in a manner as established by some other rule, for the situationally specific prescription to be rule-based it needs to state precisely what to do or what not to do. To the extent that it is a mere guideline it is discretionary.
“But, I sympathize with the idea that different situations can call for different rules.”
I agree – conditional rules are still rules. “Water your plants every day, except when on days when its raining”, etc.
Then when the watering rule turns out to not work, on the basis that the subject matter is fact humans, who learn and have their own subjective values, the mistake of watering is, as expected, perceived as a problem of the free market – which after all should behave like unconscious plants according to the positivist’s flawed epistemology – and so the state is to increase its activity against this difficult to control thing called the economy, hoping that the new watering rule will finally work, because now the technocrats didn’t forget to carry the 1 in the equation that tacitly presumes humans are plants.
Then, after repeated failures, the defense becomes “It’s not a problem of control per se, it’s that we just haven’t found the right people and the right rules for the control.”
Yes, that was way left field. But pertinent.
different rules for different stages of the game.
I think you’ve got it. Krugman has said several times that the Taylor Rule (or Mankiw Rule) calls for negative interest rates. Since that’s not possible, those rules must have limited ranges of applicability.
As Daniel Daviues pointed out, Milton Friedman could be pretty flexible about rules.
http://delong.typepad.com/sdj/2007/11/delong-smackdow.html
That’s Davies of course. He quotes from an interview:
DA: In a time of war, how do we maintain our freedom?
MF: We don’t. We invariably reduce our freedom. But that doesn’t mean it’s a permanent reduction. As long as we really keep in mind what we’re doing, that we keep it temporary, we need not destroy our freedom.
In Australia, income tax was first introduced at the start of WWI, and it was just a temporary thing, for the war effort you understand. Yeah right…
Then at the start of WWII the Commonwealth jacked up the tax rate and took over all income tax from the states (see Income Tax Assessment Act 1942). Some of the states fought it, but they lost, and every time they lost, the constitutional justification was that the Commonwealth needed the money for defence spending — this justification continued even after WWII and continues to the present day, even when they spend in on all sorts of other things that have no relation whatsoever to national defence.
Basically, people get the freedom they are willing to stand up and demand, and once lost it is very hard to get it back. Thing is, most people don’t care and while that remains the case, nothing else matters.
Out of curiosity, are you under the impression that a lot of people reading this blog are fans of Friedman?
No.
“Rule based” can mean two very different things. One kind of rule is an objective, with discretionary actions to achieve the objective. The objective may be vague (e.g. the Fed’s dual mandate) or very specific (e.g. Sumner’s GDP target). Another kind of rule specifies the actions rather than the objective. Milton Friedman’s money rule is an action rule. The Taylor Rule is a more complicated action rule.
Most economists, I guess, favor objective rules rather than action rules. Few, if any, want no rules at all.
Am I missing something? The point of QE3 and all the other QEs is to get back to the rules that have been tossed out the window.
He is saying “we need QE3” because of what the Taylor rule is saying, Bob!!
What, specifically, is the rule you advocate, Daniel?
Not sure honestly – the strange thing about right now is that we’re also in the middle of a discussion about which rule is best (not the sort of discussion you want to have in the middle of a crisis, but whatever).
Several years ago I just would have said “the Taylor rule”. Now I am definitely clued in on the dangers of targeting rates rather than levels.
Two nice things:
1. You all do not have to rely on me to make up my mind, and
2. Both say we should do about the same thing (although I’m not sure what the Taylor rule says at this point… I feel like I haven’t seen an update in a while).
DK wrote:
Am I missing something? The point of QE3 and all the other QEs is to get back to the rules that have been tossed out the window.
He is saying “we need QE3″ because of what the Taylor rule is saying, Bob!!
Yes, you’re missing something Daniel. How can you be exasperated that I’m failing to see that QE3 would just restore the good ol’ Taylor Rule, when you yourself admit in your next comment that you personally don’t know what the Taylor Rule even means in today’s environment? That makes no sense Daniel.
And what is “QE3”? It means, “The Fed should buy a lot of stuff.” It’s not, “The Fed should buy 15-year mortgage-backed securities that are rated AAA by Moody’s until the yield on 20-year Treasury securities reaches x percent.” That would be a rule, which–if known in advance–people could incorporate into their expectations.
We don’t have any of that right now. We have, “The Fed should buy more stuff–who cares what–until unemployment starts coming down.”
That’s not a rule in any sense of the term, and it certainly isn’t part of the literature showing that rules are superior to discretion in an ex ante sense.
The whole point of having the rules, guys, is to constrain the Fed policymakers to do what is SUBOPTIMAL in a crisis. That’s the paradox. It ends up giving a superior long-run tradeoff between unemployment and price inflation (in the models).
So when you say, “Well, in extraordinary times you have to throw the rule out,” you are defeating the whole purpose of the rule. Part of the reason you GET into extraordinarily bad times, is that people start expecting the Fed to do crazy stuff like buy another $500 billion in MBS as a hail Mary pass, because–as Krugman says–hey it might actually work, why not?
I can’t believe anybody is describing the above as part of the “consensus” on rules vs. discretion. It’s like Daniel trying to claim Krugman as a free-market economist. Can’t you just admit Daniel that Krugman is not advocating rules and he’s not a free-market economist, and point out why that’s a *good* thing (from your perspective)?
If the point is not to hit some interest rate target (because as of yet that’s what they’re targeting) then what do you think QE3 is supposed to be for? Just buying things for the hell of it.
And speaking of “buying things”, I’m assuming the Fed has a more laid out plan for the operation of QE3. On blogs we say things like “the Fed should buy a lot more stuff”. But that’s because we’re on blogs and not at the NY Fed making purchases. I’m not sure why “buy more stuff” is so troubling.
If transcripts from the NY Fed were published that said “uh… let’s just buy more stuff”, then I would definitely start to worry.
re: “So when you say, “Well, in extraordinary times you have to throw the rule out,” you are defeating the whole purpose of the rule.”
I AGREE!!!! I don't want to throw the rule out!!! If we actually followed an NGDP level targeting rule OR a Taylor rule we would be considerably better off today. The problem is we haven't.
re: “I can’t believe anybody is describing the above as part of the “consensus” on rules vs. discretion. It’s like Daniel trying to claim Krugman as a free-market economist. Can’t you just admit Daniel that Krugman is not advocating rules and he’s not a free-market economist, and point out why that’s a *good* thing (from your perspective)?”
Look, we know the whole “free market” thing is because there’s a real difference of opinion on whether free market means you have to be firmly in the libertarian camp, and whether markets and government are opposites or not. Our disagreement is really over what being a free market economist means, not over what you and I think Krugman thinks (well… there may be some disagreements on that but that’s not the big issue with this “free market” issue).
On rules, I’m not sure what to say. He’s always referenced a modified Taylor rule or a Mankiw rule. You achieve that with active monetary policy like quantitative easing. Applications of that rule to a zero lower bound environment introduce less traditional approaches to long-term rates, but it’s still an insistence on rules rather than discretion.
Fiscal policy – as I note above – is trickier because it’s rule by Congress, which is even worse than rule by committee, and you have to trade off the costs of discretion against the costs of doing nothing. But if you ask “what does Krugman ideally want Congress to do”, it’s still a pretty standard output-gap formula contingent on a liquidity trap. That’s not discretion. That’s plugging and chugging, and not leaving room for discretion.
Daniel wrote:
He’s always referenced a modified Taylor rule or a Mankiw rule.
And by “always” you mean, “On at least 5 percent of his blogs touching on the Fed,” right? Scott Sumner “always” references a rule of a NGDP level growth rule. Krugman hasn’t always advocated a particular rule. That doesn’t mean he is against such a thing, just that it’s not high on his priorities, and the innocent reader would certainly think Krugman was OK with anything that right now would boost aggregate demand.
I mean “always” as in throughout the crisis, not “always” as in a broken record in every single post.
Look, right now we are so far off of where we ought to be I think the perspective of a lot of people is that there isn’t much we could do that wouldn’t get us closer to the rule.
You act as if if it weren’t for these discretionary Keynesians we’d be on some rule right now. The whole problem is we’re well off the rule.
re: “Can’t you just admit Daniel that Krugman is not advocating rules and he’s not a free-market economist, and point out why that’s a *good* thing (from your perspective)?”
Well this is an easy question to answer.
It’s not good, from my perspective, to not support the free market
It’s not good, from my perspective, to choose discretion over rules (the trade-offs of fiscal policy discussed above aside).
So then you shouldn’t like Krugman. 🙂
Keynesian rule #1: Hire ME!
Austrian rule #1: If a rule requires employing it’s inventor, it’s bunk.
Hmm… I wonder which one I can trust?
Austrian rule #1: If a rule requires employing it’s inventor, it’s bunk.
Nice.
Krugman can be remarkably slippery in his NYT stuff.
For example, he’s made plenty of statements suggesting that monetary policy is useless at the zero bound, so we need fiscal stimulus, blah blah blah.
On the other hand, you can also find him making lots of statements suggesting that the Fed isn’t doing enough, and needs to engage in more stimulus.
Perhaps if you parse the statements closely enough there is some way of reconciling them, but they at least appear to be inconsistent.
Given the inconsistencies (what Bob would call “Krugman Kontradictions”) a question like “Does Krugman favor rules or discretion in monetary policy?” is surprisingly difficult to answer.
BA wrote:
Perhaps if you parse the statements closely enough there is some way of reconciling them, but they at least appear to be inconsistent.
Right. The answer is that conventional Fed policy is impotent at the ZLB, but unconventional policy isn’t. Once nominal rates hit zero, buying more bonds in the present doesn’t do anything. But if the Fed convinces people it will cause larger price inflation in the future, then real rates now go down, which is what the economy “needs.”
However, as Sumner was the first to document extensively, Krugman clearly made it sound like the Fed was useless in late 2008 and early 2009, when Krugman was pushing for more fiscal stimulus. Then later he had a change of heart, presumably because he saw Congress as less likely to provide the “needed” AD boost than the timid Fed. Call Krugman’s views what you will, but they have not been in the same ZIP code as advocating a monetary rule, the way Sumner has been.
Does Sumner support fiscal policy? If not, there was no alternative to NGDP targeting for him. For Krugman, both fiscal and (“unconventional) monetary stimulus can be effective. Are we really going to berate him for focusing on what he thought would be the most practical tool at disposal?
Does Sumner support fiscal policy?
Sumner thinks fiscal policy is mostly useless. Whatever it does will end up getting canceled out by the Fed. The only exception I’m aware of would be something like an employer-side payroll tax cut, which would have supply-side effects.
Jon Catalan wrote:
Are we really going to berate him [Krugman] for focusing on what he thought would be the most practical tool at disposal?
No, but don’t call it rule-based monetary policy.
But what if Krugman wants a rule-based monetary policy, targeted to something like the Mankiw rule, but he sees that the Fed is not providing and will likely not provide such a policy, so he’s trying to pursue alternatives like non-rule-based monetary expansion and fiscal policy in order to get us to the same place?
….then it wouldn’t be rule based?
Can’t the rule allow different means to achieve the same outcome?
How is a rule that changes with the wind not discretionary? I can’t really see how you classify something as discretionary policy vs rule based policy based on what you’ve been saying.
Maybe, but it needs to be specified at the outset. Could anybody in 2005 have predicted what Krugman would be recommending the Fed do in 2012? No way. So this is clearly missing the whole point of the literature showing that a rule-based monetary policy is superior to a discretionary one.
I don’t mean to sound like a jerk, but I don’t think you guys are recognizing the entire point of that demonstration in the literature. Nobody published a paper showing, “If the Fed does smart stuff that helps, then it’s better than doing stupid stuff that hurts. And hey, let’s have a rule that the Fed should do things that help.”
No, what people showed was that if you have a rule that prevents Fed policymakers from doing the “right” thing in the moment, during a bad economy, then it actually makes them avoid really bad situations in the first place. That’s why so many Fed officials talk about the importance of maintaining “credibility” with markets etc.
So you can say all of this is bunk, OK, but you can’t possibly say that us coming up with 15 different recommendations in the midst of a crisis–where we throw stuff at the wall and see if it “works”–is consistent with the consensus in the policy-rule literature.
Let me put it this way: During a really bad economic crisis, following the rule is supposed to suck. That’s the whole point. If the rule just had Fed officials do whatever they wanted, at the moment, then you wouldn’t need a rule. You would just be describing the pattern of what they would choose to do, in the moment.
So to say, “Hey, our rule doesn’t seem to be working right now,” is not a strike against it. Investors and businesses are supposed to see that the Fed doesn’t print up boatloads of money, even when unemployment is high. Then they realize there actually is a rule, and so going forward they think the dollar will be less volatile etc. and they make their plans accordingly. We can come up with models where this gives a superior ex ante expectation of long-term growth, unemployment, etc.
I like these series of comments you’re making, Murphy.
————
How much of this is chasing after one’s own tail? First the Fed tried the “rule” that they act as lenders of last resort for the banking system. Then, when that “didn’t work”…..at mimicking the free market of course, they dropped the old rule and adopted the new rule of price stability. Then, when that “didn’t work”, they dropped the rule of price stability and adopted the new rule of a dual mandate.
Now that the dual mandate “isn’t working”, we’re supposed to drop yet another rule and try some other rule that “works”.
I know this is slightly off topic, but at what point will most economists accept that “rules” based monetary policy can’t work, and that “discretionary” based monetary policy is even worse?
If mainstream economists will only listen to other mainstream economists, then didn’t Goodhart and Lucas show that ANY target the Fed adopts, as soon as they start targeting it, it loses the information content that initially qualified it to be viewed as a valid statistic to target before it is targeted?
I don’t get it. Why the cognitive barrier?
“I like these series of comments you’re making, Murphy.”
Dr. Murphy has a knack for making me feel like I wasted my time by leaving comments. He is able to say what I’m thinking more clearly and also add insights I wouldn’t think of.
What is the point of plans like this:
> The message would be clear: If you have any intention of ever buying a house, the next 12 months is the time to do it. This is Uncle Ben’s Crazy Housing Sale, and you’d be crazy to miss it.
Won’t we see the same “drawing demand forward” that we saw with Cash for Clunkers? House sales will fall off once the year passes, right?
Yes Marris. I ripped this at Mises U; just waiting for the video.
Rules?
Good luck with that! Everyone knows that FOMC meetings are just a beer-pong tournament where the winner gets to decide policy direction for the next month-and-a-half while the losers have to come up with a plausible set of minutes for public consumption.
There are also drinking games / sidebets based on after-announcement reactions, like: number of S&P reversals in the first hour, bps of steepening / flattening, uses of the phrase “out of bullets” or “behind the curve” on CNBC. There are also yearly awards for things like biggest post meeting vol collapses and highest implied correlations attained.
p.s. the big rumor around fixed income desks is that Yellen’s been working hard on her game(odds-on favorite for the Sep meeting.)
Speaking of RULES:
In 1977, Congress amended The Federal Reserve Act, stating the monetary policy objectives of the Federal Reserve as:
“The Board of Governors of the Federal Reserve System and the Federal Open Market Committee shall maintain long run growth of the monetary and credit aggregates commensurate with the economy’s long run potential to increase production, so as to promote effectively the goals of maximum employment, stable prices and moderate long-term interest rates.”
Definition of COMMENSURATE:
1: equal in measure or extent
So, the law should be read as follows:
“The Board of Governors of the Federal Reserve System and the Federal Open Market Committee shall maintain long run growth of the monetary and credit aggregates EQUAL IN MEASURE OR EXTENT WITH the economy’s long run potential to increase production, so as to promote effectively the goals of maximum employment, stable prices and moderate long-term interest rates.”
Thus, in order to promote maximum employment and stable prices, the Fed should do absolutely nothing and/or simply go out of business.
Speaking of more rules…..It is undeniable that the founding fathers clearly understood that the term “emit bills of credit” meant “issue paper money”. The Articles of Confederation allowed both the central government and the states to emit bills of credit. An early draft of the later Constitution granted Congress the power to “emit bills of credit” but that phrase/term was purposefully excised before finalization so that Congress would not be granted that power. Further, the power was expressly forbidden to the states.
[1777] ARTICLES OF CONFEDERATION
Agreed to by Congress November 15, 1777 then ratified and in force, March 1, 1781.
Article IX.
***
The United States in Congress assembled shall have authority *** to borrow money, or emit bills on the credit of the United States, transmitting every half year to the respective States an account of the sums of money so borrowed or emitted ***
The United States in Congress assembled shall never *** nor emit bills, nor borrow money on the credit of the United States *** unless nine States assent to the same ***
***
Article XII.
All bills of credit emitted, monies borrowed and debts contracted by, or under the authority of Congress, before the assembling of the United States, in pursuance of the present Confederation, shall be deemed and considered as a charge against the United States, for payment and satisfaction whereof the said United States, and the public faith are hereby solemnly pledged.
http://supreme.findlaw.com/documents/aofc.html
*******
1787 U.S.A. Constitution
Art. I, Sec. 8. The Congress shall have Power ***
[Cl. 5] To coin Money, regulate the Value thereof, and of foreign Coin ***
[Cl. 6] To provide for the Punishment of counterfeiting the Securities and current Coin of the United States; ***
Art. I, Sec. 10, para. 1. No State shall *** coin Money; emit Bills of Credit; make any Thing but gold and silver Coin a Tender in Payment of Debts ***
I would have thought that a bill of credit would be a promissory note. However, the present day FRN does not actually promise anything (as far as I know).
It’s just a note with a number on it… and you can pay your tax with it. That’s all it does.
“It’s just a note with a number on it… and you can pay your tax with it. That’s all it does.”
Just ask any MMTer. To them, it is magical.
Even the MMTers understand that the ultimate backing for paper money is state sanctioned violence. It generally takes a bit of back-and-forth to admit that, but fundamentally you are paying for protection, and like any other protection racket it gravitates towards a monopoly situation.
I’m not personally bothered by the idea of paying protection money. It’s a service like anything else, it’s not a job I am particularly enthusiastic about doing myself. However, the fact that it is a monopoly does tend to result in kind of poor value for money (i.e. massive inefficiency), because they don’t have to compete. In a way I guess the government protection is not a total monopoly because there are criminal sub-systems operating in parallel, but those are inconvenient to work with.
Whenever I see Don Boudreaux comment on anything, I’m reminded of those old Hulk comics:
Me Don.
Don read Keynes.
Don smash Keynes!
The guy is so ham-fisted, he’s a real embarrasment to Austrianism.
In my experience, the Hulk wins every such encounter.
That’s your subtle way of convincing me to take that holiday in Japan, right?