I really enjoy reading Kevin Drum…but I often forget about his blog because it’s not synced to my phone, which is my own fault. In any case, I’m going to comment “of the cuff” on two posts that Drum has made recently.

The first is his post on the Fed’s interest on reserves policy. I can’t really quote any of it specifically, so you’ll have to go and read it.

I think that Drum gets two things wrong in his analysis. The first is that interest on reserves is a very desirable policy that smooths out the Fed Funds rate fluctuations, reduces lending spreads, and reduces the opportunity costs of capital. Milton Friedman was the most famous proponent of interest on reserves, and Canada and Australia (if I’m not mistaken, working from memory) also pay interest on reserves.

When Kevin says that the IOR should be zero, what he should be saying is that the Fed Funds rate should be zero, and should have been in Sept 2008 (currently 0-.25, at the time it was 2). In addition, the IOR should be manipulated in a way that the interest rate on excess reserves follows the trajectory of the Wicksellian real interest rate…which is probably currently mildly negative (as shown by TIPS). Otherwise IOR is a favorable policy. Its the timing of the institution of the policy that is problematic.

On Drum’s second point, the IOR policy wasn’t the driver of the collapse in 2008, inadvertently tight monetary policy was. If you are hardcore about monetary disequilibrium, like I am, then that was the key to the entire recession (contra what was happening with financial intermediation). The IOR policy was just heaping gasoline on a fire, so to speak.

I think that it is hard to read Yglesias, Drum, and others regarding the issues because they are trying to fit the concepts into the framework of a financial crisis leading to disaster which they already hold. Reverse causality, and it is much easier to explain events.

Secondly, Drum comments on the budget deficit:

By the way, if you want to reduce the federal deficit, guess what else has to happen? The trade deficit has to come down. This is one bellwether of seriousness on the budget deficit: if you mention the trade deficit, you’re serious.

This kind of made me sigh in disappointment. It is a common fabrication that the trade deficit is harming our domestic market. What should be the trade balance? I don’t know. It would be a very peculiar world, indeed, if trade was always perfectly balanced.

Think of a local example. Do you and your best friend have a perfectly balanced trade relationship? Always one-for-one? Probably not. You probably try to approximate a level of balance, but you probably rarely get it right. You may owe your friend favors, or visa versa…and that type of relationship may persist for years…maybe even decades! One of you may get a little irritated now and again, but you remain friends…and everything ends up working out. (Not to mention, you created money out the thin air!)

Similarly, a country’s trade deficit matters in the long run only in the event that it causes a breakdown in the relationship which leads to a breakdown in trade. That is material, and severely affects both parties. Does Drum know when this is going to happen? Probably not.

I’d wager two things over the next 10, 20, 50, 150 years: the US (provided the notion exists) will continue to run trade deficits, and the US economy will continue to grow at roughly the long-run trend (3%). Care to take it?

Trade balance is solely artifact of fiscal and regulatory policy at home…which may be what Drum is getting at, but I think he’s making a normative judgement of what the balance of trade should be. It will forever baffle me why anyone would condemn getting real goods for paper is a terrible predicament. The best thing that could possibly happen to the US is if China instituted a policy of burning dollars domestically. Why you would expect a summit of international leaders to come to a conclusion regarding the situation is beyond me. Take care of your own policies on the supply side, and let the market work out the rest.


If I wasn’t unreliably tethering my internet connection, I may have noticed that Drum has fleshed out his point on the trade deficit, and broadly agrees with what I was saying. Embarrassing, yes.

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