Lots of people, including both Austrians and market monetarists, use the concept of “monetary disequilibrium” to analyze the role of monetary policy shocks in the business cycle. I generally stay away from that framework. It’s not that monetary disequilibrium never occurs, but rather that I think it lasts for just a brief period. The bigger problem is that equilibrium is re-established at a new and different NGDP level, which creates disequilibrium in the labor market. So I see labor market disequilibrium as the essence of the business cycle.
Larry White recently had this to say:
Market Monetarists who have been celebrating the Fed’s recent announcement of open-ended monetary expansion (“QE3′) seem to believe that Sumner’s 2009 diagnosis still applies. But what is the evidence for believing that there is still, three years later, an unsatisfied excess demand for money? Today (September 2012 over September 2011) real income is growing at around 2% per year, and the price index (GDP deflator) is rising at around 2%. If the evidence for thinking that there is still an unsatisfied excess demand for money is simply that we’re having a weak recovery, then as Eli Dourado has pointed out, this is assuming what needs to be proved.
. . .
While saluting Sumner 2009, like Dourado I favor an alternative view of 2012: the weak recovery today has more to do with difficulties of real adjustment. The nominal-problems-only diagnosis ignores real malinvestments during the housing boom that have permanently lowered our potential real GDP path. It also ignores the possibility that the “natural” rate of unemployment has been hiked by the extension of unemployment benefits. And it ignores the depressing effect of increased regime uncertainty.
To prefer 5% to the current 4% nominal GDP growth going forward, and a fortiori to ask for a burst of money creation to get us back to the previous 5% bubble path, is to ask for chronically higher monetary expansion and inflation that will do more harm than good.
I don’t know of any theoretical models where steady 5% NGDP growth would create bubbles. And even if bubbles did occur, I can’t imagine why they would represent a public policy problem if NGDP continued to grow at 5%. I’d also point out that the US has experienced 3 major equity or residential real estate bubbles in periods of relatively low inflation and NGDP growth (1929, 2000, 2006) and zero major bubbles in periods with high inflation and NGDP growth (1968-81). The 1987 stock market bubble was an intermediate case (which did zero harm, as NGDP continued growing after the bubble.)
However I do agree with some of Larry’s observations. As I mentioned in my previous post, you’d expect the extended UI benefits to have raised the natural rate of unemployment (although I doubt it’s risen to 8.1%.”) I also agree that the current situation is different from 2009. In 2009 I advocated going all the way back to the old trend line. I currently favor going about 1/3 of the way back. If we keep on the same track for a few more years I’ll through in the towel and advocate starting a new 5% trend line from where we are. So my policy views have changed to reflect the changing nature of the crisis, and the fact that some wage adjustment has occurred.
In reply to David Beckworth, George Selgin makes the following claim:
All these appeals to different measures of the money stock as offering evidence as to the extent to which money is in short supply or has been exposed to demand shocks really are, or should be, considered quite beside the point in the MM and other nominal spending targeting frameworks. After all, nominal spending targeting makes sense precisely to the extent that fluctuations in nominal spending serve as a good indicator of money shortages or surpluses. So who cares what M2 or M3 or m$ or other still fancier M measures are of have been up to? If spending has remained stable, the presumption is that the economy has been getting all the liquidity or exchange media it needs, and that it is therefore not tending to ride up or down a short-run Philips curve. It is precisely because NGDP targeting and similar schemes dispense with the need to track particular monetary aggregates, or worry about the stability of demand for them, while still sticking to a nominal target, that they constitute an alternative and appealing alternative to conventional “monetarist” rules.
So, when it comes to demonstrating that money is or has been in short supply, a consistent Market Monetarist has no reason to appeal to the behavior of any measure of M. What matters is whether a plausible case can be made that spending is too low, or has been growing too slowly. That of course leads to thorny questions concerning the choice of an ideal growth rate and, what amounts in the short run to the same question, the fitting of a trend to past data with the aim of finding the once that would have been most conducive to the avoidance of booth booms and busts. This latter task, it seems to me, is not quite as simple a matter as some MM’s have made it out to be.
I completely agree about the redundancy of money data in the MM model. NGDP is a sufficient statistic for any problems with monetary policy. And I agree that finding the optimal trend line for NGDP is a non-trivial exercise. All I would add is that showing the folly of the actual 2007-2012 path of NGDP is a trivial exercise. I am pretty sure that George agrees with me on that point.