A slightly off-center perspective on monetary problems.
I’ve always found it interesting that the quantity equation (M*V=P*Y) is linked to the quantity theory of money. Obviously there is no logical relationship between the two, as one is almost always defined as an identity, while the other is a theory. But there certainly is a perception that the two are somehow linked.
I wasn’t invited to participate, but since I have a blog I’ll put in my 2 cents worth anyway. In my view both sides of the debate are wrong. I disagree with pundits like DeLong, Krugman and Skidelsky, who have used this crisis to argue that mainstream macroeconomics is fundamentally flawed. Of course there are a few things I’d like to tweak, NGDP targeting rather than inflation targeting, for instance, but the basic building blocks of modern macro are sound. These include the need for explicit nominal targets for monetary policy, an assumption of efficient markets, and skepticism about using fiscal stimulus as a countercyclical tool. But what this crisis did clearly demonstrate is that most mainstream economists, indeed nearly all of them, do not know how to apply these tools to a real world crisis.
For months I have been arguing that if only the Fed had pumped enough money into the economy to keep expected NGDP growth at around 5%, then we would be back where we were in mid-2008. As you may recall, in mid-2008 we had already had nearly 2 years of orderly contraction of the housing industry. Because growth in other sectors took up the slack, unemployment remained in the mid-5% range, only slightly above the normal rate. So we weren’t doing that bad. Then the Fed adopted a highly contractionary monetary policy (see Hetzel’s discussion of what they did wrong) and NGDP starting falling fast. And now we have 9.4% unemployment, and a mind-bogglingly large fiscal deficit as the government futilely tries to stop the recession with deficit spending.
A few months ago I got into a series of arguments with some old-style Keynesians who kept insisting that monetary policy is ineffective once nominal rates hit zero. “Period. End of story.” I kept trying to explain that unconventional monetary policy could still be highly effective; the problem was that we needed to be much more aggressive. I pointed to FDR’s currency devaluation in1933 as an example of how an aggressive monetary policy could boost NGDP rapidly, even with interest rates near zero and much of the banking system shut down for months.
My post on supply and demand produced a lot of good comments, but none better than this one from Michael:
I can relate to this. I’m getting my Ph.D. in economics I feel that with every passing year I am even less confident about answering seemingly simple questions.
I also find that this specific topic makes it incredibly frustrating as a TA to grade work for intro undergrad courses. Some professors expect it to be “obvious” that if the price is lower, quantity has gone up due to the law of demand, and this is the answer they judge to be correct, whereas others are trying to weed out the students who understand that you cannot make a statement about quantity solely based on an observed change in the market price. Quantity could’ve gone up, down, or stayed the same.
I find myself explaining to students, “well, the answer for THIS professor is …” Students do not find professor-specific explanations to be very satisfactory.
Not very satisfactory? What’s wrong with the young these days, do they expect everything to be handed to them on a silver platter? I mulled over everything I learned in econ, and then accepted or rejected it on the basis of whether it made sense to me. But I guess if you’ve been reading my blog you already noticed that.
