All roads lead to market monetarism
Matt Yglesias responds to Michael Mandel’s suggestion that we should try to eliminate the trade deficit in manufactured goods, even if it results in slightly higher inflation:
Mandel thinks this would be a reasonable price to pay to rebuild America’s manufacturing base and get us back into the neighborhood of full employment. And I agree. But I would note that when you try to think clearly about what he’s saying you see that this idea””like virtually all possible roads back to full employment””crucially depends on the existence of a stimulative monetary policy paradigm. Mandel is assuming that lots of the new manufacturing employment would represent a net increase in employment, and not just displace workers from existing jobs. But that’s assuming the Federal Reserve would allow the inflation rate to rise by 0.2 percentage points per year each and every year for ten years. There’s no indication that the present Federal Reserve would in fact do this. Instead, consistent with their policy of capping price increases as a two percent annual rate, monetary policy would force net job creation to stay on a low trajectory.
A manufacturing boom would come not at the expense of higher prices and with the benefit of reduced joblessness, but rather at the expense of employment in other industries. At this point all roads to large-scale rapid reductions in unemployment””whether they involve fiscal stimulus or trade policy or something else””fundamentally depend on cooperative monetary policy. But we don’t have cooperative monetary policy. We have monetary policy that regards mass unemployment as a small price to pay for cheap gasoline, moderate rents, and subdued worker wage demands.
Why do I call this market monetarism? After all, even people like Paul Krugman advocate monetary stimulus. The difference is that Krugman also favors protectionism as a way of creating jobs, or at least he favors tariffs on goods from countries with “undervalued” currencies, like China. Yglesias is pointing out that this won’t work if the Fed targets inflation at 2%. But of course if the Fed was willing to allow higher inflation, we wouldn’t need the policy in the first place.
The “Sumner Critique” doesn’t just apply to fiscal policy. It applies to the entire General Theory, including its dark side (the paradox of thrift, neo-mercantilism, etc.)
PS. Mandel’s paper is co-authored by Diana G. Carew
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16. July 2012 at 08:46
“The “Sumner Critique” doesn’t just apply to fiscal policy. It applies to the entire General Theory, including its dark side (the paradox of thrift, neo-mercantilism, etc.)”
Yup. Time to update the textbooks. I’m serious.
16. July 2012 at 08:57
Scott,
I’m pretty sure Krugman knows that expansionary monetary policy is both necessary and sufficient to restore the economy.
And Obama and Bernanke know it too.
But neither Obama nor the Fed can flip the switch: it will expose their prior incompetency
(“You mean all this time we just needed to flip that little switch over there???”).
But if Obama gets a democratic majority, pushes some kind of New Deal 2.0, then Bernanke can restore the economy to potential through MP, while New Deal 2.0 gets all the credit, so that Bernanke and Obama save face.
Other option: the stock market, employment or the banks tank, providing Bernanke with an excuse to take ‘radical’ action.
But this is something politicians can not control.
In fact, I think even Keynes realized that monetary policy was the core issue.
Consider this thesis:
The General Theory is an elaborate rationalization that provides politicians the necessary intellectual cover to hide their prior incompetence as they restore the economy through monetary policy, but give credit to public works programs.
16. July 2012 at 08:57
i have never really understood the focus on manufacturing, as if this was “real” economic growth and somehow services (and service exports) are not (btw we export a lot of services last i checked). anyway, making steel is also a service much like cooking, one just needs a much bigger stove.
16. July 2012 at 09:19
Cedric, my Mankiw textbook devotes a couple of pages and some good diagrams to the Fed’s reaction function in the ISLM model. Same with my Bernanke textbook. The key thing missing is the visualization of AD as NGDP, the notion that the Fed fully determines NGDP expectations by controlling the medium of account, and hence fiscal stimulus only works if the Fed lets it.
As Scott once argued, fiscal stimulus is no more permanent than a temporary monetary injection. With Ricardian Equivalence the balanced-bedget spending multiplier is just 1 (of dubious value) and only lasts as long as the Treasury keeps the spending up. The hope is that the government can do this until “animal spirits” restore investment – if not (implicitly) let the government take a more permanent role in allocating resources, curing unemployment by force. But we know that investment is driven by rational expectations of consumption, which are depressed and released by monetary policy – hence investment won’t recover unless the Fed lets it. So if fiscal stimulus is effective, it’s because the Fed has chosen to “preserve” the attempted boost to spending by easing the path of NGDP – which means of course that it would have worked just as well without a budget deficit. So fiscal stimulus is just a political excuse for monetary easing (because, “spending creates jobs” whilst “money-printing creates inflation”).
So the ideal textbooks would show that the central bank fully determines AD. Better still it would ditch the AD “planned expenditures” concept and simply replace it with a hyperbola for the prevailing level of nominal spending.
dwb, today’s left still hasn’t excised the ghost of Marxist thought.
16. July 2012 at 09:22
You also got a pretty big cite in The Daily Telegraph today:
“Market monetarists around the world argue that central banks can always fight off slumps, whatever is thrown at them. But to do so policy-makers must stop targeting inflation — the wrong variable, indeed a particularly bad variable — and instead deploy nuclear force to drive up nominal GDP to a trend line growth rate of 5pc, doing so transparently so that markets know exactly what the objective is and when the stimulus will be unwound.
I have no doubt that this would bring about a full recovery very fast if conducted with enough panache, but is it possible to marshal political consent for such revolutionary action?
The Tea Party Congress, like Europe’s bourgeousie, would rather wallow in liquidation, Puritan cleansing, and mass default than tolerate the possibility of a solution.
To those who excoriate monetary stimulus as some form of devilry — most readers it seems — my question is whether would you rather see bigger deficits and bigger public debts instead. Because that is exactly what you get if central banks fail to act in a slump, if you don’t lose your democracy as well.”
See:
http://www.telegraph.co.uk/finance/comment/ambroseevans_pritchard/9401574/Fed-fiddles-as-America-slides-back-into-recession.html
16. July 2012 at 09:35
Saturos, thanks, and I totally agree with your characterization of the ideal textbook.
dwb, have you ever debated this notion with a leftist? I have, and I like to think I’ve been successful at changing minds.
16. July 2012 at 10:59
Cedric. Of course it should only be called the Sumner critique because economic ideas are never named after their actual inventor.
JL, You said;
“I’m pretty sure Krugman knows that expansionary monetary policy is both necessary and sufficient to restore the economy.”
If so, it would be nice if he would stop suggesting exactly the opposite.
I agree with your flip the switch comment, at least subconsciously that may be a factor.
Since 100s of economists sincerely believe in fiscal stimulus, I have no reason to doubt that Keynes himself was sincere. Why not?
dwb, Exactly.
Saturos, Good point. And isn’t the fiscal multiplier 1.0 only in the limiting case where the government produces output that is not valued by consumers?
asdasdasd, Thanks for the link.
16. July 2012 at 11:21
You accidentally wrote that the Fed is targeting 2% inflation. As you’ve constantly pointed out they seem to be targeting < 2%.
16. July 2012 at 11:40
Scott,
Regarding the sincerity of Keynes: I was just throwing out a hypothesis.
I think it’s more likely that Keynes was sincere, but I think it’s not implausible that he was not.
For one, he was very opposed to the gold standard; he knew that expansionary MP was necessary and that the gold standard could not provide it.
But why did he not realize MP was sufficient?
Perhaps he did. Perhaps in 1930 he started a draft book called “The Money Illusion” and then thought:
No, this will never work, politically. People will think I’m mad if I say that the simple act of turning on the printing press will solve this crisis. They’ll think I want to add Weimar-hyperinflation to the big problems they already have!
I need to find a way to convince the government to turn on the printing presses. When do governments naturally do that? When they have larges debts, above that which can be serviced by taxation. So I need to increase the debt.
And then he wrote this elaborate story about a multiplier and an alternator to justify a debt increase so that they would turn on the printing press.
Likely? Perhaps not. Plausible? I wouldn’t rule it out.
As for Krugman, I’m 99% sure that Krugman is not sincere.
He is sincere in his intentions (improve the welfare of people), but I think he saw that his MP arguments failed to convince the Japanese, whereas Keynes arguments worked in the 30s, so he’s sticking to the proven formula.
I discovered your blog way back when Krugman replied on your open letter. It was a very dishonest reply from Krugman and it was obvious (to me) that Krugman knew it was dishonest and logically unsound and that he actually sympathized with you.
From private correspondence with Brad DeLong (2 years ago) I concluded that he, too, still believes that MP can solve the crisis.
At first this greatly puzzled me, but lately (the past few weeks) I have come to the conclusion that both DeLong and Krugman, and perhaps even Bernanke, learned from history:
Keynes argument succeeded in practice, whereas Bernanke/Krugman failed to persuade Japan in the 1990s.
Thus, choose the winning strategy and use all your intellectual credibility to push for fiscal stimulus.
Even if it is dishonest, it is better for the general welfare.
16. July 2012 at 13:21
According to the NY Fed, the Fed is responsible for 50% of market gains over the last 11 years.
“Posted on the New York Fed’s web site Wednesday, the study sought out to explain why equities receive such a high premium over less risky assets such as bonds.”
“What they found was that the Federal Reserve has had an outsized impact on equities relative to other asset classes.”
“Theoretically, the S&P 500 [.SPX 1353.64 -3.14 (-0.23%) ] would be more than 50 percent lower””at the 600 level””if the bullish price action preceding Fed announcements was excluded, the study showed.”
http://www.cnbc.com/id/48165921/
16. July 2012 at 13:29
Further the report gives us some investment advice-which I for one am always looking for.
“I would conclude that correctly analyzing Fed moves is much more important than stock picking,” said Brian Kelly of Shelter Harbor Capital. “If you want to generate alpha, you should trade the stock market 24 hours before an FOMC meeting. Simply follow the trend for that 24 hours and you will outperform.”
16. July 2012 at 13:31
“The Fed’s next announcement is due August 1st and it would seem by this study, one would want to make sure they are invested in the market by 2pm on July 31st”
“It’s a QE world,” said Josh Brown, an investment advisor and popular author of The Reformed Broker blog. “We’re all just trading in it.”
16. July 2012 at 14:17
“dwb, have you ever debated this notion with a leftist? I have, and I like to think I’ve been successful at changing minds.”
not sure what notion you mean, that the distinction that manufacturing and services arbitrary?
16. July 2012 at 14:17
“dwb, have you ever debated this notion with a leftist? I have, and I like to think I’ve been successful at changing minds.”
not sure what notion you mean, that the distinction that manufacturing and services arbitrary?
16. July 2012 at 15:04
“But we don’t have cooperative monetary policy. We have monetary policy that regards mass unemployment as a small price to pay for cheap gasoline, moderate rents, and subdued worker wage demands.”
And we also have a President who does not have the political courage to do anything about it.
Obama could win the election if he would start a debate on monetary policy.
We are, after all, a democracy. To have the most basic economic decision be made by the deranged deflationists on the Fed board, with no national debate at all, is the the entire opposite of democracy. We need to toss Bernanke and the deflationists out. They are strangling the whole economy and destroying the lives of millions of people more or less just for the fun of it.
16. July 2012 at 15:11
I know you don’t like the “i” word, but I have to say that these days I keep hearing people tell different stories about why the economy is performing as it is, and I keep coming back to a little more inflation would help with that. But for the sake of your nerves, I’ll stick to NGDP growth instead.
Consumers are underwater/deleveraging? Some more NGDP will fix that.
Consumers are saving too much and consuming too little (yeah, I know, investment too)? More NGDP please.
Banks are unwilling to led? Yup, more NGDP.
Trade deficit too high/offshoring/whatever? More NGDP (and a weaker dollar) please.
Uncertainty about future deficits/taxes? More NGDP.
The market for loanable funds can’t clear at negative real rates? NGDP.
No matter the merit of the alleged concern, expansive monetary policy seems to help no matter what the resulting mix is between inflation and real growth. Or, as Scott said, all roads lead to market monetarism.
Which, of course, does not address those who think the Fed can’t create more NGDP.
16. July 2012 at 15:24
@Adam:
Great comment. What’s more, it is something that the Occupiers can rally around, too.
Student loan debt too burdensome? NGDP
Frustrated that your perceived corporate overlords are robbing Americans and hoarding all that wealth? NGDPLT will get that capital off the sidelines.
and so on.
16. July 2012 at 15:36
Yeah, Adam, speaking of inflation, Noah Smith wrote a piece about it recently and pointed out that-against those who try to claim inflation is bad for the poor-there’s a long history of the advocates for the poor arguing for more inflation, beginning of course with Mr. Inflation himself, William Jennings Bryan.
16. July 2012 at 17:05
Yeah, Adam, speaking of inflation, Noah Smith wrote a piece about it recently and pointed out that-against those who try to claim inflation is bad for the poor-there’s a long history of the advocates for the poor arguing for more inflation, beginning of course with Mr. Inflation himself, William Jennings Bryan.
Noah Smith didn’t address the actual argument being made. He just assumed inflation increases all wage earners incomes along with rising prices. He ignored the Cantillon Effect.
16. July 2012 at 17:18
Scott: But some roads, like Mandel´s, are winding and full of potholes…
Saturos: Cowen´s and Tabarocks Macro Principles Text does that.
16. July 2012 at 17:24
Adam:
“No matter the merit of the alleged concern, expansive monetary policy seems to help no matter what the resulting mix is between inflation and real growth. Or, as Scott said, all roads lead to market monetarism.”
It is truly awe inspiring to behold believers praising inflation as a panacea. The caricatures are true.
16. July 2012 at 17:42
The “Sumner Critique” doesn’t just apply to fiscal policy. It applies to the entire General Theory, including its dark side (the paradox of thrift, neo-mercantilism, etc.)
“Our criticism of the accepted classical theory of economics has consisted not so much in finding logical flaws in its analysis as in pointing out that its tacit assumptions are seldom or never satisfied, with the result that it cannot solve the economic problems of the actual world. But if our central controls succeed in establishing an aggregate volume of output corresponding to full employment as nearly as is practicable, the classical theory comes into its own again from this point onwards.” – General Theory, pg 378.
To Keynes, “full employment” was synonymous with maximum “effective demand” (see Chapter 4).
Seems like the “Sumner Critique” collapses to “What Keynes already wrote.”
16. July 2012 at 19:01
Nice blogging…yes, in the blogosphere, market monetarism is gaining ground steadily….now we must advance upon that last and strongest citadel of Theo-Monetarism, the central banking fortress known as “The Fed.”
BTW, according to this paper,
http://economistsview.typepad.com/economistsview/files/Schenkelberg-and-Watzka.pdf
QE did not cause inflation in Japan, and we saw that same result in the USA. Gee, you think maybe a shrewd business guy would suggest wiping out national debt and stimulating the economy at the same time?
“No!” say central bankers. “That is not orthodoxy.”
“Yes,” says me. “I like what works!”
16. July 2012 at 19:47
[…] Sumner’s latest post sums up the application of the “Sumner […]
16. July 2012 at 20:53
NGDP targeting absent genuine investment opportunities will result in massive capital misallocation. The stampede out of “safe” investments will be looking for a capital preserving home.
The economy is not capital starved, nor is it fearful of the future. It is actually already massively oversupplied.
16. July 2012 at 22:43
What’s this, Scott? Caplan says you had a debate with Bill Dickens?! What emerged from that?
http://econlog.econlib.org/archives/2012/07/the_contributio.html
Marcus, yes, theirs is the best introductory economics textbook in print (and appropriately expensive!).
Scott, I’m not sure what you mean, I thought the size of the multiplier was basically an expression of the circular flow of income. If the IS curve were flat (no marginal propensity to save from transitory income) then the size of the fiscal multiplier is basically M times deltaV as a function of both the rise in the interest rate and the loss of money demand due to transfer of wealth from private to public sector, divided by whatever nominal quantity was spent by the Treasury. The downward slope of IS makes the multiplier smaller than that, of course, as increased saving from the circular flow pushes rates back down. Of course Keynesians don’t see it that way, but ISLM implies it – Keynesians basically read ISLM “the wrong way around”. And also of course I’m ignoring the argument I made above, and central bank reaction functions in general; I’m just holding M constant.
The Keynesian-cross model is only accurate at the ZLB (as I once heard you remark to Mark Thoma). So I should amend my previous post – just by a priori logic, the government spending multiplier is 1 at the ZLB with Ricardian equivalence; but otherwise it is determined as above, as Keynesian cross doesn’t apply due to crowding out, and the stimulus is all due to the change in V as a function of interest and income. With Ricardian equivalence obviously rates rise by less, and the total effect or “multiplier” is smaller. But AFAIK, it has nothing to do with whether the spending is valued by consumers (unless you’re talking about some kind of wealth effect that further boosts V). As Keynes famously said,
By the way, according to your definition of V, we have to say that fiscal stimulus boosts NGDP when the central bank holds M constant by boosting NGDP/M. Very insightful. (If you bring up supply and demand, remember that since k is the fraction of income individuals hold as money, V is essentially the number of money balances the average individual spends each year, or lends to others to spend.)
16. July 2012 at 22:52
The absurd thing about the Keynes quote there of course is that if he admits that the government can create new banknotes to fill the bottles (without eg. violating the gold standard), then you could get a perfectly good stimulus without making people crawl into mines by just dropping enough of them out of – er, zeppelins? Interest rates simply don’t enter into it.
17. July 2012 at 04:54
I just had a quick question for everyone. Non-Keynesians know that the paradox of thrift is a joke right? I mean all their models explaining it are based on an economy with one consumer good and zero capital goods for crying out loud.
17. July 2012 at 05:19
Q for John Becker: WTF??
Scott may be amused or possibly enraged by this bit of reasoning from a price change by Chloe Smith MP. (Wiki tells me she is Economic Secretary to the Treasury, the fifth most senior ministerial post in the UK Treasury, after the Chancellor of the Exchequer, the Chief Secretary to the Treasury, the Paymaster-General and the Financial Secretary. It is not a Cabinet office.):
“Inflation more than halved since September, meaning less pressure on family budgets and support for high-street spending.”
https://twitter.com/hmtreasury/status/225165728834265088
17. July 2012 at 05:53
Kevin,
The paradox of thrift is silly. It would only apply to an economy without capital goods. In such an economy, decreased spending on babysitting or massages would lead to a decreased output of spending and massages. But in an economic system with savings or investment, that isn’t the case. Greater savings on the part of consumers changes the direction of spending in favor of projects with longer time horizons but it does not lower the total volume of spending. People who save more money free up additional resources to go away from providing consumer goods and to be invested, by the bank or by the consumer themselves into more capital goods production. It’s much the same as any other change in demand. There’s an adjustment period but no net losses.
The case of people fleeing to safety by holding cash or T-bills is a consequence of the depression, associated uncertainty, and perceived lack of profitable routes or investment rather than the cause.
17. July 2012 at 06:06
John Becker,
Lots of sticky-price models incorporate capital goods. It’s true that many NK models have consumption-goods only, but that’s for simplicity. It doesn’t generate the results that matter. I don’t think I’ve ever seen a sticky-price model of any kind, Hicksian or Woodfordian or whatever, that didn’t give rise to a paradox of thrift.
17. July 2012 at 07:00
John Becker – I’m no economist, but the paradox of thrift seems pretty obvious to me if consumers’ horded cash ends up as excess bank reserves.
17. July 2012 at 07:21
Major Freedom – A panacea is cure for all possible ills. More NDGP doesn’t cure every possible problem, but it can help the problems people think we are facing now.
17. July 2012 at 07:35
What is the obsession with manufacturing?
Let China, Vie-Nam, Indonesia take the low-paying manufacturing jobs. The US will keep the high paying service jobs, with the nice working conditions and the low rates of personal injury.
17. July 2012 at 12:09
Mark, Or maybe the target is 2% but they don’t try to hit the target.
JL, You make some good points, but a few corrections:
1. Keynes was not strongly opposed to the gold standard, he favored a flexible gold standard, sort of like Bretton Woods. He’d be a Ron Paul supporter today. (Just kidding)
2. Keynes didn’t win the argument in the 1930s, as not much fiscal stimulus was done. And the 1940s have nothing to do with Keynes.
Mike Sax, Data mining 101
JimP, Good point.
Adam, Good point.
Marcus, That’s right.
Ben, I agree.
NerdyDude, It’s the unstable NGDP that causes massive capital misallocation.
Saturos, I don’t recall much of a debate, as I recall he was too busy.
You said;
“The Keynesian-cross model is only accurate at the ZLB (as I once heard you remark to Mark Thoma). So I should amend my previous post – just by a priori logic, the government spending multiplier is 1 at the ZLB with Ricardian equivalence”
I can’t imagine saying that, as I don’t believe the Keynesian cross is ever useful, zero bound or not. Spending that is valued by consumers (say a school lunch program) will just displace private spending on lunches, according to Ricardian equivilence.
Regarding Keynes, you need to recall that he hated fiat money, he absolutely LOATHED it.
I’m still not buying your claim that V actually measures transactions velocity.
John. Nick Rowe has a good discussion of the paradox of thrift, he points out that the problem is actually money hoarding, not saving.
Kevin, Yup, that’s a good one.
Doug, I agree.
18. July 2012 at 00:39
Well, you did say something elliptic (during your BloggingHeads interview with him) about how Macro 101 is only applicable in the kind of situation we’re in now. And that’s how intelligent New Keynesians see it too; I remember Thoma nodding his head to that.
I think most economists agree that the spending multiplier is positive in theory even with Ricardian equivalence.
http://www.economist.com/economics/by-invitation/guest-contributions/response_roberto_perotti_0
It’s the tax multiplier that’s zero, which is I think the mistake that Perotti made.
18. July 2012 at 13:15
Adam:
Major Freedom – A panacea is cure for all possible ills. More NDGP doesn’t cure every possible problem, but it can help the problems people think we are facing now.
“No matter the merit of the alleged concern, expansive monetary policy seems to help no matter what the resulting mix is between inflation and real growth. Or, as Scott said, all roads lead to market monetarism.“
Uh, yeah.
18. July 2012 at 18:17
Saturos, As you know, I don’t think multipliers exist, at least in the sense of being stable parameters. The multiplier depends on what Bernanke had for breakfast. It could be positive or negative.
19. July 2012 at 01:25
Yes, of course, I was holding M0 constant, in reality it doesn’t work like that. Keynesians are supposed to understand this, but you’ve demonstrated that when push comes to shove they don’t.
19. July 2012 at 02:17
Dr. Sumner
Saturos, As you know, I don’t think multipliers exist, at least in the sense of being stable parameters. The multiplier depends on what Bernanke had for breakfast. It could be positive or negative.
A constant growth in M will have a long term constant growth in PY (and hence stable V), will it not?