I'm of two minds on this article. In the main, I agree with Leamer. But then I'm the sort who has been persuaded that "Less than Zero" is a good thing.
But I don't like his conclusion, specifically as regards manufacturing. It's not clear if he's talking about output (I hope not!) or employment. But if he is talking about output, I disagree with his point since U.S. manufacturing value-added is world-leading.
Wow, that article quite possibly just made me lose all respect for Ed Leamer.
First of all, let me quote Ben Bernanke: "The critical issue in thinking about deflation is whether or not the zero bound on nominal interest rates is binding." Leamer vaguely understands that deflation is bad in this situation because it causes an increase in the real interest rate, but he's making undergrad-level mistakes in thinking about the supply of and demand for savings. He dismisses the problem by saying "Real interest rates are actually low, not high"... relative to what, exactly? The only reasonable standard is their equilibrium value, and as long as we're at the zero lower bound we can be more or less certain that real interest rates are higher than the value that is consistent with equilibrium.
He's stunningly unimaginative on other points as well. He asks why the "zero-sum game" of redistributing money from lenders to borrowers would have an effect. This isn't very difficult to imagine: perhaps the borrowers are up against credit constraints (determined by the value of collateralizable assets, etc.) that prevent efficient allocation of new lending. By relaxing credit constraints, inflation can relieve this problem. It also increases the profits (and hence the internal cash that can be used to finance new projects) of highly leveraged corporations, which has an obvious effect on investment. (Empirical evidence suggests that this channel of monetary policy is more important than the bare neoclassical cost-of-credit channel.)
This is simply an embarrassing, embarrassing piece, written by someone who is out of touch yet eager to mock others. (Ironically, that's how you'd probably describe Krugman.)
Let's see, Morris... Ed Leamer is a tenured professor with an endowed chair and the director of a forecasting business, someone who has complete job security and (probably) loads of cash to boot. I meanwhile, am a humble grad student whose fate will remain uncertain until I go on the job market two years from now. Can you imagine, just for a minute, why I might have reasons for anonymity that Leamer does not?
What rational basis do you have for the position that all criticism must be backed up by a name? Has it ever occurred to you that anonymity might play a valuable role in such a situation, by facilitating deserved criticism of influential figures that no one would otherwise dare to attack?
Let's agree that harsh, yet constructive, criticism is welcome even by anonymouos posters.
Personal attacks may be tolerated, by only if the poster drops the cloak of anonymity.
I'm not sure where the attack on Leamer falls exactly, but I'm sure that the same points could have been made in a more diplomatic manner.
Accusing Leamer of making "undergraduate mistakes" is probably going a bit too far.
And btw, anonymous, how do you know what "the equilibrium real rate of interest" is? Are you confusing an equilibrium object with an historical average? That would be a typical undergraduate mistake!
"And btw, anonymous, how do you know what "the equilibrium real rate of interest" is? Are you confusing an equilibrium object with an historical average? That would be a typical undergraduate mistake!"
It would indeed, but I can't see any interpretation where that's what I'm doing. I'm saying that the current real rate of interest (which, roughly, is the near-zero IOR rate minus inflation expectations, which comes out to a slightly negative quantity), is above its "equilibrium rate". This implies that the "equilibrium rate" I am discussing is well, well below its historical norms.
I agree that it is difficult to talk with precision about an "equilibrium rate", but in some sense this is the essence of the New Keynesian view of the recession (or at least part of it): there is some little-r at which the market for savings and investments would clear without any decline in other variables, but the zero nominal lower bound and difficult-to-move inflation expectations prevent us from getting there. If the current rate was actually below its "equilibrium rate", then we would start to see inflationary pressure, which we are not.. though I admit that expectations-setting isn't perfect, and that the process operates with some lags.
(Even this wouldn't happen if people could form new expectations that in the long run the Fed was going to take us to the deflationary equilibrium where the current nominal rate is consistent with the real rate pinned down by real variables, which in all non-extraordinary times is positive. But since these expectations would be highly inconsistent with the implicit policy rule that the Fed normally follows, maintaining a near-zero interest rate would be interpreted as a further expansionary shock to policy rather than a change in implicit rule... and that would be inflationary.)
I always suspected that behavioural demons were behind the breathless arguments against deflation. Strikes me as high priest irrationality. But instead of jumping to conclusions, I'll ask if any behavioural social scientists have examined the profession's asymmetrical attitudes to inflation and deflation.
To nuance Leamer's arguments, it should be noted that weak demand and expectations of low income are behind deflation short-term but there is nothing that prevents monetary policy from shaping low stable rates of deflation over the longer term.
There is, however, a real economic threat underlying the deflation demon. Steady, constant deflation or a stable zero inflation rate would remove the socially accepted pretext of inflation for increasing salaries and wages.
Some groups of organized workers might find themselves under greater pressure to increase productivity and lower unit labour costs.
Transparency can be a bitch. Look at how hard respectable, powerful agents work to muddy the waters in political and economic sheres.
I'm of two minds on this article. In the main, I agree with Leamer. But then I'm the sort who has been persuaded that "Less than Zero" is a good thing.
ReplyDeleteBut I don't like his conclusion, specifically as regards manufacturing. It's not clear if he's talking about output (I hope not!) or employment. But if he is talking about output, I disagree with his point since U.S. manufacturing value-added is world-leading.
Wow, that article quite possibly just made me lose all respect for Ed Leamer.
ReplyDeleteFirst of all, let me quote Ben Bernanke: "The critical issue in thinking about deflation is whether or not the zero bound on nominal interest rates is binding." Leamer vaguely understands that deflation is bad in this situation because it causes an increase in the real interest rate, but he's making undergrad-level mistakes in thinking about the supply of and demand for savings. He dismisses the problem by saying "Real interest rates are actually low, not high"... relative to what, exactly? The only reasonable standard is their equilibrium value, and as long as we're at the zero lower bound we can be more or less certain that real interest rates are higher than the value that is consistent with equilibrium.
He's stunningly unimaginative on other points as well. He asks why the "zero-sum game" of redistributing money from lenders to borrowers would have an effect. This isn't very difficult to imagine: perhaps the borrowers are up against credit constraints (determined by the value of collateralizable assets, etc.) that prevent efficient allocation of new lending. By relaxing credit constraints, inflation can relieve this problem. It also increases the profits (and hence the internal cash that can be used to finance new projects) of highly leveraged corporations, which has an obvious effect on investment. (Empirical evidence suggests that this channel of monetary policy is more important than the bare neoclassical cost-of-credit channel.)
This is simply an embarrassing, embarrassing piece, written by someone who is out of touch yet eager to mock others. (Ironically, that's how you'd probably describe Krugman.)
Anonymous, if you are going to attack like that then you should sign your name. Right or wrong, Leamer at least signed his piece. Morris A. Davis
ReplyDeleteLet's see, Morris... Ed Leamer is a tenured professor with an endowed chair and the director of a forecasting business, someone who has complete job security and (probably) loads of cash to boot. I meanwhile, am a humble grad student whose fate will remain uncertain until I go on the job market two years from now. Can you imagine, just for a minute, why I might have reasons for anonymity that Leamer does not?
ReplyDeleteWhat rational basis do you have for the position that all criticism must be backed up by a name? Has it ever occurred to you that anonymity might play a valuable role in such a situation, by facilitating deserved criticism of influential figures that no one would otherwise dare to attack?
Gentlemen:
ReplyDeleteLet's agree that harsh, yet constructive, criticism is welcome even by anonymouos posters.
Personal attacks may be tolerated, by only if the poster drops the cloak of anonymity.
I'm not sure where the attack on Leamer falls exactly, but I'm sure that the same points could have been made in a more diplomatic manner.
Accusing Leamer of making "undergraduate mistakes" is probably going a bit too far.
And btw, anonymous, how do you know what "the equilibrium real rate of interest" is? Are you confusing an equilibrium object with an historical average? That would be a typical undergraduate mistake!
"And btw, anonymous, how do you know what "the equilibrium real rate of interest" is? Are you confusing an equilibrium object with an historical average? That would be a typical undergraduate mistake!"
ReplyDeleteIt would indeed, but I can't see any interpretation where that's what I'm doing. I'm saying that the current real rate of interest (which, roughly, is the near-zero IOR rate minus inflation expectations, which comes out to a slightly negative quantity), is above its "equilibrium rate". This implies that the "equilibrium rate" I am discussing is well, well below its historical norms.
I agree that it is difficult to talk with precision about an "equilibrium rate", but in some sense this is the essence of the New Keynesian view of the recession (or at least part of it): there is some little-r at which the market for savings and investments would clear without any decline in other variables, but the zero nominal lower bound and difficult-to-move inflation expectations prevent us from getting there. If the current rate was actually below its "equilibrium rate", then we would start to see inflationary pressure, which we are not.. though I admit that expectations-setting isn't perfect, and that the process operates with some lags.
(Even this wouldn't happen if people could form new expectations that in the long run the Fed was going to take us to the deflationary equilibrium where the current nominal rate is consistent with the real rate pinned down by real variables, which in all non-extraordinary times is positive. But since these expectations would be highly inconsistent with the implicit policy rule that the Fed normally follows, maintaining a near-zero interest rate would be interpreted as a further expansionary shock to policy rather than a change in implicit rule... and that would be inflationary.)
Thanks David. Good piece.
ReplyDeleteI always suspected that behavioural demons were behind the breathless arguments against deflation. Strikes me as high priest irrationality. But instead of jumping to conclusions, I'll ask if any behavioural social scientists have examined the profession's asymmetrical attitudes to inflation and deflation.
To nuance Leamer's arguments, it should be noted that weak demand and expectations of low income are behind deflation short-term but there is nothing that prevents monetary policy from shaping low stable rates of deflation over the longer term.
There is, however, a real economic threat underlying the deflation demon. Steady, constant deflation or a stable zero inflation rate would remove the socially accepted pretext of inflation for increasing salaries and wages.
Some groups of organized workers might find themselves under greater pressure to increase productivity and lower unit labour costs.
Transparency can be a bitch. Look at how hard respectable, powerful agents work to muddy the waters in political and economic sheres.