Former economist Greg Mankiw has taken up the job of arguing for the benefits of a negative real interest rate – meaning, essentially, that I pay you to borrow my money. This should be brought about, he suggests, by lighting the blue touch-paper of gargantuan monetary inflation. Peter Schiff was polite enough yesterday to call such an analysis “foolish,” which rather understates the economic illiteracy of what Mankiw is proposing here – not to mention the immorality. And as Robert Murphy pointed out a few weeks back in The Nuttiness of Negative Interest Rates
It is no coincidence that Mankiw's worldview leads him to literally propose destroying the currency in order to fix the economy. That alone should have set off warning bells. As a general rule, if your economic model pops out the result "Randomly burn a tenth of the cash every year," then you should think some more about the model rather than fire off an article to the New York Times.
And it’s not just economically illiterate, which is supposed to be Mankiw’s field, it’s historically dyslexic. After painting himself into a corner economically, Mankiw now compounds the problems by maintaining that history is also on the side of such a position: that “a commitment to producing a moderate amount of inflation would be the modern equivalent” of the abandonment of the Gold Standard at the front end of the Great Depression, something he calls “the most useful thing that the federal government did to get the country out of the Great Depression.”
But that’s just not true at all. Did abandoning the Gold Standard get the country of the Great Depression? Answer: no, it didn’t. As Robert Murphy points out in his new book, The Politically Incorrect Guide to the Great Depression and the New Deal,
this hostility to the gold standard is misplaced. Before we delve into the economic theory, just consider the brute historical facts: In prior US depressions (or "panics"), when the US dollar was tied to gold, the country began to recover typically within about two years. In contrast, it wasn't until the governments of the world all abandoned gold, that the entire world was mired in the worst downturn in history, and for a decade to boot!
If it were really true that it was the gold standard holding the US in Depression, then surely, say, five years after FDR severed the link, the economy should have been humming, right? But the official unemployment statistics (and note these BLS figures don't count people receiving WPA checks as having a real job) record that in 1938--five years into the New Deal--the unemployment rate averaged 19%. So when people tout how great things were for the US economy once we ditched gold, keep that in mind. Yes, 19% is lower than 25% (the rate in 1933), but to repeat, in all prior US history, a depression would have been long gone five years after the trough.
Mankiw used to be an economist. He used to be a scholar. He‘s now become a hack. As Murphy explains if you read on, “the high unemployment of the early 1930s [was not] the fault of the gold standard. No, the blame rests squarely on government policies (and support for unions) that kept wage rates above their free market levels.” Remember, if you will, what Professor Mankiw has apparently forgotten: that amongst other meddling Herbert Hoover did all he could to keep wages and prices up, ensuring that recovery was all but impossible. It wasn’t being tied to gold that strangled recovery – among other things, it was tying prices and wages to economic unreality.
By contrast, do you remember the ‘Great Depression’ of 1920-21? No? The reason is there wasn’t one, because when employment dropped to 11%, wages and prices were allowed to fall, and recovery kicked off again. And this, Professor Mankiw, was under a gold standard. It didn’t take massive monetary inflation to escape the slump – just fiscal discipline and letting the markets work.
- For the full understanding, I recommend reading both Murphy’s latest post:
UPDATE: Several people who still believe in tying theory to reality have commented on Mankiw’s “negative interest rate” baloney:
- Charles Anthony says : “This is effectively proposing that the Fed steals your money. Great policy proposal. Sounds like a bad joke to me… I have a feeling that Greg Mankiw also has a secret formula for turning lead into gold”
- Mike Shedlock (aka Mish) says it’s Time for Mankiw to Resign: “Both Mankiw and [Paul] Krugman have their economic models and they stick with them no matter how silly those models look in the real world… I am wondering how long it will be before the words ‘since the great depression are replaced by the single word ‘ever’… Such is the sad state of economic teaching at our universities.”
- Says Greg Ransom in Bob Murphy on Greg Mankiw’s Macro: “It’s rather telling that Greg Mankiw has no answer to the main substance of Robert Murphy’s takedown of Mankiw’s overall macreconomic vision. Instead, Mankiw fires his giant Harvard guns on an issue that was recognized long ago by economists without need of the unreal mathematical machinery of ‘new Keynesian analysis’. . . Murphy challenges Mankiw on the empirical facts here and here. Note also that Mankiw gets Murphy’s position wrong.”
- David Kendall reckons “even a careful thinker like Greg Mankiw shouldn't be left alone to think too long all by himself. . . When will Mankiw, Bernanke, Geithner, and all the rest of the really, really smart economists figure out that interest rates are prices and that meddling with prices has consequences? Some of us dumber economists already know that.”
- Save Capitalism awards Mankiw The Red Badge of Stupidity.
- Rajesh at the Objective Extrospection blog, in a point I very much enjoyed, says Mankiw’s proposal is A Union of Keynes and Kant “It is not surprising that the proposal of literally destroying currency comes from an American professor of one of the leading universities. An economics professor is the ultimate union of Kant and Keynes. Kant laid the foundation for the destruction of human mind and Keynes followed closely with his own recipe for the destruction of the capitalism.”
- Says The Liberal Order, “Mankiw fails to address Murphy’s argument. The gist of what Murphy is arguing is not the classical paradigm purporting perfectly efficient markets and instantaneous market clearing. Instead, Murphy is arguing that
1) the FED policies of the past, which Mankiw professes will bring the U.S. economy out of the current recession, were at least partly responsible for getting us into this mess in the first place;
2) that markets need to recover from the sectoral imbalances caused (at least largely) by FED policies in addition to other poor investment decisions;
3) that this recovery is effectuated through changes in prices and interest rates;
4) that markets do this naturally and manipulation of either prices or interest rates by the FED or the government undermine this process; and
5) that the Keynesian AD theory fails to understand and/or appreciate the complex nature of markets. Consequently, Mankiw's prescription is not only bad policy, it is according to Murphy, bad economics.
The way I read Murphy is not that markets rapidly clear, but that the sectoral imbalances take time to run their course. . . “
- And finally, the Saver Dollar blog says simply, “I don’t know what other evidence people need to realize that the US dollar is doomed.”