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Krugman on 2013 vs 1958 macro

January 10th, 2013

At the recent American Economic Association meeting in San Diego, Brad DeLong chaired a panel on ” Stimulus or Stymied?: The Macroeconomics of Recessions“, and has posted a transcript. Paul Krugman was there and picked up my claim that macroeconomics has, on balance, gone backwards since 1958. I’ve extracted his section here. Lots of useful stuff, but I’d stress this:

the whole basis on which we constructed monetary policy during the Great Moderation, which is that stabilizing inflation and stabilizing output are the same thing, is all wrong: you can have a sustained period of low but not negative inflation consistent with an economy operating far below its potential productive capacity. That is what I believe is happening now. If so, we are failing dismally in responding to this economic crisis. This is in contrast to what some central bankers are saying—that we have done well because inflation has stayed relatively stable.

To push this a bit further, I’d argue that there will be no real recovery as long as central banks continue to treat the inflation-targeting polices of the (spurious) Great Moderation as the pre-crisis normal to which we should strive to return

Krugman remarks to panel on The Macroeconomics of Recessions

Let me try to talk about where I think we stand and what the fiscal-policy issues ought to be.

The basic story—at least as many of us see it—is that we had this really, really dramatic shock to private spending. This is the private-sector financial deficit: gross private domestic investment minus gross private domestic saving as a share of potential GDP as estimated by the CBO. This is not the first time in the post-WWII era we have had a big drop, but it is the biggest: 10% of potential GDP. [30:00] The previous ones in the mid-1970s and early-1980s were associated with tight monetary policy, very high interest rates, and collapses in housing investment driven by tight monetary policy—which, of course, sprang back as soon as the Federal Reserve decided that the American economy had suffered enough.

This time is different. This time it came spontaneously. This time it came in spite of drastic cuts in interest rates to essentially zero.

The question is: “What do we do?”

There is an interesting debate: “When did economics go all wrong? When did macroeconomics go all wrong?” Bob Gordon has rather persuasively made the case that it went all wrong about 1978—that we would have done a better job at macro policy if we had met this crisis with the intellectual panoply we had then and had not had the thirty years since. I saw John Quiggin just made the argument that things actually went all wrong about 1958.

If an economist from 1958 had seen what is going on now, he—and back in 1958 it would have been “he”—would have said: “OK. Private sector does not want to spend. The government should spend. This is a powerful case for fiscal stimulus to prevent this from causing a persistent slump.” We have not done that. We had some fiscal stimulus delivered for a brief period of time in 2009. We have had a fair bit of allowing automatic stabilizers to operate. But at the same time we have had quite a lot of policy austerity. We had a worldwide or at least an advanced-world turn to austerity in 2010 inspired to some extent by the lessons that were drawn—I would say mostly wrongly—from the story of Greece but then applied across the board, and also from a reversion to pre-Keynesian modes of thinking about the macroeconomy. Whatever the reasons—and there are a mixture of political-economy reasons and just plain bad-economics reasons—we made a big turn to austerity. Now we debate: “Was that wrong? How wrong was it? Should we really be doing as much fiscal stimulus as the man from 1958 would say?”

Think about the objections to stimulus. I would put them into three categories:

First, perhaps we do not have nearly as much economic slack as people like—well—me say. Perhaps there is something much more structural going on, and we do not have that much room to expand. We have a huge economic failure, but the failure is not for the most part a simple failure of aggregate demand.

Second—you do not hear this story that much, but it is important to set up the third—is that we should not be using fiscal policy but should instead by using monetary policy. That is a more popular argument in the more informal discussion in the econoblogosphere than it is in academia. But there is the question of what you can do.

Third, even though we are at the zero lower bound, fiscal policy is a lot less effective than the man from 1958 would say it is, and that multipliers are quite low even under urgent conditions.

About limited economic slack:

There is a whole literature trying to identify structural issues—what does the shift in the Beveridge Curve mean—that would be an entirely different discussion. I think the most important argument that has the biggest impact is the argument: “If we have all that economic slack, where is the deflation?” When we look at core inflation, it dropped a lot in the crisis, but has been fluctuating in a 1-2%/year range since then and has not been declining. You will see the argument, which is consistent with what most Principles of Economics or Intermediate Macroeconomics textbooks say or would have said before the crisis, that if we really had a large output gap we should be seeing not just low but declining inflation. The stability of the core inflation rate is an indication that there is not a lot of economic slack. The most recent speech by James Bullard makes that case. The San Francisco Fed has a nice updated chart estimating the output gap by backing it out of a linear expectational Phillips Curve and comparing it to the CBO output gap which is a gussied-up trend. The difference is striking. The stability of inflation says that there is hardly any output gap. Comparing us to the pre-crisis trend says that there is still a very large output gap: $900 billion/year of potential non-inflationary production of goods and services is simply not happening.

Brad asked: “What have we changed our views about?” The inflation process is one area in which I have changed my views. It has become much more apparent that downward nominal rigidity—not just stickiness but people don’t like to cut nominal prices and wages—is a very significant factor. When you have a depressed economy in a state of initially low inflation the zero bound not just on interest rates but on wage changes becomes a really big deal. Again, more San Francisco Fed stuff: they have tried to back out how many people are literally getting zero wage change. The answer is: “a lot”. That suggests that we are indeed an economy in its depressed state, and that the reason that average wages continue to rise is that we have truncated the left edge of the distribution, not that we have anything close to full employment.

That is very important, if true. Among other things, it means that the whole basis on which we constructed monetary policy during the Great Moderation, which is that stabilizing inflation and stabilizing output are the same thing, is all wrong: you can have a sustained period of low but not negative inflation consistent with an economy operating far below its potential productive capacity. That is what I believe is happening now. If so, we are failing dismally in responding to this economic crisis. This is in contrast to what some central bankers are saying—that we have done well because inflation has stayed relatively stable.

Monetary policy: When I arrived at Princeton in 2000 there was a group of us—“Japan worriers”. I am the only one still there. Mike Woodford, Lars Svensson, who is now run off to the Riksbank, me, and Ben Bernanke—I wonder what happened to him? All of us were very concerned by what was happening to Japan in the 1990s. Some people looked at it and said: “That just shows how messed up the Japanese are.” Some of us looked at us and said: “Surface differences apart, Japan looks a lot like us: big advanced country, lots of room to maneuver, government officials who might not be the most brilliant but who were not complete idiots, and if they could get trapped in this sort of deflationary stagnation then it could happen to us.” Sure enough, it did.

At the time, all of the discussion was about what you could do by way of monetary policy. Could the central bank by unconventional purchases of non-standard assets move expectations? The simple fact is that dramatic changes in the simplest measures of what central banks are doing—the size of the monetary base—have been invisible in their effect on either inflation or output. I think we have to say that at this point to make the argument that if only the central bank really wanted to we would be doing much better needs to be accompanied by a very clear explanation of how that it is supposed to work and why the effects of monetary policy to date have been so limited. There is in principle the expectations channel. If a central bank can credibly promise that it will allow a higher inflation rate over the medium term then it ought to be able to reduce real interest rates and have a significant expansionary effect on the economy. The problem is how do you in fact make that promise credible. There are multiple hurdles that you have to cross. First, you have to cross the threshold of the political acceptability of the policy of changing the inflation target, which has proved virtually impossible to tackle in part because people do not think that this is a permanent crisis. They may be right. But that means that it is then very very hard to say that we should change the price-level target for five or ten years in the future to deal with a crisis that everybody expects will be over in a year .

Then, how do you make it credible? Why will the people running the central bank five or ten years from now—who are not the people running it now—go through with it? In an unfortunate phrase I used back in 1998 about Japan, they have to credibly promise to be irresponsible. That is the issue. It has turned out, I think, that, as Michael Woodford says, while in principle unorthodox monetary policy can deal with a situation like what we have now, in practice it is really really hard to see how this could work. And that makes you lean on fiscal policy.

Last comes the question about the effectiveness of fiscal policy. Valerie Ramey will present evidence on the size of multipliers. What are multipliers? That is a critical issue. The trouble is that fiscal policy is very hard to assess econometrically from the historical record. The basic rule is that when all is said and done, no matter how much effort we put it and in spite of all the valid work we do, unless you can show clear natural experiments people are not convinced. Even with natural experiments people are often not convinced, but it is your best chance. And convincing natural experiments are hard to come by. The clearly-exogenous changes in government spending are pretty much those associated with wars. This is just the very simple stuff that Bob Hall did just a little while back. They clearly show that expansionary policy is expansionary. They also show that the multiplier is less than one, which is not what an enthusiastic advocate of Keynesian fiscal stimulus would like to see. Again, the IMF tried recently very carefully to tease out the answer, and again found that expansionary policy is expansionary and contractionary policy is contractionary, but once again multipliers are less than one.

The IMF has changed its mind, or at least Oliver has changed his mind. But that’s where we are.

The question then becomes: is this historical evidence relevant for what we face now? The historical evidence incorporates a lot of crowding-out. The question is then: where is this crowding-out coming from? One answer is the old textbook crowding-out: crowding-out via rising interest rates. That is clearly relevant to the historical cases but not relevant now. A second answer is that in wartime other things are happening. I believe that a lot of the literature on this understates the seriousness of this issue. It’s not just that the multiplier is lower at full employment. During World War II there was severe rationing of consumer goods. During World War II—I have not seen this mentioned at all—there was essentially a prohibition on private construction. You look at World War II and say “private spending fell”. What relevance does that have? We are not about to have such controls on private investment. [45:00]

We can look at periods that do not have war complicating the picture, and the problem is that there is not a lot of that. For the U.S., the World War II period before wartime controls come in is about a year and a half, six quarters. If you are going to use VAR time-series methods, you can look at quarters that have both high unemployment and large changes or news of large changes in military spending, the problem is that the impulse response period extends well into the period of wartime controls. It is not at all easy to get past that.

Finally, Ricardian effects. It is really important to understand how many people misunderstand that. There are many people who believe that higher government spending now means higher taxes later and this will crowd-out private spending now. But higher spending now means higher incomes now as well. In the simplest Ricardian setup, if you believe that resources are unemployed and if interest rates are zero, the multiplier is not zero but one. It is very difficult to come up with a story in which the current multiplier would be less than one. Invoking the expectation of future tax increases as a reason for a multiplier less than one is a much more difficult story to tell than people seem to imagine.

Our evidence is not great. The closest thing to a really good natural experiment is what is happening now—the scary policies of recent years. It is not perfect. But look at the euro area countries—we talk about the great mistake of 1937, Roosevelt’s turn to austerity, but his turn to austerity was less than 3% of GDP. Compare that to what is happening to Greece or Ireland now, that is nothing. In Greece, if the whole program is implemented, we are talking about austerity on the order of 16% of GDP. These are enormous shocks. And if you do a simple regression it looks like a multiplier of 1.3.

The immediate objection is that causation is not reversed? This is where the Blanchard-Leigh stuff comes in: They look at forecast errors in output growth and forecast errors in future policy, and find that their forecasts of output growth which assumed a multiplier of 0.5 underestimated the true multiplier by about 1.0, systematically understating economic contraction in countries with larger-than-expected degrees of austerity.

I think their work is good. Of course, it fits what I wanted to believe, so you have to be careful. But very important stuff, if true.

The final point is policy: Are we sure that expansionary fiscal policy is the right thing to be doing and that austerity is a terrible, terrible mistake? No. We are absolutely sure of nothing. But the consequences, if that is the truth, and I think the evidence tilts that way, is that what we are doing right now is absolutely disastrous. And that is where we are right now.

  1. Pete Moran
    January 10th, 2013 at 08:23 | #1

    I thought the discussion of deflation was very interesting.

    Surely with a number of massive private corporations making record profits it would seem that productivity is high and costs are very very low. There’s no reason to lower selling prices? If the low costs are wages (it would seem they are, especially in the US) isn’t that your consumption problem right there. Couple that with those corporations running down inventory and not replacing capital equipment as rapidly.

    Fix the wage inequity, tax the corporations properly and then spend those taxes.

    What am I missing?

  2. January 10th, 2013 at 08:51 | #2

    One reason why macroeconomics went wrong between 1958 and 1978 might have been that economists failed to come to terms with the fundamental change in the nature of what we used as money. In 1958, the predominant medium of exchange was officially issued currency. Governments could print this money willy-nilly, earn seigniorage and set the rate of inflation at just the appropriate level with pin-point accuracy. By 1978, bank credit had usurped currency as the predominant medium, governments could no longer create money and were required to manipulate interest rates in an attempt to control banks’ credit creation and because private banks created money, governments became required to borrow in order to maintain demand.

  3. Tom
    January 10th, 2013 at 09:12 | #3

    @Peter Whipp

    Government today can still print money or increase the monetary base of the economy. The only difference in monetary base creation if we compare today to the world in 1958 would be independant central banks and legislations/agreements which prohibits centrals to directly finance government. Technically, the government can still print money if the legislations or laws which prevents it are repealed. US at the moment, the talk about the trillion dollar platinum coin is one example that the government still technically have this power. The other difference if we are to compare 1958 to today would be that banks were government owned in 1958 and that banks are private owned today which “may” or “may not” affect the government’s control on the credit money supply.

  4. John Quiggin
    January 10th, 2013 at 09:27 | #4

    @Peter Whipp

    Bank credit was already predominant in 1958, and there is still a surprising amount of cash floating about, particularly in the informal economy

  5. BilB
    January 10th, 2013 at 10:12 | #5

    Regarding the stable inflation at 1% to 2% I wonder if this might be a combination of the effects of quantitative easing, which I imagine is inflationary on the on hand, and the possibility that the US has several economies running concurently on the other. I suspect that there could be as many as 30% (made up of the disenfranchised and the huge illegal immigrant influx) of the US population living at a subsistence level utilising a combination or black market and food stamps (Krugman mentions war time rationing) operating as a subeconomy and having no effect on the national figures. Then a second economy is the middle class and above. In this group there is spending discretion and most of the economic activity passes through these hands. The elite 2% I suspect who now hold most of the global GFC losses as bank assets are doing a steady property buyup across the nation and so underpinning a low but stable inflation rate.

    My father always said of the US great depression that it was a great time to have money. No doubt this is also true of a great recession.

    Here is an example of what “living off the grid” looks like

    http://www.time.com/time/nation/article/0,8599,2105597,00.html

  6. paul walter
    January 10th, 2013 at 15:33 | #6

    It is the sort of meaty article I’d be chewing over and digesting before commenting. It resonates, but there is enough in it to keep me out of mischief for weeks.

  7. Ikonoclast
    January 10th, 2013 at 16:38 | #7

    I am breaking my own ban and talking plainly now. Prof J.Q. can ban me if necessary.

    I am out of patience with (almost all) economists and pretty much the entire economics profession. If would be a good thing if the populations of certain countries (Greece and Spain spring to mind) similarly reached the end of their patience and rose up against current mainstream economics (neoclassical and monetarists) in a general strike and revolution and tossed off the shackles of the entire sorry system. The more enlightened but still broadly orthodox economists (New Keynesians for example) sometimes seem to be too polite and too concerned with professional niceties to roast the neoclassicals and monetarists as hard as they deserve to be roasted. I have not read JQ’s book “Zombie Economics” so he may have delivered an adequate roast in that.

    John Ralston Saul said; “Economics should not lead our society. Democracy and democratic decision making should lead.”

    This statement is not a denigration of economics per se. JRS does however denigrate current dominant mainstream economics from about 1970 to the present. What he is saying essentially is that the technical professions cannot lead our society. Their prescriptions and predilictions for action should never over-rule democratic decision making. Certainly, they can aspire to advise and seek to persuade but not to lead. JRS argues that in the period 1970 to the present we have elevated economics, or one form of economics namely neoclassical and monetarist economics, to a position of de facto leadership of our society. Political action is now circumscribed to that policy area and to that limited set of “solutions” ordained as permissible and workable by neoclassical and monetarist economics.

    It becomes clear that the technical professions should not lead our society when we frame suggestions like this: “Scientists should lead our society” or “Doctors should lead our society” or to take the case which has become a sad reality “Economists should lead our society”. An even more egregious suggestion is “Lawyers should lead our society”! Technical professions see solutions to society’s problems and issues largely through the lens of their own profession. Thus to engineers, the solutions which present will be those which involve large engineering projects. (Witness Campbell Newman and his traffic tunnel obsession as Lord Mayor of Brisbane.) To nuclear scientists, the solutions will be more nuclear power stations. To lawyers, the solutions will be more legalism, especially more litigation and more obfuscation and deception.

    Finally, to narrow ideological and unempirical economists (meaning in particular the neoclassical economists) the solutions will be the application of prescriptions from ideologically conditioned models, riddled with simplistic and idealised assumptions, which bear no relation to the real world and take no notice of the feelings, needs and hopes of real people. More broadly, economists, other than those who maintain a democratic, social and human focus wider than the limits of their technical profession, will tend to see solutions in terms of abstract values like “economic efficiency” or narrow formalistic targets like inflation rates or GDP growth. Placing the emphasis on full employment, a living wage, adequate welfare support, progressive taxation, broad equality and equity, along with good public education and public health is quite different. Here, finally, we have human or humanised values; programs designed to support the entire populace and not just a privileged minority.

    Mainstream orthodox economics (neoclassical, monetarist) and even other sub-streams like New Keynesianism with their general obtuseness about the grave limitations of economics when attempting to lead society are pushing me closer to MMT. Something that attracts me to MMT is that whilst being a highly technical finance economics in one sense (the close attention to national accounts, banking processes, financial instruments, money creation, money destruction, debt, money supplies, money flows and general macroeconomic measures like GDP, unemployment etc.) it de-mystifies rather than mystifies money and finance. Some would argue strongly that this is a natural consequence of the MMT approach. The more you examine something thoroughly, the more you de-mystify it. Mainstream economics is obsessed with some of the same technical measures, but only selectively and very unhealthily in many cases and it thus takes a while for the neophyte or outsider approaching MMT to realise MMT is doing something quite different.

    Mainstream neoclassical economics uses the technical financial-economic approach in a selective, ideological and unempirical manner. The outcome of this neoclassical approach is to mystify money, finance, national accounts and macroecnomic measures in ways which obscure certain features of reality and makes out that some things are “real” when they are in fact not real. Mainstream economics jumps at shadows. In other words, I am talking here of the Reification Fallacy “also known as concretism, or the fallacy of misplaced concreteness”. “An abstraction (abstract belief or hypothetical construct) is treated as if it were a concrete, real event, or physical entity.” I take the definition and explanation from Wikipedia.

    In particular, neoclassical economics, at least in the crude and dogmatic form in which it is peddled to the public, reifies fiat money and treats it as a concrete reality. By extension, surpluses and deficits are reified and treated as concrete realities rather than as accounting conventions and abstract tools to be used to achieve other real specific ends; which ends broadly should be the equitable meeting of all reasonable needs and requirements of all the people (all members of the national polity).

    In other words to simplify, neoclassical economics is simply about protecting the “virtue” of money. Of course, the main threats to the “virtue” of money or the amount of value it represents are inflation and hyperinflation but these phenomena are not the only threats to the well-being of real human citizens. The threats, even on the monetary/finance side alone include but are not limited to inflation, hyperinflation, deflation, stagnation, stagflation, high interest rates, low interest rates (for some), high debt, credit, lack of credit and the list goes on. In addition, real pople face real threats beyond these; namely unemployment, under-employment, discouragement from entering the labour force, illness, malnourishment, lack of education, lack of medical services, crime, lack of good social order and cohesion etc. etc.

    The way mainstream neoclassicals defend the virtue and sanctity of money and government surpluses and to achieve that go ahead and sacrifice all other values and all other parties (like the unemployed) calls to mind a Don Quixote-like defence of the virtue of a lady who sells her favours.

    Looking at matters in this light we can see that mainstream neoclassical economics is at its base very crude and simplistic. In fact, it is barely one step up from bullionism. Or if that is too harsh then it is the gold standard in drag. The better minority of Mainstream economists (maybe New Keynesians) need to resuce their profession from terminal disgrace or face complete displacement (along with a number of other “profession”) by a political economy revolution. And while they are at they should stop being apologists for oligarchic capital and stop being polite and respectful to the intellectually debased and ideologically suborned part of their profession which deserves no such respect whatsoever.

  8. January 10th, 2013 at 21:15 | #8

    @Tom

    In trying to be brief, I failed to explain myself properly. In 1958, almost all wages were paid in cash. Most of this cash might well have been deposited in banks by firms as it was spent, but it was later withdrawn in order to pay wages again. It was in this function that I referred to cash as the predominant medium. The government paid wages and social benefits with cash and they could print extra new cash in order to maintain demand at just the appropriate level in the face of saving and the increasing production that resulted from productivity growth.

    By 1978, wages were paid by the transfer of bank credit and the only means by which the government could boost the circulation in order to maintain demand was by borrowing and spending bank credit. If the government now printed and spent more cash, this cash would would most likely be deposited with a bank and then returned to the central bank rather than be withdrawn and used to pay wages. The result would be that central bank would be required to credit its accounts with the commercial banks and so borrow from them. Bank credit was now the predominant medium of exchange and I feel that economists failed to change their theories and models to take account of this. The greatest change was the loss of seigniorage and the corresponding requirement for governments to borrow. Many still do not appear to understand that governments must automatically now borrow the net saving of the combination of the private and external sectors.

  9. Ikonoclast
    January 10th, 2013 at 22:33 | #9

    “Many still do not appear to understand that governments must automatically now borrow the net saving of the combination of the private and external sectors.” – Peter Whipp

    Sorry, incorrect. The Govt credits the accounts of workers and welfare recipients with a one-off boost if they must. Like they did in the GFC. Many recipients of child payments got a $9,000 deposit in their accounts and they spent it believe me.

  10. Ikonoclast
    January 10th, 2013 at 22:35 | #10

    Plus there is no requirement for Govt to borrow. Tthey can print money physically or credit accounts of welfare recipients and/or private businesses they wish to purchase goods or services from.

  11. SJ
    January 10th, 2013 at 23:20 | #11

    Peter Whipp is a goldbug. It’s pointless to try to engage.

  12. rog
    January 11th, 2013 at 02:46 | #12

    @Ikonoclast Your analysis puts me in mind of a discussion I had a few years ago on Telstra. At that time the 3 amigos were busy gouging the customer and as I had no choice but to go with Telstra (due to my rural location) I was being regularly slugged. Friends of mine, as Telstra shareholders, thought the company wonderful due to the constant stream of dividends. When I made the point that Telstra should be looking after the customer their response was along the lines of “stuff the customer”.

    The irony was that none of them were Telstra customers, “too expensive” they said “we can get a better deal elsewhere”.

    When money becomes the sole standard of value other aspects of life become devalued. When voters and politicians think and talk as if they are economic experts (usually based on how much money they have) we are on shakey ground.

  13. Ikonoclast
    January 11th, 2013 at 07:38 | #13

    @rog

    A lot of businesses do essentially say “stuff the customer” and sometimes “stuff the shareholder” and “stuff suppliers” too. This tends to happen in the following situations so far as I can tell;

    (a) large, bureaucratic and shambolic corporations (e.g. Telstra);
    (b) local monopolies (large business in a small town);
    (c) mismanagement by bull-headed, ideological and managerialist boards (e.g. QANTAS all 3);
    (d) duopolies (e.g. Coles and Woolworths);
    (e) “duopsonies” (plural of monopsony) (Coles and Woolworths again)
    (f) clandestine cartel behaviour (Oil companies); and
    (g) incompetent and gimcrack small businesses (all over the place).

    This is not a comprehensive list.

    It is pretty much a lucky dip these days. I find that one’s chances of getting good or even passable products and services is about 50-50. A lot of businesses get away with it because people are too busy or it is too inconvenient to go back and complain about dud low cost items. But these same low cost items are a high proportion (relatively speaking) of the average person’s fortnightly budget. Also, the customer base is so large in cities and suburbs that new suckers can always be found even if those burned stay away.

  14. January 11th, 2013 at 09:05 | #14

    @Ikonoclast

    Krugman maybe a bit too polite to the neoclassicals this case, however he is giving a formal talk. He although being classified as a New Keynesian by many, have questioned the assumption of rational expectation, DSGE models (both are officially part of New Keynesian Theory) and have criticised neoliberal policy multiple times in the past. He had gotten almost if not all economic forcast post GFC (interest rate, bond rate, effect of QE and the US stimulus) right and he is also in agreement in a sense with the MMTers that printing trillion dollar platinum coin is non-inflationary at least in the current situation. While he is also one of the economists that started the fight with New Classical side after the GFC.

    I don’t always agree with Krugman and sometimes he does seem to be too polite in formal talks. However, since most of the aggressive opponent of neoclassical theory do not get that much public influence, Krugman himself may think that there is a risk if he goes down that path as well. While I can’t speak on behalf of Krugman, the US is simply a too large of an economy (significant in terms of population and economic influence) on the world scale to lose one of very few sane and loud voice.

    I feel your hopelessness on the economic profession and the politicians. I couldn’t count how many times I felt so much in despair of what is going on in EU, US and what they, the IMF and the economic professions are doing the other parts of the world like there is no alternative that I resort to calming myself down with music for a whole night doing nothing and getting sleepless nights.

  15. January 11th, 2013 at 09:09 | #15

    “While he is also one of the economists that started the fight with New Classical side after the GFC.”

    That should be expanded to he is one of the economists took the economic battle to the public debate post GFC.

  16. TerjeP
    January 11th, 2013 at 10:55 | #16

    In 1958 nearly every corner of the world used gold, directly or indirectly, as the unit of account. Gold was a shared benchmark for value. The universal metric. In fact when Australia later adopted the Australian dollar it quite literally was metric with one Aussie dollar being worth one gram of gold. The experiment with inflation and floating currencies had been interesting to say the least but I think the old arrangement was superior to everything since.

  17. Ikonoclast
    January 11th, 2013 at 12:08 | #17

    Irony Alert on.

    Why stop there TerjeP?

    In 1637, Mercantilism was at its height. “Mercantilism is the economic doctrine that government control of foreign trade is of paramount importance for ensuring the military security of the country. In particular, it demands a positive balance of trade.” – Wikipedia

    Mercantilism powered the rise of England until the Industrial Revolution and allowed it to become the pre-eminent world power. I think we should return to Mercantilism. The policies needed are;

    Building a network of overseas colonies;
    Forbidding colonies to trade with other nations;
    Monopolizing markets with staple ports;
    Banning the export of gold and silver, even for payments;
    Forbidding trade to be carried in foreign ships;
    Export subsidies;
    Promoting manufacturing with research or direct subsidies;
    Limiting wages;
    Maximizing the use of domestic resources;
    Restricting domestic consumption with non-tariff barriers to trade.

    (Above list copied from Wikipedia)

    Irony alert off.

  18. Ikonoclast
    January 11th, 2013 at 12:10 | #18

    Oh, I forgot, high tariffs.

  19. TerjeP
    January 11th, 2013 at 16:36 | #19

    Why stop there TerjeP?

    Why not stop there? Why fish up some red herring in mercantilism which I neither mentioned nor support. Do you support mercantilism? If so then get on with it.

  20. Ikonoclast
    January 11th, 2013 at 17:33 | #20

    @TerjeP

    I am simply noting (now that I flesh it out) that the gold standard relates right back to bullionism, the earliest and crudest form of mercantilism. Bullionism defines wealth by the amount of precious metals owned.

    To be serious, the reasons that made gold good for money have been superseded. There is no special value inherent in gold. It’s true modern value is in its use value, for example in electronics.

    The reasons gold was good for money historically included being;

    incorruptable (chemically inert);
    malleable;
    ductile;
    divisible;
    portable;
    recognizable;
    glittery; and
    scarce.

    Scarcity made it difficult (and expensive) to obtain thus rendering it difficult to forge money. You needed real gold to make money. The other qualities made it durable and usable. It is argued that these qaulities made and make gold a stable store of value.

  21. kevin1
    January 11th, 2013 at 17:49 | #21

    @Tom
    Tom, I don’t have much to say about the theoretical discussion, but like you I am in an ongoing state of shock to hear that respected practitioners (eg PK, JQ, Brad de Long, not the charlatans who increasingly have to be pulled up for their disgraceful distortions) say that the field has unlearnt so much of the basic analytics. Rather than the (sometimes visceral) moral/philosophical critiques of JR Saul, Chomsky, etc. I believed that the rigour and explanatory power of political economy was superior, especially when it comes to prescriptions. That bunch of verities at the front of most intro. eco textbooks – opportunity cost, models and measurement, the fallacy of composition, identifying cause from effect etc. – is at least a serious go at scientific method, and still helpful for those who haven’t sold their soul or suspended their critical thinking faculty. But why is a field of knowledge so closely linked to empirics and history so riven by schisms about fundamental analytics. It’s not meant to be a religion. What’s going on here?

    And how did this come to pass? Is it that the heavy hand of vested interest is more likely to corrupt economics rather than the arts and humanities (what they think and do barely matters). As the universities became more shackled to the corporate state, free thinking seems to have largely moved out – to forums like this, which are not the place to build alternatives and new knowledge.

    I vaguely recall the Pol Econ movement at Sydney Univ in early 70s as a struggle towards interdisciplinary knowledge, free thinking and relevance to contemporary concerns – is there anywhere which gives traction to this ideal now? It’s often said that there is an overwhelming homogeneity of economic teaching (incl. disregard of history) in the academy – this determines the future of the field. What is to be done so today’s students can transcend “training” and achieve “education”? Or is TINA too entrenched?

  22. TerjeP
    January 11th, 2013 at 18:54 | #22

    Iconoclast – hold is still a good store of wealth but that isn’t the key virtue from a monetary perspective, not is it the property I actually mentioned. However as you’re still keen to conflate this discussion with mercantilism I’m not sure I will bother continuing.

  23. Katz
    January 11th, 2013 at 19:38 | #23

    But as is too well known by all but the most inveterate of nostalgics, a gold-based system lasts only as long as the governments of financially important nations agree to play by the rules.

    The history of the gold standard is littered with examples of financially important nations switching out of the gold standard – Britain, France, US, Britain again, France again, Britain again, US again.

    At least with floating exchange rates and free flows of finance the clever and the prudent can avoid the worst effects of these serial betrayals.

  24. TerjeP
    January 11th, 2013 at 23:29 | #24

    Katz – national constitutions only work so long as governments agree to be limited by them. They are still a pretty good idea. Although I know the idea of “limited government” doesn’t get much chop around here.

  25. Jordan
    January 12th, 2013 at 02:39 | #25

    @TerjeP
    “limited government” – how limited? WHat is the formula to describe the line when government is too big. I do not remember the Constitution giving a formula or describing a criterion for limitation on how many people government employs, which is what you are thinking.
    Do you really believe that they had in mind what you have in mind; that limited means how many people government employs. I say it is only your imagination that Constitution say that.
    In democracy, people trough Congress decide what they want government to spend on and how much, now you come and say that “limited government” in the Constitution means how much government can spend and how many to employ. Now you want to limit democracy instead of government.
    In what Constitution did you find how much can government spend and how many employ?

  26. Jordan
    January 12th, 2013 at 03:04 | #26

    Ikonoclast #7
    Another one of your brilliant writing.
    On the first part i would just say; When all you have is a hamer then every problem looks like a nail sticking out.

    Fetishizing the money as real value is the mistake neoclassical make all the time.
    For exsample; Everybody knows that taxes take away from private sector, but most of them forget implications of that.
    If taxes take away from private and give it to public sector, that implys that government (public) surplus means that public sector took more in then gave back to private sector.
    If taxes take away from private sector then that automaticly implys that government deficit gives more to private sector then it takes away in taxes.

    Hence gov surplus is bad for private sector and gov deficits are good for private sector.

    Deficit or surplus is not either bad or good for a sovereign government.

    For sovereign issuer of the currency it is visible that accumulated defficit does not present a problem to the government ability to keep accumulating it and by doing so benefiting the private sector. Neither as problem for servicing that debt nor as a problem for private sector trough interest rates.
    For great example is Japan, even tough USA is not a bad example of a deficit not giving any problems.

  27. Katz
    January 12th, 2013 at 05:01 | #27

    Are you suggesting that the nations of the world include in their constitutions a commitment to abide by the gold standard?

  28. Ikonoclast
    January 12th, 2013 at 05:45 | #28

    I think the onus is on TerjeP to explain why a return to Gold Money or the Gold Standard, as in the variant of 1958 or some other epoch, will cure all, or some significant ills, of the modern economy, if that is his claim.

    http://en.wikipedia.org/wiki/Gold_standard

    This is interesting;

    “According to Keynesian analysis, the earliness with which a country left the gold standard reliably predicted its economic recovery from the great depression. For example, Great Britain and Scandinavia, which left the gold standard in 1931, recovered much earlier than France and Belgium, which remained on gold much longer. Countries such as China, which had a silver standard, almost avoided the depression entirely. The connection between leaving the gold standard as a strong predictor of that country’s severity of its depression and the length of time in its recovery has been shown to be consistent for dozens of countries, predominantly in developing countries. This may explain why the experience and length of the depression differed between national economies.” – Wikipedia.

    Now even I do not say that correlation equals causation. The length of a person’s hair can predict their gender with a fair degree of accurracy.

    Saying that leaving the gold standard is responsible for part or all of economic ills now is like me saying, “You know I only started to age once I started drinking coffee. Therefore coffee causes ageing.”

  29. Ikonoclast
    January 12th, 2013 at 06:02 | #29

    As a footnote, let me say, I am always sceptical about proposals for simple solutions to complex problems. In the face of complex or “wicked problem”, a great many people tend to fixate on the possibility of a single fix-all or silver bullet (or even gold bullet) for the problem. Here’s a short list of wicked problems followed by the simple “solutions” commonly proposed;

    1. Crime -> Increase punishment
    2. Drugs – > Prohibition
    3. Refugees -> “Stop the boats”
    4. Climate change -> Deny it.

  30. Jordan
    January 12th, 2013 at 08:08 | #30

    What i think that hugely afects the fiscal multiplyer are multitude of conditions in today’s advanced economy.
    First is the high productivity, when government orders more spending in an environment with a lot of spare capacity it doesn’t take a lot of additonal spending on the side of a corporation to fill new orders and a lot of stimulus goes to profits which are not spent but saved. A corporation can add only few employees and extend hours of present ones or hire temp jobs, all on very low wage which contributes little to total buying power.

    Another condition is the borrowers on the edge of a default that were unemployed but with government stimulus get employed and decide to keep paying off the debt instead of defaulting.

    These can lower fiscal multiplyers significantly when it is considered to do fiscal stimulus.
    To make them more effective, the governments have to raise minimum wage and limit working hours.
    With rising productivity and automatisation of workplace there has to be implemented higher wages and reduced workhours or there will be need for very small workforce and rest of them will be out of job while government will be presed for finances to provide for safety nets.

    Todays advanced economies require about 15% of workforce for esential provision to 100% of population, with more and more robotization and computer use the percentage of necessary workforce will keep shrinking. Aging of population can not keep up with rise in productivity to have a work force fully employed, even with more and more people employed in entertainment sector or archeology does not cover for it.
    Work hours have to be reduced and minimum wage raised to cover for rise in productivity in order to have full employment.
    Recent debt collapse in USA and EU shows that even debt as a mean to continue Nominal Surplus Circulation has its limits. A debt jubilee could restart that cycle again without waiting for deleverage which could last another 20 years.

    Combination of debt jubilee and reduced workhours with dramatic rise in minimum wage would stop this Great recession right away.
    To accomodate for natural resource limit we have to equalize the income distribution by high marginal tax or with worker cooperatives, maybe both.

  31. TerjeP
    January 12th, 2013 at 18:53 | #31

    now you come and say that “limited government” in the Constitution means how much government can spend and how many to employ.

    Another Turkey that wants to put words in my mouth. Jordan, where have I ever said what you just claim I said? I may like such limits to be added to the constitution but I certainly never claimed that they were already there. However the condition does define other limits. For instance the just compensation clause limits the federal governments capacity to appropriate land.

  32. kevin1
    January 12th, 2013 at 20:01 | #32

    Come on Terje, stop being disingenuous: “I may like such limits.”…yay or nay – say what you mean and mean what you say! We are entitled to apply “bounded rationality” when you disguise your views.

  33. Jordan
    January 12th, 2013 at 21:22 | #33

    You asked for it:
    Katz;

    a gold-based system lasts only as long as the governments of financially important nations agree to play by the rules.

    onto which you replied

    Katz – national constitutions only work so long as governments agree to be limited by them.

    Gold standard is not in almost no state constitution so it is totaly unto a governing body to decide to get on or off a gold standard. Under gold standard it is not a democracy that can decide how much government can spend it is only a convention of Gold standard that decides and with that GS limits democracy and the will of the people.

    It is obvious that you meant GS as a limitation on govermnet, with that it means limitation on democracy deciding how much government can spend. Your sentence clearly means that “National constitutions only work so long as they agree to be limited by GS” hence it says that GS is in national constitutions.

    Under GS, only banks are allowed money printing which over time accumulates a lot of new money which when deleverage comes start destroying that same money by paying off the loans without making new ones. Total Debt service is conditioned on ever growing debt. if total debt in an economy start to shrink then total money in economy also shrinks.
    With total money shrinking but total products do not, then it comes to deflation in order to cover ammount of exchanges in economy. Prices and wages shrink but debt does not, which produces economy wide illiquidity with a lot of spare capacity which can not be used only because of illiquidity.

    GS prevents government from supplying enough liquidity needed for employing spare capacity since it is the only entity willing to do it and banks can not provide more loans due to deflation or bad liquidity.
    To provide last resort liquidity government have to get off the GS and employ spare capacity.
    GS does not prevent printing money by banks and with that can not prevent inflation.
    GS only prevents fighting deflation.

  34. TerjeP
    January 12th, 2013 at 21:48 | #34

    Jordan – a gold standard does not stop a government having a whopping load of tax and spending like drunken sailors. And your contortions to put words in my mouth are fascinating but I’ll pass up trying to defend things I never actually said. Stop being a pain.

  35. TerjeP
    January 12th, 2013 at 21:52 | #35

    Kevin1 – my apology for being unclear. I would like such limits to be in our constitution. However clearly they are not, and clearly I never claimed that they were.

  36. John Brookes
    January 12th, 2013 at 22:28 | #36

    So I don’t understand economics. But aren’t there enough accidental small experiments to be able to estimate these economic parameters from?

    For example, we just did an experiment in Australia with the carbon tax and coincident adjustment of income tax rates. We can look at the result of this experiment. Of course it may be that other factors hide the effect of this experiment, but if we find enough experiments, then the actual effect will emerge through the statistics. Another such experiment has just started with the benefit cut to single parents whose youngest is over 8 years old…

  37. Mel
    January 12th, 2013 at 23:39 | #37

    Oh feck off, Terje. Your gold bug nonsense was boring and unconvincing 5 years ago and it hasn’t improved since then. Take it somewhere else.

  38. Will
    January 12th, 2013 at 23:51 | #38

    This discussion is getting horribly off-topic, but if you want to find a subject on which more economists agree than any other, it would be hard to find one beyond “the benefits of an independent central bank over a metals standard”. This is a horribly large topic, but to sum up in a few words the gold standard is wasteful, inefficient, and leads to increased economic instability. I’m sorry, but I can’t cover on the economic side the theories of money, benefits of inflation, severe issues with deflation, problems with supply and demand of gold, fractional reserve banking etc etc. I also can’t cover on the historical side the exogenous factors that caused hyperinflation where it came about – hyperinflation occurred because there was literally no other option amidst war and chaos and ruin, and not because functional democratic governments want a “free lunch”.

  39. Jordan
    January 12th, 2013 at 23:57 | #39

    @TerjeP
    And yet you avoid explaining what you meant by “limited government”, how limited.

  40. sdfc
    January 13th, 2013 at 01:04 | #40

    Floating exchange rates are theoretically more efficient than a fixed currency standard, in maintaining the external balance the trouble is some countries cheat . It’s interesting that Terje the free market champion thinks that the government should have a policy of maintaining an often incorrect price of the currency over free market pricing.

  41. sdfc
    January 13th, 2013 at 01:09 | #41

    The New Keynesians are almost as clueless as the neoclassicals as to the dynamics of money creation. Krugman is no different to the rest in that respect, as demonstrated by Steve Keen.

  42. Jordan
    January 13th, 2013 at 02:14 | #42

    @sdfc
    Yes, but Krugman is showing a lot of improvements on the matter lately, since the last confrontation with Steve Keen.

  43. TerjeP
    January 13th, 2013 at 02:55 | #43

    Mel – love it or loath it the gold standard was used across the world in 1958.

  44. Will
    January 13th, 2013 at 11:20 | #44

    TerjeP :
    Mel – love it or loath it the gold standard was used across the world in 1958.

    That point is irrelevant when discussing the efficacy of the gold standard. To use the point above, why not mercantilism?

    Look amigo, from what you have posted I assume you follow the Austrian school? Why on Earth would anyone do that? Austrian economists are batting at a strike rate of 0.00. Literally everything they said is wrong. Historically, the only thing they do is predict fire and brimstone and economic despair, and they have successfully predicted 23 of the last 3 major financial events. Continually calling for bust periods may provide the veneer to fool the ignorant but their kind of prognostications are on the same level as me saying there will be a war in the future. True, but utterly useless.

    There has been no hyperinflation or interest rate increases or massive increases in the gold price (the highest point was $1800/oz in about August last year attributable to the Republicans holding the economy hostage) while Krugman, working with simple bog-standard macroeconomic tools, has been right more often than not. You also mention malinvestment. Malinvestment in what market? The marketplace consists of the exchange between buyers and sellers of millions of commodities, and there is simply no single natural rate of interest (this is one of the arguments used by Sraffa in the ’70s to debunk Austrian economics).

    I know why the Austrian school is more popular than not. Unfortunately it comes down to the conspiracy theory mindset. Unscrupulous folk appeal to people’s desire for secret knowledge and the feeling of being oppressed. The ego boost from knowing that you are right and everyone else is a mindless sheep is profoundly gratifying. You could critically examine the evidence, and most likely come to the conclusion that the Austrian school is more heat than light and hence begin a long, painful process of learning; or you could dismiss it all with a sneer and retreat to Cafe Mises, Drudge Report and Zero Hedge.

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