“You want more NGDP? Well why didn’t you say so!” (What Krugman doesn’t get about Barro/Fama/Cochrane)

I’m not sure whether I should be amused or frustrated by watching a Nobel Prize winner (and two people who didn’t win, but deserved to) talk past each other for two years.  Their misunderstanding is blindingly obvious, but I don’t ever see any acknowledgement.  As you know, two years ago Paul Krugman accused Eugene Fama and John Cochrane of not understanding the most basic principles of macroeconomics, the fact that fiscal stimulus can boost AD, and thus boost the level of output when there is economic slack.

And Paul Krugman keeps making this charge over and over again, despite the fact that it is clearly false (at least for Cochrane and Barro, and probably Fama as well.)  It’s true that you can cherry pick quotations that make it seem like the three deny the possible that fiscal stimulus can work, almost as a matter of logic.  If that was their entire argument, then it would be shockingly uninformed.  But both Cochrane and Barro clearly indicate that they are holding nominal aggregates constant, i.e. any shortfall in NGDP would presumably be fixed by printing money, leaving no role for fiscal stimulus.  Of course that’s also my argument, yet I do believe fiscal stimulus might be able to boost NGDP, because I don’t believe (as a matter of logic) that the Fed would necessarily create the right amount of money.  (I’m skeptical of fiscal stimulus for “likely Fed response” reasons, not as a matter of logic.)

It’s actually really simple to prove my point, as Krugman criticized a Fama and Cochrane article, and Eugene Fama links to the same Cochrane article, and also a Barro article for support.  So what do Barro and Cochrane say in their articles that Fama cites with approval?  Here’s Robert Barro:

John Maynard Keynes thought that the problem lay with wages and prices that were stuck at excessive levels. But this problem could be readily fixed by expansionary monetary policy, enough of which will mean that wages and prices do not have to fall. So, something deeper must be involved — but economists have not come up with explanations, such as incomplete information, for multipliers above one.

And here’s John Cochrane:

My first fallacy was “where does the money come from?” Well, suppose the Government could borrow money from people or banks who are pathologically sitting on cash, but are willing to take Treasury debt instead.  Suppose the government could direct that money to people who are willing to keep spending it on consumption or lend it to companies who will spend it on investment goods. Then overall demand for goods and services could increase, as overall demand for money decreases.  This is the argument for fiscal stimulus because “the banks are sitting on reserves and won’t lend them out” or “liquidity trap.” 

In this analysis, fiscal stimulus is a roundabout way of avoiding monetary policy. If money demand increases dramatically but money supply does not, we get a recession and deflation. If we want to hold two months of purchases as money rather than one months’s worth, and if the government does not increase the money supply, then the price of goods and services must fall until the money we do have covers two months of expenditure. People try to get more money by spending less on goods and services, so until prices fall, we get a recession. This is a common and sensible analysis of the early stages of the great depression. Demand for money skyrocketed, but the Fed was unwilling or, under the Gold standard, unable, to increase supply. 

This is not a convincing analysis of the present situation however. We may have the high money demand, but we do not face any constraints on supply. Yes, money holdings have jumped spectacularly. Bank excess reserves in particular (essentially checking accounts that banks hold at the Federal Reserve) have increased from $2 billion in August to $847 billion in January. However, our Federal Reserve can create as much more money as anyone might desire and more. There is about $10 trillion of Treasury debt still outstanding. The Fed can buy it. There are trillions more of high quality agency, private debt, and foreign debt outstanding. The Fed can buy that too. We do not need to send a blank check to, say, Illinois’ beloved Governor Blagojevich to spend on “shovel-ready” projects, in an attempt to reduce overall money demand. If money demand-induced deflation is the problem, money supply is the answer. 

Some people say “you can’t run monetary policy with interest rates near zero.” This is false. The fact of low interest rates does not stop the Fed from simply buying trillions of debt and thereby introducing trillions of cash dollars into the economy. Our Federal Reserve understands this fact with crystal clarity. It calls this step “quantitative easing.” If Fed ignorance of this possibility was the problem in 1932, that problem does not face us now.

So they are both basically saying; “Of course if the problem is nominal, then monetary policy can fix it much more easily.  But I don’t think it’s nominal.  And if we hold nominal spending constant, fiscal policy can’t fix it.”  And that’s true, even within the Keynesian model. Fiscal stimulus can do nothing if the Fed has got NGDP where it wants it.

[BTW, Barro's claim that Keynes assumed prices were sticky is a side issue.  I think Barro is right, but even if wrong it doesn't invalidate his argument at all.  Keynes certainly assumed higher NGDP was a necessary condition for fiscal stimulus to work.]

Needless to say I think Barro and Cochrane are wrong about the need for monetary stimulus, but it’s really rather sad when people like Krugman and Brad DeLong keep insisting that these guys don’t understand basic macro principles.  Krugman and DeLong are both very bright, and they have access to the same information I just presented to you.  Why do they ignore it?

Of course I don’t know for sure that Fama was using the same implicit assumption as Cochrane and Barro.  But earlier in the article Cochrane made the fiscal policy can’t work argument without the stable NGDP qualifier, so I think it quite likely that Fama was also cutting corners. 

Lots of brilliant people talking past each other.  Lacking a common language for communication.  Welcome to elite macroeconomics, circa 2011. 

The right doesn’t think we need more NGDP and the left doesn’t understand that the Fed is our only realistic hope for more NGDP.  Welcome to elite macroeconomics, circa 2011.

If I was going to assign blame I’d single out Krugman/DeLong for rudeness and Fama/Cochrane for poor communication skills.  But of course I have no business attacking such distinguished economists.

PS.  I’ve avoided talking about the debt ceiling thus far, partly because I don’t know much about it, partly because these things always seem to get resolved at the last minute, but mostly because the whole idea of a debt ceiling seems incredibly stupid.  This morning when I woke up up the first thing I heard was that the Gang of Six had agreed to massive spending cuts, abolition of the hated AMT, and reduction of the top rate to between 23-29%.  Oh, and a slash in the corporate top rate too.  I thought I was dreaming.  Surely this is too good to be true!  And then I heard that Obama endorsed the plan.  Now I knew I was dreaming.  Then I heard that it wouldn’t pass because of GOP opposition in the House.  Ouch, I was brutally shaken out of my reverie.  If only life could be like our dreams.  Unfortunately, there’s always the House GOP to keep it real.


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61 Responses to ““You want more NGDP? Well why didn’t you say so!” (What Krugman doesn’t get about Barro/Fama/Cochrane)”

  1. Gravatar of Benjamin Cole Benjamin Cole
    20. July 2011 at 16:18

    I understand and even concur with the current right-wing sentiment against more federal spending (although, where were they during Reagan, Bush and Bush jr?).

    It is a little alarming to see the GOP speak only of entitlements, and never, ever about defense spending. (Especially since entitlements are largely money taxed away, but then given back to the taxpayers. When I pay taxes that go into a federal civilian or military agency, it is eaten there and converted into coprolite, or larded upon the gaggle of grifters attached thereto.)

    That said, the right-wing has gone nuts and conflated federal spending with Fed stimulus. Or worse–some right-wing economic commentators, I suspect, know we need Fed stimulus, but want the economy to fail, so that Obama will fail.

    This is new-age GOP patriotism, in which partisanship trumps the commonweal.

    The Dems seem clueless–worse, even President Obama seems clueless.

    I can’t understand a Krugman at least saying, “Okay, let’s give NGDP targeting a major whirl. If it works, then great.” Krugman could even add, “Even if NGDP targeting works, I still want oodles of welfare spending.” Fine, that is a view he can defend.

    How bad has partisanship gotten: Former GOP Senator Chuck Hagel, a one-time US Marine, said R-Party Senators would not have authorized Clinton to invade Iraq after 9/11–but they would authorize Bush. So even war becomes a political football.

    Quite a statement. I just hope Bernanke decides to chuck politics and do what is right.

  2. Gravatar of Benjamin Cole Benjamin Cole
    20. July 2011 at 16:34

    BTW, Cochrane was the guy downing $350 bottles of wine with Paul Ryan. Does Cochrane, or the University of Chicago, get money from right-wing groups? Does that compromise his academic integrity?

  3. Gravatar of John Thacker John Thacker
    20. July 2011 at 16:55

    “Former GOP Senator Chuck Hagel, a one-time US Marine, said R-Party Senators would not have authorized Clinton to invade Iraq after 9/11–but they would authorize Bush. So even war becomes a political football.”

    And have you seen the votes on Libya? Jim McDermott, of all people, spoke in favor of continuing funding for the war in Libya.

  4. Gravatar of PJ PJ
    20. July 2011 at 17:22

    Fabulous post. This was my favorite part:

    “Lots of brilliant people talking past each other.  Lacking a common language for communication.  Welcome to elite macroeconomics, circa 2011.”

    I have often wondered if macro has really made much progress. This summarizes why it is hard to tell.

    Wouldn’t it be great if they would instead talk about why we do or don’t need more NGDP? And by the way, would most elite macroeconomists agree that the fed has that much influence over NGDP?

  5. Gravatar of Scott Sumner Scott Sumner
    20. July 2011 at 17:56

    Benjamin, I have no doubt that John Cochrane believes what he says, no need to worry about fancy bottles of wine.

    John, Yes, I’ve noticed that sort of thing as well.

    PJ, Hard to say, as I would define “elite” as people who do understand the Fed drives NGDP. But more seriously, this crisis has really shaken my views on what my colleagues think. I no longer know what to believe. Someone recently produced a set of statements by Blinder completely contradicting himself on monetary policy.

  6. Gravatar of Morgan Warstler Morgan Warstler
    20. July 2011 at 18:06

    Scott Sumner 2.0 is much improved.

    “The right doesn’t think we need more NGDP and the left doesn’t understand that the Fed is our only realistic hope for more NGDP. Welcome to elite macroeconomics, circa 2011.”

    This is ALMOST exactly correct. And you should keep repeating it over and over and over.

    The part you are missing is that the right WILL THINK we need more NGDP the moment that we are considered “in charge” of the economy.

    Until we get the credit, no soup for you! And to be fair, we deserve the credit.

    —–

    The debt ceiling is great.

    The WHOLE point is that the tax changes have to be tax neutral, but be expected to cause GROWTH.

    We are going to get the easy fake cuts off the table first and then talk about tax policy changes.

  7. Gravatar of Lee Kelly Lee Kelly
    20. July 2011 at 18:12

    Cochrane explains,

    [An excess demand for money] is a common and sensible analysis of the early stages of the great depression. Demand for money skyrocketed, but the Fed was unwilling or, under the Gold standard, unable, to increase supply.

    So far, so good. He then goes onto claim,

    This is not a convincing analysis of the present situation however. We may have the high money demand, but we do not face any constraints on supply.

    Cochrane just explained how the Great Depression was caused by an excess demand for money which the Fed was either unable or unwilling to resolve. If the present situation is different then he Fed must be able and willing to increase the money supply now, right? However, Cochrane only addresses the Fed’s ability to do monetary policy. He neglects to explain why his second condition, willingness, actually holds in the present situation.

    It seems to me the Fed is unwilling to do more expansionary policy (not just OMOs, but signaling future NGDP or inflation). I don’t know why, exactly.

  8. Gravatar of JTapp JTapp
    20. July 2011 at 18:19

    I made a Hayekian argument for raising the debt ceiling on my blog, and managed to mention Scott in the process. Tyler Cowen linked to it yesterday, biggest honor in 6 years worth of blogging. (But he links to a lot…)

    Scott, I just saw this report from the NY Fed reposted at Calculated Risk discussing future policy action, including how they forsee unwinding affecting interest rates. Might be worth checking out.

  9. Gravatar of anon anon
    20. July 2011 at 18:52

    Prof. Sumner,

    This is off-topic, but since you’ve identified as a neoliberal before: what do you think about the debate between Matt Yglesias and others re: the sustainability of neoliberal policy? Is it the case as Yglesias’ opponents state, that policies need to be supported by a special-interest constituency if they are to be enduring? To what extent does this argue against neoliberalism?

  10. Gravatar of TGGP TGGP
    20. July 2011 at 18:56

    I think Fama specializes in finance and doesn’t have much of a macro background. And in his “addendum” post he merely said Cochrane & Barro happened to come to similar conclusions, rather than that his thinking was based on their work.

    A different Cochrane argument I thought was terrible.

  11. Gravatar of Morgan Warstler Morgan Warstler
    20. July 2011 at 19:21

    anon, as I keep saying…

    Matty’s LOGIC on barbers IMMEDIATELY supports an end to Public Employee Unions.

    After all, the policy of TRUE progressives isn’t high wages for government workers, the goal of TRUE progressives is proving government is frugal – as in it makes the same annual productivity gains as the private sector.

    1. When people are happy with what they get for their tax $, they’ll want to buy more of it.

    2. When you reduce costs of delivery (lower public employee labor costs), more $ flows to the poorest and weakest – less friction, more good cause.

    BUT, Matty’s readership occurs SIGNIFICANTLY during day-time hours from the .GOV domain, soooooooooooooooo….

    Everything he says is bullshit. Barbers! is just his unlearned psyche not full grasping the impact of the logic.

    He’s young. By the time he’s Robert’s Reich’s age, he’ll understand how to tow the line.

  12. Gravatar of anon anon
    20. July 2011 at 19:38

    Morgan Warstler, I agree that the issues are logically similar. Moreover, I suspect that both Yglesias and his opponents understand this quite well, at least on some level. But note that some very neoliberal countries such as Denmark have strong unions.

    Nevertheless, my admittedly limited understanding is that “unions” in Europe tend to be more like mutual aid organizations, providing assorted services and including unemployed folks and workers in non-unionized shops as part of their membership. They are not pure interest groups.

  13. Gravatar of onliberty onliberty
    20. July 2011 at 19:58

    Three things.

    1) Krugman is always rude and insulting and talks past people as a matter of principle. He doesn’t care at all what others *really* have to say. He only cares about advancing his political ideology, so no matter what other people say, he simply says what he always says. No nuance, no consideration, no tact, no respect.

    2) Fiscal stimulus doesn’t work. Bastiat refuted that entire idea before Keynes was even born. It’s just that fiscal stimulus is very politician-friendly.

    3) Greg Mankiw and Matthew Weinzierl’s paper on optimal stabilization policy was awesome. Monetary policy should be our first, second, third and fourth options.

  14. Gravatar of onliberty onliberty
    20. July 2011 at 20:26

    “Nevertheless, my admittedly limited understanding is that ‘unions’ in Europe tend to be more like mutual aid organizations, providing assorted services and including unemployed folks and workers in non-unionized shops as part of their membership. They are not pure interest groups.”

    Based on my understanding, I think this is an accurate description. Unions in many European nations, especially Northern Europe, seem to have overcome the game-theory problem.

    First of all, they have fiscal citizenship, so the incentive to cheat on the system is mitigated. In other words, unions don’t act as selectorates seeking only to siphon off for themselves any benefits that taxpayers may fund.

    For some reason, in these nations, unions and citizens in general recognize that the really can achieve the optimal outcome if they decide to cooperate and ignore their own, personal, dominate strategy. I honestly think it’s remarkable.

    Of course this is only one idea based on nothing more than casual observation and wondering why American and European capitalist markets are so different yet both are largely successful.

    Unions are a necessary part of the fabric of their system, while here they just cause problems. There, it’s a cooperative and symbiotic relationship between unions and the state, and here it’s simply adversarial.

    Of course, Mancur Olsen’s book the Rise and Decline of Nations is perhaps the most fascinating book ever written on this topic and he would probably disagree with what I just said.

    Oops got waaay off topic. Sorry.

  15. Gravatar of John John
    20. July 2011 at 20:28

    Scott, it seems right now we have NGDP growth over 5%. Last I checked, inflation was 3.6 and GDP growth was 1.9. It’s possible I get how you argue we’d be fine today if the Fed had consistently maintained 5% NGDP growth, but since they didn’t, should they shoot higher now? It doesn’t seem like anyone’s too happy with 3% inflation and 2% real GDP growth.

  16. Gravatar of Morgan Warstler Morgan Warstler
    20. July 2011 at 20:44

    Europe is a new United States, where monetary union is forcing them into state budget constraint heretofore unimaginable. There are all becoming Republicans.

    Humans don’t share well – especially when they have no historical or cultural ties to each other.

    Long before Europe gets a political union, the US will devolve back to state rights – it is right around the corner.

    But we all ought to peg our currencies – after all, we have free trade agreements.

    Public employee unions here in the states are doomed. We internet startup guys will soon get a taste of automating GOV2.0, and the young earners will be SOLIDLY be forever against SEIU etc.

    We’ll do to the public sector what we did to the private sector.

    Matty truly does NOT understand this. I think deep down he has no idea what productivity gains are really about.

    Actually, I don’t even think Scott, or most any professor yet understands what productivity gains are about.

    College will be free when you buy a new TV. Your drivers license, paycheck, credit card, social security card, tax returns and cash will all reside on super cheap smart phones.

    That’s about when the leaders of the C power (the bottom 90%) will finally understand what 4-5% annual productivity gains really means.

  17. Gravatar of Morgan Warstler Morgan Warstler
    20. July 2011 at 21:09

    Scott,

    To make slight improvements on Sumner2.0, I’m going to suggest that in 1:7 of your posts you go small government, something like this:

    http://online.wsj.com/article/SB10001424053111903554904576457752586269450.html

    I’d prefer it be close to 1:3, or 1:2, but I get that you feel out of your comfort zone when more than a head-nod towards libertarian solutions are necessary.

    Fox News / Fox Business News has to be able to have you on air.

  18. Gravatar of Dustin Dustin
    20. July 2011 at 21:50

    John, we don’t have NGDP over 5% right now.

    They figure out the current dollar value of the whole economy – NGDP – and then they use price indexes to deflate it and figure an estimate for RGDP (inflation adjusted GDP).

    You can’t then take that RGDP and slap on the CPI and come up with a new NGDP, if that’s what you’re doing.

  19. Gravatar of Greg Ransom Greg Ransom
    21. July 2011 at 00:19

    The underlying “communication” problem is caused by the mathematical incompetence of Krugman & Cochrane, according to Stephen Williamson — any macro not “communicated” in some version of the Cass-Koopmans-Brock-Mirman-Kydland-Prescott neoclassical growth model is hopeless muddle, confusion, hand-waving, ambiguity, and chock with contradiction:

    http://newmonetarism.blogspot.com/2011/07/krugman-and-keynes-part-ii.html

    And, stipulates Williamson, with enough formal mathematical bells & whistles hung on it, a Cass-Koopmans-Brock-Mirman-Kydland-Prescott neoclassical growth model can represent EVERY explanatorially relevent aspect and causal mechanism needed to explain systematic discoordination in the economy.

    And anything that _can’t_ be communicated in such a math model, doesn’t exist and therefore has no explanatory significant.

    To exist is the be mathematically communicated.

    The exact equivalent of Wittgwnstein’s modeling/communication standard of existence found in the Tractatus.

    (A fatally flawed picture of reality, communication and science, as Wittgenstein, Kuhn, Popper, and Hayek showed us _long ago_.)

  20. Gravatar of Greg Ransom Greg Ransom
    21. July 2011 at 00:21

    Make that:

    To exist is to be mathematically communicated.

  21. Gravatar of Greg Ransom Greg Ransom
    21. July 2011 at 00:29

    The “to exist is to be communicated in a mathematical structure” is Kantian philosophy.

    Economists are always slaves to the philosophical tradition — to dead philosophers.

    I’m sure Williamson has no idea that he is merely attempting to force Kant down everyone’s throat — and his justification for that ultimately is no more sound than Kant’s own.

    The math certainly doesn’t fit the phenomena — in fact it falsifies it, and gives everyone a false picture of it. See Frydman & Goldberg’s new book for just a few examples.

  22. Gravatar of A. Carraro A. Carraro
    21. July 2011 at 04:13

    I agree Krugman raised a bit of a straw man arguement.

    He strongly critized fama for stating that for fiscal stimulus to work you require the gov to allocate resources more efficiently.

    And three sentences later he made the case that in certain circumstances (e.g. when perishable resources are left idle, read unemployment), almost any use is more productive than what the free market achieves.

    I guess your view would be that we can mobilize those resources more cheaply with monetary policy… Is that always true? Is the cost of monetary policy always zero? Bad monetary policy seems to have high cost.

  23. Gravatar of flow5 flow5
    21. July 2011 at 05:27

    Some people say “you can’t run monetary policy with interest rates near zero.”

    No, it’s more appropriate to say you can’t run monetary policy with interest rates period. And they give Nobel Prizes to the likes of Milton Friedman who advocated payment of interest on reserves, fabricated velocity, & preached that currency had an expansion coefficient.

  24. Gravatar of Daniel Molling Daniel Molling
    21. July 2011 at 05:39

    Scott,
    Did you read the Nick Rowe comments on the DeLong post defending Cochrane? It looks like he was way ahead of you. I didn’t see any reply from DeLong to the comments.

  25. Gravatar of Scott Sumner Scott Sumner
    21. July 2011 at 05:54

    Morgan, You said;

    “The part you are missing is that the right WILL THINK we need more NGDP the moment that we are considered “in charge” of the economy.”

    That’s a treasonous policy stance, but sadly, it’s probably true.

    Lee, He’d say the reason is that we don’t have deflation now, as we had in the 1930s.

    JTapp, That’s great, I’ll take a look.

    anon, Matt’s best argument is that his opponents offer no alternatives.

    Matt is saying we need to act with civic virtue. His opponents say we aren’t a virtuous society, so we shouldn’t even try to do the right thing–we should just fight for “our side” hoping that will lead to the right thing. But history shows it never works. All successful countries work together, rely on civic virtue.

    TGGP, I think those Chicago-types all think alike. My post title is sort of meant to be Fama’s reaction on having Krugman’s views fully explained. If Fama wanted to make a RBC argument, a nominal shocks don’t matter argument, then he should have done so. But he most certainly did not. He made an argument that only makes sense if you assume NGDP is fixed.

    onliberty, Yes, monetary policy is all we really have, everything else is illusion.

    anon and onliberty, Interesting observation on Northern European unions. If you are 70% unionized, the only way to get better off (realistically) is make your economy more efficient. If 10% unionized, you can try to steal from the other 90%.

    John, We have not had a single quarter of 5% NGDP growth since at least 2008, maybe earlier.

    I don’t know what they should do. One solution might be to shoot for 6% or 7% for two years, and then gradually slowdown. To be honest, at this point even 5% would be nice.

    Dustin, Yes, a lot of that inflation is imported oil not a part of our GDP.

    Greg, I agree with you on the math.

    A Carraro, The cost is near zero, and indeed the cost would be negative right now–we’d make a huge profit as monetary stimulus would reduce our budget deficit.

    flow5, Yes, it’s a mistake to try to run monetary policy with interest rates. And now we are paying the price.

  26. Gravatar of Scott Sumner Scott Sumner
    21. July 2011 at 05:56

    Daniel , Thanks. I actually did a similar post a couple years ago. I don’t know if Nick read my post. But it’s obvious to anyone with half a brain, and a fair mind, what’s going on. DeLong has much more than half a brain, he’s brilliant. But . . .

  27. Gravatar of flow5 flow5
    21. July 2011 at 06:01

    The “Chicago School” doesn’t represent monetarist’s doctrines. CB’s don’t loan out existing deposits, saved or otherwise. There has been an excessive reliance on the expansion of Reserve, & Commercial bank credit, to generate higher levels of NgDp. I.e., “the utilization of bank credit to finance real investment or government deficits doesn’t constitute a utilization of savings since bank financing is accomplished through the creation of new money”.

  28. Gravatar of flow5 flow5
    21. July 2011 at 06:05

    Unlike raising reserve ratios during 1936 & 1937, IOeRs induce dis-intermediation (an outflow of funds) from the non-bank financial institutions (e.g., MMMFs, commercial paper market, etc.).

    IOeRs compete with money market “paper” (the highly liquid, short-term, dealer funding market). The financial instruments traded in the money market include Treasury bills, commercial paper, banker’s acceptances, certificates of deposit, repurchase agreements (repos), municipal notes, federal funds, short-lived mortgage, and asset-backed securities & Euro-Dollar CDs.

    The money market is differentiated by its position on the yield curve (i.e., short-term borrowing & lending with original maturities within a one year period). I.e., IOeRs alter the construction of a normal yield curve, they INVERT the short-end segment of the YIELD CURVE –known as the money market.

    The money market collects & channels private savings thru the financial intermediaries (& rolls-over & refinances existing operations). The financial intermediaries include the Shadow Banks (“Paul McCulley of PIMCO’s non-bank investment conduits, vehicles, and structures”). In turn, the financial intermediaries invest their borrowings in longer-term, less liquid, earning assets (e.g., to the capital market – where money is provided for periods longer than a year).

    The non-banks are the most important lending sector in our economy — or pre-Great Recession, 82% of the lending market (Z.1 release, sectors, e.g., MMMFs, GSEs, etc.). Proper economic policy involves redirecting savings to the non-banks (the customers of the commercial banks). Doing so does not reduce the size of the CBs. Money flowing to the non-banks actually never leaves the CB system in the first place.

  29. Gravatar of nyd nyd
    21. July 2011 at 07:03

    Scott wrote, “We have not had a single quarter of 5% NGDP growth since at least 2008, maybe earlier.”

    q/q ar NGDP has averaged 3.95% from 3Q09 to 1Q11. Evidently in Sumner-world, there is a huge difference between 4% and 5% NGDP growth, even over a period as short as 18 months. Can you explain why this is?

  30. Gravatar of Benjamin Cole Benjamin Cole
    21. July 2011 at 08:12

    John Thacker-

    Even worse is the Dem prone-ness in the face of Afghanistan, which has every appearance of being a very expensive lost and bad cause.

    Who is a guy supposed to vote for?

  31. Gravatar of RGV RGV
    21. July 2011 at 10:00

    http://delong.typepad.com/sdj/2011/07/economists-views-of-fiscal-policy-retcon-department.html?utm_source=feedburner&utm_medium=feed&utm_campaign=Feed%3A+BradDelongsSemi-dailyJournal+%28Brad+DeLong%27s+Semi-Daily+Journal%29

    Delong’s response

  32. Gravatar of ssumner ssumner
    21. July 2011 at 11:28

    flow5; That’s a good point about IOR inverting the short end of the yield curve.

    Nyd; You said;

    “q/q ar NGDP has averaged 3.95% from 3Q09 to 1Q11. Evidently in Sumner-world, there is a huge difference between 4% and 5% NGDP growth, even over a period as short as 18 months. Can you explain why this is?”

    Don’t forget NGDP fell 3% between 2008:2 and 2009:2, that’s 8% below trend! And don’t forget I favor level targeting.

    To answer your question, no I don’t think 4% and 5% are very different.

    Thanks RGV.

  33. Gravatar of johnleemk johnleemk
    21. July 2011 at 11:42

    Scott,

    I know it’s not likely but your commentary on the debt crisis is so hilarious I hope you do a brief post on it at some point. Reminds me quite a bit of this Onion article, which kept me smiling for a good half hour after I read it: http://www.theonion.com/articles/congress-continues-debate-over-whether-or-not-nati,20977/

  34. Gravatar of brian brian
    21. July 2011 at 12:33

    Scott,

    If you dig more into the Gang of six plan you begin to see that most of what you hope for in the plan is a mirage:

    http://keithhennessey.com/2011/07/20/understanding-the-gang-of-six-plan/

  35. Gravatar of Justin R. Justin R.
    21. July 2011 at 14:15

    Scott, thought experiment: say Bernanke comes to you today and promises that even though he can’t take further expansionary monetary policy due to political pressures, he would not counter inflation from a fiscal expansion. Would you the support fiscal stimulus as a second best alternative?

  36. Gravatar of Bababooey Bababooey
    21. July 2011 at 14:48

    It makes as much sense to follow the day-to-day budget proposals as to follow trade rumors in baseball: might as well wait til something happens.

    But I do it for fun, so let me point out a few things. The Gang of Six plan is a Senate budget resolution, not a bill, which means:

    1. The House GOP doesn’t have anything to do with passing it.

    2. None of its tax proposals force Senate Finance Committee to adopt any particular policy (e.g., “Require the Finance Committee to report tax reform within six months that would deliver real deficit savings by broadening the tax base, lowering tax rates, and generating economic growth…”

    3. Its spending cuts are proposals that Senators can freely ignore (e.g., “Require committees to report legislation within six months that would deliver real deficit savings in entitlement programs over 10 years…”).

    4. Like all the other plans, it games CBO scoring to produce a fake accomplishment (e.g., “Slash our nation’s deficits by $3.7 trillion/$3.6 trillion over ten years under CBO’s March 2011 baseline”).

    5. None of this gets accomplished anytime soon, so the “plan” is a “resolution” that some other people do stuff. If you’re the House GOP do you toss your own plan in the trash for Democratic Senate plan that resolves to do stuff?

    To be fair, the proposal includes procedural rules that encourage the enactment of its recommendations, just like a smoker or dieter’s sets up rewards and punishments to further their resolution. They are similarly enforceable.

  37. Gravatar of Bababooey Bababooey
    21. July 2011 at 14:56

    I should add that the Ryan Plan doesn’t use CBO scoring, it uses “current policy” and the Administrations plan uses both (or neither, take your pick). AMT illustrates the difference.

    The Gang of Six make the AMT “patch” permanent (not “abolition of the hated AMT”) and credit themselves with a huge tax cut because the CBO baseline follows the law, which has the patch expiring on 12/31/11.

    The Ryan plan also makes the AMT “patch” permanent, but doesn’t score a tax cut because its baseline is Congress’s “current policy”, which is a patch every year. The Ryan plan imports flim flam elsewhere. For example it uses a 5% GDP growth rate justified because of the plan’s sheer awesomeness or Ryan’s dreamy eyes, I forgot which.

  38. Gravatar of Morgan Warstler Morgan Warstler
    21. July 2011 at 17:44

    Scott, I think I’ve figured out one of your basic mistakes. It is an easy fix though, so, good news!

    America is not a virtuous society.

    BECAUSE we are not a single country, we are 50 UNIQUE efforts at virtue. We are NOT America, we are the the United States.

    Matty’s weak argument is that we’re all sure, we all agree on what is virtuous enough to force all 50 states to abide what the majority vote for.

    You of course understand the glory of monetary union without fiscal union is that it FORCES the bad shitty states to brutally adapt and behave correctly or DIE.

    Monetary union without political union speeds up CHANGE. It speeds up human development.

    STATES’ RIGHTS is the utilitarian political strategy. it is to quote a gifted sage, “the free market version of Democracy.”

    It is a mathematical fact.

    It is the basic premise of Direct Marketing: test everything.

    Glad to help!

  39. Gravatar of TheMoneyIllusion » DeLong compounds his error by going after Lucas TheMoneyIllusion » DeLong compounds his error by going after Lucas
    21. July 2011 at 17:56

    [...] a reply to my recent post on miscommunication among the macro elite, Brad DeLong misinterprets my argument, confusing nominal [...]

  40. Gravatar of Taryn H. Taryn H.
    21. July 2011 at 18:08

    Blindingly obvious? You may be correct in your analysis, I’m not seeing that it’s blindly obvious.

    You state: But both Cochrane and Barro clearly indicate that they are holding nominal aggregates constant, i.e. any shortfall in NGDP would presumably be fixed by printing money, leaving no role for fiscal stimulus.

    OK, are you saying that they’re saying that fiscal stimulus could work, but there’s no reason for it because they’re assuming any NGDP shortfall would be fixed by printing money?

    But why all the “crowding out” arguments? Why not just argue for monetary policy over fiscal policy?

  41. Gravatar of Full Employment Hawk Full Employment Hawk
    21. July 2011 at 18:28

    I think that the positions of Barro, Cochrane, and Fama are sufficiently different that each has to be treated separately. Fama clearly shows a total misunderstanding of macroeconomics.

    Fama summarizes his posititon as follows:

    Again, here is my argument in three sentences.
    1.Bailouts and stimulus plans must be financed.
    2.If the financing takes the form of additional government debt, the added debt displaces other uses of the same funds.
    3.Thus, stimulus plans only enhance incomes when they move resources from less productive to more productive uses.
    Are any of these statements incorrect?

    Fama’s argument is valid if, and only if, the economy is at potential output. But when the economy is depressed, Proposition 3 is false because Proposition 2 is false.

    Fama assumes that the supply of loanable funds is fixed, so that the borrowing for stimulus stimulus spending (and bailouts) uses up part of this fixed supply of loanable funds, leaving less loanable funds available to finance other expenditures. This is a basic misconception. Saving, which (in a closed economy) is the source of loanable funds increases with income. Therefore increases in income shifts the entire supply of loanable funds curve to the right.

    As a result, if the economy is depressed, so that output and income can increase in response to stimulus spending, the increases in stimulus spending increase output and income. This increased income increases the supply of loanable funds. As a result the loanable funds to finance the borrowing for the stimulus comes out of the increases in loanable funds brought about by the stimulus spending itself, and therefore the amount of loanable funds available for other spending is not reduced. In other words, when there are idle resources, the stimulus spending generates the additional loanable funds needed to finance it. As a matter of fact, the intest rate would not even have to increase at all if the increased income did not increase the demand for money(medium exchange, not credit). The same logic applies to bailouts.

    Therefore the argument Fama has presented is patently false. Nothing in the argument is based on the valid argument presented by you that if the Fed SUCCESSFULLY offsets the effects of changes in fiscal policy with offsetting changes in monetary policy fiscal policy has no effect on output. That is, in order for fiscal policy to have no effect, the Fed has to be both WILLING and ABLE to offset the fiscal policy. Supporters of fiscal polcicy can challenge either the WILLIN or ABLE, or both.

  42. Gravatar of Full Employment Hawk Full Employment Hawk
    21. July 2011 at 18:38

    “The part you are missing is that the right WILL THINK we need more NGDP the moment that we are considered “in charge” of the economy. Until we get the credit, no soup for you!”

    I appreciate Morgan’s candor. The reality we are facing is that the right and the Republicans are doing everything they can to make the unemployment rate as high as possible by Fall 2012. That is why quasi-monetarists like Scott cannot get any traction with the right. What Scott is advocating would bring the unemployment rate down, and that is just what the right does not want.

    The big mistake Obama and the Democrats are making is that they are not using this as a major political issue. Obama still seems to be under the illution that he can work together with the Republicans in a bipartisan manner to solve the nation’s problems and still does not seem to understand that the Republicans’ only interest is to make him fail.

  43. Gravatar of Full Employment Hawk Full Employment Hawk
    21. July 2011 at 18:59

    “The reality we are facing is that the right and the Republicans are doing everything they can to make the unemployment rate as high as possible by Fall 2012.”

    That also explains why the Republicans in the Senate will not let the Obama administration fill the vacancies on the BOG with people who take the Fed’s mandate to achieve maxiumum employment seriously. If this were done that would also bring the unemployment rate down by Fall 2012.

    On the other hand, the Obama administration is not even making an effort to fill the positions. They have not named candidates for the Republicans to obstruct so that recess appointments could be justified if the opportunity to do them should arise. Obama has been his own worst enemy.

  44. Gravatar of Jim the Water Cat Jim the Water Cat
    21. July 2011 at 19:17

    THis is a ridiculous thread, full of Greg Ransom’s uninformed rants and ridiculous discussions of NGDP. Nobody cares about nominal GDP — what we need is more real GDP. Seems like Sumner forgot his Principles of Macro, or he is being willfully stupid like Krugman and DeLong. Whereas Ransom is just an idiot.

  45. Gravatar of Jason Jason
    21. July 2011 at 20:06

    Scott, you said: “Of course I don’t know for sure that Fama was using the same implicit assumption as Cochrane and Barro. But earlier in the article Cochrane made the fiscal policy can’t work argument without the stable NGDP qualifier, so I think it quite likely that Fama was also cutting corners.”

    I think this may be the rub of Krugman’s attack. It is a very convenient assumption for people on the right to forget to mention prominently in criticizing the left since printing trillions of dollars is anathema to many factions on the right.

    In a sense the argument is government deficit spending is unnecessary because the Fed/Treasury will print trillions of dollars to offset the output gap.

    I don’t deny that the argument is correct. It just doesn’t sound like it would go over really well on the right.

    Taryn H. above makes a similar argument from the point of view of policy advocacy absent the politics.

    To make a lefty analogy, it would be like if Krugman was insisting on fiscal stimulus in a Keynesian framework while leaving off the fact that fiscal stimulus *only* works in the form of, say, tax cuts on the rich*. Fama could come back and say that Krugman doesn’t understand macro and that tax cuts would have to be only given to the rich or that tax cuts wouldn’t work.

    I think that is the problem.

    There is a side issue of deficit financed tax cuts being “Keynesian stimulus” that seems to add to a case that the whole thing is a little muddled at best and intentionally deceptive at worst.

    *For sake of argument.

  46. Gravatar of Morgan Warstler Morgan Warstler
    21. July 2011 at 21:06

    Inflation hawk,

    If Obama wanted to be re-elected, all he had to do was CUT payments to his base, like Clinton, take from the left, focus on balancing the budget…

    And the fed would have ridden to his rescue.

    —–

    This is a FACT. Greenspan gave Bill a choice, and Bill chose correctly.

    There will be no more “free shit for voting”

    Let me say it this way…. “maybe” you will understand. it will be hard, and since you haven’t heard it before, it likely won’t sink in, but I will try.

    If Republicans had spent ALL THE MONEY before LBJ got into office, we wouldn’t have the “safety net” we have now, and the US would be much farther along economically.

  47. Gravatar of Full Employment Hawk Full Employment Hawk
    22. July 2011 at 03:25

    “uninformed rants and ridiculous discussions of NGDP. Nobody cares about nominal GDP — what we need is more real GDP.”

    NGDP growth is the dynamic version of aggregate demand. And to get more real GDP we need more aggregate demand.

  48. Gravatar of Full Employment Hawk Full Employment Hawk
    22. July 2011 at 03:30

    “The reality we are facing is that the right and the Republicans are doing everything they can to make the unemployment rate as high as possible by Fall 2012.”

    This also explains why the Republicans kept Diamond from filling one of the vacancies on the BOG. Scott is right that Diamond was not a really good choice because he seems to subscribe to the view that what the Fed can do under current conditions is limited, but it would have tilted monetary policy somewhat more toward an expansionary policy.

  49. Gravatar of Full Employment Hawk Full Employment Hawk
    22. July 2011 at 03:44

    “and the US would be much farther along economically.”

    Morgan. There is a fundamental and unbridgable philosophical chasm between people who:

    1. Believe that society should be organized on a dog-eat-dog, everybody should have to sink or swim on their own, winner take all, and the devil take the hindmost basis.

    And people who believe that society should be based on:

    2. A caring, compassionate, we are all in this together basis.

    People on both sides of the chasm will never agree on public policy and the best they can do is to agree to disagree and discuss things amicably. I believe that I can learn a lot more by talking to people who disagree with me than by talking to people who agree with me.

    Obviously I am on side 2.

    I grew up in a blue collar household, my simpathy is with working people and the poor and I do not believe that an economy where a monied elite controls an inordinate share of the nation’s wealth while working people have to settle for crumbs and the poor live in misery would be farther along in being a good society. I do not believe that a high rate of growth in real GDP if it does not benefit the general public is a good thing.

  50. Gravatar of Full Employment Hawk Full Employment Hawk
    22. July 2011 at 03:51

    “And the fed would have ridden to his rescue.”

    I consider that higly doubtful. At least some of the Federal Reserve president like Plosser and Fisher show stong indications that they are participating in the Republican strategy of making Obama fail.

    A better strategy would have been to fill the vacancies on the BOG with full employment hawks P.D.Q.

  51. Gravatar of Full Employment Hawk Full Employment Hawk
    22. July 2011 at 03:53

    “If Republicans had spent ALL THE MONEY before LBJ got into office, we wouldn’t have the “safety net” we have now”

    I agree with the first part of that statement. The purpose of the Bush administration’s tax cuts that turned the surplus into a deficit was to starve the beast.

  52. Gravatar of Edwardo Baratto Edwardo Baratto
    22. July 2011 at 03:57

    (aber dabei nicht zu aufdringlich werden, sonst merken die im Notfall, dass bei dem Hinweisgeber etwas zu holen ist und werden ihrerseits dann im Notfall aufdringlich !!)

  53. Gravatar of Scott Sumner Scott Sumner
    22. July 2011 at 07:30

    johnleemk, The debt ceiling is so crazy that I have to assume that both sides want to do a grand deal. Obama could just ignore the GOP–they aren’t going to allow a default.

    Brian, Maybe, but there are ways to finesse that issue. You could do a two part deal, where the second debt ceiling extension requires movement on the tax changes. Remember, once the AMT is abolished, the Dems can’t bring it back without GOP support–which won’t happen.

    Justin, Yes, but he can’t make that commitment, because it isn’t clear what “doing nothing” is. The Fed sabotaged the first stimulus by doing nothing. Without that stimulus they would have done QE2 in 2009. We aren’t just talking about will or won’t they raise interest rates–it’s about the long term inflation target. Bernanke would have to say “if you do fiscal stimulus, I’ll get the Fed to agree to a higher long term fiscal stimulus.” Not likely, it would be completely irrational for the Fed to think that way.

    bababooey, Those are good points, but the plan says “Permanent repeal of the Alternative Minimum Tax.” Period.

    If you are right they are lying.

    Morgan, You said;

    “BECAUSE we are not a single country, we are 50 UNIQUE efforts at virtue. We are NOT America, we are the the United States.”

    Good point, which is why I’ve advocated splitting us up into 50 countries.

    Taryn, That’s why I said their argument was sloppy. They start by saying crowding out would occur, and they are implicitly holding NGDP fixed. Then they sort of say, “well I suppose it could change velocity, but monetary policy could do that more easily. Plus, if we have a NGDP shortfall causing unemployment, we should see deflation–and we don’t.”

    Full Employment Hawk, You said;

    “Fama’s argument is valid if, and only if, the economy is at potential output.”

    That’s not quite right, unless by potential you mean that more NGDP would not boost RGDP. Then I agree. But lots and lots of economists believe that’s true right now. A poll showed 36 out of 38 oppose more monetary stimulus.

    I’m not trying to defend Fama, he was sloppy. But Barro and Cochrane said very similar things, and then later added qualifying assumptions that made their false-sounding arguments true. Fama linked to those two articles. It certainly suggests he was looking at things the same way. But Fama did a very poor job of communication–no doubt about that. He’s not a macroeconomist.

    FEH, The GOP can’t stop Obama from getting people on the Fed. He can demand a Senate vote, and if they refuse do a recess appointment.

    Jason, You said;

    “In a sense the argument is government deficit spending is unnecessary because the Fed/Treasury will print trillions of dollars to offset the output gap.”

    They don’t have to print any more money. Indeed if they adopted a higher NGDP target, they’d probably have to reduce the monetary base.

    I don’t object to Krugman criticizing the right. But he’s basically calling them morons, even though it’s clear that most do understand the Keynesian model, they just don’t agree.

  54. Gravatar of nyd nyd
    22. July 2011 at 07:50

    “Don’t forget NGDP fell 3% between 2008:2 and 2009:2, that’s 8% below trend! And don’t forget I favor level targeting.”

    thank you for the response. a follow-up question (or two): do you expect NGDP to rise 5% pa in a recession?! or do you believe better monetary policy can prevent recessions?

    re level targeting: that would be very one-sided. is the fed ever going to allow deflation? nope. bretton woods experience is testament to that.

  55. Gravatar of Scott Sumner Scott Sumner
    22. July 2011 at 17:48

    nyd, I would hope NGDP would rise 5% in a recession, if the Fed is doing its job. Obviously they’ll miss on occasion, which is why level targeting is so important. With level targeting the markets help the Fed achieve its goal, as movements in velocity tend to be stabilizing.

  56. Gravatar of Full Employment Hawk Full Employment Hawk
    23. July 2011 at 17:20

    “Fama’s argument is valid if, and only if, the economy is at potential output.”

    I was being sloppy too here. I should have said “Fama’s argument is valid IN THE LONG RUN if, and only if, the economy is at potential output.”

    “I’m not trying to defend Fama, he was sloppy.”
    I think you are being too kind to Fama. His arguments were simply wrong. They imply that REGARDLESS OF WHAT THE CENTRAL BANK DOES, expansionary fiscal policy does not increase aggregate demand. What he has stated is the discredited Treasury View, which is very different from your position. Linking to other articles when he does not incorporate what these articles say into his argument does not get him off the hook.

    “FEH, The GOP can’t stop Obama from getting people on the Fed. He can demand a Senate vote, and if they refuse do a recess appointment.”

    The Republicans can prevent recess appointments if they keep congress in perpetual session. The Democrats pulled that on Bush and the Republicans did that during the last recess. But Obama is not even trying to see if he can slip recess appointments by them. He has not even named appointments for the Republicans to obstruct so that he can justify giving them recess appointments if the opportunity arises. Recess appointing people who had not even been nominated and obstructed would create a very negative response.

    I am sure you realize that I supported Obama. And I admit that I am very, very disappointed with his performance.

  57. Gravatar of Full Employment Hawk Full Employment Hawk
    23. July 2011 at 17:27

    “The debt ceiling is so crazy that I have to assume that both sides want to do a grand deal.”

    I would not be so optimistic. This is not the Republican party we had under Reagan or even Bush Jr. A large part of the Republican delegation in the House is batshit crazy. The best that can be hoped for is that a coalition of the remaining rational Republicans in the House together with the Democrats can get a majority to raise the debt ceiling.

    The problem the remaining rational Republicans face is that if they do this, they will be in trouble in the primaries. But if they do not do this, they will be in even worse trouble in the elections themselves. Cought between the devil and the deep blue sea.

  58. Gravatar of Scott Sumner Scott Sumner
    24. July 2011 at 07:21

    FEH, You said;

    “The Republicans can prevent recess appointments if they keep congress in perpetual session.”

    But they haven’t. So why not do a recess appointment in the last adjournment?

    You said;

    “I would not be so optimistic. This is not the Republican party we had under Reagan or even Bush Jr. A large part of the Republican delegation in the House is batshit crazy.”

    But this doesn’t explain why Obama negotiates. He doesn’t have to. Just ignore any bill that comes out of Congress. He can’t legally default anyway, so he’s legally required to ignore a debt ceiling problem.

    Tell the GOP, “I’ll see you in court.”

  59. Gravatar of Full Employment Hawk Full Employment Hawk
    24. July 2011 at 12:12

    “But they haven’t.” I believe that they did do that during the last brief recess. And there is every reason to expect that they will do it from now on.

    “He can’t legally default anyway”

    The 14th amendment option should be used as a last resort to prevent default. But since the legalities under this provision have not been fought out in the courts, bonds sold after August 2 will be viewed as risky and bear a significantly higher interest rate. Therefore this should be used as a last resort only.

    “But this doesn’t explain why Obama negotiates.” Obama came to Washington under the fatal delusion that he could work together with the Republicans in a bipartisan manner to solve the nation’s problems and he still appears to be clinging to this belief after everything that has happened.

  60. Gravatar of Scott Sumner Scott Sumner
    25. July 2011 at 06:37

    FEH, I agree that Obama is foolish to negotiate with the GOP over the debt ceiling.

    And I think we agree he never used the recess appointment when he had a chance, so it’s a moot point.

  61. Gravatar of Mike Sax Mike Sax
    15. May 2012 at 18:09

    Serioulsy though as Morgan is begging off, Scott what is NGDP by now-it must be close to 4 if not higher. So when people like Morgan say they want 4.5% NGDO that’s pretty close to the status quo at this point.

    I know some people like Lars want an even lower target like 3% By that defintiion shouldn’t they be demanding the Fed tighten now?

    If I remember right I believe you have a target like 5.5%-if so still hae consdierable ground to pick up.

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