Joe Gagnon (and Michael Darda) sent me a paper from the Dallas Fed written by William White:
The central banks of the advanced market economies (AME’s) have embarked upon one of the greatest economic experiments of all time‐ultra easy monetary policy. In the aftermath of the economic and financial crisis which began in the summer of 2007, they lowered policy rates effectively to the zero lower bound (ZLB). In addition, they took various actions which not only caused their balance sheets to swell enormously, but also increased the riskiness of the assets they chose to purchase. Their actions also had the effect of putting downward pressure on their exchange rates against the currencies of Emerging Market Economies (EME’s). Since virtually all EME’s tended to resist this pressure, their foreign exchange reserves rose to record levels, helping to lower long term rates in AME’s as well. Moreover, domestic monetary conditions in the EMEs were eased as well. The size and global scope of these discretionary policies makes them historically unprecedented. Even during the Great Depression of the 1930’s, policy rates and longer term rates in the most affected countries (like the US) were never reduced to such low levels .
There’s plenty to object to in White’s call for tighter money, but I’d like to focus on a peculiar trend in macroeconomics, the bizarre equation of “ultra-easy money” with low interest rates and a bloated monetary base. Until 2008 the standard view of macroeconomists was that money was ultra-tight during the 1930s, despite the very low rates and the bloated Fed balance sheet. White is clearly familiar with the stylized facts of the Depression, and almost undoubtedly has read Friedman and Schwartz’s explanation of why money was very tight. But he seems to reject that claim. In his view money was easy during the Depression (low rates) and is even easier today.
Why has the Friedman and Schwartz view been rejected by White? And why was it rejected by John Cochrane, who made a similar claim a few weeks back? And why has it been rejected by Bernanke, who endorsed the F&S view as recently as 2003? Bernanke also claims current policy is accommodative, despite the slowest growth in M*V over the past 4 years since Herbert Hoover was President. You can explain away Bernanke’s comments, as he’s a government official. But why have roughly 99% of macroeconomists completely flip-flopped from 2008, when money was almost universally viewed as being ultra-tight during the 1930s? So much so that Friedman and Schwartz’s interpretation had worked it’s way into undergraduate textbooks. Why do they now think low rates and a bloated base mean easy money?
If the profession as a whole is unable to understand the highly contractionary nature of current policy, is it any surprise that they are having trouble coming up with remedies for our current demand shortfall?
BTW, Joe Gagnon had similar objections, and allowed me to reprint some comments from his email:
Milton Friedman warned against confusing the level of interest rates with the stance of monetary policy. Friedman pointed to the growth rate of M2 as the ultimate indicator of monetary policy, but I think his closest modern heirs (and I) would prefer the growth rate of nominal GDP. Keeping nominal GDP on a steady growth track is the best we can hope from monetary policy. Nominal GDP growth has trended downward since the 1980s and is low right now. I conclude that monetary policy is somewhat too tight.
The trend decline in the real interest rate is driven by an aging population (less demand for capital) in advanced economies plus the massive wall of official capital flowing out of the developing economies. Both of these tend to drive down the equilibrium real rate of interest in the advanced economies.
In previous posts I’ve also argued that long term real rates are on a downward trend due to demographics and high East Asian savings rates.
PS. Lars Christensen has a very good post showing that the central bank of New Zealand has essentially endorsed the (unfortunately named) “Sumner Critique.” They aim to prevent fiscal policy from impacting AD. He also links to Nick Rowe paper on this topic published back in the 1990s.
PPS. Mark Sadowski sent a link showing that Bloomberg.com has officially endorsed NGDP targeting. The momentum builds.
PPPS. An unrepentent Christopher Balding has replied to my demolition of the “50 percent of Beijing apartments are vacant” story. He repeats the absurd claim that 50% of Beijing apartments are empty. Just stop to think for a moment, there are 20 million people in Beijing–does he think there’s enough housing for 40 million? People need to use common sense. His evidence? Some unnamed people looked in a few windows at night to see if the lights were on. Well there you are!! Beijing has 20 million people, but there is enough housing for 40 million. As I type this it is 9:30pm in Beijing. I’m in a big apartment complex with about 700 units. In a typical west-side Beijing neighborhood. I can look out the window and see other buildings in the same complex. About half the lights are on. So is Balding right? The owner tells me that the complex is virtually 100% occupied. But what would she know, she’s only lived in the area for 50 years.
His evidence that China has a high cost of living (which goes against common sense, and every published study of PPP that I have ever seen), relies partly on inspecting a few grocery items in Shenzhen. That’s right, the Shenzhan that is China’s most important SEZ. The one that’s probably the richest city in mainland China. I’m sure if he lived in Palo Alto he’d tell us that the US had a high cost of living. I see that commenters have poked lots of other holes in his post.
Unlike Balding, I’ve never shopped at a Chinese Carrefour (a French chain), rather I go to supermarkets where ordinary Chinese shop. And with a few exceptions (such as dairy) the prices in China are lower. Commenters “Nick” and “Sean” provide the goods.
Balding also claimed this:
Despite all evidence to the contrary, Prof. Sumner is saying as an economy, there is no bad investment in China
When bloggers make up those sorts of fibs it tells you pretty much all you need to know about their veracity.