I Try to Get to the Bottom of the Sumner-Kimel Debate

    UPDATE: For new deveolopments please see http://diaryofarepublicanhater.blogspot.com/2011/11/krugman-vs-sumner-and-fallacy-of.html?utm_source=feedburner&utm_medium=feed&utm_campaign=Feed%3A+DiaryOfARepublicanHater+%28Diary+of+a+Republican+Hater%29

   ALSO:  For another Sumner dispute with Krugman see

    http://diaryofarepublicanhater.blogspot.com/2011/11/krugman-vs-sumner-and-fallacy-of.html?utm_source=feedburner&utm_medium=feed&utm_campaign=Feed%3A+DiaryOfARepublicanHater+%28Diary+of+a+Republican+Hater%29

    For my gloss yesterday please see

    http://diaryofarepublicanhater.blogspot.com/2011/11/i-weigh-in-on-scott-sumner-vs-mike.html

    As these guys have kept it going I will try here to boil it down to the essentials and then give a shot a adjudicating the dispute.  How magisterial of me!  Let's begin with Mike Kimel's latest piece over at the Angry Bear. Kimel calls his piece 'Scaling to New Depths with Sumner'

   http://www.angrybearblog.com/2011/11/scaling-to-new-depths-with-scott-sumner.html

   Before we get started it's interesting that in his comments directed in answer to me in a previous post, Kimel had said,"I want to get back to the "kimel curve" stuff I was working on which I find more interesting,  but I keep thinking if I write the right thing it will go away... "

   His Kimel Curve is actually an intriguing project to figure out the best top marginal tax rate for optimum GDP-he says that the optimum tax rate would be about 60-70, ie, what it was prior to Reagan, Yet it must be admitted that if Kimel wants this thing to go away you wonder why he keeps writing about it. Not that he shouldn't, just that it seems to belie his wanting it to go away.

   He and Sumner have been quibbling about what it was that really halted the sharp deflation in 1933 and led to the big recovery in production and prices. Here is Kimel's summation yesterday,

   "He insists that FDR’s dollar depreciation program began in October 1933, even though all economic historians agree in began in mid-April 1933, when the exchange rate for the dollar began declining (against gold and against other currencies.) He insists prices began rising before FDR took office off, which is not true. He presents a graph that he claims shows prices rising before FDR took office, but his graph shows inflation rates, not the price level. In fact, the graph actually supports my argument that inflation didn’t turn positive until after FDR took office. There’s a difference between the rate of inflation and the price level"

    It seems to me what's at stake is the efficacy of monetary vs. fiscal policy. What is really responsible for the sharp turnaround we saw in 1933-34? Sumner believes it was largely monetary policy. He gives short thrift to fiscal policy and said in a comment to me that FDR's NIRA was a disaster.

       http://www.themoneyillusion.com/?p=11919#comments
   
     The best way to maybe get at the bottom line of all this is to return to First Principles. Just kidding! But we should return to the First Document, as it were that started the debate. This is a piece Sumner actually wrote last year called 'Skidelsky on FDR's Gold Buying Program." It concerns a well-reviewed biography Skidelsky wrote about Keynes.

     http://www.themoneyillusion.com/?p=7914

     Sumner, not surprisingly, has a problem with Skidelsky's assertion that FDR's gold buying program, and the Fed's quantiative easing had disappointing results-not surprising because as a monetarist, this is Sumner's stock and trade: the belief in the efficacy of monetary policy to deal with deep crises and shocks.

    Here are Skidelsky's offending comments:

    "The gold-buying policy raised the official gold price from $20.67 an ounce in October 1933 to $35.00 an ounce in January 1934, when the experiment was discontinued. By then, several hundred million dollars had been pumped into the banking system."

     "The results were disappointing, however. Buying foreign gold did succeed in driving down the dollar’s value in terms of gold. But domestic prices continued falling throughout the three months of the gold-buying spree."

    "The Fed’s more orthodox efforts at quantitative easing produced equally discouraging results. In John Kenneth Galbraith’s summary: “Either from a shortage of borrowers, an unwillingness to lend, or an overriding desire to be liquid – undoubtedly it was some of all three – the banks accumulated reserves in excess of requirements. Reserves of member banks at Fed were $256 million more than required in 1932; $528 million in 1933, $1.6 billion in 1934, $2.6 billion in 1936.”

    "What was wrong with the Fed’s policy was the so-called quantity theory of money on which it was based. This theory held that prices depend on the supply of money relative to the quantity of goods and services being sold. But money includes bank deposits, which depend on business confidence. As the saying went, “You can’t push on a string.”

    "Keynes wrote at the time: “Some people seem to infer…that output and income can be raised by increasing the quantity of money. But this is like trying to get fat by buying a larger belt. In the United States today, the belt is plenty big enough for the belly….It is [not] the quantity of money, [but] the volume of expenditure which is the operative factor.”

    Again for a monetarist-whether "market" monetarist or other-this has got to be fighting words for Sumner particularly the phrase "you can't push on a string."

    Sumner fires back, "I’m afraid that his analysis is both misleading and inaccurate.  The US gradually depreciated the dollar between April 1933 and February 1934.  During that period unemployment was nearly 25% and T-bill yields were close to zero.  Keynes argued that monetary stimulus would not be effective under those circumstances, and Skidelsky seems to accept his interpretation (which was published in the NYT during December 1933"

    "Unfortunately, Keynes and Skidelsky are wrong.  The US Wholesale Price Index rose by more than 20% between March 1933 and March 1934.  In the Keynesian model that’s not supposed to happen.  The broader “Cost of Living” rose about 10%.  Industrial production rose more than 45%."

    "And the gold-buying program was not an application of the quantity theory of money.  George Warren was an opponent of the QT, insisting that the quantity of money was not what mattered, that the price level was determined by the price of gold.  His views were much closer to Mundell than Friedman.  Keynes’s views on these issues were inconsistent and borderline incoherent.  Only a few weeks after Keynes argued that it was foolish to believe that currency depreciation could boost prices, FDR finally stopped depreciating the dollar.  How did Keynes react?  He congratulated FDR for rejecting the policy advice of the “extreme inflationists.”  By early 1934 prices were rising again.

   "The “disappointing” results that Skidelsky mentions come from cherry-picking a few misleading data points.  After the NIRA wage shock of late July, the real economy slumped and commodity prices started falling.  The value of the dollar also leveled off for a few months.  This led FDR to adopt the gold buying program in late October 1933. Despite the name, the actual “gold buying” was not large enough to be important–rather it was essentially a gold price raising program–a signal of future devaluation intentions.  This was well understood by the markets, and commodity prices tended to rise on days when FDR raised the gold price.  The broader WPI was relatively stable between September and December, and then started rising briskly again in early 1934."

   "Skidelsky is a big fan of Keynes, but needs to read his hero’s writings with a more critical eye.  Other modern Keynesians like Krugman and Eggertsson have argued that FDR’s dollar devaluation program boosted the economy in 1933, and they are right.  They would also be horrified to see a Keynesian criticizing QE2."

    This was the initial piece that got Kimel going-it is a year old but he noticed it only recently. Let us take a look at his most recent attempt to "write the right thing."

     "I'm not an economic historian, but I did spend my formative years in South American in the 1970s and 1980s. As anyone who spent roughly the same years in the region as I did could tell you, or as any Zimbabwean can do today, during times of turmoil (which can last decades) the official exchange rate can come to bear no relationship with the actual price at which a currency trades against something that is considered more stable and more desirable to hold. Heck, you don't have to track down someone from Argentina or Zimbabwe - ask any European who ever visited the Soviet Block and traded in some Western currency at the airport or the border about how unrealistic official exchange rates could be. In many an economic basket case, the likelihood that a transaction takes place at anything resembling the official exchange rate is similar to the probability that someone walks into a Chevrolet dealership and pays the MSRP, in cash."

     "And like the MSRP, the official exchange rate has a purpose. Yes, there's always someone clueless or coerced enough to pay that price. But for the most part, its a fiction that either serves as a baseline for something or papers over something the government wants to really do, usually printing money. Its a handy excuse to get from point A to point B, and if the excuse doesn't fly, another one will do."

     "My guess, and I'll repeat that I'm not an economic historian, is that when FDR and Jones and Morgenthau were picking prices out of the air, it was in that vein. The country was in turmoil when FDR took office, and there were fears that if things got worse there would be an armed insurrection. It wasn't a time for half measures. My guess is the mood in the White House at the time was best summarized by a quote decades later from the immortal John Candy, "There's a time to think, and a time to act. And this, gentlemen, is no time to think."

     "So what did the fiction of changing the price gold accomplish if nobody else believe that the price had actually changed? I suspect it meant, in practice, that the Reconstruction Finance Corporation could pay more than $20.67 an ounce for gold. And why would the RFC (which, I note, could borrow outside the budget) want to pay more than $20.67 an ounce for gold if that was the price everyone was accepting?"

     "Think of the RFC the way you think of the Fed trying to bail out banks in recent years - loaning money at below market rates to banks who then used the money to buy Treasuries which paid higher rates. In effect, paying more than $20.67 an ounce was a way to funnel riskless profits to banks. (Of course, the RFC often replaced management, but things have gotten permissive as well as more sophisticated in recent decades.)"

    "Which brings us back to Sumner and "all economic historians" being right, at least technically. Yes, the currency was being devalued throughout much of 1933, but no, it wasn't. Not really. There were a series of fictional devaluations that served a specific purpose, but which nobody else made believe was real (and its possible which almost nobody else was aware were happening - don't ask me, I'm not an economic historian). Pretending otherwise, and using that fictional data to do an analysis is the equivalent of trying to understand the East German economy in 1974 using the exchange rates a traveler would have received at Checkpoint Charlie during that year."

     This anecdote of Kimel's I find very interesting. I particularly like the John Candy quote "Gentleman, there is a time to think and a time to act. And this gentleman, is not time to think."

     That is certainly an accurate description of Roosevelt Administration during the early days and for many liberals stands as rebuke to current President Obama who, it has often seemed to them, has lacked this urgency. The particular details of Kimel's narrative-FDR, Morgenthau and Company were taking prices out of thin air, etc, may be right in its particulars. Yet it seems to me that Kimel is someone whose strengths are the particulars, the details, the minutiae. As he himself says,

     "Now, I am not an economic historian, and I'm not sure I know any these days, so for all I know, Sumner is correct about what all economic historians agree happened. I am, instead a data guy. I like data. Scratch that. I love data. I go through data in my spare time. Most of the stuff I do at this blog, for instance, has absolutely nothing to do with my day job. Nothing. But its an opportunity to play with data. My wife usually scratches her head wondering why I do this kind of thing, but everyone needs a hobby and I don't watch tv."

     His attention to data is like Monk, both a blessing and a curse. I must admit that in reading this paragraphs long narrative I don't feel like he's given us the bottom line as to why he's right and Sumner's wrong. He still hasn't written "the right thing to make it go away."

    I will take a stab at it in a different direction. As we saw above, Sumner appealed to Eggertsson and Krugman against Skidelsky. They would " be horrified to see a Keynesian criticizing QE2."

    As Sumner has appealed to Eggertsson let us see what he has to say about this debate. Now Eggertsson, as I pointed out to Sumner after his rebuke to me yesterday in the comments section, "Then you’d be wrong. The fiscal stimulus was small, far too small to boost prices during 25% unemployment" and that the NIRA was a disaster, does not agree with him on that. Actually Eggertsson agrees with me-not that he was trying to-that both the fiscal and monetary policy had their part to play:

    "What ended the Great Depression in the United States? What ended the Great Depression in the United States? This paper suggests that the recovery was driven by a shift in expectations.This shift was triggered by President Franklin Delano Roosevelt’s (FDR) policy actions. On the monetary policy side, Roosevelt abolished the gold standard and announced an explicit policy objective of inflating the price level to pre-Depression levels. On the fiscal policy side, Roosevelt expanded real and deficit spending which helped make his policy objective credible. The key to the recovery was the successful management of expectations about future policy."

    
    http://www.ny.frb.org/research/economists/eggertsson/Great_Exp_AER.pdf

     It was expectations about both monetary and fiscal policy. If Skidelsky denied the efficacy of abolishing the gold standard then Eggertsson disagrees with him as Sumner says. But Eggertsson also clearly agrees with me-and Mike Kimel-that the fiscal  policy of expanded and deficit spending was important too as it made his "policy objective credible."

    A little more on the subject of fiscal stimulus, particularly the NIRA which Sumner considers a disaster. Here's what Eggertsson has to say about the NIRA:

   "Can government policies that reduce the natural level of output increase actual output? In other words policies  that are contractionary according to the neoclassical model, be expansionary once the model is extended to include nominal frictions? For example, can facilitating monopoly pricing of economists would yes under the special “emergency” conditions that apply when the short-term nominal interest the short-term nominal interestrate is zero and there is excessive deflation. Furthermore, it argues that these special “emergency”conditions were satisfied during the Great Depression in the United States."

    http://www.ny.frb.org/research/economists/eggertsson/WastheNewDealContractionary.pdf

    In general, Eggertsson does agree with Sumner's gloss that fiscal stimulus is ineffective as it is neutralized by monetary policy but in the special case of the Depression where there were the elements of the Zero Lower Bound (ZLB) being reached  becasue the short-term nominal interest rate was zero and with exessive deflation this is not so.

    "Under regular circumstances, these policies are counterproductive. A central bank that targets price stability, for example, will offset any inflationary pressure these policies create by increasing the short-term nominal interest rate.  In this case, the policy wedges reduces output through traditional channels. The New Deal policies are expansionary in the model because they are a response to the “emergency" conditions created by deflationary shocks."

     So that's the answer to Sumner's criticism of Obama's fiscal stimulus much less the demand for any more now: we are now as in the Depression facing Eggertsson's emergency conditions created by deflationary shocks, we have again reached the Zero Lower Bound in short-term nominal rates and sharp deflation. For this reason stimulus can be justified as it was in the Depression.

     Let me add, by the way, that as to my question to Kimel as to the relative effectiveness-responsibility of fiscal vs. monetary policies for the recovery in 1933-37, Eggertsson is very specific. He estimates that New Deal-fiscally stimulative-policies where 55% responsible for the recovery in output between 1933-37 and 70% responsible for the recovery in inflation during the same period.

    http://www.ny.frb.org/research/economists/eggertsson/WastheNewDealContractionary.pdf