I see market monetarism as a seamless whole, a new worldview that doesn’t just critique current Fed policy, but also questions the traditional way of thinking about stabilization policy.
Some publications have argued that I and the other market monetarists have led to an increased awareness that the Fed can and should do more to promote recovery. But how durable are those gains? Perhaps it’s just a passing fad, and when QE3 fails to achieve a robust recovery (as seems likely) the profession will move on to something new—MMT or Austrianism.
In order for the gains from MM to be (semi) permanent, we need to convince the profession that they have been thinking about macro policy in the wrong way. Here are some ideas that I’ve been pushing, where I’ve failed to make any headway:
1. Money has been ultra tight since 2008. Even most sympathetic pundits (with one exception) don’t go that far. Tight money is an implication of Bernanke’s 2003 description of how to ascertain the stance of monetary policy—which looks at NGDP growth and inflation. Bernanke’s criteria are 100% pure MM, but even Bernanke doesn’t seem to really believe it anymore. (Update: Two exceptions)
2. Tight money caused the severe recession of 2008. Even sympathetic pundits are more likely to view the recession as being caused by the financial crisis, and instead view monetary stimulus as a potential cure for the recession. This despite the fact that mainstream economists would have predicted almost exactly the current path of RGDP, if in 2007 they’d been told of the future path of NGDP, and that there’d be no financial crisis at all.
3. Tight money greatly intensified the financial crisis in late 2008. Even sympathetic pundits tend to see the financial crisis as an exogenous shock, which triggered the severe phase of the recession. This despite the fact that economic theory predicts a sharp fall in NGDP will trigger a financial crisis. And despite the fact that previous financial crises (such as 1931, or Argentina 2001) were clearly triggered by falling NGDP, not vice versa.
4. There is no “wait and see;” the effects of monetary policy initiatives show up immediately in market signals of expected NGDP growth. Even sympathetic pundits tend to read the tea leaves, watch the ups and downs or real variables (jobs/GDP) and asset prices (stocks/TIPS spreads) for signs that QE3 is “working.” This is a dead end. Policy needs to target the forecast—any other approach will lead to chronic disappointment. We knew within 5 minutes how well QE3 worked.
It is true that the markets themselves might have Knightian uncertainty about the true model of the economy. But NGDP expectations are the “thing” we need to be steering. If we do so, then we’ll radically reduce that Knightian uncertainty. We’ll never be able to steer NGDP directly–controlling NGDP expectations is the end of history, er the end of macroeconomics.
5. Fiscal stimulus makes no sense. That’s not quite the same as claiming fiscal stimulus has no effect–I may well be wrong on that point. Rather my claim here is slightly different. There doesn’t seem to be any awareness in the blogosphere about the grotesque absurdity of statements like Angela Merkel’s recent claim that Germany needs fiscal stimulus. You’d expect the usual suspects to be all over poor Merkel, mercilessly ridiculing the insanity of arguing for fiscal stimulus at the same time Germany is pressuring the ECB to squeeze eurozone NGDP ever more ruthlessly. If Germany needs more AD, how can Greece and Spain and Italy and Portugal and Ireland and Cyprus and Slovenia not need more AD! But I didn’t see even a mention of this speech. Could it be that ridicule would lead people to ask some obvious questions about the point of fiscal stimulus, when monetary policy can do the same job without ballooning government deficits? I can’t say, but it’s obvious than most people still don’t see the absurdity of fiscal stimulus. Another example would be those who call for Cameron to do fiscal stimulus, when he can simply instruct the BOE to aim for a higher NGDP target. And if Cameron instructs the BOE to keeping aiming for 2% inflation, he’s essentially asking them to sabotage fiscal stimulus. Better monetary policy is a necessary and sufficient condition for more AD, at least once you start thinking of the stance of policy in Bernankian terms:
The imperfect reliability of money growth as an indicator of monetary policy is unfortunate, because we don’t really have anything satisfactory to replace it. As emphasized by Friedman . . . nominal interest rates are not good indicators of the stance of policy . . . The real short-term interest rate . . . is also imperfect . . . Ultimately, it appears, one can check to see if an economy has a stable monetary background only by looking at macroeconomic indicators such as nominal GDP growth and inflation.
And not only are we not making progress in those key areas, the internet discussion seems to be sliding backwards, just as it did in the 1930s. MMT theories of monetary policy ineffectiveness. Austrian theories of “Cantillon effects.” Stiglitzian theories of income maldistribution causing a lack of AD. Theories of “overproduction,” or of workers suddenly lacking the skills to do anything useful. Theories of “debt burdens” causing the public to take long vacations and produce less output (aka unemployment). Obviously I could go on and on.
So while I’m happy about the recent success of market monetarism, there’s still much more work to be done.
PS. Here’s CNBC:
As Japan gears up for an election which could provide it with its seventh change of prime minister in six years, governments and economists from elsewhere in the developed world are looking East for a clue to the long-term consequences of loose monetary policy.
Sigh . . .
Update: Casey Mulligan provides the first halfway plausible explaination I have ever read as to how debt might reduce work effot:
Guest: The debt overhang is a much bigger issue in a place like Nevada. Nevada is full of people who, whether they realize it or not–I expect they do realize it–if they work, they are working for their banker. Their family is not going to get any of the proceeds of that. It’s just going to go toward digging their loan a little further out from the bottom of the ocean. So incentives, I’m afraid, are pretty bad in Nevada, California, Arizona. Hopefully getting better, but these incentive changes weren’t uniform geographically.