Depression economics

If you want further reason to be depressed about our economic future, this article Janet Yellen and the Phillips Curve will supply it. If you believe this thing called the Phillips Curve relationship works, then you believe that higher inflation can bring faster growth and lower unemployment along with it. It is exactly this that Janet Yellen apparently believes. This is a direct quote:

“Each percentage point reduction in inflation costs on the order of 4.4 percent of gross domestic product, which is about $300 billion, and entails about 2.2 percentage-point-years of unemployment in excess of the natural rate.”

That is, reducing inflation slows growth and raises unemployment. If you want growth, inflation is therefore the way to go.

Yellen believes that the central bank should maintain enough inflation to prop up business activity, because ‘uncertainty about sales impedes business planning and could harm capital formation just as much as uncertainty about inflation can create uncertainty about relative prices and harm business planning.’ This approach extends the Fed’s mission beyond even the dual mandate of Humphrey-Hawkins and into the sphere of American corporate activity, a place that the business economist Greenspan was reluctant to go. Yellen, a disciple of predictive modeling, dismisses the notion that the Fed could go too far. To her the record shows that ‘tuning works even if it is not “fine.”‘

Here’s the article’s conclusion:

It isn’t just the 1970s, but the last few years, that show how money creation does not produce permanent employment gains. This was raised time and time again at Yellen’s recent Senate Banking Committee hearing, when several Democrats bemoaned the absence of any ‘trickle down’ effect from quantitative easing. Do we want the Fed to double-down on that folly with Janet Yellen at the helm?

This is not going to end well.

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52 Responses to Depression economics

  1. .

    Yellen believes that the central bank should maintain enough inflation to prop up business activity

    But it doesn’t. It is not neutral. You are destyroying purchasing power.

    There is a presumption that the IS curve will simply follow LM as it shifts to negative real interest rates. Why would that permamently happen? It has a secondary presumption there will not be malinvestment which would stop IS shifting out again. In the Keynesian model, investment will detract from consumption, which is being lessened by lower purchasing power.

    After Australia had negative real rates in 1981-1982, we expereinced a recession in 1983. This was during a drought and with a fixed/pegged rate though. The labour market was also very inflexible. Perhaps America can inflate its way out of the minimum wage. However, America faces a pool of unemployed persons not seen in decades. Yellen is almost gambling. I will reckon they can’t get a lot of FDI needed for capital investment if Japan, the EU and China are facing decline. Especially if everyone else is engaging in QE or very generous accomodation.

    NB: I’m not syaing you shouldn’t accomodate, banks do this with M3 themselves, on expansion and contraction, and the economy does so with velocity. High powered monetary accomodation without wasteful inflation is possible, but we and most of the world are geared to inflationary bias.

  2. Spiro

    Either way, the US will have to inflate their way out of their debt problems. The Fed does not have an explicit inflation target. It is becoming clear that inflation targeting central banks are having more difficulty in generating inflation when it is too low (deflationary) that in achieving their target after inflation has been too high. This may imply that the rate of inflation that is being targeted is too low and targets should be increased. If central banks were really interested in price stability and the wellbeing/welfare of households they would target the CPI price level rather than inflation. The US dollar is a reserve currency and since the higher inflation will lead to its depreciation, the US will remain largely unaffected since it is close to achieving its long sought after goal of energy independence. Watch the aussie dollar soar!

  3. .

    Who has deflation Spiro?

    The US had it, in the middle of the “stimulus”, which destroyed capital investment in projects with a positive ROI.

    I don’t know why you’re obsessed with CPI…PPI has an impact, but it is less direct. If you could target inflation generally it would be better because it would be less distortionary on a sector by sector basis.

    I agree on the dollar and gold. I can’t fathom why the USD has appreciated with Yellen’s promotion.

  4. H B Bear

    Janet Yellen, the Affirmative Action Al Greenspan.

  5. Token

    Yellen believes that the central bank should maintain enough inflation to prop up business activity

    Remember when the leftards called supply side economics – Voodoo economics.

    We are seeing the real voodoo economics in action.

    Janet Yellen, the Affirmative Action Al Greenspan.

    Appointed by the affirmative action president.

  6. Spiro

    There are not many central banks that have explicit inflation targets. Sweden is one that seems to have a deflationary problem. Note that so too would Canada, UK, and the US had they not embarked on QE.

    http://www.riksbank.se/en/Monetary-policy/Inflation/Current-inflation-rate/

  7. .

    Spiros

    Sweden’s inflation has averaged around zero, between roughly +/- 0.5% last year.

    From 1995 to now, the long term trend is zero inflation.

    They have a near zero target in a flexible short to medium term band.

    Their monetary policy is excellent.

    Not too many central banks have an inflaiton target – and most of them are crap and poverty enabling.

  8. Empire Strikes Back

    Yellen, a disciple of predictive modeling, dismisses the notion that the Fed could go too far.

    Roll up, roll up for the greatest show on Earth. See Janet the Delusionist predict and control the future…

  9. Spiro

    They have a near zero target in a flexible short to medium term band.
    What ever your name is, did you check the link? The riksbank target is 1 to 3% and they have consistently missed the target. Inflation is a weighted average, so when inflation is zero, most prices are deflating.

  10. .

    They are doing better than their target. I should have been more accurate and stated their implicit target was around zero. 1 to 4 % is a common target band range.

    Inflation is a weighted average, so when inflation is zero, most prices are deflating.

    Erm…but purchasing power reamins unchanged.

  11. wreckage

    The only “benefit” I can see to inflation is that it effectively inflates the economy out of the minimum wage; but this turns wages into a shell game.

  12. Uber

    Holy crap there’s some dumb-arses out there getting the big jobs.

  13. Spiro

    No name says Their monetary policy is excellent.

    But their GDP growth has been shithouse. 2.3% higher than the same time three years ago!

  14. Percy

    My understanding here is limited, but wouldn’t 2.3% GDP growth combined with Zero inflation be preferable to 6% growth with the same 6% rate of inflation?

  15. .

    You are correct Percy.

    GDP growth in the long run cannot be manipulated through monetary pump priming.

    Having zero inflation would have actually maximised economic growth.

    I suggest they look at Government spending, regulation and the level and methods of taxation they use.

  16. Token

    My understanding here is limited, but wouldn’t 2.3% GDP growth combined with Zero inflation be preferable to 6% growth with the same 6% rate of inflation?

    A cynic would suggest that is a horrific suggestion (if your job is to get political donations from the executives from the companies that back the DNC). How would such people hit their revenue growth targets?

  17. Spiro

    Sorry Percy, my wording was a little poor. 2.3% real GDP growth in three years is a little more than 1% per annum. This has generated increasing unemployment which is now about 8.5%. 6% real GDP growth would lead to lower unemployment even with 6% inflation, since nominal GDP has increased by close to 12%.

    The unnamed above is correct in my opinion that monetary policy has only transitory and illusory effects, but the deflation experienced in Sweden is hampering growth by reducing revenues and profits.

    I must say though, that it is refreshing to comment on a forum where there is debate about opinions rather than being attacked by Club of Rome zealots that proclaim that there is no growth when resources have been depleted or there is no growth at some extreme temperature or that only only Clive Hamilton is qualified to have anything to say about science. I am sorry to change the topic but can you believe the School of Mathematics is sponsoring this?

    http://www.maths.unsw.edu.au/events/2013-12/limits-growth-beyond-point-inflexion

  18. .

    Sorry Percy, my wording was a little poor. 2.3% real GDP growth in three years is a little more than 1% per annum. This has generated increasing unemployment which is now about 8.5%.

    Not because of monetary policy.

    The unnamed above is correct in my opinion that monetary policy has only transitory and illusory effects, but the deflation experienced in Sweden is hampering growth by reducing revenues and profits.

    There is no way this is possible, inflation has averaged roughly zero since 1993 within a wide short to medium term band.

    Their MP has maximised real GDP growth.

  19. Spiro

    Their MP has maximised real GDP growth.

    So what you are saying noname is that the monetary policy that maximises real GDP growth is one that achieves a zero percent rate of inflation. I wish that were true, although it conflicts with macro empirical evidence. Also, from a micro perspective, if I owned/managed a firm that operated in a sector where prices were falling, I would surely consider options to shut down or even exit and sack all of my workers.

  20. wreckage

    Limits to growth assumes we’ve run out of more sophisticated technology to implement, which in turn must mean that everything has been discovered.

    What effect will it have on growth when people can design and print out exactly the device they need, at home, for a few cents? The hours, fuel and materials saved , the productivity and innovation boost of having an international network of open-license designs without royalties, patents, or import/export restrictions?

    I mean, the orthodoxy of the mainstream is that it will destroy the economy by making people stop buying stuff, but I maintain that if your model of economics implies that cheap inputs kill growth, your model must be wrong, in the same way as if you assumed that eating carbohydrates makes you starve to death.

  21. wreckage

    Inflation renders growth illusory. Inflation is not the means by which the economy expands, but can be a consequence of the economy expanding. The decider would be purchasing power.

  22. Ant

    Most Leftists, growing up smoking, inhaling and injecting the funny stuff, while at the same time being guilt-ridden, self-flagellating narcicists leading to bouts of self-inflicted depression, have their brains conditioned to think that artificial stimulation is the answer to everthing.

    That’s my professional medical opinion.

  23. .

    So what you are saying noname is that the monetary policy that maximises real GDP growth is one that achieves a zero percent rate of inflation. I wish that were true, although it conflicts with macro empirical evidence.

    No it doesn’t. You need to look back before the dawn of econometric time! Do you know anything of the US deflation in the 1800s?

    Your dataset is compromised anayway. You cannot disentangle MP from everything else, especially if the countries with the best macro policies choose a higher target which is stable, low and predicatble (i.e. otherwise good), forgetting microeconomic policies.

    Also, from a micro perspective, if I owned/managed a firm that operated in a sector where prices were falling, I would surely consider options to shut down or even exit and sack all of my workers.

    Why? Becuase purchasing power was constant over 15 years but in real terms costswere falling, but you had -.6% deflation in one quarter?

    You are being a bit irrational here, Spiros.

  24. Spiro

    Going back to Yellen, if her real motive in generating inflation is to decrease the forex value of the national debt, then we would not really see the fruits of this action for a couple of years. Whether she really believe in the short run phillips curve or not, a chair must make their actions justifiable to its shareholders. In this case the Feds primary shareholder is the US government and Mr Obama is just that person to believe such a story as the SRPC. In 2016 it may be that Mr Obama and others of his cabal will be removed from influence and a new US govt would be appreciative of Yellen’s approach in helping reduce the debt burden.

  25. Who has deflation

    Japan for the last few decades, before Abenomics. That’s the real danger that the Keynesians are worried about, lost decades of deflation as in Japan.

  26. Spiro

    noname its not irrational to abandon production when the price of your output is falling. Check the Holden story.

  27. .

    The price of their output falls by small, insignificant amounts and it rises by small, insignificant amounts.

    Their inflation rate is in the long term near zero and stable and predictable, whilst ina flexible short term band.

    You are being utterly irrational.

    If your nominal sale price fell by 0.6% in a single quarter, you’d really shut down?

  28. .

    monty what did you expect?

    They built billions of dollars of infrastructure no one wanted.

    Which is the Keynesian solution to deflation in a liquidity trap – which fiscal policy, given it’s woeful ROI, placed them in.

  29. Spiro

    noname again inflation is merely the change in the CPI, which is a weighted average of output prices. Output prices can change by much more in comparison.

  30. .

    Spiros

    What is the generally accepted real GDP maximising inflation rate in the literature, that is free from selection bias (and that of selection bias of beggar thy neighbour monetary policy) or the benefits of reducing real minimum wages?

    Can you point to a seminal paper?

  31. .

    Spiro #1106524, posted on December 11, 2013 at 3:39 pm
    noname again inflation is merely the change in the CPI, which is a weighted average of output prices. Output prices can change by much more in comparison.

    Honest question, do you know what CPI and PPI stand for as acronyms?

    Note that I wanted to broadly target inflation and before that you did not.

  32. Token

    monty what did you expect?

    They built billions of dollars of infrastructure no one wanted.

    Which is the Keynesian solution to deflation in a liquidity trap – which fiscal policy, given it’s woeful ROI, placed them in.

    They have a magnificient system of roads which their declining population can not afford to drive on due to their obscenely high cost. On a recent journey on a bus I counted over Y30000 in tolls in a short trip from Kyoto to Kobe.

  33. Spiro

    noname do you really understand the concept of aggregation?

  34. .

    spiros I know what aggregation is. Explain why you one minute want to pump up CPI but the next minute don’t want to use it – remember I want to use a very broad inflation measure for policy purposes.

    Could you also show me some of the literature I asked for?

  35. FFS, Yellen has all but admitted she will be raising inflation. If QE doesn’t result in inflation, what will?

    More QE, of course. Much, much more.

  36. Southern man

    Deflation is a good thing. What I earn today is worth more tomorrow. As long as we can also adjust wages over time and free up the employment market so employees and employers can freely negotiate, deflation is good. Inflation is theft, a hidden form of taxation. Deflation encourages saving (delayed gratification) making money available to fuel development.

    http://www.amazon.com/The-Evil-Princes-Martin-Place/dp/1456475320

  37. RexR

    @uber

    Holy crap there’s some dumb-arses out there getting the big jobs.

    I reckon you oughta give it a shot.

  38. .

    Big call Rex. I bet you think Mark Zandi’s forecasts about the US stimulus were correct, no?

  39. Anto

    When inflation occurs because of demand pull factors, there is a correlation between inflation and growth (correlation – not straight causation).

    When the authorities attempt to manufacture inflation, all they create is cost push, which is 100% bad and supports unsustainable debts, without creating healthy economic activity.

    The fact is, all economies require periods of deflation in order to “flush” the system from time to time. It’s called the business cycle and central planners from time immemorial have been trying to rid capitalism of this essential mechanism.

    Imagine what would happen if, instead of flushing your toilet, you just sprayed air freshener into the bowl forever?

  40. Andrew

    What ever your name is, did you check the link? The riksbank target is 1 to 3% and they have consistently missed the target.

    Weeeeeeellllllll, if they have consistently missed the target by achieving 0% for 18 years, and the world hasn’t come to an end, then perhaps you could infer that the Riksbank is doing it on purpose at least a little bit. (Sure, no central banker can actually come OUT and say they’re targeting 0% CPI – it’s like a politician saying they’re supportive of balanced budgets or for Holden to pull its own weight and be accountable for its own profitability.)

    It’s not like Sweden has had outrageously high interest rates for the last 2 decades. They are shit-scared of another housing boom like the one that saw them go all Lehman in 1980 and so don’t care if things undershoot a little. (Of course, they handled it sensibly – took the keys, guaranteed senior liabilities, told the shareholders to fuck off, avoided systemic collapse and ended up owning some very nice banks after 2-3 years.)

    Deflation isn’t bad per se (although it can RESULT from bad things, or be bad when the system isn’t set up around it). If people borrow at 3%, pay off their homes in 15 years, and don’t bet the farm on positive HPA, then flat prices don’t result in negative equity, don’t cause infinite deferral of consumer spending, don’t distort investment decisions and don’t trouble the Riksbank.

    When you’re the BoE and looking at the govt trying to pay off about 100% of GDP (and still 8% in the hole even during ZIRP) you’re perpared to “miss” on the upside – again, entirely deliberately.

  41. .

    Thanks Andrew for your sensible and knowledgable comments.

  42. Eyrie

    FFS people, the entire electronics industry has had falling costs and lower prices for their products for 30 years. There still seem to be plenty of manufacturers of PCs, cameras, phones ,game consoles etc.
    Inflation is theft, pure and simple. If this blog is in any way libertarian, I’m moving over to the anarchists.

  43. .

    No Eyrie, most people see this “necessity” to have inflaiton to eat at purchasing power to mitigate economic growth as a crock…but the best MP is the have a free market in money and banking.

    There are issuance and balance sheet incentives to see that inflation and deflation, along with volatility and mispricing through unrealised arbitrage are minimised.

    Anarchists are right on this count!

    I note spiros could not answer my questions or provide a sample of the literature which “proves” that zero inflation is suboptimal.

  44. .

    Eyrie your example is excellent.

    It blows this crap about how need inflation out of the water. Contrast it with spiro’s hysteria of 15 years of zero net inflation and a recent quarter of -0.6% CPI.

  45. Inflation is theft; worse it is systemic theft. I’m not sure whether it is a greater systemic theft than freehold land, but it’s certainly right up there in the league of parasitic costs.

  46. .

    Freehold land is theft?

    Whatever. What if everyone agrees to it? You can’t possibly be correct in that instance.

  47. Freehold land isn’t theft in and of itself. However it inherently over time leads to the accretion of value imparted by the community to the owner, and in doing so results in a transfer of wealth to those who hold land.

    Exactly the same process as occurs with inflation, which is not ‘theft’ either, because it is systemic.

    When you get down to it, freehold is not a market based form, but a ‘hold by force’ based form.

  48. wreckage

    Right, so if an asset appreciates, the owner is a thief. This sounds like the justification for a USSR style anti-hoarding measure.

  49. Right, so if an asset appreciates, the owner is a thief. This sounds like the justification for a USSR style anti-hoarding measure.

    It depends on why that asset is appreciating. Exhibit A – your standard Labor heavy – buys a bit of farm land out on the edges of town. His mates in the local council rezone the area industrial. His mates in the State Government then proceed to build a major arterial freight road right past the land that Exhibit A just happens to own. Exhibit A then sells the land at profit, through no risk nor labor of his own.

    Exhibit B – a farmer does work improving his land. He flattens it out, supplies irrigation, etc. He eventually sells the land – and the profit from his labours and investment is valid.

  50. .

    Drift…those who buy in a new area take a risk and the economics of land development are well known to many, even if only implictly and from a non specialist perspective.

    You can hardly call changes in zoning the same as an outright condemning of freehold. I would expect the same to apply to leaseholds, for pubs etc. especially.

  51. The nomination of zoning change is only illustrative of the effect, as the example of public infrastructure development.

    Leasehold suffers the same problems as the lease rate is not tied to the current value of the land. That there is a far future point where that is reset lessens the problem only slightly. A system based on payments reflecting the current value of the right to sole use of land rather than one based on the capitalised present value (including prospective growth) of that sole use is necessary to avoid it.

    The opposite also applies; where someone privately builds something that significantly increases the value of land surrounding, there should be a mechanism to recover that value. Currently we do this by having the government tip in funding up front for major developments, but these days we have the capacity to measure the change and recompense for actual change rather than projected.

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