If financial markets were perfect, quantitative easing would have no effect on aggregate demand. But if financial markets were perfect, we wouldn't have the financial crisis, and so wouldn't need quantitative easing.
If financial markets were perfect, Ricardian Equivalence would make a lot of sense. Current taxes and future taxes would be equivalent. A bond-financed transfer would have no effect. Fiscal policy would have little (for government spending increases) or no (for transfers or tax cuts) effect.
The same is true for quantitative easing.
If financial markets were perfect, and with zero interest rates on bonds, money and bonds would be equivalent. An open market purchase of bonds for money would have no effect. Monetary policy would have little or no effect.
We don't accept that argument for Ricardian Equivalence against fiscal policy; and we shouldn't accept that same argument for bond-money equivalence against monetary policy.
Here is an extremely crude model (or sketch of a model) to show how an increase in the money supply can still be effective even when nominal interest rates are zero.
Assume there are initially two types of people: the employed have assets (money and bonds); and the unemployed have no assets (neither money nor bonds). The unemployed will eventually find work sometime in the future, but cannot borrow against their future income (perhaps because debtors are untraceable). All bonds are government bonds (since private debt is unenforceable). All money is government fiat money. Money is a medium of exchange, but bonds are not.
There is no investment, and no physical goods that can be stored. All production is for immediate consumption, but must be paid for with cash. Think of the consumption good as being backscratching services. But there is a taboo against scratching the back of someone who has recently scratched your own back (this is why monetary exchange is needed, to get around the lack of a double-coincidence of wants). The price of backscratching services is exogenous (or slow to adjust).
Assume the nominal rate of interest is initially zero. The employed are indifferent between holding money and bonds at the margin. This requires that the rate of inflation yields a real interest rate which satisfies the Euler equation of the employed. Assume it does. It will not satisfy the Euler equation of the unemployed, but that's irrelevant, since the unemployed would like to dissave, but cannot. They have no assets and cannot borrow. There is an implicit demand-price for loans by the unemployed, which is above zero.
The unemployed want to sell their services for money, but they have no money with which to offer to buy each others' services. There is an excess demand for money by the unemployed (matching their excess supply of services). But the nominal rate of interest on bonds is zero, because there is no excess demand for money by the employed.
If financial markets were perfect, the unemployed would borrow money from the employed, and use it to hire each other, and there wouldn't be any unemployment. And if financial markets were perfect, and nominal rates of interest were zero, an increase in the money supply would do nothing. But it wouldn't be needed, either.
Now the government introduces a temporary fiscal stimulus, which is money-financed. It prints money, and hires the unemployed for one period. While the government jobs last for only one period, the effects of the monetary injection persist indefinitely. The previously unemployed continue to scratch each others' backs in exchange for the money they earned from the government.
A cash transfer to the unemployed would have exactly the same effect as a government make-work program, except for the first period. In the first period, the previously unemployed scratch each others' backs, rather than scratching the government's back.
A transfer of bonds to the unemployed may or may not have the same effect. If the employed had a large surplus of money, and would willingly swap all the unemployed's new bonds for money, at par, it would make no difference. Otherwise, the nominal rate of interest would be driven above zero, and the employed would start to save again, so unemployment could not be eliminated.
A transfer of bonds to the unemployed, plus an open market purchase of bonds from the employed, would have the same effect as a transfer of cash to the unemployed. The employed now have enough cash to swap with all the unemployeds' bonds, without driving interest rates above zero.
OK, it's not a pure monetary policy, since I need a temporary fiscal policy to get the initial monetary injection. But that's only because I'm not smart enough to dream up a model with pure monetary policy right now. But past the first period, the fiscal policy has disappeared, and only the increased stock of money remains. So the fact that unemployment stays low must be due to the fact that the temporary fiscal deficit causes a permanent increase in the supply of money.
The key to understanding this model is that even though interest rates appear to be zero, not all (implied) interest rates are zero. Because financial markets are not perfect. That's familiar. Interest rate spreads are wide right now, and some loans are only available at high rates of interest, or not at all. And monetary exchange is essential. And there is an excess demand for money (and a notional excess demand for goods), even though there doesn't appear to be, because interest rates on safe assets are zero. So only a monetary injection can be a permanent cure. Monetary policy works for the same reason Ricardian Equivalence is false: capital markets are imperfect; the unemployed are borrowing-constrained. And, representative agent models of debt don't work. The representative agent holds bonds and money, at zero interest. But not all agents do, and that matters.
Yep. It's a really crude model. But I think it works. And I think the underlying insight is correct.
If the world was made up of "K" there wouldn't hardly be a coordination problem in the market for time and productive resources and savings and investment -- as Hayek pointed out again and again and again.
But the economics profession never "got it".
So they are still modeling the world with the letter "K" and a brain dead conception of the macroeconomics coordination problem.
Read Roger Garrison's _Time and Money_. Learn.
Posted by: Greg Ransom | March 05, 2009 at 01:58 PM
I like the sketch of a model. If nothing else, it illustrates how fiscal policy can compliment monetary policy.
But Greg Ransom's criticism has some value even it goes beyond the scope of this exercise. Where is the 'co-ordination problem'? And how does policy address it? Why are backs and back-scratchers failing to meet? Why are backs reluctant to be scratched?
Posted by: westslope | March 05, 2009 at 02:24 PM
"But if financial markets were perfect, we wouldn't have the financial crisis, and so wouldn't need quantitative easing."
Financial markets aren't perfect, but this financial crisis was not born in a vacuum. Imbalances were built up over many years, partly caused by government policy (in America, China and elsewhere). This crisis is evidence that government interference is not sterile and is more an argument against further intervention by government then for it, in my opinion, because it shows how little people know about these issues until something goes boom... then all of a sudden it's plainly obvious and everyone is an expert.
I'm not an expert and I'm going to read this again more slowly later, but on the surface anyway this looks flawed to me... I see the world as rivers of cash, dollars flow like water into the pockets of those who own the means of production (or I guess the "employed" in your sketch, but in reality it would be a third category). There's a millionaire or billionaire at the top of every industry, no matter where your money is spent it trickles up to the owners. If you give a temporary stimulus to the "unemployed" no matter whose back they scratch every penny will eventually end up lining the pockets of the same "employed" who refused to hire their services to begin with.
It's like this whole auto-bailout nonsense, that money won't help the workers. How many auto-workers are going to use the bailout to create their own auto company to compete with GM? Let's get real for a second here. No matter how much money the government hands GM it won't increase car sales, therefore those who would lose their jobs will lose them anyway... GM isn't going to produce cars and bury them in the ground or dump them in the ocean. The stimulus idea doesn't make any sense unless the behavior of GM's customers change. How will you do that? Give them money too?
The question is not how to temporarily re-establish commerce amongst the unemployed, it's how to change the behavior of the employed. If they have been over-consuming for decades and now insist on under-consuming to pay down their debts, dropping money on the unemployed, even if it were possible to target them directly, won't change anything "at the margin" as you like to say. Every penny will end up with the employed and saved or paid to their creditors, unless you create a "reckless" amount of money... At which point you may simply ignite a rush to alternate forms of savings instead of reviving the economy.
Posted by: pointbite | March 05, 2009 at 03:29 PM
Animal spirits? In the twilight zone of 0% interest rates, high debts, high and rising unemployment, a smoldering pile of wreckage pretending to be a financial system, and ultra high levels of fear, people end-up doing weird things. Humans tend to put far more weight on possible negative outcomes than is strictly rational. So maybe a big part of what causes the liquidity trap is a sort of equity premium gone wild.
Right now, esp. in the US, millions of people have seen their retirement go up in flames, they're terrified of losing the roof over their head, their health care, their car, their social status, and in general their comfort. It's not surprising that money is being stuffed under the mattress and not spent. And firms aren't immune from this either, after all they do consist of groups of people.
Posted by: Patrick | March 05, 2009 at 05:21 PM
But, but, but. Can you build a model with zero nominal interest rates in which monetary policy works? Does my model do that. Of course it's got a lot of things missing; it's a model, and is supposed to have things missing. And among other things, it's missing K (or any form of capital.
westslope: "Where is the 'co-ordination problem'? And how does policy address it? Why are backs and back-scratchers failing to meet? Why are backs reluctant to be scratched?" That is a question I must address, but I thought my model did address it. You can't scratch your own back (obviously), and there is a societal taboo against scratching the back of anyone who has recently scratched your back (this is to rule out simple barter exchange "I scratch your back, if you scratch mine"). It's a quick and dirty way to prevent a double-coincidence of wants, and makes monetary exchange essential. And the unemployed don't have any money, so that's the coordination failure. And money solves it.
Posted by: Nick Rowe | March 05, 2009 at 06:22 PM
Hi Nick,
The problem, still, with the whole arguement is that you've imposed a non-negative real rate! Suppose that some fraction of the population is retired and no longer provides back scratching services but still consumes the service. Suppose tomorrow that fraction will be 3 times what it is today. Then even the previously unemployed will be trying to save a substantial fraction of their new found incomes. The fiscal stimulus still boosts consumption today but it's possible that aggregate savings are still to high to employ everyone. In this case, as soon as the government stops employing people we go back to a situation where some (maybe lots) of people are unemployed.
It still comes down to this, if the real rate that supports the current consumption path is negative but the real return on holding money is higher (say it's zero) then money is the best LONG-TERM investment you ever heard of. Holding money gets you higher than the required real return at no risk so no matter how much money you drop it all gets saved. You need expected inflation.
Consumption euler equations will always be satisfied and if the real rate won't adjust then current consumption will.
Posted by: Adam | March 06, 2009 at 03:36 AM
and btw, I'm not the only one saying this. Patrick's second paragraph is a description of an economy with a negative real interest rate (on the currrent consumption path). People who currently have a roof over their head (are consuming housing services), a car and health insurance are afraid that in future they won't have all that. Thus the marginal utility of consumption tomorrow is very high relative to consumption today, feed that into an euler equation and it spits out a negative real interest rate.
Posted by: Adam | March 06, 2009 at 04:05 AM
Adam: I don't think I (implicitly) imposed a non-negative real rate. The only assumption I did impose is that the (exogenous) actual and expected rate of inflation, plus the real rate which satisfies the Consumption-Euler equation for the employed, must equal zero (the nominal rate). So if inflation were 2%, for example, the real rate could be -2%.
Moving outside the model, if there were some storable good, the restriction would have to be that the rate of inflation on that storable good would have to be greater than the "iceberg" storage costs. The consumption-Euler equation could be satisfied that way.
And I keep coming back to an argument I heard a very long time ago, when I was first studying economics: "The equilibrium real rate of interest could never go to zero; if it did, it would be profitable to bulldoze the Rocky mountains flat and turn them into farmland, which would yield rents for ever". (This was in England, or Scotland, and nobody had ever seen the Rocky mountains. And in the days before environmentalism!).
Posted by: Nick Rowe | March 06, 2009 at 07:03 AM
Adam: second thoughts on my first paragraph in the above comment:
I have sort of answered your criticism, but really only ducked it, because you could come back with: "OK, OK, but you have imposed the restriction that the real rate of interest that satisfies the Euler equation for the employed is greater than -2%"
What I'm now wondering is this: Suppose all the people in my model had different rates of time-preference proper (Betas), and we lined them up from the most patient to the least patient. So the real rate of interest which satisfies their Euler equation at zero saving (for that individual) varies continuously across the population. Start with full employment, because everybody has money+bonds. As the money+bonds tend to accumulate with the most patient, and the nominal rate of interest drops to zero, as some of the most patient are satiated with money, we get unemployment. So we get to the point where my model above starts off.
We cannot define a unique natural real rate of interest independent of the distribution of assets, and the level of employment. Thinking out loud. Must figure this out.
Posted by: Nick Rowe | March 06, 2009 at 07:27 AM
OK, I'm figuring it out, and it's turning into a model where the distribution of wealth gets slowly worse over time, and when it gets past a certain point, the nominal rate of interest drops to zero, and then unemployment appears, and gets slowly worse! The lefties will be happy!
Posted by: Nick Rowe | March 06, 2009 at 07:34 AM
I think quantitative easing would work if it were targeted towards those with the lowest marginal propensity to save. That's why food stamps have the highest multiplier of all. The only thing is that I can't see how monetary policy can target just the poor. How would the money get from the Fed to the poor?
also, if we drop a pile of cash on the poor & unemployed, will they spend 100% of it? I think that there will still be some residual propensity to save.
on the other hand, Congressmen have 0 propensity to save (government funds), so if you want stimulus to be spent, it makes a lot of sense to hand it over to a politician. If you are looking for a prime mover, someone who will spend even when it's totally irrational to do so, a politician is just the ticket. They enjoy short-term upside (if they are up for reelection), but they don't have to deal with the long-term negative consequences of stimulus (paying off the debt), so they can mount a credible threat of reckless spending, akin to the central bank creating a credible threat of inflation. Government officials who are up for re-election have a skewed set of incentives that encourage spending and discourage saving, and we can exploit this. The asymmetry that makes it hard for politicians to save in the good times also makes it especially easy to get them to spend when no one else is willing.
If government expenditures are monetized, you get the best of both: a credible threat of inflation, and a large spender who will spend without regard for the long-term, thereby paradoxically improving long-term growth (the paradox of profligacy if you will).
If the first instance of spending is the government buying a backscratch, then we want to make sure that the person receiving it will turn around and buy a backscratch to someone else, so it makes sense to target the poor & unemployed because of their low propensity to save. The other thing is that we should pay the unemployed to do something for the government that is more productive in the long term than backscratching, ie building a bridge. If you want to see a good example of a backscratching economy, go to the poor de-industrialized areas of northern england - nothing but beauty parlors serving people on welfare. So I think it is important in the long run to ensure that stimulus is tied to investments in productivity growth, not just consumption alone. For these reasons I favor government spending on make-work projects rather than transfers of money. If you are going to hand over a stack of money, you might as well get something useful built while you are at it.
Posted by: bob | March 06, 2009 at 07:36 AM
Well Nick, what I had in mind was even a bit more basic. In your pure exchange economy with a constant population and everyone working, once we get full employment then aggregate consumption is constant and so the real rate equals the subjective discount factor. Heterogeneity in discount factors and/or wealth change the distribution of income but in the aggregate (at full-employment) it's still constant and since all discount factors will be positive you still end up with a positive real rate (we just no longer know what it is, it's some sort of "average" discount factor).
But what if, for demographic or technologilcal/resource constraint reasons (world running out of oil and no alternative technology, that sort of thing), consumption tomorrow is (feared/expected) to be very, very, very scarce (even if full employment could be maintained). In that case, anyone who can save will. Thus, once your formerly unemployed agents get a job they will start acting like the employed agents and will want to save. We end up right back with too little aggregate demand and people unable to sell their services.
Now, with enough expected inflation they can be induced to consume but, as I've been arguing all along, it is entirely due to the effect the expected inflation has on the real rate that drives things. It has nothing to do with today's money supply per se or with the first period fiscal stimulus. It also has nothing to do with completeness or incompleteness of markets.
Posted by: Adam | March 06, 2009 at 09:00 AM
Bob, Adam: I'm working on a revised version right now, and should post it soon (unless it totally screws up). But imperfect capital markets do matter. At a very minimum, the least patient individuals are the ones who will be borrowing-constrained, and if they are borrowing constrained, they are essentially out of the market. And the natural rate of interest is then determined by the more patient half of the population, and so will be lower. Getting money into the hands of the less patient will matter.
Posted by: Nick Rowe | March 06, 2009 at 10:24 AM
I'm not sure I understand what you mean by perfect. It seems you mean "have perfect foresight". Doesn't uncertainty exist at all? And isn't the obvious point of your little model that we should give money especially to the poor (or cheaper - give it to everybody and tax the rich) because we can be fairly sure they will spend it (which is what I have been saying all along). I'm a believer in "bubble up" as against "trickle down" (which only the learn resistant now believe in). Spread money about and it trickles up to the productive and useful. Give money to the rich and it gets wasted.
Posted by: reason | March 06, 2009 at 10:53 AM
Give money to the rich and it get wasted AT BEST (it might just be hoarded).
Posted by: reason | March 06, 2009 at 10:54 AM
Adam,
I'm pretty sure I fundamentally agree with you.
Posted by: reason | March 06, 2009 at 10:56 AM
pointbite
You referred to your comment here in another thread as a clarification as to why you disagreed with me in another thread. I mostly agree with what you are saying here, so I don't really understand what our differences are here. I have always pointed out the disfunctional international finance system is a big part of the problem (much as Nick likes to believe it really works). Whether that counts as "government interference" is a moot point as far as I'm concerned - never heard of the law of second best? Even if it is true there is some utopian world that would work better, we still have to do the best we can given the constraints that exist.
Posted by: reason | March 06, 2009 at 11:03 AM
Nick,
OK, I'm figuring it out, and it's turning into a model where the distribution of wealth gets slowly worse over time, and when it gets past a certain point, the nominal rate of interest drops to zero, and then unemployment appears, and gets slowly worse!
I don't think you rediscoved Marx, you rediscovered Keynes.
Posted by: reason | March 06, 2009 at 11:05 AM
Nick
1. How certain can you be that you can capture all those rents for ever?
2. Maybe the return to that farmland will deteriate over time (see Adam and resource shortages). Even if that is not certain it is possible - again UNCERTAINTY!
Posted by: reason | March 06, 2009 at 11:11 AM
Let me ask some hypothetical questions to all you money printers:
(1) Is it plausible in your world view for an economy (as a whole) to over-consume with borrowed money for a period of time and thus require some under-consumption to restore balance?
(2) If such a situation is possible, is it plausible in your world view that inflating away the debts can actually be worse than simply letting them liquidate, or are bailouts and inflation always preferable to avoiding moral hazard? In what case would letting the economy re-balance naturally be preferable, if ever?
Remember I'm talking about the whole economy, not individual companies or sectors, we have just experienced bubbles in pretty much everything for the first time in capitalist history. When everyone is suffering, are the only two options to pick and choose the survivors, or bail *everyone* out?
Please tell me if I mistate your position, but essentially all I hear is "average debt is zero therefore income to debt ratios are meaningless". Does that mean there is no limit to the amount of debt consumers should assume on their quest for ever inreasing demand, because someone, somewhere, is on the other side of that contract? Demand must always go up, regardless of savings, regardless of prices, regardless of history and imploding bubbles, regardless of production, regardless of the assets backing the debts, regardless of government solvency, regardless of anything? There is no upper limit? Even if the average income was $1 and the average consumer debt was $1 million it wouldn't be a problem, so long as more credit from the banks, or failing that, paper bills from the government are available to sustain demand for another quarter? Deflation must be avoided at all costs and at all times or, heaven forbid, somebody might go bankrupt?
I want to know the conditions that must exist for printing money and encouraging more debt to be a bad idea.
Maybe this scheme will work this time, but what about next time when the imbalances are even bigger? I'm trying to figure out the end game here, because (no offense intended, honestly) this sounds a little nuts to me. After the crisis is over, how does your plan increase income faster than debt for the next few decades, to balance the reverse trend over the past few decades?
Posted by: pointbite | March 06, 2009 at 11:41 AM
pointbite,
your request: "I want to know the conditions that must exist for printing money and encouraging more debt to be a bad idea."
FULL EMPLOYMENT (meaning unemployment at its natural rate, not zero).
happy to be of service.
Posted by: Adam | March 06, 2009 at 11:49 AM
"But what if, for demographic or technologilcal/resource constraint reasons (world running out of oil and no alternative technology, that sort of thing), consumption tomorrow is (feared/expected) to be very, very, very scarce (even if full employment could be maintained). In that case, anyone who can save will. "
But that is not the case, never has been and never will be in the long term. The problems that ruin growth are either structural in terms of bad policies, or economic sub-optimal equilibria that may be self-reinforcing, Keynes' "magneto trouble". We need both structural reform that allows us to maintain a good equilibrium, and stimulus to shift the equilibrium initially. Both of those things will happen, one way or another, sooner or later. I can't help but be a long-term optimist, because the case for inevitable long-term growth has been proven over and over.
Not really addressed to you Adam, (just going off on a rant here) but I have been hearing this particular strain of thought a lot recently, and it is really chafing me:
We simply are not running out of any currently essential resources in the next 50 years, which is more than enough time to create technological alternatives. I have no reason to think that humans have suddenly become technologically incompetent overnight. the "peak everything" theory of inevitable global collapse is a total crock of ---- and always has been. it has been proven over and over and over that humans can and will overcome perceived limits, and that pessimists just have a very narrow Malthusian view of the world, one that is unduly negative and often flat-out wrong. If anyone wants to bet against the long-term prospects of humanity, I would gladly take the other side, because you will lose.
Warren Buffet's decision to sell puts on the S&P was horribly timed (both in terms of trade date, and expiration date), but his fundamental insight is correct. There's a good word for people that get caught up in the self-reinforcing bubble mentality or deflation mentality, and extrapolate the current trajectory endlessly into the future: suckers.
Posted by: bob | March 06, 2009 at 11:58 AM
Bob, the demographic or tech/resource thing is just a device to get a negative real rate in the simple exchange economy of Nick's model (where people sell their services directly, they don't work for corporations).
In today's situation what we have is that each person (or at least many) individually worries that their consumption might be radically reduced by a long spell of unemployment. Each one, individually, is willing to save even at a zero (or slightly negative) real return. In the language I was using before, each person is trying, individually, to satisfy a consumption euler equation and each of these can only maintain the current consumption path with a negative real rate. Thus, each person tries to reduce their consumption and increase their savings, even at a zero real return.
Of course, at any given time there may always be some people in a situation like this. But when all of us (or lots and lots of us) feel this way then there is too much desired saving (in aggregate) and thus not enough aggregate demand. This is often called the paradox of thrift, if we all try to save it only accomplishes causing a recession in which we may end of saving even less.
Posted by: Adam | March 06, 2009 at 12:09 PM
Sorry, I should have been more clear on that: I realized that you were just using that hypothetical situation as a device, but many people are actually making those arguments, and that's what gets my goat.
In terms of the paradox of thrift, and its self reinforcing nature: my point was that a deflationary situation does feed on itself, but this cannot and will not go on forever. At the limit, if the price of all goods reaches zero and transactions go to zero (total deflationary collapse) people will establish the structural reforms and new currency to head back into growth. The paradox of thrift can only hold for so long. Unless you think that we are going back to the stone ages (some people actually do) and then devolving into apes, and then devolving into amoeba, the paradox of thrift will cease to have an effect at some point. People will realize that their collective interests are being harmed more than their personal interest in thrift, either sooner or later. Those of us that realize this now would rather have it be sooner, than later, thus avoiding a crippling contraction of the economy. Just because the paradox of thrift causes a self-reinforcing deflationary trend, it does not mean that it can't be broken, and logically it has to break at some point.
Posted by: bob | March 06, 2009 at 12:35 PM
"is it plausible in your world view that inflating away the debts can actually be worse than simply letting them liquidate"
I don't think inflating away the debt is being suggested. My view is that we need to not let the economy sink into a debt-deflation spiral that precludes restructuring and paying down the debts. 'Liquidate, liquidate, liquidate' is an extraordinarily bad and dangerous idea. Look at recent history: the failure of Lehman in some ways stopped the world's economy for at least a few days if not a couple of weeks. If Citi, BoA, AIG, etc ... all go bankrupt the economy will stop indefinitely. We'd be looking at depression era levels of unemployment within weeks. People would stop talking about the Great Depression because what we'd get would be so much worse.
Posted by: Patrick | March 06, 2009 at 12:45 PM
Adam, for the love of GOD, I hope that was sarcastic. If you really believe that ANY problem that includes unemployment, as a consequence or symptom, can be resolved with more debt or money, you are living on a different planet. Marc Faber is right, we have officially legitimized a new school of economic thought, the Zimbabwe school. Time to start hoarding food? This is craziness.
Posted by: pointbite | March 06, 2009 at 12:49 PM
I don't think Adam is being sarcastic. He has a valid point. If the real rate of interest required for full employment is negative, then the way out is through inflation, so we can have a negative real rate of interest despite a positive nominal rate of interest. A few percent inflation should do it, not Zimbabwe-style.
Posted by: Nick Rowe | March 06, 2009 at 01:04 PM
Patrick, in that case, please answer the last line of my comment:
"After the crisis is over, how does your plan increase income faster than debt for the next few decades, to balance the reverse trend over the past few decades?"
Posted by: pointbite | March 06, 2009 at 01:05 PM
pointbite: the average (net) debt is always zero, so can never be a problem (since it can never change from zero). But the distribution of debt can matter (if half the population owes a lot to the other half). Indeed, that's exactly what's going on in my model.
Posted by: Nick Rowe | March 06, 2009 at 01:09 PM
Nick, it doesn't matter WHY? Every disease with the same symptoms has the same cure?
Posted by: pointbite | March 06, 2009 at 01:16 PM
pointbite: I agree that debt is a problem. In my view, channeling Andrew Mellow to 30% unemployment is not going to help the situation. I'd rather at lest try to get an orderly workout.
Posted by: Patrick | March 06, 2009 at 02:14 PM
pointbite, I have a feeling you will get an answer in Nick's next post. I'm looking forward to it.
We're not all crazy either. Once upon a time I held views very similar to your own. the "conventional wisdom" of most people who invest (the angle I came at economics from) is decidedly libertarian. The only problem is that the framework is wrong. Look at Peter Schiff's performance. He was right (about a crisis coming), and invested based on a libertarian understanding of the modern economy. He has lost a vast amount of money. He knew there was a problem, but didn't really understand the nature of it, and destroyed his wealth, his clients' wealth and his reputation as a result. He did everything that a libertarian-tyoe investor would want to do, and it backfired horribly. Jim rogers is another guy who has pretty good calls sometimes, but his libertarian streak causes him to make extremely bad trades (shorting treasuries).
I know some of this stuff may sound "out there", but I think you're here because something tells you it might just be right. If you take the time to mull it over and dig deeper, I think you will find that it contains a more accurate view of human nature, and will provide you with a superior framework to evaluate trades. If you read between the lines here, Nick is actually providing almost all the tools you need to accurately pick a market bottom.
Posted by: bob | March 06, 2009 at 02:18 PM
pointbite, please stop putting words in my mouth. Nobody here is saying that any problem that involves unemployment can or should be solved with money. I for one am just saying that this problem does. In the UK we've been arguing the merits of QE for a while. One complaint you often hear is that it's basically a major wealth transfer to bond holders. The thing is, a deflation is also a major transfer of wealth to bond holders and along the way you impoverish debtors, including ones that have not leveraged themselves stupidly and really, truly are decent credits in any normal time. If you inflate then at least a lot of deserving people get to keep their house.
Furthermore, Zimbabwe style hyper inflations are really due to printing more money than could possibly be taxed because the country just isn't generating any wealth. That's not the case here, we simply commit to an appropriately high inflation target and stick to it. My view is that in the current situation the lack of inflation is more distortionary than would be 6% inflation for 6-8 years.
Finally, see Sargent's "End of four big inflations" paper for some empirics on how surprisingly painless ending a hyper-inflation can be if we do happen to end up there. But as I've said before, I don't see why a 6% inflation target is not doable without any real risk of hyper-inflation.
Posted by: Adam | March 06, 2009 at 03:06 PM
Bob, Peter Schiff's investment performance over the past 9 months is irrelevant to the fundamental economic arguments. Look at the top of this post, "If financial markets were perfect..."
Posted by: pointbite | March 06, 2009 at 04:00 PM
Adam, this is an honest question, I'm not trying to be "pissy" (which I think you or someone else accused me of a few weeks ago) is there any evidence such policy has ever worked before? I would like to read about it.
Posted by: pointbite | March 06, 2009 at 04:02 PM
"Bob, Peter Schiff's investment performance over the past 9 months is irrelevant to the fundamental economic arguments. Look at the top of this post, "If financial markets were perfect..."
No it is not. Schiff got the fundamentals wrong, just like 90% of libertarians who were calling for a dollar crash in the midst of deflation. The mechanics of the market dictate that a deflationary spiral will result in increasing demand for treasuries and falling prices for most commodities. People who bet on inflation plays last spring got burned because they lack the faintest clue about how the economy actually functions, so they blame the 'irrational' market when it is their job to understand the market. If Schiff thought that the market was truly irrational, why would he put his clients money there? Poor excuse for flat-out wrong predictions, predicated on flawed economic theories. If you believe that there is a massive over-leveraged private debt bubble collapsing, shorting US dollars or treasuries during the collapse is just about the stupidest thing you could possibly do.
Both Keynesians and libertarians agreed that there was a debt bubble collapsing last spring. The Keynesian play was short oil and long treasuries, the libertarian play was short treasuries and long oil. which one actually understands how an economy works? the proof is in the pudding.
this is only the tip of the iceberg really, for an extensive and devastating critique of Schiff (by another libertarian who is a lot less wrong):
http://globaleconomicanalysis.blogspot.com/2009/01/peter-schiff-was-wrong.html
Posted by: bob | March 06, 2009 at 05:42 PM
Bob, it's totally irrelevant. It wasn't my intention to defend Peter Schiff on this blog but you are completely mis-representing his position. His play against the dollar is primarily based on how he felt governments (America and others) would *react* to a deflation. If you actually read or listen to him you would realize Peter understands bursting debt bubbles are deflationary and that typically increases the value of money, but he argues dollars are fundamentally different than the money we remember. Today, they are just pieces of paper that people can print like Christmas cards to make ourselves feel better. His biggest fear was not the economic crisis, but the government reaction to the economic crisis. Peter's scenario hasn't even started yet, wait until we experience Nick's quantitative easing and Adam's 6% inflation for 8 years and if China and the bond-flippers are still pushing up the treasury market (like condo flippers in Florida) then you'll have a point. Until then, just sit tight and watch the show. You remind me of a story Nassim Talib wrote about in Fooled By Randomness, I think it was the first chapter, called "Solon's warning". Look that up. I recommend both his books.
Peter Schiff never pretended to be a short-term trader, but I will nevertheless remind you that gold was up in 2008, and 2007, and 2006, and 2005, and 2004, and 2003, and 2002, and 2001. Libertarians are doing pretty damn well, if you ask me. How's the DOW? How's real estate? How's just about everything else on the planet over the same time period, including the US dollar? It's easy to sound smart when you only talk about the years everything you say is right, isn't it?
And by the way, Mish Shedlock isn't a Keynesian.
Posted by: pointbite | March 06, 2009 at 11:12 PM
pointbite: "is there any evidence such policy has ever worked before"
Oh please. Mish Shedlock? The guy tries to discredit Paul Krugman by accusing him of using calculus. It's pathetic.
Posted by: Patrick | March 06, 2009 at 11:59 PM
Patrick, I don't understand your comment. You didn't answer the question. The Mish comment was regarding the link from Bob, he's using commentary from a Libertarian to attack a Libertarian in defence of Keynes.
Posted by: pointbite | March 07, 2009 at 12:25 AM
Here's what Mish thinks, from last fall.
http://www.lewrockwell.com/podcast/?p=episode&name=2008-12-09_081_the_answer_to_the_economic_crisis.mp3
Posted by: pointbite | March 07, 2009 at 12:29 AM
Pointbyte
Re your comment 11.41
What do you mean by "economy" exactly. (Sorry I keep insisting on clearly defined terms). Do you mean a national economy or a world economy. The answer depends.
At the moment the US has the de-facto world currency, and its debts are denominated in that currency. That is a completely different situation to say Zimbabwe. It can literally print money to pay off its debts, at the cost of debasing that currency. Given that your alternative is that some debts get wiped out by default in a deleveraging spiral, I don't see how that scenario is worse for creditors, let alone debtors. The thing is faced with debt deflation, relative inflation (particularly if created by spreading money around evenly) is the fairest and smoothest solution.
If however, you want to talk about a generic (small) national economy that has been running payments deficits for some time, yes it will have to save to repair its balance sheets. But that may mean relatively small but sustained adjustments. But the Keynesians don't disagree with you here - see Krugman's much misunderstood piece about the temptations of protectionism and the need for international co-ordination.
Posted by: reason | March 09, 2009 at 05:23 AM