If You Are Looking for a Monument to John Hicks, Look Around You!
8/19/09 12:38 PM
Grasping Reality with Both Hands The Semi-Daily Journal of Economist Brad DeLong: A Fair, Balanced, RealityBased, and More than Two-Handed Look at the World J. Bradford DeLong, Department of Economics, U.C. Berkeley #3880, Berkeley, CA 94720-3880; 925 708 0467; delong@econ.berkeley.edu. Weblog Home Page Weblog Archives Econ 115: 20th Century Economic History Econ 211: Economic History Seminar Economics Should-Reads Political Economy Should-Reads Politics and Elections Should-Reads Hot on Google Blogsearch Hot on Google Brad DeLong's Egregious Moderation August 13, 2009
If You Are Looking for a Monument to John Hicks, Look Around You! Pro Growth Liberal accuses me of burying the lead: EconoSpeak: Why Deficits Have Not Increased Interest Rates: Brad DeLong Makes Me Go Huh?: Brad DeLong makes an interesting observation: it is astonishing. Between last summer and the end of this year the U.S. Treasury will expand its marketable debt liabilities by $2.5 trillion--an amount equal to more than 20% of all equities in America, an amount equal to 8% of all traded dollar-denominated securities. And yet the market has swallowed it all without a burp... If Brad wanted to mock the standard new classical belief that we are always near full employment so any significant fiscal stimulus would drive up interest rates, this observation would be a nice rebuttal along the lines of the old fashion Keynesian notions that we are both below full employment and are in a liquidity trap... Well, yes, that is what I do want to mock (and make a couple of other points alongside). So let me be more explicit: Last fall I had a large number of conversations with bond market observers who said things like: "Interest rates are low now, but look at how much the Treasury is going to borrow over the next eighteen months. When those borrowings hit the market, Treasury bond prices are going to fall bigtime and interest rates rise. At the moment bond prices are high and interest rates are low, but that's only because finance firms' top management aren't letting traders off their leash to short Treasuries. The traders all expect Treasury prices to fall and interest rates to rise. Mark my words: when the Treasury tries to sell all those bonds next http://delong.typepad.com/sdj/2009/08/if-you-are-looking-for-a-monument-to-john-hicks-look-around-you.html
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If You Are Looking for a Monument to John Hicks, Look Around You!
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rates to rise. Mark my words: when the Treasury tries to sell all those bonds next year, it won't find buyers at anything near current prices. Where will all the extra savings to buy those bonds come from?..." As I wrote: [S]upply-and-demand are supposed to rule--and a sharp increase in Treasury borrowings is supposed to carry a sharp increase in interest rates along with it to crowd out other forms of interest sensitive spending. Yet:
Hasn't happened. Hasn't happened at all:
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If You Are Looking for a Monument to John Hicks, Look Around You!
8/19/09 12:38 PM
It is astonishing. Between last summer and the end of this year the U.S. Treasury will expand its marketable debt liabilities by $2.5 trillion--an amount equal to more than 20% of all equities in America, an amount equal to 8% of all traded dollar-denominated securities. And yet the market has swallowed it all without a burp... And the interesting thing is that I knew that this was going to be what would happen--or, rather, I strongly believed that this was going to be what would happen-and all because I had read John Hicks (1937). Let me give you the Hicksian argument about what happens in a financial crisis--a sudden flight to safety that greatly raises interest rate spreads, and as a result diminishes firms' desires to sell bonds to raise capital for expansion and at the same time leads individuals to wish to save more and spend less on consumer goods as they, too, try to hunker down. In Hicks's model, the immediate consequence is an excess demand for (safe) bonds in the hands of investment banks: bond prices rise, and interest rates falls. As interest rates fall, (a) firms see that they can get capital on more attractive terms adn so seek to issue more bonds, and (b) households see the interest rate they can get on their savings fall, and so lose some of their desire to save. The market heads toward equilibrium. But as the market heads toward equilibrium, something else happens as well: the fall in interest rates and the rise in savings is accompanied by a greater desire on the part of households and businesses to hold more of their wealth safely--in pure cash. And so the speed with which cash turns over in the economy, the velocity of money, falls. And as the velocity of money falls, total spending falls, and workers are fired, and as workers are fired and lose their incomes their saving goes from positive to negative. Thus the process of return to equilibrium takes two forms: interest rates fall, boosting investment and curbing savings. http://delong.typepad.com/sdj/2009/08/if-you-are-looking-for-a-monument-to-john-hicks-look-around-you.html
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If You Are Looking for a Monument to John Hicks, Look Around You!
8/19/09 12:38 PM
spending and thus employment and production fall, further curbing savings. In normal times, the correct policy response is for the Federal Reserve to inject more money into the economy: through open-market operations it should buy bonds for cash, thus increasing the amount of cash so that even at the lower velocity we still have the same volume of spending, and thus transform the adjustment process from a fall in interest rates, spending, employment, and production to a fall in interest rates alone. A little thought, however, will lead us to the conclusion that such open-market operations may fail. In them, the Federal Reserve is buying bonds, shrinking the supply of bonds out there--and thus pushing up their price and pushing down interest rates. For each amount that the Federal Reserve expands the money stock, therefore, it puts downward pressure on interest rates and thus on monetary velocity. In the limit where interest rates are so low that people don't really see a difference between cash and short-term government bonds like Treasury bills, openmarket operations have no effect because they simply swap one zero-yielding government asset for another. It is in this situation that a government deficit can be useful. A government deficit means that the government is printing and issuing a lot of bonds at exactly the same moment that private investors are looking for a safe asset to hold. As these bonds hit the market, people who otherwise would have socked their money away in cash-thus diminishing monetary velocity and slowing spending--buy the bonds instead. A large and timely government deficit thus short-circuits the adjustment mechanism, and avoids the collapse in monetary velocity that was the source of all the trouble. Thus a Hicksian analysis last fall would have said--did say--"don't worry: a large flood of government bond issues won't push up interest rates; it will stem a collapse in monetary velocity instead as people who want to hold their wealth in safe form and would otherwise be holding money find themselves happy holding government bonds instead." And it has all come true. Lector, si requiris monumentum Hickium, circumspice! RECOMMENDED (5.0) by 2 people like you [ How? ] You might like:
The U.S. Can Sell Bonds. Boy! Can the U.S. Sell Bonds!(this site) Why Deficits Have Not Increased Interest Rates: Brad DeLong Makes Me Go Huh?(EconoSpeak) 2 more recommended posts Âť Brad DeLong on August 13, 2009 at 06:22 PM in Economics, Economics: Federal Reserve, Economics: Finance, Economics: Fiscal Policy, Economics: Macro | Permalink
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If You Are Looking for a Monument to John Hicks, Look Around You!
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Comments You can follow this conversation by subscribing to the comment feed for this post. Well put! Posted by: pgl | August 13, 2009 at 06:30 PM This can't go on forever. They are going to run out of people with savings, worldwide, to buy the bonds. Posted by: Nancy Kirsch | August 13, 2009 at 06:43 PM What interests me is that the fiscal policy skeptics like Tyler Cowen and Greg Mankiw who had endless posts on the subject several months ago are silent now. Posted by: Phil P | August 13, 2009 at 06:49 PM i agree with pgl - this is well put - but i don't think we should let it go by without noting that there's a good argument that the world (in particular, the prc) thinks we're too big to fail. Posted by: howard | August 13, 2009 at 07:55 PM So far so good. Only 29 years and 364 days left to go on those 30 year bonds the folks bought today. But I'm sure John Hicks' model demonstrates that it is reasonable to buy these bonds and hold to maturity, right? Personally, I hope somebody who can afford to lose 80% of their money bought all those 30 year bonds. Somebody like Ben Bernanke or Goldman Sachs or the PRC. Oh, wait, John Hicks says it was my grandma who bought all those bonds because my grandma has a preference for a safe place to put her cash, but she needs some yield. Oops. Fortunately my grandma is part of an efficient market, so she has perfect information. Or else her broker who is working 100% in her best interest will get her out before the price goes down. Posted by: albrt | August 13, 2009 at 08:25 PM I have rarely seen economists explaining their trade so clearly, and I have always believed that "please excuse, this is going to be wonkish" is just an excuse for being lazy. Posted by: Keynesian | August 14, 2009 at 12:34 AM So what? Government spending does not replace consumer spending, remember Brad's postulate about government goods being a direct substitute for consumer goods? Hicks works only to the extent that the consumer is not satisfied (he does not get a government substitute for consumer goods). Basically Brad shows the economies that reach a sudden constraint revert to serfdom (or fix the constraint). The Hicks analysis says a lot about the unconscious history of money being derived from feudalism more than anything else. Posted by: Mattyoung | August 14, 2009 at 02:40 AM "Megan McArdle’s Hypocrisy Exposed: Portrait Of A Libertarian As A Taxpayer-Subsidized Brat" http://exiledonline.com/megan-mcardles-hypocrisy-exposed-portrait-of-a-libertarian-as-ataxpayer-subsidized-brat/ http://delong.typepad.com/sdj/2009/08/if-you-are-looking-for-a-monument-to-john-hicks-look-around-you.html
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taxpayer-subsidized-brat/ "Just when you think you’ve seen so much hypocrisy that nothing can shock you, along comes Megan McArdle. McArdle, who blogs for the Atlantic Monthly, presents herself as a principled libertarian, fiercely denouncing any attempt to provide any sort of government-funded health care, because as she argues, big government is bad, bad, bad. She’s written some truly appalling things over the years as a shill for big corporate interests, recently defending Goldman Sachs because, as she wrote, “financial meltdowns offer no villains.”" "Last week, McArdle posted an encyclopedia-length article on the Atlantic Monthly’s site, denouncing Obama’s health care plan in a rambling piece that essentially boiled down to this: big government is a bad thing, and free markets are the medicine you need, even if you don’t like it, and even though you can’t afford it. McArdle’s post sparked a series of smackdowns, including Ezra Klein in the Washington Post, and Jane Hamsher at Firedoglake." "What Megan McArdle doesn’t mention is that her own privileged upbringing was funded by public money. That’s right, Megan McArdle is just a second-generation product of the sleazy NYC construction business, which has been using public money for private gain since the Tammany Hall era. Even more galling is that Megan’s father got his start in the public sector working in taxpayer-funded health care programs. If it weren’t for her father’s employment as a public health care official in the 1970s, Megan McArdle’s life might have turned out completely different from the privileged one she enjoyed." "Megan McArdle is the daughter of one Francis X. McArdle, who built his career as a public servant in the New York City administration, then moved over to the private side, where he could leverage his contacts with the government — and finally moved back onto the public payroll in 2006, when Mr. McArdle was appointed by then-Sen. Hillary Clinton to advise the federal government how public funds should be spent, and on whom. Earlier this year, Mr. McArdle was reportedly in Albany lobbying the New York state government for a job as the “stimulus czar,” appropriating President Obama’s federal spending money." Posted by: Tom Jackson | August 14, 2009 at 02:51 AM Very well put and explained. thanks Brad Posted by: erik | August 14, 2009 at 03:46 AM Excellent post. Plus if the deficit spending is going to the states to keep them from cutting workers, projects and spending or to worker training, health care, unemployment benefits and income supplements to those at the bottom of the ladder (with the highest spending velocity) the spending can act directly on velocity in the short run. Posted by: bakho | August 14, 2009 at 04:57 AM What does Mr. Hicks say about the desired eventuality of a recovery when interest rates should rise and the majority of the debt issued by the government matures within a few years of that recovery? Or do we have to have a pepetual crisis in order for this financing regime to maintain equilibrium? This is of critical importance as we are told that the recovery is nigh. Posted by: Neal | August 14, 2009 at 05:42 AM Matt Young, got to love him. His whole interest rate are rising! screaming has collapsed and now he changes course to show even less understnading of macro. Posted by: Rob | August 14, 2009 at 06:29 AM Despite a debt-to-GDP ratio in excess of 100%, the Bank of Japan never lost the ability to set the key overnight interest rate, which has remained below 1% for about a decade. And, the debt http://delong.typepad.com/sdj/2009/08/if-you-are-looking-for-a-monument-to-john-hicks-look-around-you.html
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the key overnight interest rate, which has remained below 1% for about a decade. And, the debt didn't drive long-term rates higher either. The chart below shows that rates on 10-yr government bonds trended sharply downward as Japan's public sector debt exploded... The prediction about what will happen to U.S. interest rates as a consequence of the Obama stimulus package are based on a faulty understanding of the relationship between deficit spending, bank reserves and interest rates. The Japanese experience serves as prime example of his flawed logic. Read more here: http://neweconomicperspectives.blogspot.com/2009/06/will-run-up-in-government-debtdoom-us_17.html Posted by: Economist | August 14, 2009 at 08:31 AM If Brad Delong had kept up with John Hick's more recent writings he would have read J.R. Hicks "ISLM : An Explanation", JOURNAL OF POST KEYNESIAN ECONOMICS, Winter 1980-81 issue, where Hicks indicates that over time he became completely dissatisfied with ISLM framework he developed in 1937. In this "ISLM:AN EXPLANATION" article Hicks completely recants on the ISLM apparatus and indicates that the ISLM framework has nothing to do with Keynes or reality. Too bad Brad is wedded to the classical efficient market hypothesis and has never been able to understand the ontological uncertainty involved in the concept of a nonergodic stochastic process that was the basis of Keynes's general thoery and which Hicks ultimately claimed that "nonergodic"system was the same as his own analysis. Paul Posted by: Paul Davidson | August 14, 2009 at 09:27 AM Interest rates are not just driven by increases in public sector borrowing but the combination of public AND private sector borrowing. The private sector isn't borrowing because the economy is bad, indeed the private sector is de-leveraging, so in that light there is no reason for rates on Treasuries to rise. Posted by: David68 | August 14, 2009 at 02:01 PM Since you know what I'm getting at, I'll be brief. Since Oct., I've been advocating the Chicago Plan of 1933. I supported QE plus a reinforcing Stimulus. My disagreement about the Stimulus with others was that I wanted a Sales Tax Holiday. About QE, I said that, in order for it to work, short term interest rates should stay very low, but longer term rates should go up. I suggested that 4% for 10 yr t's was perfect. When it got to that point, I heard that Hyper-Inflation was coming. I argued that, on the contrary, it showed that QE was working. From my perspective, in order to counter Debt-Deflation ( The Flight to Safety ), you want short term rates low, as a disincentive, and longer term rates higher, to encourage lending for the future. If they're too low, it won't work as an incentive. I see businesses as needing to sell bonds for loans, meaning that interest rates cannot be too low. As well, you needed the spreads to come down, otherwise corporate rates would be too high for borrowing. As near as I can tell, this is working. I would have liked more QE, and a little more Stimulus as well. Nevertheless, it's working. But I see this as confirming Fisher's view of Debt-Deflation, and as confirming the Chicago Plan of 1933. I guess that the difference with Hicks boils down to this: In The Flight to Safety, people are buying Treasuries not based on the Interest, but on the Govt Guarantee. This is shown by the movement out of Agencies and into Treasuries. In my opinion, they would buy even negative rate bonds. In fact, some investors, counting selling losses and other costs, did that. I need to see some evidence of China, for example, holding cash. Indeed, if they fear inflation going http://delong.typepad.com/sdj/2009/08/if-you-are-looking-for-a-monument-to-john-hicks-look-around-you.html
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see some evidence of China, for example, holding cash. Indeed, if they fear inflation going forward, they're accepting a loss when they buy the Treasuries. Don't they? Posted by: Don the libertarian Democrat | August 14, 2009 at 02:52 PM "(b) households see the interest rate they can get on their savings fall, and so lose some of their desire to save." Actually, what you see is households with savings losing their ability to spend. That's been the story for the past two or three years. Posted by: Kaleberg | August 14, 2009 at 04:44 PM
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