A bit more on Bitcoin-based innovation

Such “permissionless innovation”, in the jargon, should in time result in a cornucopia of applications. Bitcoin’s technology could be used to transfer ownership both in other currencies and of any kind of financial asset. This, in turn, would allow the creation of decentralised exchanges which let asset holders trade directly. And money could be “programmed” […]

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Schuck on Why Government Fails So Often, by David Henderson

I’m working my way through Peter H. Schuck, Why Government Fails So Often. It’s due out next month from Princeton University Press and I’m writing a review of it. I’m over halfway through and I’m loving it. Schuck does a beautiful job of laying out all the problems with government intervention. I’ll have trouble narrowing the list of juicy items to highlight in my review.

The book is subtitled "And How it Can Do Better." I’m skeptical that he’ll come up with much in that department given how powerful a case he makes for the thesis in his title. But, hey, I’ll keep an open mind.

As I said, there are many gems in this book. In a section on how little effect political contributions and lobbying have on changing votes, Schuck quotes the following from another author:

In 2011, the Chamber of Commerce and the AFL-CIO joined together to call for a major reinvestment in American infrastructure. None passed. In 2010, most of the health care industry was either supportive or neutral on the Affordable Care Act, and if any one of them could have swung the votes of even a few Republican senators or congressmen, the desperate Democrats would have let them write almost anything they wanted into the bill. But not one Republican budged. In 2009, the Chamber of Commerce endorsed the stimulus bill as a necessary boost to the economy. Not one House Republican voted for it.

Question: Who said it? If you Google, then please don’t report your answer. (7 COMMENTS)

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Unemployment was 9.0% in May 1975, and money was too easy, by Scott Sumner

There’s a lot of discussion about the natural rate of unemployment. Some think we are already close to the natural rate. Others think the labor market is much weaker than the official 6.6% figure would suggest. Evan Soltas has what looks to me like the best analysis of the situation:

The fact that the unemployment rate appears to be a robust predictor of the quit rate both before and after the 2007-2009 recession suggests that the unemployment rate, our imperfect observation of labor-market tightness, is a close proxy for the tightness people think is important when they decide to quit or not to quit.

Evan calls the labor market "tight." I probably wouldn’t use that term, but we both agree that 6.6% unemployment is a pretty fair characterization of the actual state of the labor market. The natural rate of unemployment has not changed much in recent decades.

In May 1975 the unemployment rate was 9.0%. And yet strangely enough monetary policy was actually too loose at the time. NGDP grew at a 9.1% rate in the second quarter of 1975, and an astounding 12.1% over the next 4 quarters. The high inflation of the 1970s had nothing to do with supply shocks (RGDP growth was normal) it was simply excessively fast NGDP growth, plain and simple. Easy money.

The Fed should have tried to gradually reduce the NGDP growth rate, over a period over years. Instead the problem got worse after 1975. Indeed even Volcker initially made the problem worse. His sharp swing toward easy money in the run-up to the 1980 election pushed NGDP growth to an annual rate of 19.91% in late 1980 and early 1981. (No, that’s not a typo.) Only after Reagan took office did Volcker finally decide to bring inflation down.

The central bank can never really know where the natural rate of unemployment is. If they had a proper monetary policy they would not even pay any attention to unemployment.


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Is Abenomics working?, by Scott Sumner

Tyler Cowen recently linked to an interesting post by Edward Hugh. Hugh argues that much of the recent uptick in Japanese inflation is due to the recent depreciation of the yen. That may be true in an accounting sense, but it leads Hugh to misinterpret the situation in Japan:

Even the 0.7% annual rise in core-core inflation isn’t all it seems to be, since some 40% of the increase is accounted for by a one-off rise last year in charges for accident insurance and public services. The key point to grasp in all this is that the rise is due to what we could call "cost push" rather than "demand pull". As Takeshi Minami, chief economist at the Norinchukin Research Institute put it,"Those increases had little to do with demand and supply."

If that were true, then we’d see Japanese inflation rising at the same time that RGDP growth was falling. That’s what cost push inflation does, it shifts the AS curve to the left. Now look at this graph from a recent Marcus Nunes post. Screen Shot 2014-03-02 at 9.23.53 AM.png

This is precisely what a demand shock looks like. When monetary policy causes a currency depreciation, and both NGDP and RGDP rise, then you have experienced a demand shock. It’s not even a debatable point, the data is crystal clear.

Suppose the recent gains were merely due to the currency depreciation, and not an underlying boost to domestic spending. In that case the trade balance would obviously "improve." Here’s what Hugh says actually happened:

But it’s worse, the monetary expansion has driven down the value of the yen but in the context of the second arrow – a double digit fiscal deficit – this drop in value is leading to a growing not a declining trade deficit.

Actually this is a good sign, as faster economic growth will often worsen a trade deficit. The US trade surplus shrank immediately after the sharp devaluation of 1933.

If Shirakawa is right all the ongoing attempts to reflate the Japanese economy may be simply working against history, with the central bank governors sitting there, like modern Canutes, trying to order back the waves. Maybe the theoretical debate is far from over, but the evidence is mounting that Abenomics may lead Japan’s economy to shipwreck, tossed between the Charybdis of a growing external imbalance and the Scylla of a deflation driven monetary black hole.

As an aside, I’m not sure Shirakawa is the person you want to cite here, as he is merely trying to explain away his failed monetary policy when he ran the BOJ. I certainly agree that Abenomics is likely to lead Japan to a shipwreck, however it will probably be on a soft sandy beach, rather than sharp rocks. As things stand today, Abenomics has clearly improved the situation in Japan, but just as clearly the improvement has not been sufficient. Japan still faces a fiscal crisis. Things are still likely to end badly. They are unlikely to hit the 2% inflation target in a sustained way, nor are they likely to hit the much more important milestone of 3% trend NGDP growth. They need to do so in order to reduce the extreme fiscal imbalances.

On the other hand, when compared to pre-Abe policies, Abenomics has been a smashing success. Things are finally moving forward.

There is much in the Hugh piece that I agree with. For instance, I agree that the amount of slack in the Japanese economy is much less than many assume. Don’t expect (RGDP growth) miracles from Abenomics. Yes, the policy has helped already, and further depreciation of the yen would help even more. However I see no sign that the Japanese government plans on further yen depreciation. And if they begin to allow yen appreciation for a sustained period then they will slide back into deflation.

The most discouraging aspect of the situation is that neither the Japanese government nor the American economics profession seems to understand the real issues facing the Japanese. They face a trade-off between NGDP trend growth rates and size of central bank balance sheets. If they want a low NGDP growth rate, they must accept an exceedingly large balance sheet, and vice versa. Prior to 2013 they seemed to want low NGDP growth but not a big balance sheet, and their policy predictably failed. But even today I don’t see much evidence that they understand that this is a choice they must make. Nor do I see any signs that American economists understand this dilemma.

Abe is also trying to pressure Japanese firms to raise nominal hourly wages, thus repeating the very worst mistake of the Roosevelt administration. Japan is still far from being out of the woods.

Update: In a comment section Mark Sadowski comments on a different part of the Hugh post. First he quotes Hugh:

"In the words of former Bank of Japan governor Masaaki Shirakawa, "Seemingly, there would be no linkage between demography and deflation. But it may not be the case. A cross-country comparison among advanced economies reveals intriguing evidence: Over the decade of the 2000s, the population growth rate and inflation correlate positively across 24 advanced economies."

And then he responds:

This claim comes from the following paper (Chart 14)


The paper finds no significant correlation for the same group of nations in the 1990s. Moreover the paper points out in a footnote that:

"Another cross-country inspection based on a broader sample, including developing countries, does not detect positive correlation between inflation and population growth in the 2000s and in earlier periods likewise."
Mark’s comment has much more empirical evidence on this assertion.


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