Japan’s economy expanded the most in a year last quarter as consumer spending and export gains outweighed the weakest business investment since the wake of the March 2011 earthquake and tsunami.

Gross domestic product rose an annualized 3.5 percent, a Cabinet Office release showed in Tokyo. Private consumption, making up 60 percent of GDP, contributed 2.3 percentage points to the jump. The Bank of Japan may upgrade its assessment of the economy after a May 22 policy meeting, according to people familiar with the central bank’s discussions.

. . .

Annualized real growth exceeded all but two of 36 estimates in a Bloomberg News survey. Nominal GDP, which is unadjusted for changes in prices, rose 1.5 percent, also the most in a year. The nominal gain was 0.4 percent from the previous three months, less than the median forecast for a 0.5 percent increase. 

On the plus side, it certainly supports my claim that faster NGDP growth in Japan would not merely lead to equally higher inflation.  But as Matt Yglesias correctly points out, it’s almost too good for the demand-side framework.  Faster nominal growth should boost both RGDP and inflation.

Still, I’d caution readers not to overreact to this data.  Recall that in the 15 years before the 2008 recession Japanese NGDP was basically flat (one percent RGDP and minus one percent deflator).  The Japanese labor market had mostly adjusted to low NGDP growth, although I think money illusion near the zero nominal wage increase point had still modestly depressed Japanese employment and output. 

If we use a standard expectations-based natural rate model, then a 1.5% NGDP growth rate in Japan is sort of like a 6.5% NGDP growth rate in the US., i.e. about 1.5% higher than “normal.”  If America suddenly got a 6.5% NGDP growth rate for a single quarter, and it broke down as 1% inflation (i.e. 1% less than the normal 2%) and 5.5% real GDP growth, then I think most people would see that as a sign of robust AD, even though they’d be mildly surprised by the low inflation number.  In other words:

1.  Japanese data must be seen from the Japanese perspective, not the American perspective.

2.  Quarterly results bounce around quite a bit.

I think this is modest evidence that Abenomics is beginning to work, but I also believe that Japanese RGDP growth cannot be maintained at 3.5% for any extended period of time.  Still, faster NGDP growth also makes the debt situation in Japan slightly less catastrophic.

I’ve been quite busy recently, and hence haven’t had time to blog.  I will eventually get to the old comments.

The immediate effect would have been a boom in asset prices, and most likely Lehman would not have failed. The big financial crisis of October 2008 would not have happened. In other words, macroeconomic conditions in 2009 would have played out much like the consensus of economists expected in mid-2008—nothing special.

But let’s say I’m wrong, what then?

1.  A sharp drop in demand for credit due to the real estate crash. Note that “demand” is a misleading term, as some of the drop comes from tighter lending standards. This drop in demand for credit would sharply reduce real interest rates in the US, which would reduce the value of the dollar in forex markets.

2.  The lower real interest rate would tend to boost consumption, business investment (including infrastructure), and the lower dollar would boost exports. However another factor (what Tyler Cowen calls “we’re not as rich as we thought we were”) would reduce consumption. The wealth loss comes from the housing crash and an adverse move in the terms of trade (higher oil prices.) Net effect: business investment and exports rise, residential investment falls, and consumption is ambiguous.

3.  There are also cross currents in the labor market. The loss of wealth would increase labor supply, boosting employment. But the re-allocation out of housing construction lowers employment.  Net effect is ambiguous.

4.  The rising oil prices and weak productivity would reduce real wage growth. The RGDP/P split from 5% NGDP growth would be modestly less favorable than normal. Maybe a couple years of 1.5% RGDP growth and 3.5% inflation. If Europe had a severe recession despite sound US policy, then that would make the RGDP/P split even more unfavorable.

PS.  Tyler Cowen has a recent post discussing how capital controls might be able to prevent an overheated economy.  In my view NGDP targeting is the best way to prevent “overheating.”  Real overheating is not much of a problem.  As long as nominal national income continues to grow on trend, the labor market will stay close to equilibrium.

Always focus on the labor market.  Keep that in equilibrium and the free market can handle the rest.

PPS.  Lars Christensen has an excellent new post pointing that that devaluations caused by monetary stimulus tend to boost output by stimulating domestic demand, not net exports.  If I had more time I’d do a post.  BTW, I’ll be busy for the next week, and will have very little time to answer comments.  I will get to them eventually.

The substance of DeLong’s complaint about my column and post appears to be that they lack supporting documentation. I asserted (thinking it self-evident) that many Republicans are thoughtful and public-spirited. DeLong is incredulous and finds it revealing that I failed to give examples. I also accused Krugman of letting partisan politics taint his analysis and said he cared as much about undoing the Bush tax cuts as about expanding and extending the fiscal stimulus. At this, DeLong is aghast. He demands to see my evidence.

Will this do? From Krugman’s column, Let’s Not Make a Deal, in December 2010.

Back in 2001, former President George W. Bush pulled a fast one. He wanted to enact an irresponsible tax cut, largely for the benefit of the wealthiest Americans. But there were Senate rules in place designed to prevent that kind of irresponsibility. So Mr. Bush evaded the rules by making the tax cut temporary, with the whole thing scheduled to expire on the last day of 2010.

The plan, of course, was to come back later and make the thing permanent, never mind the impact on the deficit. But that never happened. And so here we are, with 2010 almost over and nothing resolved.

Democrats have tried to push a compromise: let tax cuts for the wealthy expire, but extend tax cuts for the middle class. Republicans, however, are having none of it. They have been filibustering Democratic attempts to separate tax cuts that mainly benefit a tiny group of wealthy Americans from those that mainly help the middle class. It’s all or nothing, they say: all the Bush tax cuts must be extended. What should Democrats do?

The answer is that they should just say no. If GOP intransigence means that taxes rise at the end of this month, so be it.

Krugman proposed raising taxes on all Americans while the recovery was still very weak. He recognized this as a fiscal tightening that would put people out of work. He advocated it because the alternative of retaining the Bush tax cuts would have handed the Republicans a victory, and because — get this — he was worried about the long-term deficit implications. There you have it: Krugman the apolitical Keynesian.

Isn’t putting ideology ahead of pragmatism exactly what Paul Krugman accuses those fools and knaves on the GOP side of doing?  Why yes it is.

Am I (and others on my side of the issue) that much smarter than everyone else? No. The key to understanding this is that the anti-Keynesian position is, in essence, political. It’s driven by hostility to active government policy and, in many cases, hostility to any intellectual approach that might make room for government policy. Too many influential people just don’t want to believe that we’re facing the kind of economic crisis we are actually facing.

In many ways Krugman’s position is even less defensible.  At least those on the right claim to believe that fiscal stimulus won’t help the unemployed.  (And I for one really believe that.)  Krugman thinks it will help, but is willing to put his annoyance at the rich paying too little in taxes ahead of the well-being of the unemployed.

Keynesian bloggers are constantly whining about fiscal austerity in America.  But most of the austerity came from the tax increase bill that President Obama signed December.  I opposed the bill.

PS.  I presume that Brad DeLong opposes the effort of a number of GOP senators to reform the immigration laws.  After all, there are no examples of public-spirited behavior by the GOP.

PPS.  Someone sent me an investment report from a British financial firm that has a market monetarist approach to the BoE.  In the previous post I linked to a similar report from Lars Christensen.  It seems that MM is making inroads into the investment community.

HT:  Caroline Baum

Each day I check out the major stock markets.  This morning I saw that Hong Kong and Singapore were down over 1%.  Britain, Germany and France were also down.  But the Japanese market, which tends to move with the other Asian markets, was up by 1.90%.  That’s a surprisingly large divergence.  Is there any news?  It turns out that there is news, but only if you don’t believe in “liquidity traps.”  Travis Allison sent me the following:

The yen slumped to the lowest in more than six months against the dollar on prospects Japanese elections next month will hand power to an opposition party that advocates more aggressive monetary easing.

.   .   .

Japan’s currency weakened to almost a two-week low versus the euro on speculation the vote will favor Shinzo Abe, who called for the central bank to provide unlimited stimulus.

.   .   .

The yen dropped 1.4 percent to 81.39 per dollar at 8:47 a.m. New York time, after touching 81.46, the weakest level since April 25. It depreciated 1.7 percent to 103.92 per euro.

.  .  .

“The biggest economic problem is prolonged deflation and a strong yen,” Abe, the head of the largest opposition Liberal Democratic Party, said in a speech in Tokyo today. “Markets will only start to react once unlimited monetary easing is conducted.”

Of course if you are one of those Keynesians who do believe in liquidity traps, then you’d have to conclude that this speech had no impact on the Japanese exchange rate, or the Japanese stock market.

And if you believe in liquidity traps then you also must believe that the fact that the Swiss franc has been stable at 1.20 per euro for the past 14 months is just an amazing coincidence, having nothing to do with the fact that in September 2011 the Swiss government announced a policy of pegging the SF at 1.20 per euro.

And yet if you read the economics blogosphere you’ll find one economist after another prattling on about how monetary policy is ineffective at the zero bound.  Outside of the blogosphere it’s even worse, even though our best-selling monetary textbooks say that view is wrong.

BTW, the yen fell to 101.6 today.  Back when I wrote that post the Nikkei rose from 8665 to 8830.  Today it rose another 416 points to 14,607.  Up 68.6% since the Abe speech.  How many Keynesian bloggers were on the story from day one?

Yes, they are also doing a bit of the same fiscal stimulus that failed miserably over the past 20 years, producing the worst AD performance in modern world history as the debt ballooned to over 200% of GDP.  Keep in mind that almost all of the stock price increases have been on news of monetary stimulus and/or a falling yen.  Also keep in mind that monetary stimulus depreciates a currency and fiscal stimulus appreciates a currency.

PS.  Abe was wrong about one thing.  Markets start reacting when “unlimited monetary easing” is anticipated, not when it is conducted.

PPS.  Of course stock markets outside of Japan are plunging, as they steal jobs from America and Germany with their beggar-thy-neighbor policies.  Oh wait . . .

Update:  Even more evidence on Japan from Lars Christensen.  And although my belief in the EMH leads me to wimp out on market predictions, Lars Christensen is less inhibited (and hence much richer.)  His predictions from last year are looking pretty good right now.

A former student of mine named Garrett MacDonald read my entire blog over the winter break between semesters.  And he actually wrote summaries of about 300 posts.  I include the link here, an case anyone wants to skim them in search of a particular post.  I hope to better organize my blog this summer.

I only recently found out about his marathon reading session, and asked him if he noticed any pattern.  In my view the blog has gotten worse over time; when I go back and look at the earlier posts I feel like I’ve lost a step.  The earlier ones seem more thoughtful.  Baseball players max out at age 27.  I’m not sure about bloggers, but it’s clearly younger than 57 (my current age.)

Garrett had a much higher opinion of my blog than I do—he didn’t see any deterioration.  Since he was so positive, I thought I’d include his overall appraisal, even though I think he’s being too kind:

You asked me what I thought of your blog on the whole, so I decided to go through the notes I took over winter break while reading through your posts and here are my main conclusions:

1.       The best thing about your blog is that when you make an argument you back it up in several different ways. You explain the economic theory behind what you’re saying, show how your point is logically consistent, use thought experiments and metaphors to illustrate your ideas, and finally, connect your argument to events in economic history. This last step is the most important to me. You’ve made several posts over the years connecting 2008 to 1929 and 1937 and showing how similar policy mistakes led to similar economic results. Nuanced analysis of economic history with applications to the present is sorely lacking in many sources of opinion on the internet.

2.       I think you’ve really benefited from the diversity of commentary you’ve received over the years. I’m sure it’s been tiring to dismantle the same arguments again and again but by defending your views from so many attacks it really drives the points you’re trying to make home. It also helps to flesh out your posts as people who disagree try to poke holes in your arguments.

3.       Finally, the thing I respect most about you as an intellectual is your consistency. All your ideas and positions on issues are congruent with one another. From your affection for Richard Rorty, to your thoughts on economic development, to what you think fairness in taxation would look like, to politics, to monetary economics, your blog is cohesive in a way that many others in the blogosphere cannot hope to match.

PS. You’ve done a pretty good job over the years of making Krugman, DeLong and a few other bloggers look pretty bad at times. I’m sure this was never really your intention but their posts always felt sloppy to me after reading your stuff. This is especially true during the little skirmishes you all have had. Your position came out looking like the best researched and articulated every time.

BTW, totally unrelated to Garrett’s views on my blog, in my 32 years of teaching he is probably the student who is best qualified to be an investment manager.  Whenever I try to defend the EMH with him, he always blows me out of the water with counterexamples.  He has an uncanny ability to see the bias in other investors.  And yet he also has a healthy respect for market efficiency.  That’s the right balance.

PS.  Now let’s balance this post with some negative overall appraisals in the comment section.  Geoff?

The number of Americans filing new claims for unemployment benefits dropped to its lowest level in nearly 5-1/2 years last week, signaling labor market resilience in the face of fiscal austerity.

On the other hand, Matt Yglesias points out that most pragmatic economists are at least partly Keynesian:

A meta-point that is a little underappreciated here is that private sector macroeconomists all use models that embed broadly “Keynesian” assumptions about the behavior of the economy. Government economists at the OMB and CBO do it too, but they’re really just following the lead of what you would find at any bank or consultancy. Obviously that doesn’t prove that these models are correct—in fact that record of forecasting accuracy isn’t stellar—but I don’t hear much from anti-Keynesian types about why their preferred models have failed the market test.

If I were going to treat Yglesias the way he recently treated Alex Tabarrok, I’d say he’s attacking a strawman.  But Yglesias (and Tabarrok) obviously understand the opposing argument.  Nonetheless I find many people do misunderstand what “monetary offset” is all about.

It’s quite possible to write down a model where, ceteris paribus, fiscal austerity reduces output, and monetary stimulus (such as the recent actions of the Fed) raise output.  You can call that model “Keynesian,” and attach a positive multiplier to fiscal policy if it makes you feel good.  But what matters are counterfactuals.  And if more fiscal stimulus leads to less monetary stimulus (as the Fed claims!), then the fiscal multiplier estimates will be nearly worthless.  This is a subtle game theory problem, which as far as I can tell hasn’t even been considered by many Keynesian economists.

One can talk all one wants about Keynesian forecasters predicting that fiscal austerity would have a sharp contractionary impact in 2013.  But the fact of the matter is that the consensus forecast for 2013 from all these supposedly Keynesian economists was about the same as for 2012, despite a much higher level of fiscal austerity in 2013.

By the way, the real “market test” isn’t what forecasters think, it’s what markets think.  And as I’ve pointed out numerous times, the markets are market monetarist.

PS.  Here’s the sort of slowdown expected by The Economist:

Yes, this could still happen.  Market monetarism says fiscal stimulus estimates are nothing more than estimates of central bank incompetence.  And central banks are far from perfect.  But I continue to believe that 2% RGDP growth should be the baseline forecast for 2013.  Now we’ll just have to wait and see just how incompetent the Fed actually is.

Here’s an interview I did this morning (May 8) with Tom Keene and Michael McKee.

And from last week an interview with my colleague Aaron Jackson, and also Marvin Goodfriend of Carnegie Mellon.

In its efforts to get banks lending again, the ECB is looking at excess reserves — some 120 billion euros ($157 billion) the banks have been holding on deposit at the central bank for safekeeping. If the ECB were to introduce a negative interest rate on deposits, effectively charging a fee, the banks might choose to lend the money out rather than watch it lose value.

This logic is far from ironclad. Instead of lending the money to businesses and individuals, the banks could simply park it elsewhere — for example, in the sovereign bonds of Germany and other countries perceived to be financially healthy. This might benefit Germany by further pushing down its borrowing costs, but would do little to unblock credit to businesses.

This is actually an argument in favor of negative interest on reserves.  One common fear expressed by monetary stimulus opponents is that the major central banks will artificially inflate another credit bubble.  Thus an ideal monetary stimulus would be neutral—boosting NGDP without favoring the lending channel.  I think Greene is right that the initial effect of negative IOR would be for banks to buy government bonds.  This means that banks would essentially be doing “QE.”  Why is that better than the ECB doing QE?  It’s not clear it is, although some people worry about the bloated balance sheets of the major central banks, and negative IOR would greatly reduce that “problem.”

Of course all this is a sideshow, as what’s really needed is NGDP targeting.  Here’s Greene:

Even if the ECB could encourage banks to lend, though, that doesn’t mean businesses will borrow. The primary issue in the euro area isn’t the cost of funding. The main problem is that few businesses want to borrow at any cost. According to a recent ECB study on access to financing in the euro area, “finding customers” is the No. 1 concern for businesses in the region. If businesses are worried about demand, they will not seek loans to grow.

Exactly.  BTW, several commenters asked me about the Danish program of negative IOR.  That was not aimed at monetary stimulus (their currency is pegged to the euro, making stimulus almost impossible), but rather at arresting an inflow of hot money.  The Swiss have enacted similar policies on occasion.

If the Danes want to stimulate their economy they need to copy the Swiss, and devalue.

PS.  Some have tried to make a contrarian argument that pushing IOR below zero is somehow contractionary.   I’m not buying (after all, it reduces demand for the MOA), and neither are the markets:

The euro immediately slumped against the U.S. dollar after Draghi’s statement.

All this comes out clearly in Krugman´s May 6 column for the NYT, but I want to be specific in my comment, so I´ll concentrate on one of his favorite arguments, and show it´s misleadingly wrong. Krugman writes:

F.D.R. cut back sharply in 1937, plunging America into recession; the Recovery Act had its peak effect in 2010, and has since faded away, a fade that has been a major reason for a slow recovery.

Wow! In 1937 real government purchases recoiled 4.2% and the economy tanked. In 2012 real government purchases were 4.8% below the 2010 level and the recovery is slow!

Surely something is going on that´s making comparable ‘fiscal austerity’ so much less damning in 2012 than in 1937.

And that ‘something’ is monetary policy.

Brad DeLong, an economist at the University of California, Berkeley, has posted a long list of conservative attacks on Keynes that have used his homosexuality as a reason to reject his economic theories. But even economists who had no interest in this aspect of Keynes’s life, like the economist James Buchanan, have criticized Keynesian economics for its excessively short-term focus and negative long-run consequences.

Unfortunately, Keynes himself was to a large extent responsible for giving this criticism of his work currency. That is because he titled his most important work “The General Theory of Employment, Interest and Money.” The term “general theory” obviously implies that it is applicable at all times, in all economic situations.

This was an unfortunate error, because the core insight of Keynesian economics is that there are very special economic circumstances in which the general rules of economics don’t apply and are, in fact, counterproductive.

This happens when interest rates and inflation are so low that there is no essential difference between money and bonds; money, after all, is simply a bond that pays no interest. When this happens, monetary policy becomes impotent; an increase in the money supply has no stimulative effect because it does not lead to additional spending by consumers or businesses.

This is interesting.  Both John Hicks and Milton Friedman also thought the liquidity trap was the core insight of the General Theory.  In Friedman’s case, perhaps I should say the core “idea,” as he didn’t think much of the concept.  But Keynes himself actually thought his theory was much more general, and so do many of his followers (who like to quote Keynes’s statement that it is unlikely that there has ever been a case of absolute liquidity preference.)

I think Hicks and Friedman were right and Keynes was wrong.  Keynes certainly saw the impact of FDR’s dollar depreciation policy of 1933.  When FDR finally gave in to pressure from people like Keynes, and stopped devaluing the dollar, Keynes congratulated him for ignoring the advice of the “extreme inflationists.”  Keynes once said that the only monetary regime that was worse than a pure gold standard was a pure fiat money regime.  That’s the real reason Keynes worried about monetary policy ineffectiveness at the zero bound; he opposed what Lars Svensson calls the one foolproof escape technique—devaluing as much as it takes to generate higher inflation rates.

Bartlett continues:

Keynes called this situation a “liquidity trap.” Under such circumstances, government spending can be highly stimulative because it causes money that is sitting idle in bank reserves or savings accounts to circulate and become mobilized through consumption or investment. Thus monetary policy becomes effective once again.

This is an extremely important insight that policy makers have yet to grasp, even though interest rates on Treasury bills are just a couple of basis points above zero and inflation is virtually nonexistent.

Here I think that Bartlett has things exactly backward.  I believe most policymakers do agree with Keynes and Bartlett, i.e. they wrongly believe that monetary policy is ineffective at the zero bound.  That’s why it took the Japanese 20 years to even attempt a policy of inflation.  That’s why New York Fed President Dudley now says that Fed policy was too tight in 2009, but wasn’t saying that in 2009.  That’s why the non-German European governments haven’t been pressuring the ECB to boost NGDP.  That’s why Ed Balls opposes a higher inflation target for the BoE.

In the 1930s FDR knew how to debase a currency.  Modern policymakers seem to have forgotten how, and thus embarked on a long and fruitless detour into the morass of fiscal stimulus.

HT:  Caroline Baum

PS.  I may be on Bloomberg radio (Boston) tomorrow morning around 9am.