Eggertsson (2): Fiat optimism

Excerpts from the Eggertsson PDF

Page 1477:

Roosevelt immediately implemented several radical policies which had a strong impact on expectations. As if mobilizing the nation for war, the government went on an aggressive spending campaign, nearly doubling government consumption and investment in one year. This spending spree was not financed by tax increases, but instead by some of the largest budget deficits in US history outside of wartime. On the monetary side Roosevelt announced that the value of the dollar was no longer tied to the price of gold, effectively giving the administration unlimited power to print money. The overarching goal of these policies was to inflate the price level...

I think Eggertsson's summary is crude. The "overarching goal" may have looked at the time to be to inflate the price level. Perhaps it looks like that still, today. But the overarching goal, really, was to obtain economic recovery, right? And whether anyone knew it or not, they did it by correcting the monetary imbalances that had created the Depression.

It was not inflation for its own sake that Roosevelt desired. It was inflation to restore balance between the components of money. I doubt Roosevelt ever knew it. But I am saying we should be able to look back now, evaluate what happened, and come up with something a little better than a blind call for more inflation. Because if we can do it better, we can do it better.

Page 1477:

The turning point cannot be explained by contemporaneous changes in the money supply, as stressed by Temin and Wigmore (1990). As shown in panel D of Figure 1, the money supply did not change around the turning point.

There was a temporary increase in currency in circulation due to the banking crisis, but this was offset by a drop in nonborrowed reserves, leaving the monetary base virtually unchanged.

Temin and Wigmore (1990) document that the real value of some broader monetary aggregates such as M2 declined considerably in 1933.

The turning point, perhaps. Nonetheless, for more than a decade after 1933 the level of debt fell with respect to the quantity of money. I would remind you that, as Eggertsson writes, "Roosevelt abolished the gold standard and announced an explicit policy objective of inflating the price level". So the quantity of money *should* have gone up. Though maybe not at the very moment of the Inauguration.

Early in the Obama administration there was talk of "green shoots" and other yap intended to bolster confidence and get the economy moving again. Policymakers focus on confidence simply because they don't know what else to try.

Confidence is nice, but confidence emerges from conditions. If we had coupled confidence-boosting with debt forgiveness of some kind, we would have been changing conditions in a way that improved not only confidence but the economy as well.

We didn't do that.

Page 1479:

The Hoover Administration is constrained by the policy dogmas (i.e., the gold standard, balanced budget, and small government dogmas), while the Roosevelt Administration is not.

Maybe so. But the actual effect of that absence of constraint was to reduce the level of total debt per dollar of M1 money.

Page 1480:

Milton Friedman and Anna Schwartz (1963), and a large literature that followed, suggest that the recovery from 1933–1937 was driven primarily by money supply increases. Nominal interest rates, however, were close to zero during this period. According to the model in this paper, a higher money supply increases demand only through lower interest rates, so at the zero lower bound it is only through the expectation of future money supply, and thus future interest rates, that the money supply affects spending...

This is where I disagree with Gauti Eggertsson. He says the assumption (that the Depression was ended by increasing the quantity of money) is flawed because with interest rates at zero, the normal effects of increased money were unavailable. And Eggertsson concludes that it was expectations that brought recovery.

"Recovery" implies growth. Growth implies the expansion of credit-use. The expansion of credit-use implies accumulation of debt. So we should see an increase of debt as the economy recovers (as we see in my DPD graph, beginning in 1947).

The problem is not to increase demand. The problem is to reduce debt now so that it can expand again ASAP. After we reduce debt, the rest will follow. Increased demand will follow. Growth will follow.

The page 1480 excerpt continues:

...Through the expectation channel the main point of Friedman and Schwartz is confirmed in this paper: appropriate monetary policy was essential to end the Great Depression, and could have prevented it altogether. The twist is that this could be achieved only through the correct management of expectations, not contemporaneous increases in the money supply per se.

The twist is that this could be achieved only through the correct management of expectations. First of all, that's a creepy, manipulative, and totalitarian approach. Too much "behavioral" and not enough "economics". Second, I think it is really sad that economics has given up on economic policy, fiscal and monetary policy, in favor of behavior modification and fiat optimism.

Page 1480:

Several papers study the Great Depression in DSGE models, and the current paper shares many elements with them. The main difference is the focus on the regime shift associated with Roosevelt’s rise to the presidency, which is used to explain the recovery. While many of these papers recognize the importance of expectations, they do not model explicitly why and how they changed in 1933 with Roosevelt’s inauguration.

I'm writing these remarks as I read Eggertsson's paper, so I may head off in the wrong direction. But again here he emphasizes expectations and "how they changed in 1933 with Roosevelt’s inauguration." Yet just a moment ago he was talking about events of the 1933-1937 period. And again a moment or two before that, he showed an unidentified money supply that was not growing for six months either side of the FDR inauguration.

Overly optimistic expectations would not have endured for four years. Spending money (the economists' M1 money) increased from 19.91 billion in 1933, to 30.91 billion in 1937, according to the Historical Statistics (Bicentennial Edition, Series X414). It was an increase of eleven billion dollars, or more than 55% in four years. Match that against Eggertsson's empty expectations.

Match it against what Eggertsson says about money.

Graph #1: 1916-1950

My graph #1 shows M1 money and Total Debt with each series indexed on its 1923 value. This makes the two trend lines overlap and makes them equal in 1923. What that means is the numbers themselves are not comparable. I cannot say "money is higher than debt in 1916" or "debt is higher than money in 1931" or "money is higher than debt in 1945". (If I had chosen some year other than 1923, the lines would not be as they appear on this graph.)

However, what this graph *does* show is that total debt was growing faster than M1 money in the years leading up to the Depression. And that after reaching a low point in 1933, the quantity of money grew much faster than total debt, until 1947.

These dates, 1933 and 1947, correspond exactly to the turning-point dates identified on my DPD graph in the previous post.

Graph #2: 1916-1970

When we take Graph #1, caveats and all, and extend it out to 1970, it becomes obvious that in the 1950-1970 period debt was growing significantly faster than M1 money. That trend continued almost without letup until 2007.