What monetary policy can and cannot do

Today’s Free Exchange post is entitled “Scott Sumner is Wrong.”  I certainly can’t disagree with that claim, but I’m not sure I’m wrong in quite the way that M.C.K. asserts.

LAST Thursday, Jeremy Stein, a governor of the Federal Reserve Board, gave an important speech outlining the ways that monetary policy can inflate—and prevent—deeply destructive debt bubbles. (You can read my summary of his main points here. The speech was not about current policy so much as how the Fed should behave in general.) Scott Sumner, a blogger, was unimpressed by Mr Stein’s analysis, arguing that it was uninformed by history. However, the latest empirical studies support Mr Stein’s thesis that monetary policymakers who care about the long-term well-being of the citizenry should monitor private credit creation and prevent it from growing too rapidly.

.  .  .

Banks and other financial intermediaries usually create credit whenever they can earn what they believe is a risk-adjusted spread between their funding costs and the rates they charge their borrowers, both of which are affected, if not determined, directly by the monetary authority. Tobias Adrian and Hyun Song Shin have shown that the balance sheets of financial firms that mark their assets to market grow and shrink based on changes to the level of short-term interest rates. Meanwhile, Markus Brunnermeier and Yuliy Sannikov have shown that monetary policymakers can alter the willingness of banks to create credit by adjusting the shape of the yield curve. (I wrote a more detailed summary of this new research here.)

I read M.C.K. as assuming that short term rates are a good indicator of the stance of monetary policy.  More specifically, that easy money leads to low short term rates, which leads to extra leverage.  I don’t agree. For simplicity, let’s use Bernanke’s benchmarks for the stance of monetary policy; NGDP growth and inflation.  More specifically, let’s assume the Fed pegs the price of a futures contract linked to a weighted average of NGDP growth and inflation.  So we have a monetary policy that, by construction, is always neutral in Bernankian terms.  It’s never easy and it’s never tight.  But short term interest rates would still move around quite a bit.  And the leverage of financial firms might well be highly correlated with the movements in short term rates.  So it would look like monetary policy is having a big impact on leverage, whereas in reality (by assumption) it would be having no impact at all.

If you don’t like my assumption, change it as you please.  Assume the Fed is targeting M2 growth at 4%/year, as Friedman once advocated.  You get the same result, neutral money and volatile short term rates.

The bottom line is that short term interest rates are a lousy indicator of the stance of monetary policy, even though (paradoxically) on the day of a FOMC meeting a higher than expected setting of the fed funds target is almost always an easier than expected monetary policy.  But over any longer period of time (when a central bank is targeting inflation or NGDP growth), short term rates will reflect conditions in global credit markets.  For instance, we know that the 1% interest rates of 2003 did not represent “very easy money” because it did not lead to particularly high expectations of inflation and/or future NGDP.  If low short term rates lead to a credit bubble (under NGDP targeting) the credit bubble is not caused by the Fed, it’s caused by an inflow of Asian savings, or some other (non-monetary) credit market factor.

The yield curve might be a slightly better indicator of the stance of money policy, but unfortunately it’s also an excellent indicator of changes in expected NGDP growth.  A sharp slowdown in expected NGDP growth can even cause the yield curve to “invert.”  If that leads to deleveraging, it might well be due to fear of recession, not the direct effect of changes in short term rates.

Mr Sumner says that central banks would do better taming the credit cycle solely with regulatory tools, although he does not specify how this would work in practice. Moreover, he asserts that monetary policy is too “blunt” to be helpful. But Mr Stein explained that monetary policy can be a useful supplement to regulatory measures precisely because those can only be applied to areas of the financial system that are being actively monitored by regulators. Unlike regulation and supervision, monetary policy “gets in all the cracks” because all financial intermediaries are exposed to the interest rates under the central bank’s control.

My first best solution (admittedly not realistic today) is to get rid of all government intervention in credit markets.  No Fannie and Freddie, no FHA, no deducting interest on mortgage loans, no FDIC, etc.  Laissez-faire.

My second best solution is to try to regulate to make our system look more like Canada’s.  Unlike 99.99% of bloggers I think small banks are the problem and big banks (like Canada) are the solution.  I also favor bans on making sub-prime loans with taxpayer-insured funds.  Require a minimum of 20% down, unless the lender is not insured by FDIC.  Also change laws on non-recourse loans, etc.  Change tax laws so that debt is not subsidized (as compared to equity.)

I agree that monetary policy “gets in all the cracks” but I disagree with the implications he draws:

Mr Sumner might argue that monetary policy “gets in all the cracks” because it affects the level of nominal output. But the cutting-edge research makes it clear that financial firms operate according to a unique set of incentives different from those of the broader economy. Monetary policy affects those incentives, which I described above, more directly than it affects the incentives of the nonfinancial sector. Regular people and firms in the “real” sector simply do not care about small changes to the level of short-term interest rates to the same extent as commercial banks, investment banks, insurers, the repo market, and all of the other intermediaries responsible for creating money and credit.

File this under “never reason from a price change.”  If the change in short term rates reflects credit market conditions (which is usually the case) then I agree that most people don’t care.  But if it reflects a change in monetary policy then it really does get in all the cracks—Main Street is affected as much or more than Wall Street.  The tight money of late 2008 (not picked up by the short term rate indicator, BTW) was devastating to Main Street.

Thus, the evidence suggests that the Fed and other central banks can in fact use monetary policy tools to restrain credit growth without crushing the economy—if they want to.*

That’s not how I read the evidence from 1929.

My bigger problem with this entire line of analysis is that it’s all (implicitly) based on a giant misconception, that the severe recession was caused by financial turmoil, not tight money.  If the Fed had kept NGDP plugging along at a 5% rate we would have had some very mediocre years—call it stagflation if you wish.  Maybe 1% RGDP and 4% inflation until the excesses were worked off.  But the high unemployment and greatly intensified debt crisis need not have happened.

My view is obviously the minority view, held by neither policymakers nor my fellow academics.  But it does follow from what we’ve been teaching our students in recent decades; that the Fed has both the ability and the duty to keep expected NGDP growth plugging along at a decent rate.  Until we correctly diagnose the real problem, we will not be able to come up with solutions.  Unfortunately, the newly resurgent credit view reflects a basic misconception about what went wrong.

But I’ll give M.C.K. and Stein a lot of credit in one respect.  If my view is wrong and the now standard credit view of 2008 is correct, then there might be a role for monetary policy in this area.  The people who should really be embarrassed here are the professors who continue to teach Sumnerian macroeconomics out of their Mishkin textbooks (Fed never out of ammo—low rates aren’t easy money), but don’t believe a word of what they teach.

PS.  In their paper, Adrian and Shin call for monetary policy to be more forward looking than traditional interest rate targeting rules.  I agree, and believe a policy of targeting NGDP one or two years out would do a lot to prevent the build up of credit excesses, or excessive deleveraging on the other side of the crisis.

PPS.  Karl Smith asks two questions.  Here are my answers:

1.  Maybe; not in a mechanical sense, but perhaps in a signaling sense.  Yes, but it’s probably ineffective.

2.  Yes, as much as required to keep the central bank’s subjective forecast of NGDP growth on target.

PPPS.  This debate reminds me a bit about the debate over utilitarianism.  Some anti-utilitarians believe the world would be a happier place if we abandoned utilitarianism.  Some NGDP opponents believe NGDP would grow at a more stable rate if central banks targeted something other than NGDP.

PPPPS.  Noah Smith recently pointed to the fact that Japan grew at a decent rate from 2000-07 without anything close to 5% NGDP growth:

On the other hand, as we saw above, Japan remained in or very near deflation for the entire period, and ever since (meaning that NGDP didn’t grow anywhere near the 5% that Scott Sumner and others claim is optimal).

Just to be clear, I’ve never claimed Japan needs 5% NGDP growth to have healthy RGDP growth.  Indeed I don’t even think that is true for the US.  In the long run monetary policy doesn’t affect RGDP growth (very much), and in the short run what matters is the NGDP growth rate relative to expectations from a few years back.  I do believe that very low trend NGDP growth rates will slightly reduce the level of RGDP, but that was “priced in” by 2000, and so would not have been expected to impact post-2000 RGDP growth rates in Japan.

Japan did have relatively poor RGDP growth after 1991, but the big problem in Japan since 2000 is excessively low levels of RGDP, relative to the US.  Low productivity.  For people of my generation, who recall the incredible dynamism of the Japanese economy in earlier decades, the big shock is that they have actually grown slightly slower than the US since the bubble burst in 1990.  Not much slower, but I would have expected further convergence.

As an aside, I expect Zimbabwe and North Korea to grow faster than the US over the next 20 years, although I’m not at all positively inclined toward their economic policies.

HT:  Travis V.


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51 Responses to “What monetary policy can and cannot do”

  1. Gravatar of TravisV TravisV
    11. February 2013 at 11:06

    By the way, M.C.K.’s name is Matthew C. Klein. Below is his Twitter feed:

    https://twitter.com/Matthew_C_Klein

  2. Gravatar of Dennis Dennis
    11. February 2013 at 11:09

    I know you disagree with many of the underlying premises of stopping bubbles, etc., but in a narrow sense could you both be right? What if the Fed targeted both interest rates and NGDP semi-independently using a combination of OMOs and IOR?

  3. Gravatar of marcus nunes marcus nunes
    11. February 2013 at 11:31

    Scott
    I think there is an ‘infight’ within Free Exchange between Ryan Avent (RA) and Michael Klein (MCK). You are the ‘sparring’ that MCK is using!
    Here´s how RA ended his critical piece on MCK´s piece on Stein:
    “And so while I applaud Mr Stein’s efforts to improve the Fed’s approach to financial stability I also note that he has been voting in favour of the current policy approach—to keep pushing policy in an easier direction until the high-unemployment problem is solved—and for good reason. There are worse things than overheating credit markets, and America has them.”

  4. Gravatar of Suvy Suvy
    11. February 2013 at 11:36

    If you believe that banks create money by issuing credit and if you believe that the amount of credit issued in unrelated to the amount of savings/banks of credit, then by controlling the interest rate, you have control of the interest rate or the “price of a loan”. You could either target growth in the base money supply or the rate of interest.

    Also, I think 1929-1933 is a bad example. This is because while debt levels dropped in nominal debt levels may have fallen; however, debt/income ratios rose in the same process because incomes fell faster. I think MCK is advocating that the central bank should control debt/income ratios in such a way so that they can correct.

    As for the tight money from late 2007-late 2008, I agree with you. Debt/income ratios rose over that period primarily because incomes fell so drastically.

  5. Gravatar of Jim Glass Jim Glass
    11. February 2013 at 11:57

    As an aside, I expect Zimbabwe and North Korea to grow faster than the US over the next 20 years…

    I dunno about Zimbabwe, as its finance minister says the government is down “to its last $217.”

    Though I guess it can always print more.

  6. Gravatar of Kailer Kailer
    11. February 2013 at 12:18

    Yours is a problem of communication. Monetarism doesn’t offer any cute little analogies that can be wrongly applied to the macro economy. The credit cycle view does. People borrowed too much money and now they have to pay it back. A nice simple morality tale. You take out too much money and you have to pay it back, just like my student loans.

    What’s the equivalent monetarist story? “Prices are ultimately determined by the quantity of money, because prices (and especially wages) do not instantly adjust to unexpected declines in the quantity of money, quantities have to fall and this causes recession. Yuck, what a mess. I probably misstated your views, and you could do it tighter, but the basic criticism is the same. I think you’re probably right, but it’s hard to communicate to non-specialists because it’s not relatable.

  7. Gravatar of marcus nunes marcus nunes
    11. February 2013 at 12:21

    Scott
    The poit is that MCK has little understandin of NGDP-LT, unlike RA. So anything SS says must be wrong!
    http://thefaintofheart.wordpress.com/2012/12/19/matthew-klein-mck-could-have-talked-to-ryan-avent-ra-before-writing-foolish-things-about-ngdp-targeting/

  8. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    11. February 2013 at 12:25

    ‘I also favor bans on making sub-prime loans with taxpayer-insured funds.’

    If we’d simply avoided mandating that such loans be made, we’d never have had a housing bubble in the first place.

  9. Gravatar of Scott Sumner Scott Sumner
    11. February 2013 at 13:13

    Thanks Travis.

    Dennis, Monetary policy can generally only hit one target, or perhaps a linear combination of several targets. But I see no benefit in targeting interest rates.

    Marcus, Interesting.

    Jim, When there’s nowhere to go but up . . .

    If those two countries had stock markets I’d invest in them now. North Korea made the cover of this week’s Economist—in a good way.

    Kailer. Interesting point.

    Patrick, That would have been a good start.

  10. Gravatar of Justin Irving Justin Irving
    11. February 2013 at 13:27

    “Unlike 99.99% of bloggers I think small banks are the problem and big banks (like Canada) are the solution. ”

    Scott, you are once again in the same boat as Svensson. He’s said in the past that Sweden’s top heavy banking oligopoly is stabilizing.

  11. Gravatar of J J
    11. February 2013 at 13:40

    Sort of unrelated….

    It seems (maybe I’m wrong) you believe that the growth rate of NGDP doesn’t really matter, as long as it is stable. Money is neutral in the long-run, so a higher NGDP growth rate eventually just translates into a higher inflation rate. Moreover, you don’t believe that the Fed ever ‘runs out of ammo.’ So, we don’t need 3% inflation to give us room to cut nominal rates before hitting the ZLB. Then, should we choose the NGDP growth rate to be about what we expect will be the RGDP growth rate in the long-run? Why not just shoot for 0% inflation in normal times?

    I suppose perhaps some inflation could be better because maybe a little inflation makes it easier for wages and prices to adjust quickly.

  12. Gravatar of Bill Woolsey Bill Woolsey
    11. February 2013 at 14:03

    In my view, unstable nominal GDP makes the use of credit contracts less desirable. Much of the pain occurs when nominal GDP drops.

    If we compare two countries, one using more debt contracts and the other less, and they have the same fluctuations in nominal GDP, then the country that happens to use less credit will suffer less harm.

    But if two countries have the same amount of debt contracts, one one has less fluctuations in nominal GDP than the other, then the country with the smaller fluctuations in nominal GDP would be better off.

    Can a central bank use its control over the quantity of money to deter the use of debt contracts without causing additional fluctuations in nominal GDP?

    How?

  13. Gravatar of Recreating the Asset Bubble: The Fed’s Plan for Economic Recovery :: The Circle Bastiat Recreating the Asset Bubble: The Fed’s Plan for Economic Recovery :: The Circle Bastiat
    11. February 2013 at 14:04

    [...] demand stimulus and the horrors of austerity and “market” monetarists prattle on about deficient growth in nominal GDP, the signs of an incipient asset bubble become more evident every day. In fact it would not be [...]

  14. Gravatar of Bob Murphy Bob Murphy
    11. February 2013 at 14:32

    Scott Sumner wrote:

    “Japan did have relatively poor RGDP growth after 1991, but the big problem in Japan since 2000 is excessively low levels of RGDP, relative to the US. Low productivity.”

    As usual, I’m just trying to understand your worldview. Recently you’ve referred to Japan as having the most deflationist monetary policy in world history for a fiat currency (or something like that). But are you saying that fact is independent of the Japanese lost decade(s)? At the time, I had assumed you were arguing that the reason Japan’s economy was in the toilet, was that the BoJ was deliberately keeping low NGDP growth.

  15. Gravatar of James in London James in London
    11. February 2013 at 14:32

    Laissez-faire is an impossibility with big banks. You admire Canadian banking but do you know that these banks benefit hugely from a state guarantee on most of their mortgage lending. These loans require very little capital as a result, and mean the returns on equity in Canadian banks are artificially very high.

    It is very similar to the socialised housing finance system of the US. It may be better administered, have better underwriting, but hasn’t yet been tested by bad monetary policy.

    The microeconomic world of banking is a grubby old place of regulatory capture, and big banks are far more adept at that than smaller ones. You are just too idealistic (or naive?) sometimes about the way business operates. Adam Smith understood the way cartelising businessmen worked far better than anything I’ve ever seen on this blog – even if you are best for monetary policy.

  16. Gravatar of nickik nickik
    11. February 2013 at 15:00

    @J

    The problem with your idea of 0% inflation or in NGDP terms basiclly a traget on the exact long term growth rate of NGDP (say 2%-3%) is that you are failing to see that wages should rise.

    When the economy is growing wages should grow too. Going full on 0% NGDP target would make it possible to have rising wages in a growing economy WITHOUT ajustment in wages.

    I suppose you can make a argument that economys grow faster if wages ‘lack behind’ but I dont think thats a good argument.

    This was discussed allready, look for example on the brilliant book of G. Selgin “Less then Zero” (free online).

  17. Gravatar of Recreating the Asset Bubble: The Fed’s Plan for Economic Recovery – Unofficial Network Recreating the Asset Bubble: The Fed’s Plan for Economic Recovery - Unofficial Network
    11. February 2013 at 15:03

    [...] demand stimulus and the horrors of austerity and “market” monetarists prattle on about deficient growth in nominal GDP, the signs of an incipient asset bubble become more evident every day. In fact it would not be [...]

  18. Gravatar of 123 123
    11. February 2013 at 16:21

    @Scott
    @Bill Woolsey

    My usual kid-spanking trick:

    In my view, unstable nominal GDP makes the use of long term labor contracts less desirable. Much of the pain occurs when nominal GDP drops.

    If we compare two countries, one using more labor contracts and the other less, and they have the same fluctuations in nominal GDP, then the country that happens to use less labor contracts will suffer less harm.

    But if two countries have the same amount of labor contracts, one one has less fluctuations in nominal GDP than the other, then the country with the smaller fluctuations in nominal GDP would be better off.

    Can a central bank use its control over the quantity of money to deter the use of long term labor contracts without causing additional fluctuations in nominal GDP?

    How?

  19. Gravatar of 123 123
    11. February 2013 at 16:31

    Don’t fear the debt. Don’t fear the employment. For most people, debt is better than equity, and regular employment is better than self-employment and freelancing.

    Ignore those who hate debt and regular employment because they cause externalities such as interest rate volatility and NGDP volatility.

  20. Gravatar of TravisV TravisV
    11. February 2013 at 16:49

    Marcus Nunes, I really really really wish your blog had an RSS feed……… :) :)

  21. Gravatar of A BBB world | Historinhas A BBB world | Historinhas
    11. February 2013 at 16:54

    [...] demand stimulus and the horrors of austerity and “market” monetarists prattle on about deficient growth in nominal GDP, the signs of an incipient asset bubble become more evident every day. In fact it would not be [...]

  22. Gravatar of TravisV TravisV
    11. February 2013 at 17:00

    Bob Murphy,

    I’m curious exactly what Prof. Sumner is saying too.

    My guess is that he’s saying that Japan’s tight money was responsible for its slow RGDP growth during the 1990′s. By 2000, wage growth expectations and leverage had adjusted downward enough to allow for faster RGDP growth.

  23. Gravatar of TravisV TravisV
    11. February 2013 at 17:15

    Does anyone else think Tyler Durden at Zero Hedge is an idiot for writing this?

    http://www.zerohedge.com/news/2013-02-11/abe-vs-bernanke-why-japans-yen-target-means-sp-will-suffer

    “Abe Vs Bernanke: Why Japan’s Yen Target Means The S&P Will Suffer”

  24. Gravatar of TravisV TravisV
    11. February 2013 at 17:33

    Does Tyler Durden even understand market expectations?

    Ever since Abe’s election became expected in mid-November, both the Japanese and U.S. stock markets have been rising significantly.

  25. Gravatar of Nick Rowe Nick Rowe
    11. February 2013 at 17:44

    Scott: “Some NGDP opponents believe NGDP would grow at a more stable rate if central banks targeted something other than NGDP.”

    Yep. What alternative target does MCK have in mind? Total nominal debt? OK, now let’s have a debate: NGDP vs TND.

  26. Gravatar of W. Peden W. Peden
    11. February 2013 at 17:55

    TravisV,

    No, I don’t think he is an idiot BECAUSE he wrote that.

  27. Gravatar of TravisV TravisV
    11. February 2013 at 18:00

    W. Peden,

    Do you not think that that is a foolish blog post?

  28. Gravatar of Saturos Saturos
    11. February 2013 at 21:15

    “Unlike 99.99% of bloggers I think small banks are the problem and big banks (like Canada) are the solution.”

    Could you expand on this?

    Travis, W. Peden has clearly thought “Tyler Durden” to be an idiot for some time now.

  29. Gravatar of Saturos Saturos
    11. February 2013 at 21:19

    Travis, I get Marcus’ blog on RSS, as well as this one. Don’t you use Google Reader? I use that with my FeedDemon client.

  30. Gravatar of 123 123
    11. February 2013 at 22:41

    Nick Rowe: “Yep. What alternative target does MCK have in mind? Total nominal debt? OK, now let’s have a debate: NGDP vs TND.”

    Here is a reasonable alternative, not a straw man:

    If the Fed allows the NGDP expectations to fluctuate inside a narrow corridor, ex post volatility of NGDP would be lower.

    Or

    If the Fed allows the NGDP expectations to fluctuate inside a narrow corridor, ex post tail risk of NGDP volatility would be lower.

  31. Gravatar of ssumner ssumner
    12. February 2013 at 06:08

    Thanks Justin,

    J, Your final sentence almost gets it, but replace “a little inflation” with “a little NGDP growth.” It’s not clear what the optimal rate of NGDP growth is, but it is NGDP growth that matters, not inflation.

    Bob, I think the very low NGDP growth lowered RGDP growth in the 1990s, and again after 2008. During the in between period they were probably close to trend growth.

    Now here’s what may confuse you–during the middle period (2000-07) I think growth was fine, but since the level of output was depressed in the 1990s, it remained somewhat depressed in the “good years.” I think people often overlook growth rate/level distinctions. China has fast growth, but a low level of GDP/person, for instance.

    Then the tight money after 2008 further reduced Japanese RGDP.

    James, That’s a good point, the political power of big banks is worrisome. But the political power of small banks in the US is also powerful, and has prevented needed reforms. The small banks are the ones that have required repeated and massive taxpayer expenditures—money down the drain. In contrast, the big banks repay their government loans. So while both are a problem, I see the smaller banks as being more wasteful–as taking greater risks, as requiring more tax dollars, and hence the bigger problem.

    Or maybe I am naive.

    123, I think you overestimate how much difference it would make. If NGDP was just modestly more unstable, I’d expect labor contracts to be about the same as what they are today. Obviously I can’t be sure, but that’s my best guess.

    TravisV, I agree with you on the US/Japan connection.

    Nick, The credit view of monetary policy reminds me of DSGE, or behavioral economics, or alternatives to the EMH, or alternatives to ratex. We keep being promised better models, but it will never happen. That’s because when new ideas come along their useful implications are almost immediately evident, or else they never show up. (Coase is the exception that proves the rule.)

    Saturos, See my response to James on the big banks. I believe the main banking problem in the US is smaller banks, mostly in the sunbelt, taking big bets in rapidly growing real estate markets. Big established banks have less incentive to do that because they are more diversified. Their extra diversification means if one segment of the bank did poorly, other segments would absorb part of the losses. For “double or nothing” smaller sunbelt banks, it’s heads I win tails the taxpayer loses. In this crisis the taxpayers who lent to the big banks weren’t the losers from their MBS investments, it was their own stockholders who lost.

    I do not claim this is true for other places like Ireland and Iceland.

  32. Gravatar of Geoff Geoff
    12. February 2013 at 07:00

    Dr. Sumner:

    What are you wrong about? You said you can’t disagree with the notion that you’re wrong, but then you followed that up with you saying you’re not “quite” wrong about this particular issue.

    If one knows one is wrong about something, then why continue believing it?

  33. Gravatar of Geoff Geoff
    12. February 2013 at 09:12

    Dr. Sumner:

    “My first best solution (admittedly not realistic today) is to get rid of all government intervention in credit markets. No Fannie and Freddie, no FHA, no deducting interest on mortgage loans, no FDIC, etc. Laissez-faire.”

    Does your first best solution that is admittedly not realistic today include getting rid of all government intervention in money altogether? No central banks, no exclusive taxation in the currency that only the state issues, etc, Laissez-faire laissez-faire?

  34. Gravatar of dtoh dtoh
    12. February 2013 at 12:13

    Re: Japan

    There have been statutory and other changes to the retirement age (i.e. a gradual increase from 60 to 65) during the period in question. I haven’t taken a careful look at the numbers, but just from casual observation, I believe there has been a significant uptick in the labor participation rate for adults aged 60-65.

    I think if you normalized for this change in retirement age, and just measured GDP/ adult (aged 15-60), you would see that the Japanese malaise continues.

  35. Gravatar of 123 123
    12. February 2013 at 12:47

    Scott:”I think you overestimate how much difference it would make. If NGDP was just modestly more unstable, I’d expect labor contracts to be about the same as what they are today. Obviously I can’t be sure, but that’s my best guess.”

    The same applies to debt. Only marginal jobs would be gone and only marginal debt would default if there is a modest uptick in NGDP volatility.

  36. Gravatar of James in london James in london
    12. February 2013 at 13:37

    Smaller banks go bust quite regularly, and that is perfectly OK. That is just capitalism at work. Failure in the market, rather than failure of the market. It keeps non-guaranteed counterparties on their toes. When big banks totter, non-guaranteed counterparties can and do force bailouts. Small banks failures don’t fall on the taxpayer but on the FDIC, the (admittedly) state-organised, bank-funded insurance fund. In a laissez-faire world I think there would be such entities, and some banks would use them. And then it would be up to the counterparties which banks they used, insured or uninsured. Banks should be no more special than car companies.

  37. Gravatar of Fed Up Fed Up
    12. February 2013 at 14:01

    Nick Rowe’s post said: “Scott: “Some NGDP opponents believe NGDP would grow at a more stable rate if central banks targeted something other than NGDP.”

    Yep. What alternative target does MCK have in mind? Total nominal debt? OK, now let’s have a debate: NGDP vs TND”

    OK! Make total nominal debt equal 0 (zero)!

  38. Gravatar of Fed Up Fed Up
    12. February 2013 at 14:05

    “Assume the Fed is targeting M2 growth at 4%/year, as Friedman once advocated.”

    But does it matter how whatever M you are targeting is created, how it is distributed in time, and how it is distributed between the major economics entities?

  39. Gravatar of Fed Up Fed Up
    12. February 2013 at 14:12

    “If the Fed had kept NGDP plugging along at a 5% rate we would have had some very mediocre years—call it stagflation if you wish. Maybe 1% RGDP and 4% inflation until the excesses were worked off.”

    So what happens if productivity is +1.5% to +2.5% and employment falls?

  40. Gravatar of Morgan Warstler Morgan Warstler
    12. February 2013 at 23:51

    We hereby admit that fear of Econ crisis increases contract length, so if stability becomes long term norm, risk appetite increases, and contract length, thus sticky prices, decreases.

    I didn’t grant Sumner argument strength over mine willy-nilly. There are real negative effects to the private sector when couch potatoes care enough to vote for more couch.

    Everyone should vote, the fact that those at margins choose not to vote (over-riding the obvious should vote imperative), likely increases quality of vote on policy outcomes.

    But they should vote.

    Conservatives need to grok a world where 90% are voting.

    The thing is, there are awesome viable government shrinking strategies that are growth oriented WHERE VOTERS GET MORE.

    We should have no problem running the local, state, and federal government with only 10M total employees (less than half).

    No one needs fired. On the the glories of attrition is that the people retiring are the least tech savvy, so going balls to the wall with new tech, should be embraced as long as we make sure we keep our past promises.

    —-

    So gents, don’t tread lightly into the land of Econ Crisises are ok.

    You walk into a sticky wicket.

  41. Gravatar of ssumner ssumner
    13. February 2013 at 08:26

    Geoff, I was wrong in assuming you had a sense of humor.

    dtoh, Very good point.

    123, I still don’t see much gain, and there’s a risk of more macro instability.

    James, FDIC is “the taxpayer,” and in any case it must occasionally be bailed out by the Treasury. The costs of small banks are huge, running up into the $100s of billions. Big banks are not a burden on US taxpayers. I have problems with big banks too (TBTF), but they aren’t the main problem.

    Fed Up, No monetary policy can or should try to prevent all employment fluctuations. But if productivity is rising fast, the output/inflation split will be more favorable.

  42. Gravatar of Fed Up Fed Up
    13. February 2013 at 14:55

    “But if productivity is rising fast, the output/inflation split will be more favorable.”

    Would not have to be. You are just stuck on the supply side. There could be a demand side problem. Rich people and rich entities may not want/need anymore, and other entities may not be making enough to buy the output.

  43. Gravatar of Fed Up Fed Up
    13. February 2013 at 23:52

    “Fed Up, No monetary policy can or should try to prevent all employment fluctuations.”

    In this case employment falls. That leads to less spending (real GDP). The labor market is oversupplied so more price inflation means negative real earnings growth, which should also lead to less spending. There will probably be more debt defaults in the banking / bank-like sector, which lowers the number of demand deposits (MOE & MOA). Employment falls again. At some point, companies will remove capacity with more employment losses.

    The economy starts spiraling backwards in time to a lower level.

  44. Gravatar of Recreating the Asset Bubble: The Fed’s Plan for Economic Recovery | Liberty Hall Recreating the Asset Bubble: The Fed’s Plan for Economic Recovery | Liberty Hall
    14. February 2013 at 05:01

    [...] demand stimulus and the horrors of austerity and “market” monetarists prattle on about deficient growth in nominal GDP, the signs of an incipient asset bubble become more evident every day. In fact it would not be [...]

  45. Gravatar of 123 123
    14. February 2013 at 06:03

    Scott, I agree potential gains from using expected NGDP to fight the financial instability are mild at best. There is some chance that by triggering small mini-credit cycles a larger credit cycle would be avoided, but there is no good evidence for that.
    Nick’s comment thread has a good discussion about the two target single instrument problem:
    http://worthwhile.typepad.com/worthwhile_canadian_initi/2013/02/a-monetary-policy-target-can-only-be-defeated-by-a-better-monetary-policy-target.html#comments

  46. Gravatar of Rien Huizer Rien Huizer
    14. February 2013 at 18:12

    Scott,

    Apologie s for such a late response. But this post is most illuminating about the pos and cons of various policy options, and differences in preferences among commenters. Of course my comment is highly stylized.

    The preferences are a mix of preferred tools ( status quo/established vs theoretically superior but untested) a mix of preferred institutional arrangements (your comments about banking, credit, subisidies and taxes) that may be crucial to the effcectineness of some policy tools and a mix of preferred outcomes (do you care about the business cycle, do you care about employment, do you want to keep the door closed for gvt intervention, etc).

    I think people should be clear about each of their stances viz tools, institutional arrangements and preferred outcomes.

    The way I read your work, is that you are prepared to use tools with little proven track record (but you believe that existing tools have not been effective of ineffectively used) you dislike the existing institutional arrangements and your preferred outcomes are that the business cycle should not be allowed to run its course without intervention (at least cyclical fluctuations in AD).

    Apart from using prototypes (not a responsible way to manage the interests of a large, dominant country) which is iom the greatest weakness of your program, I largely agree, especially with your critique of institutional arrangements (but there is no feasible political path to changing them, the situation is an entrenched analog to the zero bound in monetary policy) and to a lesser extent with your preferences if market monetarism could indeed reduce the impact or occurrence of AD shocks (there is no point in having unfeasible preferences). To what extent that can be done with the tools you propose and in the available institutional environment is too difficult to assess for academia (apparently, after several years of following this and similar blogs) let alone for the politicians and their constituents who have to cooperate to facilitate this policy experiment.

    So let’s hope that the UK experiment (if that becomes reality) will shine some light. At least the UK lacks the most of the institutional features of the US (banking, credit, subsidies) and it has a political system that makes the gvt of the day practically dictatorial (though it has to regard voters). Maybe that will provide more useful evidence.

  47. Gravatar of Geoff Geoff
    15. February 2013 at 07:26

    Dr. Sumner:

    “Geoff, I was wrong in assuming you had a sense of humor.”

    Insert “bad” before “sense” and you’ll be spot on.

  48. Gravatar of ssumner ssumner
    18. February 2013 at 07:48

    Fed Up, I think you are confusing demand and supply shocks, The factors you mention pertain to demand, not supply.

    Rien, You said;

    “The way I read your work, is that you are prepared to use tools with little proven track record (but you believe that existing tools have not been effective of ineffectively used) you dislike the existing institutional arrangements and your preferred outcomes are that the business cycle should not be allowed to run its course without intervention (at least cyclical fluctuations in AD).”

    No, I want to use tools with proven track records (OMOs) and I want the Fed to avoid creating business cycles, which has nothing to do with “run its course,” a phrase that implies a demand shock can happen outside of Fed policy. I want a stable monetary policy, after which you can allow the real economy to run its course.

    I very much doubt that the UK will run any useful experiments.

  49. Gravatar of Fed Up Fed Up
    19. February 2013 at 15:00

    “Fed Up, I think you are confusing demand and supply shocks, The factors you mention pertain to demand, not supply.”

    A MOA/MOE shock (like debt defaults) can lead to a demand shock which can lead to both prices and quantities falling which can lead companies to remove supply which lowers employment. More debt defaults. Cycle repeats.

  50. Gravatar of The ‘cello approach to monetary policy | Fifth Estate The ‘cello approach to monetary policy | Fifth Estate
    21. February 2013 at 03:58

    [...] become. Taxation might be a more effective brake on excessive bank lending than either monetaryor regulatory policy: monetary policy is too much of a blunt instrument to act at the individual bank level, and [...]

  51. Gravatar of Addicted to Asset Bubbles | Anything Voluntary Addicted to Asset Bubbles | Anything Voluntary
    27. February 2013 at 23:24

    [...] demand stimulus and the horrors of austerity and “market” monetarists prattle on about deficient growth in nominal GDP, the signs of an incipient asset bubble become more evident every day. In fact, it would not be [...]

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