Letters and Numbers

Four years ago, roughly two dozen economists and financial theorists signed an open letter to Ben Bernanke urging him to back off the policy of quantitative easing, citing, among other things, the risk of inflation.

Bernanke was apparently unmoved, and quantitative easing went ahead as scheduled. Inflation has not materialized. This raises a number of questions for the signers of the letter. Should they be ashamed? Do they have anything to apologize for? Should they renounce everything they thought they knew about economics and relearn the subject from scratch?

Cliff Asness, one of the signers, responds here. This is a terrific essay, not just on the specific topic of quantitative easing but on the general topic of the lessons we should and should not learn from our mistakes and/or from concerns that don’t materialize.

Postscript: True to form, Paul Krugman concludes that Asness, because he disagrees with Krugman, must be entirely ignorant of all the macroeconomic literature on liquidity traps. I wonder if Krugman wants to draw the same conclusion about Asness’s fellow signer John Taylor, whose likely future Nobel prize, unlike Krugman’s (who won for trade theory and economic geography), will recognize Taylor’s widely acknowledged first-rate scholarship and influence in the field of macroeconomics.

Click here to comment or read others’ comments.

Print Friendly, PDF & Email
Share

37 Responses to “Letters and Numbers”


  1. 1 1 Daniel

    Just linking directly to Brad Delong who in fact does make the counter argument, that Krugman never thought QE would be a slam dunk during a liquidity trap, just that it was probably better then doing nothing.

    http://delong.typepad.com/sdj/2014/10/no-cliff-asness-still-has-not-done-his-homework-on-what-a-liquidity-trap-is-why-do-you-ask.html

    And is it just me, or do you think every article that insults Krugman is the best thing since sliced bread?

  2. 2 2 Jason Hartley

    This is the first time I’ve seen the “my Nobel is bigger than yours” argument.

  3. 3 3 ryan yin

    Asness refers repeatedly to “unprecedented loose monetary policy” in the context of low interest rates. I assume (perhaps incorrectly) you take this to be a correct assessment of the US’s monetary stance of the past 6 years. If so, what do you take as the best counterargument to the monetarist position (notably Scott Sumner) that low interest rates do not imply loose money and that money has in fact been excessively tight? It strikes me that the absence of inflation** and unimpressive nominal growth are pretty decent indicators here.

    ** No, I don’t take a rising asset prices as a good indicator of inflation. I mean, sure, you can define words to mean whatever you want. But surely it’s obvious why such an unusual definition of inflation makes it unclear why you think very high inflation would be bad — I for one would really like it if my assets prices always went up so long as the price of goods & services didn’t go up at the same time! So I don’t see the point of abusing standard English this way.

  4. 4 4 Daniel

    @ryan yin,

    “** No, I don’t take a rising asset prices as a good indicator of inflation. I mean, sure, you can define words to mean whatever you want. But surely it’s obvious why such an unusual definition of inflation makes it unclear why you think very high inflation would be bad — I for one would really like it if my assets prices always went up so long as the price of goods & services didn’t go up at the same time! So I don’t see the point of abusing standard English this way.”

    Right, this part struck me as odd as well. If the average consumer basket is only rising by 2.0% inflation, then regardless of what asset prices do his immediate income will be decreased by 2.0% all else equal, so I’m not really sure what Asness was getting at here. Maybe that the entry price to investment becomes higher relative to income, so that the average consumer will be less likely to purchase investments? This makes some sense, since

  5. 5 5 ryan yin

    @Daniel,

    I took it to be just semantics: he’s defining “inflation” as “when anything that could be called a price goes up.” Ergo, if the S&P 500 gains 20%, then you have 20% inflation in that part of the market. Which is fine if you’re very clear that’s what you mean, but it seems like the entire point of such a definition is that you’re trying to leverage the negative association related to more standard definitions.

    And in that case, why not just go full Brain Candy? “Would you agree this looks like money is too loose? Ok, well, would you agree that Paris is the capital of France? Ok, so we’re back in agreement.”

  6. 6 6 khodge

    Steve, thanks for the reference. It was terrific.

  7. 7 7 Jack PQ

    I am agnostic on the whole thing, but I think commentators (economists or journalists) who think they are vindicated by a sample of one observation (count ’em!) do not understand the basic principles of scientific investigation.

    A journalist may be excused for being clueless about this, but economists in top universities?…..

  8. 8 8 Satish

    Krugman’s paper on Japan is the first result on Google scholar if search for “liquidity trap”. I think he knows more than just trade theory and economic geography.

  9. 9 9 ryan yin

    Well … doesn’t each year where we’re assured there’s about to be some hyperinflation count as new information? What about examples in other countries?

  10. 10 10 AMT buff

    This is the first time I’ve seen the “my Nobel is bigger than yours” argument.

    LOL Jason. My Nobel is bigger than Obama’s. Yours is too, even though neither of us has one.

  11. 11 11 Advo

    Testing for italics. How do you do bold or italics?

  12. 12 12 Advo

    John Taylor doesn’t appear to understand what monetary policy actually does. In a recent editorial, he actually compared it to rent control.

    So if investors are told by the Fed that the short-term rate is going to be close to zero in the future, then they will bid down the yield on the long-term bond. The forward guidance keeps the long-term rate low and tends to prevent it from rising. Effectively the Fed is imposing an interest-rate ceiling on the longer-term market by saying it will keep the short rate unusually low.

    The perverse effect comes when this ceiling is below what would be the equilibrium between borrowers and lenders who normally participate in that market. While borrowers might like a near-zero rate, there is little incentive for lenders to extend credit at that rate.

    This is much like the effect of a price ceiling in a rental market where landlords reduce the supply of rental housing. Here lenders supply less credit at the lower rate. The decline in credit availability reduces aggregate demand, which tends to increase unemployment, a classic unintended consequence of the policy.

    I hope I don’t have to explain why this is total nonsense. This statement reveals a total lack of comprehension. Taylor appears to be the perfect example of the dangers of relying on modelling while forgetting how the economy actually works.

  13. 13 13 Advo

    As regards the Asness article – I see absolutely no indication in the article that he has read anything of what Krugman wrote about the liquidity trap.

  14. 14 14 Pete

    I was expecting a defense along the lines of “we were just warning of a risk,” which is in there, and satisfies me. Scholars should provide a different point of view and are worthless if they can’t warn of anything about which they aren’t 100% certain.

    I, for one, completely forgot that the banks never really did what the Fed had hoped and that QE was significantly less potent, in both the good and the bad, than what was expected.

  15. 15 15 starman

    funny, I thought Krugman received his Nobel for his anti-Bush pieces in the New York Times

  16. 16 16 Ken B

    Advo: “I hope I don’t have to explain why this is total nonsense.”
    Yes, you do. Very carefully.

  17. 17 17 Martin-2

    Asness’ main points are good. Here’s one thing I’ve gotten tired of that I see in his article, Delong’s post linked by Daniel, and econ blogs and comment sections abound; the premise that Professional Economist X clearly has no understanding of or has not heard of basic and widely discussed Point Y, or has obviously never read the work of whoever they’re writing about. Take Delong’s article, part of an “Asness has not done his homework on blah” series. Asness, Delong, and Delong’s better commenters know economics, but when Asness joined the thread – well, see for yourself. The truth is, if you push your way to the front of the line and ask Asness/Krugman/whoever nicely about the point you think they’re missing they’ll probably give you a perfectly sane answer. Make digs at they’re honesty or level of education at the same time and they might not be eager to help you.

  18. 18 18 Advo

    Advo: “I hope I don’t have to explain why this is total nonsense.”
    Ken: Yes, you do. Very carefully.

    Alright:
    Here is how monetary policy works: The Fed buys treasury bonds (and these days, other securities as well). The price of treasury bonds rises. The yield falls. Other investors are forced into buying other bonds and other asset classes, increasing demand for those bonds and assets whose yield also falls.

    Unlike what Professor Taylor seems to think, monetary policy does not act like a price control on debt (other than treasuries). Nobody’s keeping a bank from lending money to a company at 5, 10, 15, 20, 50%. (Aside from ursury laws, I suppose, but I don’t think that’s a big issue in the US).
    If banks aren’t lending to a debtor, it’s because they don’t want to lend money to that debtor at a price that is acceptable to the debtor.
    There is no conceivable theoretical reason why Fed purchases of treasury bonds might keep creditors from lending money to borrowers at whatever price the parties might agree on.
    The only thing the Fed does is make alternative investments such as treasury bonds less attractive.

  19. 19 19 Josh

    I don’t quite get the rent control analogy either. Sure, the rate a lender can lend at may for certain types of loans effectively be much lower today than 8 years ago because of the Feds actions, but the lender can also likely borrow at lower rates… Or am I missing something ?

  20. 20 20 Advo

    Josh,

    you’re not even quite understanding just how WRONG Taylor is. Taylor thinks low interest rates limit the availability of credit, when there is no conceivable way how this could happen. Low interest rates on treasuries and other debt instruments don’t limit how much a lender can demand from a borrower, unless it’s because THE BORROWER CAN GET A LOAN FROM SOMEWHERE ELSE AT BETTER TERMS. If that is the case, however, then the borrower is obviously not prevented from obtaining credit!

    Professor John B. Taylor, nobel laureate, inventor of the “Taylor Rule”, highly esteemed luminary in the field of monetary policy, doesn’t actually understand, in basic terms, what monetary policy does.
    It’s kind of like having a infectious disease specialist with a Nobel Prize in medicine not understand the germ theory of disease.
    I guess that after experiencing what went on between 2004 and 2008, nothing should shock me anymore, but this still did.

  21. 21 21 RJ

    There is no conceivable theoretical reason why Fed purchases of treasury bonds might keep creditors from lending money to borrowers at whatever price the parties might agree on.

  22. 22 22 RJ

    There is no conceivable theoretical reason why Fed purchases of treasury bonds might keep creditors from lending money to borrowers at whatever price the parties might agree on.

    Yes there is. They’ll invest money in other securities or higher yield investments. A more textbook explanation is people want to hold more money than what is available.

  23. 23 23 nivedita

    RJ @22, “investing in other securities or higher yield investments” is lending money to borrowers.

    A more plausible story is that because the different rates are compressed, the opportunity cost of not lending money is much reduced, so lenders can sit on cash and wait for better opportunities to come along.

    That is, say the investing alternatives are 3-month bills, 5-year treasuries, or 5-year loans. Absent the Fed intervention, the 3-month bills yield 0.25%, the 5-year treasuries yield 5% and the 5-year loans yield 7%. Every year that you sit on cash, you’re giving up 4.75% or 6.75% in foregone interest by not investing longer term. If instead the 5-year rate is only 2% and the loans yield 4%, you’re only giving up 1.75% or 3.75%.

  24. 24 24 nivedita

    Of course, the reason those 5-year rates are normally higher is to compensate for risk associated with the uncertainty of future short rates. If the Fed has committed to keeping short rates low, the term premium should be lower anyway even absent intervention in longer term markets

  25. 25 25 RJ

    Yeah, I guess that’s true. I was thinking more along the lines of less credit available to individual borrowers (think “Mom & Pop”) as opposed to going to large corporations offering higher interest payments.

    That being said, I don’t see how there isn’t any conceivable theoretical reason why Fed purchases of treasury bonds might keep creditors from lending money to borrowers at whatever price the parties might agree on. One is, as you stated, lenders are anticipating higher rates in the near future or deflation.

    A passing thought too, though I haven’t completely thought this through yet, is if bankers are anticipating higher inflation in the near future as well, why lend now and have less cash to lend later?

  26. 26 26 Advo

    @RJ:
    That being said, I don’t see how there isn’t any conceivable theoretical reason why Fed purchases of treasury bonds might keep creditors from lending money to borrowers at whatever price the parties might agree on. One is, as you stated, lenders are anticipating higher rates in the near future or deflation.

    That’s not a reason for lenders not to lend money. That’s a reason for lenders to charge a higher interest rate. To repeat: With regard to lenders, the only thing Fed monetary policy does is make investing in treasuries (and other assets) less attractive for the lenders. It doesn’t interfere with the lending process as such. The lender can charge whatever interest rate the borrower might pay.
    Again, it’s very simple: If a borrower cannot get any credit, it’s because lenders will not provide a loan at terms which are acceptable to the borrower.

    There is no way Fed treasury purchases will make lenders want to charge higher interest rates.

  27. 27 27 Advo

    To make it more clear – this is what the world is like according to Taylor:

    A prospective borrower walks into a bank. He says: “I would like to take out a loan at 15%.” The loan officer says: “I’m sorry, we won’t do that because interest rates on treasuries are so low.”

    If you think Taylor is right, you have to explain how this would make any sense.

  28. 28 28 Harry

    Professor Landsburg,

    Inflation has not materialized? Does it take another three or five trillion of Federal Reserve e-notes to be issued before inflation materializes?

    Today Larry Summers talked about his fears of deflation, and went on to talk about oil prices. He might have just as well talked about the price of soybeans, which like crude oil, happens to be in good supply. He hedged on the question of whether we should print another few trillion.

    I am sure Steve Landsburg knows all about the difference between inflation and fluctuations in the price level, and that the CPI, or other measures used by the government or the financial press, and how our government relentlessly cheapens our money. are two separate subjects.

    Larry also reiterated how we cannot have stagflation, though he did say we need growth, which, I assume means the world should not end coal tomorrow.

  29. 29 29 Harry

    What the Fed has done is issue the Treasury a line of cheap credit until the first Tuesday, 2016. This depends on the rest of the world not figuring out what they are up to, assuming everybody believes in Taylor. We have seen this movie before.

    Who, beside the Fed, is paying high prices for ten-year Treasurys at $45 billion per month, and another $40 billion per month for dirty CDO’s? Everybody else is staying close to the door, waiting for the first smell of smoke.

  30. 30 30 Bob Murphy

    Harry they’ve been “tapering” though. It’s down to $15 billion this month.

  31. 31 31 Bob Murphy

    Yeah I loved Asness’ article too Steve, especially the analogy with climate change.

  32. 32 32 Daniel

    Yeah Bob Murphy, global warming and inflation are so much alike. On the one hand we have savers being slightly less rich than they would have been otherwise and debtors being slightly less indebted if the warning aren’t heeded and they are correct. On the other we have a possibility of an agricultural system that can no longer sustain it’s population if the warnings aren’t heeded and they are correct. So funny and well thought out! It’s not like one is virtually irreversible while the other can be dealt with using well known policy instruments. That’s definitely the best part of Asness’ argument!

  33. 33 33 Steve Landsburg

    Daniel: Did you actually read Asness’s argument? The analogy with global warming had nothing to do with policy analysis; it was all about standards of evidence.

  34. 34 34 iceman

    I’m not seeing the big “gotcha” here – everyone seems to agree that if QE had “succeeded” (been viewed as a ‘credible regime change’ in DeLong’s terms) this would have raised inflation expectations. Some viewed this as a risk, if banks actually lent the money out and people spent it, i.e. if we did not in fact enter into a liquidity trap. Others in the past had viewed this as a *desirable objective* (e.g. Krugman argued throughout the 90s that was precisely what Japan *needed* to do), but apparently this time in the US they did not expect it to happen. Either way it’s not clear what this proves about one’s theoretical understanding of liquidity traps.

    BTW to understand why it didn’t happen this time it seems we need to know if people really wanted to hoard cash or banks just didn’t want to lend it out which gets back to the Taylor thread.

  35. 35 35 Daniel

    @landsburg,

    I did read the whole thing. Maybe why I believe it to be a bad analogy wasn’t very clear. Given what he said, I think we should always reassess our priors, something we are constantly doing on the matter of global warming and something for which we continually come to the same conclusion based on evidence besides mean global temperatures. The one with the highest cost to society should have the lowest burden of proof. In other words we should take great pains to ensure that global warming is false before we decide not to act on it, because the costs to society if it does occur could be catastrophic and we have no current tools to deal with it after the fact. So the burden of proof to falsify this evidence should be high. On the other hand the cost to society if higher than expected inflation occurs is subjective (people with a lot of debt will feel it good while people with high savings will feel it bad). We also have pretty good ideas of what to do if it does occur to mitigate the rise in inflation. So the burden of proof that falsifies this hypothesis of higher than expected inflation should be lower.

    Asness also talked about whether we should consider the burden to falsify on the immediate term versus the longer term. Inflation has to do with constraints and expectations; things which occur in the immediate term and that we expect to have a direct impact in the immediate term. When either expectations change or constraints change towards inflation, that’s when it will occur. The global climate on the other hand is a physical system which is affected by carbon dioxide levels which once changed exogenously will remain at the new higher level for 100’s of years. So to directly answer his question, no I don’t think we should consider the possibility of inflation on the long term just because we consider the possibility of climate change on the long term. Hence why I think the analogy on standards of evidence was a bad one.

  36. 36 36 Harry

    Iceman, nobody wants to hoard money if it can be put to a better purpose, and that includes bankers holding deposits, who always hypothecate every dime they hold as fast as they can.

    There are many considerations, of course, These considerations become especially important when talking about one’s own money and the money of people to whom one owes a moral duty to protect.

    It is a big worry when the Federal Reserve, unfettered by the inconvenience of having to print fiat currency, does it with a few keystrokes on a wireless keyboard at a rate of $80 billion a month for six years. Today, we do not fear people loading up wheelbarrows of Deutschmarks to buy loaves of bread; a SNAP card, more money created out of thin air, will buy three lobster sushi rolls for the next meal and there will be a banquet every day before the card gets recharged, creating more money. We are tapering, but we are still riding the tiger.

  37. 37 37 Advo

    @Harry:

    “Riding the tiger” how? What do you expect could happen, precisely, and how would it come about? Somewhere in that line of reasoning there should be the sentence “and then US wages started rising sharply, starting a wage/price spiral” and some explanation under what circumstances that would reasonably happen.

Leave a Reply