J. Bradford DeLong's Blog, page 2139

Liveblogging World War II: December 13, 1940

Robert Paxton: Vichy France: Old Guard and New Order:

On the afternoon of Friday, December 13, 1940, Pierre Laval, home from the second round of military talks on Africa with General Warlimont, presided over a routine cabinet meeting. A few hours later, a surprise meeting of the whole Council of Ministers was called by Marshal Petain. The Marshal asked each member of the government to write out a letter of resignation. Then he accepted those of Pierre Laval and Georges Ripert, minister of education. In the meantime, Laval's floors of the Hotel du Parc were occupied by special security forces.... Laval was... placed under house arrest. Communications with Paris were cut off. This was the most Byzantine of all the many Vichy changes of cabinet, the only one accomplished by the threat of force....

Yet Another One from Nick Rowe

"Illiquid" and "insolvent" are not clearly distinguished:

Nick Rowe: Worthwhile Canadian Initiative: Sovereign insolvency and illiquidity: If a country has a debt/GDP ratio of 100%, and is paying 9% interest, and nominal GDP is not rising, then it's got a solvency problem. It needs to run a budget surplus of 9% of GDP just to stop the debt/GDP ratio rising further. And that is very hard to do.

But why would a country ever be paying 9% interest and have 0% nominal GDP growth? By David Beckworth's simple, crude, but nevertheless useful measure of the tightness of monetary policy -- the gap between nominal interest rates and expected nominal GDP growth rate -- a gap of 9 percentage points is very tight monetary policy. No country that had control over its own monetary policy would set monetary policy that tight (OK, unless its population were falling exogenously at around 9% per year, or if it were a purely temporary measure to reduce entrenched inflation).

Countries like the UK, US, Japan, have large debts and deficits. But they control their own monetary policy, and none of them have monetary policy anywhere near that tight. If they did set monetary policy that tight, they too would have a solvency crisis.

Ireland has a solvency crisis, but only because it has a liquidity crisis. Ireland does not control its own monetary policy. Money is the most liquid of all assets.

If monetary policy were less tight, so the gap between nominal interest rates and nominal GDP growth were 1%, a country with a 100% debt/GDP ratio would only need a budget surplus of 1% of GDP to prevent the debt/GDP ratio from rising. That's doable. That country is solvent.

Time to Go Crouch in the Basement...

Metafilter has noticed my existence...

At least it isn't 4chan...

Would somebody please email me when it is safe for me to come out?

Why Was Europe So Cold in the Hottest November on Record?

Joe Romm sends us to: NASA’s James Hansen, Reto Ruedy, Makiko Sato and Ken Lo, “2010 — Global Temperature and Europe’s Frigid Air”:

This is the warmest January-November in the GISS analysis, which covers 131 years. However, it is only a few hundredths of a degree warmer than 2005, so it is possible that the final GISS results for the full year will find 2010 and 2005 to have the same temperature within the margin of error.... November 2010 surface temperature anomalies based only on surface air measurements at meteorological stations and Antarctic research stations... to allow extreme temperature anomalies to be apparent. Northern Europe had negative anomalies of more than 4°C, while the Hudson Bay region of Canada had monthly mean anomalies greater than +10°C. The extreme warmth in Northeast Canada is undoubtedly related to the fact that Hudson Bay was practically ice free. In the past, including the GISS base period 1951-1980, Hudson Bay was largely ice-covered in November.... Sea ice insulates the atmosphere from ocean water warmth, allowing surface air to achieve temperatures much lower than that of the ocean. It is for this reason that some of the largest positive temperature anomalies on the planet occur in the Arctic Ocean as sea ice area has decreased in recent years.

The cold anomaly in Northern Europe in November has continued and strengthened in the first half of December.... [I]s it possible that reduced Arctic sea ice is affecting weather patterns?... The fixed location of the Hudson-Baffin heat source could plausibly affect weather patterns, in a deterministic way — Europe being half a Rossby wavelength downstream, thus producing a cold European anomaly in the trans-Atlantic seesaw. Several ideas about possible effects of the loss of Arctic sea ice on weather patterns are discussed in papers referenced by Overland, Wang and Walsh. However... the few years just prior to 2009-2010, with low Arctic sea ice, did not produce cold winters in Europe. The cold winter of 2009-2010 was associated with the most extreme Arctic Oscillation in the period of record.... 7 of the last 10 European winters were warmer than the 1951-1980 average winter, and 10 of the past 10 summers were warmer than climatology. The average warming of European winters is at least as large as the average warming of summers, but it is less noticeable because of the much greater variability in winter.

Sunday Morning Monetary Theology

Nick Rowe asks me three questions in his Worthwhile Canadian Initiative: If cows were money (a response to Brad DeLong):

Nick: If cows were money, an increased demand for milk would cause a recession. People would stop spending their cows to buy goods and services, because if you spend your cows you don't have as much milk. Was the recession caused by an excess demand for milk, or an excess demand for money?

Me: If the Federal Cow Reserve conducted expansionary monetary policy by selling cows in exchange for promises to deliver milk, then its open market operations in cows would have no stimulative effect on the economy: the cows it sold would not enter the circulating medium but would instead be kept in reserve to replace the milk that the Federal Reserve had bought. Since open-market operations that boost the money stock are ineffective, it is clear that the recession was not caused by an excess demand for money but by an excess demand for milk.

Nick: If gold bars were money, an increased demand for bling would cause a recession. People would stop spending their gold bars to buy goods and services, because if you spend your gold bars you don't have as much bling. Was the recession caused by an excess demand for bling, or an excess demand for money?

Me: If the Federal Jewelry Reserve conducted expansionary monetary policy by selling gold in exchange for other forms of bling, then its open market operations in gold would have no stimulative effect on the economy: the gold it sold would not enter the circulating medium but would instead be used as bling replace the bling that the Federal Reserve had bought. Since open-market operations that boost the money stock are ineffective, it is clear that the recession was not caused by an excess demand for money but by an excess demand for bling.

Nick: If dollars were money, an increased demand for savings would cause a recession. People would stop spending their dollars to buy goods and services, because if you spend your dollars you don't have as much savings. Was the recession caused by an excess demand for savings, or an excess demand for money?

Me: If the Federal Reserve conducted expansionary monetary policy by selling dollars in exchange for other savings vehicles like bonds, then its open market operations in dollars and bonds would have no stimulative effect on the economy: the dollars it sold would not enter the circulating medium but would instead be used as savings vehicles to replace the bonds that the Federal Reserve had bought. Since open-market operations that boost the money stock are ineffective, it is clear that the recession was not caused by an excess demand for money but by an excess demand for savings vehicles.

Now that that is clear, let me say that Nick's post is very good. He goes on:

It has almost come down to a semantic dispute.... [W]e are arguing about the referential opacity of demand functions. If I demand milk, can I be said to demand the medium of exchange, if, as a contingent fact, the medium of exchange just happens to provide milk, and I want the medium of exchange only for its milk?

But it matters. Because the way you frame the cause of the recession may influence where you look for a cure.

If you say that the recession is caused by an excess demand for milk, you start looking for ways to either increase the supply of milk or reduce the demand. Can the government breed some goats, and increase the supply of milk that way? But if you see the recession as being caused by an excess demand for cows, you also start to think of other solutions. Perhaps the government could tax ownership of cows? Even, as a last ditch policy, make the cows stop giving milk? If you think of the recession as being caused by a shortage of milk, then taxing cows, or making the cows stop giving milk, look like totally daft solutions. They wouldn't cure the shortage of milk. But they would cure the recession. With a tax on cows, or if cows stopped giving milk, people would start spending their cows again.

But I also see the point of looking at it from Brad's perspective. An open market operation of cows for goats, where the government imports cows, uses them buy goats, and exports the goats, may not work. The total supply of milk is the same, and if cow's milk and goat's milk are perfect substitutes, people have no additional incentive to get rid of their cows to buy the goods and services that are in excess supply. If, at the margin, the demand for cows is a demand for milk only, the demand for cows will increase one-for-one with the increased supply of cows, if that increased supply of cows is the result of an open market purchase of goats. But why did the demand for cow's milk increase in the first place? Was it that all the goats went dry? Or might the increased demand for milk be a consequence of the recession, and so a consequence of the excess demand for cows? "I had better hang on to my cows, because I won't be able to sell my labour to buy milk in this recession!"

I don't know whether Brad is right about the shortage of other safe savings vehicles being the cause of the increased demand for money qua second best savings vehicle. But, even if he is wrong, this is something that might happen.... [C]orrectly diagnosing the proximate cause of the recession as an excess demand for the good that happens to be the medium of exchange, even if that excess demand is not a demand for that good qua medium of exchange, lets us start thinking about radical solutions.

And we need to start thinking about radical solutions, because as history teaches us, and as this recession reminds us (and judging by the Eurozone we are going to be reminded again) stuff happens. Things go wrong. Safe assets become unsafe. Goats stop giving milk. And we need a monetary system that is robust in the face of human stuff-ups. A shortage of milk is a problem, but it didn't ought to cause a recession too. A shortage of safe assets is a problem, but it didn't ought to cause a recession too. And if it didn't cause an excess demand for the medium of exchange, as a contingent side-effect, it wouldn't cause a recession to compound the original problem. And it's just because those side-effects are contingent, and don't follow of necessity, that I insist on my way of framing the problem. A shortage of safe assets may cause an excess demand for money. An excess demand for money will cause a recession. We can break that first link in the causal chain, because it's only a contingent link. The second link follows of metaphysical necessity, unless we switch to barter.

What's the solution that could prevent an excess demand for the medium of exchange, and so prevent general gluts? Silvio Gessell? Barter on Ebay? Funny money systems where you can't hold a positive balance? God only knows. But we ought to start thinking about it. Quasi-monetarism (which is really Keynesianism too, if you are the sort of Keynesian that recognises that Keynesian economics doesn't make any sense in a barter economy) can be a radical approach.

The one thing this left out, I think, is that "money" becomes a first-rate savings vehicle and store of safe value only when nominal interest rates hit their zero lower bound.

Actually, it left out something else: in comments to Nick, Andrew Harless starts musing about money not just as a medium of exchange and a store of value but a unit of account...

Dana Milbank Tries to Win This Year's Stupidest Man Alive Contest

Entry by Paul Krugman:

Orwellian Centrism: [T]he Washington Post... I’m inside the Beltway right now, so I spared a peek — and for my sins ended up reading Dana Milbank, who praises Obama for punching the hippies. So far, so usual. But then I read this:

This is a hopeful sign that Obama has learned the lessons of the health-care debate, when he acceded too easily to the wishes of Hill Democrats, allowing them to slow the legislation and engage in a protracted debate on the public option. Months of delay gave Republicans time to make their case against “socialism” and prevented action on more pressing issues, such as job creation. Democrats paid for that with 63 seats.

Um, that’s not what happened — and I followed the health care process closely. The debate over the public option wasn’t what slowed the legislation. What did it was the many months Obama waited while Max Baucus tried to get bipartisan support, only to see the Republicans keep moving the goalposts; only when the White House finally concluded that Republican “moderates” weren’t negotiating in good faith did the thing finally get moving.

So look at how the Village constructs its mythology. The real story, of pretend moderates stalling action by pretending to be persuadable, has been rewritten as a story of how those DF hippies got in the way, until the centrists saved the day.

The worst of it is that I suspect Obama’s memory has gone down the same hole.

Why oh why can't we have a better press corps?

David Broder Enters This Year's Stupidest Man Alive Contest

There should be resignations from the Washington Post every day.

Today, more than usual, they should be in disgust at the low quality of the thought expressed.

David Broder:

Centrist on the rise: [Barack Obama] has regained the economic initiative from the victorious Republicans, separated himself from the left of his own party and staked a strong claim to the territory where national elections are fought and won: the independent center... [by] opting to accommodate reality by acceding to the Republican demand for maintaining all the Bush tax cuts... yielding temporarily to the GOP on its insistence for preserving the top-bracket tax cuts.... [T]he $900 billion this deal will add to the national debt increases the pressure on Obama and Congress to undertake the kind of tough-love budgetary changes outlined by the presidential commission on deficits... improves the odds for tax reform, an effort that Obama is now perfectly positioned to lead...

If adding $900 billion to the national debt is a step toward fiscal responsibility and tax reform, why stop there? Why not add $3 trillion to the national debt? Or $9 trillion?

To say that we should add $900 billion to the debt because it increases the pressure on us to deal with our long-term fiscal problems is like saying that we should cut off our hand in order to increase the pressure on us to go to the doctor.

Don't get me wrong: I think the $900 billion deal is better than nothing--although I bitterly, bitterly regret Obama's failure to hold out for a short-term debt-limit increase and for long-term standby tax increases and spending cuts: "I will sign no bills that increase the debt looking ten years forward" ought to be his line in the sand.

Why oh why can't we have a better press corps?

Worst Christmas Special of All TIme

DeLong Smackdown Watch: Nick Rowe Metaphysical Necessity of Monetarism Edition

The thoughtful and intelligent Nick Rowe asks:

What Does Cutting-Edge Macroeconomics Tell Us About Economic Policy for the Recovery?: You see, Say(1803) (lovely way to express this, by the way) was very nearly right. Suppose we start in equilibrium, then there's a sudden desire to stop buying newly-produced goods and buy land instead. Either the price of land rises to equilibrium or it doesn't. If the price of land rises to equilibrium, then people stop wanting to buy land and return to buying newly-produced goods. If the price of land stays fixed (it's sticky, or whatever) people cannot buy land because nobody is willing to sell. So they have to buy something else with their income instead, or else hoard money.

Ultimately there are only two things an individual can do with his income, if everybody else is trying to do the same thing: buy newly-produced goods, where there are plenty of willing sellers in a general glut; or hoard money, by not buying things, which nobody else can stop you doing.

And:

What Does Cutting-Edge Macroeconomics Tell Us About Economic Policy for the Recovery?: OK Brad, a challenge for you:

A general glut means an excess supply of newly-produced goods. You say that a general glut can be caused by an excess demand for financial assets: which could be money, bonds, or safe assets. Is it theoretically possible for a general glut to be caused by an excess demand for something that is neither a financial asset nor a newly-produced good? For example, could it be caused by an excess demand for: land, old houses, old books, antique furniture etc.? Or, what about intermediate cases, like an excess demand for gold, where new and old gold is identical, but new production is very small and inelastic compared to the existing stock?

My position is that a general glut can only be caused by an excess demand for the medium of exchange. An excess demand for any of those other assets can only cause a general glut if it spills over into an excess demand for the medium of exchange. The distinction between financial and non-financial assets is irrelevant. Why should it matter?

I'm trying to smoke out your inner quasi-monetarist!

Let's try to think through whether it is money that matters or rather financial assets...

Since I am in Berkeley let's think of an economy with two occupations: baristas and yoga instructors. Baristas make lattes and yoga instructors teach you how to do the Downward-Facing Dog. Can there be a situation in which baristas have brewed more cups of coffee than than yoga instructors want to buy who are offering more yoga lessons than baristas want to take? The way Say expresses it in 1803 is roughly as follows: nobody makes anything unless they intend to use it or sell it, and nobody sells anything unless they intend to buy something with the proceeds of the sale. Thus, "by the metaphysical necessity of the case," as John Stuart Mill was to put it, there has to be the purchasing power to buy everything offered for sale--there can be particular gluts of commodities, but every market in which there is excess supply must be balanced by another in which there is excess demand.

This is an anticipation of what we now call Walras' Law: that the sum across all markets of all excess demands must equal zero.

And here Mill comes in: it is perfectly possible for there to be an excess supply of goods and services—for the current flow of aggregate demand for goods and services to be less than the cost of the goods and services currently being produced--if there is an excess demand for financial assets. As Mill put it:

Although he who sells, really sells only to buy, he needs not buy at the same moment when he sells.... [I]t may very well occur that there may be... a very general inclination to sell with as little delay... accompanied with an equally general inclination to defer all purchases.... It is true that this state can be only temporary and must even be succeeded by a reaction of corresponding violence... [but] this is no more than may be said of every partial over-supply.... It must, undoubtedly, be admitted that there cannot be an excess of all other commodities and an excess of money at the same time. But those who have... affirmed that there was an excess of all commodities never pretended that money was one of these commodities.... What it amounted to was that persons in general... liked better to possess money than any other commodity. Money, consequently, was in request, and all other commodities were in comparative disrepute...

Now does it have to be an excess demand for money?

Consider, first, a normal shift in demand: Berkeleyites decide that they want to spend somewhat less on lattes that make them jumpy, irritable, and stressed. Berkeleyites decide they want to spend somewhat more on yoga lessons in order to seek inner peace. Baristas find that they have brewed more lattes than they can sell. Some cut their prices and see their incomes fall, some cut back on hours, some find themselves unable to buy the shade-grown beans for their next round of production and are unemployed.

Yoga instructors find demand booming.

They schedule extra classes.

They work late into the night chanting “om mani padme hum” to satisfy demand.

They raise their prices.

They take on extra apprentices to help them carry the load.

Prices fall in the coffee industry. Prices rise in the fitness industry. Excess supply of coffee and baristas comes with excess demand for yoga lessons and yoga instructors.

In a short time the economy adjusts.

Labor exits the coffee industry and enters the yoga industry. And in a short while the economy has rebalanced with fewer baristas and more yoga instructors, the structure of production has shifted to accommodate the shift in demand, and there is no more excess unemployment.

But now consider, instead, what Jean-Baptiste Say and John Stuart Mill were talking about in 1829 with an excess demand for financial assets.

Consumers decide that they want to spend somewhat less on lattes purchased from baristas and to hold more bonds and more cash. Those with less than their new higher target of financial assets simply spending until somebody buys some of what they have to sell.

What happens in the coffee industry is the same thing that happened when there was a shift in demand from caffeine to inner peace. Baristas find that they have brewed more lattes than they can sell. Some cut their prices and see their incomes fall, some cut back on hours, some find themselves unable to buy the beans for their next round of production and are unemployed. Inventories of unsold beans and cold coffee pile up. Entrepreneurs looking at their growing piles of unsold inventory cut back on hours and production even more.

But there is no countervailing increase in spending, employment, and hours for yoga instructors.

Things then snowball. The unemployed baristas now have no incomes. They cannot afford to buy as many yoga lessons or, indeed, as much of the coffee made by other baristas. Employers cut back production and employment even more. Thus there is a second-round fall in demand which renders even more people unemployed--and then there is a third round. Moreover, everybody sees rising unemployment and falling incomes around them. Can you imagine a better signal to make you decide to try to hold onto more cash? Instead of cutting back on spending on coffee when you have less than $20 in your pocket, people start cutting back on all spending when they have less than $40 in their pocket. And the more the prices at which you can sell your goods falls and the higher unemployment climbs, the more desperate people are to pile up more cash in their wallets.

In a normal market adjustment--a fall in the demand for lattes and a rise in the demand for inner peace--the workers fired from the coffee industry would rapidly be hired into the yoga instructor industry. But this is not a normal market adjustment: this is depression economics.

Things would be different if we were on a gold standard there were a bus to Sacramento. Unemployed baristas would then say: "I'm unemployed, and the economy is way short of financial assets--I know! I'm going to take the bus to Sacramento and enter the gold-money producing industry by panning for gold!" Then labor would flow out of latte-making and into money-production, and we would have a normal adjustment process.

But our currently-unemployed have little ability to go down into their basement and make the assets of which the world economy is currently short--whether they are Federal Reserve notes or 30-Year Treasuries.

I cannot see that it makes a good deal of difference whether the financial excess demand is for liquid cash money, or for bonds as savings vehicles, or for the class of safe nominal assets. In each of these three cases it seems likely that you get downward pressure on demand for those industries that can fire people and little if any upward pressure on demand in any industries that can hire people.

You will respond that what I call a "shortage of bonds" is really a shortage of money, as the spending velocity of money will fall as demand for currently-produced goods and services falls. I would say that the spending velocity of money has fallen because people are short of savings vehicles, and so are holding on to their money as a second-best to holding bonds. I would then say that if we had the same amount of money but more savings vehicles--if the government sold bonds and bought a dam, things would be fine, but if we had the same amount of savings vehicles but more money--if the central bank bought bonds for cash--we would not be fine. It seems distinctly odd to call that situation a shortage of money...

DeLong Smackdown Watch: Dean Baker on Origins of the Present Crisis

Dean Baker believes that even if the financial crisis of 2007-8 had been handled perfectly, we would still be in a deep recession:

Beating Up On Brad DeLong: [DeLong]ees the core problem as a loss of $500 billion in housing wealth from excessive exuberance in a few markets pushing house prices too high. Due to poor regulation, this triggered the financial earthquakes of September 2008, putting us where we are today. My arithmetic is a bit different. I see the collapse of an $8 trillion housing bubble that was driving the economy. The collapse of this bubble cost us more than $1.2 trillion in annual private sector demand (@ 9 percent of GDP).... There is nothing in our economists' bag of tricks that gives us an easy mechanism for replacing 9 percent of GDP quickly, which leaves me wondering what the reality grasping Mr. DeLong been smoking?...

By the peak of the bubble in 2006, house prices were more than 70 percent above their trend level. This created more than $8 trillion in housing bubble wealth. This wealth drove the economy in two ways. It had a direct effect in propelling construction, which peaked at 6.2 percent of GDP, about 2.5 percentage points above its post-war average. The bubble wealth also lead to a huge surge in consumption -- through the long-known housing wealth effect. With a wealth effect of 5-7 cents on the dollar, the bubble would have been expected to lead to $400 billion to $560 billion in excess consumption demand.

When the bubble burst, consumption predictably plummeted. Throw in another $6 trillion in lost stock wealth and we get a decline of $600 billion to $800 billion in consumption. (The stock wealth effect is estimated at 3-4 cents on the dollar.)...

The huge overbuilding of the bubble years meant that there was an enormous oversupply of housing. Residential construction has fallen back by more than 3.0 percentage points of GDP or close to $500 billion a year.... Add in the loss of another $100-$200 billion in annual demand from non-residential construction.

This gets a total loss in annual demand of more than $1.2 trillion. Note that the financial crisis appears nowhere in this story. Exactly what mechanism do we have in the private economy for replacing $1.2 trillion in private demand in a short period of time?...

Frankly, I am at loss to understand the fixation on financial markets as an explanation for the crisis. Large firms are sitting on more than $2 trillion in cash. Furthermore, they can borrow much more at historically low interest rates. If there are good investment opportunities out there, we should expect these highly liquid large firms to be running wild taking advantage of them while their smaller competitors are crippled by a lack of access to credit. We don't see this. In fact, Wal-Mart, Starbucks and the rest of scaled back their expansion plans in recognition of the weak economy. Let's get this discussion back to reality. The problem was and is the housing bubble, let's not muddle the picture...

I think I differ from Dean in two big places:

First, the stock market decline is a consequence of the financial crisis--not of the housing bubble. And there is some double-counting in the wealth-effect-of-the-housing-stock, for one thing that people were buying with their housing wealth was bigger and even more leveraged houses. And I am inclined to see a 4% marginal propensity to consume out of housing wealth than a 7% one. So my point estimate of the housing-bubble-collapse-induced fall in the flow of nominal demand is not $1.2 trillion/year but rather $800 billion/year.

Second, the Federal Reserve saw the fall in demand from the collapse of housing wealth coming and took steps to offset it: it dropped the Federal Funds rate by 400 basis points from the winter of 2007 to the winter of 2008. The back-of-the-envelope number I have in my brain is that each basis point of decline in interest rates boosts nominal demand by $1.25 billion/year through the exchange-rate exports, the interest rate-investment, and the interest rate-wealth channels.

Thus as of the spring of 2008 I was looking at a demand shortfall of not $1.2 trillion/year but rather $300 billion/year--which is a one-year pause in growth and a 1% rise in the unemployment rate. It would have been one of the smaller post-WWII recessions. But then came the financial crisis, which turned a small post-WWII recession into the worst post-WWII recession.