Saturday, September 22, 2007

Keynes (quoted by DeLong) on Liquidationism

Brad DeLong digs up a nice quote from Keynes, which makes a point similar to what I was trying to argue here, here, and here. I can't claim that the recent US housing boom was either quite as benign or quite as productive as the investment boom of the late 1920s, but the same general principle applies. The behavior of investors in the late 1920s appeared quite reckless in immediate retrospect, but they obviously did more good than harm (or at least, the great harm that resulted indirectly was only because of subsequent bad policies). And we do now, of course, have to be concerned about the risk of inflation, which was not (or shouldn't have been) an issue in the early 1930s. But the idea that speculators have to be severely and broadly punished by the monetary authority for taking excessive risks -- that idea, I contend along with Keynes, is foolish. It is very hard to distinguish which speculative actions were ex ante prudent and/or valuable and which were excessive. It is (as the Fed now clearly realizes) not the job of the central bank to make such judgments after the fact (or, except in its regulatory role, before the fact). The mandate is for high employment and reasonable price stability, and it is not desirable that the mandate should be broadened to include assuring the right incentives for speculators.

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11 Comments:

Blogger Gabriel M. said...

Hold it right there! Compare and contrast...

1) The Fed should not bail out speculators.

vs.

2) The Fed should punish speculators.

Some of the people you critique are simply saying that speculators should be left to their fate because bailing them out comes at a cost to everyone else.

Should the Fed impose further inflation on me, a lowly wage earner, so that it can bail out the gambles of my millionaire neighbor?

Sat Sep 22, 02:18:00 PM EDT  
Blogger knzn said...

I'm saying the Fed's only concern with speculators (aside from its regulatory function) should be how their condition affects its ultimate objectives. But I would suggest that optimizing with respect to the Fed's "high employment and price stability" objectives often involves actions that many people would regard (and perhaps rightly so) as bailing out of speculators -- because the existence of levered speculators creates the possibility of a debt deflation, which has obvious implications for employment and price stability. I would say, if the Fed alters its optimum to avoid bailing out speculators, then it is effectively punishing speculators.

I do agree, of course, that the Fed shouldn't alter its optimum to help speculators. I think pretty much everyone (except for speculators who feel the need of a bailout) would agree. But much of the talk about "moral hazard" and the like seems to suggest that the Fed ought to have its effect on speculators in its objective function (particularly since there is no hard evidence that the "Greenspan put" ever existed, and the game becomes one of avoiding the appearance of bailing out speculators).

(As an aside, I don't see how inflation hurts the lowly wage earner. It might reduce real wages in the short run if nominal wages are sticky, but that's more the cost of a job insurance policy for the lowly wage earner, a net benefit if he is risk averse and faces -- as he inevitably does -- an incomplete insurance market, rather than a net harm.)

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