Saturday, June 03, 2006

Amateur's Luck

According to Jimmy Rogers (quoted in today’s Barron’s), Ben Bernanke is “an amateur with no knowledge of markets.” The article doesn’t make explicit the context of this characterization, but it implies that Jimmy thinks the new chairman’s lack of knowledge of markets will lead to more inflation.

It’s fair enough to point out that Uncle Ben (in contrast, for example, to Alan Greenspan) is a strictly ivory tower guy without much direct “real world” experience. It’s also fair enough to anticipate that this background might in some cases lead Bernanke to make mistakes that Greenspan wouldn’t have made. But I don’t see any reason those mistakes would be biased toward more inflation rather than less. (As I argued in an earlier post, Bernanke’s confidence about the Fed’s ability to deal with deflation should lead him to be more aggressive in combating inflation. That’s a separate issue, though.)

If we look at Greenspan’s time at the Fed, there certainly was some dispute between the ivory tower guys and the real-world-minded chairman. (I get into trouble using the word “guy” to refer to Janet Yellen, though.) The ivory tower people put up a fair amount of resistance to Greenspan’s relatively easy money policy in the mid-to-late 90s. It was the ivory tower people who concerned themselves with the spectre of inflation that Greenspan recognized as a mere phantom. If they had had their way, we almost certainly would have had less inflation (and perhaps deflation) in the late 90s and early 00s.

Possibly, the situation could be different now, but my reading is that it is more extreme in the same direction. Academia has a tradition of regarding the unemployment rate as a critical indicator of inflationary pressure. The “Natural Rate” or “Non-Accelerating Inflation Rate” of Unemployment is a staple of macroeconomics textbooks. Almost anyone who takes this ivory tower view would have to be a little concerned about today’s historically low 4.6% unemployment rate. But other indicators – less popular in academia and on the Fed staff – of labor-market inflationary pressure come in much weaker, indicative of plenty of room to grow without stressing the labor market. For example, help wanted advertising (even if you include the Internet) is still near an all-time low when measured relative to the size of the labor market.

If anything, I would argue, Ben Bernanke will listen to the Fed staff, apply his own ivory tower knowledge, and be induced to tighten more than is necessary. While I share Jimmy’s concern that the bull market in commodities could be a continuing source of inflation, I would point to the present Fed’s tendencies as a counterweight rather than an intensifying factor.

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13 Comments:

Anonymous mvpy said...

"Jimmy thinks the new chairman’s lack of knowledge of markets will lead to more inflation."

Well, sorry, knzn, I wouldnt read it like that. Id read it as Bernanke will create volatility in markets since the markets dont fully understand him. BTW, I think the fact he isnt holding a party on July 4 (as ManQ pointed out) is pretty bad if he wants to keep journalists on his side. I think that matters a lot, theory or no theory.

"As I argued in an earlier post, Bernanke’s confidence about the Fed’s ability to deal with deflation"

Read Larry Meyers book on the FED. It clearly says that Bernanke lost faith in the "helicopter drop" thingie. Instead, he embraced Mike Woodfords theory of path dependent monetary policy; basically committing to low int rates, regardless of subsequent events. Go figure!

"I get into trouble using the word “guy” to refer to Janet Yellen, though."

Oh, you're such a cutie, knzn! You dont wanna incur the wrath of your leftist friends here. Oh my!

"If they had had their way, we almost certainly would have had less inflation (and perhaps deflation) in the late 90s and early 00s."

Well, if they had their way, we wouldnt have had such a long boom at all! I dont think deflation was an issue in the 90s, though, in any case.

"Almost anyone who takes this ivory tower view would have to be a little concerned about today’s historically low 4.6% unemployment rate."

Well, knzn, Im in the ivory tower and I think the NAIRU is a silly, meaningless concept. And, some academics like Solow, think likewise. There are two problems with it; its wrong in theory and wrong in practice. For starters, Stock and Watson have basically said it could be anything; the confidence intervals are gargantuan. As an operational tool I cant see how any responsible banker would use it. Second, in theory, I dont think it holds up. Labor is procyclical so surely in booms and busts the NAIRU changes endogenously.
So, forget about the NAIRU my friend. Like the Phillips curve its a UFO; an unidentified flying object!
Also, many top supply siders like the brilliant Larry Kudlow vehemently oppose it. I couldnt agree more. Further, its a facet of central planning; it gives leftists (like you knzn!) a sense that they can "control" the economy. Huh!

"If anything, I would argue, Ben Bernanke will listen to the Fed staff, apply his own ivory tower knowledge, and be induced to tighten more than is necessary."

Such a pity. The real problem it that universities are indoctrinating students with old, outmoded ideas. I mean, theyre still teaching the Keynesian cross. Good grief!


..................
Also, related to your previous post, do you really think Mankiw had much influence in any case. I doubt it. Politicians are politicians, y'know, knzn. (Indeed, my friend, I dont know why ye lefties support big gov at all, given the widespread and oh-so-obvious political failures). I think its really sleazy of DeLong to blame Mankiw for the budget mess, which he does habitually.

Sat Jun 03, 09:47:00 PM EDT  
Anonymous Battlepanda said...

The NAIRU always stuck me as a little bit of a fishy concept too. I can see theoretically how there could be such a point where the rise in wages across the board causes inflation, but how is that point to be determined? From what I can see, economists determine the natural rate by taking a guess, and if their guess is shown to be wrong then they fudge to take the new information into account. No matter how well-informed and packed with analysis, repeated guessing and fudging does not make a great basis for monetary policy.

FWIW, the unemployment rate in Taipei is at a rock-bottom 3.75%. There are "help wanted" signs in approximately every third store or restaurant in my neighborhood. Interest rates are low too (hovering around 2 percent). Funny thing is, the wages haven't leaped like you would expect from the "ivory tower" theory. There are some inflationary pressures, but they mostly stem from more global causes like the rising price of oil. I'm stumped as to why the price of labor have been so sticky. But one thing is clear -- employment levels, wages and inflation are simply not the tightly interlocking cogs that NAIRU theory assumes them to be.

Besides, given the relative stagnancy in wages in America in the recent decades despite impressive growth in the overall economy, should we really be in such a hurry to stack the decks against the workers in fear that his wages might catch up? I'm amused that MVPY sees NAIRU as some kind of a lefty plot because I think its chief promulgators are big-business conservatives who are scared shitless about inflation. Lefty economists tend to be more chill about inflation and would take low unemployment over low inflation anyday.

Tue Jun 06, 12:09:00 PM EDT  
Blogger knzn said...

The NAIRU theory does get attacked from both the right and the left (although I use the terms loosely, because opinions about macroeconomic theory don’t correlate perfectly with political opinions). When the “Natural Rate” theory (the acronym came later) first came out, it was certainly considered a “right-wing” challenge to the orthodoxy of the time. (The main proponent was Milton Friedman, who is, of course, usually considered a rightist, although Ludwig Von Mises reportedly once called him a socialist.)

But the NAIRU theory subsequently became the orthodoxy; proponents of the old orthodoxy capitulated or went into hiding; and most subsequent challenges to the NAIRU theory have been from the right. The most prominent serious academic challenge was from the real business cycle theorists, though they seem to have dropped by the wayside. The supply-siders (who are seldom taken seriously as a “school of thought” in academia, although some of their arguments are considered respectable) have also always been skeptical of the NAIRU theory.

The theory hangs on today mostly because nobody has a better alternative (kind of like what Winston Churchill said about democracy). It’s very hard to defend the NAIRU theory, except when somebody comes up with another theory that’s supposed to replace it. Then it usually becomes clear that the other theory is even worse.

Personally I am quite loyal to the Keynesian paradigm in which the NAIRU theory is embedded, but I’d prefer to do Keynesian economics without the NAIRU. There are two issues I often concern myself with in this context: (1) the pre-NAIRU orthodoxy may not have been entirely wrong; and (2) the U in NAIRU may be the biggest problem. That is, there may be a “non-accelerating inflation rate of labor market slack,” but unemployment (or any single statistic) may be the wrong measure. Maybe I’ll do a post about this at some point.

The Taipei situation points to a third issue, namely that there may be severe nonlinearities in response to labor market conditions. There may be some point where things suddenly snap, rather than the smooth response assumed in the traditional Phillips curve view.

Tue Jun 06, 02:33:00 PM EDT  
Anonymous mvpy said...

battlepanda, I think the main NAIRU lovers are leftist academics. More below.
Knzn said:

"The NAIRU theory does get attacked from both the right and the left"

Very true, but I think there more division on the left. Far lefties hate it cos they say it keeps unemployment too high, they say. Moderate lefties love it cos it gives them a feeling that they can "control" the economy as they feel fit.

"although Ludwig Von Mises reportedly once called him a socialist."

Yep, he stormed out of a room at the Mount Perrion meetings. Stigler was there too.

"The theory hangs on today mostly because nobody has a better alternative"

Well, that begs the deeper question, why must there have to be a theory. Surely, its better to have no theory than a wrong one.

"but unemployment (or any single statistic) may be the wrong measure."

In my view, lfp is procyclical (one reason being, "laziness" is stigmatized in a boom, theres definitely some sorta dynamic like that). If this is the case, then the NAIRU is lower in a boom and higher in a recession. Which means tradition stabilization policy is misguided. Furhter, I really like the hysteresis thing a lot, which again invalidates NAIRU theories.

Basically knzn, Nairu people like you say:

Ok theres a nairu, but were not sure where it is. And after a boom or recession we could be at a different nairu.

Now, sit back for a moment, my friend, and consider that. Thats pretty much tantamount to saying nothing, eh.

Tue Jun 06, 03:37:00 PM EDT  
Anonymous mvpy said...

(I get into trouble using the word “guy” to refer to Janet Yellen, though.)

And what about Alice Rivlin knzn.
Oh, now, now, dont be so chauvinist knzn. You pig!

Tue Jun 06, 03:40:00 PM EDT  
Blogger knzn said...

mvpy: ”Surely, it’s better to have no theory than a wrong one.”

I’m not sure it’s possible to have “no theory.” If you want to draw policy conclusions from empirical results, you need to have some theory – expressed or implied – about how those results relate to policy. It is helpful to be able to describe the theory rigorously. In a sense, all theories are wrong (just approximations of reality), but some are wronger than others. (I suppose you could have a completely intuitive approach to policy – Greenspan taken to the logical extreme – but then you’re outside the domain of economics.) The NAIRU theory, even though it’s hard to defend, seems to have been a reasonably successful guide to policy (which I hate to admit, because…

“Nairu people like you”

I feel a bit strange being considered a NAIRU person. In my real life personality, I’m on record having sided with the “far lefties” (yes, those communists like James Tobin) on this issue. Lately I find myself in the position of defending the NAIRU because I’m afraid of throwing out Keynesian economics with the bathwater.

“lfp is procyclical”

This is generally recognized, I think, but it doesn’t, in and of itself, invalidate NAIRU theory. There is no question that the unemployment rate is countercyclical. Labor force participation just moderates this tendency. It’s not very meaningful to say that “the NAIRU is lower in a boom and higher in a recession,” because if we are in a boom or a recession, then we are, by definition, not at the NAIRU. Presumably there is also a NAIRLFP. If the NAIRLFP is constant and the factors affecting the NAIRU are constant, then the NAIRU will be constant too.

Tue Jun 06, 05:12:00 PM EDT  
Blogger knzn said...

Just to clarify something from earlier:

mvpy: “’Jimmy thinks the new chairman’s lack of knowledge of markets will lead to more inflation.’ Well, sorry, knzn, I wouldnt read it like that.”

Out of context, I wouldn’t either, but the article introduces the comment about Bernanke with, “Inflation will continue to flair, and not just because of rising raw-material prices.” The author (Jonathan Laing) is clearly implying that Bernanke’s inexperience is one reason to expect inflation. (Whether Jimmy Rogers actually said so, or whether the author just drew this conclusion, I’m not quite sure.)

Tue Jun 06, 05:23:00 PM EDT  
Anonymous mvpy said...

knzn,

You have misrepresented my claim. You are suggesting now Im some philistine rejecting all those academic theories. Far from it.

I emphasized that its better to have no theory than a wrong one. And yes of course all theories are necessarily wrong in a pedantic sense, some theories are just outright false in every sense. The old Harrod Domar model, for instance, claimed you could always increase the growth rate by increasing the savings rate. Piles of development theories were based on that and billions of foreign aid was predicated on that. However, the Solow model said; well, thats only a little part of the story; what really matters ultimately is technology A.
So, in this sense Harrod Domer was dangerously wrong. While the Solow model is also wrong in a pedantic sense, its, to a first approx, right.
And while we're talking about unemployment, look at the damage the Phillips curve exploitation did. That theory was wrong and immensely damaging.

"Lately I find myself in the position of defending the NAIRU because I’m afraid of throwing out Keynesian economics with the bathwater."

Well, from what I said earlier, I think lefties like yourself seek refuge in this Nairu thing cos it justifies interventionist policies. I find it quite revealing that you openly admit you are now seeking refuge, so to speak, is this last facet of keynesian stabilization policy.

Also, I think Greenspan approach to policy was pretty good. AFter all, knzn, think of the LUCAS critiqe; what with globalization blah blah blah, policy parameters are changing all the time. Im extremely skeptical of any operational model like those they use at the FED etc(with a billion eqns etc).

"Presumably there is also a NAIRLFP. If the NAIRLFP is constant and the factors affecting the NAIRU are constant, then the NAIRU will be constant too."

Yes, yes of course. But my point is the awkward fact that we dont know what these are; in fact, we have little idea. Im not denying the existence of a point where we exceed capacity. My point is that we we ought not make policy on the basis of unknown and changeable parameters.

Also, surely, the relevant labor market is now the world labor market. So, in this sense, the NAIRU becomes even more untenable.

Ok. Enough.

Tue Jun 06, 06:00:00 PM EDT  
Blogger knzn said...

mvpy: “Nairu … justifies interventionist policies”

With fiat money, monetary policy is inherently interventionist. NAIRU just helps the Fed decide between one intervention and another. Are you saying that NAIRU is what justifies fiat money? (I guess you would have stormed out and called Stigler and Friedman socialists, too…)

“the relevant labor market is now the world labor market”

Not unless exchange rates are fixed. (Of course, in the long run, yes, but…)

Regarding the wrongness of theories: Phillips curve exploitation may have done damage, but alternative theories might have done more damage. You can’t have a meaningful conversation about monetary policy unless you have a theory (or theories). Right now, arguably, nobody has a theory that will do less damage than the NAIRU theory. (Hopefully I’ll be able to come up with one over the next few years, though…)

Tue Jun 06, 07:05:00 PM EDT  
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