exemplify unprincipled courtiers, who talk sagely of important considerations, and can find sage reasons for any opinion

From Overcoming Bias:

"Defending Mankiw

By Robin Hanson · June 7, 2009 11:00 pm · Discuss · « Prev ·

Via Will Wilkinson, I learn Ezra Klein heartily endorsed Matt Yglesias’s complaint on “the habit of distinguished economists using prestige acquired within their field to pass off sloppy work in other fields.” He gives only two examples; one is Greg Mankiw’s “pretty half-assed moral philosophy.” Mankiw had argued:

The moral and political philosophy used to justify such income redistribution is most often a form of Utilitarianism. For example, the work on optimal tax theory by Emmanuel Saez … is essentially Utilitarian in its approach. … If you are going to take that philosophy seriously, you have to take all of the implications seriously. And one of those implications is the optimality of taxing height. … A moral and political philosophy is not like a smorgasbord, where you get to pick and choose the offerings you like and leave the others behind without explanation.

Matt Yglesias was outraged:

I think there are a ton of mistakes being made here. … How dangerous it is that the public discourse is so dominated by low-quality freelance philosophy done by people with PhDs in economics. I’m fairly certain that if Mankiw were to walk over to Emerson Hall he could find some folks (possibly T.M. Scanlon who I know sometimes reads this blog) who could explain to him that there’s little grounds for the belief that a commitment to utilitarianism is the main justification for redistributive taxation.

Gee Matt, given such strong language, don’t you feel some obligation to offer supporting evidence? Mankiw cited an example, and you even cite your classmate Neil Sinhababu supporting redistribution on utilitarian grounds. Where is the contrary evidence? And even if Mankiw happens to be wrong here, he doesn’t seem crazy or sloppy wrong - an awful large fraction of ethical analyzes justifying redistribution are utilitarian, even if they aren’t strictly the most common.

Note that it isn’t obvious that a Rawlsian analysis won’t similarly support a height tax. Also note that many professional philosophers blog, and none have yet voiced support for your condemnation of Mankiw’s unexcusably sloppy philosophy.

Yglesias continued:

I think the “smorgasboard” argument is a confused way of thinking about moral reasoning. … If forced to contemplate the alleged contradiction, there are a bunch of things we might want to consider. Maybe the analysis of the height issue has gotten something wrong, utility-wise. After all, though the paper is clever, it’s hardly a comprehensive review of all of the hedonic issues in play. Or maybe utilitarianism isn’t the best theoretical grounding for the conviction that murder is wrong. Or, maybe the height tax thing actually is a good idea, albeit an unrealistic one. But since this isn’t a “live” subject of political controversy, and since there seem to be a lot of other more clear-cut policy issues, we decide to spend our time and energy thinking about less outlandish policy suggestions.

So the reason Yglesias gives that Mankiw’s “alleged contradiction” is wrong is that, hey maybe Mankiw made a mistake, and anyway Yglesias is too busy to think about crazy proposals? (Though not too busy to defame Mankiw based on them.) Yglesias learned of Mankiw’s claim via Conor Clarke, who similarly said:

Everyone has moral intuitions they can’t justify in the same we can justify the pythagorean theorem, and I don’t see the point of fighting that strong impulse in the name of a hobgoblin-ish consistency. … I have a strong moral intuition — even though I know it’s one I can’t justify — that height is something I deserve. But proving that my moral intuitions are an inconsistent smorgasbord doesn’t mean I’m going to give them up!

To me, Yglesias and Clarke exemplify unprincipled courtiers, who talk sagely of important considerations, and can find sage reasons for any opinion, and so need never allow analysis to move them from the dictates of inertia or fashion. In contrast, principled philosophers understand that raw moral intuitions are noisy, and so seek coherent moral frameworks which they expect will require them to reject some raw intuitions, and embrace some unfashionable conclusions.

What am I missing Matt? Is this your whole case for saying Mankiw’s philosophy is “half-assed,” and half your case that sloppy economist-philosophy is destroying public discourse? That Mankiw plausibly claims most philosophy analysis supporting redistribution is utilitarian, and that you don’t have time to consider Mankiw’s proposal?

In another post, Yglesias elaborates on economists’ bad philosophy:

Fairly abstract misguided ideas in ethics, political philosophy, and economics have come to have extraordinary cultural and political power … all to incredibly pernicious effect. … Most of these ideas are propounded, originally, by people whose degrees are in economics. …

One important set of ideas is the perverse notion that it’s wrong or inappropriate to subject people to moral criticism for making selfish decisions as long as the decisions don’t involve breaking the law. … Another example is … under guise of eschewing values, economics has adopted a philosophical value system which says that the well-being of rich people is more important than the well-being of poor people. … As a third example, … the idea that when empirical evidence seems to contradict basic economic theory … that we ought to accept the theory as true.

These seem bizzare complaints. I’ve never heard any economist say theory should always trump data, nor that legal acts are beyond criticism. We criticize, for example, folks who selfishly drive at rush hour, getting in other folks way. And standard econ lectures emphasize that the efficiency standard has little to say against unexpected redistribution; it mainly recommends allowing trade after redistribution.

Added: An anonymous reader offers more cites of utilitarian justifications of redistribution:

Chapter 23 of Dave Schmidtz’s Elements of Justice.

Nagel, Thomas 1991. Equality and Partiality. Oxford: Oxford University Press, 65.

Hare, R.M. 1982. “Ethical Theory of Utilitarianism,” in Sen and Williams, eds. Utilitarianism and Beyond. 23-38. Cambridge: Cambridge University Press, 27.

Baker, Edwin. 1974. “Utility and Rights: Two Justifications for State Action Increasing Equality,” Yale Law Journal 84: 39-59, 45-47.

Lerner, Abba. 1970. The Economics of Control. New York: Augustus M. Kelley Publishers, 28 & 32."

Me:

Don the libertarian Democrat

June 8, 2009 at 10:33 am | Reply

Your comment is awaiting moderation.

“The moral and political philosophy used to justify such income redistribution is most often a form of Utilitarianism.”

“there’s little grounds for the belief that a commitment to utilitarianism is the main justification for redistributive taxation.”

These are both put forward as statements of fact. I have no idea if either is true. Does anyone else? Philosophically speaking, following Austin, say, we might want to begin by asking what kind of utterances these are, and what justification is given for them.

Sonia Sotomayor is a millionaire three times over

From Grasping Reality with Both Hands:

"Most Unfair Attack on Sonia Sotomayor" Contest Entry: Greg Mankiw

The amount of s--- that has been thrown at Sonia Sotomayor is truly amazing.

Now we have another entry in the "most unfair attack on Sonia Sotomayor" sweepstakes...

Greg Mankiw writes:

Greg Mankiw's Blog: SCOTUS nominee is a spender: [T]here are two types of people: Some save and intertemporally optimize their consumption plans, while others live paycheck to paycheck.... Some people with low incomes manage to scrimp and save (I always think of my grandmother), and some people with high incomes spend most everything they earn. Apparently, the new Supreme Court nominee Sonia Sotomayor is an example of the latter. The Washington Post reports that the 54-year-old Sotomayer has a $179,500 yearly salary but on her financial disclosure report for 2007, she said her only financial holdings were a Citibank checking and savings account, worth $50,000 to $115,000 combined. During the previous four years, the money in the accounts at some points was listed as low as $30,000. My grandmother would have been shocked and appalled to see someone who makes so much save so little...

Sonia Sotomayor has a large defined benefit pension with a current market value of roughly $2.5 million.

Sonia Sotomayor has roughly $1 million in equity in her Greeenwich Village condo.

Sonia Sotomayor has no descendents to bequeath wealth too.

I bet Greg Mankiw's grandmother would indeed be shocked and appalled--but not at the fact that Sonia Sotomayor is a millionaire three times over."

Me:

Is that there some kind of requirement that you have to go to a few select law schools in order to qualify as a Supreme Court Justice? She seems fine, but this Ecole Normale quality to these appointments strikes me as weird. Posted by: Don the libertarian Democrat

the FOMC would have to reduce the funds rate to -5% by the end of this year—well below its lower bound of zero

TO BE NOTED: From Greg Mankiw:

"More on Negative Interest Rates From Glenn Rudebusch of the San Francisco Fed:

The recommended future policy setting of the funds rate based on the estimated historical policy rule and these economic forecasts is given as the dashed line in Figure 2. This dashed line shows that, in order to deliver a degree of future monetary stimulus that is consistent with its past behavior, the FOMC would have to reduce the funds rate to -5% by the end of this year—well below its lower bound of zero."

And:

"FRBSF Economic Letter

2009-17; May 22, 2009

The Fed's Monetary Policy Response to the Current Crisis

• Interest rate actions and enhanced communications
• Fed's balance sheet actions
• Summary
• References

Download and Print PDF Version (133KB)
Download data file (Excel file)

---

The global financial market turmoil that started in August 2007 has been followed by a severe economic downturn. Indeed, the U.S. economic recession is on track to be the longest and deepest of the postwar period. This Economic Letter describes the Federal Reserve's monetary policy response to this financial and economic crisis. A key element of this response has been a reduction of the federal funds rate—the Fed's usual monetary policy instrument—essentially to its lower bound of zero. Still, with the economy continuing to slump, additional stimulus appears warranted, and the Federal Open Market Committee (FOMC 2009) has promised to "employ all available tools to promote economic recovery and to preserve price stability." Therefore, the Fed has eased financial conditions by employing a variety of unconventional monetary policy tools that alter the size and composition of its balance sheet. It has also communicated more explicitly its expectations for the course of monetary policy and the economy in order to help guide households and businesses during these uncertain times.

Interest rate actions and enhanced communications

As shown in Figure 1, over the past two decades, the Fed has set the federal funds rate, a key gauge of the stance of monetary policy, in a fairly consistent fashion relative to various economic indicators such as unemployment and inflation. (Figure 1 shows the quarterly average funds rate and unemployment rate, and the four-quarter inflation rate for prices of core personal consumption expenditures. See the related data file.) During the current and two previous recessions—around 1991, 2001, and 2008—the Fed responded to large jumps in unemployment with aggressive cuts in the funds rate. In addition, episodes of lower inflation also were generally associated with a lower funds rate.

A rough guideline for setting the federal funds rate that captures the Fed's behavior over the past two decades is provided by a simple equation that relates the funds rate to the inflation and unemployment rates. This equation is obtained by a statistical regression of the funds rate on the inflation rate and on the gap between the unemployment rate and the Congressional Budget Office's estimate of the natural, or normal, rate of unemployment. The resulting empirical policy rule of thumb—a so-called Taylor rule—recommends lowering the funds rate by 1.3 percentage points if core inflation falls by one percentage point and by almost two percentage points if the unemployment rate rises by one percentage point. As shown in Figure 2, this simple rule of thumb captures the broad contours of policy over the past two decades. Differences between the recommended target rate from the estimated policy rule (the thin line) and the Fed's actual target funds rate (the thick line) are fairly small. Exceptions occurred during the mid-1990s and mid-2000s, when the funds rate was set somewhat higher or lower than the policy rule recommended. During 2007 and 2008, by this rudimentary empirical metric, the Fed's lowering of the funds rate by over five percentage points was roughly in line with its historical behavior.

The estimated Taylor rule can also be used in conjunction with economic forecasts to provide a rough benchmark for calibrating the appropriate stance of monetary policy going forward. The dashed lines in Figure 1 show the latest forecasts for unemployment and inflation provided by FOMC participants—the Federal Reserve presidents and governors. (The dashed lines are quarterly linear interpolations of the median forecasts in FOMC, 2009.) Like many private forecasters, FOMC participants foresee persistently high unemployment and low inflation as the most likely outcome over the next few years. The recommended future policy setting of the funds rate based on the estimated historical policy rule and these economic forecasts is given as the dashed line in Figure 2. This dashed line shows that, in order to deliver a degree of future monetary stimulus that is consistent with its past behavior, the FOMC would have to reduce the funds rate to -5% by the end of this year—well below its lower bound of zero. Alternative specifications of empirical Taylor rules, described in Rudebusch (2006), also generally recommend a negative funds rate.

The shaded area in Figure 2 is the difference between the current zero-constrained level of the funds rate and the level recommended by the policy rule. It represents a monetary policy funds rate shortfall, that is, the desired amount of monetary policy stimulus from a lower funds rate that is unavailable because nominal interest rates can't go below zero. This policy shortfall is sizable. Indeed, the Fed has been able to ease the funds rate only about half as much as the policy rule recommends. It is also persistent. According to the historical policy rule and FOMC economic forecasts, the funds rate should be near its zero lower bound not just for the next six or nine months, but for several years. The policy shortfall persists even though the economy is expected to start to grow later this year. Given the severe depth of the current recession, it will require several years of strong economic growth before most of the slack in the economy is eliminated and the recommended funds rate turns positive.

Economic theory suggests that it is useful for the Fed to communicate the likely duration of any policy shortfall. Monetary policy is in large part a process of shaping private-sector expectations about the future path of short-term interest rates, which affect long-term interest rates and other asset prices, in order to achieve various macroeconomic objectives (McGough, Rudebusch, and Williams 2005). In the current situation, the FOMC (2009) has noted that it "anticipates that economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period." Other central banks have been even more explicit about the duration of low rates. For example, the central bank of Sweden has recently stated explicitly that it expects to keep its policy rate at a low level until the beginning of 2011. Rudebusch and Williams (2008) describe how such revelation of central bank interest rate projections may help a central bank achieve its policy goals.

Last February, FOMC participants also started to publish their long-run projections for output growth, unemployment, and inflation—in keeping with a trend toward greater transparency (Rudebusch 2008). Such long-run projections can help illuminate the FOMC's policy strategies and goals, and these revealed that most FOMC participants would like to see an annual inflation rate of about 2% in the longer run. Such an expression of a positive inflation objective may help prevent inflationary expectations from falling too low and forestall any excessive decline in inflation.

Fed's balance sheet actions

The size of the monetary policy funds rate shortfall has also caused the Fed to expand its use of unconventional policy tools that change the size and composition of its balance sheet. The Fed started to employ these balance sheet tools in late 2007 as unusual strains and dislocations in financial markets clogged the flow of credit. Typically, changes in the funds rate affect other interest rates and asset prices quite quickly. However, the economic stimulus from the Fed's cuts in the funds rate was blunted by credit market dysfunction and illiquidity and higher risk spreads. Accordingly, the Fed started to lend directly to a broader range of counterparties and against a broader set of collateral in order to enhance liquidity in critical financial markets, improve the flow of credit to the economy, and restore the full effect of the monetary policy interest rate easing.

Toward the end of 2008, the recession deepened with the prospect of a substantial monetary policy funds rate shortfall. In response, the Fed expanded its balance sheet policies in order to lower the cost and improve the availability of credit to households and businesses. One key element of this expansion involves buying long-term securities in the open market. The idea is that, even if the funds rate and other short-term interest rates fall to the zero lower bound, there may be considerable scope to lower long-term interest rates. The FOMC has approved the purchase of longer-term Treasury securities and the debt and mortgage-backed securities issued by government-sponsored enterprises. These initiatives have helped reduce the cost of long-term borrowing for households and businesses, especially by lowering mortgage rates for home purchases and refinancing.

In terms of overall size, the Fed's balance sheet has more than doubled to just over $2 trillion. However, this increase has likely only partially offset the funds rate shortfall, and the FOMC has committed to further balance sheet expansion by the end of this year. Looking ahead even further over the next few years, the size and persistence of the monetary policy shortfall suggest that the Fed's balance sheet will only slowly return to its pre-crisis level. This gradual transition should be fairly straightforward, as most new assets acquired by the Fed are either marketable securities or loans with maturities of 90 days or less. Still, any economic forecast is subject to considerable uncertainty. Some outside forecasters have warned of a deeper and more protracted recession, in which case, the monetary policy funds rate shortfall and the balance sheet expansion would be even larger and more persistent. In contrast, other analysts have argued that the Fed's growing balance sheet will lead to a resurgence of inflation (despite Japan's recent historical experience to the contrary of an increasing central bank balance sheet and falling inflation). With much higher inflation, the policy shortfall would be reduced and the Fed would need to shrink the size of its balance sheet and raise the funds rate earlier than suggested by Figure 2. Still, the Fed's short-term loans can be unwound quickly, and its portfolio of securities can be readily sold into the open market, so there should be ample time to normalize monetary policy when needed. Finally, some economists have cautioned about reading too much into policy shortfall projections (and negative funds rate recommendations) that rely on uncertain estimates of the degree of economic slack. Such considerations are always important for real-time policymaking (Rudebusch 2001, 2006), but the degree of uncertainty regarding estimates of the natural, or normal, rate of unemployment over the past two decades pales in size relative to the depth of the ongoing recession.

Summary

The Federal Reserve is employing all available tools to promote economic recovery and price stability by lowering borrowing costs and boosting credit availability. In particular, after lowering the federal funds rate to essentially zero, the Fed has turned to unconventional policy tools to help accomplish its goals. Eventually, as the economy recovers, it will be appropriate for the Fed to reduce the size of its balance sheet toward pre-crisis levels and to raise the funds rate, and the Fed has both the means and the determination to do so.

Glenn D. Rudebusch
Senior Vice President and Associate Director of Research

References

[URLs accessed May 2009.]

Federal Open Market Committee. 2009. "Minutes of the Federal Open Market Committee," April 28­-29.

McGough, Bruce, Glenn D. Rudebusch, and John C. Williams. 2005. "Using a Long-Term Interest Rate as the Monetary Policy Instrument." Journal of Monetary Economics 52, pp. 855-879.

Rudebusch, Glenn D. 2001. "Is the Fed Too Timid? Monetary Policy in an Uncertain World." Review of Economics and Statistics 83(2) (May) pp. 203-217.

Rudebusch, Glenn D. 2006. "Monetary Policy Inertia: Fact or Fiction?" International Journal of Central Banking 2(4) December, pp. 85-135.

Rudebusch, Glenn D. 2008. "Publishing FOMC Economic Forecasts." FRBSF Economic Letter 2008-01 (January 18).

Rudebusch, Glenn D., and John C. Williams. 2008. "Revealing the Secrets of the Temple: The Value of Publishing Central Bank Interest Rate Projections." In Monetary Policy and Asset Prices, ed. John Campbell. Chicago: University of Chicago Press, pp. 247-284."

The basic story was and is the housing bubble. How could they miss an $8 trillion housing bubble?

From Dean Baker:

"Sorry Greg, This Crisis Was Completely Predictable and Predicted

Gregory Mankiw uses his NYT column today to give us an explicit "who could have known?" about the economy crisis. He tells readers that: "fluctuations in economic activity are largely unpredictable."

No, this crisis was completely predictable. The problem was that the leading lights in the economics profession completely missed the boat and are now using their platforms to tell the public that it wasn't their fault.

The basic story was and is the housing bubble. How could they miss an $8 trillion housing bubble? What were they smoking?

We have a hundred year long trend, from 1895 to 1995, when nationwide house prices just track the overall rate of inflation. Suddenly in the mid-90s, coinciding with the stock bubble, house prices begin to hugely outpace inflation.

The run up in prices cannot be explained by any obvious shifts in the fundamentals of supply and demand. Furthermore there is no remotely corresponding increase in real rents. And, the vacancy rate for housing rises to record levels.

If economists could not see this bubble, then they should look for another line of work. Sorry, this fluctuation was entirely predictable. The people whose job responsibilities including recognizing a dangerous bubble like this one just blew it completely. It speaks volumes about the nature of the U.S. economy that almost all of those people still have their jobs, unlike the tens of millions of other workers who lost their jobs or can only work part-time because of the incompetence of the economists.

--Dean Baker

Posted by Dean Baker"

Me:

I think it's fair to criticize people for missing the housing bubble, but the appearance of Debt-Deflation might well have caught many intelligent people by surprise. It certainly caught William Gross by surprise.

On the housing bubble, I don't believe that it was totally crazy from a human point of view, but it was economically crazy. I mean by that the desire to own a house was driven by fears of being impoverished during old age. For twenty years, we've heard warnings that we will not receive social security. Pensions have also been seen as less viable. Consequently, many people looked into saving more for retirement. This was sensible.

However, many people find it very hard to save for retirement. Hence, it seemed sensible to see if they could find savings from their monthly expenses. This led to the perception that renting is a sucker's game, and that the only real possible for saving for retirement was to turn rent or housing expenses, which are necessary, into an investment. This was not a stupid idea.

The bubble was dependent on this perception, and another one often heard during the bubble, which is that, if you don't buy a house now, then you never will. That was the real motivation behind the asinine theory that housing prices always go up.

I guess you can tell that I believe that people were taken advantage of in this crisis. This motivation also fed into the tech bubble.

To not understand the panic that many people feel about retirement will skew the explanations of what really caused this crisis.

I know that other countries don't fit this theory as well as the US, but I haven't seen enough data to discount it.

I could say more about this issue, but I simply want people to understand why people felt desperate to own a house.

Posted by: Don the libertarian Democrat

inference has to be done from model-based extrapolation rather than from clean "natural experiments" whose results we can all agree on

TO BE NOTED: From Statistical Modeling, Causal Inference, and Social Science:

"Difficulty of forecasting, and of causal inference when n=1

By Andrew Gelman on May 18, 2009 2:14 PM | 9 Comments

Greg Mankiw has a nice little discussion of the difficulty of evaluating the effects of interventions in the n=1 setting:

As Mankiw points out, the bad news about the unemployment rate is bad news with or without the recovery plan and thus--although it certainly seems to knock down the predictions shown in that graph--it does not provide much information on the causal effect of the fiscal stimulus. Especially given that the graph comes from a report released in early January, before anyone knew what would end up being included in the final version of the stimulus plan.

As Mankiw writes, this is "a reflection of the inherent uncertainties associated with macroeconomics." It's a tough problem, because decisions have to be made, and these decisions will implicitly or explicitly be based on causal inference. It's just that much of this inference has to be done from model-based extrapolation rather than from clean "natural experiments" whose results we can all agree on.

P.S. I'm wondering a little bit about the placements of the points on the graph. First, I'd recommend against using triangles as a graphing symbol! Is the exact value supposed to be in the middle of the triangle, or maybe the top vertex? I think dots would be better. Second, I can't quite follow the x-axis. The graph places March halfway between Q1 and Q3, but is that right? I'd think that halfway between Q1 and Q3 would be the center of the year, that is, June/July. But I could be missing something here; I don't have experience working with this sort of data.

P.P.S. This is an interesting example of a graph where perhaps it's actually appropriate for the y-axis not to go down all the way to zero, if we accept 3% as some sort of lower bound on unemployment in normal circumstances."

If Americans were convinced of the Fed’s commitment, they’d buy and borrow more now, he says.

TO BE NOTED: From Bloomberg:

"U.S. Needs More Inflation to Speed Recovery, Say Mankiw, Rogoff

Share | Email | Print | A A A

By Rich Miller

May 19 (Bloomberg) -- What the U.S. economy may need is a dose of good old-fashioned inflation.

So say economists including Gregory Mankiw, former White House adviser, and Kenneth Rogoff, who was chief economist at the International Monetary Fund. They argue that a looser rein on inflation would make it easier for debt-strapped consumers and governments to meet their obligations. It might also help the economy by encouraging Americans to spend now rather than later when prices go up.

“I’m advocating 6 percent inflation for at least a couple of years,” says Rogoff, 56, who’s now a professor at Harvard University. “It would ameliorate the debt bomb and help us work through the deleveraging process.”

Such a strategy would be risky. An outlook for higher prices could spook foreign investors and send the dollar careening lower. The challenge would be to prevent inflation from returning to the above-10-percent levels that prevailed in the 1970s and took almost a decade and a recession to cure.

“Anybody who has been a central banker wouldn’t want to see inflation expectations become unhinged,” says Marvin Goodfriend, a former official at the Federal Reserve Bank of Richmond. “The Fed would have to create a recession to get its credibility back,” adds Goodfriend, now a professor at Carnegie Mellon University’s Tepper School of Business in Pittsburgh.

Preventing Deflation

For the moment, the Fed’s focus is on preventing deflation -- a potentially debilitating drop in prices and wages that makes debts harder to repay and encourages the postponement of purchases. The Labor Department reported May 15 that consumer prices were unchanged in April from the previous month and were down 0.7 percent from a year earlier.

“We are currently being very aggressive because we are trying to avoid” deflation, Fed Chairman Ben S. Bernanke told an Atlanta Fed conference on May 11.

The central bank has cut short-term interest rates effectively to zero and engaged in what Bernanke calls “credit easing” to spur lending to consumers, small businesses and homebuyers.

Bernanke, 55, said the risk of deflation was receding and that the Fed was ready to reverse course when needed to maintain stable prices and prevent an outbreak of undesired inflation. The Fed has implicitly defined price stability as annual inflation of 1.5 percent to 2 percent, as measured by a price index based on personal consumption expenditures.

Lifting Prices, Wages

Even after all the Fed has done to stimulate the economy, some economists argue that it needs to do more and deliberately aim for much faster inflation that would also lift wages.

With unemployment at a 25-year high of 8.9 percent, workers are being squeezed. Wages and salaries rose 0.3 percent in the first quarter, the least on record, according to the Labor Department, as companies including Memphis, Tennessee-based based package-delivery company FedEx Corp. and newspaper publisher Gannett Co. of McLean, Virginia slashed pay.

Given the Fed’s inability to cut rates further, Mankiw says the central bank should pledge to produce “significant” inflation. That would put the real, inflation-adjusted interest rate -- the cost of borrowing minus the rate of inflation -- deep into negative territory, even though the nominal rate would still be zero.

If Americans were convinced of the Fed’s commitment, they’d buy and borrow more now, he says.

Mankiw, currently a Harvard professor, declines to put a number on what inflation rate the Fed should shoot for, saying that the central bank has computer models that would be useful for determining that.

Gold Standard

In advocating that the Fed commit itself to generating some inflation, Mankiw, 51, likens such a step to the U.S. decision to abandon the gold standard in 1933, which freed policy makers to fight the Depression.

Faster inflation might be preferable to increased unemployment, or to further budget stimulus packages that push up the national debt, says Mankiw, who was chairman of the Council of Economic Advisors under President George W. Bush.

The White House has forecast that the budget deficit will hit $1.84 trillion this fiscal year, or 12.9 percent of gross domestic product. Rogoff doubts that politicians will be willing to reduce that shortfall by raising taxes as much as needed. Instead, he sees them pressing the Fed to accept faster inflation as a way of easing the burden of reducing the deficit.

Easier Debt Repayment

Inflationary increases in wages -- and the higher income taxes they generate -- would make it easier to pay off debt at all levels.

“There’s trillions of dollars of debt, in mortgage debt, consumer debt, government debt,” says Rogoff, who was chief economist at the Washington-based IMF from 2001 to 2003. “It’s a question of how do you achieve the deleveraging. Do you go through a long period of slow growth, high savings and many legal problems or do you accept higher inflation?”

Laurence Ball, a professor at Johns Hopkins University in Baltimore, says it’s risky to try to engineer a temporary surge in inflation because it might spark a spiral of rising prices.

Even so, he sees good reasons for the Fed to lift its implicit, medium-term inflation target to 3 percent to 4 percent from 1.5 percent to 2 percent now.

To battle recession, the Fed had to cut interest rates to 1 percent in 2003 and zero in the current period. That implies its inflation target has been too low because it’s left the Fed running up against the zero bound on nominal interest rates.

Inflation Advantage

“The basic advantage of pushing inflation a little higher is that it would make it less likely that we run into the problem of the interest rate hitting zero and the Fed not being able to stimulate the economy if necessary,” Ball says.

John Makin, a principal at hedge fund Caxton Associates in New York, wants the Fed to go further and target the level of prices instead of simply a rate of inflation. Such a policy would mean that if inflation fell short of 2 percent over a period of time, the Fed would have to push inflation above that rate subsequently to make up for the shortfall and keep prices rising on the desired trajectory.

While that might sound radical, it’s the same sort of policy that Bernanke advocated Japan follow in 2003 to fight deflation. In a speech in Tokyo that year, then-Fed Governor Bernanke called on the Bank of Japan to adopt “a publicly announced, gradually rising price-level target.”

‘Bad for Creditors’

Some investors are already worried that Bernanke will go too far. “We’re on the path of longer-term, higher inflation,” says Axel Merk, president of Merk Investments LLC in Palo Alto, California. “It’s good for debtors but it’s bad for creditors. It’s dangerous and irresponsible.”

Billionaire investor Warren Buffett, chairman of Berkshire Hathaway Inc. in Omaha, Nebraska, suggested that faster inflation was all but inevitable.

“A country that continuously expands its debt as a percentage of GDP and raises much of the money abroad to finance that, it’s going to inflate its way out of the burden of that debt,” he told the CNBC financial news television channel on May 4, adding, “That becomes a tax on everybody that has fixed- dollar investments.”

To contact the reporter on this story: Rich Miller in Washington rmiller28@bloomberg.net"

not a feature on this specific administration but is, instead, a reflection of the inherent uncertainties associated with macroeconomics

TO BE NOTED: From Greg Mankiw's Blog :



"Accountability? Click on the graphic to enlarge. Source.

When the Obama stimulus plan was proposed, the president's economic team put out a report in January 2009 that purported to show what would happen with and without the fiscal stimulus. The chart above is from page four that report, together with the actual results over the past couple months. As you can see, the actual outcome is significantly worse than the projection with the stimulus plan and is, in fact, roughly on track with what was projected without the stimulus.

What does this mean? One interpretation is that the fiscal stimulus has failed to achieve what Team Obama thought it would. Another interpretation is that the baseline was worse than they believed at the time. I am confident the report authors would adopt the second interpretation. If so, that fact is consistent with what I said in a previous post: In light of the shifting baseline, it is impossible to hold the administration accountable for whether its policies are achieving their intended effects.

To be clear, this lack of accountability is not a feature on this specific administration but is, instead, a reflection of the inherent uncertainties associated with macroeconomics. The administration, however, has not been particularly forthright in admitting to this lack of accountability. Indeed, the act of releasing quarterly reports on how many jobs have been "created or saved" gives the illusion of accountability without the reality.

Wir lernen dort, dass die amerikanische Zentralbank den optimalen Zins bereits bei "minus 5 Prozent" sieht

TO BE NOTED: From Chiemgauer:

"Presse und Medien

Harvard-Professor Mankiw empfiehlt der US-Notenbank Negativ-Zinsen

Die Krise in den USA ist mittlerweile so tief, dass ernsthaft über die Geldpolitik nachgedacht wird. Kein Geringerer als Prof. Gregory Mankiw greift die Freigeld-Idee Silvio Gesells auf, um einen einfachen Vorschlag auf den Tisch zu bringen: Das Festhalten von Geld wird besteuert. Diese Methode sei sehr viel effektiver als die immense Überschuldung des Staates.

Mankiw zitiert den Vorschlag eines Studenten: In nicht vorausgesagten Abständen erfolgt eine Verlosung der letzten Ziffer der Seriennummern des Geldes. Wer im Besitz eines Scheins mit der gezogenen Endziffer ist, bezahlt eine Geldsteuer von zum Beispiel 10%. Diese Verlosung wird so oft durchgeführt, bis die Umlaufgeschwindigkeit des Geldes wieder ein hohes Niveau erreicht.

Diese "überraschende Auslosung einer Teilmenge des Geldes" wurde übrigens nicht von dem von Mankiw anonym zitierten Studenten erfunden, sondern bereits 1950 von Ernst Winkler in den "Blättern der Freiheit" vorgebracht (heute "Fragen der Freiheit"). Auf diesen Hinweis von mir hat sich Prof. Mankiw freundlich bedankt.

Der Vorschlag des Harvard-Ökonomen wird nun zunehmend ernsthaft diskutiert. Auch die Financial Times Deutschland (FTD) nimmt sich des Themas in der Ausgabe vom 28. April. Wir lernen dort, dass die amerikanische Zentralbank den optimalen Zins bereits bei "minus 5 Prozent" sieht.

Gar nicht so weit weg von den minus 8% des Chiemgauer. Beim Chiemgauer erfolgt die Besteuerung durch eine vierteljährliche Klebemarke im Wert von 2% des Nominalwertes. Beim Chiemgauer-Konto ist der Umlauf-Impuls noch intelligenter, denn erst nach mehr als 30 Tagen erfolgt die Berechnung eines Negativ-Zinses. Wird beim Chiemgauer das Geld regelmäßig weitergegeben, werden für den einzelnen Nutzer keine Kosten fällig.

Mankiw ist übrigens nicht der erste moderne Ökonom, der über Negativzinsen nachdenkt. Prof. Buiter von der London School of Economics, Prof. Fukao und Prof. Goodfriend haben sich in wenig beachteten Diskussionspapieren schon vor einigen Jahren im Zuge der japanischen Deflation für eine sogenannte "Gesell-Steuer" ausgesprochen.

Von: Gelleri

28.04.09

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Links:

www.ftd.de/boersen_maerkte/aktien/anleihen_devisen/:Geldpolitik-Fed-w%FCnscht-Zins-von-minus-f%FCnf-Prozent/505988.html

www.nytimes.com/2009/04/19/business/economy/19view.html

received more hate mail from my NY Times article on the topic than from anything else I have ever written

TO BE NOTED: From Greg Mankiw's Blog :

"More on Negative Interest Rates From LSE economist (and former central banker) Willem Buiter, who concludes

Removing the zero lower bound on nominal interest rates would represent a valuable addition to the policy arsenal of the central banks. We know something about how interest rates work. There is no reason to believe there would be any dramatic change in the effectiveness of policy rate cuts if these cuts to the rate [are to a] level below zero. We know next to nothing about the effectiveness of the alternative policies that central banks are forced to adopt if they don’t just want to sit on their hand[s] once the[y] hit the zero lower bound: quantitative easing and credit easing, relaxing the collateral requirements for central bank lending etc.

I should note that, economic logic aside, the "optics" of negative interest rates are not very good. I received more hate mail from my NY Times article on the topic than from anything else I have ever written. Indeed, Harvard University President Drew Faust received several emails suggesting that I be fired for writing the piece. She graciously copied me on her replies, which noted that Harvard faculty are not sacked for espousing controversial ideas. Central bankers, however, do not enjoy the same luxury."

It would be administratively costly and unpleasantly intrusive. This may well endear the notion to our governments.

From Willem Buiter:

"Negative interest rates: when are they coming to a central bank near you?

May 7, 2009 2:27am

The problem

I agree with Greg Mankiw[1] that it is time for central banks to stop pretending that zero is the floor for nominal interest rates. There is no theoretical or practical reason for not having the Federal Funds target rate and market rates at, say, minus five percent, if that is what your Taylor rule, or whatever heuristic guides your official policy rate, suggests.

Economics as a science and economic reality have never had problems with negative real (inflation-adjusted) interest rates. So what is the problem with nominal rates? In a word, it’s currency.

Financial instruments can be categorised as bearer instruments (bearer securities) or registered instruments (registered securities). Bearer instruments are instruments for which the issuer does not know the identity of the owner. So, unless you can prove the opposite (after a mugging say), the holder or bearer is the owner - possession is most of the law. Currency is an example of a bearer instrument. It is a negotiable bearer bond - it is transferable to another party by delivery. And it does not have to be endorsed by the party transferring it. Many bonds are bearer securities as well, but through a variety of arrangements (including clipping coupons in the old days) it has been possible to get over the problem of paying interest on these non-currency bearer instruments.

Registered securities or instruments are securities or instruments where the issuer knows the identity of the owner. Shares are an example, so are bank accounts and reserves held by banks with the central bank. Paying interest, negative or positive, on registered instruments is trivial. In many cases today interest payments are entries in some electronic ledger. When I get a positive five percent annual interest rate on my deposit account, I put in $100 and get out $105 a year later. When I get a negative five percent interest rate, I put in $100 and get out just over $95 one year later. The same holds for bonds. I issue a one-year zero-coupon bond with a minus five percent interest rate and a year later I repay my creditors just $95 for every $100 borrowed through bond issuance.

Central banks have no problem whatsoever paying negative interest rates on deposits (reserves) held by banks with them. Neither is it any more difficult to charge a negative interest rate on collateralised borrowing by commercial banks from the central bank than it is to charge a positive interest rate. If there are Millennium-Bug-style problems with programs and spreadsheets that take the logarithm of a nominal interest rate (rather than the logarithm of one plus the interest rate, as any sensible person would have coded it), it’s time to do some overtime correcting such silly ‘technical’ obstacles to negative interest rates. The brainless should not be in banking.

Currency is the only problem. Paying positive interest on currency is difficult because you don’t know the identity of the owner. The same note could be presented repeatedly to earn the interest due for a single period. To get around this problem, the instrument itself must be clearly identified as current or non-current on interest. Once interest has been paid, it is marked, traditionally by stamping it or by clipping a coupon off it.

With negative interest, the problem is not the owner turning up too often to claim his interest. It is getting him to turn up at all. Since the authorities don’t know I am the owner of the currency I own, why should I volunteer to pay the government money for the privilege?

It is this prima facie trivial obstacle of paying negative interest on currency that has prevented central banks from breaking through the lower floor (no stories about Switzerland, please).

Stricly speaking this story must be qualified in minor ways. If currency is the most liquid security, no other risk-free nominal instrument can earn less than it, net of carry costs (costs of storage, safekeeping and insurance). Carry costs for currency are higher than for Treasury bills or reserves with the central bank. The zero lower bound is therefore, strictly speaking a lower bound somewhat below zero. But not enough to achieve a minus five percent Federal Funds target rate.

Fortunately, it turns out to be extremely simple to remove the zero lower bound on short, risk-free nominal interest rates.

Solutions

There are three practical ways to implement negative nominal interest rates.

(1) Abolish currency. This is easy and would have many other benefits. The main drawbacks would be the loss of seigniorage income to the central bank. There may be a ‘millennium bug’ type transitional problem, if a lot of bad programmers have written code that blows up when the nominal interest rate hits zero (taking the logarithm of zero or of a negative number has interesting consequences), but all that means is a couple of wasted weekends at the office re-writing the relevant code.

Advanced industrial countries can move to electronic and bank-account-based means of payment and media of exchange without like problem. Negative interest rates on bank accounts and on balances outstanding on ‘centralised or networked electronic media’ like credit cards are as easy as positive interest rates. Debit cards simply transfer money between two accounts, both of which could pay negative interest rates and don’t pose a problem. You could even retain a measure of anonymity and have ‘cash-on-a-chip cards’, which, whenever the balance on the card is replenished by drawing funds from some account, calculate the average balance held on the cash card since the last replenishment and arrange for the appropriate interest rate (positive or negative) to be applied.

The only domestic beneficiaries from the existence of anonymity-providing currency are the criminal fraternity: those engaged in tax evasion and money laundering, and those wishing to store the proceeds from crime and the means to commit further crimes. Large denomination bank notes are an especially scandalous subsidy to criminal activity and to the grey and black economies. There is no economic justification for $50 and $100 bank notes, let alone for the €200 and €500 bank notes issued by the ECB. When asked why the ECB subsidises and encourages crime by issuing these large-denomination notes, the answer comes back that Spaniards like to make large transactions in cash, and that the ECB does not want to be responsible for an increased incidence or herniated discs, caused by people having to schlep large suitcases filled with small bills to make their next home purchase. There is an answer to that answer: kvatsch!

For foreigners in developing countries and emerging markets with high-inflation-prone monetary systems, the disappearance of the US dollar notes and the euro notes could be a setback, as these provide welcome stores of value when domestic inflation rages. It has been estimated that as much as 70 percent of all US dollar bills (by value) are held outside the USA (not all by people wanting to hedge against hyperinflation at home, of course) and that up to 50 percent of all euro notes (by value) are held outside the Euro Area. To those people I would say, I feel your pain, but this is the time to replace exit with voice. Go and create a polity that will support a government that does not abuse the printing presses.

As a concession to the poor, we could keep a limited number of 1$ and 5$ bills (1€ and 2€ coins and 5€ bills) in circulation. I cannot envisage banks and other big financial players would wish to store warehouses full of small bills). If the small bills were not supplied on demand, but had their quantity exogenously determined, my option 3 below would be likely to kick in. The remaining dollar bank notes would not exchange at par with dollar deposits, dollar cash-on-a-chip or other dollar e-money, but would trade at a varying relative price (exchange rate) vis-a-vis these other, negative interest-bearing means of payment and media of exchange. The depreciation of this exchange rate would make traders and portfolio holders indifferent between holding zero interest currency and negative interest bank deposits.

My good friend and colleague Charles Goodhart responded to an earlier proposal of mine that currency (negotiable bearer bonds with legal tender status) be abolished that this proposal was “appallingly illiberal”. I concur with him that anonymity/invisibility of the citizen vis-a-vis the state is often desirable, given the irrepressible tendency of the state to infringe on our fundamental rights and liberties and given the state’s ever-expanding capacity to do so (I am waiting for the US or UK government to contract Google to link all personal health information to all tax information, information on cross-border travel, social security information, census information, police records, credit records, and information on personal phone calls, internet use and internet shopping habits).

But given the fact that e-money that can pay positive or negative interest without any additional cost can now be made available to all, in the advanced (post-) industrial countries, and given that even traditional bank accounts, credit cards and debit cards can take care of most of the retail payment system without creating a zero lower bound constraint on nominal interest rates, we really don’t need cash to facilitate trade and commerce. It is a redundant, indeed dominated medium of exchange and means of payment for legitimate transactions. Do we really want to retain cash just because it (1) allows us to hide some of our legitimate financial transactions from the government (as insurance against government abuse of the information), and (2) is a source of revenue to the central bank? These arguments pro are surely dominated by the two arguments against currency, (1) that, as currently construed (but see my third way of removing the lower bound), currency imposes a zero lower bound on nominal interest rates and (2) that it subsidises the grey and black economies and makes life easier for the global criminal and terrorist fraternity.

Instead of abolishing currency altogether, we could only issue low denominations, say nothing larger than $5 or €5. The carry costs (safe-keeping, insurance and storage) for large amounts of cash are likely to become prohibitive if you have to do it all in fivers. The zero lower bound would be likely to shift to a significantly negative lower bound.

(2) Tax currency and ‘stamp’ it to show it is ‘current on interest due’. This is Silvio Gesell’s proposal, supported by Irving Fisher and re-introduced into the policy debate by Marvin Goodfriend and by myself and Nikolaos Panigirtzoglou.[2] When the interest rate on currency is positive, the currency must be marked (by stamping or clipping coupons) to make sure the (anonymous) bearer does not present it repeatedly for the payment of interest. When the interest rate is negative, the (anonymous) bearer must (a) be induced to come forward to receive his negative interest (i.e. pay interest to the central bank) and (b) must be able to demonstrate that the negative interest has been received. To ensure (b), the currency must again be stamped or marked (electronically tagged). To get the bearer to come forward to pay the negative interest we can either rely on honesty and a sense of patriotic duty, or we can impose sanctions for non-compliance. I am afraid penalties for non-compliance (fines, a day in the stocks) would be required to make negative interest on currency work. This would require random checks etc. It would be administratively costly and unpleasantly intrusive. This may well endear the notion to our governments.

(3) Unbundle currency from the unit of account. This ideal goes back at least to Eisler (1932), was drawn to my attention by Stephen Davies in 2004 and has been formalised by me in a couple of papers since then.[3] The basic idea is simple. In an economy where the dollar is the unit of account for price and wage contracts and most other market transactions, the fact that the currency is also the dollar (that is, the fact that X dollars worth of currency purchases X dollars worth of short-term nominal public debt (or X dollars worth of reserves with the central bank) establishes a zero lower bound on the nominal interest rate (what matters is that the exchange rate of currency and short nominal debt is constant, not that it is unity).

Now abolish the dollar currency and introduce a new currency, the rallod. The exchange rate between the rallod and the dollar is not constant. It can either be determined by the government or let by the market. In the first case, the government (central bank) supplies rallod on demand at the government-determined exchange rate; in the second case, the stock of rallod currency is exogenous (determined by the government but not available from the government in whatever quantity demanded at a given exchange rate. Since the rallod is the currency, there is a zero lower bound on the rallod interest rate on rallod-denominated securities (I am ignoring carry costs and assume that solution 2 is not applied to the rallod). However, since there no longer is dollar currency, the nominal interest rate on dollar securities can be negative as easily as it can be positive.

Let S_t be the spot exchange rate between the dollar and the rallod in period t (number of rallods per dollar), F_t+1,t the forward exchange rate between the dollar and the rallod in period t, i_t+1,t the one period interest rate on safe dollar securities and i*_t+1,t the one-period interest rate on safe rallod securities. No arbitrage implies that these four variables are related through covered interest parity (CIP):

As long as the interest rate on rallod securities is positive, it does not matter what the spot and forward exchange rates between the dollar and the rallod are. Assume that we hold the spot exchange rate constant and keep the forward rate equal to the spot rate. This means, from CIP, that dollar interest rates are the same as rallod interest rates.

Now assume that both interest rates would have to go below zero if the monetary authority were to follow its Taylor rule, or whatever heuristic for driving the policy rate that floats its boat. The rallod interest rate is constrained to be non-negative and therefore equals zero. However, the dollar interest rate is set at whatever negative value the central bank thinks best - minus five percent, say. Can the dollar interest rate be - 0.05 and the rallod interest rate 0.00 without this creating opportunities for pure profits - a certain positive payoff without putting any money at risk? It can provided the forward price of the dollar in terms of the rallod is five percent higher than the spot price. This follows straight from the CIP condition above. With i_t+1,t = - 0.05 and i*_t+1,t = 0.00, the no-arbitrage condition is satisfied provided S_t/F_t+1,t = 0.95. If the authorities announce a path for the future spot exchange rate that is perfectly credible, the forward rate will be equal to the expected (and actual) future spot rate. Let E_t denote an expectation or anticipation formed at time t, then, with perfect credibility, F_t+1,t = E_tS_t+1 = S_t+1. In this case there is uncovered interest parity (UIP) as well as covered interest parity.

UIP

The monetary authority has three instruments in the rallod currency world: the interest rate on dollar securities (the central bank’s official policy rate), the spot exchange rate of the dollar and the rallod and the forward rate. Given these three, the interest rate on rallod securities follows (subject of course, to the non-negativity constraint on rallod interest rates.

The zero lower bound on dollar interest rates has been removed. It has been replaced by a zero lower bound on rallod interest rates, but these don’t matter, as it is the dollar general price level that matters, and the dollar is the numéraire/unit of account.

Those who want to work through these things will note that, if there is UIP, real interest rates (inflation corrected interest rates) will be the same on nominal dollar bonds as on nominal rallod bonds. This is because the law of one price implies that the dollar price level, P, say, is related to the rallod price level, P^*, say, by the law of one price, that is

PS = P*

Even though dollar and rallod real interest rates are the same, the creation of the rallod and the unbundling of the medium of exchange/means of payment and the numéraire/unit of account makes a real difference to the behaviour of the economy and the effectiveness of monetary policy, whenever there is any probability that the zero lower bound would become binding in the dollar currency economy. In that case, in the rallod currency economy, dollar real interest rates and rallod real interest rates will be equal to each other, but they are different from what they would have been in the dollar economy.

What can go wrong? The only thing that can go wrong is that the dollar would cease to be the numéraire for key private contracts (especially wage and price contracts) when the dollar is replaced by the rallod as the currency. If that were to happen, if the numéraire ‘followed the currency’, the price level that matters is the rallod price level, not the dollar price level. We would be back in the dollar currency economy, simply having renamed the dollar the rallod. This would be a currency reform of the kind that replaced 100 old French francs with 1 new French franc.

The numéraire is not chosen by the monetary authority or by the government. It is the outcome of an uncoordinated social decision process. Sometimes multiple numéraire have coexisted. But while the authorities cannot legislate the numéraire, they can strongly encourage the use of a specific numéraire. In the rallod currency economy, the government can insist that all contracts in and with the public sector be denominated in dollars. They can require tax returns to be made using the dollar as numéraire, and they can insist that taxes be paid with dollar deposits or other dollar-denominated (non-currency) means of payment. They can discourage or ban the creation of checkable accounts denominated in rallods, etc. etc.

So I have little doubt that the rallod currency economy could be nudged towards retaining the dollar as the numéraire in systemically important contracts and transactions. So the zero lower bound that matters would have been removed.

After this good news, the better news. It isn’t even necessary to abolish the dollar currency and replace if by the rallod currency. You can keep the dollar currency. All that is required is that the authorities no longer maintain a fixed exchange rate (equal to 1) between bank reserves with the central bank and currency. Instead they let the exchange rate between dollar reserves with the central bank and dollar currency, S_t, be market-determined. The authorities of course can no longer supply dollar currency on demand (or take it back on demand) at a fixed exchange rate (currently 1) with bank reserves with the central bank. Instead they determine the stock of currency dollars exogenously.

So the authorities have two instruments in the floating exchange rate case: the dollar interest rate and the quantity of dollar (or rallod) currency it issues. The remaining degree of freedom has to be provided by a terminal condition for the exchange rate in the long run. Speculative bubbles could arise in this market, if the exchange rate is left to float.

With a floating exchange rate between the reserve dollar and the currency dollar, UIP will not in general hold. Instead we have an equilibrium relationship, shown below, that says, effectively, that the interest-rate differential between the reserve dollar and the currency dollar equals the expected proportional rate of depreciation of the reserve dollar vis-a-vis the currency dollar plus an exchange rate depreciation risk premium, as shown below.

So a reserve dollar would no longer automatically be worth a currency dollar. If that is confusing, call the currency dollar the rallod instead.

I gave a lecture on these issues at the Center for Financial Studies of the Goethe University in Frankfurt, Germany, today. Otmar Issing was in the audience. He listened carefully (he always does) and gave me quite a grilling during dinner afterwards. I don’t think I have convinced him yet of the merits of the case for breaking through the zero lower bound on nominal interest rates, but here’s to hoping! The Powerpoint slides of the presentation can be found here.

Conclusion

Removing the zero lower bound on nominal interest rates would represent a valuable addition to the policy arsenal of the central banks. We know something about how interest rates work. There is no reason to believe there would be any dramatic change in the effectiveness of policy rate cuts if these cuts to the rate level below zero. We know next to nothing about the effectiveness of the alternative policies that central banks are forced to adopt if they don’t just want to sit on their hand once the hit the zero lower bound: quantitative easing and credit easing, relaxing the collateral requirements for central bank lending etc.

All these alternative measures also blur the distinction between the responsibilities of the monetary and the fiscal authorities. It undermines central bank independence, something which, up to a point, I consider valuable.

There are at least three ways to remove the zero lower bound that are feasible: abolish currency, tax currency and ensure that currency is not the numéraire. Taxing currency may be awkward and intrusive, but abolishing currency is not just easy (just do it) but also has considerable advantages as a blow against criminality and terrorism. Unbundling currency and numéraire is something that can be done over the weekend.

I really don’t understand why central banks are not aggressively pursuing options for removing the zero lower bound. It is that they love the seigniorage so much? But they retain seigniorage revenue from currency issuance in the rallod economy. Is it hidebound conservatism and lack of imagination. Quite possibly. But if so, this is a costly mistake. Central banks should act to remove the zero lower bound on nominal interest rates now.

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[1] N. Gregory Mankiw (2009) “It May Be Time for the Fed to Go Negative”, in: New York Times April 18

[2] Goodfriend, Marvin (2000), “Overcoming the Zero Bound on Interest Rate Policy“, in: Journal of Money, Credit, and Banking, Vol. 32(4)/2000, S. 1007 - 1035.

Buiter, Willem H. and Nikolaos Panigirtzoglou (2001), “Liquidity Traps: How to Avoid Them and How to Escape Them”, with Nikolaos Panigirtzoglou, in Reflections on Economics and Econometrics, Essays in Honour of Martin Fase, edited by Wim F.V. Vanthoor and Joke Mooij, , pp. 13-58, De Nederlandsche Bank NV, Amsterdam.

Buiter, Willem H. and Nikolaos Panigirtzoglou (2003), “Overcoming the Zero Bound on Nominal Interest Rates with Negative Interest on Currency: Gesell’s Solution”, Economic Journal, Volume 113, Issue 490, October 2003, pp. 723-746.

[3] Buiter, Willem H. (2004) ,”Overcoming the Zero Bound: Gesell vs. Eisler; Discussion of Mitsuhiro Fukao’s “The Effects of ‘Gesell’ (Currency) Taxes in Promoting Japan’s Economic Recovery” . Discussion presented at the Conference on Macro/Financial Issues and International Economic Relations: Policy Options for Japan and the United States, October 22-23, 2004, Ann Arbor, MI, USA. International Economics and Economic Policy, Volume 2, Numbers 2-3, November 2005, pp. 189-200. Publisher: Springer-Verlag GmbH; ISSN: 1612-4804 (Paper) 1612-4812 (Online).

Buiter, Willem H. (2007), “Is Numérairology the Future of Monetary Economics? Unbundling numéraire and medium of exchange through a virtual currency with a shadow exchange rate”, Open Economies Review, Publisher Springer Netherlands; ISSN 0923-7992 (Print); 1573-708X (Online). Electronic publication date: Thursday, May 03, 2007. See “Springer Website”.

Davies, Stephen [2004], “Comment on Buiter and Panigirtzoglou”, mimeo, Research Institute for Economics and Business Administration, Kobe University, May.

Eisler, Robert (1932), Stable Money: the remedy for the economic world crisis: a programme of financial reconstruction for the international conference 1933; with a preface by Vincent C. Vickers. London: The Search Publishing Co."

Me:

"(2) Tax currency and ‘stamp’ it to show it is ‘current on interest due’."

I'm for Stamping. It was also defended and commented upon in the FT here:

http://blogs.ft.com/economistsforum/2008/11/the-case-for-negative-interest-rates-now/#more-259

The case for negative interest rates now
November 20, 2008 12:35pm
by FT

By Brendan Brown

A conundrum has long been known to monetary economists, but only comes into the open during the once in a quarter-of-a-century type of recession apparently plaguing the global economy.

The quandary is how, in a conventional monetary economy, to bring interest rates down to the negative levels essential to speedy recovery during periods when there is a sharp decline in spending propensities.

If interest rates fall below zero, the public would simply seek to transfer their savings into hoards of banknotes.

The interest rate under discussion is the risk-free nominal rate as quoted on short-maturity government bonds, most obviously US T-bills or short-dated German government bonds.

Over the course of decades, particularly during the Japanese “lost decade” of asset deflation, suggestions have emerged as to how to solve the conundrum.

These include the periodic stamping (for a small fee) of banknotes (without the stamp they would not be valid). The idea is that by imposing a running tax on banknote hoarding, nominal risk-free rates could fall to negative levels.

In the age of the information technology revolution, surely the authorities could devise a simple and practical method of effective taxation of banknote hoards?...... "

Excellent comment by Martin Wolf:

" Martin Wolf: This is ingenious and would, no doubt, permit negative real interest rates. But I would prefer it if vigorous action were taken by the monetary authorities to sustain inflation, before deflation set it, in which case we would never need negative nominal interest rates in order to obtain negative real rates.

If it is already too late for this, I agree that this scheme would make it possible for the authorities to impose negative real short rates. Another justification for negative real rates is that it would reduce the danger of debt deflation - the rising real level of debt as the price level falls. It would be wildly unpopular, of course, among politically powerful savers. It would have to be pointed out that this loss is offset by the rising real value of nominal claims.

But would it work in the way Brendan suggests? I am not sure. Equity markets might rise a little. But I very much doubt whether companies would start to issue equity in order to invest in a substantial way, in the midst of a deep recession. The underlying logic is Hayekian. I have never been convinced of this theory of the credit cycle.

So is there an alternative? Yes. The central bank can lend directly to the government, which can spend on investment and public consumption or make transfers to consumers to spend. If real interest rates were negative, this would be even cheaper for the government. That would certainly add to the effectiveness of such a policy, in any case.
Posted by: Martin Wolf"

Both Nick Rowe and Scott Sumner have good points against Stamping, but I find it simple and effective. I'm less concerned on the method used, than on the use of the concept. Brad De Long has also commented on it recently:

http://delong.typepad.com/sdj/2009/04/silvio-gesell-and-stamped-money-another-thing-fisher-and-wicksell-knew-that-modern-economists-have-forgotten.html

But Silvio Gesell is the topic of part VI of chapter 23 of Keynes's flagship work, The General Theory of Employment, Interest and Money. And it's not just Keynes in his flagship work. There are 55,000 google hits for "Silvio Gesell." Patinkin (1993) reports that Irving Fisher advocated Gesell-based "velocity control" in his 1932 Booms and Depressions. Nobel prize-winning Maurice Allais was an advocate as well. Gerardo della Paolera and Alan Taylor are Gesell's biggest boosters today in their book Straining at the Anchor: The Argentine Currency Board and the Search for Macroeconomic Stability, 1880-1935, a University of Chicago Press book that is part of the NBER's series on "long term factors in economic development." Willem H. Buiter and Nikolaos Panigirtzoglou writing in the Economic Journal in 2003: "Overcoming the Zero Bound on Nominal Interest Rates with Negative Interest on Currency: Gesell's Solution."

This is, I think, yet another example of how much economics has lost by cutting itself off from its moral philosophical and historical roots. Something that Keynes and Fisher and the other founders of monetary economics seriously wrestled with is today seen as something unknown and new to be thought of by clever graduate students. Once again the answer to Olivier Blanchard's question "What Do We Know that Fisher and Wicksell Did Not?" is that Olivier is asking the wrong question: what did they know that we have forgotten?

Here is John Maynard Keynes writing in 1936, summarizing Silvio Gesell writing in 1916:

J.M. Keynes, General Theory of Employment, Interest and Money, chapter 23: It is convenient to mention at this point the strange, unduly neglected prophet Silvio Gesell (1862-1930), whose work contains flashes of deep insight.... [T]he English version (translated by Mr Philip Pye) being called "The Natural Economic Order". In April 1919 Gesell joined the short-lived Soviet cabinet of Bavaria as their Minister of Finance, being subsequently tried by court-martial.... Professor Irving Fisher, alone amongst academic economists, has recognised its significance. In spite of the prophetic trappings with which his devotees have decorated him, Gesell's main book is written in cool, scientific language; though it is suffused throughout by a more passionate, a more emotional devotion to social justice than some think decent in a scientist.... I believe that the future will learn more from the spirit of Gesell than from that of Marx.... Gesell's specific contribution to the theory of money and interest is... that the peculiarity of money, from which flows the significance of the money rate of interest, lies in the fact that its ownership as a means of storing wealth involves the holder in negligible carrying charges.... [H]e had carried his theory far enough to lead him to a practical recommendation, which may carry with it the essence of what is needed... the prime necessity is to reduce the money-rate of interest, and this, he pointed out, can be effected by causing money to incur carrying-costs just like other stocks of barren goods. This led him to the famous prescription of 'stamped' money, with which his name is chiefly associated and which has received the blessing of Professor Irving Fisher.... [C]urrency...would only retain their value by being stamped each month, like an insurance card, with stamps purchased at a post office. The cost of the stamps... should be roughly equal to the excess of the money-rate of interest (apart from the stamps) over the marginal efficiency of capital corresponding to a rate of new investment compatible with full employment. The actual charge suggested by Gesell was 1 per mil. per week, equivalent to 5.2 per cent per annum.... The idea behind stamped money is sound..."

It would be wonderful if this idea was seriously considered.

"Taxing currency may be awkward and intrusive"

This is easily the most effective proposal, since it fits into our system of government. Posted by: Don the libertarian Democrat

And:

The point of stamping, in my view, is to give a disincentive to buying bonds in a Debt-Deflationary situation. In other words, when investors are driving down yields in a panic in the flight to safety and liquidity, you tempt them to put their money into other assets, like stocks or corporate bonds or helping a friend start a business.

It makes sense to me to invest in stocks when the market is low and you are getting nothing in return for buying bonds. Then, when bond yields go up, you buy bonds. That's why some inflation in the future is a good sign.

QE can work as well, and so read this:

http://ftalphaville.ft.com/blog/2009/05/07/55605/the-qe-stockmarket-effect/?source=rss

"But, as Lewis also points out, QE may be having another, perhaps less expected, but nonetheless still very welcome effect - on equities. As he explains (our emphasis):
Possibly, the chief impact of QE will come through the equity market. If ‘other financial institutions’ see their bank deposits increasing, they may be inclined to commit some of these funds to equity investment. "

In my view, with low yields on short term bonds, and gradually increasing yields on longer term bonds, this result is expected. Posted by: Don the libertarian Democrat