Is there too much gloating by market monetarists?

George Selgin has a characteristically thoughtful column warning against excessive gloating by market monetarists. He points out that the new Fed policy is far from optimal (and far from the recommendation of us market monetarists) and that there’s a danger of it generating another cycle of boom and bust–just like the low rate policy of 2003-04.

My views on monetary policy aren’t actually all that different from George’s, but I have a somewhat different view of the overall picture.  I’ll try to break it down into several separate issues:

1.  When I started blogging in 2009 there was almost no one who believed the Fed could do more, and should do more.  I believe that by 2010 we (market monetarists) where able to convince many in the blogosphere that the Fed could and should do more.  Here’s Ryan Avent in 2010:

I SEE that Scott Sumner is taking a victory lap of sorts—not unearned—over the fact that views of monetary policy have come full circle since the years before the crisis. Once upon a time, the Fed was viewed as having near-absolute power over the path of the economy. Then crisis struck and many argued that the Fed had run out of ammunition and fiscal policy was required. Eventually people began arguing that the Fed could do more and should do more, thanks largely to the efforts of Mr Sumner himself.

Ouch!  I guess I do gloat too much.  Sorry.

But I do take great satisfaction that there has been progress on that front.  I believe that George Selgin agrees with me that the Fed should have and could have done more in 2009, although he is less convinced about the need for monetary stimulus under current conditions.  I’ve also tried to convince the blogosphere of other ideas, such as “targeting the forecast” and that there is no “wait and see.”  I think it’s fair to say I’ve completely failed (thus far) to make headway in that direction.  Roughly 100% of the blogosphere has reacted to QE3 by discussing likely future outcomes for AD/NGDP, as if in the future we’ll learn more than we already know.  I view that as akin to astrology.  I’ve argued that the lack of a government subsidized RGDP and NGDP futures market represents gross negligence on the part of the Fed, and more broadly the economics profession, which has not demanded that such a market be created and subsidized.  It would be as if astrologers opposed Federally funded studies to see whether people with certain birth “signs” had certain personalities.  Oh wait . . . the astrologers do oppose those studies.

Despite those failures, I can’t help but be pleased that the market monetarists have been successful in convincing many pundits (perhaps including the Fed) that monetary policy can and should do more when NGDP growth has been the slowest since the Herbert Hoover administration.  At the same time, I’d like to emphasize that most of the “gloating” has been done by non-market monetarists.  Numerous press outlets have basically said; “The Fed is doing market monetarist policies, and it’s likely to be highly successful.”  I’ve consistently said they are only doing about 10% of what we advocate, and it’s likely to be only modestly successful in boosting RGDP.  We already know that it’s only been modesty successful in boosting NGDP expectations–that’s not even in doubt.)  In the post that George linked to I emphasized that the Fed still wasn’t doing targeting the forecast, or level targeting, which were two key components of market monetarism.  So most of the gloating has been in the popular press.  I still think money’s too tight.

I have a “glass half full” personality, so I tend to focus on where progress has been made.  Take the problem of deciding on an optimal policy target.  Some advocate a weighted average of inflation and output gaps.  Some advocate a weighted average of inflation and unemployment gaps.  Market monetarists advocate the sum of inflation and real growth, level targeting.  Unfortunately the Fed did not adopt NGDP targeting.  But in my view the main problem in recent years is not the failure to adopt NGDP targeting, but rather that policy has been far too contractionary using any plausible policy target.  So I can take pleasure in the fact that the Fed is finally waking up to the reality that it needs to do much more to hit its own preferred policy target(s).  And yet I still believe that we’ll have to return and fight another day for NGDP level targeting.  It’s progress, but there is much more work to be done.

George’s most serious charge is that this policy initiative might lead to another boom/bust cycle, such as the recent housing bubble.

Having kept the federal funds rate at 1.75 percent for a year after the economy began to recover in November 2001, the Fed lowered it to 1.25 percent in November 2002, and to 1 percent in June 2003. Then, in August 2003, the FOMC, still unhappy with the sluggish pace of the recovery, and especially with the high unemployment rate, announced that the f.f.r. was “likely” to remain low for an “extended” period of time. Not for the first time, the Fed in its zeal to assist recovery was in fact setting the next boom in motion. And how!

I’m tempted to respond; and how?  Most people, including George Selgin and market monetarists like David Beckworth, believe that an easy money policy during the early 2000s led to an overheated economy in the middle of the decade, and that this was one factor in the crash during the latter part of the decade.  I’m not convinced, or perhaps I should say I doubt the effect was as strong as most people believe.  First of all, I see little evidence that monetary policy was particularly expansionary during the early 2000s.  Some people cite the low rates, but we all know what Milton Friedman said about that.  I agree with Ben Bernanke that NGDP growth is a good indicator of whether money is easy or tight.  Here are the facts about NGDP growth during the previous expansion:

1.  NGDP grew at a slower rate during the 2001-07 expansion than during any other expansion during my lifetime.

2.  NGDP growth modestly exceeded 5% during the peak of the housing boom.

Those facts tell me that while monetary policy might have been a bit too expansionary during the housing boom, the overall level of spending wasn’t particularly excessive, at least by historical standards.  So I reject the implication of “and how!”  George seems to imply that easy money was the key mistake that led to the boom/bust cycle of 2003-09.  I believe there were two key policy failures:

1.  Flawed regulation of banking combined with financial innovation, which pumped up the housing boom.  (Not easy money.)

2.  Tight money in 2008 that turned a mild slowdown involving Hayekian reallocation of capital into a deep “secondary deflation.”

George is particularly concerned about our (my?) silence on the dangers of targeting employment:

But the Fed, in insisting on treating the level of employment as an indicator of whether or not it should cease injecting base money into the economy, departs not only from Market Monetarism but from the broader monetarist lessons that were learned at such great cost during the 1970s. If Market Monetarists don’t start loudly declaring that employment targeting is a really dumb idea, they deserve at very least to get a Cease & Desist letter from counsel representing the estates of Milton Friedman and Anna Schwartz telling them, politely but nonetheless menacingly, that they had better quit infringing the Monetarist trademark.

I have two responses to that charge:

1.  Targeting Employment is a really, really bad idea!!

2.  A target that is a weighted average of inflation and (estimated) employment gaps, is also a somewhat bad idea.  But it’s also almost indistinguishable from targeting a weighted average of inflation and (estimated) output gaps (the Taylor Rule.)  After all, output gaps are estimated partly on the basis of whether or not unemployment looks “high.”  Obviously I believe the Fed is not just targeting employment, they are targeting a weighted average of inflation and employment gaps.  Yes, NGDP targeting is superior, but I’m less concerned about this than George is.  Late in his life Friedman admitted that Taylor Rule-type policies can do about as well as money supply targeting.  The disastrous monetary policies of the 1960s-1970s were not primarily caused by the Fed putting too much weight on employment (though they were), the key problem was that they were ignoring the rise in inflation.  They frequently cut interest rates during periods when inflation was far above 2%.  I don’t see any evidence that the Fed is about to repeat that mistake.  Nor do the markets, which I trust much more than my opinion, or the opinion of any other individual.

Here’s where I think we are:

1.  Market monetarists have a set of ideas that constitute optimal monetary policy.  Others like George Selgin have slightly different views, but accept some of our broad principles.

2.  The Fed is not following the sort of policy that either George or I would favor.

3.  It is often the case that two economists who have almost identical views of the optimal policy rule, have very different views on the best “next step” for a central bank operating under a discretionary regime (like ours.)  I feel that as a public policy pundit I am almost forced to hold my nose and say “well done” when the Fed moves from 4 to 5 on a scale of one to 10.  And I do this knowing that people in the press will misinterpret this “support” as implying I don’t think the next 5 steps (to get to 10) are very important.  I may say they are important, but the message gets lost in all the “gloating.”  So maybe George is right, maybe I need to try harder, so that we don’t rest on our laurels.  I’ve gotten way more laurels in the last week than I deserve, so it shouldn’t be hard for me to pivot to the “glass half empty” message.

PS.  Many NGDPLT advocates favor going back to the pre-2008 trend line.  I’ve recently been arguing for going perhaps only one third of the way back, given how much time has gone by.  So as a born and bred University of Chicago inflation hawk, I’m not unaware of the dangers mentioned by George Selgin.  I want to go to LA, but I’m sitting in the back seat of a car driven by someone who has turned off the GPS.  Despite my annoyance at the driver’s method of navigating, I feel I must do my best to give advice, so that the Fed car doesn’t end up lost in the middle of the Nevada desert.

PPS.  Ryan Avent does a really outstanding job of explaining market monetarism.  But my “no such thing as wait and see” comments are partly directed at his post.  He’s also too generous in his evaluation of my role—but I’m not going to complain.

PPPS.  I don’t like to read other relies before writing my own.  So after I was surprised to find that Lars Christensen’s reply had so many uncanny similarities, such as the “glass half full” metaphor, and the use of bold font in opposing employment targeting.


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35 Responses to “Is there too much gloating by market monetarists?”

  1. Gravatar of Bill Ellis Bill Ellis
    16. September 2012 at 15:13

    Scott,
    I should have said so earlier… Congratulations!…You deserve it. You have been essential in getting a policy adopted that will help The World….Let that sink in…The world….Fucking amazing.

    And you guys deserve to have a big party all over the internet.

    I hate to be a sick in the mud…

    But… I do see a lot of irrational exuberance on the part of the M&M’s over how the Fed is trying to do QE3…Almost a reflection of the irrational doom saying coming from RomRyan and the tea folk.

    I am not saying you personally are going over board…(your metaphor of going from bow and arrows to machine guns was excellent. ) But I do see it on these threads and other places.

    After all the celebrations what will be interesting how different camps observe this experiment. Fed has not given us the a really clear experiment, so there will be lots of weasel room for everyone.

    You know my Keynesians will be looking at the short comings as proof that Monetary policy is not an magic bullet and that we still need fiscal stim.

    Others will try and conflate anything less than perfection as refutation of NGDP targeting.

    M&M’s have to be careful not to oversell this. You need your own weaselly point of view.

  2. Gravatar of Martin Martin
    16. September 2012 at 15:33

    “PPPS. I don’t like to read other relies before writing my own. So after I was surprised to find that Lars Christensen’s reply had so many uncanny similarities, such as the “glass half full” metaphor, and the use of bold font in opposing employment targeting.”

    Either you work with long and variable leads, or Lars works with long and variable lags :P.

    That said, whilst PY might not have been above 5% in the 2000′s, PT might have and we would expect to see that back in the asset prices, right?

  3. Gravatar of Benjamin Cole Benjamin Cole
    16. September 2012 at 17:31

    Well, for the first time in history the blogosphere is having a meaningful and positive impact on national economic policy, or at least the case can be made.

    A little gloating is in order.

    Woodford’s paper would have sunk like a stone into a sump, if the blogosphere hadn’t primed reading audiences for several years….

  4. Gravatar of ssumner ssumner
    16. September 2012 at 18:04

    Bill, The results are in. This policy boosted NGDP growth expectations by a little, but not by a lot. There’s nothing more to say. No “results to come in.”

    Martin, PY is what matters, PT is a meaningless number, dominated by zillions of dollars of transactions in the forex market, etc.

    Benjamin, Your final comment is a very interesting observation, and I think it’s at least partly true. There was a receptive audience for his message.

  5. Gravatar of George Selgin George Selgin
    16. September 2012 at 18:18

    I’m actually hoping that some newspaper or magazine will one day write an article about how I influenced the great Scott Sumner. Then I can do some gloating of my own!

  6. Gravatar of dtoh dtoh
    16. September 2012 at 20:29

    Scott,

    A couple of things.

    1) As I have said before you should be pushing for an NGDP indexed Treasury or Fed Notes (Growth Adjusted Income Notes) rather than a futures market. This is solely a practical consideration as an indexed note is much more likely to be developed than a futures market.

    2) Don’t blame financial innovation for the bubble, a lot of that happened 25 years earlier. The problem was the implicit TBTF guarantee combined with a lack of granular regs on asset/equity ratios.

  7. Gravatar of James in London James in London
    16. September 2012 at 22:21

    1.  Flawed regulation of banking combined with financial innovation, which pumped up the housing boom.  (Not easy money.)
    Good point, but shows how much confusion there still is out there about money vs credit. Bernanke targetting lending for home purchases is part of this confusion. And it may come home to bite, yet.

  8. Gravatar of Saturos Saturos
    16. September 2012 at 22:34

    As I said, James, the current policy is barely a money policy at all, given continuing IOER.

  9. Gravatar of Mattias Mattias
    17. September 2012 at 03:58

    Scott,

    I think you deserve a lot of praise but I think it’s wise to be humble. We don’t know how this will play out and what the net effect of market monetarism’s breakthrough will be.

    I think there’s a potential risk that QE3 might make the political parties in USA more complacent about the fiscal cliff. If Obama and the congress goes over the cliff, maybe we’ll get a good test of the Sumner critique.

  10. Gravatar of Saturos Saturos
    17. September 2012 at 04:38

    Well Bernanke explicitly said he would be unable to offset it. Now we know that’s not true, but it’s hard to see how he’s going to walk away from that – unless he claims that the damage from the fiscal cliff was overestimated, rather than attributing the lack of damage to his monetary offset.

  11. Gravatar of Mike Sax Mike Sax
    17. September 2012 at 05:08

    See Bill, speaking as a Keynesian, I’m not looking for any shortcomings right now. Honestly, I love what Bernanke said-”joblessnes is a national problem that conerns every American.”

    I don’t know how much it will or won’t work but you know what they say-no atheists in foxholes.

    The important thing is that this ends any hope for Romney-Ryan-not that they had much prior to it.

    So I for one am not eager to discover it’s not working-I’m speaking only for myself not some of the more prickly MMTers.

    I’m eagaer to see that it works and by all means Scott you guys can take your victory lap-I know I would.

  12. Gravatar of dwb dwb
    17. September 2012 at 05:24

    i think you deserve a victory lap, honestly. Sure its not perfect, but we cannot let the perfect be the enemy of the good. It’s almost certainly a step in the right direction, which probably would not have happened in the first place without your persistence. Even Krugman, who 3 years ago was all “the fed can not do much” is now almost (but not quite) saying hooray for the new fed policy of double-secret NGDP targeting. Its ok to pat yourself on the back once in a while.

  13. Gravatar of Lars Christensen Lars Christensen
    17. September 2012 at 06:15

    Scott, it is kind of scary that our posts are so similar, but listen I Think it is just the influence of uncle Milty – our Bob H who happens to be in Copenhagen right now!

  14. Gravatar of Free Banking » How? Free Banking » How?
    17. September 2012 at 08:20

    [...] which Scott Sumner replies, I’m tempted to respond; and how? Most people, including George Selgin and market monetarists [...]

  15. Gravatar of Mike Sax Mike Sax
    17. September 2012 at 08:31

    Hey I give you guys credit for nothing more than the fact that you seem to have finally rendered Major Freedom speechless.

    Then again, the idea that we’re finally doing something isn’t bad either. So take your victory lap by all means. I’ve got mine ready for November 6.

  16. Gravatar of Greg Ransom Greg Ransom
    17. September 2012 at 08:46

    I’m not sure the dates on it, but at some point the Hayek/Bagehot influenced economists economists were saying that the Fed could & should do more, and that they had botched their job from the point of view of Bagehot’s rule for monetary systems run by central bankers (Bagohot was anti-central bank and favored free banking).

    “When I started blogging in 2009 there was almost no one who believed the Fed could do more, and should do more.”

  17. Gravatar of Arthur Arthur
    17. September 2012 at 08:49

    Scott, I disagree with you about what the future could tell us.

    As the Fed is communicating rather inefficiently the actual events will tell the markets something new. Like how much inflation the fed will tolerate. If inflation go above, let’s say 4%, and there’s no response from the fed I think markets will revise up theirs RGDP Inflation and NGDP estimates.

  18. Gravatar of Mike Sax Mike Sax
    17. September 2012 at 08:53

    Arthur, I see lot of big economists are complaining that the Fed didn’t give us any specific targets. But isn’t that the brilliance of his plan?

    He couldn’t do explicilty what Evans wanted-say that we’ll allow 3% inflation until unemployment until it’s under 7% or 6%.

    However, doing it this way gives him the leeway to do something like that partiucalry as he says QE3 won’t get pulled back the minute we recover.

    My guess is that it might not have been politcally tenable to get specific.

  19. Gravatar of Greg Ransom Greg Ransom
    17. September 2012 at 08:59

    Good to see the bold type.

  20. Gravatar of Scott Sumner Scott Sumner
    17. September 2012 at 10:20

    George, I teach at a relatively small school and yet almost no one here knows about all this press coverage. Out in the real world I assure that I’m a complete nobody. I could walk into the econ department at local schools like Harvard, MIT, BU, BC, and no one would know who I am. Which is fine with me as I don’t like being in the spotlight.

    Saturos, Yes, a 100% fiscal cliff would reduce growth in the short run–I agree on that. Partly because it’s partly a supply side issue (marginal tax rates) and partly because the Fed would not do enough, quickly enough.

    Greg, I recall in late November 2008 (at the Southern Economics Association meetings) that many economists in the Hayek tradition were opposed to monetary stimulus, that’s one reason I got into blogging. I’m not going to name names because I don’t recall the specific comments–but the general views were quite clear.

  21. Gravatar of Philo Philo
    17. September 2012 at 10:24

    “. . . the markets, which I trust much more than my opinion, or the opinion of any other individual.” Except that as an EMHer you are an *opinion parasite*: your way of forming “your own opinion” is just to take on whatever the market’s opinion seems to be.

    Recall the old joke:
    “Don’t ask your wife, use your own judgment.”
    “I am using my own judgment, and in my judgment I ought to ask my wife.”
    In economic forecasting you are married to the market.

  22. Gravatar of Bill Ellis Bill Ellis
    17. September 2012 at 11:19

    “Now We Wait”… Tim Duy’s from Fed Watch.

    Now, of course, the question is will it work? This is, of course, an experiment. I tend to think that monetary policy would be much more effective if backed by a rational fiscal policy, but at the moment central banks in both the US and Europe left to do the job by themselves.

    http://economistsview.typepad.com/timduy/2012/09/now-we-wait.html

  23. Gravatar of Saturos Saturos
    17. September 2012 at 11:30

    David Henderson responds to this post: http://econlog.econlib.org/archives/2012/09/woolsey_and_sum.html

  24. Gravatar of Bill Ellis Bill Ellis
    17. September 2012 at 11:53

    Mike, I know exactly what you mean by no specific target being the brilliance of the plan…it makes it seem politically doable for the Fed.

    But why isn’t a solid target doable ?
    The Teapublicans would try and smack back the Fed if they announced a solid target…but they are going to go after the Fed with the same ferocity over this open ended approach to “debasing the dollar” anyway.

    Seems the only reason a solid target is not doable for the Fed is the Fed lacked the backbone to go for it… thinking this would might get by the teapubs.

    But ironically what the Fed has done is give the Tea folk a monthly occasion for attacking the policy. The Press loves stories they can count on with regularity.

    The Market’s have to recognize that Ben’s vague goal of keeping it going till the employment picture looks better is basically meaningless and gives him room to declare success at any time.

    Even If the Fed stays the course, the Teapub’s monthly attacks will at least serve to add volatility.

  25. Gravatar of Bill Ellis Bill Ellis
    17. September 2012 at 11:59

    Scott,
    So all the benefits from QE3 are already set in stone ?

    If the Fed announced sometime in the near future that they now see that the employment picture is actually super peachy (when it is not really ) so they can back off it would not matter ?

  26. Gravatar of Martin Martin
    17. September 2012 at 12:14

    Scott,

    “Martin, PY is what matters, PT is a meaningless number, dominated by zillions of dollars of transactions in the forex market, etc.”

    My bad, I was thinking more along the lines of instead of using PY, using X, where X also includes the change in asset prices. I believe something similar was suggested by Alchian & Klein (1973)?

  27. Gravatar of Major_Freedom Major_Freedom
    17. September 2012 at 12:36

    ssumner:

    Most people, including George Selgin and market monetarists like David Beckworth, believe that an easy money policy during the early 2000s led to an overheated economy in the middle of the decade, and that this was one factor in the crash during the latter part of the decade.  I’m not convinced, or perhaps I should say I doubt the effect was as strong as most people believe.  First of all, I see little evidence that monetary policy was particularly expansionary during the early 2000s.  Some people cite the low rates, but we all know what Milton Friedman said about that.  I agree with Ben Bernanke that NGDP growth is a good indicator of whether money is easy or tight.

    Constantly deferring to Friedman’s assertion that low rates means “money has been tight” is not a rigorous demonstration that this is indeed the causal explanation for low interest rates for the period leading up to 2005. You yourself have often presented this assertion with the caveat “usually means money has been tight”.

    In order to know if the period leading up to 2005 is in fact an example of a “usually means” as opposed to “this is one of those times that are different”, we should look at the data.

    From late 1994, prior to the start of the equity bubble, to late 2005, just before the end of the real estate bubble, the quantity of fiduciary media in the banking system increased from $1.91 trillion to $4.93 trillion. This is annual rate of increase over 9% over the 11 years.

    From late 1999, just before the start of the real estate bubble, to late 2005, the quantity of fiduciary media increased from $3.25 trillion to $4.93 trillion, an annual increase of 7.2%.

    These funds were created on the basis of a quantity of required reserves that was gradually reduced by Greenspan. Required reserves fell and this created a situation in which the quantity of fiduciary media was a very large multiple of reserves. This ratio was 136 times in 2005. Just two years later, the ratio increased to 160 times. In total, from 1999 to 2005, over $1.7 trillion in new dollars (fiduciary media) was created ex nihilo. These funds poured into the real estate market, and it is these funds that drove interest rates, particularly long term mortgage rates, down in the early 2000s. It was NOT “tight money” that did it. Selgin and “most people” are correct to say that “easy money” is responsible for the low rates.

    Now it is true that NGDP was rising at only moderately high rates during this period. To those who gauge monetary policy according to this statistic, it appears as though money was not as loose as “most people” are saying it was. But bubbles are not caused by money inflation as measured by domestic NGDP. Bubbles are caused by central banks deliberately reducing interest rates below market rates by way of expanding bank reserves which ultimately allow for expansions in credit (fiduciary media).

    Domestic NGDP ignores the very important phenomena that occurred during the bubble period. A substantial quantity of money that was created the Fed System was “exported” to foreign countries via a gigantic current account deficit. This subdued nominal spending at home in the US. But, and this is important, the bubble effects of the monetary policy were no less strong, because the main bubble driver is low interest rates. So the massive inflation lowered interest rates, but it did not increase domestic NGDP all that much because of the current account deficit.

    Thus, you can see why focusing on domestic interest rates and concluding “money has been tight” is very sloppy reasoning. Never reason from interest rates!

    Free markets are not supposed to have constantly growing country level aggregate spending. They are “supposed” to have as much money as is profitable to produce, given the relative valuations of money vis a vis non-money goods and services, and given the WORLD MARKET conditions. As Hayek alluded to via his rather muddle headed discussion on “rational” central banking, if country level central banks are to exist, then they should behave AS IF there is a world central banking system. This of course means that country level money and spending should fluctuate according to world supply and demand conditions. Considering how much inflation from the Fed was “exported” abroad, this SHOULD have dramatically reduced domestic money and spending if we did have a “rational” central banking system that closely mimicked a world central banking system.

    This would have resulted in falling US prices, which would have made US goods and services more attractive on the world market, and at some point, money outflow would have “stabilized”, and domestic NGDP would have stopped falling and eventually “stabilize” as well. It is quite likely that the large increase in debt financed consumption during the last 20 years or so in the US would, in a free market, have resulted in a fairly large drop in domestic money and spending, similar to how a household that substantially increased its consumption (at the expense of saving and investment) would have resulted in capital consumption and a reduction in that household’s ability to attract new funds.

    But domestic NGDP did not fall in the US during this period. Indeed, it kept growing.

    The key thing to understand is that even when our monetary system is completely monopolized by the state, it does not mean that market forces regarding money do not exist. They are constantly present. They take the forms of fluctuating demands for money for holding, among other forms. By all rights, NGDP MAY have “supposed” to fall during the period leading up to 2005 according to market forces. Thus, a 5% or slightly greater than 5% NGDP growth would represent a substantial “loose money” episode, that just isn’t communicated by NGDP.

    For some reason, market monetarists are able to grasp that low interest rates do not necessarily imply easy money, yet they do not use the same logic for NGDP to grasp that 5% or slightly greater than 5% NGDP also does not necessarily imply money is not historically loose. Just like those focusing on interest rates are ignoring NGDP, so too are those who focus on NGDP ignoring something, and in their case it is money supply, specifically credit expansion. It is simply absurd to believe that $1.7 trillion dollars of fiduciary media can be created in just 6 years or so without generating a bubble. Market monetarists are not looking at the correct statistics. A bubble can be blown up on the basis of easy money from the Fed System, DESPITE the fact that NGDP is rising at historically “stable” rates. No market monetarist is asking whether or not 5% NGDP growth was just way too high for the specific period leading up to 2005.

    A free market does not contain constantly growing NGDP. A free market contains an NGDP consistent with a combination of the relative profitability of money production at the time, plus demand for money holding at the time, plus geopolitical factors that affect money production at the time, plus a whole host of other factors that affect money and spending at the time. The key words are “at the time.”

    If you can understand that a free market does not have a constantly growing supply and demand for something like housing, then you should understand that a free market would also not have a constantly growing aggregate spending. It is extremely sloppy to claim that history has to repeat, and it is the height of sloppiness to claim that the same economic data regarding money has to have the same economic effects with respect to things like bubbles. It is quite possible that a 5% NGDP growth can be associated with extremely loose money, or extremely tight money, depending on prevailing market forces at the time. We just can’t observe the market forces in terms of price signals because the Fed System is overruling them with signals of their own. The forces exist no doubt, and it is these which determine whether 5% NGDP growth is “tight” or “loose.”

    Unfortunately, market monetarists are using circular logic and judging whether 5% NGDP is loose or tight by comparing it to…5% NGDP growth. This method will always cloud the actual state of money tightness or looseness. The correct standard is the NGDP that would have resulted from unhampered free market forces, because then and only then are the price signals an actual reflection of individual relative marginal utilities between money and non-money goods and services. As noted above, these signals are unobservable so we have to make inferences. This is what I did when I judged the $1.7 trillion in new fiduciary media to be “loose” money. It’s a judgment call, but I think the fact that gold and silver production were nowhere near as high in percentage terms, can tell us that fiat money was loose. After all, in a free market, it is almost a certainty that gold and silver would be the money of choice.

    So we can use the quantity of gold and silver production as a proxy for what the unobserved free market process would have resulted in. This is far superior to chasing one’s own tail and judging 5% NGDP growth as tight or loose by comparing it to…5% NGDP growth.

    Bottom line: NGDP analysis is far too one dimensional and crude to enable an understanding of the complex market. It is wrong to claim that a 5% NGDP growth necessarily implies the Fed is not responsible for the real estate bubble. There is way more to the story. Furthermore, as the above analysis shows, Greenspan did not tighten money up during the period leading up to 2005. This period is NOT a “usually means money is tight” period. It was a “this is one of those times that ‘usually’ does not hold” period.

  28. Gravatar of Bob Murphy Bob Murphy
    17. September 2012 at 12:55

    Scott, as always, I don’t understand your position. You wrote:

    Unfortunately the Fed did not adopt NGDP targeting. But in my view the main problem in recent years is not the failure to adopt NGDP targeting, but rather that policy has been far too contractionary using any plausible policy target. So I can take pleasure in the fact that the Fed is finally waking up to the reality that it needs to do much more to hit its own preferred policy target(s).

    I really thought David Beckworth and you kept telling the Austrians that if the Fed did what you guys wanted, its balance sheet would actually shrink. Did I misunderstand, or is that view consistent with the above excerpt?

  29. Gravatar of Bill Ellis Bill Ellis
    17. September 2012 at 12:59

    Excerpt from…http://krugman.blogs.nytimes.com/2012/09/16/ron-paul-on-money-market-funds/

    How do the Austrians propose dealing with money market funds?

    I mean, it has always been a peculiarity of that school of thought that it praises markets and opposes government intervention — but that at the same time it demands that the government step in to prevent the free market from providing a certain kind of financial service. As I understand it, the intellectual trick here is to convince oneself that fractional reserve banking, in which banks don’t keep 100 percent of deposits in a vault, is somehow an artificial creation of the government. This is historically wrong, How do the Austrians propose dealing with money market funds? (…) would a Ron Paul regulatory regime have teams of “honest money” inquisitors fanning across the landscape, chasing and closing down anyone illegitimately creating claims that might compete with gold and silver? How is this supposed to work?

  30. Gravatar of Bill Ellis Bill Ellis
    17. September 2012 at 13:13

    Bob Murphy,

    Is the Feds’ policy of buying Mortgage backed securities a reason to buy or sell a fund like PIMCO that is heavily invested in Mortgage backed securities ?

  31. Gravatar of James in London James in London
    17. September 2012 at 13:25

    Saturos
    Sometimes you don’t have to do any actual easing, but just talk about. IOER may not be an obstacle as you think. In Europe the ECB has just announced its policy of “Outright Monetary Transactions”. Fantastic impact on markets, for sure, but:
    There are no transactions without a request from a troubled country.
    They will not be monetary as they will be sterilised.
    They will not be outright as they are conditional (on further austerity in the troubled country requesting the aid).
    But, hey, they do sound good.

  32. Gravatar of chad chad
    18. September 2012 at 05:45

    What if QE1 had worked? You think the FED would be shifting to NGPD targeting?

    I think it would say a lot more about NGDP targeting had the FED shifted its philosophy during a “stable” economic environment.

    Seems to me, they went with NGDP targeting because of all the other solution they had tried have failed – which they thought would work. They aren’t here because they want to be. They aren’t targeting NGDP because they believe its always been the “right” thing to do. They’re doing it now because everything else they’ve tried hasn’t worked.

    This is how policy evolves. From a series of failure and crises to the next failures and crises.

    In due time, they’ll need to exit NGDP targeting because of unforseen risks this policy – like all other – will expose.

    Monetary Policy is merely an excuse to keep digging.

  33. Gravatar of QE3 Commentary « azmytheconomics QE3 Commentary « azmytheconomics
    18. September 2012 at 12:45

    [...] the QE3 commentary curve, so I’m not going to try to do a long winded post. Instead read Scott Sumner, Bill Woolsey and George Selgin. The big advantage of the Fed’s new action is that at long [...]

  34. Gravatar of ssumner ssumner
    18. September 2012 at 14:16

    Bob, Yup, if they did what we want the balance sheet would shrink.

    Bill, No they can’t back off when things first become “peachy” because they promised not to.

  35. Gravatar of Bill Ellis Bill Ellis
    18. September 2012 at 14:32

    “Peachy” is subjective. Who decides ?

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