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we know what happened then but this does not mean the argument is correct we don t know that the circumstances are similar we cannot measure potential output it is all a guess dismiss the analogy to the 1970s then do what you will with the rest of their argument at the fed they attribute changes in productivity trends to events such as wars changes in government policies or structural change in the economy kahn and rich elsewhere that is anywhere but at the fed i on the other hand attribute changes in productivity trends to changes in the debt per dollar ratio the reliance on credit and the factor cost of money nowhere but at the fed here s the thing at the fed they re wearing blindfolds and swinging sticks trying to hit potential gdp meanwhile i am saying that what they think are changes in potential output are simple results of changes that you can see in the debt per dollar curve part 1 part 2 this is part three posted by the arthurian at 7 04 am 7 comments labels 3 bullard s earthquake wealth shock krugman has an interesting take on james bullard s wealth shock idea maybe the idea is that the burst bubble reduces demand and hence leads to lower production yeah that s how i took it though i had to wait for krugman to make it clear but what else can it be if a wealth shock leads to lower gdp it s not that we re suddenly able to produce less it s that we re suddenly buying less that follows from the wealth effect i don t buy the wealth effect story myself i m with jazz on that given empirical data that closely links consumption to income how can consumption depend primarily on wealth rather than income but falling demand due to a wealth shock and its wealth effects was the only way i could make sense of bullard s rather direct words the negative wealth shock lowers consumption and output krugman again maybe the idea is that the burst bubble reduces demand and hence leads to lower production but at that point you re into a keynesian world of deficient demand and you should be talking about ways to close the gap not accepting it as a fact of life i thought that was clever rubbing bullard s nose in his own keynesian poo you should be talking about ways to close the gap not accepting it as a fact of life i m with krugman on that here s mine if andolfatto was trying to explain why gdp was slumping and why potential gdp was slumping because of excessive private debt for example i would have some use for his analysis but like bullard he brushes aside any concern with special factors and headwinds david andolfatto seems to be saying only that things are bleak and we ought not expect anything better we do expect better however krugman tells only one side of a story yes demand is inadequate the other side of the story is that demand must be excessive according to bullard remember inflation is already above our new explicit 2 target level he wouldn t tell us that unless he thought it time to start pushing interest rates up again to curtail demand so demand must be excessive in bullard s view only two percent yeah and if i thought bullard s wealth shock analysis was right i d support him at two percent other people think we ought to push the inflation target higher up to four percent maybe if i thought that would solve the problem i would support it but the problem is certainly not that prices are going up too slowly that s not the problem at all the problem as krugman said is that we re in a world of deficient demand but it s an inflationary world of deficient demand so wait let s not talk about ways to close the gap let s talk about how we got into this mess because this world of simultaneously insufficient and excessive demand is a result of the problem that needs to be fixed we got into this mess when everybody started deleveraging paying down debt rather than borrowing more and spending more we started borrowing less and paying off more so the reduced borrowing is spending that we re not doing and the paying off is more spending that we re not doing a double whammy on spending so paying down debt is the problem no paying down debt is our solution to the problem the problem is that we had so much debt in the first place private debt i left bullard hanging bullard is concerned about inflation now i know a lot of people just want to dismiss that concern because we have bigger problems but you can t just dismiss arguments you don t like you have to deal with them and show them wrong or accept them or bide your time and don t jump to any conclusions that s always a good rule so the inflation i don t think inflation is a crisis but i don t like a two percent target i like a zero target even if i can only fail to achieve my target and i really don t like the doublespeak that says a constant price level when it means a constant inflation rate bill mitchell recently pointed out an example of that in that press release the ecb said it main role was to achieve price stability that is stable inflation anyway bullard he says if we over estimate potential output and set policy by it we will encourage excessive demand and we will get inflation like we got in the 1970s and he says inflation is already above target everybody else says the economy is not growing enough and we don t have jobs enough and unemployment is too high and demand is insufficient not excessive how can there be such a difference in views i think the trouble arises from the way we explain inflation here s mitchell again inflation is driven by nominal aggregate demand growth that exceeds the capacity of the economy to respond in real terms that is to increase output too much money chasing too few goods for billy as for milton and anna inflation is caused by excessive demand by demand that exceeds the capacity of the economy to respond demand being excessive relative to potential output is the cause of inflation they say exactly what jim bullard says if you think of inflation along those lines and you admit we re getting inflation already then you end up thinking that the capacity of the economy to respond must somehow have been crippled you end up thinking that there must have been a sudden drop in potential output exactly what jim bullard says but all we need if we wish to undermine jim bullard s argument is to realize that demand pull isn t the only inflation story there is there is also a cost push inflation economists seem always to pooh pooh and ha ha the concept of cost push inflation but it makes perfect sense to me there is a nice short wikipedia article on cost push inflation and if i take two parts of it and put them in reverse order i get what seems to me an excellent explanation of cost push inflation monetarist economists such as milton friedman argue against the concept of cost push inflation because increases in the cost of goods and services do not lead to inflation without the government and its central bank cooperating in increasing the money supply keynesians argue that in a modern industrial economy a supply shock would cause a recession i e rising unemployment and falling gross domestic product it is the costs of such a recession that likely causes governments and central banks to allow a supply shock to result in inflation i accept both sides of that disagreement it doesn t even seem to be a disagreement with the order reversed like that here s what i see yeah it is demand that affects prices more demand pulls prices up more less demand pulls prices up less and demand expresses itself as spending and spending is done for the most part with money money and credit with things that work like money so the quantity of money has to have an influence on prices the quantity of stuff that works like money i accept that i accept it even though i do not accept the graphs milton friedman offered to convince us of the truth of it but if something happens a shock call it pathetic as that explanation is and it drives costs up then the existing quantity of money has to stretch to cover the higher prices that accompany increasing costs and if the money doesn t stretch enough then the spending has to shrink and if the spending shrinks enough you get a recession and if the central bank has a dual mandate to keep prices stable and to keep the economy growing getting a recession means it has failed to meet its mandate and if the central bank decides to take a safe middle of the road position it ends up compromising between recession and inflation and getting some of each and the inflation we get in such circumstances arises as monetarists argue because the quantity of money was allowed to expand but actually the prices had to go up anyway because the costs were going up and the central bank opted to allow some of that cost push inflation to continue rather than creating another recession that s what it was like in the 1970s that s the future jim bullard sees the alternative is to figure out why we have cost push and to fix that problem at the root of cost push you will find the ever increasing cost of accumulating debt part 1 this is part two part 3 posted by the arthurian at 5 00 am 7 comments labels 2 bullard s earthquake bleak apologists federal reserve economist david andolfatto says maybe there is no output gap the output gap is the gap between where we are and where we ought to be people who see an output gap think we ought to be on the same gdp path we were on before the crisis but andolfatto says maybe potential output has collapsed maybe where we ought to be has collapsed and maybe where we are today is as good as it gets andolfatto and his boss james bullard and their friends cochrane and taylor bullard writes for those who take the large output gap view the expectation is for real gdp to grow rapidly after the recession comes to an end as the economy catches up to its potential it is like a rubber band there is supposed to be a bounce back period of rapid growth in fact most analysts have been looking for exactly this effect since the summer of 2009 it has not happened this has led to a lot of analysis concerning special factors and headwinds that might be inhibiting the bounce back effect the wealth shock view puts a different expectation in play the negative wealth shock lowers consumption and output but after the recession ends the economy simply grows from that point at an ordinary rate neither faster nor slower than in ordinary times it is more like an earthquake which has left one part of the land higher than another part there is no expectation of a bounce back to a higher level of output after the recession ends this is closer to what has actually happened since mid 2009 taylor s graphs show both circumstances large output gap and bounce back after the 1981 recession wealth shock and no bounce back after the 2008 recession bullard seems to be saying that it s potential output that is wrong that a realistic evaluation would have us push the red line down to meet the blue rather than expecting the blue line to bounce back up and meet the red talk about lowering expectations what bullard s wealth shock view means if true is less income all around perhaps 5 5 percent less he says or if the proceeds of growth are not evenly distributed more that 5 5 percent less for most of us andolfatto writes i think that bullard makes a persuasive case that the amount of household wealth evaporated along with the crash in house prices should likely be viewed as a permanent highly persistent negative wealth shock the implication is that the so called output gap the difference between actual and trend gdp may be greatly overstated by conventional measures the view that one takes here is likely to influence what one thinks about monetary policy the conventional view seems to support the fed s current policy of keeping its policy rate close to zero far into the future in his speech bullard worries that this may not be the appropriate policy if in fact potential gdp has experienced a level shift down or what amounts to the same thing if conventional measures treat the bubble period as the economy being at and not above potential fair enough if we think of the housing bubble years as normal we are probably overestimating potential output now and if that s the case our overestimate does not apply only to the years after the recession the housing bubble years bubble years are good years unsustainable but good so the housing bubble years should have been better than normal i should think after all housing is the backbone of the u s economy a magnificent boom in housing should have made the whole economy magnificent and yet robert brenner observes the business cycle that just ended from 2001 through 2007 was by far the weakest of the postwar period despite the major stimulus provided by a bubble in housing the performance of the economy was weak weak when it should have been better than normal david andolfatto wants us to think that our expectations were too great he is concerned that we ll get policy wrong if we think of the economy in those years as normal rather than bubbly if conventional measures treat the bubble period as the economy being at and not above potential and weak as the economy was in those years andolfatto wants us to think of 2001 2007 as above potential if da didn t stop there i might agree with him if he was trying to explain why gdp was slumping and why potential gdp was slumping because of excessive private debt for example i would have some use for his analysis but like bullard he brushes aside any concern with special factors and headwinds david andolfatto seems to be saying only that things are bleak and we ought not expect anything better and bullard good god bullard is ready to create another recession right now in the opening statement of his 6 feb 2012 paper he says at the january meeting the federal open market committee fomc took an important step forward by naming an explicit numerical inflation target for the u s of 2 percent as measured by the personal consumption expenditures pce price index we now have an official inflation target of two percent next bullard says in a targeting context inflation means headline inflation by the headline pce measure u s inflation is running somewhat above target right now at 2 4 percent we are now above our official inflation target of two percent it is time bullard implies time to jack up interest rates and tamp out growth this is part one part 2 part 3 posted by the arthurian at 4 00 am 3 comments labels 1 bullard s earthquake sunday february 12 2012 improved google docs spreadsheet charts lots of new formatting options for my google docs charts for example i can now set the font size for the chart title not a big thing maybe but a huge improvement thanks google posted by the arthurian at 7 32 pm 1 comments alan b krueger the rise and consequences of inequality from a whitehouse blog click the four arrows icon in the lower right corner for a full screen version the rise and consequences of inequality i...
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