Krugman’s blog, 8/16/13

There were five posts yesterday.  The first was “Ireland Is The Success Story Of The Future, And Always Will Be:”

Via Mark Thoma, Kenneth Thomas analyzes the latest attempt to claim that Ireland is a success story — is this the third or the fourth time around? — and concludes that the modest fall in unemployment is all about emigration. Actually, we can reach the same conclusion by going straight to employment data:


This is not exactly a policy triumph.

The one sense in which Ireland has made some progress is that it has somewhat reassured bond investors that its population will continue to sullenly acquiesce in austerity; as a result, Irish 10-year rates, while still at a large premium, are now 60-80 basis points below those of Italy and Spain.

But the repeated invocation of Ireland as a role model has gotten to be a sick joke.

The second post of the day was “Banks and the Monetary Base (Wonkish):”

Cullen Roche is unhappy with the way I treat monetary expansion in my old Japan paper (pdf); or actually he’s unhappy with the way I talk about it. I’m actually kind of reluctant to even get into this, because any discussion of these issue brings out the people who believe that they have discovered the hidden secrets of the monetary universe, somehow missed by generations of economists. But here goes anyway.

When I think about the role of banks in the economy, I generally rely on two models, which are both partial pictures but add up to a reasonable overall approach. One is Diamond-Dybvig (pdf), which portrays banks as providers of liquidity services, and also shows how bank runs can happen. The other is Tobin-Brainard (pdf), which portrays the financial system in terms of a portfolio equilibrium, in which each sector — households, banks, firms, etc. — choose the mixes of assets and liabilities they want to hold, and asset prices adjust to make these choices consistent.

What I did in that old Brookings Paper was a quick-and-dirty merger of these two approaches, in which I got the monetary base into the story in the form of required reserves held by banks. That was a strategic simplification, and an unrealistic one — almost all of the monetary base is actually held in the form of currency, not bank reserves. But it was obvious to me that it didn’t really make any difference for the question at hand.

And how did I know that? Basically from Tobin-Brainard, who showed that whether banks hold monetary base in the form of reserves makes no fundamental difference to the monetary mechanism, as long as somebody wants to hold base money — and the public does, in the form of currency.

Actually, Tobin-Brainard is to many of the controversies that swirl around banks and money as IS-LM is to controversies about interest-rate determination. When we ask, “Are interest rates determined by the supply and demand of loanable funds, or are they determined by the tradeoff between liquidity and return?”, the correct answer is “Yes” — it’s a simultaneous system.

Similarly, if we ask, “Is the volume of bank lending determined by the amount the public chooses to deposit in banks, or is the amount deposited in banks determined by the amount banks choose to lend?”, the answer is once again “Yes”; financial prices adjust to make those choices consistent.

Now, think about what happens when the Fed makes an open-market purchase of securities from banks. This unbalances the banks’ portfolio — they’re holding fewer securities and more reserve — and they will proceed to try to rebalance, buying more securities, and in the process will induce the public to hold both more currency and more deposits. That’s all that I mean when I say that the banks lend out the newly created reserves; you may consider this shorthand way of describing the process misleading, but I at least am not confused about the nature of the adjustment.

And the crucial thing is that there are no puzzles or misunderstandings here. Tobin and Brainard got it all straight half a century ago, and anyone who thinks that there’s a big flaw in their reasoning is almost surely just getting caught up in his own word games.

The middle post yesterday was “Stagflation, Stagnation, and Intellectual Asymmetry:”

Brad DeLong weighs in on the Friedman legacy, and notes that there have been two big successful sort of meta-predictions in macroeconomics over the past half-century. In the late 60s, Friedman and Phelps warned of the risk of stagflation, and were vindicated in the 1970s. In the late 1990s, some economists warned of the risk of Depression-type liquidity traps, and were vindicated in the Naughties. The first success led to Friedmam’s promotion to demigod status; the second success has not produced any comparable elevation.

But never mind the personal aspect. More important, stagflation led to a major rethinking of macroeconomics, all across the board; even staunch Keynesians conceded that Friedman/Phelps had been right (indeed, they may have conceded too much), and the vertical long-run Phillips curve became part of every textbook. But the Great Recession and the long stagnation that followed (and continues) have brought no such concessions from the anti-Keynesians. As I often note on this blog, even the most spectacular failures of prediction (and successes for the other side) have been met with nothing but excuses (It’s Obamacare! It’s interest on reserves! It’s uncertainty!)

What accounts for this asymmetry? Partly, I think, there’s an economics-specific aspect: anti-Keynesian macroeconomics is a comfortable position, because it involves a return to notions of perfect markets and perfectly rational individuals; so the anti-Keynesians find it hard to leave that comfort zone, while even Keynesians sort of liked introducing a bit more rationality into their models.

But it’s also the usual left-right asymmetry. Keynesianism isn’t exactly left-wing, but monetarism was clearly conservative, and equilibrium business cycle theory even more so. And left and right in modern America are not mirror images. The right is purist, uncompromising, and ultimately not interested in contrary evidence; the left is much more open and empirical. And the economics profession, it turns out, is not that different from the political sphere.

This is an uncomfortable truth to acknowledge. Many economists would like to believe that we’re having a reasonable, civilized discussion, rather than dealing with denialism and bad faith. But you go to economic debates with the profession you have, not the profession you want.

The fourth post yesterday was “Schroedinger’s Price Index:”

Apparently Republicans are trying, once again, to extract chain-linking of Social Security benefits as the price of some kind of deal. I have no idea whether this will go anywhere; my guess, or maybe just my hope, is that Obama the Grand Bargainer has vanished from the scene.

But there’s a funny point I hadn’t thought of until Matt O’Brien pointed it out. The alleged justification for chain-linking is that the conventional consumer price index overstates true inflation; it might overall, but probably not for seniors. In any case, however, as Matt points out, the very same Republicans who claim that Social Security benefits should be cut because the CPI overstates true inflation also insist that the Fed must stop quantitative easing, despite the absence of any visible inflation threat, because the real inflation rate is much higher than the official statistics indicate.

But Matt, I think, fails to grasp the subtlety of the GOP position here. He accuses them of not knowing what they’re talking about. But surely what’s really happening is that they have a quantum-mechanics view of the situation: the state of the world in which the CPI overstates inflation and the state in which it understates inflation coexist in a condition of superposition, and what happens when you collapse the wave function depends on the position of the observer — that is, whether he’s trying to slash Social Security or bash Ben Bernanke.

Or, on the other hand, maybe they don’t know what they’re talking about.

As usual, the last post yesterday was “Friday Night Music: Carolina Chocolate Drops, Leaving Eden:”

A little plain and simple beauty to end the week:


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