Quote of the Day

From a great Washington Post profile of Stanley Fischer:

Around the same time, Fischer tackled John Maynard Keynes’s “The General Theory of Employment, Interest, and Money.” “I was immensely impressed,” he said, “not because I understood it but by the quality of the English.”

(ht: Greg Mankiw)

Confusions on the “President’s Monetary Policy”

This article by Ed Butowsky is just strange enough to warrant a post.  In fact, it’s so bad I think it might qualify for an article in The Onion.  In short, it claims that (1) the president decides on monetary policy, (2) the president chose monetary policy instead of fiscal policy, (3) the monetary policy he chose did not work, (4) the monetary policy is generating high rates of inflation, and (5) rates of inflation are mismeasured (which is apparently somehow related to the number of people on welfare and the size of the national debt).

From the article:

Faced with very bad economic conditions, the president decided that monetary policy  (printing money and infusing it into the economy ) was a better choice than attempting to fix the economy by fiscal policy (in this case, reducing the tax burden on corporations and individuals).

First (and I really hope Butowsky knows this), the president does not decide when to print money and infuse it into the economy.

Second, unless I’m really confused, we did actually have a fiscal policy response that both reduced the tax burden and increased government spending.  Now, one could argue for or against the merits of the particular fiscal policy that was used, but how can Butowsky possibly claim that the president decided to use monetary policy instead of fiscal policy?  Has he missed the entire debate about the stimulus?

His mistakes continue:

recent M3 data prove that the money supply is growing at a very rapid rate, and this is a leading indicator of inflation.

This is odd since the Fed stopped publishing M3 statistics in 2006.  But, let’s assume that’s a slip, and he actually meant M2.

It is true that the level of M2 rose sharply as the Fed tried to deal with the financial crisis:

But the year-over-year growth rate in M2 has been trending lower – not higher – all year.  Here it is:

And the inflation that is supposedly following from all this?

What about the latest estimates of expected future inflation rates?  The Federal Reserve Bank of Cleveland’s latest estimate of 10-year expected inflation is 1.26 percent.  Not quite Weimar Republic territory.

One could make a case that inflation is a risk (Feldstein here and Taylor here), but Butowsky’s appeal to imaginary trends in “M3″ is not very compelling.

And the rousing conclusion?

I continue to contend that inflationary pressures are great in this country, but the government simply does a terrible job calculating it. We all know the numbers — 47 million people on food stamps, 25 million underemployed, lowest number of people employed since 1980′s, $16 trillion in debt (and we require $1.3 trillion more each year to meet our budget shortfall).

 

However, what is about to make this even worse is that, due to the choice the president made in early 2009 to print money, we are about to see prices soar in this country. Add to this unnecessary and ineffective approach that we might see more destruction of the U.S.  dollar with QE3.

So inflationary pressure is great, yet we don’t measure it in the traditional statistics [oh, and I retract my earlier comment that Butowsky must really know that the president is not in charge of monetary policy].  Okay, how about  the Billion Price Project at MIT?

The economy remains depressed and there is practically no inflationary pressure from labor markets:

As Greg Mankiw explained a year ago:

The slack labor market has kept growth in nominal wages low, and labor represents a large fraction of a typical firm’s costs.  A persistent inflation problem is unlikely to develop until labor costs start rising significantly.  Notice in the graph above that the period of stagflation during the 1970s is well apparent in the nominal wage data.  The same thing is not happening now.  This is one reason I think the Fed is on the right track worrying more about the weak economy than about inflationary threats.

Since he wrote that, the year-over-year growth rate in earnings has fallen from about 2% to nearly 1%.

These facts are not that hard to understand nor are the data difficult to obtain, so I’m left with this question: how on earth does this stuff get published?

Following the Yellow Brick Road

The Republican Party will include a “return to the gold standard” plank in its platform, which has me wondering what prompts all this (other than an effort to appease Ron Paul)?

Paul Krugman recently reiterated the point that many have made about the gold standard: we tried it, and it wasn’t quite as rosy as some would like to believe:

Faced with the kind of shock we’ve just experienced, the real price of gold would “want” to rise. But under a gold standard, the nominal price of gold would be fixed, so the only way that could happen would be through a fall in the general price level: deflation.

 

So if we’d had a gold standard operating in this crisis, there would have been powerful deflationary forces at work; not exactly what the doctor ordered.

 

Now, the gold bugs will no doubt reply that under a gold standard big bubbles couldn’t happen, and therefore there wouldn’t be major financial crises. And it’s true: under the gold standard America had no major financial panics other than in 1873, 1884, 1890, 1893, 1907, 1930, 1931, 1932, and 1933. Oh, wait.

 

The truth is that returning to gold is an almost comically (and cosmically) bad idea.

The advantage of a gold standard is long-run price stability (well, at least in the Classical gold standard period from 1880 to 1914), but that does not come without its own costs; in particular, there are resource costs of maintaing the standard, as Bernanke pointed out:

Gold Standards are far from perfect monetary systems… have to go to South Africa and dig up tons of gold, and move it to New York and put it in the basement of the Federal Reserve bank of New York.

The more important cost is the increased volatility of real output and the price level, and the removal of an important countercyclical policy tool from the toolkit.

Even Milton Friedman opposed a return to the gold standard –  here’s Murray Rothbard, criticizing Milton Friedman for advocating a break from the gold standard:

Milton Friedman is a radical advocate of cutting all current ties, however weak, with gold, and going onto a total and absolute fiat dollar standard, with all control vested in the Federal Reserve System.  Of course, Friedman would then advise the Fed to use that absolute power wisely…

And Friedman in his 1986 JME article with Anna Schwartz:

I regard a return to a gold standard as neither desirable nor feasible — with the one exception that it might become feasible if the doomsday predictions of hyperinflation under our present system should prove correct.

Friedman believed that the Fed’s efforts to defend the gold standard resulted in the disastrous bank failures of the early 1930s, which greatly exacerbated the depression.

James Hamilton has pointed out that short-term interest rates became much more stable after the establishment of the Federal Reserve, while the duration of recessions became shorter.  Those volatile short-term rates and long recessions occurred during the classical gold standard, from 1880 to 1914.

Hamilton reminds us that countries abandoning the gold standard during the depression were fastest to recover:

U.S. recovery began more or less immediately with the elimination in 1933 of the legal convertibility of dollars to gold at the price of $20.67. And our experience was not unique. The 14 countries that decided to abandon the gold standard two years earlier than the U.S. began their economic recovery in 1932…Countries that stayed on gold, by contrast, experienced an average output decline of 15% in 1932. The U.S. recovery began after we abandoned gold in 1933, the Italian recovery began after they went off in 1934, and the Belgian recovery began after they went off in 1935. The three countries that stuck with gold through 1936 (France, Netherlands, and Poland) saw a 6% drop in industrial production in 1935, while the rest of the world was experiencing solid growth.

Underlying the push for a return to gold is, of course, a desire for price stability.  Here is Mitt Romney (to his credit, he has not joined the goldbug movement), from a recent Reuters story:

I want to make sure the Federal Reserve focuses on maintaining the monetary stability that leads to a strong dollar and confidence that America is not going to go down the road that other nations have gone down, to their peril.

So, we want the Fed to maintain monetary and price stability.  Okay, is there any evidence that it has failed in that objective?  Even if one were to take the position that the Fed’s dual mandate should end, and that it should focus exclusively on price stability, is there any reason to claim that it has not achieved a relatively low and stable price level?  Quite simply, no.  Bernanke assumed the chairmanship of the Board of Governors in February 2006.  Using the all-items seasonally-adjusted CPI, the average inflation rate under his watch is a whopping 2.3 percent.

And under the much-admired Alan Greenspan, the inflation rate averaged almost a full percentage point higher, 3.1 percent.  Why were there no calls for Greenspan to be fired for his inflationary policies?  Far from it;  in the Republican primaries, Herman Cain claimed that Greenspan was the best Fed Chairman in 40 years (which prompted a memorable retort from Ron Paul that “he was a disaster!” – at least Paul is consistent).  Cain, by the way, later joined with Newt Gingrich in advocating that Bernanke be “fired.”

Let’s hope that this latest push to return to the 19th century is merely a manifestation of political silly-season, and that the rest of the campaign will be about the important problems that lie ahead.  Solutions in search of problems are not generally worth pursuing.

The Federal Reserve Town Hall Meeting with Teachers

Here’s the link to a “Town Hall” meeting between Bernanke and selected economics educators at the Federal Reserve.

Fed Vacancies Filled

Finally, some progress on filling Fed vacancies:

The Senate on Thursday confirmed two nominees chosen by President Obama for the Federal Reserve Board of Governors, overcoming Republican objections and bringing the seven-member board to full strength for the first time since 2006, before the economic crisis.

Inflation Phantoms Again

The New York Post’s John Crudele thinks we have inflation and that it’s all to be blamed on the Fed (here’s the article):

The actions taken so far by the Fed should have gotten the economy booming. Interest rates this low should have caused a resurrection in the housing industry. And companies should be more than confident enough to hire tons of workers.

 

Instead, all that Bernanke has really accomplished — aside from getting stock prices higher — is to raise inflation levels. It’s funny but no matter how hard I look I don’t see any mention of inflation, and especially rising gasoline prices, in Bernanke’s speech yesterday to the Conference.

 

Yet inflating gas prices — and other signs of Ben-flation — are what’s clearly causing the most disruption in the household economy today.

I suppose evidence does not really matter, but here it is anyway.  According to the Cleveland Fed, 10-year expected inflation rates are averaging 1.4 percent (here’s a description of the model they use).

The University of Michigan’s inflation expectations index is a bit higher at 3.3 percent, but even that does not quite get us into galloping inflation territory:

Other measures of expected inflation tell the same general story but even if the expectations are somehow wildly underestimating future inflation, there is no indication of Ben-flation in the actual historical inflation data.  I’m starting to wonder if those who have been sounding the alarm on inflation have missed the decimal point…the latest year-over-year change in the all-items CPI was 2.9 percent, not 29 percent:

And wage growth (a big part of firm costs) remains practically nonexistent:

Yes, we all know that gas prices have recently spiked (here is James Hamilton’s “rational reason for high oil prices”) but it is bizarre to blame that recent jump in the price of one particular commodity solely on Fed policy that started 4 years ago.  And if Ben-flationary practices are the true culprit, why did oil prices drop by 70 percent between June 2008 and February 2009, just as all the monetary aggregates were skyrocketing?