Of the three questions, I think this is the most important:
“How long will inflation expectations remain anchored?”
mainly because it has a follow-up – if inflation expectations become unmoored, how long will it take to re-anchor them?
In the case of ‘recovery’, while it might be slow, year on year progress will do some of the healing. In the case of the bond market, they are impressed by fiscal action. Inflation expectations, however, cover a much wider set of people, often with opposing priorities – businesses see input costs rising so want higher output prices, but not higher wages. Workers see prices rising so want higher wages, but not higher interest rates. Central Banks see prices and wages (mostly wages I reckon) rising and so want higher interest rates, but these damage economic activity.
As Mr. Mankiw says, this can happen vey quickly, even in benign times. Look at the inflation rates in Ireland during the boom. Look at the current Argentinian inflation rates.
Once the unmooring happens, there is, in my amateur view, a folk memory of it that persists long after it is ‘necessary’. The good news is that also works for low inflation expectations (i.e. they persist into periods of price rises). The bad news is that we’ve had sustained rises in the cost of living (who eat food and use fuel Mr. Bernanke!) for the past few years.
Eesy Peesy:
1: When our incomes are sufficient to pay back interest, principal and leave a little on the side for necessaries and desirables – but we must have cut up our credit cards first! That ‘our’ includes Gov.
2. Inflation anchored? QEx? Whence the money? It is either in the system or not (used to pay down debt). If the former, it has gone somewhere and it appears not to be into wages and salaries, ‘cept the very well paid. Is Mankiw paying attention? Food and energy price increases in US are near +3% (on an annual basis).
3. Not long. 🙂
Brian Snr
is comparison to the 1980s recession is ludicrous or more precisely disingenuous
I’ve always been skeptical of people who claim to know the answers to intractable questions, but I’m skeptical of Gregory Mankiw even when he’s claiming not to know the answers. The first three quarters of his discussion of Question 1 is a thinly veiled diatribe against Obama and a eulogising of Reagan, replete with false dichotomies and spurious comparisons.
The question of what’s happening with, and what to do about, the long term unemployed is important and hopefully they won’t be forgotten once the recovery beds in. Dr. Delaney, of this parish, spoke about the huge effect unemployment has on wellbeing, and how this can damage someone’s ability to get back into a job, in an interesting webinar today (http://liamdelaneyecon.blogspot.com/2011/05/irishdebateie-session-irish-policy.html)
The role of expectations, both in creating inflation and in setting rates in the bond market, is very interesting, and it’s perhaps a little strange that we still have only the vaguest idea how these things work. Get to work Macro guys! 😉
@FOH
“The role of expectations, both in creating inflation and in setting rates in the bond market, is very interesting, and it’s perhaps a little strange that we still have only the vaguest idea how these things work. Get to work Macro guys! 😉 ”
Dammit! You’ve ruined my follow-up riposte that I had pre-prepared that 3 is dependent on 2 (government funding depends to a large degree on keeping a lid on inflation – if inflation is kept low, funding costs for government will be stable within a range of expectations (capacity for fiscal retrenchment if required)).
How long will the bond market trust the United States?
I don’t believe it does trust the US. All the large volume sovereign bond issuers are bowel looseningly scary. The risks associated with the dollar are not all that very exceptional, and the Chinese can be relied upon to limit the rate of movement in the dollar’s value out of their own self interest.
@hogan
Roger Bootle used to bang on about how inflation was extinct, in the late ’80s. He was right but way too early. RPI hit 9.8% in the UK and base rate 15% in ’92. There were some fairly tetchy discussions over asset allocation.
It took a long time for inflation as an investment consideration to go out of fashion. If you look at CPI from “82 onwards you are really looking at the driver of the bull markets. People have learned to ingore inflation expectations and may be right to do so for a while.
If they do get unanchored – as some in the Keynesian camp actually want so as to get QE to really “work” – then you can forget about anybody selling bonds remotely close to todays bund yield. It could be quite a slow process though.
Curiously, the seventh edition of Mankiw’s Macroeconomics (2010) contains no reference to Lehman Brother, AIG or any of that, and the single page (out of 600) devoted to discussing bank failures refers only to the 1930s. His latest graph on unemployment shows the rate (for 2008) at under 6%.
@grumpy
Tell me about 1992 in England! I was there and paying a mortgage!
“If they do get unanchored – as some in the Keynesian camp actually want so as to get QE to really “work” – then you can forget about anybody selling bonds remotely close to todays bund yield. It could be quite a slow process though.”
Well this is, I think really important and unknown. I agree with you which is why I said 3 was dependent on 2 – if bond yields rise beyond growth, fiscal sustainability declines.
I don’t know that it is possible to say that it could be quite a slow process. While clearly it *could* be, it *could* also be that it happens quickly as the financial crisis unravelled the cosy consensus despite the best efforts of the Central Banks. What would it take? Perhaps as little as a few poorly managed bond auctions? A major pay demand from IGMettal? Oil remaining about 100 dollars a barrel?
Once the inflection point is reached, the expectation upslope could be incredibly swift. This is an astonishingly large risk. It’d almost make you buy some gold…
Well, Professor Mankiw, you asked. Rather than just give you the answers, I want to start by suggesting you are looking in the wrong places. That wrong place, is the field of economics.
Let’s put aside the fundamental error of classical economics — that Humans are rational, self-interested, profit maximizing creatures. They are clearly not; Humans are actually irrational social animals with flawed cognitive apparatus. Frequently emotional, occasionally self-destructive, often times erratic, humans only rarely exhibit the traits that economics ascribe to them. If the study of economics begins with such a shaky foundation, is it any wonder they get so much wrong?
…..
1) How long will it take for the economy’s wounds to heal?
Most economists seem to focus on the post WWII economic cycles. This is the wrong approach. The most recent contraction was quantitatively different than the typical recession/recovery cycles. To get a better grasp as to what to expect, turn to history and statistical analysis instead of economics.
That is essentially what Reinhart & Rogoff did. In their December 19, 2008 paper, they showed historically, “the aftermath of banking crises is associated with profound declines in output and employment.” They had identified this phenomena 3 years ago, while the collapse was still unfolding. Their book, This Time Is Different: Eight Centuries of Financial Folly, expanded their prior paper on credit-crisis recessions.
2) How long will inflation expectations remain anchored?
Like the premature New York Journal obituary for Mark Twain, reports of inflation expectations have been greatly exaggerated. Human beings cannot forecast their own behaviors, let alone act on their expectations for inflation. Indeed, the only time most people even notice inflation is AFTER prices have skyrocketed — not before. The Recency Effect, the tendency to over-emphasize a single data point of what has just occurred rather than focus on long term series or trends –THAT is what drives behavior.
Friedman’s belief that people were engaging in immediate behavior based upon their momentary consideration of long term inflation reveal he hadn’t a clue as to how actual human beings operated in the real world. No wonder he foolishly believed we could get rid of the FDA — who needed Food inspections anyway? And the marketplace will help determine what Drugs will and should sell.
As Prof Mankiw writes, this “theory is now textbook economics, and is at the heart of Federal Reserve policy.” Which perhaps goes a long way in explaining why the Fed gets so much wrong in terms of recognizing inflation on a timely basis.
3) How long will the bond market trust the United States?
This is the most revealing question, because it reveals some biases that Professor Mankiw labors under.
He writes: “A remarkable feature of current financial markets is their willingness to lend to the federal government on favorable terms.” This must be a change of heart for the professor, given his role as Chairman of the Council of Economic Advisors from 2003-05. He never said much — at least publicly — about this “unsustainable fiscal trajectory” when his boss was busy turning a surplus into a “huge budget deficit.”
From the CBO to the GAO, every honest broker who has analyzed the situation has observed that the Bush tax cuts, the war of choice in Iraq, the prescription drug entitlement were the biggest factors pre-2008 in the runaway budget. Add to that the collapse of revenues brought about by the financial crisis, and you have the makings of a awful balance sheet.
Ironically, this is the one question Prof Mankiw asked that COULD be solved by economics. I do not know why he chose to ignore the answer. Perhaps it might be because he did not care for the answer economics gave.
12 replies on “Greg Mankiw in the NYT”
Dean Baker’s response may be of interest.
Of the three questions, I think this is the most important:
“How long will inflation expectations remain anchored?”
mainly because it has a follow-up – if inflation expectations become unmoored, how long will it take to re-anchor them?
In the case of ‘recovery’, while it might be slow, year on year progress will do some of the healing. In the case of the bond market, they are impressed by fiscal action. Inflation expectations, however, cover a much wider set of people, often with opposing priorities – businesses see input costs rising so want higher output prices, but not higher wages. Workers see prices rising so want higher wages, but not higher interest rates. Central Banks see prices and wages (mostly wages I reckon) rising and so want higher interest rates, but these damage economic activity.
As Mr. Mankiw says, this can happen vey quickly, even in benign times. Look at the inflation rates in Ireland during the boom. Look at the current Argentinian inflation rates.
Once the unmooring happens, there is, in my amateur view, a folk memory of it that persists long after it is ‘necessary’. The good news is that also works for low inflation expectations (i.e. they persist into periods of price rises). The bad news is that we’ve had sustained rises in the cost of living (who eat food and use fuel Mr. Bernanke!) for the past few years.
Eesy Peesy:
1: When our incomes are sufficient to pay back interest, principal and leave a little on the side for necessaries and desirables – but we must have cut up our credit cards first! That ‘our’ includes Gov.
2. Inflation anchored? QEx? Whence the money? It is either in the system or not (used to pay down debt). If the former, it has gone somewhere and it appears not to be into wages and salaries, ‘cept the very well paid. Is Mankiw paying attention? Food and energy price increases in US are near +3% (on an annual basis).
3. Not long. 🙂
Brian Snr
is comparison to the 1980s recession is ludicrous or more precisely disingenuous
I’ve always been skeptical of people who claim to know the answers to intractable questions, but I’m skeptical of Gregory Mankiw even when he’s claiming not to know the answers. The first three quarters of his discussion of Question 1 is a thinly veiled diatribe against Obama and a eulogising of Reagan, replete with false dichotomies and spurious comparisons.
The question of what’s happening with, and what to do about, the long term unemployed is important and hopefully they won’t be forgotten once the recovery beds in. Dr. Delaney, of this parish, spoke about the huge effect unemployment has on wellbeing, and how this can damage someone’s ability to get back into a job, in an interesting webinar today (http://liamdelaneyecon.blogspot.com/2011/05/irishdebateie-session-irish-policy.html)
The role of expectations, both in creating inflation and in setting rates in the bond market, is very interesting, and it’s perhaps a little strange that we still have only the vaguest idea how these things work. Get to work Macro guys! 😉
@FOH
“The role of expectations, both in creating inflation and in setting rates in the bond market, is very interesting, and it’s perhaps a little strange that we still have only the vaguest idea how these things work. Get to work Macro guys! 😉 ”
Dammit! You’ve ruined my follow-up riposte that I had pre-prepared that 3 is dependent on 2 (government funding depends to a large degree on keeping a lid on inflation – if inflation is kept low, funding costs for government will be stable within a range of expectations (capacity for fiscal retrenchment if required)).
How long will the bond market trust the United States?
I don’t believe it does trust the US. All the large volume sovereign bond issuers are bowel looseningly scary. The risks associated with the dollar are not all that very exceptional, and the Chinese can be relied upon to limit the rate of movement in the dollar’s value out of their own self interest.
@hogan
Roger Bootle used to bang on about how inflation was extinct, in the late ’80s. He was right but way too early. RPI hit 9.8% in the UK and base rate 15% in ’92. There were some fairly tetchy discussions over asset allocation.
It took a long time for inflation as an investment consideration to go out of fashion. If you look at CPI from “82 onwards you are really looking at the driver of the bull markets. People have learned to ingore inflation expectations and may be right to do so for a while.
If they do get unanchored – as some in the Keynesian camp actually want so as to get QE to really “work” – then you can forget about anybody selling bonds remotely close to todays bund yield. It could be quite a slow process though.
Curiously, the seventh edition of Mankiw’s Macroeconomics (2010) contains no reference to Lehman Brother, AIG or any of that, and the single page (out of 600) devoted to discussing bank failures refers only to the 1930s. His latest graph on unemployment shows the rate (for 2008) at under 6%.
@grumpy
Tell me about 1992 in England! I was there and paying a mortgage!
“If they do get unanchored – as some in the Keynesian camp actually want so as to get QE to really “work” – then you can forget about anybody selling bonds remotely close to todays bund yield. It could be quite a slow process though.”
Well this is, I think really important and unknown. I agree with you which is why I said 3 was dependent on 2 – if bond yields rise beyond growth, fiscal sustainability declines.
I don’t know that it is possible to say that it could be quite a slow process. While clearly it *could* be, it *could* also be that it happens quickly as the financial crisis unravelled the cosy consensus despite the best efforts of the Central Banks. What would it take? Perhaps as little as a few poorly managed bond auctions? A major pay demand from IGMettal? Oil remaining about 100 dollars a barrel?
Once the inflection point is reached, the expectation upslope could be incredibly swift. This is an astonishingly large risk. It’d almost make you buy some gold…
William Mitchell’s response:
http://bilbo.economicoutlook.net/blog/?p=14429
With some similarities to Baker’s, above, he highlights the New Keynesian framework as putting Mankiw awry.
Another biting response, this time from Barry Ritholtz. http://www.ritholtz.com/blog/2011/05/look-beyond-economics/
Well, Professor Mankiw, you asked. Rather than just give you the answers, I want to start by suggesting you are looking in the wrong places. That wrong place, is the field of economics.
Let’s put aside the fundamental error of classical economics — that Humans are rational, self-interested, profit maximizing creatures. They are clearly not; Humans are actually irrational social animals with flawed cognitive apparatus. Frequently emotional, occasionally self-destructive, often times erratic, humans only rarely exhibit the traits that economics ascribe to them. If the study of economics begins with such a shaky foundation, is it any wonder they get so much wrong?
…..
1) How long will it take for the economy’s wounds to heal?
Most economists seem to focus on the post WWII economic cycles. This is the wrong approach. The most recent contraction was quantitatively different than the typical recession/recovery cycles. To get a better grasp as to what to expect, turn to history and statistical analysis instead of economics.
That is essentially what Reinhart & Rogoff did. In their December 19, 2008 paper, they showed historically, “the aftermath of banking crises is associated with profound declines in output and employment.” They had identified this phenomena 3 years ago, while the collapse was still unfolding. Their book, This Time Is Different: Eight Centuries of Financial Folly, expanded their prior paper on credit-crisis recessions.
2) How long will inflation expectations remain anchored?
Like the premature New York Journal obituary for Mark Twain, reports of inflation expectations have been greatly exaggerated. Human beings cannot forecast their own behaviors, let alone act on their expectations for inflation. Indeed, the only time most people even notice inflation is AFTER prices have skyrocketed — not before. The Recency Effect, the tendency to over-emphasize a single data point of what has just occurred rather than focus on long term series or trends –THAT is what drives behavior.
Friedman’s belief that people were engaging in immediate behavior based upon their momentary consideration of long term inflation reveal he hadn’t a clue as to how actual human beings operated in the real world. No wonder he foolishly believed we could get rid of the FDA — who needed Food inspections anyway? And the marketplace will help determine what Drugs will and should sell.
As Prof Mankiw writes, this “theory is now textbook economics, and is at the heart of Federal Reserve policy.” Which perhaps goes a long way in explaining why the Fed gets so much wrong in terms of recognizing inflation on a timely basis.
3) How long will the bond market trust the United States?
This is the most revealing question, because it reveals some biases that Professor Mankiw labors under.
He writes: “A remarkable feature of current financial markets is their willingness to lend to the federal government on favorable terms.” This must be a change of heart for the professor, given his role as Chairman of the Council of Economic Advisors from 2003-05. He never said much — at least publicly — about this “unsustainable fiscal trajectory” when his boss was busy turning a surplus into a “huge budget deficit.”
From the CBO to the GAO, every honest broker who has analyzed the situation has observed that the Bush tax cuts, the war of choice in Iraq, the prescription drug entitlement were the biggest factors pre-2008 in the runaway budget. Add to that the collapse of revenues brought about by the financial crisis, and you have the makings of a awful balance sheet.
Ironically, this is the one question Prof Mankiw asked that COULD be solved by economics. I do not know why he chose to ignore the answer. Perhaps it might be because he did not care for the answer economics gave.