Krugman’s blog, 5/6/15

There were two posts yesterday.  The first was “The Worst Ex-Chairman Ever:”

When Alan Greenspan left the Fed, he had nearly divine status in the eyes of the financial press and, I’m sorry to say, quite a few economists. In retrospect, of course, his reputation has faltered badly; whether or not you blame Fed policy for the housing bubble (you shouldn’t), Greenspan denied the bubble’s existence and even its possibility as it was inflating, while actively blocking efforts to tighten financial regulation.

But it’s his track record since leaving office that is truly remarkable. He has been an inflation and debt fear monger, helping to make his successor’s already hard job a bit harder — and famously complained about ungrateful markets that keep failing to deliver the crises he predicts. After a brief moment of doubt about the wisdom of financial markets, he went right back to denouncing regulation while proclaiming that markets get it right “with notably rare exceptions”.

Now I have in my inbox a notice that as the Fed holds its annual meeting in Jackson Hole, Greenspan will address a counter-conference organized by a group called the American Principles Project. The group combines social conservatism — it’s anti-gay-marriage, anti-abortion rights, and pro-“religious liberty” — with goldbug economic doctrine.

The second half of this agenda may be appealing to Greenspan, a former Ayn Rand intimate — as Paul Samuelson remarked, “You can take the boy out of the cult but you can’t take the cult out of the boy.” But the anti-gay stuff? And helping these people attack his former colleagues?


Yesterday’s second post was “The Fed Does Not Control the Money Supply:”

Brad DeLong points us to David Glasner on John Taylor; I don’t think I need to add to the pile-on. But I do think Glasner misses a point when he says that

the quantity of money, unlike the Fed Funds rate, is not an instrument under the direct control of the Fed.

Actually, under current conditions — in a liquidity trap — it’s not even under the indirect control of the Fed. The same impotence of conventional monetary policy that makes open-market purchases of Treasuries useless at boosting GDP also mean that broad monetary aggregates that include deposits are largely immune to Fed influence. The Fed can stuff the banks full of reserves, but at zero rates those reserves have no incentive to go anywhere, and even if they do they can sit in safes and mattresses.

This is not a new point. Back in 1998 I covered it pretty well:

Putting financial intermediation into a liquidity trap framework suggests, pace Friedman and Schwartz, that it is quite misleading to look at monetary aggregates under these circumstances: in a liquidity trap, the central bank may well find that it cannot increase broader monetary aggregates, that increments to the monetary base are simply added to reserves and currency holdings, and thus both that such aggregates are no longer valid indicators of the stance of monetary policy and that their failure to rise does not indicate that the essential problem lies in the banking sector.

The effects of quantitative easing in Japan a few years later, which failed to raise M2, confirmed this conclusion. And sure enough, here’s what happened to US M2 as the Fed increased the size of its balance sheet:

By the way, in discussing monetary policy I sometimes write “money supply” as shorthand for “monetary base”; it has always been clear, if you read my work, that I know that the Fed only truly controls the base and that this need not translate into changes in broader aggregates.

So we had a simple prediction, completely borne out by experience. And you can therefore understand why I want to bang my head against the wall when economists say things along the lines of “the Fed can just target the money supply” or “we would have had runaway inflation except that for some reason banks just increased excess reserves — who could have predicted?”

So much heavy going over such basically simple stuff. But then, to expand on and somewhat ruin Upton Sinclair, it’s difficult to get a man to understand something when he has strong incentives, which may be ideological rather than or in addition to financial, not to understand it.



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