Tuesday, May 16, 2017

Long run money

Continuing in the Il Sole series on Italy and the Euro, Alberto Bagnai writes that the euro is a "big defeat for the economics profession'' here in English, here in Italian.  He takes particular issue with my earlier case for a common currency, here in English, in Italian, and blog post.
"John Cochrane’s idea that money is irrelevant for growth (economists say that money is “neutral”) not only clashes with major scientific results, such as Dani Rodrik’s analysis of the role of excessively strong exchange rates in slowing the growth of a country, but also with what the European institutions are finally admitting through clenched teeth: the reforms are causing deflation and failing to promote employment in any decisive way (footnote 23 in the above-mentioned ECB Economic bulletin).
The best economists had also addressed this point: the negative consequences of structural reforms on the productivity of labour were illustrated by Robert Gordon in 2008. For Cochrane, money is like oil in a motor. The metaphor is (unwittingly) correct. Bad management of oil has long-period consequences like bad management of currency: in the first case the head fuses and the motor stops; in the second a continent, and the world economy stops.
If De Grauwe is incoherent with data and Cochrane with theories,..."
I have long been accused of being theoretically pure but incoherent about the "real world." (As if the real world could ever conform to no theory, rather than a better theory). This is the first time I, or the proposition of long-run monetary neutrality, have been accused of theoretical incoherence.

First let's be clear what we're talking about. My article was clearly about long-run growth. And I wittingly made the oil comparison -- and also said that bad monetary policy, like not enough oil, can drag an economy down.
"For today, let's focus on the long-run question, leaving out for now the transition and any immediate benefits and costs...  
Remember first that monetary policy cannot substantially improve long-run growth. Long-run growth comes from people and productivity, how much each person can produce per hour of work.... Improvements in long-run growth come only from structural reform, not monetary machination. 
Money is like oil in a car. Bad monetary policy, like too little oil, can drag an economy down. But after a point more oil will not help you to go faster — you need a bigger engine."
We shouldn't be arguing about things I didn't say!

But to the substantive point.  How about "the idea that money is irrelevant for growth (economists say that money is “neutral”) not only clashes with major scientific results, such as Dani Rodrik’s analysis of the role of excessively strong exchange rates in slowing the growth of a country"

The clearly stated proposition is that money is irrelevant for long-run growth. Italy's postwar miracolo economico was not the result of a finely calibrated monetary policy under the Lira. The fact that Italians today are so much better off than their ancestors in 1917, 1817, or, heck, 1217, is just not centrally about better monetary policy under the Lira than under gold coins.

Rodrik? Sure. Out of whack anything can cause trouble for a while. A stack of dishes in the kitchen causes a spat. That's not a reason to divorce.

Structural reforms not working? What structural reforms? In my view, they haven't started. Call me when you can hire and fire people, government spending is under 50% of GDP, marginal tax rates are less than half, rent control is gone, it takes less than a decade to get a building permit, or when the World Bank ease of doing business ranking doesn't look like this

Update: Alberto Mingardi graciously came to my defense in the arguments following this post. Yes, I got rent control wrong (it was a big problem the last time I lived in Italy, but this tells you how long ago that was.) Alberto points out that it's still hard to evict people, as it is in the US. And he goes over a number of detailed sands in the Italian gears.  


  1. Dear John,

    it was a terrible mistake to take part in this debate with a bunch of clowns. Nobody in Italy, apart from a few mentally retarded, takes seriously these pathetic liars who advocate the end of the euro. Most of them are not economists, but just parasites without any credential. The others are trying to place themselves in the short list of candidates for ministerial posts if Grillo wins the elections. If he does not win, they will look for another master, as they have done throughout their miserable life.

    The newspaper that hosts this debate is bankrupt after its managers have stolen hundreds of millions from the shareholders.So its editor is desperately trying to sell copies to those who vote for a demented comedian or for the fascio-nationalists.

    1. Dear Fabio Scacciavillani,

      the debate around the Euro has been hosted in a very popular economy blog (more than 4000 followers and winner of the last two macchia nera awards).

      In my personal experience reading the books of Prof. Bagnai and Prof. Cesaratto has requested pretty much concentration and time, but since they are both educational works I guess a mental retarded would just need a bit longer than you need to complete the reading successfully.

      Nobody who is seriously trying to address the Euro issue would vote for the Grillo party

    2. Searching for "Macchia Nera" you find a Walt Disney character. Are you sure to be in the right blog? Probably not but then you already know this dear boy. You can try here:http://it.paperpedia.wikia.com/wiki/PaperPedia_Wiki. Regards,

    3. I meant this: http://www.downloadblog.it/post/158470/macchianera-internet-awards-2016-tutti-i-vincitori
      thanks for the link to paperpedia, I didn´t know about its existence

  2. I don't really understand your point.

    Do you argue that the economy is self healing? That wrong monetary policy will damage growth for a period of time and then the economy will adjust to the new system?

    That doesn't seem obvious to me. If the economy requires a certain amount of liquidity and the central bank is systematically incorrect in assessing liquidity requirements, wouldn't that cause a change in the long term growth?

    The idea that given a suboptimal monetary regime, the economy would just adjust after some time to return to the previous growth level path or even growth rate seems like a strong statement. It would not be true in the engine example for sure.

    You could make a reasonable case that a correct monetary policy is a necessary condition to reach your growth potential. That it's like any other technology and that improvements in the understanding of the correct monetary policy will improve growth.

    In a way the statement that money is neutral is a static statement. If you double money, prices will double and nothing changes. By if money is a facilitator of trade, an incorrect amount of money will lower trade and lower production. If the correct amount of money changes constantly due to changes in the rest of the economy, this could create a constant drag in the economy. The economy is always out of monetary balance because monetrary demand changes continuosly due to changes in the real economy. I don't think this is so fanciful...

    1. Unless I am missing something, I think the point is that whether the economy is or is not growing in the long run has almost nothing to do with the supply of money. What ails the EU and U.S. economies cannot be fixed via monetary policy.

  3. Anyway, to suggest that Italy would be better under it's own currency than in a reliable monetary union isn't only bad economics but also a great example of neopopulist delusional thinking.

  4. Good stuff, especially in that last paragraph where I almost spilled my coffee from laughing pretty hard (and agreeing).

  5. "The clearly stated proposition is that money is irrelevant for long-run growth."

    Indeed, therefore the consideration that a dead car is a log-run outcome:

    "Bad management of oil has long-period consequences like bad management of currency: in the first case the head fuses and the motor stops; in the second a continent, and the world economy stops."


    "Italy's postwar miracolo economico was not the result of a finely calibrated monetary policy under the Lira."

    Italy's postwar miracolo economico was also the result of a finely calibrated monetary policy under the Lira.

    However, the end of the Italy's postwar miracolo economico in 1963-64 was caused by a bad monetary policy, forced by Germany.

    In Italy, we do not have rent control; marginal tax rates are less than half (maximum is 43%); government spending has been slightly under 50% of GDP in 2016, and, yes!, you can hire and fire people.

    I also suspect that it takes less than a decade to get a building permit.

    1. Thanks. Glad to know rent control is gone, it was a big problem last time I was there. You can't have marginal tax rates of 43% and 50% government spending! The relevant marginal tax rate adds up everything between the extra value you provide for an employer and the extra thing you get to buy -- including payroll taxes, income taxes, and VAT. It looks like you're referring only to the income tax. Isn't payroll (social insurance) tax around 40%, plus around 20% VAT? Labor "protections" abound in Italy -- you just banned Uber!

    2. Social contributions (employer+employees) sum to 31%, not 40%. If you want to add VAT (22-10-4-0% depending on the good) you can do it only after rescaling it as a percentage of labour cost (hence if the rate is 20%, it less than 8% to the marginal tax wedge). You'll find that the total marginal wedge is not higher than in most other European countries.
      Finally, Uber has been recently banned in countries like Denmark, and it's going to have a hard time all over Europe http://www.marketwatch.com/story/uber-handed-big-blow-in-europe-after-latest-legal-setback-2017-05-11
      (Maybe in order to allow Uber, we will have to leave the euro)

    3. Yes, 43% is the maximum (State) marginal tax rate on income. I think that this is the standard definition, http://www.cnbc.com/id/49521672.

      I would also say that banning Uber has more to do with market regulation than with labor protection.

      Anyway, rent control was abolished in 1992 (since then the landlord and tenant can agree freely on the rent): it's time to come to visit Italy again!

    4. Dear Prof. Cochare,
      with all the possible admiration and respect for your work, I have to point out an observation about methodology in this particular article.
      You wrote <<<
      Structural reforms not working? What structural reforms? In my view, they haven't started. Call me when you can hire and fire people, government spending is under 50% of GDP, marginal tax rates are less than half, rent control is gone, it takes less than a decade to get a building permit >>>
      As Giorgio D.M. correctly points out, this is a collection of false information.
      Some of them even ridiculously false (like the one about rents).
      This is made even worse by how easily is to check.
      That short paragraphs shows that
      1. you have a remote knowledge of Italy, mostly based on preconcept and generalization,
      2. you really don't care about checking what you are writing.
      This is normal for every human in many circumstances, don't worry, but is not much appreciated in a scientist.
      It could seem that the intent of the whole article is not to transmit knowledge, and explain your reasons, but to gain easy favor by repeating clichés and commonplaces.
      This is exactly what a scientist should avoid.
      My kindest regards,


  6. Dear Mr Cochrane there is no rent control in Italy, I can assure of that (my family manages apts in different locations). You can also get eviction of the tenant after 1 month of unpaid rent and in 4 months he is gone.
    You can also hire and fire easily in Italy, labor reforms were introduced, and you can hire people for a day or two. Public expenditure is 45% of GDP and with interest comes to 48% and Italy has 3,7 millions public employees while the UK more than 5 millions and France 6 millions. Compared with Germany we have the same % of public employeesin terms of the total population (1 per 17 people).
    When you debate the economy of a foreing country you shouldn'assume that some tales you read in the papers years ago are actually the reality
    By the way, Italy paid 3,400 billions in interest expenses of which 900 billions went abroad since it stopped financing public deficits with CB money in 1981. Our Public Debt of 2,200 billions is all due to interest expenses because we have a primary surplus of 1,5% of GDO on average since 1995

    1. Thank you gz for this little fact checking.
      In Italy you can even hire people for just hours and still we have to read such clichés even from such a respectable author like Cochrane :(

  7. Basically you are writing about a country you know nothing about. And apparently you know nothing about the rest of Europe as well. Shouldn't someone that tries to analyse economic data get some data first instead of relying on old movies?

  8. I know nothing of economics, but this man gives wrong information on Italy.

    Anyways in my view of ignorant in economics, in 2017 saying that economical growth is linked with human productivity sounds... XIX century to me.

    Talking about growth as a consequence of productivity is hilarious when you have ADDED VALUE. You know, if my company and yours are collaborating our work will worth more, we can do more, develop more products, expand on more markets...
    Growth in function of productivity brings to my mind these images of 1800's factories, you know what i mean.

    It's just a dumb example, but this man seems to forget it: pardon my ignorance but in the age of digital services and robots, i find dismal that whole political thoughts are founded on anachronistic economic paradigms.
    It is anachronistic even for a pariah of economics as me.

    Anachronistics....as long as we don't reintroduce prolets. THEN it won't be anacronistic anymore. Anyone draws his conclusions here.

    You tell me...this is a political evaluation, not economical.

  9. Dear Mr. Cochrane,
    I have two points to make: the first, you may or may not care about; the second should raise your attention.
    1: When will the "long-run" come? Italian (and Greek and Spanish and Portuguese...) demand was effectively destroyed in order to gain external competitiveness, and this has a bad influence on all the G7 economies.
    But after this "blood and tears" policy of wage reduction, we found that our main competitor on these "external" markets was one who had unfair advantages, such that could easily counter any effort from our side. German-€ appears the same as Italian-€ in the US, but it is substantially undervalued against its neighbours in spite of all our sacrifices to boost competitiveness. The labor market of Germany is distorted by state incentives that "integrate" wages that would be otherwise below the bare necessity; also, a substantially lower capital cost gives German enterprises an edge on productive investments, no matter what we do. These advantages have been used in order to eat up the competitors' productive structure. Plus, this shadow-deutschemark-€ will be always unfairly undervalued relatively to its neighbours, and it is undervalued relatively to the US. Can Trump obtain a re-evaluation of €? Maybe, but Italy will lose the only markets that still sustain our economy and "our engine" will be finally and totally recycled as scrap metal for Germany. If this makes you think that US economy will be able to export in Italy, you should rethink: there will be no demand left in Europe for any import that is not German. Their hegemonic and mercantilistic culture is reported in Machiavelli's writings, before the term itself was invented, and it won't change in the foreseeable future.
    2: This brings me to the point that you will probably care about: Germany is building muscles by constantly leeching off its neighbours, both in capitals, know-how, brands, and manpower. This already allowed them to accumulate a huge and growing trade surplus vs. the USA. With the victory of Macron in France, his choices of cabinet, and his projects of "common defense" institutions - that will be not common nor defensive - Germany will also de-facto have strategic weapons.

    In conclusion, this "long-run" risks to be extremely un-profitable for the whole Western world. I tried to explain, maybe clumslily, why this is not an armchair debate; and it seems to me that if you trust second-hand, biased reports (like the hedge-fund manager based in Oman that appears in the first comment...), you might use your scientific authority in the direction opposite to your own deep-rooted values. As a gentleman and a scholar, you can do a great deal in helping Europe sort out its unbalances fairly via the market forces (the currency market IS a market after all!), rather than through some Frankestein €uro-institutions.
    Thank you.

    1. He explicitly wrote that "long-run" is meant to be centuries or millennia, so bad we just live one life.

    2. No, long run in this context is about a decade. Money loses its power at least that fast.

  10. Really? Italy is now free-market nirvana, hire and fire as you wish, start new businesses everywhere, low and seamless tax and regulatory burden, no need for structural reform? I wonder how the world bank gets it so wrong. Clearly, commenters are right, I'm overdue for another visit.

    1. I live in Italy. I employed, i am employed. To start a business here you must be mentally challenged or a masochist.
      There are so many rules you have to hire 3 or 4 specialists to deal with every State demand.
      And even than it is never sufficient, so you're always under the thumb of any authority's official who's having a bad day.
      I never employed abroad so I can't tell how it is compared to any other place. But here, it is no nirvana.
      Overall taxation is well above 60%. Up and over 70% for some stupid or unlucky employer who pays all his/her taxes.
      Building permit in 10 years? You must be friends with somebody to get one. Or maybe you should just run for mayor. Which is something people don't avoid doing.
      And it is illegal to fire someone, even if he does nothing but stare at you all day and work as slow as he can, or do nothing at all, not even pretending.
      You cannot open a pharmaceutical because they're compartmentalized. You cannot open a notary because they are compartmentalized. You cannot open a tobacco shop because they are compartmentalized, you cannot open a newsstand because they are compartmentalized. Alcohol licenses can be given or taken easily from local officials, crating be-friend-or-perish administrators.
      You're welcome to visit at any time or ask anyone who tried to do business here to see if I'm wrong.
      There should be given medals in Italy for doing business

    2. Dear Claude, you admit that you didn't employ outside of Italy. This is showing, since you seem to believe that in USA there's no need for accountants, lawyers or other consultants.
      Do you think that you do not need an alcohol license there? That the fire department doesn't check on your public venue? That there's no health department to check on your restaurant?
      About the hire-and-fire policies, you do not know about vouchers here? Short-term contracts? Even long-term contracts can now be terminated without hassle. And how can you even compare the taxation level, since here we have near-free healthcare, education, and a public system of retirement? How can you compare the policy on building permits, when Italy has one of the highest "inhabitants per square km" ratio, one of the highest geological risk in the world, AND the highest concentration of historically valuable architecture?

      As an answer to Mr.Cochrane's irony, I'd love to hear what is the point in maximizing productivity (with costly investments) when the internal demand is destroyed, and the export has an average 10% higher price vs the competition because of the change.
      It's not a smart move to produce or invest in productivity, if you'll keep your goods in the warehouse.

  11. You talk about in the long run neutrality of money in general terms, but your detailed discussion seems to be quite asymmetric: bad monetary manipulations can make things worse short- and long-term; but no departure from optimal policy can increase long term performance. Do I understand correctly?

  12. I completely agree with you, John. In terms of long-term growth, keyword long, monetary policies have little to no effect on the development of an economy looking in the future. Long-term growth is mainly derived from people and the structural reform and innovation that comes from these people, not monetary policy.

    I specifically liked the comparison with oil in the tank. Oil, being like monetary policy, can only help the car move forward as an extremely short term goal. If you really want to improve the car and how fast or reliable it is, you would need to focus on the engine or other important aspects of the car. Innovation, in my opinion, is the key to long term growth in any economy. Monetary policy has no little to no effect on innovation and is thus inefficient when speaking about long term growth.

    I believe the only reason you've received any criticism from your original article was a huge misunderstanding on what it represented. I believe your critics completely lost the point that your main focus was about long term growth and not growth overall or even short term growth.

    Italy is a perfect example to bring up to further your articles point.

    1. Try not checking your oil for 25 years. See where you go in the long run.

  13. Good monetary policy and general productivity from the people go hand in hand in long-run growth. Even if the car had prime oil with good monetary policy, it wouldn't matter if the car's other parts (being the productivity of the people) were not working up to snuff.


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