Central banks need to promise to be responsible

In the late 1990s Paul Krugman did some clever work on the role of expectations in monetary policy.  At one point he provocatively argued that centrals banks needed to “promise to be irresponsible” when stuck at the zero rate bound.  I certainly understand the logic of his argument—it can help to boost inflation expectations—but it turns out that this phrase did more harm than good.  Central banks are never going to adopt a policy that seems irresponsible, and hence it becomes easy for central bankers to dismiss all proposals for monetary stimulus, including the sorts of responsible proposals put forward by market monetarists (and later endorsed by many Keynesians.)  It so happens that 5% NGDP targeting is both the right policy and the responsible policy.  It’s pro-growth, but also has a nominal anchor.  It fulfills the Fed’s dual mandate, which they are legally obligated to adhere to.

This provides one more reason why inflation targeting should be abandoned and replaced with NGDPLT.  If inflation targeting can only work at the zero bound if austere conservative central banks promise to behave like drunken teenagers with the keys to their dad’s Porsche, then it can never work.

This post was motivated by a Brad DeLong post that CA sent me:

Hoisted from Comments: Daniel Kuehn on Credible Federal Reserve Commitment to Incredible Responsible Future Irresponsibility

Brad quotes his commenter Daniel Kuehn:

Precisely.

We have the confidence fairy. We need to start talking more about the “expectations fairy” in reference to market monetarists like Scott Sumner. Of course in the best of all possible worlds the expectations channel works great and we can talk about monetary policy with confidence even with a non-existent interest rate channel. But we don’t live in that world and we can advocate monetary policy while still having reservations about its effectiveness. Sumner seems to interpret that as opposition. So let’s talk more about the “expectations fairy”.

Actually I don’t interpret it as opposition, I interpret it as ineffective advocacy.  There’s something very wrong when 99.99% of Paul Krugman’s readers in late 2008 and early 2009 thought he was claiming that monetary policy was ineffective at the zero bound, partly because he frequently did claim that monetary policy was ineffective at the zero bound (before putting an asterisk about possible but unlikely expectations channels in a footnote.)  Just to review the evidence for DeLong and Kuehn:

1.  No evidence of a determined central bank failing to inflate at the zero bound, while there is evidence of success.

2.  Bernanke insists the Fed can do more.  Bernanke (and Cameron in Britain) are not taking steps that they could take.

3.  All the asset markets react to hints of monetary easing as if it’s a massively important issue.  By late 2010 when rumors of QE2 were pushing up TIPS spreads, Krugman was forced to admit that yes it was working in practice, but gosh darn it, it couldn’t possibly work in theory.

I’m actually not as stubborn as I look.  I’ve been wrong about plenty of things before, and I change my mind when new evidence comes in.  But until the Fed sets a higher NGDP target, or does level targeting, and buys up another $10 trillion in debt and eliminates IOR (not one of those actions, but all of them) then there’s no point in even talking about running out of ammunition.  And since they obviously won’t do those things, I won’t have to admit I was wrong on this issue.

Matt Yglesias has it exactly right in the title of this post:

Ben Bernanke Says Ben Bernanke Could Reduce The Unemployment Rate But He Prefers Not To

And no sooner do I find this post, than I see Matt has a new one that basically anticipates my argument:

One area in which I think some prominent left-of-center voices have gone badly awry is in suggesting that the Federal Reserve faces some serious credibility problem in attempting to reflate a depressed economy. Paul Krugman’s famous  line about trying to credibly promise to be irresponsible is funny, but I think makes the issue sound more paradoxical than it is.

And while I’m quoting progressives that “get it,” how about a couple Tim Duy gems sent me by “dwb”:

In some sense, this is right – market participants expect that economic conditions will be such that the Fed will need to keep interest rate low for a long time. But the Fed should not be content with low rates. If policy was effective, longer term interest rates would rise in expectation of eventual Fed tightening. The collapse of rates – again – is an indication that the Fed needs to be doing much, much more. And Yellen is a dove!

And this:

The Federal Reserve would have been better off to buy a set quantity of assets every week, adjusting that number as they might the interest rate, until certain macroeconomic objectives are met.  This would let the expectations channel shoulder some of the work by laying out a clear path for monetary policy.  Moreover, they would probably need to buy fewer assets overall.  Instead, now we have policy scheduled to end discretely in the absence of the consideration of the macroeconomic backdrop, thus disrupting the expectations channel because market participants don’t know what will trigger continuation of the policy.  It simply isn’t the way to manage the monetary affairs of the nation.

I love that stuff.  Easy money can raise rates by boosting growth.  That’s Milton Friedman.  Switching to a money supply form of communication because interest rates go “mute” at the zero bound—that’s Nick Rowe.  And the Fed won’t have to buy as much stuff if they get serious about a credible policy of reflation—that’s all of us market monetarists.  Interestingly, Ben Bernanke discussed this idea in a 1995 JMCB article, and called it “multiple monetary equilibria.”

BTW. I’m not trying to embarrass Duy by dragging him into the market monetarist camp—I don’t doubt that we disagree on many issues.  But it is surprising how many bridges are being built across the ideological divide on the issue of monetary policy.  (Now if we could only convince our fellow conservatives.)

And finally, Saturos sent me a Justin Wolfers tweet indicating that Bernanke’s recent statements somehow undercut the “monetary offset” argument for the zero fiscal multiplier.  Just to be clear, even I think the fiscal cliff would slow GDP growth, if only for supply-side reasons.  But in terms of demand-side policy, this is what it would take to convince me.  Suppose Ben Bernanke said the following:

My fellow Americans, the Fed recently announced a 2% inflation objective.  We are now changing that policy.  We have decided that we will only aim for 2% inflation if Congress does our preferred fiscal policy.  If they do more than we want, we will shoot for more than 2% inflation, even though that violates our dual mandate.  And if they do less than we want we will shoot for less than 2% inflation, even though that also violates our dual mandate.

I’m not too worried about Bernanke saying anything like that—so until further notice the “Sumner critique” remains operative.


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85 Responses to “Central banks need to promise to be responsible”

  1. Gravatar of TallDave TallDave
    8. June 2012 at 12:34

    I think the Japanese may get to NGDP targeting before we do. They’ve had a couple decades to learn that fiscal stimulus just piles up debt without yielding growth.

    Here’s an interesting paper on Japan’s monetary policy, it also cites that Krugman statement.

    http://www.nber.org/chapters/c0092.pdf?new_window=1

  2. Gravatar of JoeMac JoeMac
    8. June 2012 at 12:39

    Professor Sumner,

    If interest rates are zero on all government bonds, then wouldn’t market participants not find the policy credible?

    For example, the markets would say to the CB, “We know you really want to and will try really hard to increase prices in the future, but we know that there is no way you will be able to influence AD in the future because interest are and will be zero”

    The CB responds, “But we are going to try really hard and do everything we can in the future, we promise!!!”

    The markets respond, “We believe you when you say that you will do everything possible. But it won’t matter, you will fail because interest rates on all government bonds are zero.”

    Sumner responds, “Markets, you’re forgetting that Friedman explained that the CB can buy any asset in existence, or just do a helicopter drop. Therefore, when they try in the future to raise prices by increasing AD, they will be able to.”

    Markets respond, “In principle, yes. But in practice, CBs are institutionally constrained to only purchasing their own country’s gov. bonds. So, there is nothing they will be able to do. The policy announcement is not credible.”

  3. Gravatar of Dan S Dan S
    8. June 2012 at 12:43

    Looks like you and Yglesias have a telepathic connection. Check over at his blog.

  4. Gravatar of Cedric Cedric
    8. June 2012 at 12:44

    Can someone please explain to me why The Krug is afraid of liquidity traps? In liquidity traps, the government can inject money into the system and it won’t cause inflation because low interest rates make it desirable to hoard money.

    But doesn’t that mean that the government could grow as big as it wanted without any effect on demand? The government could print money, spend it, and there would be no inflation. Heck, the government could stop borrowing and cut tax rates to zero, and it wouldn’t matter. Is not a liquidity trap a big government liberal’s dream state?

    I’m sure I’m missing something, and I’ll be very grateful for explanations.

  5. Gravatar of Dan S Dan S
    8. June 2012 at 12:47

    Oh no I did not see that you already caught it. Please ignore me.

  6. Gravatar of johnleemk johnleemk
    8. June 2012 at 12:51

    Re Krugman’s ineffective advocacy, this is what pisses me off whenever I have to deal with left-leaning economic literate folks who quite rightly point out Krugman doesn’t oppose monetary stimulus. So what? If I show his writings from since 2008 to a random sample of the general population, most of whom are economically illiterate, would you bet against me if I claimed that you wouldn’t find more than 10% (I’m being generous) who would list “The Fed can and should be doing more” as one of the top 10 takeaways from Krugman’s writings?

    The business press has, for as long as I can remember, interpreted “interest rate setting” and “monetary policymaking” as synonymous. When rates hit zero, it’s unsurprising that the business press and the man on the street think “Well, there’s nothing monetary policy can do.” Regardless of his million squirreled away caveats, Krugman’s emphasis on the notion of a liquidity trap at best does nothing to dispel these unfounded beliefs, and at worst, implicitly perpetuates them.

    I blame the median voter on the FOMC, the median voter in Congress, the median voter in the executive (essentially the president, since he can override the Cabinet), and the median voter at large for the horrible monetary policy we have seen in the US over the last four years.

    But economists know these monetary policies have been so harmful. Why isn’t that knowledge disseminating out of the ivory tower? We have to blame economists too, for either doing nothing to dispel economic myths, or actively perpetuating them.

  7. Gravatar of Morgan Warstler Morgan Warstler
    8. June 2012 at 12:53

    Stop telling DeKrugman Monetary will be effective, we KNOW that. Who cares what he thinks?

    What matters is that since we KNOW what Ben wants:

    1. Tax cuts right now
    2. Credible cuts to future spending

    AND we know that after Nov. 2012, if Romney wins, we are more likely to get those things…

    Then IF Matty gets it so much, and BELIEVES it, when does he decide to support Romney?

    When does the rational take hold?

  8. Gravatar of Cedric Cedric
    8. June 2012 at 13:00

    JoeMac,

    I think the bigger constraint on CBs is political pressure, but you’re basically right that CB credibility is a big issue as long as we have discretionary monetary policy. Scott’s rules-based policy would kill the credibility issue, I believe.

  9. Gravatar of JoeMac JoeMac
    8. June 2012 at 13:02

    Cedric, you said, “Scott’s rules-based policy would kill the credibility issue, I believe.”

    But it won’t work now that interest rates are zero. If the CB tries to raise expectations then the markets would believe it can be done because interest rates are zero.

  10. Gravatar of Daniel Kuehn Daniel Kuehn
    8. June 2012 at 13:02

    I can’t speak for Brad (although I assume it’s pretty close to his thoughts at least), but I completely agree with this point “1. No evidence of a determined central bank failing to inflate at the zero bound, while there is evidence of success.” I definitely think its been successful, which is why there should be more of it.

    I also agree with the Yglesias title strongly.

    What I don’t know is whether or not Bernanke, even if he would fulfill our wildest dreams, would solve this soon enough. And I wonder about that not because I’m a Keynesian that only thinks of interest rates (though those are worth talking about), but because I’m concerned about expectations around what Bernanke will do in the future. It’s true, the expectation is not that will do nothing. That was not the claim. But even if there were expectations of 2% inflation (which he probably could achieve), I’m not sure he could establish expectations that he’ll hit the NGDP trendline the way the Fed has been acting. That’s the concern. Certainly there’s evidence that monetary policy has had an effect. Will it be enough in time? That’s what I don’t think we’re willing to gamble on.

    As you and Lars have pointed out, the Fed can always neutralize fiscal policy. If they end up doing that what have we lost really? What’s the risk?

  11. Gravatar of Cedric Cedric
    8. June 2012 at 13:11

    JoeMac,

    Sorry, I need some coffee or more explanation. Is your argument that the Fed could not credibly commit to 5% NGDP growth if interest rates are zero? If Bernanke can’t figure out how to inflate, couldn’t he ask Hugo Chavez for advice?

  12. Gravatar of ssumner ssumner
    8. June 2012 at 13:11

    Talldave, Let’s hope so.

    JoeMac, That’s unlikely to happen, but it would be great if it did. It would mean that government bonds would essentially be currency, and hence open market operations would have no effect. In that case you’d want to buy other assets such as gold or silver or corporate bonds or foreign government bonds.

    But it’s not something I’m “worried” about. (in both senses, it won’t happen, and wouldn’t be bad if it did.)

    Cedric, His argument is more complicated. He doesn’t think it would apply to long rates. So he fears the Fed would buy long term debt, and then later have to sell it at a loss to prevent hyperinflation. I think that’s wrong, but it’s not a ridiculous assertion.

    johnleemk, Yup, everyone’s to blame.

    Dan, Great minds think alike (although in this case only Matt has a great mind.)

  13. Gravatar of Daniel Kuehn Daniel Kuehn
    8. June 2012 at 13:12

    I agree with Cedric. An announcement of an explicit NGDP level targeting rule is likely to do it. I can’t tell the future, but that seems plausible.

    Do you think the Fed is going to do that? I have my doubts.

    As long as I have that doubt it seems very reasonable to say let’s do both. I see very little risks associated with saying “let’s do both”. I see more risks saying “forget fiscal policy, let’s do monetary policy” and hoping for the best.

  14. Gravatar of Daniel Kuehn Daniel Kuehn
    8. June 2012 at 13:12

    re: “(although in this case only Matt has a great mind.)”

    We’re allowed to leech on I think :)

    Thanks for the link and the thoughts, btw.

  15. Gravatar of Mike Sax Mike Sax
    8. June 2012 at 13:19

    “Now if we could only convince our fellow conservatives”

    That’s Morgan’s job isn’t it. It is ironical though Morgan-when you start trying to explain why conservatives should sign up for NGDPT they never buy in-I imagine your GI will have an even steeper climb. I noticed there was mostly total skepticism in the commments at your blog when you wrote it.

    On the other hand when you start explaining how great it is for conservatives it makes me start to beleive it. That’s the opposite of optimum. Ideally you’d like to sway conservatives with your arguments but I on the other hand shouldn’t buy them.

  16. Gravatar of Cedric Cedric
    8. June 2012 at 13:21

    Scott, I think I understand the possible downside here, but it seems to me to be (1) not that big of a risk; (2) not that bad of an impact; and (3) outweighed by the upsides.

    But then again, I’m extremely reasonable.

  17. Gravatar of TallDave TallDave
    8. June 2012 at 13:45

    I had an amusing thought reading this thread: say the Fed adopts NGDPLT but gets up to, oh, $7T in assets before the markets decide they really believe in NGDPLT. It’s funny to think the Fed’s primary anti-inflation tool for a long time might be the selling of those assets, esp. if we’re in a TGS world where real returns continue to be low.

  18. Gravatar of Morgan Warstler Morgan Warstler
    8. June 2012 at 13:47

    Sax,

    Scott is well aware there’s an exact moment when NGDP will get paid attention to by conservatives.

    He just wants it to come sooner.

    The far more interesting point is that we KNOW what Ben wants and instead of saying it over and over, we are continuing to just pretend shouting ans shaming him will work.

    He wants Tax Cuts Now and Credible Spending Cuts for the future.

    So the far more interesting discussion is when we require the left to CHOOSE:

    1. sacrifice your policy objectives to get Monetary faster.

    2. keep pretending you want Monetary without doing the nasty to get it.

    One side (not mine) is going to bleed deeply here, fish are going to get gutted.

    So we can judge the seriousness of the left about NGDP by how weak and soft they are acting.

    Until then, calls from the left for Monetary aren’t credible, when DeKrugman / Matty scream for QE to make up for the deflation of slashing public employee unions – I’ll believe the scales have fallen form their eyes.

    Until then, eyes on the prize.

  19. Gravatar of ssumner ssumner
    8. June 2012 at 13:49

    Daniel, I mostly agree. On neutralizing fiscal, I’d rather they neutralize a smaller budget deficit with monetary expansion than a bigger budget deficit with tighter money. But I don’t support the fiscal cliff approach, I think that’s too big a shock and also a supply-side shock. I’d like to see a more “gradual” approach to solving our budget problems.

    If find it hard to even think about what would happen if the Fed got really serious about a much higher inflation or NGDP target, because it’s so unlikely. But I think a radical change in Fed policy would be believed by the markets, why wouldn’t they? If it’s a small change, then there is some risk of “diminishing returns” to use Bernanke’s phrase. I.e. I think it’s possible that QE3 doesn’t do too much.

  20. Gravatar of ssumner ssumner
    8. June 2012 at 13:51

    Daniel, And thanks for commenting over here.

  21. Gravatar of Cedric Cedric
    8. June 2012 at 13:54

    Good point, TallDave. Side question: wouldn’t you have to adjust the level target to something like 2.5 or 3% is you expected perpetual 1% RGDP growth because of supply side issues? What would the world look like 60 years from now if France had 2.5% NGDPLT (in the abstract — I’m ignoring euro issues) and the U.S. had 5% NGDPLT?

  22. Gravatar of ssumner ssumner
    8. June 2012 at 13:56

    Cedric, I completely agree, as I hinted in my earlier comment.

    Talldave, In practice they’d never get that far, unless their communication strategy was extremely inept . . . come to think of it . . .

  23. Gravatar of JoeMac JoeMac
    8. June 2012 at 14:37

    Cedric,

    Sorry, I made a typo. I meant to say “If the CB tries to raise expectations then the markets would believe it CAN’T be done because interest rates are zero.”

    I mean the following. Imagine the CB is institutionally constrained by Congress/Parliament to ONLY be able to buy and sell its government bonds. Then, imagine all government bond rates have been brought to zero. Expectations policy would then never be credible because the markets would know that there is nothing the CB could purchase later to successfully increase AD.

  24. Gravatar of Mike Sax Mike Sax
    8. June 2012 at 14:43

    “Scott is well aware there’s an exact moment when NGDP will get paid attention to by conservatives”

    Banking on Romney?

    “One side (not mine) is going to bleed deeply here, fish are going to get gutted.”

    Not necessarilyo. The Dems just have to call the GOP’s bluff. If they’re really going to allow the Bush tax cuts to expire it’s a win-win. I never liked them anyway. I’d rather just let the top rates expire but because the GOP has-smartly no doubt-tethered all the tax cuts together if they wont budge let them all expire.

    At the least we’ll hear the end of all this tiresome breat beating about deficits-that really don’t matter anyway.

  25. Gravatar of Rajat Rajat
    8. June 2012 at 15:10

    “There’s something very wrong when 99.99% of Paul Krugman’s readers in late 2008 and early 2009 thought he was claiming that monetary policy was ineffective at the zero bound”

    Isn’t it ridiculous that after all this time, macro seems like such a black art? There is so much disagreement over fundamentals, which just isn’t the case in micro. If I find this frustrating, you must be ropeable.

  26. Gravatar of Mike Sax Mike Sax
    8. June 2012 at 16:08

    Markets post best week of the year

    http://diaryofarepublicanhater.blogspot.com/2012/06/market-finishes-best-week-of-year.html

  27. Gravatar of Morgan Warstler Morgan Warstler
    8. June 2012 at 17:35

    Great article on why Athens burns…

    http://partialobjects.com/2012/06/why-athens-burns-waiting-for-the-germans-to-put-it-out/

  28. Gravatar of Alex Godofsky Alex Godofsky
    8. June 2012 at 18:18

    JoeMac:

    If interest rates are zero on all government bonds, then wouldn’t market participants not find the policy credible?

    For example, the markets would say to the CB, “We know you really want to and will try really hard to increase prices in the future, but we know that there is no way you will be able to influence AD in the future because interest are and will be zero”

    That only works if interest rates will be zero forever. But pretty much everyone believes that eventually the recession will end and the natural rate of interest will be positive again. What the Fed promises about the level of NGDP then influences NGDP now.

  29. Gravatar of Morgan Warstler Morgan Warstler
    8. June 2012 at 21:24

    Perfect grasp of reality:

    What matters, both sides say, is an ever more interdependent global economy that can determine national elections worldwide.

    “The one startling new facet of the transatlantic relationship is a very deep economic and financial integration,” said Constanze Stelzenmueller, who runs the Berlin office of the German Marshall Fund of the United States, a body whose founders commemorated U.S. aid to Europe after World War Two and which works to promote understanding between the two continents.

    “Volatility and contagion risks go both ways. That has not just fiscal and financial implications but political, diplomatic and security consequences. That is the reason for the nervousness of the Obama campaign. They are realizing that what happens in Europe has a major impact on the U.S. economy.”

    Merkel, 57, knows that German voters will not reward her Christian Democrats in a parliamentary election due by September 2013 if, to save euro zone partners like Greece or Spain, she “wastes” their money or exposes their savings to inflation – a historic national dread that dates back to the rise of Hitler.”

    http://www.reuters.com/article/2012/06/08/us-obama-merkel-idUSBRE85718N20120608

    This is such an interesting vein of politics, it’ll spawn brand new nation state theory for 20 years.

  30. Gravatar of DonG DonG
    8. June 2012 at 21:48

    I am finalizing my tattoo design, but I am still not sure which is the correct abbreviation?

    1) NGDPLT
    2) NIT (National Income Targeting)
    3) nGDPlt
    4) NILT (natl. inc. level targeting)

    I believe in the power of a brand, I just want to get on the right bandwagon.

    Thanx!

  31. Gravatar of Benjamin Cole Benjamin Cole
    8. June 2012 at 22:18

    Print more money. Please.

  32. Gravatar of dtoh dtoh
    8. June 2012 at 23:04

    Scott gets around the ZLB by arguing that monetary policy works primarily through the hot potato effect. I don’t think this is right. People hold more cash if they are buying more stuff not the other way around. Monetary policy works because you drive up the price (i.e. lower expected return) of financial assets so people exchange financial assets for real goods and services.

    I don’t think you need to go down the hot potato path to dispel the ZLB myth.

    1) There are tons of assets out in the market that are not trading anywhere near a zero rate of interest. The Fed could easily buy these.

    2) Even if all financial assets were trading at a zero interest rate, the Fed could enter into rate swaps where they paid floating and received fixed. This would drive long rates below zero.

    3) The Fed could easily create negative rates of interest on M0 by paying negative IOR and charging a transaction fee for conversion into cash.

    That being said, Scott may be partly right about the hot potato effect but only at the ZLB and only because at the ZLB, M0 becomes a substitute financial asset. The expectation of inflation will then translate directly into a drop in the expected return on M0, which in turns causes an increased exchange of M0 (to the extent it is held as a financial asset) into real goods and services.

  33. Gravatar of Saturos Saturos
    9. June 2012 at 00:44

    Scott, Miles has a new post: http://blog.supplysideliberal.com/post/24677919422/is-monetary-policy-thinking-in-thrall-to-wallace

    Thought you might find it interesting. Note Lulu Wang’s bold attempt to advocate Market Monetarism to Miles (first comment beneath). Also, he says he’s going to respond to your response to his first post, eventually.

  34. Gravatar of Saturos Saturos
    9. June 2012 at 01:01

    dtoh, driving up the price increases the return (capital gain) to people already holding bonds (but not to maturity). Of course people are then less willing to buy bonds, or exchange money for those assets. But people are more willing to issue and sell them. So it comes down to the increased inflow of money and spending – but if NGDP expectations are fixed then V will fall to offset deltaM and nothing happens.

    “People hold more cash if they are buying more stuff not the other way around.”

    Which is why the hot-potato effect eventually comes to an end once nominal income has risen enough that people are willing to hold the extra cash.

    It’s simple. NGDP is determined by the long-run supply and demand for money. Since a permanent increase in supply doesn’t cause a permanent increase in demand (the Fed doesn’t need to keep buying bonds forever to permanently increase the stock of money, just hold some to maturity), it will lead to some increase in NGDP. Of course demand is also affected by expectations, but these would tend to lower demand further – such that you don’t need to buy much (or any) in the first place.

  35. Gravatar of Saturos Saturos
    9. June 2012 at 01:17

    Sorry Scott, back on the subject of models:

    Noah Smith has a response: http://noahpinionblog.blogspot.com.au/2012/05/economists-who-dont-do-it-with-models.html

  36. Gravatar of ssumner ssumner
    9. June 2012 at 05:57

    Rajat, Yup.

    Morgan, That’s exactly why monetary stimulus, not fiscal union, is the (partial) answer.

    DonG, NGDPLT.

    Ben, Good to see you back, I mentioned you in my newest post.

    dtoh, You said;

    “Scott gets around the ZLB by arguing that monetary policy works primarily through the hot potato effect. I don’t think this is right. People hold more cash if they are buying more stuff not the other way around.”

    But that is the hot potato effect! It says that people don’t want to hold more money if they aren’t planning to buy more stuff.

    Saturos, Thanks for the links.

  37. Gravatar of Dtoh Dtoh
    9. June 2012 at 06:39

    Scott,
    I agree, but you assume that there is an increase in spending because OMP puts more money in people’s hands. That’s not what happens. Think about it in terms or real world behaviour. Suppose your broker decides to close your account, sells off $100k worth of Treasuries, and drops off a briefcase with $100k in cash on your doorstop. Are you suddenly going to decide that your previous decision about how much to keep in financial assets and how much to spend on real good and services is going to change. No it’s not; if you’re rational you’ll just go somewhere else and buy another $100k in Treasuries. Unless…..

    the price of Treasuries has risen in which case you’ll shift your allocation to hold fewer Treasuries and to spend more on real goods and services.

  38. Gravatar of Saturos Saturos
    9. June 2012 at 09:14

    dtoh, and what does the person who sells you those Treasuries do with the money?

  39. Gravatar of Dtoh Dtoh
    9. June 2012 at 11:12

    Uses it to settle his earlier trade where he bought Treasuries which your original broker sold when he closed your account.

  40. Gravatar of Saturos Saturos
    9. June 2012 at 11:30

    I don’t think you’re describing a disequilibrium, dtoh.

  41. Gravatar of Major_Freedom Major_Freedom
    9. June 2012 at 11:40

    ssumner:

    It so happens that 5% NGDP targeting is both the right policy and the responsible policy.

    It’s both wrong and irresponsible. It turns out a free market in money production is both the right policy and the responsible policy.

    Never reason from a spending change.

  42. Gravatar of Dtoh Dtoh
    9. June 2012 at 13:40

    Saturos,
    Correct, but if the Fed buys Treasuries then it causes an Increase in Treasury pricing which creates a new equilibrium where the increase in price generates a sufficient increase in demand for real goods and services such that the money needed for those transactions is equal to the money paid for the Treasuries. The important point is that it is the increased price of financial assets (Treasuries) that generates the incremental demand for real goods and services. It is not the extra money causing the increase in AD.

  43. Gravatar of Full Employment Hawk Full Employment Hawk
    9. June 2012 at 18:25

    “Ben Bernanke Says Ben Bernanke Could Reduce The Unemployment Rate But He Prefers Not To”

    1. Republicans want to make Obama fail.

    2. Bernanke is a Republican.

    Conclusion: Bernanke wants to make Obama fail.

  44. Gravatar of Full Employment Hawk Full Employment Hawk
    9. June 2012 at 18:25

    “Ben Bernanke Says Ben Bernanke Could Reduce The Unemployment Rate But He Prefers Not To”

    1. Republicans want to make Obama fail.

    2. Bernanke is a Republican.

    Conclusion: Bernanke wants to make Obama fail.

  45. Gravatar of Full Employment Hawk Full Employment Hawk
    9. June 2012 at 18:47

    “He wants Tax Cuts Now and Credible Spending Cuts for the future.”

    ABSOLUTELY CORRECT!

    This is Mitt’s macroeconomic policy. A tax-based Keynesian stimulus. With Tax Cuts Now and spending cuts later, the initial effect will be a Keynesian stimulus to AD.
    This is in line with what Mankiw must be advising. Mankiw may be a CONSERVATIVE Keynesian, but he IS a Keynesian. If this is supported by the Fed with an accomodive monetary policy, and Bernanke will do this, it will cause output to grow and unemployment to come down.

    Bernanke is a Republican and we should not be surprised that he supports mainstram Republican economic policies and not progressive economic policies. Until the election, Bernanke is going to maintain the Fed’s current regime of monetary austerity. That is, keeping the economy on a starvation diet of very limited monetary stimulus that will make the economy grow too slowly to bring the unemployment rate down significantly.

    Reappointing Bernanke was Obama’s most serious economic policy mistake and if Obama loses, Bernanke’s policy of monetary austerity will be by far the most important reason. Apperently the other people Obama has appointed to the BOG are too dense to figure out what Bernanke is up to and therefore are not forcing him to change, which they could if they knew understood what was going on.

    I PREDICT THAT IF ROMNEY WINS, THE FED WILL ABANDON ITS CURRENT STRATEGY OF KEEPING THE INFLATION RATE AT, OR BELOW, 2% AND WE WILL HAVE SIGNIFICANTLY MORE INFLATION. Just as we did under Reagan.

  46. Gravatar of Bob Murphy Bob Murphy
    9. June 2012 at 18:59

    Scott, a word of advice: I’ve grappled plenty with Daniel Kuehn over the years, and you *really* don’t want to start arguing with him about what Krugman meant when he wrote such-and-such. Abandon all hope, ye who enter that debate.

  47. Gravatar of Morgan Warstler Morgan Warstler
    9. June 2012 at 19:21

    FEH,

    no duh…

    —-

    The real issue for your side is this: you ought to be ASSUMING THIS SHIT and because of it be FAR MORE ready to trade as if you are in a position of weakness.

    Because you are.

    Your problem stems from thinking the both sides win 50% of the time, they don’t.

    Your side loses far more than it wins, and as such, it should set out to be as frigging conservative as possible about being progressive.

    You need to approach the war as if you are the weaker party and you know it.

    Start with the premise that you will get AS MUCH QE AS YOU WANT, as long as the left is cost cutting the bejesus out of govt.

    Obama had his chance.

    Everybody understands Obama didn’t want to be VClinton.

    He could have come inn and said:

    1. Oops tax hikes are first and they go deeper than 250K, sorry!

    2. No Fiscal Stimulus

    3. No Obamacare

    4. Come hell or high water, we’re going to Balance the Budget – cut public employees, not services

    And then he could have turned to Ben and said GET BUSY.

    And today, unemployment would be down much further.

    Obama chose.

  48. Gravatar of Full Employment Hawk Full Employment Hawk
    9. June 2012 at 21:16

    “(Now if we could only convince our fellow conservatives.)”

    Your fellow conservatives WANT THE UNEMPLOYMENT RATE TO REMAIN HIGH until the election. If Romney wins, they can be persuaded.

  49. Gravatar of Full Employment Hawk Full Employment Hawk
    9. June 2012 at 21:30

    “Your side loses far more than it wins”

    That is true. This is because too many people on my side are a bunch of wimps who bring pillocases to gun fights and are not agressive enough if promoting their cause.

    Obama’s most fatal error was that he believed that he could be a post-partisan President who could work together with the Republicans to solve the nation’s problems, while the Republicans had no intention of doing so, and from Day 1 set out to make him fail. It took Obama about 2 1/2 years into his term until he began to figure this out. This should have become apparent to him when the Republicans obstructed the stimulus. From that point on he should have treated the Republicans as dangerous enemies who had to be neutralized if he was going to succeed.

    Instead of doing what you wanted him to do he should have immediately filled the vacancies on the BOG with people who took the Fed’s mandate to achieve maximum employment seriously. And instead of reappointing Republican Bernanke, he should have appointed someone like Christia Romer, who would have gotten busy. And he should have filled the other vacancies on the BOG as they arose with full employment hawks, using recess appointments if needed.

    In addition, he should have reinforced a more expansionary monetary policy with a larger fiscal stimulus, using reconciliation to overcome the Republican filibuster. And there are a number of other policies on which he should have been much more agressive, such as foreclosure mitigation.

  50. Gravatar of Full Employment Hawk Full Employment Hawk
    9. June 2012 at 21:30

    “Your side loses far more than it wins”

    That is true. This is because too many people on my side are a bunch of wimps who bring pillocases to gun fights and are not agressive enough if promoting their cause.

    Obama’s most fatal error was that he believed that he could be a post-partisan President who could work together with the Republicans to solve the nation’s problems, while the Republicans had no intention of doing so, and from Day 1 set out to make him fail. It took Obama about 2 1/2 years into his term until he began to figure this out. This should have become apparent to him when the Republicans obstructed the stimulus. From that point on he should have treated the Republicans as dangerous enemies who had to be neutralized if he was going to succeed.

    Instead of doing what you wanted him to do he should have immediately filled the vacancies on the BOG with people who took the Fed’s mandate to achieve maximum employment seriously. And instead of reappointing Republican Bernanke, he should have appointed someone like Christia Romer, who would have gotten busy. And he should have filled the other vacancies on the BOG as they arose with full employment hawks, using recess appointments if needed.

    In addition, he should have reinforced a more expansionary monetary policy with a larger fiscal stimulus, using reconciliation to overcome the Republican filibuster. And there are a number of other policies on which he should have been much more agressive, such as foreclosure mitigation.

  51. Gravatar of Full Employment Hawk Full Employment Hawk
    9. June 2012 at 21:43

    “Obama’s most fatal error was that he believed that he could be a post-partisan President who could work together with the Republicans to solve the nation’s problems”

    When Obama took office I too believed that he could be a post-partisan president who could work together with the Republicans to deal with the serious economic crisis that faced the nation. I actually believed that with the serious crisis facing the nation, the Republicans would put country first above partisan interests. (How could I have been so incredibly naive?)

    But by the time the Republicans were obstructing the filibuseter, I had figured out that this was not going to happen and that the Republicans were Obama’s deadly enemies.

  52. Gravatar of dtoh dtoh
    9. June 2012 at 22:07

    FEH,
    So what you are saying is that Obama is an incompetent political leader. Why wasn’t this obvious to you in 2008?

  53. Gravatar of Saturos Saturos
    9. June 2012 at 22:40

    dtoh, you’re reasoning from a price change. The increased price of treasuries, or rather the lower price of loanable funds, leads to greater spending on output insofar as it admits a greater inflowing supply of funds, which did not exist before (were not diverted from elsewhere). It is the extra money causing the increase in AD. Try and think about it in MV = PY terms.

  54. Gravatar of Major_Freedom Major_Freedom
    9. June 2012 at 23:54

    Saturos, you’re reasoning from a spending change. Greater spending on output doesn’t create greater output. It redistributes scarce resources.

  55. Gravatar of Saturos Saturos
    10. June 2012 at 02:29

    I absolutely agree, Major Freedom (when the economy is not demand-constrained). Once again you fail to realize what everyone else is talking about (what causes greater spending).

  56. Gravatar of Pacemaker Pacemaker
    10. June 2012 at 04:33

    Scott, the title of your post seems to me like another important reason why people are still doubtful of NGDPLT even if they believe that the Fed isn’t out of ammunition. I believe many people still underestimate the Fed’s ability to set a level path of NGDP as the nominal anchor, even they believe in some ability to set expectations.

    The framing of a “promise to be irresponsible” suggests that there HAS to be some inevitably terrible economic outcome that the Fed has to allow to maintain its credibility. It turns faith in the Fed’s ability to inflate into overblown fears of runaway inflation, as “irresponsible” suggests, if the Fed actually makes good on its threat. Of course, we know that that wouldn’t happen with a properly set nominal anchor, that is if the Fed is explicit about its target, but the framing of “promise to be irresponsible” obscures that part of the argument for NGDPLT.

    Admittedly, compensating for undershooting NGDP or just the price level leads to temporarily higher inflation. Still, this is not the same as runaway inflation, and merely reflects somewhat lower standards of living rather than anything inherently bad about inflation, as I imagine you would say.

    But apart from that, I see two wrong points that are likely to be reinforced by this framing:

    1) Monetary stimulus that is inflationary to get us out of bad times now is also supposedly too inflationary if not rolled back when things get better in the future.

    2) The Fed cannot be credible about monetary stimulus without actually being “irresponsible” in the future

    On the first point, I think it appeal to a certain mechanical understanding of monetary policy. Not rolling back monetary stimulus is likened to the Fed pushing the expansionary levers of discretionary monetary policy twice, once in recession and another time even when out of recession. But unless market forecasts of future inflation say so, this view defies the logic of “target the forecast”. And to dismiss market forecasts of future inflation is to say that markets are essentially ignorant of the time path of monetary policy, which is only possible if the Fed fails to communicate it. This accounts for the failure of the current promise of holding rates down, and shows the power of the nominal anchor that is the Fed’s implicit 2% inflation ceiling.

    On the second point, the problem lies with what exactly the Fed has promised. Again, those with the mechanical understanding implicitly assume that the Fed only commits to a particular course of monetary stimulus, which may become suboptimal or “irresponsible” in the future. But Market Monetarists know that the Fed should instead promise to hit its target, no matter the means. As long as the Fed makes its promise (AKA a “responsible” target) clear, rolling back monetary stimulus when the Fed overshoots its target would fulfill that promise instead of breaking it. The credibility problem wouldn’t exist with NGDPLT.

    And in fact, this problem exists with flexible inflation targeting. The Fed’s promise of higher inflation in 2014 in order to raise inflation now isn’t so credible when it can later say in 2014 that it wants lower inflation.

    To sum up, I don’t think it’s entirely fair to say that people don’t get that expectations are important. The problem is that they are still stuck thinking mechanically about how discretionary monetary policy influences expectations rather than how rules such as NGDPLT can anchor expectations.

  57. Gravatar of Morgan Warstler Morgan Warstler
    10. June 2012 at 06:25

    FEH,

    “Obama’s most fatal error was that he believed that he could be a post-partisan President who could work together with the Republicans to solve the nation’s problems”

    No this contradicts EXACTLY what I’m talking about.

    Obama’s FATAL CHOICE were the CHOICES HE MADE.

    He could have CHOSEN:

    1. Fiscal (govt. spending) deflationary pressure via REAL productivity gains (GROWTH) int he public sector.

    End Davis Bacon, put public employees on 401Ks, make them contribute mightily to their health care etc.

    No Obamacare.

    2. Minor tax increases (he’s a Dem) + deregulation

    And turned to Ben and said make sure we stay at 2%.

    ——

    FEH, I can’t say this enough, this is what my bet with Scott is about.

    FDR and LBJ CANNOT HAPPEN AGAIN.

    Meaning once the GOP got everyone used to low taxes and bankrupted the govt. ($17T debt) without letting Dems pay off their voters…

    The GOP reduced the risk of a proactive “tough” Dem from ever coming close to repeating the sins of the 30′s and 60′s.

    Scott and you fail to understand that human beings can be CHANGED, they can be ALTERED, and political outcomes are not simply just tied to monetary policy.

    In fact it is the reverse: monetary policy right now is a function of politics, and it shouldn’t be, but until YOUR SIDE admits its inherent weaker state, being held back by forces greater than the Fed, then you will continue to imagine Obama woulda / could / shoulda…

    And the only thing Obama woulda, coulda, shoulda done is BE CLINTON.

    In no alternative universe does Obama do what Obama did AND the economy zooms along with a compliant Fed, no Tea Party and no 2010.

    Once you FORGET that day dream, you can more productively play the game of realistic progress.

  58. Gravatar of dtoh dtoh
    10. June 2012 at 06:48

    Saturos,
    Sure MV=PY, but unless you understand the transmission mechanism, it’s just a mathematical equality. You have no idea whether an increase in M will cause PY to increase of V to decrease.

    One of the weaknesses of market monetarism has been that it incorrectly explains the dominant transmission mechanism, by saying people spend more money because they have more money. This is not correct.

    The mechanism is that a change in the price of financial assets relative to the price of real goods and services causes people to spend (i.e. consume or invest) more or less on real goods and services.

    To be more precise, the transmission mechanism works via changes in the expected future price of financial assets versus current PY and expected future PY.

    The problem is that the asset price argument has often been made using nominal (or real) rates as a measure of the price of assets. This leads to some seriously incorrect conclusions (i.e. interest rates are low therefore monetary policy is accomodative). This has caused you, Scott and others to assume a different transmission mechanism (hot potato) which is more often correct… but not always correct, and correct only from a correlational point of view and not from a causative point of view.

    If you assume an asset pricing mechanism using a correct measure of price (i.e. not interest rates) than you get a transmission model which is both more accurate and which better reflects the causative relationship.

  59. Gravatar of Saturos Saturos
    10. June 2012 at 07:26

    dtoh,

    Imagine an economy with no credit or financial markets. Now suppose the monopoly producers of green bits of paper print some more and buy cows and refrigerators. What happens to NGDP?

  60. Gravatar of Saturos Saturos
    10. June 2012 at 07:39

    You are talking about people spending more because they feel wealthier. But what you don’t see is that the wealth effect is itself caused by a rise in the long-run path of NGDP.

  61. Gravatar of Major_Freedom Major_Freedom
    10. June 2012 at 08:25

    Saturos:

    I absolutely agree, Major Freedom (when the economy is not demand-constrained).

    You have no way of knowing when an economy is “demand constrained”, without resource to the system of profit and loss, the price system, for the production of money and hence demand.

    Once again you fail to realize what everyone else is talking about (what causes greater spending).

    I realize what you are talking about now, I am making a point that addresses what you and “everyone else” constantly make here, which is that various events are caused by aggregate spending changes, that can allegedly be revealed to you empirically by observing the spending changes.

    E.g. “Employment fell because NGDP fell.” This argument is reasoning from spending changes. For it ignores the opposite conclusion that is also entirely consistent with the observed correlation, namely, that NGDP fell because employment fell.

    Reasoning from a spending change is what leads you to conclude that NGDP drives employment, rather than vice versa. If you didn’t reason from an aggregate spending change, then you wouldn’t say the data “confirms” NGDP changes cause employment changes.

  62. Gravatar of Saturos Saturos
    10. June 2012 at 08:45

    MF, since you bring it up – what evidence would falsify your theory?

  63. Gravatar of dtoh dtoh
    10. June 2012 at 09:25

    RGDP goes up, but you can’t say anything about NGDP unless you know more about the MOA.

    Your hypothetical is only analogous if you assume the green bits of paper have some monetary function, in which case given the absence of other credit/ financial instruments, they function as a single integrated instrument of credit and exchange, but where the supply of the instrument is controlled through rationing rather than price. I think that’s consistent with but doesn’t confirm either theory (hot potato or asset price) of the transmission mechanism.

    Your hypothetical is a useful model for thinking about the problem. Another similar approach is one which assumes all transactions are done solely on credit (there is no separate MOE) and where the CB is the sole intermediary/ clearinghouse who sets the price and/or availability of credit.

  64. Gravatar of Full Employment Hawk Full Employment Hawk
    10. June 2012 at 09:39

    “He could have CHOSEN:

    1. Fiscal (govt. spending) deflationary pressure via REAL productivity gains (GROWTH) int he public sector.

    End Davis Bacon, put public employees on 401Ks, make them contribute mightily to their health care etc.

    No Obamacare.

    2. Minor tax increases (he’s a Dem) + deregulation

    The Democratic party would never have permitted Obama to do this even if he wanted to. But Obama did not want to govern like a country club Republican, he wanted to govern as a very moderate progressive. So this agenda was no more acceptable to Obama than to the Democratic base (or to me). And adopting this agenda was not neccessary. What was needed was that Obama quickly understand that the Republican party was a very dangerous enemy that was out to do him in, and that he had to neutralize them if his administration was to be successful.

    He could have gotten a Fed that made the economy grow fast enough to get the unemployment rate coming down at a solid rate. Imagine Christina Romer as Fed chair instead of Bernanke. And he could have gotten a larger fisal stimulus using reconciliation. (No tax increases on ANYBODY at this point, not even the 1%.) This would have permitted Obama and the Democrats to run on a “Its morning in America” platform in the 2010 campaign, taking credit for preventing another Great Depression and moving the economy onto a path toward full employment. That could well have resulted in Democratic gains in the 2010 election, or at least prevented serious losses. Then Obama should have used as much political capital as needed to end the filibuster in the Senate and restore the Senate to majority rule. (That would have meant facing down Harry Reid, but with the political capital gained from “Its Morning in America,” Obama would have been greatly strenghened politically.) Under such an environment he could have carried his agenda forward during the second half of his term and would be unbeatable this Fall.

  65. Gravatar of Full Employment Hawk Full Employment Hawk
    10. June 2012 at 09:42

    “Minor tax increase”

    That would have involved repeating one of Herbert Hoover’s mistakes.

    When Clinton increased taxes the economy was already on an upward path.

    Raising taxes when the bottom is falling out of the economy, as it was when Obama took over, is almost as bad as cutting government spending.

  66. Gravatar of ssumner ssumner
    10. June 2012 at 10:54

    Dtoh, You said;

    “I agree, but you assume that there is an increase in spending because OMP puts more money in people’s hands. That’s not what happens. Think about it in terms or real world behaviour. Suppose your broker decides to close your account, sells off $100k worth of Treasuries, and drops off a briefcase with $100k in cash on your doorstop. Are you suddenly going to decide that your previous decision about how much to keep in financial assets and how much to spend on real good and services is going to change. No it’s not; if you’re rational you’ll just go somewhere else and buy another $100k in Treasuries.”

    This completely misses the point. The hot potato effect cannot be seen at the individual level, that’s the fallacy of composition. It does no good to say someone will buy a T-bond from someone else, as that person also doesn’t want to hold $100,000 in cash!

    Bob, Thanks for the tip.

    Pacemaker, You said;

    “The framing of a “promise to be irresponsible” suggests that there HAS to be some inevitably terrible economic outcome that the Fed has to allow to maintain its credibility.”

    Not at all. There need not be any terrible outcome with 5% NGDP targeting. Of course there might be a bad outcome if say an asteroid hit Earth, or we adopt socialist policies, but no one thinks monetary policy can prevent that.

    You said;

    “2) The Fed cannot be credible about monetary stimulus without actually being “irresponsible” in the future”

    Not with 5% NGDPLT.

  67. Gravatar of Mike Sax Mike Sax
    10. June 2012 at 16:21

    “FDR and LBJ CANNOT HAPPEN AGAIN.”

    “Meaning once the GOP got everyone used to low taxes and bankrupted the govt. ($17T debt) without letting Dems pay off their voters… ”

    Yeah so you always say. So how did they happen the first time as they had low taxes and bankrupt government in the 20s? Hell we had even smaller government and the gold standard and no income tax at all unitl 1913 and yet Wilson, FDR and LBJ happend after this “utopia” how’s that?

    If only repeating the same line a real lot made it true.

  68. Gravatar of Mike Sax Mike Sax
    10. June 2012 at 16:22

    Obviously the above post was directed at you Morgan

  69. Gravatar of Morgan Warstler Morgan Warstler
    10. June 2012 at 16:27

    FEH,

    “The Democratic party would never have permitted Obama to do this even if he wanted to”

    Wrong. See Clinton.

    “But Obama did not want to govern like a country club Republican, he wanted to govern as a very moderate progressive.”

    Too bad, he’s not allowed.

    “So this agenda was no more acceptable to Obama than to the Democratic base (or to me)”

    Screw the Dem base (all bases are not created equally), that’s the hole point, they can be taken for granted – look at how they roll over on war.

    FEH, the WHOLE point is that Clinton proves what works, Obama CHOSE not to do it.

    “And adopting this agenda was not neccessary.”

    Yes it was.

    “What was needed was that Obama quickly understand that the Republican party was a very dangerous enemy that was out to do him in, and that he had to neutralize them if his administration was to be successful.”

    This is idiocy, again, NO ONE IN THE MIDDLE, NO INDEPENDEMNT wants a bigger government.

    The ENTIRE Dem effort then is to promise the base butter, butter, butter, WIN, deny them butter, butter, butter…

    And meet the independents EXACTLY where they are.

    FEH, image a Dem party, imagine an Obama that convinced 25% of Republican voters to trust him, and paid no attention to Democrats at all.

    That’s a winning Obama strategy.

  70. Gravatar of Morgan Warstler Morgan Warstler
    10. June 2012 at 16:31

    Sax, I’m fine with you not believing me. It is my seocnd choice, but it is still ok.

    First choice, you listen to me, and realize the best days of the left will be found with devolving power to the states, where the Blue Rich can keep their tax dollars at home.

    Second choice, you don’t listen and it takes another couple cycles of Clinton wins, Obama loses for you to see the facts for what they are.

  71. Gravatar of dtoh dtoh
    10. June 2012 at 16:55

    Scott,
    You said, “This completely misses the point. The hot potato effect cannot be seen at the individual level, that’s the fallacy of composition. It does no good to say someone will buy a T-bond from someone else, as that person also doesn’t want to hold $100,000 in cash!”

    I completely understand that, but the transmission mechanism is not that extra M0 directly causes people to spend more money any more than putting extra gas in the tank causes someone to drive more. The mechanism is that the extra M0 pushes up T-bond (and other financial asset) prices which causes people to reduce their holdings of financial assets and increase their spending on real goods and services. This increased spending requires additional money and a new equilibrium is established where people are content holding the extra money because it’s needed for the higher level of expenditures. Ignoring expectations, if there were no increase in asset prices, there would be zero impact on PY.

  72. Gravatar of Major_Freedom Major_Freedom
    10. June 2012 at 17:09

    Saturos:

    MF, since you bring it up – what evidence would falsify your theory?

    Economic propositions are of a different logical category than empirical propositions. The law of marginal utility for example is not a proposition that can potentially be falsified by experience. It is a logically necessary truth. Only empirical propositions can be falsified by experience.

    If there is always an observable correlation between NGDP and employment, and one advances the theory that the latter drives the former, rather than vice versa, which is what you believe is the correct theory, then neither of our theories could ever be falsified by observing them being correlated all the time. It would be like us seeing a correlation between a person’s consumption and their wealth earning capacity, and you advance the theory that the former drives the latter, and I advance the theory that the latter drives the former. Again, neither of our theories can be falsified by observation, because we both have theories consistent with the observations, and yet our theories contradict.

    This is where economic science comes in. Economic science is a field of inquiry concerning non-hypothetical, non-empirical propositioning, by grounding propositions on a non-empirical foundation. It’s very much like grounding the empiricist epistemology itself on something other than itself. If one were to make an argument of the validity of empiricism, then I hope you can understand that the argument cannot possibly presuppose the validity of empiricism, that is, it cannot possibly be grounded on empiricism. The validity of X cannot be based on taking X for granted.

    So just like the empiricist method is grounded on something outside of empiricism, so too is economic science grounded in something outside empiricism.

    The theory that employment changes in part drive NGDP changes has been confirmed by decades of data. Look at any historical chart of NGDP and employment, and you will see a pretty tight correlation between the two. When employment goes up, NGDP goes up. When employment goes down, NGDP goes down.

    You might be thinking “Hey wait a minute, why doesn’t the correlation between NGDP and employment confirm the theory that NGDP drives employment? I will answer: You’re right, the data ALSO confirms that theory. For the correlation is still the same!

    Well, if both of our theories are confirmed by the data, and our theories cannot both be true, then obviously we’re going about this the wrong way by trying to settle things by observing the data!

    So to make a long story short, there is no observations that can falsify the theory I am advancing of employment driving NGDP, the same way there are no observations that can falsify your theory of NGDP driving employment! You’re just as unable to use the data to prove your theory as I am.

    Ever heard of the expression “Don’t mistake correlation for causation”? Well, when you observe a correlation between NGDP and employment, and you conclude BASED ON THIS CORRELATION that NGDP drives employment, then you’d be making the famous mistake.

  73. Gravatar of ssumner ssumner
    11. June 2012 at 06:19

    dtoh, You keep insisting you understand the hot potato effect, but keep talking like you don’t. I agree that at the individual level giving people more cash doesn’t make them spend more. But at the aggregate level it does—even in a society that doesn’t have any financial assets.

  74. Gravatar of Negation of Ideology Negation of Ideology
    11. June 2012 at 06:59

    FEH – you say:

    “That would have involved repeating one of Herbert Hoover’s mistakes.

    When Clinton increased taxes the economy was already on an upward path.

    Raising taxes when the bottom is falling out of the economy, as it was when Obama took over, is almost as bad as cutting government spending.”

    Aren’t you forgetting the Sumner Critique? (And on Sumner’s blog!) Fiscal policy only works to the extent the Fed accommodates it. Hoover’s mistake was worshiping a shiny yellow metal while M2 dropped by a third and NGDP dropped by half. Roosevelt reversed Hoover’s monetary policies, he didn’t repeal his tax increases. Thatcher raised taxes and cut spending and the economy recovered because of good monetary policy. If Obama had followed the Thatcher/Clinton model, he’d have an approval rating over 60%.

    With bad monetary policy, fiscal stimulus is insufficient. With good monetary policy, fiscal stimulus is superfluous.

  75. Gravatar of dtoh dtoh
    11. June 2012 at 13:18

    Scott,
    You keep insisting you understand the hot potato effect, but keep talking like you don’t. I agree that at the individual level giving people more cash doesn’t make them spend more. But at the aggregate level it does—even in a society that doesn’t have any financial assets.

    If you have money, you defacto have a financial asset. Also if there is financial assets, then Fed action as we conceive it today would have to work by the Fed exchanging money for real goods and services. That in itself would increase PY.

    The Fed doesn’t work by giving people more money. It works by doing an exchange where they get money for other assets.

    I agree that if you exchange other assets for money, it will push up spending, but…it happens through the mechanism of higher asset prices.

  76. Gravatar of Major_Freedom Major_Freedom
    11. June 2012 at 14:01

    dtoh:

    I think you have a point in challenging Sumner on the hot potato effect. He writes:

    “I agree that at the individual level giving people more cash doesn’t make them spend more. But at the aggregate level it does—even in a society that doesn’t have any financial assets.”

    This is simply wrong. If more money doesn’t make them spend more, then it cannot possibly be the case that inflation leads to higher spending. It is only if individuals do spend more when they receive more cash, can there be more spending in the aggregate. Aggregate spending is, after all, just the abstract sum total of all individual spending.

    The hot potato effect is just a popular way of describing instances where the increase in money supply exceeds the demand for money holding.

  77. Gravatar of Floccina Floccina
    12. June 2012 at 08:53

    I am a little off topic but along with the fed moving to NGDP targeting to help with unemployment shouldn’t the government end all automatic cost of living increases for SS and salaries of their employees. Sometime it is necessary for real compensation to fall. An economic decision should be made on each CPI raise.

  78. Gravatar of Floccina Floccina
    12. June 2012 at 09:00

    Major_Freedom do you think that it would be good for people to pay down debt, borrow less and save more, particularly if we are going to have slowing population growth? If so wouldn’t that require either more base money or significantly lower wages?

    Also in a pure gold standard wouldn’t more people go into mining if the price of gold rises relative to other goods and services and isn’t that what Scott wants to mimic NGDPLT?

  79. Gravatar of ssumner ssumner
    12. June 2012 at 09:13

    dtoh, I don’t think the particular asset being bought is what matters–gold and T-bills would have similar effects. What matters is the increase in the base.

    Floccina, I agree.

  80. Gravatar of Major_Freedom Major_Freedom
    12. June 2012 at 10:13

    Floccina:

    Major_Freedom do you think that it would be good for people to pay down debt, borrow less and save more, particularly if we are going to have slowing population growth?

    As long as they respect other people’s property rights, yes. Individuals should be free to pay down debt, borrow less, and save more. Although I do not believe they ought to do so for the sake of the changing population growth. But if they do so for that reason, then they aren’t stealing from anyone nor are they hurting anyone, so I am OK with it.

    If so wouldn’t that require either more base money or significantly lower wages?

    When you said “save more”, did you mean “hoard more cash”? If you did mean that, then I will caution you not to conflate saving with cash hoarding. Saving is abstaining from consumption. Investments imply dollar for dollar saving.

    If people borrow less, and save more, then that could mean people are investing more, as the drop in borrowing is offset by an equivalent drop in lending, but the additional saving per se leads to higher investment relative to consumption.

    If the preference for cash does increase, then that means people want more purchasing power. They can get it without the central bank’s assistance, by the natural fall in prices and costs that would occur. So sure, if people hold more cash, then falling wage rates is one manifestation of higher cash balances.

    But remember, lower nominal wage rates does NOT, and I can’t repeat this enough, it does NOT imply a fall in standards of living. This is because wages are also a business cost, and for most goods sold in our economy, prices gravitate to costs plus profit, so when wage rates fall, business costs and hence prices fall. Wage earners will make fewer dollars per year, but their earnings will be worth more in real terms.

    If the fall in wage rates takes place during a period of high unemployment such as today, then actual GAINS can be made by falling wage rates. This is because with a fall in wage rates, investments that were postponed up until that time, awaiting for a fall in costs, will be made. As these investments are made, total wage payments in the economy will almost certainly rise, and productivity will rise too, as more workers are working helping to produce goods. The net upshot here is a RISE in real wages. This is a politically unpopular, but devastatingly effective way at raising the standards of living of the poor. The problem is that the belief that falling wage rates ipso facto means lower standard of living, is so ingrained in people’s minds. We can thank the Keynesian morons for that.

    Also in a pure gold standard wouldn’t more people go into mining if the price of gold rises relative to other goods and services and isn’t that what Scott wants to mimic NGDPLT?

    Yes, and yes. But, and this is a HUGE but, central planners CANNOT “mimic” the free market. Oskar Lange thought the state could do it with “market socialism” back in the 1930s. But there is no substitute for the free market price system.

    Yes, if the relative profitability of gold mining went up, because people demanded more gold relative to other goods, then capital will be redirected to gold production and the growth in gold supply will tend go up. And by the same token, if the relative profitability of gold mining went down, because people demanded less gold relative to other goods, then capital will be redirected to other goods production, and the growth in gold supply will tend go down.

    It seems like something so “simple” can be mimicked by central planners, doesn’t it? When people’s demand for fiat cash goes up, the central bank can create more. When people’s demand for fiat cash goes down, the central bank can create less. What could be a better mimic of the market, right?

    The problem is that central planners cannot know what people’s actual demand for cash relative to their spending is, ever. They can see total spending decline by 5%, as people try to hold more cash, but this doesn’t mean that “the market” is pleading that they want whatever quantity of money is sufficient to get spending to rise back up to eliminate the previous fall in spending. For there is nothing “special” about yesterday’s spending. People who spend yesterday such that NGDP is $10 trillion, are not saying to the central bank “Print more money” when today’s NGDP is $9.9 trillion, such that tomorrow’s NGDP gets back up to $10 trillion, or $10 trillion plus 5%.

    People in the market aren’t demanding “spending” when they hold more cash, they are demanding more MONEY and purchasing power. The difference is crucial. If people demand more cash, then the central bank cannot possibly know how much more cash people actually want. This is why Sumner is forced to fall back on an arbitrary aggregate “spending” quantity. He makes the tacit assumption that people never change their spending habits. He assumes that a fall in NGDP from yesterday to today means that people are demanding HIS proposed quantity of money that would get spending back up to his arbitrary target, when in reality people don’t want HIS proposed quantity of money. They want THEIR OWN proposed quantity of money.

    The only way to give the market what it wants, monetarily, is to let the market decide how much money is to be produced, AND how much aggregate spending there is. When the central bank targets a 5% NGDP, then the market’s ability to decide how much money AND spending there should be, is lost.

    What will invariably end up happening is that when the market otherwise wanted $100 billion more money, and, say, 0.5% less aggregate spending, then the central bank that is trying to “mimic” the market, by, say, targeting “aggregate spending”, will have to overrule this. They will have to produce MORE money than the market wants.

    The typical response to this from market monetarists is for them to arrogate themselves as being able to know that millions of people in the market don’t really want to reduce their nominal spending, ever, and so when NGDP growth is less than the arbitrary 5%, then they believe those in the market are destroying themselves, that they are engaging in self-destructive activity, that when they seek to hold more cash, they aren’t “really” asking for a change in aggregate spending, so if their attempts to hold more or less cash does result in an aggregate spending that is above or below the arbitrary 5% number, then market monetarists use circular logic and say only a “strong” central bank can solve this problem of aggregate spending deviating away from the central bank’s own, non-market determined, desired aggregate spending path.

    The only way anyone can know how much money and spending there would be in the free market, is to integrate money production into the free market process. The price system, of profit and loss in production, is the only way to know how much money those in the market want. Sumner believes what he wants is a market driven want, when in reality it is not. It is a central planner want. A market want is a want based on private property, not communist institutions like central banks. If those in the market want more money, then each individual’s wants is restricted to what every other market participant wants, and the resulting investment, production and exchange of money that results, will be what “the market” wants. Of course it won’t be what central planner wannabes like Sumner want. What they want is rigidity, control, and stability. 5% NGDP growth, controlled by communists, never changing. Anyone who is partial to the free market would feel a shudder down their spines at this. I guess the free market is not worth fighting for on this blog.

    The market process in money production INCLUDES not only fluctuating money supply growth rates, but also fluctuating spending growth rates. It is wrong to believe that a central bank can mimic the market by choosing an arbitrary aggregate spending path, and then print arbitrary quantities of money whenever the market process leads to a deviation away from the arbitrary 5% constant, rigid growth. The market process simply cannot be mimicked. It if could, then North Korea and the former USSR would have been the most advanced, prosperous, most productive economies in the history of mankind. In reality of course, they are/were hell holes. Why? Because the leaders, much like Sumner, have/had delusions of grandeur, that intelligent people can either improve the free market, or mimic it as a central planner.

    Let me make this as easy as possible: Suppose we had a free market in money production. Suppose I decide to lengthen the time in between between my paycheck to when I spend the money, compared to two weeks ago. NGDP would fall from where it was two weeks ago, all else equal, correct? Now, is my choice to hold money for a little longer than before, also an investment in more money production? Obviously not, correct? Well, my question is this: How on Earth can anyone believe that my choice to delay my spending in a free market, be “mimicked” by a central bank printing whatever money is necessary for SOMEONE ELSE to spend more to “make up” for my reduction in spending? It’s totally absurd. A free market in money production that sees people holding on to their money for a little longer than before, is not at all “mimicked” by a money printer that immediately prints and spends money on itself and its friends.

    So when WOULD money be produced in a free market you ask? Well, it clearly doesn’t take place when NGDP falls, as we have just seen. No, it results when the relative profitability of the RESOURCES that go into money production, increases. This occurs not when NGDP falls, but when the relative prices of goods other than precious metals falls, to a degree that would entice investors to redirect their capital into gold production. Once gold production goes up, then gold money spending for all goods goes up, and that will increase the relative profitability of other goods.

    Thus, over time, as capital accumulation occurs, the rate of gold production will only increase when people value more gold relative to other goods, such that it is economically viable to devote more scarce resources into money production instead of other goods production, REGARDLESS of aggregate spending. A central planner cannot mimic this. He lacks a price system for the means of producing money itself. He doesn’t know if producing more money would generate a gain or loss if it took place in a free market.

    If he prints whatever amount of money is necessary to make aggregate spending rigid, then he doesn’t know if this would have created huge losses if he were a gold miner in the free market. He could be giving the market more money than it actually wants. Indeed, this is typically the rule for fiat money systems. They almost always produce more money than the market wants, and we can infer this from the fact that their inflation almost always exceeds the rate of precious metals production, which WOULD have almost certainly been the money in a free market.

  81. Gravatar of Floccina Floccina
    12. June 2012 at 11:18

    Major_Freedom
    One point: Right me if I am wrong but I believe that hording cash is not the only way to save. Since debt is saving with a negative sign then paying down debt is saving and is contractionary.

    I mostly agree (I would like to see free banking with money backed by whatever people accept) but I think all long as we have a Central Bank, it should try to be as close to what free banks would do as possible and I think that NGDPLT is the best option for that for now.

  82. Gravatar of Major_Freedom Major_Freedom
    12. June 2012 at 11:36

    One point: Right me if I am wrong but I believe that hording cash is not the only way to save. Since debt is saving with a negative sign then paying down debt is saving and is contractionary.

    Only if the debt was created out of thin air by the banking system, would paying down debt be contractionary.

    For example, suppose you and I were a two person economy. I have $100 and you have $100. Total money supply is $200. I lend you $10 today. Thus, I now have $90 and you have $110. Total money supply is still $200. After one year, you pay me back $11. Now you have $99, and I have $101. Total money supply is still $200. No contraction.

    Now suppose everything is the same, but instead of my lending you money I have, I lend you a fiduciary claim, a promise to pay. So suppose we both start with $100 again, and now I give to you a claim that says “The bearer of this note can redeem it for $11 on June 12th, 2013.” So now I have $100 today, you have $100 today plus a redeemable claim of $11. Suppose also that this redeemable claim is generally accepted as a medium of exchange. So what happens? Total money supply is now $100 + $100 + $11 = $211.

    Now fast forward to next year. This redeemable claim is now going to be paid. Suppose you still have the claim. I pay you $11, and the redeemable claim is extinguished. So at the end of the year, you have $111. I now have $100 – $11 = $89. Total money supply went from $211 to $200. That is contractionary.

    Notice how there is a contraction when credit is expanded out of thin air and paid back/extinguished, but when credit is backed by prior saving, debt pay backs are not contractionary?

    I mostly agree (I would like to see free banking with money backed by whatever people accept) but I think all long as we have a Central Bank, it should try to be as close to what free banks would do as possible and I think that NGDPLT is the best option for that for now.

    I disagree. I think allowing country level fluctuations in money and spending, can take place even with central banks, and allowing country to country fluctuations of money and spending are even closer to a free market in money production.

  83. Gravatar of Floccina Floccina
    12. June 2012 at 11:42

    One more thing, I think that had we had free banking from the beginning of the industrial revolution until now that the system would have evolved away from precious metals to money backed only by bank assets. Consider old collectable baseball cards, they hold their value partly because the company that made them is committed to not digging out the old machines and making more. Bank issues money could be similar. In this case currency would like bearer bonds backed by the bank’s assets and commitment to avoid inflation and not all that different from money in a demand deposit account. If a bank’s currency rises in value they print more, if it falls in value they take in more than they issue and destroy some.

  84. Gravatar of Major_Freedom Major_Freedom
    12. June 2012 at 11:49

    Floccina:

    The problem with that argument is that the prices of the bank assets themselves are a function of the money supply. So the prices of bank assets can rise if the banking system as a whole expands fiduciary credit.

    Fiat money backed by bank assets, the prices of which are themselves backed by fiat money, is still a monetary system backed by nothing. If the prices of those assets falls, during a credit crunch say, then the money you thought was worth something more, will be worth less.

  85. Gravatar of TheMoneyIllusion » What the blogosphere does best TheMoneyIllusion » What the blogosphere does best
    22. February 2013 at 14:12

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