Slides for a paper I have not yet written--but very much want to write--on whether or not loose monetary policy is especially dangerous as a creator of potential bubbles.
Posted by DeLong at October 23, 2004 09:57 PM | TrackBackRe: Inflation slide.
Dr. DeLong,
Is it still conceived that, in order to control inflation, growth must be greatly slowed? Isn't the "push-pull" view of inflation flawed? I may have been too open-minded, but I have heard from some economic circles that it has to do with the availability of money, that is, too much liquidity.
Undoubtedly, the monetary policy during the mid 1990s should have been slightly more restrictive. The financial markets have this perverse view that run-ups in stock price do not show inflation because playing the equity markets is considered investment, a good thing. Of course, the stock markets post-IPO are no such thing. Purchase of a stock on the exchange is no different than buying beany babies or new cars. The Fed merely misread where the extra liquidity sloshing around in the markets was finally landing.
Posted by: PrahaPartizan at October 24, 2004 03:46 AMHi Brad,
Having worked in the investment banking business in the years up to 2000, one thing which was particularly striking to me was the enormous level of bank and bondholder lending to emerging telecom companies, of which Worldcom and Global Crossing are only the most well known. These companies went bust in a period of 18 months and I think Fed policy was really aimed at protecting the banks from bankruptcy themselves, a bigger issue than just restricting credit channels to businesses. After all, it was the banking collapse after 1929 that did the real damage, and the real estate banking crisis in the 1980s was the cause of the last big recession.
You are absoulutely right of course that the much better policy in hindsight would have been to choke off the original stock market bubble, as it was this that finally led the banks to abandon their cautious lending approach to speculative telecoms businesses.
Posted by: willchill at October 24, 2004 05:37 AMSorry to display my ignorance on the matter of M1, M2, M3; but the growth of the money supply seemed to triple the growth rate of the GDP or inflation. Is it irrellevant compared to the usual monetary statistics? Is there a relationship with GDP growth, M3 and dollar devaluation? And how about the current art of counterfitting? How measureable is this within M3?
Am I holding potential wall coverings in my wallet?
Posted by: don majors at October 24, 2004 06:38 AMThe problem with monetary is that it can seldom be focused on a sector of the economy. Short term interest rate changes by the Federal Reserve have a broad impact. Globalization and fiscal policy of the 1990s allowed for lower and lower interest rates with no inflation danger. Job creation boomed and unemployment was reduced to levels that in the 1980s would have been unthinkable to most economists. The were pronounced gains in income and wealth by middle class households. Had the Fed tightened monetary policy to limit the rise in the stock market, we would have sacrificed solid economic growth that was dearly welcome through America.
Posted by: anne at October 24, 2004 06:40 AMhttp://www.nytimes.com/2004/10/24/business/yourmoney/24view.html
Counting the Hidden Costs of War
By ANNA BERNASEK
IT'S often said that truth is the first casualty of war. During a presidential campaign, that may be more apt than ever. Consider a seemingly simple question: What is the cost of the Iraq war to the United States? President Bush and Senator John Kerry have given different answers, but both candidates have ignored what may be the biggest cost item: the war's impact on the overall economy.
After all, the real cost of war is not only the money spent but also the economic effects, good or bad. For example, World War II led to huge levels of production and employment in the United States, while the Vietnam War dragged down economic growth as it wore on.
So, after 19 months of conflict in Iraq, how has the war affected America's economy, and what about the future?
Of course, calculating the net effect of a continuing war is neither easy nor exact. That's why many analysts are reluctant to try. But a few knowledgeable economists have made reasoned estimates, and the results are surprising.
The economic cost incurred so far may be as large as - or larger than - what has actually been spent directly on the war. (While estimates vary, the official figure for spending stands at around $120 billion since the conflict began.) And there are likely to be major economic costs as long as the war continues.
But start with the economic impact to date. Two economists, Warwick J. McKibbin of the Brookings Institution and Andrew Stoeckel of the Center for International Economics in Australia, have calculated that the war may have already cost the United States $150 billion in lost gross domestic product since fighting began in March 2003. That is close to one percentage point of growth lost over the past year and a half. If that figure is correct, the nation's annual economic growth rate, which has been 3.7 percent during this period, could have been nearly 4.7 percent without the war.
Where does that $150 billion figure come from? The study took into account factors like higher oil prices, increased budget deficits and greater uncertainty. When analyzing the effects of uncertainty, the authors estimated the impact of the war on financial markets, business investment and consumer spending.
Of course, the results of any economic model are open to debate, and the $150 billion estimate is no exception. Some economists, like David Gold at the New School University, argue that the figure may be too low while others, like Mark Zandi of
Economy.com, contend that it's on the high side.
But if Mr. McKibbin and Mr. Stoeckel are correct in their estimate, the real cost of the war to date, including direct spending and lost economic growth, is in the neighborhood of $270 billion.
Most economists would agree that the war has hurt the economy, mainly through higher oil prices and continuing uncertainty. The war's effect on oil prices is hard to disentangle from factors like higher global demand and supply disruptions, but it is commonly thought that the war's role has been significant.
Excellent and informative post. Thank you.
Posted by: Dave Schuler at October 24, 2004 06:52 AMA most important article:
http://www.nytimes.com/2004/10/24/international/africa/24africa.html?
In Africa, Free Schools Feed a Different Hunger
By CELIA W. DUGGER
MALINDI, Kenya - More than 200 first graders, many of them barefoot, clothed in rags and dizzy with hunger, stream into Rebecca Mwanyonyo's classroom each day. Squeezed together on the concrete floor, they sit hip to hip, jostling for space, wildly waving their hands to get her to call on them. Their laps and the floor are their only desks.
One recent afternoon, the line of wiggly children waiting to have Mrs. Mwanyonyo check their work snaked around the bare, unfinished classroom walls. Girls and boys crowded around her, pressing their notebooks on her. Some cut in line. Fights broke out. Boys wrestled. Girls dashed from the room. Giggles and shrieks drowned out her soft voice.
Mrs. Mwanyonyo pulled a boy in front of her and eyed his attempt to list his numbers. "Can you write 1 and 2?" she asked quietly. His head sank to his chest as he shook it no. While she laboriously graded each child's work, the noise level rose to deafening. "Quiet, keep quiet!" she shouted, her voice on the edge of desperation.
Overnight, more than a million additional children showed up for school last year when Kenya's newly elected government abolished fees that had been prohibitively high for many parents, about $16 a year. Many classrooms are now bulging with the country's most disadvantaged children.
Kenya is not alone. Responding to popular demand for education, it is one of a raft of African nations contending with both a wondrous opportunity and nettlesome challenge: teaching the millions of children who have poured into schools as country after country - from Malawi and Lesotho to Uganda and Tanzania - has suddenly made primary education free. Mozambique will join them in January when it abolishes fees.
The explosion in enrollments has put enormous pressure on overburdened, often ill-managed education systems.
What hangs in the balance is the future of a generation of African children desperately reaching out for learning as a lifeline from poverty, even as poverty itself presents a fearsome obstacle.
Near the end of a school year that runs from January to November, Mrs. Mwanyonyo, an earnest wisp of a woman, is still struggling to teach most of her students the alphabet and basic counting. She knows the names of only half of them. She estimated that 100 of her 250 students - split into morning and afternoon shifts - would have to repeat the grade.
Salama Kazungu, a willowy girl of 12, sits among Mrs. Mwanyonyo's multitudes, her small shapely head rising above those of the 6- and 7-year-olds. She failed last year in the class of another first grade teacher who had 248 pupils. ("If I could have, I would have run away," the teacher confided, relieved he has just 110 pupils this year.)
Not Enough to Eat
It is hard for Salama to learn because her belly is often empty. Her mother sells charcoal but makes too little to buy enough food. Salama never eats breakfast. For supper, she often has only boiled greens foraged from the wild.
On her hungriest days, the child said, she looks at Mrs. Mwanyonyo and sees only darkness. She listens, but hears only a howling in her ears. Yet she is determined to continue. At 12, she has already had her fill of the African woman's lot: fetching water, collecting firewood and carrying it to market on her back like a beast of burden.
"I was always working and working," she said. "I told myself that the best way to get out of this is to come to school and get an education."
In large measure, the idea of free education has gained powerful momentum because politicians in democratizing African nations have found it a great vote-getter. Deepening poverty had meant even small annual school fees - less than an American family would spend on a single fast-food meal - had put education beyond reach for millions.
The abolition of school fees is also owed to the changing politics of international aid. In the 1990's, the World Bank, the largest financier of antipoverty programs in developing countries, encouraged the collection of textbook fees. Its experts had reasoned that poor African countries often paid teacher salaries but allotted little or nothing for books. If parents did not buy them, there often were none.
But evidence began to mount that fees for books, tuition, building funds and other purposes posed an insurmountable barrier for the very poor.
In 1996, Uganda's newly elected president, Yoweri Museveni, abolished fees for four children per family. His message that education was free sounded through the country like a clanging school bell. In 1997, 2.3 million additional children showed up for class, nearly doubling enrollment to 5.7 million.
Then in 2000, world leaders met in New York and agreed on an agenda to reduce global poverty, setting as one of the main goals that every child should be able to complete an elementary education by 2015.
That same year, Congress, lobbied by advocacy groups for the poor, adopted legislation requiring that the United States oppose World Bank loans conditioned on user fees in education. In 2002, the World Bank, already supporting several free education initiatives, officially reversed its policy, deciding to oppose all such fees.
The tide had turned.
"In sub-Saharan Africa, almost all countries are under pressure to abolish school fees for primary education," said Cream Wright, education chief for the United Nations Children's Fund. "It will spread, especially if we show it works."
The track record is mixed.
Malawi's decade-old, underfunded and largely unplanned experiment is generally regarded as a disaster. The number of children in a first-grade class averages 100. Four out of ten of first graders repeat the year. Children's achievement scores are among the lowest in Africa.
Uganda, often held up as a model, also found that achievement fell as classes swelled with highly disadvantaged students.
But in the past eight years, donors have invested more than $350 million and the government also increased spending. Test results from last year show that achievement bounced back, though more than half of third graders still performed poorly in math and English.
Why is fiscal policy excluded from the model? Politically, the Fed has to work with the fiscal policy an administration hands it. Federal revenue went from 18.1% of GDP in 1994 to 20.9% of GDP in 2000 (CBO). Should the Fed have considered that fiscal policy was working in the same direction? Should the Fed have raised rates as they did when the revenue collection was increasing by $450 billion per year between 1997 and 2000? Should monetary policy have remained more neutral and encouraged collection of much needed revenue as the brake on the economy?
The increases in productivity have freed workers needed for manufacturing that can now be directed to building infrastructure. There is private infrastructure (housing and commercial buildings) and public infrastructure (roads, sewers, public buildings). If public infrastructure is being underfunded, then doesn't that allow both labor and investment dollars to flow into the public sector?
Has the fiscal policy of the current administration of funnelling money out of the US treasury and into the hands of the investor class guaranteed a bubble in public infrastructure investing? If overcapacity in mfg has limited opportunities for new investment, will that investment not be directed toward infrastructure?
The Federal government needs to increase its revenue intake. The argument is made that increasing revenue will depress the economy. However, why can we not have a looser monetary policy coupled with increased revenue collection?
IMHO, monetary policy attacks on bubble sectors (such as the tech stock bubble which BTW did not apply to all stocks) is like using a sledge hammer to attack a problem that requires a scalpal. The interest rate hikes may have popped the bubble (maybe not) but simulatneously had a negative impact on non-bubble sectors. The longer time needed to implement fiscal policy is its drawback. But there were fiscal and regulatory mechanisms for addressing bubbles (the fine scalpal) that were not utilized. The late 90s mistake in monetary policy was not anticipating the effects of fiscal policy trends of increasing government revenues.
Our current problems are less from monetary policy than from a failure of fiscal policy. Money that should have been used to adequately fund public infrastructure has been diverted to an overheated private infrastructure sector. The fine scalpal of fiscal policy has been sheathed. That left the recovery to the sledge hammer of too loose monetary policy.
Bottom line: Solving our current economic problems requires better fiscal policy.
Posted by: bakho at October 24, 2004 08:47 AMThe Federal Reserve began a tightening sequence in 1999, but stopped the sequence well before the end of the year and increased liquidity to make sure there was no untoward year 2000 financial problem. Then, in 2000 the Fed began to tighten again and draw liquidity from the financial sector. Though the stock market began to falter in March 2000, the Fed raised the Federal Funds rate by 50 basis points in May 2000. That was the end of the tightening sequence, and the Fed began a sharp reversal in Januard 2001. The need for the tightening in 2000, has struck me as questionable.
Posted by: anne at October 24, 2004 09:35 AMBut the problem with the whole sledgehammer/scappel analogy is that it assumes that there is a skilled surgeon around who is able to use it, instead of a bunch of politicians who would gouge out their own eye (or someone's eye) to win votes (see: latest corporate tax bill). Though I'm a non-expert, it seems like elected officials would be unlikely in the extreme to risk doing anything to the then beloved tech sector.
Posted by: Walkwood at October 24, 2004 09:42 AMThose who yell 'bubble' because certain asset prices don't fit their models are missing something fundamental. As a result of baby boom demographics and wealth disparity there is currently a global desire to save which puts us in a low return environment for a while at least. It's not that assets are priced perfectly, but the prices are definitely trying to make a statement about reality and encourage proper action. First the savers attempted to push business investment earlier in time and that became reflected in stock markets. Then when reality dictated this could only be done to a limited extent, the next choice was a rather clever one--build durable items like housing which will still be around when future production is constrained by retirement. And of course this failed in a country like Japan with a non-growing population and limited land, so perhaps they are clever to loan the US money to construct housing. Neither of these are going to have good returns, it's just making the best out of a bad situation and it is silly to criticize this behavior and not suggest an alternative other than mass unemployment.
As usual, Anne and Bakho are correct that it is not the Fed's job to concentrate on individual sectors of the economy at the expense of keeping the overall balance, and Bakho is additionally correct that this would be a good opportunity to invest in the public infrastructure since things have the potential to become tight in the future.
Posted by: snsterling at October 24, 2004 09:46 AMI am convinced that monetary policy has little to do with Inflation. Its only participation is in the arena of registered Reserves. The real culprit behind Inflation and poor economic performance is inadequate tax rates. Deficit Government spending is the major seed of Inflation, leaving Business interests with too much Cash to be invested in too few actual investment opportunities. These investments stack up poor Returns and unnecessary Product, while the deficit government spending pushs Resource pricing up.
The NYTimes has an economic article on the total economic cost of the Iraq War. I had previously estmated the total cost would be $560b through Y2005, and $200b more throughout the decade, if the occupation was continued. The quoted cost of $1.9t seemed a little high, but still my estimate is expensive. lgl
Posted by: lgl at October 24, 2004 10:23 AMA couple of corrections to my previous post. I meant to write that money was flowing into PRIVATE infrastructure at the expense of public infrastructure. The bubble is in PRIVATE infrastructure (housing). Didn't Reagan also create a private infrastructure bubble in office space? What happened to that?
Walkwood is correct that it is difficult to implement any reasonable fiscal policy in the current political climate. However, the scalpal is still there, but its use requires political will.
We have one party control of Congress and the Executive and they still cannot agree on a budget?? When one political party (in this case the GOP) has as its guiding ideology that the government can do no good except in its funding of the military, then that is a recipe for a failed fiscal policy. If government programs can do no good, then the US Treasury becomes little more than a slush fund to be used as kickbacks for political support and contributions. Competent fiscal policy for achieving national goals and objectives devolves into a grab fest of favored pork for the home district. This ideology is conducive to neither good fiscal policy nor wise investment in the future.
Good monetary policy should work hand in glove with good fiscal policy. Monetary policy, no matter how good, cannot correct the failures of bad fiscal policy. A more interesting seminar might compare monetary policy given better fiscal policy.
Posted by: bakho at October 24, 2004 10:32 AMHaving worked on econometric models for decades, I came to the conclusion that our profession has not got the faintest idea how expectations are formed. Rational expectations may work well most of the time, but from time to time there are exceptions, and these exceptions are the ones that really matter. Also, if a new genius would make a major breakthrough in the field of expectation formation, would not this discovery itself change the way expectations are formed? In other words, perhaps Soros is right and we all are chasing an unattainable goal?
Posted by: Thomas T. Schweitzer at October 24, 2004 10:52 AMOops, Brad forgot the impact of low wage outsourcing.
I myself was replaced by two Russian employees. My brother, in another company, was replaced by Indians. We all know the stories of the millions of manufacturing jobs that have moved to Mexico and China. But, Brad doesn't see any impact there.
Too many economists think outsourcing either doesn't exist or is unimportant. The really sad thing is there will be no action, no widespread understanding, and no policy changes until the economists start to understand and can explain it to the policy makers.
Why don't economists see what is happening and at least acknowledge it and look for creative solutions? Instead, they seem to deny it, ignore it, and act like, even if it is a problem, there's nothing that can be done.
Posted by: Oops at October 24, 2004 11:08 AMSNSterling and Bakho make the point that fiscal policy can be finely aimed. I wish to mention this again.
Posted by: anne at October 24, 2004 11:59 AMThe Fed has come to believe that federal and household debt is less of a factor now than earlier because there is more of a pool of
international liquidity for America to draw on. Also, the Fed argues that families as well as financial corporations have become more adept
at handling debt. Certainly interest rates are low enough that debt servicing is generally not a severe household problem. And, financial
corporations as a whole have come through the bear market from 2000 to 2003 with no significant damage. The Fed theory is new and may prove wrong, but we can not tell.
Good luck with this paper. The slides seem to present the view of the bond market bubble as being a consequence of the Fed actions. But how could the Fed get away with such easy policy for such a sustained period of time without the bond market itself being in someway a creator of the bubble? A 1980s bond market would have freaked at the kind of policy the Fed pursued. But this one didn't.
Posted by: P O'Neill at October 24, 2004 07:01 PMI love your slide shows. Really well done. Do more!
The characterization of Europe's dilemma (in the slide show below) in conjunction with your characterization of of the choice the United States made is very compelling.
Posted by: Jim Harris at October 25, 2004 05:52 AMBrad, what makes Pam Woodall authoritative on the US housing market? She does not do her own research. She does not have direct experience of the market on which she is commenting. She is a journalist with rather good credentials for her field of journalism, not an authority on any particular sector of the US (or any other) economy. Report, yes. Opine, no. Her views on whether the US housing market is overvalued carry no more authority than your average teeny rocker's views on price gouging in the music CD market.
Snsterling, nice to see you back.
Posted by: kharris at October 25, 2004 06:14 AMThis presentation is simply excellent. The first portion distills down the competing viewpoints on where the ecomomy is and helps everyone understand why different people view the economy's progress differently. The second portion is equally excellent in that it provides a range of views on why on current asset pricing could lead us to trouble.
I might suggest adding a couple of slides. The first new slide would be between the first and the second portions. You present the original views of the economy (Production, employment, etc.) which show that the FOMC could have been either too tight or too loose. From these viewpoints you select one particular viewpoint (housing) as the most important but you don't tell us why. You do say on the second slide "I'd like to focus on housing", but the viewer is left with no reason why this should be the predominate view.
The other two new slides would follow Pam's slide. The first would be a slide which presents the 0pposing Viewpoint(s). You would then rebut these viewpoints on the next slide. This would lead to the summary.
As a final thought, I'm not sure if the final purpose of the paper is to say "We have an asset bubble problem..." or "We have an asset bubble problem, therefore we need to be able to model some elements of asset pricing". The body of your presentation leads me to believe that your purpose is the first, but the conclusion seems to be the second. IF your pupose is the second, then I think you need some slides about why the current modeling is not adequate.
All in all very well done and very educational as well.
Posted by: Keith at October 25, 2004 10:23 AMmortgage leads
Posted by: mortgage leads at October 26, 2004 03:26 AMmortgage leads
Posted by: mortgage leads at October 26, 2004 04:14 AMThe "Two Asset Booms" slide says the Nasdaq boom created $7 trillion over 4 years, while the housing boom created $5 bln. The "View Summarized" slide says the FOMC's twist has creasted a bigger problem - a housing bubble. How is a $5 bln change in wealth (which you anticipate will evaporate) a bigger problem than a $7 bln change in wealth?
Posted by: kharris at October 26, 2004 09:39 AMAnne says, “… Globalization and fiscal policy of the 1990s allowed for lower and lower interest rates with no inflation danger. Job creation boomed and unemployment was reduced to levels that in the 1980s would have been unthinkable to most economists. There were pronounced gains in income and wealth by middle class households. Had the Fed tightened monetary policy to limit the rise in the stock market, we would have sacrificed solid economic growth that was dearly welcome through America.”
I say, Such does not excuse authorities from responsibilities to watch out for bubbles, irrational exuberance, and what not. Neither does it excuse authorities from the unheeded responsibility of taking away the punch bowl say about 1995 or 1998.
Bahko says, “Our current problems are less from monetary policy than from a failure of fiscal policy. Money that should have been used to adequately fund public infrastructure has been diverted to an overheated private infrastructure sector. The fine scalpel of fiscal policy has been sheathed. That left the recovery to the sledge hammer of too loose monetary policy. Bottom line: Solving our current economic problems requires better fiscal policy.” (and) “”Good monetary policy should work hand in glove with good fiscal policy. Monetary policy, no matter how good, cannot correct the failures of bad fiscal policy. A more interesting seminar might compare monetary policy given better fiscal policy.”
I say, echoing Otmar Issing, Kenneth Galbraith, Hyman Minsky and others, Good monetary policy is aware of emerging bubbles, and working hand in glove with fiscal policy deals with them before the Minsky-predicted “ponzi finance” stage sets in wherein irrational exuberance and corruption reign supreme. It does little good to pretend or act like the left hand doesn't know what the right hand is doing.
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