This is inspired by Mankiw’s Pigou Club; and like Mankiw I’m not asking permission—I get to decide who belongs. Surely some of the people who participate in this blog would qualify, but I’ll leave that up to them. I have also clearly hinted that I think George Warren, Earl Thompson and Robert Hall all belong. Warren is dead. My hunch is that Thompson wouldn’t mind being included, whereas Hall would. But they have no choice—all three go in. Today I add another member to this distinguished group:
FREDERIC S. MISHKIN
Now I know what you are all thinking. What? Has Sumner lost his mind? Mishkin is just another new Keynesian, with his best-selling textbook full of IS-LM diagrams. Former member of the Board of Governors. Distinguished professor at Columbia. Not known for saying highly controversial or outrageous things about monetary policy. But please hear me out. If you still insist he doesn’t belong we can have a vote, and kick him out if necessary.
I have used Mishkin’s text in my money class for many years. I always end with his chapter on transmission mechanisms, where he makes an impassioned argument that we can draw four lessons for monetary policy from his book. These lessons are on page 606-07 of the current (8th) edition, and clearly provide a sort of summation of everything that has come before. Here are the four lessons for monetary policy:
1. It is dangerous always to associate the easing or the tightening of monetary policy with a fall or a rise in short-term nominal interest rates.
What??? No one told me this. I thought we had been told for months that the constant rate cuts by the Fed last year were “monetary easing.” Yes, Mishkin didn’t say low nominal rates were never a sign of monetary easing; he merely said that it was dangerous to make that assumption. We don’t know that he would agree with my views on Fed policy during 2008. So let’s go on and look at the second lesson:
2. Other asset prices besides those on short-term debt instruments contain important information about the stance of monetary policy because they are important elements in various monetary policy transmission mechanisms.
Note that he doesn’t say that monetary aggregates contain important information, only asset prices. Does this sound familiar? In two separate posts here and here, I collected graphs and tables showing the movement in six key asset prices in late 2008:
1. Real interest rates
2. Expected inflation
3. Commodity prices
4. Stock prices
5. Housing prices
6. Exchange rates
If you read chapter 23 of Mishkin’s text, he makes it very clear that these are exactly the sort of “asset prices” that he is referring to. So what happened to these asset prices in late 2008? The fall in housing prices, which had previously been mostly confined to certain (sub-prime) markets, spread across almost all housing markets after August 2008. Real interest rates rose sharply in the indexed bond market. Inflation expectations plummeted (as measured by the TIPS/conventional yield spread.) Commodity prices crashed spectacularly. So did the stock market—falling 23% in just the first 10 days of October, and nearly in half between mid-May and mid-November. Despite the extreme weakness in the U.S. economy, which would normally depress the exchange rate, the dollar soared in value between July and November—the key months I keep referring to.
If Mishkin believes it is “dangerous” to assume low nominal rates mean easy money, and if he says “other asset prices . . . contain important information about the stance of monetary policy,” and if all of those other indicators were screaming warnings that policy was highly contractionary, then I think it’s safe to say that the message of Mishkin’s best-selling text is that Fed policy was not just contractionary late last year, but highly contractionary.
You might argue that he does agree with me that monetary policy had accidentally stumbled into a contractionary stance, but that doesn’t mean he agrees with my specific criticism of Fed policymakers. After all, once they had cut rates to zero there was nothing more the Fed could do. So let’s move on to lesson #3:
3. Monetary policy can be highly effective in reviving a weak economy even if short term rates are already near zero.
The sine qua non of a monetary crank is the bizarre belief that even depressions featuring zero interest rates can be magically cured by printing money. In his explanation of point three he discusses the widespread view that the Japanese case showed that policy was ineffective when rates hit zero, and then indicated that “this view is false.” You might argue that just because monetary policy might be effective, doesn’t make it as desirable as fiscal policy. But Mishkin also says that “because of the lags inherent in fiscal policy and the political constraints on its use, expansionary monetary policy is the key policy action required to revive an economy experiencing deflation.”
The only lesson that is slightly different from my own view is number 4:
4. Avoiding unanticipated fluctuations in the price level is an important objective of monetary policy, thus providing a rationale for price stability as the primary long -run goal for monetary policy.
It is clear from his other writings that by “price stability” Mishkin means something more like 2% inflation. So I don’t really see any great difference from my own 5% NGDP growth target. That target shares 2% inflation “as the primary long-run goal for monetary policy.” Regarding the short run, Mishkin observes that:
Inflation targeting also does not ignore traditional stabilization goals. Central bankers in inflation-targeting countries continue to express their concern about fluctuations in output and employment, and the ability to accommodate short-run stabilization goals to some degree is built into all inflation targeting regimes. (p. 407)
In other words, if there is a severe supply shock that depresses output, then the Fed should let inflation exceed the target for a period of time—which is just what occurs under an NGDP growth rule. Now I am not saying Mishkin supports NGDP targeting, but we aren’t all that far apart.
Here you might say there are some similarities in our views of monetary policy, but he certainly doesn’t hold my extremely wacky “reverse causation” view, the idea that rather than the financial crisis causing the falling NGDP, it was the other way around. As anyone with two eyes can see, the financial crisis came first, and just as in Japan it was the financial crisis that caused the deflation, not the other way around. Well, you are right that Mishkin has nothing to say about reverse causation in 2008, but that’s because his text was published before the current crisis. However he does have something to say about Japan:
“The deflation in Japan in recent years has been an important factor in the weakening of the Japanese financial system.” (p. 407.)
I rest my case.
My goal is to find as many economists as possible saying things before 2008 that might be retrospectively viewed as critical of current Fed policy. So please help me look for incriminating statements by Mankiw, McCallum, Woodford, Svennson, etc. Perhaps something said about 1936-37, pointing out how the Fed caused a depression in late 1937 by encouraging banks to raise their reserve ratios. Even better would be statements from Obama people like Christy Romer and Larry Summers. The more they would abhor being included in with a minor right-wing monetary crank like me, the more fun it will be to hunt them.
But there are two people that I would especially like to be able to include in my league (based on past statements.) One is obviously Ben Bernanke. I won’t mention the other name. Let’s just say I have an Ahab-type obsession with catching this other economist making monetary crank-like statements. (And no, merely having a cranky personality doesn’t count.) Let’s just call him the “Keynes of the 21st century.” I think you know who I mean.
1. BTW, how do I get included in Mankiw’s Pigou Club? Will this work?
“Because massive holdings of excess reserves are privately beneficial to banks, but deflationary for the economy as a whole, excess reserves create negative externalities during a liquidity trap. Therefore they should be taxed.”
It seems to me that Mankiw only includes famous people in his exclusive club. Although he called me a “prominent economist,” I think even that was a stretch. Let’s see if he takes the bait.
2. I added an update at the end of my previous reserve penalty post, reflecting some advice offered by Bill and JKH.