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Eric Rosengren winks at the 4% Club. The FOMC member devotes most of his speech to credit easing but notes

While lower long-term rates are likely the primary channel through which asset purchases would influence the economy, purchases of Treasury or mortgage-backed securities also expand the Federal Reserve’s balance sheet and increase the amount of reserves in the financial system.  This expansion of reserves might serve as an effective signal that highlights the determination of the Federal Reserve to reduce disinflationary pressures.

Emphasis mine

Note he didn’t say deflationary pressures. He said disinflationary pressures. Disinflation refers to reductions in the rate of inflation. Rosengren is telling us that the Fed is determined to fight reductions in the rate of inflation and that it has the balance sheet to prove it.

America, however, is a wounded lover. She knows you love her but she needs to hear you tell her that you love her. She needs your words. Is the Fed going after an inflation target?

Why does that matter?

It matters because an explicit statement by the Fed produces credible expectations.  Some people are confused by this. They think actions should count louder than words. Words are just promises.

I won’t do my full, full song-and-dance on this but the entire financial economy is just promises. Investment Bankers are in the business of selling promises. Investors are in the business of buying promises. Traders are in the business of swapping promises. Your mortgage is just a promise. Your credit cards are little promise makers.

Even the cash in your pocket is just a joint promise from the Federal Reserve and the US Judicial System. It says so right on the little promissory note: Legal Tender for All Debts Public and Private. That is, we promise to let you out of your obligations if you turn over enough of these little slips.

All things financial are ultimately promises.

Promises, however, matter. Ultimately they matter because promises are how we coordinate people to make stuff that is bigger and better than any one person could make alone. If we couldn’t make promises to each other we could never build factories, homes, cars, etc. In truth specialization would all but collapse and the modern economy would cease to function.

Many economists like to pretend that the economy functions on the basis of trade. The baker makes bread and trades with brewer who makes beer. But, this isn’t how the real world works is it? The real world is full of promises.

When the baker wants beer he give the brewer a promise. When brewer wants bread he gives the baker a promise. If they don’t trust each other very much they trade in government promises, that’s called legal tender or money. When they trust each other a lot they trade in private promises, that’s called credit.

I have occasionally received gifts in appreciation for my lectures but mostly I receive a big chunk of promises at the end of every month. I use those promises to meet other promises that I have made. And, with the promises I have left over I can get other things that I might want for the month. I keep some of my promises stored away, as a promise to myself.

In the old days when even trust in the government was low promises took the form of metal. For most people the metal had little value but they knew someone else might want it so it was good enough. Today, trust is high. Our legal system is strong and most promises are just bits in a computer system, a little electronic maker that says society promises resources to John Doe. Promises are the foundation of our economy.  That’s why when promises go bad, as they did in the sub-prime crisis, the whole economy goes bad. That’s why some of think the government needs to make some new promises. We are running short.

An explicit inflation target is a verbal financial contract or promise to America and as long as the Fed has some credit worthiness that promise has value. It says:

    We, your monetary authorities, promise to continue to push out aggregate demand until sales volumes are rising faster than otherwise would have been expected and businesses are forced to increase the rate at which they raise prices. We make this promise to you knowing that the intermediate effect will be for businesses to try to meet market demand at the current inflation rate and thereby lower unemployment.
Its a promise I hope they make and keep.

A while back, Dylan Matthews asked where the Laffer Curve bends. A few numbers were thrown out. I would tend to estimate something around 70%. However, I want to talk Laffer Curve Theory for a minute.

So leaving behind for a moment the important issues of avoidance and evasion it’s key to remember that there is no particular reason to think taxes in and of themselves have any impact on people’s incentives.

What matters is the net of tax return to the activity, working, saving, etc. So suppose that for whatever macro-economic reasons the return to being a hedge fund manager has increased 2 fold over the last 10 years. Now suppose that I raise that hedge fund manager’s total marginal tax rate from 44% (including state and local) to 72%, so that her take home ratio falls from 56% to 28%.

Even though I have radically increased her taxes, her return to work is essentially the same as it was a decade ago. If a decade ago it made sense to become a hedge fund manager and work 90 hours a week, it will still make sense today.

This fact makes the observation that there is little secular trend in hours worked per American important. There is strong trend in the return to working and it is going up. There is also fairly turbulent flow in the mix of labor, more women / less men, etc.

However, the total hours worked is per American is not changing that much and what change there is seems to be dominated by the unemployment rate. Now in the interest of intellectual honesty this goes both ways. Supposing I have a constant number of structurally unemployed workers, then adding more workers to the mix will lower the unemployment rate. However, I think with other data series we have ample evidence that the unemployment rate is dragged around primarily by monetary policy.

The graph below shows the average hours worked per working age American in blue and the inverse of the unemployment rate in red. They track each other pretty closely. I would suggest this implies that the amount of work done in America is determined by the number of Americans who can find work.


This leads to the astounding conclusion that the vast area of social, economic and policy changes that we have had over the last 40 years have had very little impact on the total amount of work being done in America.

To wax extremely nerdy for a moment, but this is exactly what you expect if you had labor supply decisions made at the extended family level and something functionally akin to logarithmic utility. In more human terms, that says that we don’t just think of ourselves when we decide to work but our children and our parents and to a lesser extent our siblings and cousins. It also supposes that the relative happiness generated by having more stuff and having more free time is more or less written into human DNA and is not altered that much by relative costs of each.

As an interesting side note, while something like logarithmic utility would imply that taxes and wages “don’t matter” they do not imply that “welfare” doesn’t matter. Under logarithmic utility welfare dramatically reduces the incentive of people to work. Explaining that dichotomy is beyond the scope of this post but it is easy to verify mathematically.

So suppose that utility is something like logarithmic. Then extend family behavior is invariant to real wage and things like entry of women into the workforce. The decision of women to work more, under this formulation, is implicitly the decision of men to work less.

This isn’t by any means a flawless representation of what’s going on but we can’t ignore the fact that it predicts the historical data. A massive lifting of labor force constraints on women seemed to have only a small and temporary effect on labor supply. Taxes, unions, trade, etc are barely noticeable.

Again even the trend that we do see could largely be explained by changes in the unemployment rate. Changes that I believe are mostly driven by monetary policy.

Some commentators – I am thinking Reihan Salam in particular – might wonder how this could ne possible when we can easily observe massive social change and differences in work patterns over the last 40 years. I would first say that the aggregate stats are what they are and we have to accept that whether or not they make sense.

The point of science is to come up with theories that explain and predict the data. Not, to adopt a theory and then attempt to impose it upon the data.

Intellectually though I would say these facts suggest that there are deep fundamental forces at work and that what we think of as our culture and social norms are actually products of those larger forces.

For example, one might suggest that it is precisely because women can now reasonably earn a living as single mothers that more families have children out of wedlock and the social culture allows the fathers to skip out on their children. If the economics did not allow these women to make it on their own then social culture would respond by berating and tracking down deadbeat dads.

Likewise it is precisely because the returns to skilled labor are so high that aggressive professionals will wind up working 80 hours a week just out of college. However, that same high return to skill is why so many of them feel fine taking 6 years to graduate college or going on to graduate school in a field unrelated to what they will actually do. If the return to labor was less they would get themselves out into the workforce sooner, work fewer hours when they go there, retire later and actually end up supplying roughly the same amount of labor over their lifetime.

In short, there are all of these trends going on but they are honed and balanced against one another by the basic economic returns. If the “fundamental” family labor supply function is nearly vertical then all sorts of complex social dynamics will evolve to ensure that total labor supply is constant in the face of changing incentives.

If integrating a school garden into curriculum can help teach kids subject matter better and get them to eat healthier, then I’m all for it. Likewise, I think improving school lunches and making them healthier are something worth spending money on. People like TV chef Jaime Oliver and school garden maven Alice Waters who are working to push these issues into mainstream deserve praise. Unfortunately, it seems that these genuinely useful policies and programs are being bogged down with wasteful progressive ideas.

Case in point is this paragraph from a recent Atlantic piece on Alice Waters:

…Waters recruited chef Ann Cooper (a.k.a. the Renegade Lunch Lady) to revamp what was on the school lunch menus in Berkeley, which then reflected typical school-lunch fare. As Director of Nutrition Services, Cooper banned processed foods and started making everything from scratch. She sought local produce, dairy, and bread, and, as much as possible, organic foods, too.

The first problem here is teaching kids to spend any time or money on organic foods, or spending public funds on such things. This may be good for the earth, but as several  comprehensive literature reviews have shown, organic foods aren’t any healthier. Here’s liberal wonk and foodie Ezra Klein summing up the evidence:

The most recent data on this come from a massive literature review commissioned by Britain’s Food Safety Agency (their version of our FDA, essentially) and conducted by Britain’s London School of Hygiene and Tropical Medicine. They concluded that a “systematic review of literature over 50 years finds no evidence for superior nutritional content of organic produce.”

Local is useful so long as it means more fresh, as fresh foods deliver more nutrition than frozen. But local for the sake of local is the kind of thing you worry about when you’ve got time and money to spend on luxuries; it’s not an important value to instill in kids, and especially not poor kids.

Waters and her organization are touting a new study showing that school gardens get kids to eat more vegetables. This isn’t surprising, but how much does it impact their lives once they graduate? Are future blue collar workers really going to take the time to grow themselves vegetable gardens in window boxes outside their apartments? A lot of working people, like Megan McArdle and Matt Yglesias, frequently don’t have time for fresh vegetables. Like Matt, many people have to teach themselves late in life how to make quick delicious snacks out of frozen vegetables. This would be a much more valuable lesson for poor kids then how to select the freshest kale at your local organic farmers market, or even more ridiculously, how to grow your own.

From every description of these programs I’ve read they have an obsession with local, fresh, organic, and growing your own food. The obsession should be on quick, easy, delicious, and inexpensive. These sets of descriptors are damn near antonyms.

If you can get kids to eat and prefer frozen vegetables then you’ve got a sustainable improvement in diet and nutrition. If you get them to like fresh organic vegetables they’ve grown in the garden or bought at the farmers market, then you’ve temporarily instilled in them the tastes of upper middle class people with enough time and money on their hands for such luxuries.

If people like Alice Waters and Jaime Oliver want wider support for heathy schools movements they need to purge them of the wasteful upper-class liberal obsession over local, fresh, and organic foods, and instead focus them on practical and sustainable lessons like how to prepare frozen vegetables cheaply, quickly, and deliciously.

Robin Hanson makes a list of warning signs that you are arguing for sport rather than arguing for insight.

My favorites

You have little interest in getting clear on what exactly is the position being argued.

Nailing down mutual definitions and exact positions can be annoying and it is common for certain intellectuals to overinvest here. However, skipping over them completely is a recipe for disaster.

Relatedly, I’d suggest trying to use as a debating point the fact that someone has misused a term is another sign that insight is not what we are after. If the definition of marriage is X then fine, I want narriage which is exactly like marriage except it also includes two dudes.

Realizing that a topic is important and neglected doesn’t make you much interested.

This is a big one. Realizing that not enough people are talking about an important issue is reason to run around like your hair is on fire; not move on to something else.

Likewise, once the conversation moves beyond your ability to contribute its time to look for something else.

You find it easy to conclude that those who disagree with you are insincere or stupid.

My bugaboo. As far as I can tell the number of people who are engaged in a consistent and deliberate attempt to argue for something they know is false is vanishingly small. Moreover, even when you suspect it, it is not worth worrying about because the fact that your opponent is lying or stupid is not somehow worse than the fact the she is just mistaken or confused on a particular point.

Bad actions have bad consequences regardless of why we choose them.

Your opinion doesn’t much change after talking with smart folks who know more

Our opinions should change a little bit even if we are talking to stupid folks who know less. The chances that a person is so stupid and so ignorant that they literally have zero value to add is probably not high enough to measure.

For example, a lot of people are making fun of Christine O’Donnell. However, I’ve learned a lot from listening to her. Despite having some odd opinions she is an incredibly clear communicator and thus a lot of useful information can be transmitted from her.

In particular I have learned from her that many people are not concerned about the expansion of government because they think the government will do a bad job at running the economy. They believe that the government will move to actively oppress them and they are concerned that the government will do a good job at that.

As such pointing out that TARP was actually run fairly well, all things considered, does little to ease their concerns. Indeed, it heightens them.

Will Wilkinson asks, what things are we doing now that our grandchildren will condemn? Both Will and the op-ed that inspired him noted, among other things, industrial meat. I agree with this one.

On the dissenting side, Josh Barro argued in a recent twitter conversation that the slaughter of animals for food is morally equivalent to torturing animals. No, Josh is not a hard-core animal rights activist arguing against carnivorousness, he is arguing for the legality of torturing animals. In contrast, one could embrace his argument as support for banning the slaughter of animals, after all most people are against the legality of animal torture. But I don’t believe that taking an animals life for food is always ethically equivalent to torturing it.

For one thing most people, including those who highly value the utility of animals, are willing to call an animal “better off dead” and say we should “put it out of their misery” much faster than we would for a human. Despite putting not suffering before life, this is widely understood to be the most humane choice. Animals are unable to appreciate life qua life as humans can. A horse would not be content to rest on broken haunches and enjoy its golden years reminiscing and visiting with younger relatives. They want to walk, run, and be as a horse. When they are too injured to do walk we put them down because it’s the most humane thing to do. I don’t think you’d make the same argument for grandma. We seem to intuitively understand that for animals the moral calculus between suffering and dying is different than it is for humans.

This is not to argue that putting an animal out of its misery is the only time it is morally acceptable to kill them, it’s just to show that relative to humans one should weigh suffering higher than the value of life when considering the welfare of animals.

Likewise, I don’t think you can argue that we should be indifferent to the suffering of animals. What is it that privileges human animals such that we should consider their suffering but not other animals? There are surprisingly few mental characteristics that humans have which one could plausibly consider that some animals don’t also have. There are also few characteristics that most humans have that some percent of humans, especially the mentally disabled, do not.

There are also non-humans of the homo genus and non-human intelligent life to consider. Any moral system should be able to encompass previously existing and potentially existing creatures. By what criteria would we decide whether we should consider their suffering or not? Or, for that matter, by what basis should our vastly superior future alien overlords consider our suffering? Or shouldn’t they?

In one place I do think Josh is correct. He argues that there are many things we do to animals in leading up to the slaughterhouse that make the illegality of explicit animal torture hypocritical. As there are many animals in these situations that would be better off dead, I agree with him. Unlike Josh, however, I take the logical conclusion that those kinds of industry practices should be banned, not that animal torture should be legalized.

Because I don’t want to call Josh a monster, I have to presume he is deluding himself to justify egregious conditions in industrial meat industry. Here is why I don’t believe him: imagine if Josh walking down the street and came upon a man beating a perfectly healthy dog to death (it looks exactly like Lassie). Do I really think that Josh wouldn’t a) call out to the policeman, and b) be very, very glad that it is illegal to beat a dog to death. I don’t think this would be a momentary selfish attempt to end something he finds viscerally unappealing. He would go home and be glad it was illegal. He would wake up the next day, still glad it was illegal.

In reality, Josh probably eats meat that has been tortured every day, but rarely witnesses animal torture; it would be a lot harder to end the former than to rationalize the latter. My guess if Josh had to witness more than a little animal torture he would change his mind. And if not then, with all apologies, I actually do think he is a monster. Which would be a shame, since he seems like a nice guy.

As a final note I want to add that deciding the “correct” policies with respect to animal welfare is difficult. At a bare minimum I think explicit torture should be illegal, and that anything where an animal would be fairly judged better off dead should be banned as well.

Why won’t you consider my suffering

in your social welfare function, Mr.Barro? I too

have von NeumannMorgenstern preferences.

His Application via the Financial Times

[Adam Posen] is the first MPC member publicly to call for a second-round of quantitative easing, often referred to as QEII.

“It is right for both long-term stability and short-term performance for central banks to do more now,” Mr Posen told a business audience in Hull.

He certainly advocating Quantitative Easing by the Bank of England and his use of the plural Central Banks leads me to suppose that he is pointing at the Fed and ECB as well.

Posen adds a warning. One that I will be echoing though perhaps a mildly less alarmist way.

“Let us not forget that it was sustained high unemployment and austerity, the sense that governments were unresponsive to average people’s dire economic conditions, which led to the rise of extremist intolerant parties in pre-war Europe,” Mr Posen concluded.

Daniel Indivglio is alarmed at consumer debt in the United States

consumer debt per capita 2010-07 indiviglio.png

This chart should be startling. It shows that total debt has increased from around $1,186 per person in 1948 to $10,168 in 2010. And remember, that’s using 2010 dollars — and it doesn’t include real estate debt either like mortgages or home equity loans. This debt includes credit cards, auto loans, student loans, personal loans, and other non-real estate consumer debt.

Perhaps an even more interesting observation is the rise of credit card debt. They account for most of the “revolving” debt shown with the green line. It was virtually non-existent until 1970. Now Americans average $3,480 in credit card debt per capita. Since just 1980, that’s an increase of 285%.

Daniel is charting real per-capita consumer debt and its growing out of control!

Which reminded me of another real per-capita stat that is growing out control: personal disposable income.

So I decided to see how the debt compared to disposable personal income.


When we take out Credit Cards (revolving debt) consumer debt per disposable dollar has actually fallen. That’s what we would expect if credit cards were a substitute for other forms of credit.

The consumer debt-to-income ratio has risen when credit cards are included. However, I must wonder how much of that is credit cards replacing informal lending channels. If you can borrow from VISA at 9% APR then that might be better than borrowing from Mom and Dad and paying the implicit and nearly infinite APR of weekly scoldings and endless guilt.

However, there is a more fundamental question – can this go on forever? Can we pile more debt on top of more debt. Yep, we sure can. There is no limit.

To prove this I am offering to loan one of my co-bloggers (either can take up the offer) $100 every millisecond on the millisecond. All I ask in return is that they loan me $100 every millisecond on the millisecond.

By my count we should be able to rack-up, between the two of us, about $6.3 Trillion in debt by the end of the year. Of course, we’ll also rack up about $6.3 Trillion in assets. Each loan is a debt to the borrower and an asset to the lender. On net we’ll be no richer and no poorer. That’s why its important to look at the balance sheet. How much of what you got is owed to someone else?

Lets look at America’s balance sheet. We’ll compare consumer credit to total assets.


We see a rise through the sixties but we can’t see the effect of credit cards at all. The mean has been roughly the same since 1966.

That could mean that we’re borrowing heavily on our credit cards as we see our 401(k)s rise. I doubt that though.

I suspect it means credit cards are replacing informal channels. That loan from Mom and Dad didn’t show up as a household liability in 1965, but it didn’t show up as a household asset either.

In truth, it was both. It was your liability and Mom’s asset. When formal channels replaced informal channels recorded liabilities rose, but so did recorded assets. Of course this also applies to shall we say, less loving-parent more break-your-legs-if-you-don’t-pay type of debt markets.

I do notice, however, that there are two nasty spikes just recently. Is that America growing deep in debt just before the dot-com and housing bubble crashes?

Actually, it looks like just the opposite. Its Americans suddenly seeing their balance sheets deteriorate as a result of the dot-com and housing bubbles bursting.


There is a lot more data where this came from. In particular just from glancing, we can see a much stronger trend in mortgages. However, consumer credit doesn’t look like its raging out of control.

A recent story on how the minimum wage is hurting South African workers is getting some attention. It opens with this tragic scene:

The sheriff arrived at the factory here to shut it down, part of a national enforcement drive against clothing manufacturers who violate the minimum wage. But women working on the factory floor — the supposed beneficiaries of the crackdown — clambered atop cutting tables and ironing boards to raise anguished cries against it.

“Why? Why?” shouted Nokuthula Masango, 25, after the authorities carted away bolts of gaily colored fabric.

The story naturally generates sympathy for the workers and should make anyone question the desirability of the minimum wage in that country. In one sense though these workers are relatively lucky; when the minimum wage destroys their jobs they at least have a chance to cry out and get attention for their plight, most jobs destroyed by the minimum wage are jobs that are never created, so the workers never even get a chance to be heard. I think progressives should think about this story when they consider whether minimum wages help the poor.

Conservatives will probably agree with this and want to call progressives hypocrites or uncaring, but would they feel better if the sheriff gathered these workers up and deported them after they closed down the business? The minimum wage is not the only thing destroying jobs, so too are the stepped up immigration restrictions that most conservatives support.

Structural labor market problems are not the majority of what’s causing unemployment, but they are a significant and potentially growing problem. It’s time to reconsider policies like minimum wages and immigration restrictions that prevent job creation or, even worse, actively destroy jobs.

Yesterday I wrote this:

If I had to play homeowner psychoanalyst I would guess that homeowners with a strong preference for homeownership saw cap rates were changing and believed house prices were heading towards a permanently higher plateau that would permanently price them out of homeownership. People who would want to buy houses in the future but were currently renting had this fear as well and rushed into the market. Risk aversion here thus did not lead to selling when prices rose as a simple model might predict.

I was drawing on the work of Todd Sinai and Nicholas Souleles who have shown that housing works as a hedge against rental volatility. My thinking was that because owners often have strong preferences for home-ownership and are not indifferent between renting and owning, that those who planned to buy a house in the future would see buying a house now as a hedge against house price risk, much in the same way as the Sinai Souleles model. Well yesterday after I wrote that I came across a brand new paper that makes a very similar argument:

Our contribution is to focus on the importance of ownership as a hedge against future house price risk as individuals move up the ladder. We use a stylized model to show that increasing house price risk acts as an incentive to become a home owner earlier in the life-cycle and, once an owner, to move more rapidly up the housing ladder.

Increases in volatility are shown to increase ownership and to increase the quantity of housing wealth conditional on ownership in earlier periods of the life-cycle. We then establish that these relationships hold empirically using panel data on families in different geographic markets in Britain and in the US.

The authors use data from the UK and US to provide empirical support for their model. This is an under-explored causal mechanism for the bubble: house price risk went up, people bought homes to insure against that risk, which drove prices up, which increased perceived house price risk, etc. The cascading nature of this is clear, and it’s not hard to see how this could create a bubble.

So housing risk makes people want housing even more. I’m not sure if this will comfort or aggravate people like Felix Salmon and Ryan Avent who have been arguing that households are too risky in their housing consumption/investment decisions, but it should help explain why what looks to them like overly risky behavior is in fact caused partly by risk aversion.

However, this explanation for the behavior does offer a potential solution. Local REITs could be created for very small geographic areas designed to help young households who want to insure against price increases in a specific neighborhood but do not yet want to take the large risks of buying a house. They could even be metro area REITs that are heavily weighted in a particular submarket.

If Felix and Ryan want to get households to stop overleveraging themselves in housing debt, maybe their best option is to start looking for venture capital.

Tyler Cowen writes:

Ben Daniels writes to me:

Seen at Johnny Rocket’s near LACMA:

Pancakes. Delicious buttermilk pancakes, served with bacon or sausage & warm syrup.

Two pancakes 4.99 

Three pancakes 4.99

Error aside, how might we account for this?  One option is that the company wants to give the "three pancake consumers" the sense they are receiving a bargain.  I suspect, by the way, that the marginal supply cost of an extra pancake is quite small.  The extra pancake may also increase your demand for high-margin beverages.  What else might be the explanation?

Having been a cook in a breakfast restaurant I’d argue that the marginal cost of pancakes is indeed essentially zero. At least, off-peak. On-peak perhaps not.

Pancake batter is made all at once and the squirted onto the griddle with a machine. The difference between two squirts and three is negligible as is the attention difference associated with monitoring the extra pancake. They will all be flipped at the same time and served at the same time.

So the major cost difference is the batter and even then its only stochastic since you always make more batter than you need. I suppose giving away a free third pancake raises marginally the probability of having to whip up a new batch of mix before the shift is over, but only by the tinniest of amounts.

My guess is that the same list price is to be cute. It costs essentially nothing and it has already produced free publicity.

Scott Sumner and David Beckworth are vocal in their defense of NGDP targeting over inflation targeting.

I want to start by saying I applaud the efforts of both economists to raise attention to the issue of insufficient aggregate demand and means by which the Federal Reserve can combat it. Economists and economic philosophers have long recognized the important role that the quantity of money plays in the business cycle.

Since the work of Milton Friedman, many of us have come to the conclusion that money and credit are the primary drivers of fluctuations in economic activity. Scott and David are calling our attention to the need to act on such knowledge to alleviate human suffering. This is the highest and best role for scholars within our society.

However, the case for supporting a target for Nominal GDP is by no means open and shut. There are at least four reasons why this is the case, two academic and two practical. I will begin with the academic.

First, instability. It is at least a theoretical possibility that Nominal GDP target could lead to instability because prices and output do not respond at the same time to a single action by the Fed.

Suppose that we enter a credit bubble where nominal spending expands rapidly as credit risk is underpriced. Such a bubble would show up as a rise in Nominal GDP. The Fed would respond by tightening the money supply.

Tightening would have the immediate impact of raising unemployment and bringing real GDP down. Nominal GDP would fall as well and the Fed will meet its target.

Over the next 18 months, however, the rate of inflation would trend down in response to tightening. This would lead the Fed to loosen money. Unemployment would fall, Nominal GDP would expand and the Fed would hit its target.

However, over the next 18 months, the rate of inflation would trend up wards in response to looser money. The Fed would tighten money. Unemployment would rise, Nominal GDP would fall and the Fed would hit its target.

However, over the next 18 months . . .

This process could in theory continue indefinitely. The Fed is hitting its target every time but because the same policy instrument effects the different parts of Nominal GDP at different times a permanent instability is induced. Both unemployment and inflation are high in one period. Both unemployment and inflation are low in the next. Nominal GDP is stable but the variables of interest are not.

There are perhaps ways of combating this but we should be aware of the risk.

Second, changes in productivity growth rates. We have seen at least two secular changes in productivity. The slowdown of the 1970s and the speed-up of the 1990s. Both of these changes in productivity will tend to alter the rate the trend rate of Nominal GDP.

In the 1970s the Fed would have responded to the change in trend with expansionary monetary policy raising the rate of inflation unnecessarily. In the 1990s the Fed would have responded with contractionary monetary policy leading to unnecessarily heightened unemployment.

Note that these are not the policy responses to simple shocks but the policy responses to changes in trend.

Those are two academic reasons for being somewhat wary of a Nominal GDP target. The next two reasons are more practical in nature.

First, we have extensive experience with inflation targets and we can even speak a little to practical aspects of creating them. For example, many have noted that point targets actually result in more monetary flexibility than ranges. These type of experience lessons are valuable. Moving to an NGDP targeting regime would eliminate them.

I recognize that this is merely a restatement of the “First Mover Disadvantage” inherent in policy making. It is always better if the other guy makes the mistakes first and you can learn from him. At the same time the disadvantage is real and cannot be ignored, especially when one is dealing with the largest economy in the world and the international reserve currency.

Second, inflation is a topic which the financial community has a lot of experience with and a lot of concern over. It is clearly and without a doubt meaningful when we speak to financial actors about inflation targets.

Moreover, the general public does not internalize the Phillips Curve. It is hard enough to convince them that inflation might be good. If we start saying that the Fed is going to target growth then I am certain they will accuse us of thinking that we can “print growth on the printing press” and that we don’t even understand that printing money just produces more inflation.

I would judge it easier start by focusing on the fact that money does cause inflation, a fact which the public accepts, and then try to convince them that a little inflation is a good thing. This is merely a judgment, however, and I have no hard data either way.

I will say, however, that I very much like David Beckworth’s framing of a “National Spending Target.” This seems like an idea that we could work from. Though, I still think we will run into the  “these guys think spending = growth” problem.

So, I recognize and very much appreciate the attention that both Sumner and Beckworth have brought to this problem. I hope the will continue with their excellent work. However, at the same time I do not think that we should be whole heartedly committed to an NGDP target especially when the relatively low hanging fruit of an inflation target may be within reach.

Catherine Rampbell points us to an EPI report combating the arguments that our high unemployment is structural in nature. Rampbell notes

A few economists have been vigorously arguing against claims of structural unemployment, which they fear are being used merely to weaken the case for additional stimulus (which is generally intended to address more temporary, cyclical issues).

I don’t doubt that there are economists out there who are arguing against the structural hypothesis because they support more stimulus. I am not one of them. If you want to search this blog you can read some of my old takes on stimulus. However, I am not particularly interested in even having that debate.

You don’t like stimulus. Fine. I don’t care why. I am not interested in why.

I am interested in whether or not you support efforts to raise the level of inflation in the United States. Economists of all political stripes have long noted what former George W. Bush Advisor Greg Mankiw has called “The Inexorable And Mysterious Tradeoff Between Inflation And Unemployment

Let me offer two quotes from David Hume. The first to prove that he was no wide-eyed progressive.

I must, therefore, be of opinion, that [taking away power from the King and Nobility] would introduce a total alteration in our government, and would soon reduce it to a pure republic; and, perhaps, to a republic of no inconvenient form. . . . Let us cherish and improve our ancient government as much as possible, without encouraging a passion for such dangerous novelties.

The second to show Hume could observe the relationship between money and employment

In my opinion, it is only in the interval or intermediate situation, between the acquisition of money and the rise in prices, that the increasing quantity of gold or silver is favourable to industry. . . . The farmer or gardener, finding that their commodities are taken off, apply themselves with alacrity to the raising of more. . . . It is easy to trace the money in its progress through the whole commonwealth; where we shall find that it must first quicken the diligence of every individual, before it increases the price of labour.

Determining whether or not the millions of unemployed Americans are without jobs for structural or cyclical reasons  is not a partisan issue. It is not cudgel with which to beat up the other side. This is a question of whether or not we are going to exploit a long established trade-off to end the suffering of millions of our countrymen or whether like the Bank of Japan we are going twiddle our thumbs while our economy lies in ruin.

Arpit Gupta writes:

Yet Milton Friedman’s arguments against bubbles remains powerful. Why would investors not respond to the addition of crazy money by betting against the bubble? Sure, most investors can’t technically bet against housing, but home owners could choose to rent, there are REITs out there, etc. Why couldn’t rational trading eliminate the mispricing induced by government spending, assuming that the government did intervene in unprecedented amounts before 2002?

I think Arpit is underestimating the difficulty of making negatives bets on housing here. First off, rental markets for single family homes are thin in many areas and the stock of housing there is systematically different than the stock of owner occupied housing. People also do not appear to be strictly indifferent between renting and owning, and transaction costs can be very large.

Even if some homeowners are able to bet against the market, investors not currently owning homes cannot. So you have a market where investors and owners can bid the price up but only owners can bid the price down. It’s not really surprising in this circumstance that when opinions differ about what the relationship between fundamentals and prices should be that a bubble occurs. Without the ability to bet against housing the market essentially becomes an auction where only the highest valuations are observed. When the variance of expected prices among potential market participants increases it’s not surprising that observed prices increase as well, since only those in the high-end of the distribution will be observed.

Another issue is that unlike the market for pork-belly futures, housing markets are dominated by naive investors, e.g. owner-occupied buyers. Given emotional attachments and lack of sophistication about markets is it unsurprising that too many homeowners did not sell but instead held when prices rose above believable levels? In a country with so much owner-occupied housing, investors have a limited ability to affect markets compared to financial markets.

If I had to play homeowner psychoanalyst I would guess that homeowners with a strong preference for homeownership saw cap rates were changing and believed house prices were heading towards a permanently higher plateau that would permanently price them out of homeownership. People who would want to buy houses in the future but were currently renting had this fear as well and rushed into the market. Risk aversion here thus did not lead to selling when prices rose as a simple model might predict. Believable models of how rational households should have behaved in the bubble need to be pretty complex and account for things like this. Not knowing what behavior it prescribes, appeals to rationality here don’t persuade me.

Despite Bernanke’s outright rejection of a higher target James Hamilton notes that the Fed’s statement is a de facto attempt to signal a higher medium term inflation target

The most natural interpretation of those words is that the Fed is aiming at a long-run inflation target that’s higher than what we’ve been seeing lately. By its nature, that is a statement about what the Fed will be doing several years down the road, not a signal of something it’s going to do in November. In other words, it sounds a lot like the Fed is trying to follow the Eggertson-Woodford policy prescription.

To a large extent I agree with this. I also agree with Jim’s statement that

But [buying large quantities of long dated debt] are a blunt and potentially risky policy instrument, and are certainly not the only way the Fed is thinking about responding to the current difficulties.

One the advantages of an explicit, mildly higher inflation target is that we can nail down the risks fairly precisely. Indeed, the primary “risk” is that it will work and we will get temporarily higher inflation.

The same cannot be said for the type of qualitative easing that Bernanke seems to favor. Don’t get me wrong. I understand the logic. Some members feel that this is primarily an extended panic and that the Fed can arbitrage away some the of fear. Investors are more than willing to pile into short term US government debt. They are less willing to pile into mildly longer term agency debt. From a profit maximizing point of view this makes little sense.

Even if the Tea Party swept the Congress, impeached the President and Vice President and installed Speaker of the House Ron Paul as Commander-in-Chief I am still betting 3-to-1 that the US Treasury will continue to back Fannie and Freddie packaged debt.

The President doesn’t govern by sheer force of will. Actions need to be carried out by an administrative staff and such an action would be blocked by a bureaucracy that has no interest in hastening the end of the 300 year-old Anglo-American economic hegemony.

So why are investors pouring into Treasuries? I suspect and Bernanke may suspect that this is a Principle-Agent problem. No one can blame you for buying Treasuries in a crisis no matter what happens. Even if for very normal reasons Agency debt were to suffer mark-to-market losses the managers who bought it would be punished.

How could you have bought housing bonds in this crisis, the investors will demand. Arguments about implied risk will fall on deaf ears. Thus it makes sense for the Fed to arbitrage the difference.

However, this strategy itself is not without risks. The Fed is not immune to interest rate risk. It may seem as if the Fed controls interest rates but it does so in response to larger goals and conditions over which it has little control accept by adjusting interest rates. The Fed cannot defend its own balance sheet and the broader macroeconomy at the same time.

Inflation targeting on the other hand has been tried and tested. Experience tells us that markets will take a such a target seriously and modern macroeocnomics tells that such a target would be effective in reducing unemployment.


Will Wilkinson writes

Nobody has a problem with the idea that Americans and Canadians face different rates of inflation. Oh, different currencies? Then nobody has a problem with the idea that the French and the Spanish face different rates of inflation. Suppose God took the wealthiest, middle, and poorest third of Americans and put each group in their own new country. They all use U.S. dollars, just like the French, Germans, and Spanish all use the Euro. Would you freak out were you to find that inflation, as measured by a consumer price index, is different in these different countries? No, you would not freak out. It would be perfectly natural for each country’s government statistics nerds to track a basket of goods typical for that country’s consumers.

The price index problem is a gnarly one that I won’t pretend I have fully wrapped myself around. I struggled with a bit in the 90s when tech was growing so fast that everyone knew it was screwing with the indices. Since then I have left it alone.

To answer Will’s question though, I am puzzled at different price indices for different Eurozone countries. My understanding is that inside the Eurozone we have labor mobility, we have capital mobility and we have a standardized system of business law. That sounds close enough to me to induce the law-of-one-price.

The law-of-one-price is the idea that the exact same good should sell for the same price from two different vendors. If we observe different prices then that tells us that the good is somehow different. For example, an espresso in Paris is not the same as an espresso in rural Slovakia because the espresso in Paris comes with the ability to drink it on Parisian streets. People like Parisian streets and they like drinking their espressos there.

This is presumably why people choose to live in Paris despite the fact that land, housing and just about everything else is cheaper in Slovakia.

Thus, I would argue, saying Paris has a higher cost of living is just another way of saying that out of all the places that Europeans could live, work and shop relatively more of them prefer Paris and prices reflect that.

Also, I am not arguing that Parisians have more control over their lives.  An argument that Will acknowledges and waves away.

clearly, wealthier people have more such control than poorer people. Moreover, there can be no doubt that there is some value in having this kind of control, and that this is one of the things that money buys (in a sense of “buys” broader than the one that concerns the BLS). My sense is that critics of multiple price indexes believe that once we take into account the deeper utility or value of this kind of control over our own consumption pattern, we’ll see that overlooking the fact that the quality of low-cost goods has improved faster than the quality of high-priced goods has not led us to overestimate inequality, in a sense of “inequality” broader than income inequality.

Now, I am more than willing to entertain arguments to this effect, but it does need an argument. And it needs to be acknowledged that raising the question of the value of higher-level control over one’s consumption choices has no real relevance to the methodological correctness of using different price indexes for the rich and poor to estimate trends in income growth and inequality.

I largely agree that trying to value control only confuses the matter. If we are going to get into that then we have to start thinking about the hotshot computer programmer who spent all his high school days learning code because he couldn’t get a date with the prom queen. If he would have traded away all his subsequent earnings for one night under the stars with the girl of his dreams is he richer or poorer than the former quarterback who is now working at the mall selling the games our programmer designed?

However, that’s not the argument I am making. I am arguing that the fact that people who have more money choose to buy good X  and that retailers internalize this fact and charge more money for good X is hefty evidence that good X is more desirable and therefore better. Hence, we shouldn’t call people poorer because they choose to buy it.

Is there any reason to be fearful of diet soda? The overwhelming scientific consensus is no, there is not. Yet as a consummate consumer of Diet Pepsi I am frequently told that diet soda is dangerous, because it causes cancer or some other health problem. Now I won’t disagree that I’m digesting an unhealthy amount of caffeine, but that’s not what people are usually talking about; they’re talking about the “dangers” of artificial sweeteners. The frequency with which smart, educated people tell me  this is startling, and it makes me wonder to what degree the continued consumption of regular soda is this country is based on irrational and unfounded beleifs about artificial sweeteners. So as a (potentially pointless) public service, I’m going to explain exactly why we nothing to fear from diet soda and artificial sweeteners.

The controversy over artificial sweeteners is not old. Saccharine was invented in 1879, and the first attempt to ban it was in 1911 when panel of federal scientists called it “an adulterant” and concluded it was only fit for food “intended for invalids”. Aspartame was first synthesized in 1965 and initially approved by the FDA in 1974, but critics challenges to the initial studies and claims of conflicts of interest led the FDA to place the approval on stay which prevented it from being used until 1981.

Much of the opposition I hear to artificial sweeteners, and indeed medicine in general, is an appeal to uncertainty. People are think we don’t know what the long-term effects are and have a suspicion about what they see as some brand new chemical; the novelty itself being a cause for concern. But clearly these chemicals have been around for a long time, and one FDA official calls aspartame “one of the most thoroughly tested and studied food additives the agency has ever approved”, and it has also been called “one of the most rigorously tested food ingredients to date”. So appeals to lack of knowledge on the subject are unfounded.

What do these studies tell us? Here is what leading health and science organizations conclude:

  • American Cancer Society: Research on artificial sweeteners, including aspartame, continues today. Current evidence does not demonstrate any link between aspartame and an increased risk of cancer
  • National Cancer Institute, National Institutes of Health: There is no clear evidence that the artificial sweeteners available commercially in the United States are associated with cancer risk in humans…
  • Mayo Clinic: …numerous studies confirm that artificial sweeteners are safe for the general population.
  • FDA: Food safety experts generally agree there is no convincing evidence of a cause and effect relationship between these sweeteners and negative health effects in humans. The FDA has monitored consumer complaints of possible adverse reactions for more than 15 years.

So there is a large consensus among health and food safety organizations that artificial sweeteners are safe with respect to both cancer and other negative health effects.

Aside from the vast empirical literature showing the safety of artificial sweeteners, there is good theoretical reason to believe they are safe. For example, contrary to popular perceptions that aspartame is some new mystery chemical that directly impacts the body in unknown ways, it is actually broken down by the body into three common metabolites: methanol, phenylalanine and aspartic acid. Wikipedia provides a useful overview of why these chemicals are safe in the amounts found in aspartame.

The amount methanol isn’t a cause for concern because it’s less than is found in fruit juice and other natural sources. Phenylalaline is an essential amino acid that is “required for normal growth and maintenance of life”, and is present in any normal diet in larger amounts than will be found in typical consumption of aspartame. Aspartic acid is “one of the most common amino acids in the typical diet”, and the amount of it found in aspartame is around 1% to 2% of the normal daily consumption of it.

You can’t really be suspicious of artificial sweeteners without taking a paranoid stance towards leading health and scientific organizations in this country, and towards science itself. Most educated people who hold suspicions about artificial flavorings nevertheless trust the conclusions of science and scientific institutions on other issues, like global warming and evolution. So how do these people decide when to trust scientific consensus and when not to? If you’re going to be a scientific nihilist, then you should at least do so consistently.

Matt Yglesias made the case recently that we should increase teachers’ salaries in order to raise teacher quality. He provides this graph showing teacher salary compared to per capita GDP in different countries:

Unfortunately for Matt, if he wants to increase teacher salaries the last thing he should be doing is telling people how much teachers make. A 2009 survey by Education Next and Harvard’s Program on Education Policy and Governance surveyed 3,000 people and split them into two groups. In the first group they found that 56% supported increasing teachers’ salaries and 46% supported increased education spending. The second group was first told the average teacher salary in their state and the average spending per pupil and then they asked them the same questions. Support for more teacher pay fell from 56% to 40% and support for more education spending fell from 46% to 38%. Apparently a majority of people favor higher teacher pay, but not when they know how much teachers currently make.

In reality the responses would probably be different if they were shown Matt’s graph rather than just told how much we spend. But the fact that people support higher education spending less when they know more doesn’t bode well for those who want to increase it.

Arnold Kling starts a list.

I’ll add the early 1980s. Intellectually its one of the most fascinating because

1) Its as close to a test of modern macro theory as we have. We thought if we shrank the growth rate of the money supply we would get a recession but we also lower the rate of inflation. That’s exactly what happened.

2) It was the beginning of the Great Moderation, a period that despite our current problems, I still hold up as one our greatest victories.

In the spirit of openness and admission of our own weaknesses I will say that there is the potential I am biased by (2). I’d like to believe that I have accounted for my own bias and that I am basing my statements on the evidence.

However, it would be foolish to ignore the possibility that I want to believe that monetary policy was responsible for the Great Moderation and so I am blaming monetary policy for the poor performance today. It could be wishful thinking that if only the Fed did things right prosperity would return.

I’ve done what I can to check that bias internally. I leave it to my readers and colleagues to judge whether my evidence is compelling.

Move over George Mason. The DC and NYC blogging communities trying to keep up, fuggedaboutit.

UNC is on the march. Consider mega-opinion makers:

Modeled Behavior


Economics Roundtable

NC Criminal Law

I am sure there are more I don’t know about.

From Fiscal Times

Many economists think the Fed could bring about this positive trend simply by announcing that it has raised its inflation target from two percent to three or four percent. If people believe the Fed means it will take actions to bring it about, then it becomes a self-fulfilling prophecy.

It’s a neat theory and it might work, but it hinges critically on the Fed finding a way, institutionally, of raising its inflation target and having the credibility that people will believe it. I have serious doubts on both counts.


Getting the Fed to adopt a more expansionary monetary policy is a theoretical, institutional and political problem. What it will take to force action at this point is anyone’s guess. The one thing that unambiguously would help is to get the board to full strength so that there will be more voices at the next FOMC meeting urging action to counter those that fear inflation like little children fear the boogeyman.

Having this conversation is the important first step. I am happy to hear Bruce’s voice. I’d argue that inflation targeting per se has long been a topic of interest in monetary policy. I wouldn’t think of it as a fad or neat theory.

Nor, does the Federal Reserve have an explicit inflation target. Various officials have from time to time framed the issue as a comfort zone. But, more typically the Fed itself makes opaque comments about “the level consistent with price stability.”

These differences may seem esoteric but they matter. A Fed which takes inflation as an indicator is different than one which makes a commitment to the market that it will do everything prudent to achieve a specific goal.

Lastly, not to start a nerd food fight, but I would say the dispute between  inflation targeting, price level targeting and NGDP targeting generates more heat than light.

As former Fed Governor Mishkin points out  market participants tend to think of inflation as a long run trend rather than a month to month indicator. The data are noisy and participants understand that the central bank will respond to threats to growth over the short term. Adopting a meaningful inflation target is largely equivalent to adopting a medium term price level target.

A true distinction only emerges over long time periods, of four to five years or more. In such cases I believe the Fed can meaningful and credibly discuss the extent to which inflation has run below expectations and that there is a need to make up for that. At the heart of the matter is the desire  that long term contracts be made with the least uncertainty possible.

Lastly, and I know I may be stepping on some toes here, but I am not sure there is an enormous practical distinction between NGDP targeting and a well applied Taylor Rule.

Unless we think the Fed is influencing productivity or the growth of the labor pool then functionally NGDP is a composite of the rate of inflation and the rate of unemployment. If you want higher NGDP you either have to make more stuff or that stuff needs to cost more. That means more employment or more inflation.

Where a difference could arise is if you move to a formal scheme of targeting NGDP futures as Scott Sumner suggests. This is an interesting proposal and it warrants a thorough discussion. However, at this moment our primary concern is to induce expansionary monetary policy. I believe that is most plausibly framed as a temporarily higher inflation target.

The Obama administration has a plan to make it harder for poorly performing for-profit colleges to receive funding while ignoring poorly performing non-profit colleges. While a move in the right direction, this generally reflects the non-profit bias we have in this country. Tax laws contain numerous benefits that vary state by state but can include state property, sales, and income tax exemptions. In addition, there are federal tax exemptions for certain types of non-profit organizations. Why should it be that organizations which generate a profitable amount of value be privileged over activities which generate only as much or less value than is profitable?

The implicit notion here is that activities that are profitable are less socially valuable than activities that aren’t, and this strikes me as a pretty poor proxy for welfare. I would venture that Google and all other web companies create more consumer surplus than every non-profit in the country combined. Before you start singing the praises of the Salvation Army or some other charitable organization that does good, keep in mind that the total value of non-profits includes the value of James Dobsons’ Focus on the Family and Swift Boat Veterns For Truth, which is significant and negative. Compare the combined net value of any given 1,000 non-profits to the value of Google Maps, Gmail, Youtube, and all of the other free services Google provides and I would wager that Google wins.

Internet companies are not alone in generating lots of welfare either, think of the welfare generated New York Times, the Washington Post, and the L.A. Times that they are not capturing in revenues.

According to the National Center for Charitable Statistics, as of 2005 and measured by expenses, 15.1% of non-profits are education oriented and 60.5% are health oriented, the majority of which are hospitals and other primary care facilities. Now health is a valuable thing, but it is not the same thing as health care. Most experts would agree that a lot of money spent on health care is unnecessary or even harmful, and because of the public subsidies to health care, prices are inflated. Pretty much the same thing can be said of education. This is not to say that these things aren’t valuable, but that every dollar of spending from these organizations does not necessarily generate a dollar in value, and on average the value created may be equal to or less than the total amount spent. If I were Robin Hanson I would argue that the value generated is certainly much less than the total amount spent.

Of course some health spending, like basic research, would also qualify as non-rivalrous public goods, and the value there is probably much higher than what is spent. But that is likely a small percentage of the total non-profit healthcare spending in this country.

Much of what’s produced by Google and the New York Times, in contrast, is to a large extent non-rivalrous, public goods. Every dollar of revenue they receive reflects more than a dollar of value they generated, because they only capture a very small fraction of the value they provide to consumers. It is not hard to imagine that for every $1 of Google’s $23 billion in 2009 revenue they generated $25 in value, meaning a consumer surplus of $552 billion. Does that number sound crazy? Just looking at the U.S., that would mean they’re generating $1,840 of value per person per year. That sounds believable if not conservative to me. If all websites could perfectly price discriminate, most people would be willing to pay much more than that for all of the services Google offers.

All U.S. non-profits in contrast spent $1.4 trillion in 2007. If they’re getting around than $2 for every $1 they spend, it means the welfare Generated by Google alone is equal to 1/6 of the welfare of all non-profits combined. Again, I’m sure Robin Hanson would argue nonprofits do even worse than that.

I can understand why we want to subsidize activities that generate lots of social welfare, but there has to be a better proxy than a promise to not profit.

Tyler Cowen points to an interview with Justin Wolfers on interdisciplinary work. The money quote:

So [psychologists] have a different method of trying to isolate causation. I am certain that we have an enormous amount to learn from them. But I am curious why we have not been able to convince them of the importance of careful analysis of observational data.

At the recent economics conference I had an opportunity to hear from a very bright young psychologist. The data measures that psychologist had were fascinating but the regression analysis was horrid.

I wouldn’t let a senior seminar student get away with what was in that presentation. I suggested to the psychologist that we trade insights over the year. I am still hopeful that we will.

UPDATE: Just to be clear I didn’t mean this as a dig at psychology but a cosign on Wolfers’ contention that we have much to learn but much to offer as well.

I don’t have time to do too much on this but thanks to the folks at the St. Louis Fed – who are doing the Lord’s work – I can produce a quick graph to make a point.

There are lots of explanations for why we had a housing bubble, but I suggest that there was nothing unusual about the price of housing. Construction costs went up a bit during the boom. What really soared in price was the land the housing was sitting on.

What was the cause of this: Fannie/Freddie, the CRA, the Ownership Society, Republicrats and Democans, Countrywide!? Well, I don’t know about all those but I do know that the soaring price of land didn’t look any different than the soaring price of everything else that comes out of the ground.

Here is the run-up in housing prices versus the Producer Price index for Crude Goods, ie stuff that comes out of the ground. The thick pink line is the Crude Goods index.The thin lines are the housing price indexes from the various census regions. The top thin blue line is the Pacific Region. The bottom green line is the East North Central Region, which is basically the rust belt.

The index is based on 100 for everything just before the 2001 recession started.


As you can see crude prices are more volatile. I argue this is because housing is in part made of an actual house not just the land the house sits on. But, you can see that places were land is the majority of the cost of housing – the coastal regions – saw the biggest run up and the biggest decline.

I chose the beginning of the recession as the index period for the very sophisticated reason that its one of the options on the FRED instant graph drop-down box. If you look at the end of the recession the dominance of crude goods is even more obvious.


Now we can ask and I think we should, why housing prices actually started to tank so soon. I think that has to do with the fact that the credit collapse came in the US before the rest of the world and so internationally traded crude goods continued to rise in price even after demand for land  in the US had slowed down.

Though let me be clear. I don’t mean this as the definitive word by any means. This is the just a rough cut from 15 mins on FRED. However, I think it makes the basic point: the soaring price of land didn’t look weird in comparison to the soaring price of other crude goods.

As a side note, I’d be interested to see if we had a mobile home bubble. I don’t know the details on lending for the purchase of mobile homes but regardless I am guessing that the price appreciation for mobile homes sans land was negligible.

There must be something about nail salons that causes them to price discriminate more actively than other businesses. Recently a story made headlines about a nail salon charging higher prices for overweight customers, and now there is another story about a nail salon charging men higher prices. The former is potentially justified on a cost basis, e.g. heavier customers wear out the chair faster, but I can’t see any reason why men would cost more than women to do a manicure for. Since cost does not appear to be the issue, it must be the case that the average willingness to pay is higher for men then for women.

The story is that Jimmy Bell went into a nail salon to get a manicure and was charged $4 extra for being a man. Being that Jimmy Bell is, as the Washing Post put it, a “lawyer with a knack for the headline-making case” he obviously could not tolerate this grievance and is suing the salon for $200,000.

Whether or not Jimmy Bell is a crybaby and a waste of everyone’s time and money is an issue I’ll leave aside, because I’m more interested in where society and the legal system will draw the line on issues like this.

For starters, there appears to be a significant stigma against charging different prices to the obese, and somewhat less of a stigma against charging to different genders, whereas nobody seems to have any objection to senior citizens and children’s discounts. This is somewhat counterintuitive, as you would expect people to be more against charging based upon something upon which we have absolutely no control, such as age or gender, rather than something over which we have some control, like weight.

One explanation for this counterintuitive belief may be that people are more willing to tolerate discriminations that are framed as discounts rather than penalties. Senior citizens and children get discounts, whereas men and the overweight are charged a premium at a nail salon. These are functionally the same, but the framing is different.

People may also be more tolerable of discrimination that is widely shared rather than singling out some minority. So a premium for a man in a nail salon (where men are a minority) is less acceptable than a premium for men at a gym, where the gender mix is more equal.

Intuitively, most people don’t object to Ladies Night discounts at bars, although enough have taken the trouble to bring lawsuits that it is illegal in several states. California’s Unruh Civil Rights Act has been ruled as prohibiting Ladies’ Night at a nightclub and Ladies’ Day at a carwash, and the Gender Tax Repeal Act of 1995 specifically outlawed any gender based price discrimination. Californians, it seems, have something against price discrimination. Other states, like Illinois, Pennsylvania, and Washington have allowed it.

In contrast, there is a generally widespread agreement that businesses should not be allowed to price discriminate against people on the basis of skin color, although some libertarians will dissent (cue Bryan Caplan to defend race based discrimination).

So is there a clear line about what kind of price discrimination is acceptable and which isn’t? Some states like California have taken a very hard-line against price discrimination, putting the burden of proof upon businesses to provide cost based justifications. For example, auto insurance companies are forbidden from setting rates for an individual based on anything other than three factors: their driving record, how many miles they drive, and their years of driving experience. Others states, in contrast, are more lenient.

Libertarians who support businesses’ right to discriminate have the advantage of a clear-cut and unambiguous line, whereas those who object have to explain why some is okay and some isn’t, and provide some consistent basis for doing so. Otherwise you’re left consistently rejecting price discrimination like California does, which is clearly an inefficient overreach, or wasting time and money on what most would regard as frivolous cases. On the other hand, those who object have the advantage of pointing to race based discrimination, which based on our ugly history of racism in this country we have a strong reaction against.

I suspect our solution will continue to be ad hoc and messy, which very well may be the best approach. My hope is that we can prevent drifting towards California.

Scott Sumner complains that liberals are suddenly changing their tune on monetary policy. Perhaps, but this is the time to make love not distracting infighting.

I don’t have to remind Scott that he and I live a life that is virtually recession proof. Millions of Americans do not. This isn’t the time to be alienating anyone who might help our cause.

And just for the record, since I didn’t make the initial list


100 Basis Points

I am off to the state legislature this morning so no faux statement. However, I still maintain that there is no tightrope. The Fed has to be focused on preventing the liquidity trap and jump starting credit markets as soon as possible.

Moreover, M1 is flat and credit contracting. This should be leading to an effective decline in the money supply. Ultimately that is deflationary.

The statement should have some nod to commodity prices and risks but the predominate concern is stability in financial markets and the outlook for growth. In short, look out below, we are heading for 1% as fast as is prudent.


and of course

FRIDAY, MARCH 14, 2008

Liquidity Trap, Delfation, ZLB

Lots of people have said to me both on and off line that we don’t have to worry about the Japan Scenario because we have a solid inflation buffer in the US.

While the inflation buffer gives us more room in a sense, it is important to remember that it is not deflation per se that causes a liquidity trap. It is that the equilibrium interest rate is below zero.

It is possible that the equilibrium risk free interest rate is a real negative 3% in this crisis, which implies that we still won’t be able to get there with 2.7% inflation.

Exploding risk premiums could drive the equilibrium real rate that low because what matters is credit availability to firms and consumers.
So we are not in a position were we can ignore the liquidity trap possibility. On top of that is the issue that there are increasing deflation pressures in the decline collateral values, falling consumption and the potential for dramatically slower global growth. While ultimately they might not override inflationary effects of recent Fed policy, they are not to be ignored.

In short deflation cannot be ruled out and the liquidity trap remains a threat even in a moderately inflationary environment.


I think I have as much standing as Scott to grumble about Johnny-come-latelies but this simply isn’t the time.

Menzie Chinn makes the point that there is no sharp distinction between cyclical unemployment and structural. That is, the longer a recession goes on the more and more people will become semi-permanently unemployed. Ryan Avent co-signs.

I think the data on this phenomenon, known in economics circles as hysteresis, is compelling. Though, we don’t know exactly why it occurs. Stories about lost skills and disaffected workers are easy to come by. Hard data is not.

However, hysteresis should be properly interpreted as saying “Monetary policy has long lasting real effects” not that recessions are purely the result of real shocks or mismatch.

Hysteresis increases the urgency for higher inflation targets and indeed encourages us to pursue higher permanent inflation. If we believe hysteresis is true then that suggests that there is a semi-permanent tradeoff between inflation and unemployment.

This is the exact opposite of the matching / micro-imbalance story. I have not emphasized hysteresis because I think it is controversial and I don’t think we need to focus on it to come to an agreement that the Fed needs more aggressive monetary policy.

However, the take away is this: to the extent hysteresis is true this episode of disinflation and recession has dragged up the NAIRU, or natural level of unemployment. Yet, the same theory suggests that a period of rising inflation levels could drag down the NAIRU.

Hysteresis is not a reason not to act but a further imperative to action.

As far as I am aware the only reasons not to act are that either

1) We think 3 – 4% inflation is worse than 10% unemployment.

2) We believe that there are purely real effects at work and monetary policy cannot affect those.

The first is, of course, a value judgment though I consider it wildly off base. Still, I am willing to give more time to discussing the long run consequences of a little inflation.

The second is an empirical question with a right answer and a wrong one. I suggest that the right answer is that monetary policy can affect our situation and I will continue to post that evidence here.

The illegal immigrants come seeking higher wages, steady employment and a chance at better lives for their families. They cross the border in remote stretches where there are no fences or they pay traffickers to sneak them past border guards.

Then they work as maids, harvest crops or toil hunched in sweatshops.

Think you’ve heard this story before? No, it’s not illegal Mexican immigrants coming into the United States, but Southeast Asian, North Korean, and African illegal immigrants coming into China. If you think our border problem is daunting, consider that China’s mostly unprotected border stretches 13,670 miles across rain forests, mountains, and deserts.

According to the article, from the L.A. Times, the demand for foreign labor comes from rising Chinese wages and a shortage of low-skilled workers, and those willing to do harder field work at profitable pay. For instance:

Chinese farmer Lu Qixue hires Vietnamese laborers before the autumn sugar cane harvest. For as long as five grueling months, the foreign workers put in 10-hour days thwacking sugar cane stalks with scythes.

“They work slowly and we always have to train them, but we can’t find enough skilled Chinese,” said Lu, a rail-thin 58-year-old village chief with gravelly stubble. “If we don’t hire the Vietnamese we won’t be able to grow as much.”

“I don’t want to carry sugar cane down the mountain,” said his youngest son, Lu Xinghuan, 26, who aspires to own a trucking company. “It’s hard work.”

Labor activists said the increasing use of undocumented foreigners is undermining gains made with China’s 2008 labor law regulating working hours and workplace conditions.

For those who oppose more immigration and want to crack down on illegals, I am curious if they think that welfare would be increased in this scenario by preventing the vietnamese workers from coming into the country, and thus decreasing the output of the cane farmer and his wealth and spending power. I suspect people will be more sympathetic to illegal immigration into China than they are with illegal immigrants into this country.

Duke University surveys 937 Chief Financial Officers. The relevant highlights:

“Cash exists in two locations: bank reserves and balance sheets of healthy companies,” Harvey said. “Banks show no sign of unfreezing credit. They are lending to the government, not to businesses. However, U.S. firms are sitting on over $1.8 trillion in cash. When will it be unleashed?”

The survey results show 50 percent of respondents have no intention of deploying their cash over the next 12 months. More than half of responders say they will continue to sit on cash for liquidity to protect against another round of credit tightening and general economic uncertainty. Of the 50 percent that will deploy cash, only 56 percent will allocate to capital spending and investment.

“We were especially interested in the type of capital spending that creates jobs,” Harvey said. “The survey shows only 22 percent of firms say their new capital spending will lead to hiring. This bodes very poorly for employment in 2011.”

Its tempting to think big problems must have big complicated causes. Yet, there is a simple story that explains our economic woes: a dramatic increase in liquidity demand which the Fed still refuses to address.

So far, the data seem to support that simple story.

The 4% Club is still accepting nominations.

Just a reminder folks: Larry Summers is leaving his job as head of NEC when Larry Summers feels good and god-damned ready and not a moment before. That is unless you want to see him start exploding heads with his giant-brain-powered telekinesis.

Yeah, I didn’t think so.

I was going to write up a post on my exasperation at the Fed’s recent meeting statement, but Ezra Klein got to it before me and did a good job, so you should go read what he has to say. One point that I want to highlight, because I have made the point that the dual mandate is mostly just an insiders joke:

Paragraph two: We admit everything is terrible. In fact, it’s so terrible that it means we’re failing our mandate. “Measures of underlying inflation are currently at levels somewhat below those the Committee judges most consistent, over the longer run, with its mandate to promote maximum employment and price stability. With substantial resource slack continuing to restrain cost pressures and longer-term inflation expectations stable, inflation is likely to remain subdued for some time before rising to levels the Committee considers consistent with its mandate.”

[Image Courtesy of David Beckworth]

How many of you wish that you had a job where you could consistently fail at the very time when it is clutch that you deliver in a big way? How many of you would like to say, “Well, I have a model of the economy that says we won’t be hitting any of our own targets…but oh well”? The Federal Reserve is in the exact position in the economy where they can act quickly and decisively and actually make a large impact on nominal spending. I would even go as far as to say that they can do so without “long and variable lags”, as markets should price in actions by the Fed nearly immediately, and indeed they have been.

Contrary to the popular narrative, I believe that it is this very passivity by the Fed that brought us to the brink in the fall of 2008, when every indicator of economic activity (industrial output, consumer spending, business confidence, NGDP expectations, etc.) were found to be in sudden free-fall mode. At that time, interest rates were in the 1.5%-2% range, and the Fed’s target was still 2% until October 2008!

And here we are, fully two years later, and we still cannot get the Fed to act…nor can we get the executive branch of government to take the problem seriously! This inaction belies an institution that either is ill-equipped to respond when necessary, or is structured in a way that prevents decisive action. Since I believe that the Fed has all the tools it needs (it being a monetary superpower), I would place the blame on the structure of the network.

There is nothing more important on the Fed’s plate right now than bringing nominal spending back in line with the previous trajectory of NGDP. Not only to assist 50 million people who are currently unemployed, and help numerous others rebuild their balance sheets…but to save our economy from the whims of populist sentiment that will likely take hold if our economic malaise continues for very much longer. That means rounds and rounds of fiscal stimulus. That means the development of an entire class of freeters who never reach full potential. And most importantly, that means the loss of real goods and services that could otherwise be produced in our economy — which translates into a lower real standard of living for everyone.

At this point I would do anything for a little more monetary stimulus.

Even if I think I know someone’s policy preferences I haven’t included them on the list unless they tell me themselves they want to be included or I find a written work advocating a higher inflation target or something functionally equivalent.

Greg wrote this a while back and I read it, but had forgotten.

If [randomly destroying unspent cash] seems too outlandish, there is a more prosaic way of obtaining negative interest rates: through inflation. Suppose that, looking ahead, the Fed commits itself to producing significant inflation. In this case, while nominal interest rates could remain at zero, real interest rates — interest rates measured in purchasing power — could become negative. If people were confident that they could repay their zero-interest loans in devalued dollars, they would have significant incentive to borrow and spend.

Having the central bank embrace inflation would shock economists and Fed watchers who view price stability as the foremost goal of monetary policy. But there are worse things than inflation. And guess what? We have them today. A little more inflation might be preferable to rising unemployment or a series of fiscal measures that pile on debt bequeathed to future generations.

I want re-emphasize Greg’s last point.

A little more inflation might be preferable to rising unemployment or a series of fiscal measures that pile on debt bequeathed to future generations

Today stimulus is a bad word. We had a big one and people are still hurting. We can debate whether or not fiscal stimulus is effective at all. However, I will lay down a bet that if unemployment hovers near its current rate for the next 3 –5 years then yearly stimulus will become de rigueur in the United States.

Lets look at what happened in Japan, a very business friendly nation with taxes that have been traditionally lower than the United States.


Conservative pundits take heart. We’re still accepting applications

Embarrassingly, I tweeted a request to Neil after his article was published. I apologize for the oversight. Neil’s application:

Somewhat higher inflation could strengthen the ailing economy. Inflation would make the heavy debt that Americans carry a bit more manageable as wages rise but the amount owed stays the same. And it would create more incentive for businesses to invest their cash rather than sit on it, because inflation would reduce the value of hoarded money.

He also notes

Fed policymakers could try to break this cycle with large-scale purchases of bonds, essentially flooding the economy with hundreds of billions of dollars in new money. The Fed will discuss such an approach at a policy meeting Tuesday but is unlikely to take the steps then.

Which is correct. This is the long war. However, if Japan is any guide we could be in for high unemployment for a decade or more unless action is taken.

In my darker movements I worry that some of my more conservative friends are reluctant to join because the poor economy has been so bad for Obama’s poll numbers.

Have no fear. Increasing the target itself is a long process and the effects come with lags. This isn’t about where unemployment will be come November. It will take months, perhaps a year or more , to even begin to see an effect. Even if the Fed announced a higher target today, it wouldn’t save the Democrats this Fall.

Paul Krugman has linked approvingly to Karl’s post on Fannie and Freddie, and I want to use this renewed attention to his piece as an opportunity to disagree with it. Well, maybe not disagree, but at the very least I want to present an alternative story of Fannie, Freddie, and the bubble that is inconsistent with his, and which I have yet to see a strong argument against.

Whether or not you agree that a bubble had actually started by 2002, it’s clear that fundamentals had become divorced enough from historical levels to begin convincing some people, notably Dean Baker, that a bubble was present. To me this divergence and the subsequent uncertainty around it was a key driver of the huge and indisputable bubble that followed the debatable 2002 and 2003 semi-bubble.

Once fundamentals were potentially outside historical levels, it became unclear to market participants and economists what the fundamentals were anymore. Thus, a signal which traditionally could be used to hold prices in check was gone, and the only signal market participants were left with was prices themselves. It’s as if someone turned out street lights and the only way drivers could navigate is by looking at each others headlights and tail lights. It’s easy to see how this could lead everyone collectively far from the roads despite behaving rationally individually given the information available to them. This uncertainty and unanchoring of fundamentals set off the herd behavior that drove prices even higher, this lured private companies in who eventually crowd Fannie and Freddie out of the market.

Now herd behavior of market participants is also causal here, but that doesn’t mean that the initial divergence of fundamentals that set the herd off was not causal as well. However, this story does make Fannie, Freddie, and their enablers less negligent than typical stories that assign causality to them. This is because few could have foreseen that causing fundamentals to somewhat diverge from historical levels would set off such extreme herding behavior. This unforseeableness of the consequences means you can’t exactly call their policies reckless. In contrast, had they been the primary force continually driving the prices higher and higher to manic levels, as some narratives of the bubble hold, then one might call them reckless.

So that’s one story of Fannie, Freddie, and the bubble. Maybe it’s not the right one, and maybe Karl’s is, but I’ve yet to hear a convincing case for why it’s wrong.

I want to continue my assault on the idea that we need to look under every rock for the causes of our current economic tragedy. Lots of things are going on for sure. There are trade imbalance, skill mismatches, Wall Street shenanigans, and uncertainty about the future of taxes and regulation.

However, good science seeks to abstract from the messy details of reality and get right to the core story. A the end of the day what is the biggest economic driver?

This is not to say that economic particulars are not important; no more than the ideal gas law implies that hydrogen and water vapor behave the same. However, if you want to understand why your boiler exploded you are probably going to look to a modified gas law as a start.

I want to abstract from everything else and just look at whether or not employment can be jerked around by monetary policy. Can printing money at an ever faster rate lead to the creation of jobs as many economists suspect?

We know that printing money at a faster rate will eventually lead to increasing inflation. So, lets take a look at increases in the rate of inflation versus increases in the number of jobs.

The correlation is not perfect, but there seems to be a fairly strong relationship. Especially if we allow, as Milton Friedman suggests we do, for “long and variable lags” we see a strong pattern.


Here I have chosen a lag of 12 months. Remember that I am not charting inflation but the change in the rate of inflation, year-over-year. So there is a built in lag in addition to the one I am performing manually.

Also, note that it looks like the lag time between real effects and inflation might have been longer in the 60s and shorter just recently, though its seems like 12 months is right on for the 70s and 80s.

Now, here is the thing. A lot of other stuff is going on here. There is the entry of the baby boomers into the workforce, the productivity slowdown, the entry of women into the workforce, the secular decline of manufacturing, several wars, etc, etc.

None of that is being controlled for. What this chart implies is that even given all of those “big things” much of the change in the employment growth can be explained by changes in the rate of inflation. And this is without any attempt to model the “expectations” that virtually all economists, myself included, think are important.

If we restrict our attention to construction and manufacturing, I think the relationship becomes tighter though the timing more varied.


Next I want to put a moving average on price acceleration instead of a lag. If you notice price acceleration bounces around a lot more than employment growth. A moving average will give a smoother – though less responsive – picture of what’s happening.


Again, no labor unions, no tax policy, no rise of China. None of that is in here. Its inflation and jobs in the construction and housing sectors.

Now, let me show you the chart including what I consider the very likely and very dangerous “Japanese Scenario”

Here I show what would happen to price acceleration if year-over-year inflation continued to fall. I model year-over-year inflation bottoming .2% in the spring of next year then slowly rising a holding steady at .5% Note, that there is no actual deflation in this story. Its just near zero and then very low inflation.


I haven’t developed an actual forecasting model, so I can’t show you what construction and manufacturing employment growth would do over that same period. However, you can infer that such a path for inflation would imply that employment growth in manufacturing and construction will soon peak (at around zero) and then start to fall again.

This gives you a sense of what’s on the line when we think about inflation expectations. Currently they are very low and declining. Chart courtesy of David Beckworth.


This suggests a bleak future for employment regardless of what happens with stimulus, taxes, health care, unions, China, Europe, or any other non-monetary factor you can imagine.

Even if the Fed moved immediately to a target of 4% it would take many months and probably years to hit that target. In the mean time employment in construction and manufacturing will suffer. At this point that’s likely unavoidable.

The question is what actions can we take now to pull off a robust recover over a two to five year horizon. If we fail to do that, the Japanese Scenario will be upon us.

Arnold Kling has become a leading critic of Hydraulic Macro, the notion that you add up economic aggregates pull a few levels and watch the economy respond.

In response he suggests that the economy is incredibly dynamic with millions of jobs being lost or gained every month. He points to JOLTS data as evidence.


I couldn’t agree more. I’ve argued that the economy is a dynamic churn ever since graduate school. The thing is – so is hydraulics. All liquids are composed of millions of rolling molecules going to and fro. The net of all of that is what we think of as macro level hydraulics.

Personally, I prefer the comparison to fluid dynamics more generally, which allows for interface instability, distinctions between compressible and non-compressible flow, turbulent and laminar flow, etc.


We have millions of particles that are sometimes moving in patterns that can easily be modeled and then sudden breaks where those easy models fall apart completely.


We have micro world that is much richer and much more dynamic than the marco world we observe.


And we have everyday phenomena which are fundamental to our society but scientists still have trouble explaining to laymen why they occur.


Wikipedia on aerodynamic lift

An explanation of lift frequently encountered in basic or popular sources is the equal transit-time theory. Equal transit-time states that because of the longer path of the upper surface of an airfoil, the air going over the top must go faster in order to catch up with the air flowing around the bottom.[27] i.e. the parcels of air that are divided at the leading edge and travel above and below an airfoil must rejoin when they reach the trailing edge. Bernoulli’s Principle is then cited to conclude that since the air moves faster on the top of the wing the air pressure must be lower. This pressure difference pushes the wing up.

However, equal transit time is not accurate[28] and the fact that this is not generally the case can be readily observed.[29] Although it is true that the air moving over the top of a wing generating lift does move faster, there is no requirement for equal transit time. In fact the air moving over the top of an airfoil generating lift is always moving much faster than the equal transit theory would imply.[6]

The assertion that the air must arrive simultaneously at the trailing edge is sometimes referred to as the “Equal Transit-Time Fallacy”

This is Fluid Dynamics and its not as different from macroeconomics as you might think.

I have long made the point that economic value is not GDP – not even in theory. You don’t have to step outside of economics to see this. Its right there in Econ 101.

Two markets. Same contribution to GDP. Very different Consumer Surpluses and hence very different economic values.

The George Mason lunch group asks

What non-subsidized common products and services do you think have the highest average consumer surplus? Cell phones? Shampoo? Antibiotics? Just wondering.

Tyler responds with

Obviously it depends what margin you are at; for many people antibiotics or pharmaceuticals mean the difference for life or death but right now they do not for me.  And surely we cannot answer with “all food” or “all water.”

So I am not sure what he means by the margin here. I thought the question was asking if we add up the total consumer surplus and then divide by the number of consumers which market has the biggest number. This is inherently an average based stat. But, anyway.

I do think potable water would rank pretty high though in general it is subsidized. If the we think about the alternative of getting your water through household production then I am pretty sure people would be willing to trade away much of their endowment – the wealth, talent and physical labor power they were born with – in order to get market supplied water.

Food probably not as much, actually.

My “non-necessity” answer though is pretty conventional: internet content. Not access. Content. Most people pay nothing for it. However, if there was a scheme that eliminated transactions costs but nonetheless charged for everything you watch, listened to or read online, I am guessing it would fetch a hefty fraction of most families income.

Another chart to steal from Real Time Economics, this time provided by Justin Lahart.

The classic hydraulic macro story would imply that someone is hoarding cash. It would be really nice then if we could look around and see some cash being hoarded. Indeed, we do.

A point I want to make is that none of these pieces of evidence is in-and-of itself conclusive: The small business survey, the flow of funds, inflation expectations, etc.

There could be explanations for all of them that involve something other than the traditional liquidity demand story: that is that recessions are caused by excess demand in the market for cash/bonds/safety.

However, the liquidity demand story suggests that certain things should all be happening at the same time: a decline in the demand for labor, a decline in the purchase of durables, a decline in consumer prices and business’s pricing power,  a decline in asset prices, a decline in inflation expectations, an increase in cash holdings, an increase in the ease of finding workers, etc.

And, all of those things are happening.

I like to focus on inflation because I think just about all of us have agreed that inflation is primarily controlled by actions at the Fed. Thus close patterns between inflation and other variables should suggest that they are also controlled by the Fed.

Here is fraction of income spent on durables and inflation.


Ed Leamer likes to say that its all durables and housing. I think there is more going on in housing than money creation but lets check the Leamer story versus inflation.


Looking at durables only suggests that inflation might flatten out soon. Looking at durables and new houses suggests that deflation will be upon us for sure. It will be interesting to see what happens.

Note, however, that this is not saying that a reduction in income spent on durables and housing will cause a decline in inflation. Its saying the Fed has already taken certain actions. The immediate result of those actions is a decline the fraction of income spent on durables and new houses. The future impact of those same actions will be a decline in inflation.

In other words the inflation decline is already baked in. What we have to ask ourselves now is whether we want to take actions that would raise inflation expectations for the medium future.

Just about everyone is familiar by now with the so called “hockey stock graph” showing that global temperatures have gone from steady to a sharp increase over the past two decades. The reason for it’s name is apparent in the graph below: the previous 1000 years are long and flat, like the long handle of a hockey stick, and the past few decades show a sharp increase, like the end of a hockey stick. A new paper from two statisticians questions whether the data actually produce a hockey stick shaped graph at all.

The paper look at the methods used to estimate a single global temperature series from the hundreds of data sets on temperature from tree rings, ice cores, and other natural phenomenon.  The dataset used to create the above graph contains 1,209 climate proxies ranging from 8855 BC to 2003 AD, eight global annual temperature aggregates from 1850-2006 AD, and 1,732 local annual temperatures dating 1850-2006 AD. Reducing these series to one timeseries of global temperatures is a difficult statistical task, especially given the spatial and temporal autocorrelation, missing observations, more covariates than timeperiods, regime switching, and weak signal to noise ratio.

The basic statistical task is that the authors have to model a relationship between the longer-time series, which are temperature proxies, and the more recent time series, which are actual temperature measures. If a reliable relationship can be modeled, then actual temperatures in can be backcasted in periods where such measures don’t exist, e.g. back before 1850, using the proxy variables.

Here is how the authors summarize their results:

On the one hand, we conclude unequivocally that the evidence for a ”long-handled” hockey stick (where the shaft of the hockey stick extends to the year 1000 AD) is lacking in the data. The fundamental problem is that there is a limited amount of proxy data which dates back to 1000 AD; what is available is weakly predictive of global annual temperature. Our backcasting methods, which track quite closely the methods applied most recently in Mann (2008) to the same data, are unable to catch the sharp run up in temperatures recorded in the 1990s, even in-sample… Consequently, the long flat handle of the hockey stick is best understood to be a feature of regression and less a reflection of our knowledge of the truth.

The authors present the following graphs of global temperature generated using bayesian models:

The long story short is that a hockey stick shape may not be the best representation of the data; some of their models produce graphs that look like hockey sticks, and some don’t. As seen in the figure above, using bayesian methods the long-handle of the hockey stick disappears. They conclude that proxy data may not be useful for predicting actual temperatures at time periods of several decades, let alone centuries.

However, the authors importantly note that “the temperatures of the last few decades have been relatively warm compared to many of the thousand-year temperature curves sampled from the posterior distribution of our model.” Furthermore, the evidence for global warming comes from a variety of sources and “paleoclimatoligical reconstructions constitute only one source of evidence in the AGW debate”. Global warming is still real, and still a serious threat, but this single visually compelling piece of evidence does not appear to be the best interpretation of the data.

ADDENDUM: In the comments Kevin Drum says that he doesn’t see a substantial difference between the two graphs. Fair enough. But I would point out two things about the graphs that illustrate the important differences. In the hockey stick graph the recent run-up in temperature anomalies exceeds the confidence intervals for the past century, whereas in the authors’ graph the recent run-up does not. Thus in the former case we can say the current run-up exceeds previous values in the past 1,000 years, whereas in the latter case we may not have exceeded previous values.  Comparing confidence intervals over the entire series emphasizes that fact further.

As one more illustration I’ll provide another graph from the paper which shows three different models that perform similarly:

Here the difference is clear. If the red line is the correct measure of temperature anomalies it is a significantly different story than if the green line is correct. The red line here provides a hockey stick graph consistent with the first graph that we are all familiar with, whereas the green and blue lines don’t look like any hockey stick I’ve ever seen. Now I know they do some things a little different in California where Kevin is from than they do here on the east coast, so I could chalk this up to cultural sporting differences… but I saw The Mighty Ducks, Kevin, they were from Anaheim, and their hockey sticks handles were flat like the red graph.

Final note,  please avoid using the comments to debate anything other than the statistical issues at hand; this is not the place to argue about climate science or climate politics in general. Let’s keep it limited to dimensionality reduction and time series statistical analysis.

Update: I probably should have put “during the recession” in the title. Unfortunately it’s gone to press.

Chevelle, at Models and Agents, explains why the previous round of “quantitative easing” performed by the Fed did not have a [sufficient] expansionary effect:

By that metric, the Fed’s past LSAPs have probably fallen short. Clearly, measuring the counterfactual is impossible, but there are reasons to believe that the impact on aggregate demand was small. Why? First, because the reduction in mortgage rates boosted refinancings only by people who could refinance—i.e. people with jobs and some positive equity in their home. Not exactly the most cash-strapped ones who would have spent the extra cash.

Second, the portfolio-balance effect of the LSAPs on the prices of assets like corporate bonds or equities is at best weak, if not counterproductive. The reason (which I explained in detail here) has to do with the fact that US Treasuries and MBS are not “similar in nature” to corporate debt and equities. Unlike the latter, Treasuries/MBS have more of a “safe haven” nature—so that removing them from investors’ portfolios create demand for more “safe” assets, rather than boosting the prices of equities, high yield bonds, etc.

Luckily, one Benjamin S. Bernanke explained how to perform private asset purchases that would, in fact, have an expansionary effect:

If the Treasury issued debt to purchase private assets and the Fed then purchased an equal amount of Treasury debt with newly created money, the whole operation would be the economic equivalent of direct open-market operations in private assets.

If you see that guy around, tell him to talk to the Federal Reserve. I remember hearing a podcast with Scott Sumner a while back where he floated the idea of the Fed buying bonds off of the public (i.e. You and I), and paying for them with cash. Lets get to it!

Surowiecki’s application

If the Fed were to moderately raise its inflation target—currently around two per cent—and commit itself to keeping prices moving higher for the next couple of years, it could help change this dynamic. If people believe that prices are going to rise in the future, they may be less cautious about spending in the present, since money that isn’t put to work will lose value. And, because inflation erodes the real value of debts, people’s debt burdens would shrink.

James we’re glad to have you and love that you are taking the time to address fears surrounding a higher target. This is the conversation we need to be having.

If people have concerns about a moderately higher target, let them be known. We are not looking to steam roll anyone. Please, tell us what worries you.

Would love to hear some voices from the National Review or Weekly Standard.

Reihan Salam?

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