Two Visions of Macro

There seem to be two approaches to macro policy, once interest rates hit the zero bound:

1.  The pessimistic view: In this view, monetary policy can do no more.  Trade balances become a zero sum game.  The US gains from some (not all) contractionary policies adopted by other countries, such as currency revaluation.  If China sharply revalues its currency, it may cost millions of jobs in China, and hurt countries that export materials and machines to China, but it will boost jobs here.  It might not be accurate to claim this is a zero sum game view of the world, but it comes pretty close.  (By the way, I used the term ’sharply revalue’, as I think a gradual revaluation is in China’s own interest.)

2.  The optimistic view: Even at the zero bound monetary policy is still the most important factor driving NGDP growth.  It’s not a zero sum game.  A sharp Chinese revaluation might reduce world AD.  A dramatic easing by the Fed would not just depreciate the dollar against goods and services, it would sharply raise world AD, and world RGDP if there is slack in labor markets.  This could easily help overseas firms, even in countries whose currencies might rise a bit against the dollar.  In this view, you don’t look for jobs by trying to take them away from other countries, even countries that might be “misbehaving” according to some sort of arbitrary “rules of the game” that never did and never will exist, but rather you try to generate jobs in your own country by boosting your own AD.

Check out this recent news story—I could have found 100 similar ones over the last month (in case anyone thinks I’m cherry-picking.)

LONDON (AP) — World markets mostly rose Thursday as investors remained buoyed by the prospect of more monetary stimulus from the Federal Reserve. However, predictions of looser U.S. policy have not done the dollar any good as it slid to a 15-year low against the yen and multi-month troughs against the euro and the pound.

.   .   .

Once again the main focus in the markets is on what the Fed is planning to do at its next rate-setting meeting in early November to shore up the U.S. economy and prevent prices from falling. The minutes to the last meeting of the Federal Open Market Committee gave a big hint that the Fed is planning another monetary stimulus, that could involve the setting of an inflation target.

All eyes will be on Fed chairman Ben Bernanke Friday when he delivers a speech on monetary policy, more or less at the same time as monthly inflation figures are set to show price pressures in the U.S. economy remain subdued.

Analysts said it’s no longer a question of if but how and how much money the Fed will pump into the U.S. economy.

Stocks have been buoyant for over a week as investors have priced in the growing likelihood that the Fed would join the Bank of Japan in easing monetary policy further in an attempt to further drive down rates on mortgages, corporate loans and other debt in the ultimate hope of boosting economic activity and supporting prices.

For those who don’t follow world equity markets, the strong stock market rally since September 1 that most are attributing in large part to growing expectations of Fed easing, has been mirrored in the major overseas markets.  Yet a “beggar-thy-neighbor” view of economics would predict that foreign firms should be hurt if the US depreciates the dollar.

After my most recent defense of the EMH, some commenters asked me incredulously whether I really thought investors understood complex economic models as well as the model builders, who are some of the smartest people around.  You misunderstood my argument.  I’m not saying markets are as smart as elite macroeconomists, I’m saying they are much smarter.  Individual investors are often dumb as door knobs, but collectively they understand how the world works even better than some Nobel Prize-winning economists.

That’s why 1000 people can look at a jar of jelly beans and individually not have a clue as to how many there are.  But collectively they know the right answer.  It’s all about the wisdom of crowds.

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