Neo Fisherianism: Crazy Trick or the Right Way Forward?

A debate has broken out on the blogs over the wisdom of an interest rate increase. Stephen Williamson, who identifies as a ‘new-monetarist’ thinks that we need to raise rates to generate inflation. Narayana Kocherlakota, who once advanced this idea himself, has now reversed his position and calls it a ‘crazy trick’.

These are two very smart people. Stephen is  a Vice President at the Federal Reserve bank of St Louis and  the author of one of the leading undergraduate textbooks in macroeconomics that is now in its 5th edition. Narayana is the former President of the Federal Reserve Bank of Minneapolis and now the Lionel W. McKenzie Professor at the University of Rochester. The fact that they have both entertained this idea at one point in the recent past suggests that it is not such a crazy trick as Narayana now suggests.

In his argument against raising rates, Narayana points out that new-monetarists, like Stephen, see the economy as self-stabilizing. Raise rates now, and the economy will soon find its way back to full employment. Perhaps there will be some minor pain along the way. But keeping rates low, or even lowering them into negative territory, is a much worse option. Just look at Japan.

According to Narayana

“…., it would be remarkably irresponsible to take the risk of raising rates based purely on a theoretical belief in macroeconomic self-stabilization.”

I am on Stephen’s side in this debate. But I do not, I repeat I DO NOT, believe that the economy is self-stabilizing. If the Fed raises rates before the private sector has begun to recover, and if that is the only change to either monetary or fiscal policy, Narayana would be right: the Fed action would derail a nascent recovery. To prevent this from happening; a rate rise must be accomplished by a simultaneous intervention in the asset markets to prevent the crash in the values of other risky and long dated asset classes that will inevitably accompany a Fed increase in the policy rate. This is what Willem Buiter has called ‘Qualitative Easing’.

Inflation is persistent in historical data. But it is not persistent because private actors are prevented from changing prices by what New-Keynesian economists refer to as ‘sticky prices’. As I explain in my forthcoming book, inflation is persistent because people's beliefs about future NGDP growth are persistent. We ARE in a low inflation trap. The way out is not through further interest rate cuts, as some have advocated. It is through a rate rise, accompanied by a fiscal/asset market intervention.

How would that be achieved? Some have argued for a money financed program of new federal and state expenditure on infrastructure. Some have argued for printing money and distributing it to the public, so-called helicopter money. I have argued for a central bank  intervention that boosts the value of risky and long-dated assets and that would increase private demand through a wealth effect. The details are secondary. The main point is that the economy is NOT self-stabilizing. Treasury actions AND the way those actions are financed, are BOTH important determinants of economic activity. If we  wait for the private sector to recover on its own; we may be waiting for a very long time.

New Comment Format

I am now using Disqus to manage blog comments.  Disqus should allow embedded urls and I am hoping it will be a significant improvement. Unfortunately, the move appears to have caused comments that were posted under the previous format to evaporate into cyberspace. I am working to see if I can recover them. Stay tuned.

Property Rights, the Income Distribution and China

In my post, The UK and Europe: The Way Forward, I say that

"A persistent free fall in the financial markets will, if allowed to occur, cause a major recession. [ ... ] My recommendation is based on empirical research that shows a stable persistent connection between the value of financial assets and the unemployment rate."

Commenting on this blog, Blissex Walex replies,

"This seems to me the best and clearest yet expression of the neoliberal trickle-down policies aimed at redistribution from workers to asset owners.

It even goes further than B DeLong "suggestion" that Keynes would have added a fourth, one known to us today as the “Greenspan put" – using monetary policy to validate the asset prices reached at the height of the bubble"

There are two issues here that should not be confounded. 

First: Can central banks and national treasuries intervene in either asset markets or goods markets, or both, in a way that improves upon unregulated private markets? By 'improves upon' I mean: is there a feasible policy that can make everyone better off; both workers and capital owners? Keynes thought so. So do I, for the reasons I explain in my forthcoming book, Prosperity for All.

Second: why has the distribution of income, in the United States and Europe, tilted towards capital and away from labor over the past few decades? There is growing evidence that this redistribution is connected with the opening of trade with China. Globalization has lifted a billion Chinese workers out of poverty and it has led to huge income gains for Americans and Europeans at the top of the income and wealth distributions. These gains have not been shared with middle class and working class people in the US and Europe. This second issue is hugely important, but it is distinct from the question of asset price stabilization. Nobody will gain from a global depression. 

My own view is that solving the first issue at a national level will lead to a reformation of world capital markets and a redesign of global financial institutions. It is also possible to conceive of alternative forms of democracy that would provide greater rights to workers. Workers councils, for example, have proved to be relatively successful in Germany. 

The concept of private property is contingent on rights that are defined and enforced by national governments. Those rights are constantly evolving. When the US founding fathers signed the Declaration of Independence, it was still possible to buy and sell human beings. The idea that a national government would enforce the property rights of a slave owner is, to today's sensibilities, abhorrent. It is entirely possible that a system of property rights that allows a factory owner to close down a large manufacturing plant without consulting the workers whose livelihoods depend on its continued operation, will, in another two hundred years, appear to be equally abhorrent.

You can read more about these ideas in my new book, Prosperity for All.

Should we Target NGDP?

In my last post, The UK and Europe, the Way Forward, I wrote that 

"The Bank of England should make clear that a catastrophic drop in the financial markets will not be permitted. I recommend a statement that the Bank will, if necessary, buy shares in an  exchange traded fund to support the value of the FTSE and that it will pay for those shares by selling short-term treasury securities. As I argued here, if necessary, the Treasury should support that action by providing the Bank with the authority to borrow on its behalf."

Thomas Hutcheson, commenting on my blog writes,

"This is fine so far as it goes, but we should deal as well with the policy response of the ECB and the Fed, as well. Whatever long term damage may occur from slightly less free trade (including investment to trade) cannot be prevented by central banks, but they can prevent the damage that comes from uncertainty about the future course of NGDP. It is expectations about that they should seek to stabilize."

Here is my response. 

I am in broad agreement with the proposal to stabilize expectations of future NGDP growth and, in the simple models that guide my thinking, stabilizing asset price growth and stabilizing expectations of NGDP growth amount to the same thing. The question is: how to achieve that goal?

If central banks simply substitute NGDP targeting for inflation targeting, and if they continue to try to achieve their objective by adjusting short term interest rates, not much will have been achieved. Scott Sumner has proposed instead, that central banks should trade NGDP futures. Robert Shiller goes further and advocates that national governments finance their borrowing requirements by issuing equity-like instruments that pay a trillionth of GDP: Shiller calls these 'trills'. I wholeheartedly endorse both of these proposals. Creating a market for nominal GDP futures, and actively trading trills for Tbills would have much the same effect as stabilizing asset price growth. 

I differ from Scott in one important respect. Whereas Scott sees NGDP targeting as a substitute for inflation targeting, for me, it is a complement. Central banks should set interest rates to target inflation, and they should set the growth rate of some other object, be it asset prices, NGDP futures, or the price path for trills, to target the unemployment rate.

You can read more about these ideas in my new book, Prosperity for All.

The UK and Europe: The Way Forward

I am British,  I am American, and I am continental European.  I was born and raised in Britain and I am a British citizen by birth.  I have lived in the United States for thirty years and I am an American citizen through naturalization.  I am a continental European through my two year stint of teaching economics in Italy where  centuries of European culture seeped into my pores by osmosis and took up residence in my bones.

The British people have voted to leave the European Union. You may, or may not,  have strong views about the outcome of that vote. All of us, wherever we are located  in this existential adventure that we call the planet earth, will be affected by it. Now is the time for those of us most directly affected, whether British or Continental European, to come together and help to forge a future in which all of us can prosper. That may not look much like the vision of Jean Monnet for a European Federation, but I am confident that it will not lead to a return to the Europe of fractured nationalisms that ended in two world wars.

I did not join the chorus of economic experts who threatened Armageddon if the vote were to turn out in favour of leave. There were persuasive arguments to be made for significant economic costs of leaving the EU. Some suggested that these costs would be long-term.  That is a hard case to make. Economists cannot accurately predict what will happen six months from now. If you want a long-term prediction I hear that reading entrails was effective for the Emperor Augustus.

That  is not to say we can avoid  short-run economic costs. But those costs will be a great deal worse for all involved if we allow an atmosphere of panic to take hold in the financial markets.  Mark Carney, Governor of the Bank of England, has promised to support UK financial institutions. That  was a good start and it will, I believe, prevent a further slide in the exchange value of the pound.

I am not overly concerned by the decline in the value of the pound that has occurred to date. I am more concerned by its cause. The pound fell because international investors pulled money from UK asset markets and fled to gold and to US treasuries. So far, with the possible exception of the French stock market, international asset markets have been volatile but they have not gone into free fall. A persistent free fall in the financial markets will, if allowed to occur, cause  a major recession.

The Bank of England should make clear that a catastrophic drop in the financial markets will not be permitted. I recommend a statement that the Bank will, if necessary, buy shares in an  exchange traded fund to support the value of the FTSE and that it will pay for those shares by selling short-term treasury securities. As I argued here, if necessary, the Treasury should support that action by providing the Bank with the authority to borrow on its behalf.

My recommendation is based on empirical research that shows a stable persistent connection between the value of financial assets and the unemployment rate. My own research was conducted on US data. Studies conducted at the Bank of England and at Hamburg University have replicated my findings  on UK data and on German data.

Some economists have called for lower interest rates, perhaps even moving into negative territory. I do not think that is the right answer. Interest rate control was effective for more than twenty years as a tool to control inflation. We need a new approach to deal with financial crises. That approach should, in my view, take the form of a direct intervention in the asset markets by the Bank of England,  to prevent the excess volatility that is caused by fear of the unknown. It is the job of policy makers to contain that fear. It is the responsibility of journalists and opinion makers to refrain from exacerbating it.

We should refrain from pouring petrol onto the fire of volatile financial markets by speculating that the sky is falling. It isn’t: Yet. Words are powerful and may become self-fulfilling prophecies. Let us choose them carefully.

I discuss these ideas, and many more, in my forthcoming book, Prosperity for All.