Monday, April 16, 2012

"Groupthink," and the FOMC

I have been on something of a blog vacation (and about time, you might say), though I can assure you there has been nothing relaxing about it. I was reading Laurence Ball's paper on "Ben Bernanke and the Zero Bound, I think that it raises some interesting questions, and I would like to relate this to current thinking (and current thinkers) on the FOMC.

Ball wants to have us think that the pre-2003 Ben Bernanke was a sensible person who argued that, in the context of the zero lower bound on the overnight nominal interest rate, a central bank is not powerless. According to Ball, pre-2003 Bernanke thought, first, that forward guidance (announcements about future monetary policy actions) and quantitative easing (large-scale asset purchases) at the zero bound are a good idea. Those policy options are indeed reflected in post-financial crisis monetary policy in the United States. Second, and more importantly, Ball argues that pre-2003 Bernanke advocated another set of zero-bound accommodative policies, which are:
(i) exchange rate depreciation
(ii) targets for long-term nominal interest rates
(iii) money-financed tax cuts
(iv) higher inflation targets

Ball is bothered by the fact that such policies have not been pursued by the current incarnation of the FOMC, as he appears to think that those policies would be appropriate at the current time. Ball has little to say - explicitly - about the science of monetary policy. He's thinking about a model of Ben Bernanke, not a macroeconomic model designed to evaluate and guide monetary policymakers.

Ball's premise is that pre-2003 Bernanke was right, and post-2003 Bernanke was wrong. What could have made Ben do such stupid things? Did he fall and hit his head? Not at all. The answer is "groupthink," and what Ball calls "personality." You have all probably heard about groupthink, which has entered the realm of pop psychology. The idea seems to be that a group may not be greater than the sum of its parts. Group members may interact in a way that produces bad results, if an urge to cooperate and forge consensus overwhelms good ideas. There's a long Wikipedia entry where you can read all about it. On the personality front, Ball characterizes Bernanke as "shy," and provides plenty of supporting evidence.

Actually, the general thrust of the paper can be summarized by: "Ben Bernanke is a wimp." I may be wrong, but I don't think he is. Economists are tough. We cannot survive as academics without being willing to defend our ideas. Bernanke flourished as an academic, and worked at Princeton, which of course is no slouch institution. He survived a period as department chair there, a position in which I'm sure he developed considerable skills in forging consensus. There is nothing wrong with consensus. Many healthy decision-making bodies thrive on it.

The key question, which I'm sure you are asking, is: What do we think of those zero bound accommodative policies - (i) through (iv) above - anyway? First, it's important to understand that a Central Bank is just that. It is a special kind of bank - a financial intermediary with some unique powers. In the United States, the unique powers of the Fed are its ability to issue currency (actually an implicit special power, but I don't want to elaborate on that here) and its ability to issue reserves which are used in intraday payments and settlement. Unless the Fed is exploiting those special powers, it really cannot influence anything.

What can the Fed do under current circumstances? It can change the interest rate on reserves (IROR). That's a decision that can only be made by the Board of Governors - not the FOMC. We're currently operating under a floor system (for a brief rundown read this post by Todd Keister) under which, roughly, the interest rate on reserves governs the behavior of the fed funds rate, with some slippage due to the idiosyncrasies of the US financial institutional setup. The Fed can also buy and sell assets - quantitative easing (QE). Finally, the Fed can resort to forward guidance - it can tell us about its intentions for future policy.

Everyone agrees, I think, that changing the IROR matters in the current context. Not everyone agrees that QE does what the Fed thinks it does. My view is, that with a large stock of excess reserves outstanding overnight, QE is irrelevant. Basically, that's a neutrality theorem. Under current circumstances, the Fed has no advantage over the private sector in turning long-maturity assets (Treasury bonds or mortgage-backed securities, for example) into overnight assets, so QE cannot matter. To my knowledge, no FOMC member agrees with me, and blog commenters tend to call me an idiot whenever I mention this. Watch.

Finally, what about forward guidance? When the Fed first "committed" to its forward guidance policy in August 2011, I stated that I thought this was bad commitment, and would create more confusion rather than less. That initial forward guidance policy has since been extended, and now reads like this:
...the Committee decided today to keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that economic conditions--including low rates of resource utilization and a subdued outlook for inflation over the medium run--are likely to warrant exceptionally low levels for the federal funds rate at least through late 2014.
But, the minutes of the March 13 meeting state:
It was noted that the Committee's forward guidance is conditional on economic developments, and members concurred that the date given in the statement would be subject to revision in response to significant changes in the economic outlook. While recent employment data had been encouraging, a number of members perceived a nonnegligible risk that improvements in employment could diminish as the year progressed, as had occurred in 2010 and 2011, and saw this risk as reinforcing the case for leaving the forward guidance unchanged at this meeting. In contrast, one member judged that maintaining the current degree of policy accommodation much beyond this year would likely be inappropriate; that member anticipated that a tightening of monetary policy would be necessary well before the end of 2014 in order to keep inflation close to the Committee's 2 percent objective.
So what are we to make of that? Does the forward guidance mean anything at all? I don't know about you, but I'm confused.

So, what of policies (i)-(iv) above? First, exchange rate depreciaton and higher inflation targets are not explicit policies. Exchange rate deprecation and higher inflation can be the result of policy actions by the Fed, but we can't just wish for these things and expect them to happen. Indeed, under current circumstances, the Fed simply cannot engineer a currency depreciation, or a a higher inflation rate, on its own. The IROR is not going lower. Ben Bernanke himself has stated that there are technical reasons why the IROR cannot go below 0.25%, and we're not going to get much from a quarter-point reduction anyway. Further, as I stated, asset purchases are irrelevant under current circumstances. Finally, there is enough noise in the forward guidance signal now to make that signal uninformative. Thus, exchange rate depreciaton and higher inflation are not happening, at least as the result of anything the Fed does currently.

What about targets for long-term nominal interest rates? Not happening. The Fed should not be setting a target for something it cannot control. What about money-financed tax policy? Not happening. That's the province of the Congress. Maybe you think Ben Bernanke can influence those crackpots, but you're wishing for a lot in that case.

So much for Ball's paper. But here's something interesting, which is related. Read this speech by Narayana Kocherlakota, President of the Minneapolis Fed. Speaking of turnarounds in thinking, I would not have predicted a few years ago that stuff like this would come out of Narayana's mouth.

What's Kocherlakota's view of policy under the current circumstances? He thinks that changes in the IROR matter, he thinks QE matters, and he thinks forward guidance matters. What's the model that helps him think about how to formulate policy? It seems to be some some kind of 1974-ish expectations-augmented Phillips curve. The inflation rate is determined by the output gap and the anticipated rate of inflation, and the anticipated rate of inflation in turn seems to be determined (in Kocherlakota's mind) by what the Fed says. What does the Fed care about? The output gap and the inflation rate. As is usual given this type of thinking, the idea is that we can get more output if we are willing to sacrifice by accepting a higher inflation rate.

What's wrong with that view of the world? (i) Where's the money? Inflation is always and everywhere a monetary phenomenon. Milton Friedman's quantity-theory view of the world was in several ways wrongheaded, but we can't escape the idea that the prices of goods and services are in fact the prices at which particular liabilities (public and private) are exchanged for those goods and services. The quantities of the particular liabilities in question have to be important for determining the prices. (ii) Phillips curve thinking got us into trouble before - in the 1970s - and it can do so again. (iii) If people on the FOMC think that QE and forward guidance work, those things should be in the model, so we can understand exactly how these things are supposed to work, and can evaluate the Fed's policy actions accordingly.

It's quite possible that Kocherlakota does not even believe in the model in the speech I linked to above, or in the model in this talk, for that matter. Here's a possible explanation for what is going on. Kocherlakota may think that if he stuck to what he actually knows about modern monetary economics - which is a lot - in framing arguments at FOMC meetings, that the other participants would not get it. After all, even some of the more sophisticated economists on the FOMC - John Williams and Charles Evans, for example - are Phillips curve guys. But maybe those people can be educated. I think it's worth a shot.

I think that Kocherlakota basically arrives at the correct conclusion about Fed policy here:
I would say that it would be appropriate to change the Fed’s current forward guidance to the public about the future course of interest rates. Currently, the FOMC statement reads that the Committee believes that conditions will warrant extraordinarily low interest rates through late 2014. My own belief is that we will need to initiate our somewhat lengthy exit strategy sometime in the next six to nine months or so, and that conditions will warrant raising rates sometime in 2013 or, possibly, late 2012.
It's the right conclusion, but it's actually inconsistent with what he's said in the rest of the speech. If he thinks that QE works, he should just want to do everything in reverse - sell the assets until excess reserves are down to zero, then start increasing the fed funds target, which will at that point in time be the policy rate. Some people on the FOMC might think this policy - reverse QE followed by increases in the target policy rate - would in fact be appropriate. What they need to understand is that QE doesn't work right now, and bad things can happen while they are learning by doing.


  1. "Ball's premise is that pre-2003 Bernanke was right, and post-2003 Bernanke was wrong. What could have made Ben do such stupid things? Did he fall and hit his head?"

    I didn't interpret Ball's paper this way at all. While I'm sure his prior is that the Fed should be doing more, Ball's paper really just focuses on identifying the change in policies advocated by Bernanke over time and speculating about why this might have happened, but does not address the question of whether Bernanke's old policy suggestions would be better. I think your post really fails to address the central issue considered by Ball: why did Bernanke change his views so drastically? So you don't think Ben is "shy" or that "groupthink" is to blame, fine so what's the reason? The (admittedly more important) question of whether Bernanke's pre-2003 views would make for better policy is not what the paper is about.

    - C

    1. It's clear Ball thinks that pre-2003 Bernanke was right, and that he thinks Bernanke was somehow beaten into submission in adopting something inferior to the "right" policy (i.e. the pre-2003 Bernanke policy). I'm not sure how you could read Ball's paper and think otherwise. Group dynamics are interesting, but my take on Beranke's personality is that "shy" actually means that the guy knows his own mind. He is willing to listen to other people, but he's a strong leader who is going to do what he thinks is right. I may not agree with what he does, but I don't think the guy is weak.

    2. I think everyone knows Ball's priors about monetary policy. And the paper is not about whether the pre-2003 or the post-2003 Bernanke is better. You've made your case about appropriate policy responses before, so we know where you stand on this. The interesting question in Larry's paper is, given the clear break in Bernanke's stated views, what happened that changed his mind? Ball suggests a shy personality unwilling to challenge the prevailing consensus in FOMC. Since you don't seem to buy this, what's your explanation for this turnaround? That's an actual question for you, by the way ;)

      - C

    3. I think he learned some things and revised his position.

    4. In my (admittedly limited) experience, senior economists almost never change their minds about anything. I'd be very surprised if your view is correct. And if it is, I wonder what evidence exactly caused him to change his mind... Not that much was done on these questions during this short time period that could plausibly have generated a large change in beliefs on his part, no? I'm very much with Larry Ball in finding this deeply puzzling.

    5. Previous post was me again, by the way.

      - C

    6. "...senior economists almost never change their minds about anything."

      Has anyone ever told you that you're a cynic? I have known plenty of senior economists, and they change their minds all the time. If you don't learn in this business, you die.

    7. Learn, yes, but change their minds about big policy questions, rarely. For example, David Romer has a recent paper which summarizes (very briefly) recent work on the effects of fiscal stimulus at the zero bound. Most of this research points to large economic effects when monetary policy is not leaning against the wind. Has any of this work changed senior economists' beliefs about fiscal multipliers at the ZLB? I doubt it. Those who were initially skeptical of stimulus will remain skeptical but will use other justifications or point to flaws in these studies. The same logic will apply to work focused on estimating the effects of QE on the economy. I suspect that your prior that QE cannot work will not be changed by any empirical evidence to the contrary (since there are always weaknesses in these papers), nor will Larry Ball's prior that the Fed should do more be altered by your theoretical arguments. I continue to be amazed by how tight people's priors are about these policy matters: given the uncertainty associated with empirical (and theoretical) macro work, you'd expect most of us to have very diffuse priors. This never seems to be the case for senior economists.

      To put it another way, when was the last time you changed your mind about a significant macro policy question in light of empirical evidence? That's not a dig at you, by the way, I'd happily ask the same question to Krugman or Larry Ball.

      - C

  2. Interesting post. I agree that there seems to be a lot of overanalysis of Bernanke. Sure there are political constraints that exist at his position, but some people are definitely taking it overboard. You don't get to the position he's in by being a total pushover. As a relatively new reader to this blog I have a question about Kocherkalota's views on future policy. You seem to agree that the FFR should be raised sometime at the end of this year or in early 2013. Where do you see the nominal growth coming from to justify this position?

    1. If I were forecasting, my prediction would be Kocherlakota's. Obviously there is a lot of uncertainty, but eventually the prices of real estate are going to start increasing, the construction sector will come back, and the value of collateralizable assets will rise in a way that supports more credit.

    2. “...but eventually the prices of real estate are going to start increasing...and the value of collateralizable assets will rise in a way that supports more credit.”

      Stephen, is this really the best way to get us out of the Great Recession? By having people go back to using their homes as ATM’s to keep up with their peers in consumer spending?

      1) I don’t know if you fully realize how insecure people’s lives are today, having a high paying job you can never lose with great insurance for decades. A great way to find out is at least looking through “the Great Risk Shift” by Yale political scientist Jacob Hacker. Taking out more debt on people’s homes is a great way to just make things a lot worse. One of the best things a family can do for its financial security is to pay off its home (and otherwise lower its fixed costs, or Must-Haves as Elizabeth Warren calls them in “All Your Worth”)

      2) Yes, I mentioned positional externalities. Here’s a great quote from Nobel Prize winning economist Gary Becker introducing the branch of formal evidence for them substantially existing:

      "Formally, we argue that a happiness function that combines strong habits with strong peer comparisons can help account for several empirical findings and, simultaneously, has a biological foundation."

      "Traditionally, utility functions were assumed to depend on only the absolute level of current consumption, with no reference to past and peer levels. However, a large body of work now shows that our tastes are strongly influenced by our personal histories and social environment (e.g., Robert H. Frank 1985; Abel 1990; Becker 1996; and Brock and Durlauf 2001). Indeed, the explanatory power of economic models is greatly enhanced when including simple forms of per-sonal and social capital in the utility function. In this way, otherwise puzzling phenomena-such as social influences on price, persistent habitual behavior, and neighborhood segregation-can be better accounted for.

      Consistent with these conclusions, the anal-ysis of happiness surveys has delivered two systematic results concerning the relationship between income and self-reported happiness (for a detailed review, see Andrew E. Clark, Paul Frijters, and Michael A. Shields 2006). First, as suggested by common wisdom, income is strongly habit forming. While changes in income have a reliable impact on reported hap-piness, this impact is mostly, if not entirely, short lived. Second, subjects also exhibit strong positional concerns. Their reports of happiness are highly dependent on the difference between their current income and the average income of an appropriately defined reference group (e.g., individuals with similar demographic char-acteristics)."

      AssociationHabits, Peers, and Happiness: An Evolutionary PerspectiveAuthor(s): Luis Rayo and Gary S. BeckerReviewed work(s):Source: The American Economic Review, Vol. 97, No. 2 (May, 2007), pp. 487-491


      I’d rather see us get out of the Great Recession with spending on education, infrastructure, basic scientific and medical research, alternative energy, and other high return public investments than people using their homes as ATMs to buy new cars with bigger wheels and more horsepower, and granite countertops.

    3. It is amazing how Serlin knows better than other people what they want. Just because you think they shouldn't spend their income as they choose doesn't make it so, Richard.

      Why don't you get back to your thesis, and leave the hard thinking to people better armed for it.

    4. "...but eventually the prices of real estate are going to start increasing...and the value of collateralizable assets will rise in a way that supports more credit."

      dont conflate demand (Q) with prices. prices are not likely to rise for some time. credit is already being created at new lower housing prices. theres no evidence or model to suggest otherwise, just hope.

      you can only look at nominal aggregates to see the effect of monetary policy.

    5. Ok, the predictable libertarian response, I always know what's best for me.

      1) You totally miss (or hope others miss) the concepts of positional externalities (see the giant Gary Becker quote in front of your face), free rider problems, poor information in an extremely complicated world, and other market problems.

      2) There's a long behavioral (and sociological and psychological) literature showing that for many things, people often make poor decisions.

      I know these interfere with the libertarian fantasy, but that's the reality.

    6. Anon wrote:

      It is amazing how Serlin knows better than other people what they want. Just because you think they shouldn't spend their income as they choose doesn't make it so, Richard.

      So you think we should have the same credit bubble that lead us to the Lesser Depression repeat itself?


    7. John D, you can't hide from me. Omitting your first initial doesn't work, I know where you are.

    8. In 1918, Keynes urged the cancelation of inter-Allied debts arising from World War I. “We shall never be able to move again, unless we can free our limbs from these paper shackles,” he wrote. And, in 1923, his call became a warning that today’s policymakers would do well to heed: “The absolutists of contract…are the real parents of revolution.”

      Today's WSJ:

      Europe's Rescue Plan Falters

      Today at Delong


      From The Magic about where revolutions end, the death of the Princesse de Lamballe

      you know they put her head on a pike and danced around it

    9. Wow, Steve has really pulled in the crazies today.

    10. Martin Wolf, the FT, this week:

      Historically, political pressure has destroyed such resistance. Political pressure drove the UK off gold in 1931. But it also brought Hitler to power in Germany in 1933. The eurozone should take note.

  3. “What can the Fed do under current circumstances? It can change the interest rate on reserves (IROR). That's a decision that can only be made by the Board of Governors - not the FOMC.”

    There are currently five members of the board of governors. Bernanke just needs three including himself.

    Yellen, you could definitely see doing something strong, or unusual, to stimulate the economy, like a negative rate on reserves. So Bernanke needs just one more vote. Raskin was an Obama appointee, so you could see how she could be willing to take strong action, especially if the chairman was really pushing it hard.

    So, if Bernanke really wanted to, really wanted to push hard, it seems like he’d have at least a decent chance of getting a majority on the Board.

    Maybe then the bank presidents on the FOMC could retaliate, but they need to be reappointed every two years by a majority of the Board, so again, if Bernanke really wanted to, and he had Yellen and Raskin with him, he could not reappoint those presidents. There’s a lot more at stake here than the hurt feelings of a few men.

    1. And I see Tarullo is a Obama appointee and a former member of the Clinton administration. It definitely looks like the Chairman and Vice chair of the Fed would have a decent chance of getting that third vote for strong action.

    2. Do you think a negative interest rate on reserves is a bad idea, even if it could be done?

      Do you think Bernanke couldn't get Yellen and one of the two other Democratic appointees to go along with them if he really pushed for this?

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  6. yep, we are all confused, that part i agree with.

    If monetary policy works through expectations, and expectations are muddled, then is the transmission mechanism broken?

    QE works in no small part by signalling expectations and forward guidance, especially in terms of showing that the FOMC is committed to closing the output gap - and the FOMCs willingess to tolerate inflation mildy above the 2% target while unemployment is high (so that 2% is an average not a ceiling).

    The bulk of the evidence is that wages are downwardly rigid: For those with some bargaining power, increases are anchored around the 2% inflation target while wages are downwardly nominally rigid for a substantial fraction of employees (see the SF Fed letter a few weeks ago).

    Inflation targeting is a resoundingly bad idea when the economy is buffetted by productivity and supply shocks... as we are discovering. time for a new CB paradigm.

    Its really hard to see how one gets material demand-side inflation when wages are downwardly rigid and UE remains high.

    1. What matters are not wages, but the wages of the newly employed. It is not clear at all that these are rigid.

    2. why do you think that the wages of newly employed are more important?

  7. Thank you for linking to the Kocherlakota speech.

    It seems to me his most important sentences were these:

    My story for the past four years centers on two key changes in the economy. The first is that from 2006 to 2012, households have lost trillions of dollars in wealth and net worth, as housing and other assets have fallen in value. The second is that households and firms now feel that they must stay prepared for the kind of financial market shock they experienced in 2008.

    As for "policies," which you always seem to be advocating against, it seems to me you miss the most obvious point: the policies are not up to the task of doing anything real or meaninful about these two key changes.

    In fact, economics has become like the weather: everyone talk about it but does nothing to change it


    1. If I may add a supplement and further question?

      Today, Framer wrote a guest post to Noah in which he linked to a draft paper in which he makes the following statements:

      Neither of these conventional models of macroeconomic fluctuations can explain financial crises.

      "Financial crises are preceded by a period of rapid expansion in economic activity followed by a crash in asset prices and a sharp increase in the unemployment rate. They are difficult to explain with conventional models because the increase in asset prices during the expansion phase that precedes a financial crisis is not accompanied by any observable movement in economic fundamentals. And conventional models cannot explain what causes a crash.

      Now these statements seem to corrobate entirely what Kocherlakota says in his speech: we are in a hell of a bad shape, we don't know, what to do, and people know we don't know.

      What am I missing?


    2. There are existing models - maybe not mainstream ones - that can capture some of the features that Farmer is discussing. He's trying to sell his own framework, of course, which I think is interesting. I think there are other useful ways of thinking about these events, and some of those approaches are in my work, and the work of people like Randy Wright, Ricardo Lagos, and Guillaume Rocheteau, for example. We never know exactly what is going on, but we're not totally in a fog here. Economists are using the available tools to make sense of what is going on in the world. Don't be so pessimistic.

    3. Pessimistic

      understates my negative POV

      Eventually the prices of real estate are going to start increasing, the construction sector will come back . . .

      don't you read the Post? $225 million office tower in STL going vacant in 2015, when ATT exits. The scale of the damage doesn't show in the models.

      They said the same thing about Toyko, which is now (20 years later) being bought by China for pennies and nickels.

      It is over; in Europe, first, and then here

    4. P.S.

      Why I am right to be pessimistic (per Waldman, and why you are wrong on inflation and Burnake can burn in H@@@):

      But the preferences of developed, aging polities — first Japan, now the United States and Europe — are obvious to a dispassionate observer. Their overwhelming priority is to protect the purchasing power of incumbent creditors. That’s it. That’s everything. All other considerations are secondary. These preferences are reflected in what the polities do, how they behave. They swoop in with incredible speed and force to bail out the financial sectors in which creditors are invested, trampling over prior norms and laws as necessary. The same preferences are reflected in what the polities omit to do. They do not pursue monetary policy with sufficient force to ensure expenditure growth even at risk of inflation. They do not purse fiscal policy with sufficient force to ensure employment even at risk of inflation. They remain forever vigilant that neither monetary ease nor fiscal profligacy engender inflation. The tepid policy experiments that are occasionally embarked upon they sabotage at the very first hint of inflation. The purchasing power of holders of nominal debt must not be put at risk. That is the overriding preference, in context of which observed behavior is rational.

    5. You do realize that most of the holders of "nominal debt" are people with cash or bank deposits? And that inflation hurts them a lot more than rich guys holding T-bills? Sometimes I wonder if there ought to be a filter on the Internet that prevents stupidity.

    6. Anon, from reading your post it is apparent that we need filters against both stupidity and a!!!CVVFF, like you, who cannot even read.

      Waldman's point had nothing to do with rich v near rich, 1%, or whatever your pitching.

      His point is that incumbent creditors of all stripes(which would include the creditors whom you mention and others) are not going to pursue either monetary or fiscal policy "with sufficient force to ensure employment."

      Your post has convinced me incumbent creditors are right. Given you lack of ability and an insufferable personality, we would have to easily helicopter drop several trillion dollars to force someone to hire you.


    7. John D, we know it is you. We are everywhere, and your stupidity will not be tolerated.


  8. Stephen Williamson, thank you for simply existing, and warming all of our hearts with your posts.

    So you're view is:
    1. QE does nothing. Indeed there's nothing much the Fed can do to help the economy.

    2. The economy will be helped by a reversal of QE and a monetary tightening over the next 6-9 months.

    How are those logically consistent? Either QE 'did nothing', in which case reversing it won't do anything, or it did do something, in which case we should be doing more given that inflation is still low and the economy is still doing poorly. And, if we were in a liquidity trap, where the Fed can't stimulate the economy, but can only contract it, then why should the Fed start contracting it now?

    Another question -- if QE does nothing to long-term government bond prices, then what would happen if the Fed purchased all long-term bonds outstanding? Nothing would happen to the price? That doesn't make much sense...

    Announcements of QE certainly make a large impact on markets. So, if allowing that it probably had a small impact at the margin, you're basic point is reduced to the belief that the Fed has been too expansionary the past four years, when core inflation has average well below 2 percent.

    Ah, but you might say, QE does nothing but create inflation. Well, Stephen, most of that QE happened in 2008. It's 2012. Where is this inflation you've been predicting for years?

    1. Since QE did nothing, it would not create inflation. You're not too bright, are you?

  9. Steve: "Actually, the general thrust of the paper can be summarized by: "Ben Bernanke is a wimp." I may be wrong, but I don't think he is."


    Steve: " Third, and I may be wrong about this, but I think Bernanke is probably a wuss."

    Did you change your mind about Bernanke, or are wuss and wimp different in your terminology?

    1. Dear Professor Williamson:

      Today's WSJ had a very provocative opinion piece, How the Fed Favors the 1%, which seems to be tied directly to your arguments about the FOMC

      What are your thoughts on the piece?

    2. Wow, nice catch JP!

    3. We can all change our minds. Bernanke, me, whoever.

    4. On the WSJ piece: The writer is very confused. There is actually a literature on the redistributional effects of monetary policy, and a set of models - market segmentation or limited participation models - where the effects of monetary policy work through redistribution. In those models, people who are closely connected to financial markets in fact benefit from the first round effects of expansionary monetary policy. That's not what the writer is discussing though - mostly it's pseudo-Austran nonsense.

    5. Would you please write the WSJ, cc: Cochrane, Taylor, and others that it has a pattern and practice of printing "pseudo-Austran nonsense?"

      They are more likely to publish your letter than mine.

    6. I don't really read the WSJ, other than for the price information. Cochrane and Taylor aren't about pseudo-Austrian nonsense. Sometimes those people make sense. Sometimes they don't.

    7. I was just nitpicking/teasing. Opinions on BB's intelligence shouldn't detract from this blog post more important points regarding zero-bound policies.

  10. Dear Professor Williamson,

    First, I would like to thank you for your lucid writing. I really enjoy reading your papers, but I have 2 questions regarding the forthcoming AER paper which you have recommended through your blog as well.

    The first one is my question and concerns your assumption about the buyer making a take-it-or-leave-it offer to the seller with the promise to pay in the following day. Since this assumption greatly affects the deposit contract that will be offered by the bank, I would like to ask how critical it is or how common it is to assume this form of forward payment in models.

    The second question concerns the following point expressed in:
    where the author of the blog asks:

    "In the real world, individuals don’t deposit goods at banks – they deposit currency."..."Secondly, Williamson has already defined all consumer goods as perishable, presumably to prevent inhabitants of the centralized market from taking their goods over to the decentralized market and bartering them. But if goods are perishable, how can banks accept a deposit of goods only to on-sell them? By definition, haven’t they already perished?"

    Thanking you very much for your time,

    Nick C.

    1. 1. Take-it-or-leave-it: That's just a simplifying assumption. We could use some more complicated mechanism for splitting up the surplus from trade. That would make things more complicated, and would obscure the key points.
      2. The depositors could work, buy assets, and deposit the assets in the bank. Then the bank chooses its portfolio. Or the depositors, could work, acquire goods, deposit the goods in the bank, and then the bank buys the assets. It makes no difference. This is how banking models work. It's standard. In a Diamond and Dybvig model - a standard one in the literature - the depositors have goods, they deposit them in the bank, and then the bank invests those goods in a storage technology. That approach seems widely accepted as a nice model of a bank, and it actually looks much less like a real-world bank than mine does. What's the problem.
      3. What is JP's problem anyway? The guy seems to be on my back lately.

    2. I ain't on your back Steve ;)

      Your blog is on my top-3 list, and I'm always curious what you have to say. But that doesn't mean I won't have questions/criticisms now and then.

      Since we're on the topic thanks to Anon's points; if consumption goods aren't perishable in your model, after all, individuals can take them to the bank and the bank can hold them long enough to resell them, then what's to prevent traders from just taking these consumption goods to the DM?

      But my main bone with your paper is that your banks abstract quite a bit from real world banks. Real banks also create deposit accounts through loans, and not solely by accepting deposits of already-existing cash/gov bonds.

    3. There are loans in the model too. Keep reading.

  11. S (I don't forecast) W: "Don't be so pessimistic."

    Don't be so pessimistic. (Isn't this a forecast?)


    Read more:

    1. Yes, the world will end some day. Death is certain for each of us. Lighten up.

    2. If you are Spain, Italy, Greece, How do you get out of this situation except by leaving the Euro?

      What do your "models" show will happen if that wise choice was made this summer?

    3. Scare quotes don't work on smart people, jackass.

  12. SW

    Project Syndicate has up a new essay on capital flight from Southern Europe

    A Crisis in Full Flight

    How can we even think about raising our rates (which will make the bad situation even worse in all of Europe)?

    Aren't we not all in the same lifeboat and isn't it time that essay's like yours start on that premise?

    IOW, it's not up the the FMOC whose hands are tied, viz unilateral action. For example, if we raise rates that will only put more pressure on Europe. We should QE, etc., until capital starts to flow back into Spain, Italy, and even Greece.

  13. Surprisingly, SW did not amend this essay to include one of his usual rants against Krugman, which wrote in the NYT Magazine on the 4/24:

    My best guess is that the disappointing response of the Bernanke Fed represents the effects of both bullies and the Borg, a combination of political intimidation and the desire to make life easy for the Fed as an institution. Whatever the mix of these motives, the result is clear: faced with an economy still in desperate need of help, the Fed is unwilling to provide that help. And that, unfortunately, makes the Fed part of a broader problem.

  14. Let's compare and contrast Bernake and Hamilton:

    Bernanke flourished as an academic, and worked at Princeton, which of course is no slouch institution. He survived a period as department chair there, a position in which I'm sure he developed considerable skills in forging consensus. There is nothing wrong with consensus. Many healthy decision-making bodies thrive on it.

    Hamilton, well how about just a link to:

    We need a Hamilton. We have a Bernanke.

    Enough said

  15. Stiglitz: Let me break this down in a slightly different way. Academic economists played a big role in causing the crisis. Their models were overly simplified, distorted, and left out the most important aspects. Those faulty models then encouraged policy-makers to believe that the markets would solve all the problems. Before the crisis, if I had been a narrow-minded economist, I would have been very pleased to see that academics had a big impact on policy. But unfortunately that was bad for the world. After the crisis, you would have hoped that the academic profession had changed and that policy-making had changed with it and would become more skeptical and cautious. You would have expected that after all the wrong predictions of the past, politics would have demanded from academics a rethinking of their theories. I am broadly disappointed on all accounts.

  16. Soros, from his recent lectures at the Central European University, on economists who have group think about economics and economic models:

    But by far the most impressive attempt has been mounted by economic theory. It started out by assuming perfect knowledge and when that assumption turned out to be untenable it went through ever increasing contortions to maintain the fiction of rational behavior. Economics ended up with the theory of rational expectations which maintains that there is a single optimum view of the future, that which corresponds to it, and eventually all the market participants will converge around that view. This postulate is absurd but it is needed in order to allow economic theory to model itself on Newtonian physics.


    Financial markets provide an excellent laboratory for testing the ideas that I put forward in an abstract form yesterday. The course of events is easier to observe than in most other places. Many of the facts take a quantitative form, and the data are well recorded and well preserved. The opportunity for testing occurs because my interpretation of financial markets directly contradicts the efficient market hypothesis, which has been the prevailing theory about financial markets. That theory claims that markets tend towards equilibrium; deviations occur in a random fashion and can be attributed to extraneous shocks. If that theory is valid, mine is false-and vice versa.

    * * *

    Let me state the two cardinal principles of my conceptual framework as it applies to the financial markets. First, market prices always distort the underlying fundamentals. The degree of distortion may range from the negligible to the significant. This is in direct contradiction to the efficient market hypothesis, which maintains that market prices accurately reflect all the available information.

    Second, instead of playing a purely passive role in reflecting an underlying reality, financial markets also have an active role: they can affect the so-called fundamentals they are supposed to reflect. That is the point that behavioral economics is missing. It focuses only on one half of a reflexive process: the mispricing of financial assets; it does not concern itself with the impact of the mispricing on the so-called fundamentals.

    There are various pathways by which the mispricing of financial assets can affect the so-called fundamentals. The most widely travelled are those which involve the use of leverage-both debt and equity leveraging. The various feedback loops may give the impression that markets are often right, but the mechanism at work is very different from the one proposed by the prevailing paradigm. I claim that financial markets have ways of altering the fundamentals and that may bring about a closer correspondence between market prices and the underlying fundamentals. Contrast that with the efficient market hypothesis, which claims that markets always accurately reflect reality and automatically tend towards equilibrium.


    "The fault, dear Brutus, is not in our stars, But in ourselves, that we are underlings."

    Julius Caesar (I, ii, 140-141)

  17. Soros knows about as much about economics as I know about gene splicing. Running a business is not the same as understanding how the macroeconomy works.

  18. Have you actually about his background, or read his books and listened to his talks? Or, do you just dismiss him by projecting that he couldn't know because he did not continue and become a mere economist after the London School of Economics?

    When the four best economic minds (Soros, Buffett, Munger, and Kahneman) of the last 50 years reject the fundamental assumptions of macro, and have shown by a demonstrated record that they know how the macro economy works by applying entirely different theories and checklists, someone needs to self-question, a lot.

    1. Keep telling yourself that, and it will make you feel better. You won't be any more correct, but at least you won't realize it.

  19. "Where's the money? Inflation is always and everywhere a monetary phenomenon."

    "The quantities of the particular liabilities in question have to be important for determining the prices."

    You always say this kind of stuff, but I never recall hearing you talk about the velocity of money. Do you not believe in some kind of MV = PY relationship? In a very depressed economy, V can be very low, allowing for a high M yet no inflation. Why do you never figure the V into your analyses, only the M?

    1. Richard,

      If you knew any economics, you would know that MV=PY is an identity, true by the definition of V. Discussing M is the same as discussing V.

      Again, your ignorance shows through. Please get some education before you hurt yourself speaking in public.

    2. Ok, ha ha jerkface. One of the purposes of blogs is to educate and to answer questions of people not specialized in the sub-area.

      The identity is to give lessons, and one is that velocity matters too, not "inflation is everywhere and always a monetary phenomenon". And, you might notice that there's more in that equation that can adjust to a change in M than V. There's also P and Y. So discussing M is not necessarily the same as discussing V. M and V can move in opposite directions.

    3. Or they can move in the same direction. They can move independently of each other with P and/or Y picking up the slack.

      And the identity wasn't devised just for the fun of it. It was devised because the author thought that velocity was an important concept, not the same as M.

    4. Jerkface

      Discussing M is not the same as discussing V.

      Narrowly, the only place M is talked about is at the Bureau of the Mint or the Bureau of Printing and Engraving.

      Now, there are a lot of near substitutes for M that one can add, but I am not going to go into that an invite further arguments with a jerkface fool. I follow the Mark Twain rule and avoid arguing with fools.

      Krugman and DeLong have been posting about the zero bound we are occupying in which treasury bills and notes have become M or almost M. This is well beyond your capacity to consider.

      Like Richard, I would be interested in what SW has to say about V.

    5. "Now, there are a lot of near substitutes for M that one can add, but I am not going to go into that an invite further arguments with a jerkface fool. I follow the Mark Twain rule and avoid arguing with fools."

      I guess you don't talk with yourself much, then. Probably best.

  20. Deutsche Bank Explains What Just Happened In Greece, And Why Markets Are Getting Hammered Tonight

    Read more:

  21. MV = PY,

    all variables are endogenous in the short-term, with Y and V becoming exogenous to M in the long-term. Y will be driven by productivity and V will by driven by financial innovation. In other words, M --> P relationship strongest/consistent in the long-term.


  22. Let me try and turn the other cheek and be magnanimous and maybe help you learn, in the good spirit of what blogs should do.

    Here's my current understanding of identities:

    An identity is an equation that always holds true (by definition). A + B = C is true in this case, right now, but maybe next month A and B will be greater than C. But add a third line to the equals sign, and it's always true. If A goes up, it's still true. It's just either B must have gone down, or C must have gone up.

    Now, this, as you can see, doesn't mean talking about A is the same thing as talking about B. If you're very sure A will go up next month, that doesn't mean you know what B will do. It could go up, in which case C goes up, or it could go down, in which case C doesn't go up as much, or stays the same or goes down.

    And this doesn't mean identities are unimportant and you can't learn from them. Assets – Liabilities = Equity is an identity, but it tells us that assets are important and so are liabilities, because the concept of equity is important – very important, as many people painfully know today. Talking about assets is not the same as talking about liabilities. Equity is not, everywhere and always an assets phenomenon. Liabilities can move independently of assets. Your assets can go up and up, but somehow your equity goes down and down, and you become bankrupt, like if you're over-spending on consumption, and/or if the interest on your debt is very high.

    I'm not a monetary policy expert, but I think what MV = PY tells us is that all other things equal, a big increase in M doesn't necessarily mean high inflation because there could be a big boost in production,Y, or that money may just really sit in a vault and not get spent on anything, (low V), so it's just not out there bidding up prices. And again, everything in that identity can move independently of everything else. You only get dependence if you've already fixed ALL of the quantities except one.