Thursday, July 5, 2012

The Devaluation Chorus Sings again

The chorus to devalue (and then inflate) the euro as the key to solving Europe's ills is singing again.

Ken Griffin and my colleague Anil Kashyap have a big OpEd on the Euro in the New York Times. They want Germany to leave the Euro, followed by quick euro depreciation relative to the Mark and Dollar.

Martin Feldstein, writing in the Wall Street Journal, echoes this faith in devaluation
The only way to prevent the dissolution of the euro zone might be a sharp decline in the value of the euro relative to the dollar and to other currencies
As you might have guessed, I think it's a terrible idea.

The biggest reason is the vanity that you can do it just once. "Devalue and inflate the currency" is hardly a new idea. Portugal, Italy, Spain, and Greece lived on a cycle of continual devaluation and inflation until they joined the Euro.  Going on the Euro was a hard won transformation to precommit to get off this cycle.

Imagine that  your brother in law had been drinking too much for 40 years, perpetually on and off the sauce, never really able to give it up. He went  through a painful 12 step program and rehab, and finally quits the sauce for 10 years. He threw away all the liquor in the house. Then he loses his job. Is "one more big night out to soothe the pain, and then I'll really really never do it again"  at all a credible plan?  That's exactly what my normally sensible colleagues are advocating.

Kashyap and Griffin make some sharp predictions.
Reintroducing the mark [and devaluing the Euro] would not solve the debt burdens of southern European countries, but it would give them needed breathing room to restructure their economies, reform labor markets, collect more taxes and reassure investors
When in human affairs has "breathing room" ever led to expeditious "reform," especially when such reform meant stepping on the toes of very powerful interests?

Witness: The Germans gave Greece three years of "breathing room" already, repeatedly bailing out and rolling over its debts. And look at the great progress Greece has made on "structural reform." Not. Italy just backed off its effort to repeal its stultifying labor law. Heck, look at the "breathing room" of the forty previous years of perpetual devaluation when all the "structural rigidities" were enacted.

With the "breathing room" of currency depreciation and inflation, won't the unions and other powers arrayed against reform just reassert themselves?

A crisis is indeed a terrible thing to waste. Nobody ever reforms in good times. Heck, look at how well the US is doing -- we have the same entitlement disaster heading our way, we just have a few more years of "breathing room." And we're  really putting the pedal to the metal on tax and entitlement reform, aren't we?  We advocate "structural reform" in Greece, yet where is the deregulation effort here?

Kashyap and Griffin make some more interesting cause-and-effect predictions
 a weaker euro would give a boost in competitiveness to all members of the monetary union, including France and the Netherlands,
A weaker euro would also encourage greater foreign investment. For example, Spain’s distressed real estate market would become far more attractive.
Let's see if they come true. The first: Is there any exchange rate at which France ships Citroens to Stuttgart? Are Europe's "compeititiveness" problems really all about some mysterious exchange rate misalignment and not pervasive sand in the gears? Would Detroit roar back if it could only introduce a Detroit dollar and finagle its monetary policy?

The second: When Germany goes its own way, and Spain has embarked on a let's-all-inflate-our-way-out-of-this-mess along with its neighbors, will this really be the signal of great times to invest?

My prediction -- investment runs to Germany anyway. Even faster, Why? Ken and Anil recognize
Although repeated currency devaluations are not the path to prosperity,
Right. Just this once. But how do you sin just once? How do you devalue once, then convince the rest of the world that the rump euro is now a hard-money area, determined for structural reform, and not back to its  pre-euro history of  repeated and continual devaluations?

Investmet and growth are about expectations, institutions, rules, commitments, not one-time devaluations with empty promises not to do it again. That's what the euro was about. You can't throw out the euro and have anyone believe a devaluation is just this once, and not back to the perpetual stagnation of the 70s and 80s.

Kashyap and Griffin go on twice to argue that devaluation will lead to greater "dignity" for Southern workers. We know a little about how printing money devaules a currency and inflates. We know a tiny bit about whether that effort can give a one time boost to exports, and sets up poor expectations about another bender. This is the first time I've heard serious economists adduce that we know a cause and effect relationship from monetary policy to "dignity," and that depreciating the currency promotes more of the latter.

Doesn't devaluation automatically mean inflation, at least eventually? Kashyap and Griffin are silent. Feldstein goes on to 
Although a decline of the euro would mean higher import prices in euro-zone countries, it need not mean higher inflation or even a higher overall price level. The ECB could in principle continue to aim at a 2% inflation rate with lower prices of domestic goods and services offsetting the higher prices of imports from outside the euro zone. At worst, the ECB could allow a one-time pass-through of the higher import costs but prevent any further increases in inflation rates.
I thought the one thing we all agreed on is that money is neutral in the long run.  Certainly the repeated devaluations of the 70s and 80s were almost perfectly matched with extra inflation. Why would this time be different? We might as well hope that the Physicists at CERN will repeal conservation of energy with the new Higgs Boson.

OK, one point of agreement: 
What is essential is the preservation of the European Union’s greatest accomplishment: the free movement of labor, goods and services.
Yes. Keep the euro, and all its comitments against devaluation and inflation. [Update to clarify in response to comments: the most important commitments are that the South, as part of the euro, does not resort once again to devaluation and then inflation relative to the North. The second most important commitement is that the ECB was once set up as a central bank with a pure inflation target. This is a precommitment against deliberate devaluation and inflation relative to the rest of the world.]   Recognize that a currency union, without fiscal union, works only if you countenance sovereign default and default of banks who invest in sovereign debt.

In the end, the devaulation idea is this: In the warmth of summer, the crickets of Europe voted in laws that you can't fire people, can't lower wages, and they will only work 35 hours, with long paid vacations. Now those structures are no longer tenable. In winter, der ants don't want to buy stuff that crickets are producing with those huge labor costs. What to do? Let's devalue the hour! Pass a law that the hour is 75 minutes.

Really. The euro is the unit of value, as the hour is the unit of time and the meter is the unit of value. You could engineer a one-time boost by fiddling with the hour, the meter, the kilo and the euro. Until people catch on and rewrite contracts. And then they are aware you will do it again, since you throw out all the precommitments not to devaule built in to the current system of units.

Anyone for a drink?


  1. I can think of only one good reason for devaluation, and that is when the issuer of the money has become insolvent, and is unable to buy back all its money at par. For example, a bank has issued 100 drachmas, which are supposed to be worth $1 each, but the bank's assets are only worth $99. In that case, the bank can either devalue to 1 drachma=$0.99, or else face a bank run. But the reason given by Kashyap et. al. is that a cheaper currency makes a country more competitive. That's just a simple economics fallacy that was refuted centuries ago.

  2. That is a acatou thought that you have been an economist for oh so many years and still does not know that movements in nominal exchange rates in general cause movements in real exchange rates, I.e. devaluations DO NOT cause inflation of the same magnitude.

    That is why devaluations are usually the harbinger of recovery, any undergraduate student of macroeconomics should know that.

    Moreover, it is scary that you argue that southern Europe was stagnant when it had its own currency. Don't you have no shame of blabbering about what you do not know? If anything, southern Europe in the years before the introduction of the euro was one of the greatest success stories of the second half of the twentieth century.

    For comments like this, you have become the butt of jokes among us economists. And by the way, it is obvious that if Detroit could devalue the dollar, it would roar again.

    1. Come on, read it before going nuts. I said that devaluations can cause a temporary boost in output and exports. That's not the issue. Like a drink causes a temporary stimulus too. The question is whether throwing out all the precommitments implied by the euro not to devalue are worth this one high

    2. There's a wonderful HBS case about Detroit in the 80s. When the yen appreciated sharply, Detroit responded not by expanding output and market share but by raising prices.

    3. Undergraduates are usually taught economics by SOSH profs. SOSH profs have no understanding of economics

    4. Dave, so what that Detroit raised prices instead of expanding output?

      With higher auto prices, the Detroit companies either paid higher salaries, bonus and dividends; or improved their net worth.

      Either way, the Detroit economy benefited and almost certainly must have expanded as Detroit workers, managers and shareholders increased their consumption of Detroit produced goods (e.g. schools, housing, haircuts) on account of the income/wealth shock.

    5. "The question is whether throwing out all the precommitments implied by the euro not to devalue are worth this one high"

      Which commitments? You seem to be confused here. Feldstein and others have argued that the euro should depreciate. There is no commitment of any kind that the euro should not depreciate.

      Moreover, your metaphor of drink and temporary stimulus is just that, only a folksy metaphor, not an argument.

    6. "Either way, the Detroit economy benefited and almost certainly must have expanded ..."

      ... which ultimately led to Detroit's tremendous degree of long-term prosperity that we see today.

      This is completely consistent with John's argument and Dave's story. Instead of Detroit using the "breathing room" gained by the strong yen to do everything possible to secure long-term prospects, they just collected the short-term rents.

    7. Mr. Anonimo. Are you from Detroit? You must be, since it seems you gained so much from that improved education system from GM's excellent performance in the '80s!

      First, before you talk about ECB commitments, you should probably read a little. At all. I mean, anywhere. Literally. I'll help you out. In "The European Central Bank - History, Role, and Functions" published by (surprise!) the ECB and available (surprise!) on their website, you don't even need to read any of the text! Just look at the Index. Section 2.2 "Objectives", and... 2.2.1 "The primary objective of price stability". If you want to be pedantic, go ahead and actually read the section and you'll see that the ECB has, in fact, made an explicit commitment to price stability, "In line with Article 105(1) of the Treaty, the primary objective of the ESCB is to maintain price stability" (First sentence of section 2.2.1! Still not much reading necessary).

      Anyway, the rest of your argument is about as ludicrous, but anybody reading this blog knows that. Just thought you could use a little humility and a reminder that research is usually helpful, unless you want to be a philosopher.

    8. Mr. Phipps, a commitment to price stability DOES NOT entail a commitment not to depreciate its currency. That is basic open economy macro.

    9. Phipps
      I want to point out that you Mormons believe opium and cocain and tea should be illegal.

    10. Phipps
      And also
      China rejected J Huntsman. You Zionists can keep your missionaries and triad secret societies out. We know what you are up to. And we remember what mariner eckles and FDR and chang Kai check did with your silver purchase. You Mormons, we know what you are. TRIAD

    11. John, seriously, how can you write what you write, and the way you write it, and not expect some serious push back?

      Any empirically literate international macroeconomist understands "O" Anonimo's righteous anger.

  3. For the record Southern Europe did have a period of convergence, but I think it stopped in the 80's.

    I think the last post is too optimistic about the length of the boost from nominal devaluation and its importance.

    A priori I have never been sure why even with nominal price or wage rigidity devaluation wouldn't do more harm than good by raising the cost of hard to substitute foreign intermediate production inputs.
    Also, there's this business of euro denominated debt contracts and to what degree they could be converted to drachmas or pesetas to avoid private defaults in case of devaluation.

    That being said, there has been some formal work finding large positive effects on gdp from large nominal devaluations. I would be interested in professor Cochrane's comments on the following papers:
    These papers seem to make a pretty convincing case for nominal devaluations in sudden stops (a version of which has been happening in Southern Europe), though the arguments are more subtle than 1st year undergrad principles of macro and I haven't yet seen a quantitative analysis trading this off against costs of higher intermediate imports and debt deflation effects through foreign currency debt contract. And needless to say, you wouldn't buy these arguments if you're not a big believer in the real effects of nominal rigidities.

    1. Europe and the rest of our financial mess are not some phenominon. This whole thing is a conspiracy. Conspiracy ie. corruption ie disease is what economics is to identify. Why do you refuse to use the word conspiracy. This is not some a phenominon. You say it is a phenominon so that you can continue selling escape plans. Escape plans is your business. In order to sell them you need prisoners. You are a sharlotin.

  4. "you wouldn't buy these arguments if you're not a big believer in the real effects of nominal rigidities."

    One wouldn't buy these arguments if one is a card-carrying ideology-before-facts lazy-ass small-town economist who probably does not even know where to download a series of GDP growth for Italy.

    1. ROFL!!! OH Mr. ANONIMO!! oh such witty arguments! I mean, oh, just... you're killing me with your ... ... wait for it ... ... oh wait, hahahaha your arguments have no ... arguments!!! Dude, seriously, you need to learn that ad hominem attacks make you look like a high school liberal arguing for the legalization of Marijuana. Nobody takes you seriously buddy, I'm sorry. BUT, you do provide entertainment. This post is fun just to find your comments. So please, do continue.

    2. This violates the "keep it polite rule." I do have the ability to delete comments, and I'll use it.

    3. John, not sure if you refer to me or Mr. Phipps, but my point was that what you called "perpetual stagnation of the 70s and 80s" is a figment of your imagination and does not stand the test of spending 2 minutes of your life downloading the Italian or Spanish GDP series.

    4. Phipps
      Are you saying phylosophy requires no research???
      It is pretty clear that many in the modern economics field are trying to RE-invent the wheel. If they would just go to the University of Chicago Library. They would quickly find that they have wasted their lives tumbling in their own minds. The only reason they are tolerated among their peers is because their peers are also tumbling in their own minds. Communication is not part of the modern education. Take the Austrians for example. The only one who accepted Darwin as an economist originating marginal utility, and competitive advantage/Nash was Hayek. Everyone thought he was a quack. Time has told (2000years) and it has proven again that modern economics trying to pretend that the past never happened is only to their damnation. A person without phylosophy is the only one who doesn't appreciate phylosophy. It is after all the one thing that separates man from animals. Your rejection of it does not do you well.
      Go to the library.
      Learn some phylosophy
      M. Friedman "I have diliberatly avoided the real issues to flatter myself among my peers" last page of consumption function. Without phylosophy you will never know what the REAL issues are or how to apply your "research" to those issues. We have a lot of problems in our society and it is all because our Ph,D's have no idea what phylosophy is.
      You Monkey
      Become a real man
      Learn from whence you come.

    5. Phipps
      "I have deliberately avoided the real issues to flatter myself among my peers WITH PURE RESEARCH. " M. Friedman second to last page of 2nd edition of Consumption function.
      Pure research. Mathematical gymnastics.

  5. I don't get the argument of economists claiming that no exchange rate realignment would be able to balance trade. Since when have we lost our belief that prices affect supply and demand? Do we really believe the supply and demand elasticities are 0?

    Picking the car sector as a sector with low elasticities makes it not a valid argument for the whole economy.

  6. First, you're exactly right that we need policies focused on long-term performance. Compare Mexico in 1995. They had no choice but to balance the budget etc even in the midst of a crisis. They bounced back a year later. Greece: not so much.

    Second, all of us should show more humility about exchange rates. The facts show they respond much more -- in crises and otherwise -- than any theory of fundamentals would suggest. If we're honest, I think we need to avoid making statements about them with any degree of confidence. Would it help to devalue? Hurt? My answer: we don't know.


    Link to Mexico story, but of course you can look up the numbers yourself:

    1. Dave, I do not understand the point of the Mexico-Greece comparison as regards this post. Mexico had the benefit of being able to devalue its currency, and the Mexican peso had a large real depreciation; Greece was not allowed this escape route, and that is why it cannot even gather the consensus for needed structural reforms. There is no exit for Greece without a large real depreciation, and that is as safe a bet one can have in open-economy macro.

    2. I understood John to be saying you're better off focusing on long-run performance, that the exchange rate is a distraction from that. So my first comment is about long-term performance, not the exchange rate. Greece has yet to do much about many of its long-term problems, but on fiscal policy specifically, it is still running large deficits, financed in one way or another, by the rest of the EU. Why the difference? Because (as John says) the EU is giving Greece "breathing room." Mexico had little of that, maybe to its benefit.

      But you're right, Mexico also had a large devaluation. Was that the key difference? Or fiscal policy? Or NAFTA and proximity to the US? Probably all played a role.

    3. I'd say that structural reform and real depreciation are complements. It is probably near impossible to rely solely on structural reform because wages are downwardly rigid for several reasons (in some countries, constitutional clauses!), and the pain of adjustment without the support of a real depreciation may be unbearable.

      I'd also say that there are many examples where structural reform was AIDED by real depreciation. Take Brazil in the late nineties, Sweden post-banking crisis, most East Asian EMs in the late nineties etc. On the other hand, examples of countries undertaking successful structural reform under a hard peg are Hong Kong and...

    4. Devaluation is merely another way of getting around sticky wages. What you are advocating is a continued policy of living beyond your means, then destroying a portion of your people's wages and savings by devaluing their currency and making everything more expensive.

      You might be correct in saying it is the only way "politically" out of this crises (it is most certainly not the only possible way out). But Dr. Chochrane is right is saying it will make no long term difference until there is a political will fro real structural reform.

  7. Seems to me you have the right question but wrong answer.

    Let's stay with Greece. You admit that Greece must devalue, for the intended effect of the policies you advocate will be a devaluing of whatever currency the country uses.

    So the question really is, In addition to devaluing, must Greece do anything else?

    The answer is yes. As explained by Martin Jacomb in a long series of essays in the Financial Times, your stories about sand in the cogs, etc. etc. is a false one.

    Greece is where it is because of location economics. People and firms are moving economic activity to Germany, due to the efficiency of being closer to the action, the predicted response to the advantages of the Euro.

    We are seeing this same movement from the US to China. First go the mfg. jobs, then the design, and engineering, etc. China, meanwhile, is not starting to buy and relocate entire firms.

    This force is so powerful that Greece could do everything you advocate and it wouldn't make any difference.

    The only counterbalance to location economics is what we do in the United States. We tax our wealthy states and via federal government transfer payments ship money to unproductive states like KY, TN, Miss, Ala, SC, etc. CA, ILL, NY, and MN provide the money that keep the later from being Greece.

    The difference is that German taxpayers are not about to ship transfer payments to Greece, as wisely pointed out by Soros.

    My two cents. I don't see a solution. I don't believe Greece would ever have a chance, once one has free movement. All the Euro did was make a bad situation worse.

    1. I disagree entirely. Your location theses seems to be operating in a vacuum. Why exactly did people want to relocate to Germany? Because Germany was "closer" to something? Or because Greece was a basket case socialist nation with a poor business ethic and sometimes an open hostility to commerce?

      Likewise in the United States, the presence of redistributive payments has not helped California from bleeding most of it's entrepreneurs, thousands of other businesses, and billions in capital.

      Why did they leave what many people consider a natural paradise? Because California is more like Greece than it is like Germany. Meanwhile places which were backward banana republics for decades, such as Louisiana, are experiencing a boom in job creation. The key in all of this is attitudes. Policies which are pro-commerce, and pro-growth will always get positive results and attitudes which are pro-socialist, and anti-business will always result in a negative to growth.

    2. KyleN

      you are are world class idiot, I mean world class.

      California does not get money from Uncle Sam. Only about 40 cents of every tax dollar sent to Washington DC is return to CA.

      CA's dollars prop up red states like KY, TN, Miss, Ala, SC

      CA is our Germany.

      And, BTW, Germany spends more of its GDP on gov't than Greece

      In sum, two words for you invincible ignorance

  8. If someone doesn't want to be PRODUCTIVE is it your job to make them productive. Do you think they are your capital and you need to manage them. This is a serious mental disease. If someone doesn't want to work that is their choice. This is just like the doctors saying they need to have control of all the drugs so the people can't escape through suicide. What if the person wants to die. Does the doctor who has ABSOLUTELY NO moral training have the right to force that person to live. Any person with an education in the classics (Cato the younger) would understand immediately that the doctor is the one with the mental disease. He sees people as his capital to be managed. Now pull your head out of your capital management ass. Stupid people are people too. You have no right to force them to live under your management. Your management is the problem. You are the reason people want to kill themselves.
    Long live the memory of Cato the younger. Down with you capital managers. You sick bastards.

  9. The U.S stock market didn't respond positively to news of inflation in the 1970s. It does respond positively to it now. The same is true of the Eurozone now. As Glasner & Sumner point out, that should tell you something. The "Reagan recovery" under Volcker had significantly higher inflation rates than now. It wasn't an alcoholic falling off the wagon after Volcker tightened to break the back of inflation, it was the beginning of the "Great Moderation".
    And where is the evidence that policy improves when there is less "breathing room"? The Great Depression led to centralization & cartelization in numerous places. Bryan Caplan argues in "The Idea Trap" that it is actually good economic times that give rise to better economic policies. People whose incomes increase are more likely to "think like an economist", during bad times people embrace protectionism & make-work.

    Greece was screwed up before it went on the Euro, it pretended not to be so it could join, and it has continued to be screwed up on the Euro. It will also be screwed up when its off. But the Euro itself was an economically infeasible idea, the Eurozone is astonishingly far from an optimum currency area. Years ago policy needed to be stimulative for the German-dominated "core", and was inflationary for the periphery. Nowadays it is the opposite. Greece will likely not do a good job of managing policy after the Grexit, but at least it will have one less problem of being shackled to a monetary policy only appropriate for different countries.

  10. @ anonimo just took 2 minutes out of my life and yep definitely stagnation in Europe from 1980-1985, most of the 70s don't look that bad compared to the 60s say, but in comparison to the late 80s 90s and even today....stagnation almost seems a kind word

    1. The statement by Professor Cochrane was: “You can't throw out the euro and have anyone believe a devaluation is just this once, and not back to the perpetual stagnation of the 70s and 80s.”

      That is obviously a silly statement.

      Back to the data, the euro was introduced as a unit of account in January 1999, with the banknotes entering in circulation three years later.

      In the dreadful years of “perpetual stagnation of the 70s and 80s”, Italy – the quintessential Southern European country – had an annual growth rate of 2.7%; while in the ten years leading to but not including the financial crisis (1998-2007), its growth was 1.3%. For Portugal, the drop was from 4.0% per year to 1.6%. For Spain, there was a slight improvement from 3.1% to 3.4%. Finally for Greece, a big improvement, which we all know was unsustainable, from 2.6% to 3.7%. No need to explain to anybody that adding the last 5 years will make the comparison more in favor of the 70s and 80s.

      It is clear from the data that (1) adopting the euro in general did not bring higher growth rates to Southern European countries; (2) even before the crisis – up to 2007 – the only Southern European country with faster growth inside the euro than in the 70s-80s was Greece; (3) nowadays no Southern European country even dreams to achieve through structural reform growth rates as high as the ones they had in the years of “perpetual stagnation” for Professor Cochrane.

      Of course, anyone with passing knowledge of international macroeconomics and a little bit of curiosity knows all that I am saying.

    2. hmmm yes, I just redid my numbers on rgdp from FRED instead of gdp numbers from whatever google's numbers are and I am seeing results similar to yours, thanks

  11. Yes! Sarcasm helps you to keep your balance in the midst of so much confusion. And it makes for good posts. ('Breathing space'! God knows we need it!)

  12. Milton Friedman must be turning in his grave at the current state of Chicago macro. What Europe needs is higher NGDP growth.

  13. Europe is very likely to get it, certainly the N part. Whether the GDP part follows, and inflation fuels a return to european prosperity will be interesting to see. Stagflation is also a historical possibility.

    1. Well seeing as they're suffering from sky high unemployment and a large output gap I'm sure a nice healthy chunk of that will be in the form of R.

  14. "Europe is very likely to get it, certainly the N part. Whether the GDP part follows, and inflation fuels a return to european prosperity will be interesting to see."

    That is a non-starter. Inflation is not a fuel for growth, but a mechanism to achieve realignment of relative prices. Perhaps because you come from finance, a field where prices are jump variables, you do not acknowledge the possibility of real rigidities, which are the bread and butter of macroeconomists.

    In theory, inflation is not necessary to realign relative prices. All that is necessary is that wages in Greece fall relative to wages in Germany, and a nominal wage cut would do it in a lab environment.

    But in practice, it is nearly impossible to achieve the adjustment in relative prices without some moderate inflation in the euro area, and even if possible, the risk of political radicalization is very high.

  15. By hook or by crook. Bothe of which are things humans use to catch animals. Now that there are no more animals on the earth, you have turned on your own kind with your crooked hooks.
    Darwin must be turning in his grave. The only living thing left on the earth and Accadementia is strong as ever.
    Suicide/ Nash/ No farmer will kill his own breeding stock. Darwin.
    Nature is always right. Man is always wrong.

  16. The free trade of goods is a function of the The Single Market Act, not the institution of a single currency, which has its roots in the Maastricht Treaty. By eliminating the currency but keeping the institution that currently issues it (the EU) would we not be able to keep the best thing that Europe has done for its constituent countries while disposing of the most harmful aspect it has brought to the union? Or would the friction of different currencies be too strong in your opinion?

  17. The only reason anyone would want the government to debase the money is to force the people to be dependent on the government, so the government can force the people to fund their Pure Research, because no conscious person will invest in someone else's interests , unless it is in his own interest to do so. So government destruction of people's interests is in your interest. Interest requires consciousness of your environment, and this is why there are no wild animals on the earth any more. The earth is dying and it is because you aren't interested. You aren't interested because you are not conscious of the world you live in. That is because you are completely dependent on a corrupt government for your income. Because nobody gives a damn about your interests. Why else does the lay man call economics the dreary science. Dreary=lifeless. Lifeless is what this world is quick becoming.

  18. This is somewhat off topic, but what do you think about level targeting by central banks? Either price level, or nominal income level targeting which Scoot Sumner of the money illusion supports. It is beyond me why worshippers of the price stability fetish, like you and John Taylor (and by that I mean stability in rates, which DOESN"T take into account past shocks) dont support LEVEL targeting.

    P.S. By the way, on devaluation what would you have a country that suffers from an A.D. shortage do? Wage Cuts? We have enormous empirical evidence, such as the study by Akerlof, DIckens, and Perry, of profound money illusion at zero rates of inflation. Price rate Stability isn't sufficient!!

    Grumpy Eddie

    1. Personally, I think NGDP targeting is the way to go. BTW I love that , Scoot Sumner !

    2. I like a price level target. I view money as a set of units for value, and I don't think the government artfully devaluing the meter and kilo to give shopkeepers a boost is a good idea, any more than fooling with inflation to do so, even if it does "work," at least once. I'm less of a fan of NGDP targets, and the link from interest rates to price level is pretty tenuous...More coming, a comment isn't the place for an entire monetary-fiscal program.

    3. Your position on price-level targeting is interesting to me ... it seems to contradict the gist of your post.

      If you favor a price-level target, then you must believe that below-trend European inflation over the last few years has led to a significant gap between current prices and this hypothetical price-level target. Trying to hit the target would mean further ECB monetary easing, which would weaken the euro relative to the rest of the world. But your post is full of ideas like this:

      "The second most important commitement is that the ECB was once set up as a central bank with a pure inflation target. This is a precommitment against deliberate devaluation and inflation relative to the rest of the world"

      I feel like many of your posts are entertaining, in the sense that it can be fun to read a grumpy economist ranting, but sometimes they lack consistency and intellectual rigor.

  19. "I like a price level target." Well thats good at least :-) "I view money as a set of units for value, and I don't think the government artfully devaluing the meter and kilo to give shopkeepers a boost is a good idea, any more than fooling with inflation to do so, even if it does "work," at least once"
    So, again, what would you do to deal withan A.D. shortage, given that wage cuts are unbelievably difficult to achieve?
    "I'm less of a fan of NGDP targets, and the link from interest rates to price level is pretty tenuous" Why? whats wrong with NGDP? Its provides a clearer measure of demand than the price level, It also allows the CB for more flexibility to acommodate positive and negative supply shocks. And INTEREST RATES ARE MEANINGLESS as a gauge of monetary policy. Dont you read scott sumner and Milton Friedman? "Low nominal interest rates are more often than not a sign that money has been too tight!" That was Milton FriedmaN who said that by the way. and Bernanke in 2003 said the ight gauge for monteray policy is inflation and.. you guessed it NGDP.
    "More coming, a comment isn't the place for an entire monetary-fiscal program"

    I look forward to it!
    Not so grumpy Edward

    1. If you actually achieve a price level target, which means no deflation either, then it's not clear that "AD shortages" which are, by budget constraint, money demand increases, are a problem. Money supply must expand to exactly meet money demand if you're nailing the price level. Friedman and Schwartz said that inadequate monetary expansion led to deflation...that's not a successful price level target.
      More later...

  20. Oh and Prof Cochrane, I also wanted to point out, contrary to your assertion that no country has ever reformed unless its back is against the wall- contrary to that, we have Iceland, Iceland which devalued and did monetary stimulus with almost no fiscal stimulus, and that was enough. Also, want to point out that hard money is an incredibly dangerous game to pursue to get countries like greece to pursue structural reform. One of the reasons that we had had the New Deal and all its horrors including the NIRA was the fact that the Fed didn't do its job 1929-1933. Even more seriously, tight money encourages and brings out despots, look at hungary now, and it was the policies of Chancellor Bruning, the hard money policies,of the early 1930's not the Weimar hyperinflation that brought Hitler to power in 1933

    Concerned Edward

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  22. I'll use Spain as my representative not-Germany country. Suppose Spain has an output gap that 'should' produce deflation. However, due to downward nominal rigidities, this deflation is not occurring and instead there is just no movement in prices and wages. Thus, if Germany leaves the euro, then Spain can have a real depreciation: as soon as prices would come up due to the nominal depreciation as you suggest, the deflationary pressures are able to kick in and keep them down. There can be as much nominal depreciation without creating inflation as there would be deflation without downward nominal rigidities.

    It seems as though you are suggesting that no country can ever have a real depreciation; you claim that all nominal depreciations will be followed by inflation to keep the real exchange rate constant in the medium or long run. Can you explain why the above example is not accurate?

  23. "If you actually achieve a price level target, which means no deflation either, then it's not clear that "AD shortages" which are, by budget constraint, money demand increases, are a problem. Money supply must expand to exactly meet money demand if you're nailing the price level."

    :-) Youve no idea how glad i am in dealing with a monetarist by some measure, and not a die hard New Classical. Price level targets are good things, dont get me wrong, and much better than simple growth rate targeting of 2% without reference to the past... BUT I guess the question with PL targeting is why make life more difficult for yourself. Price level targeting gives false signals in the face of positive and negative supply shocks. For example, say theres another oil disaster that sends the price of crude soaring. The Fed is currently targeting Core CPI at a level of 2%. the oil shock sends Core CPI to 4% and headline inflation spikes at 6.5%. The Fed is scared out of its wits, because the oil shock filtered down to the imperfect measure of Core CPI so they tighten, even though money has been no looser than before, sending the economy into an unnecessary recession.

    On the other hand, a POSITIVE supply shock will actually lower inflation down past zero. Say some brilliant MIT grad builds a viable commerical superbattery and figures out a way to mass produce nuclear fusion at a cheap price for commercial use. An enormous shock like that could send RGDP into the stratosphere. The real economy can actaually grow faster than the supply of money in circulation, the very definition of "good deflation" My question is, why worry? The money supply isn't contracting so wages arent either. But if the Fed is targeting the price level, it will panic for absolutely no reason whatsoever eacting to a price level decrease irrationally (since New Keynesians and central bankers are constitutionally incapable of even admitting the possibility of "good deflation". An NGDP level target on the other hand solves all these problems. If the inflation reaches 6 % from a Neg. supply shock, the Fed will realize it hasnt increased NGDP/MV/PY past 5% and it won't do anything to make things worse. On the brighter other hand however if a supply shock pushses RGDP up to 10% with a 5% NGDp level target, The Fed wont hyperventilate hysterically for no reason at all, and pass the benfits of lower prices to Americans.

    Joshua Weiss, good question, I'll look forward to hearing about that too

    Relaxed Edward :-)

  24. Bernanke.
    "my purpose in being here is to make prices rise"

  25. Mathematical fact
    Compound interest on 800T is not the same as on 50K when the food supply for compounding is the same for bothe. It is the 50k owner who must supply the NEW FAKE MONEY to feed the INTERESTS of the 800T owners before satisfying his own needs. Professors refusal to acknowledge this structural FACTor is CONSPIRACY.

  26. Bloodthirsty Conspiracy

  27. Great text! Devaluation only hides the need for structural reforms of the labour markets and in countries like Greece it wouldn't even raise confidence at all.

    Two great examples of refusing to devalue and sticking to reforms are the Baltic countries (which seem to be very popular nowadays in the blogosphere) - Latvia and Estonia.

    What proponents of devaluation fail to realize is that in countries like Latvia or Estonia, people have a vast majority of loans denominated in euros so a depreciation would increase their loan repayments. At the same time unions could ask for nominal wages to adjust to the depreciation, thus offsetting the whole competitiveness effect. Besides, in countries like Greece where it takes 10 months to open an online store, devaluing the currency is really missing the point.

    A currency depreciation is no easy way to get out of the crisis. It didn't help Germany in 2003 and it didn't cause the Swedish 1992 restructuring. A pledge to reform did. And that's all Europe has to do - it's hard but necessary.

  28. Vuk Vukovic,

    What about Iceland? Iceland devalued without nearly as much agonizing pain as Latvia and Estonia.


    1. I'm glad you raised that point, as Iceland was a good example of letting the risk-takers go under without imposing a cost on the society as a whole (see here).
      Devaluation made the deleveraging easier, but was by no means the main cause of the bounce back. And mind you, Iceland was deep in "agonizing pain" back in 2009.

      Some take Iceland as a good case study example to Greece to devalue and impose capital controls, but what worked there won't work in a country like Greece, primarily because of a very different institutional environment and signals sent to investors on each sides (which are much better in Iceland, despite the capital controls). First of all, people in Iceland pay their taxes and the state performs its revenue collecting function there pretty efficiently, unlike Greece. Second, the rule of law is strong, implying that political stability will be strong as well. The best proof are the trials against the former PM which emphasize the point on better signals to investors. Finally, Iceland doesn't suffer from a constraining labour market, nor does it suffer from regulations and bureaucracy that stifle market opportunities. One can claim that devaluation in these circumstances can help smooth the reforms, but it isn't the crucial assumption of a recovery.

  29. I would like to hear what comparisons people can make between (Greece / Europe ) and ( Goldman Sachs / Zenga dud and renaming it with a new IPOO Facebook) I'm seeing some similarities. I'm thinking this P&D is the appropriate model. Classic Pump&Dump

  30. Those articles are shocking to me. The lightness with which devaluations are suggested is staggering. Especially coming well-respected economists. There is NO devaluation made by decree -as the kind they appear to suggest- that comes without a traumatic shock. Their "ideal" devaluation utopically needs to be done in secret and announced by surprise, and that means no leakage of information. This is IMPOSSIBLE in practice. The instant the plan to devalue/re denominate is shared with the supposedly "inner circle", greed forcibly precipitates traumatic currency runs. And even if they were talking about the "soft" devaluation kind -the inflationary kind-, their suggestion is outright irresponsible. The biggest asset any central bank that issues a fiat currency is reputation. And this is only gained after DECADES of prudent, autonomous monetary policy execution. Once reputation is shattered by an event like this, it takes GENERATIONS to build the institutional credence needed to underpin a hard currency like the Euro -which "inherited" the Mark's and the Bundesbank's reputational credence.

    1. The Central Bank "broken reputational trap" is something apparently those economists are simply ignoring. They shouldn't.
      If you don't believe me, ask Brazil:


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