How to tell if you understand monetary economics

There’s an easy way to tell whether or not you understand monetary economics. If you understand why all of the following seemingly contradictory sentences are true, and can clearly explain why using graphs showing the time path of interest rates and NGDP in response to both one-time changes in the monetary base, and permanent changes in the growth rate of the base, then you are all set.

1.  The bigger the monetary base, the more expansionary the monetary policy.

2.  The bigger the base/GDP ratio, the more contractionary the monetary policy.

3.  A move to a more expansionary monetary policy lowers short-term interest rates.

4.  In general, the higher the level of short-term rates, the more expansionary the monetary policy.

5.  The more expansionary the monetary policy the faster the growth in NGDP.

6.  The faster the growth in NGDP the more expansionary the monetary policy.

Many people, including pundits, policymakers and academics, never really grasp the intuition behind the seemingly contradictory statements 1 through 4.  They may understand them at some level, but have not internalized the concepts.

Statements 5 and 6 are not at all contradictory.  There is no puzzling paradox to wrestle with.  No conundrum. It’s simple, clear and straightforward.

One can argue that the Great Recession was largely caused by the general tendency to think of monetary policy in terms of money and interest rates, not NGDP growth.  Because these policy indicators are simply too confusing for the vast majority of influential pundits, policymakers and academics to work with, policy went tragically off course.

PS.  All of this was well understood long ago.  I studied these ideas in the 1970s. But they have never really been internalized, as Milton Friedman discovered in 1997.

PPS.  Nick Rowe gets it.


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43 Responses to “How to tell if you understand monetary economics”

  1. Gravatar of Mario Mario
    25. October 2013 at 05:41

    I’ll admit that #2 had me stymied for a bit. I just kept thinking: “if you hold GDP stable, how does this not directly contradict #1?” Then I realized that I was holding GDP stable.

  2. Gravatar of Mike Mike
    25. October 2013 at 05:59

    “1. The bigger the monetary base, the more expansionary the monetary policy.”

    You mean the growth rate of monetary base? If the base isn’t expanding literally (stuck around some nominal level) then isn’t it more accurate to say MP is neutral?

    The value of the monetary base of the US is greater than that of Australia (it is bigger) but I don’t think the US has a more expansionary policy.

  3. Gravatar of Nick Rowe Nick Rowe
    25. October 2013 at 06:36

    Thanks Scott!

    Yep. It’s so hard to explain this simply. The best I can come up with is the pole/broomstick metaphor: you are balancing a pole upright on the palm of your hand. If you want to move your hand North, you must first move your hand South, let the pole start to lean North, then move your hand North.

    But that metaphor doesn’t work exactly, because economies are composed of people, who have expectations, unlike dumb broomsticks.

    “If you want peace, prepare for war” doesn’t work exactly either, but sort of gets the element of conditional expectations.

    We really need a better metaphor.

  4. Gravatar of TravisV TravisV
    25. October 2013 at 06:58

    “Rand Paul threatens to hold nomination of Janet Yellen to Fed chair”

    http://www.cnbc.com/id/101128769

  5. Gravatar of lxdr1f7 lxdr1f7
    25. October 2013 at 06:58

    Nick Rowe
    “We really need a better metaphor.”

    When you want to turn left on your bike you always turn right a little bit first to get your weight over to the left side then you turn left on the handlebars. Or before jumping up you go lower to the ground to be able to jump.

  6. Gravatar of Saturos Saturos
    25. October 2013 at 07:03

    Very relevant: the Economist on the natural rate of interest: http://www.economist.com/news/finance-and-economics/21588354-central-banks-ignore-century-old-observation-their-peril-natural

  7. Gravatar of ssumner ssumner
    25. October 2013 at 07:19

    Mike, The problem here is language. There is a one time increase in the base. And a permanent increase in the growth rate of the base. I say either is an expansionary policy, if exogenous.

    Nick and lxdr, Yes, those are good analogies for 3 and 4, but still don’t quite get at the paradox in 1 and 2.

    Travis, Doesn’t Paul know that Yellen automatically becomes chair when Bernanke steps down? She is vice chair right now. He can’t do anything about it.

    Saturos, Good find.

  8. Gravatar of Carl Carl
    25. October 2013 at 07:35

    I don’t understand item 2. If I have a $100 monetary base and a GDP also of $100 and then I print 100 more $1 dollar bills and drop them frm a building I will be conducting contractionary monetary policy?! Would I in turn be conducting expansionary monetary policy by burning 50 $1 bills?

  9. Gravatar of TravisV TravisV
    25. October 2013 at 07:35

    Prof. Sumner,

    Whew, that’s a relief!

  10. Gravatar of Mike Mike
    25. October 2013 at 07:39

    ssumner
    Would you say it is expansionary policy if the fed reduced reserve requirements and the base and currency stayed the same but the C/D ratio decreased as a result of increased deposit issuance. Deposits are money and would affect prices and growth with greater issuance.

    Commercial bank deposits are called currency by most people and they are used as a medium of exchange much the same as notes and coin (even more efficiently because of electronic payments). Would it be more accurate to include deposits in the definition of currency as opposed to just notes and coin?

  11. Gravatar of Mark A. Sadowski Mark A. Sadowski
    25. October 2013 at 07:43

    Scott,
    “Travis, Doesn’t Paul know that Yellen automatically becomes chair when Bernanke steps down? She is vice chair right now. He can’t do anything about it.”

    To explain in more detail…

    Suppose the Senate fails to confirm Yellen to the Chair. Janet Yellen’s term as Governor doesn’t expire until January 31, 2024.

    In the absence of a Chair, the Vice Chair serves as Chair. Therefore, if Bernanke resigns from the Board before the end of his term as Chair, as he has indicated he might do, Yellen would serve as acting Chair until January 31, 2014. If there is still no Chair when her term as Vice Chair expires, the rest of the Board must elect a Governor to act as Chair pro tempore.

    http://www.federalreserve.gov/aboutthefed/section%2010.htm especially part 4

    Furthermore how many Governors will there be come January 31?

    1) Duke resigned at the end of August.
    2) Raskin resigned to become Deputy Treasury Secretary.
    3) Powell’s term expires on January 31, 2014.

    If Bernanke resigns as Governor (his term as Governor doesn’t expire until January 31, 2020) that leaves only Stein, Tarullo and Yellen to decide who among them will become the Chair pro tempore.

    Under those circumstances who do you think will end up being the Chair?

    Yellen of course.

  12. Gravatar of jknarr jknarr
    25. October 2013 at 07:47

    Scott, given these observations, why not just give the Fed the mandate to maintain a base/NGDP of 7%?

    This would lead to a stable 5% rate on the 10 year bond and around 3% in bills, and to-trend NGDP growth.

    http://research.stlouisfed.org/fred2/graph/?g=nJs

    From the 1820 through 1914, base/NGDP was incredibly steady at 10%. We can argue that this was the entire and only virtue of the gold standard: stabilizing base/NGDP.

    Constant base/NGDP would imply pro-cyclical monetary policy (shinking the base when NGDP declines), but would stabilize nominal growth and interest rates in the long run. Pro-cyclical policy would suffer greater short-term volatility (defaults and downward wages), but stabilize growth in the long run. In effect, malinvestment-debt gets liquidated faster, and at an earlier, smaller scale: wouldn’t this be a desirable efficiency gain?

  13. Gravatar of Mario Mario
    25. October 2013 at 07:48

    Carl:

    You are thinking of it the same way I did. I think its easier to intuit the answer if you hold the monetary base stable instead. If the base/GDP ratio is rising in that case, GDP must be going down. In what way could that be described as expansionary?

    If you hold GDP stable, it might be less obvious, but if you increase the monetary base, GDP should also increase. Since it doesn’t, it’s fair to assume you aren’t doing enough.

  14. Gravatar of Bob O’Brien Bob O'Brien
    25. October 2013 at 08:29

    Has anyone read Steve Hanke regarding government regulations and the monetary base:

    http://www.realclearmarkets.com/docs/2013/10/Hanke%20November1.pdf

    It seems to me that Steve makes some good points that I have not seen discussed on this blog in the past.

  15. Gravatar of Michael Michael
    25. October 2013 at 08:58

    Is point 2 better stated as:

    “The more contractionary the monetary policy, the bigger the base/GDP ratio will be.”

  16. Gravatar of Gregor Bush Gregor Bush
    25. October 2013 at 09:32

    jknarr, you said:

    ” Scott, given these observations, why not just give the Fed the mandate to maintain a base/NGDP of 7%?…Constant base/NGDP would imply pro-cyclical monetary policy (shrinking the base when NGDP declines), but would stabilize nominal growth and interest rates in the long run.”

    I think you’re missing a key part of Scott’s message. If you’re hit by a negative demand shock the base/NGDP ratio will rise. But the only way to get back to your target 7% NGDP/base ratio is to ease policy (point #1) by expanding the base even faster and temporarily pushing the base/GDP ratio even higher. This will allow NGDP to rise and for the central bank to unwind the base expansion at some point in the future.
    It’s analogous on the interest rate side. Suppose we’re in equilibrium at r* which is equal to 4%. And then the economy is hit by a negative demand shock. It would be a horrible mistake to look at Scott’s point #4 and conclude that the central bank should raise the policy rate. What you need to do is marry points #3 and #4 and realize that the only way to get rates higher in the future is to push the policy rate lower today. For any given set of economic conditions a lower policy rate to means a higher policy rate at some point in the future.

    So a central actively trying to push policy rates lower and/or the monetary base higher today is more likely to lead to a higher policy rate and a higher NGDP/base ratio in the future. If three years from now the monetary base is still bloated and the Fed funds rate is still at zero it means that the Fed was not expansionary enough today.

  17. Gravatar of Rob Rob
    25. October 2013 at 09:54

    I scratched my head briefly for #2 also. (Heh, I admittedly also have a bad habit of assuming GDP refers to real GDP.)

    I’m curious if the following logic is valid:

    Can base/NGDP be rephrased as “m/mv”? In that case, you’re really talking about 1/v. If that’s true, is #2 really saying that the higher 1/v, the more contractionary monetary policy is?

    So the lower the velocity of money is, the more contractionary monetary policy is? The higher the velocity of money, the more expansionary monetary policy?

    Or am I thinking about the issue wrong?

  18. Gravatar of Carl Carl
    25. October 2013 at 09:59

    Thanks Mario. That clears it up. I understand now that contractionary is determined by the change in the ratio of monetary base to GDP, but that raises a new question for me. If I double the number of dollar bills and the gdp stays the same why should I assume that I’m not doing enough instead of assuming that I’m devaluing my currency for no real benefit?

  19. Gravatar of jknarr jknarr
    25. October 2013 at 10:20

    Gregor Bush,
    It’s the step two to: 1) “base/GDP ratio even higher”, 2) “?”, 3)”allow NGDP to rise” that I don’t quite get. We have immensely high base/GDP right now for five years and 3% NGDP.

    The intervening variable seems to be creditworthiness and borrowing at step two. You need a deleveraged economy: reducing the base into a slump would deleverage faster and recover faster.

    Witness the 1921 recession: NGDP crashed, base/ngdp was kept steady by shrinking the base alongside NGDP, long rates remained firm, short rates dipped, balance sheets were purged and cleaned up, and the recovery was very fast.

    Your model leads to the Great Depression, Japan, and the current climate via the build-up of leverage through serial low-rate bailouts: hugely volatile in the long run, stable in the short, and a path straight into zero interest rates (to preserve debt and prevent default at all costs).

    (In the absence or restriction of the free flow of currency in the monetary base), debt formation has to be the vector for the base. Constantly lowering rates to bail out leveraged demand shocks leads to a debt overhang — and, ironically, not enough NGDP. Keeping a steady base/NGDP would entail short run pain, but long run debt stability and steady growth.

  20. Gravatar of Dan W. Dan W.
    25. October 2013 at 10:29

    Scott,

    I read your article on National Affairs and have found a strong point of agreement. It is in the last paragraph and in particular this sentence: “Monetary policy is not an answer to structural policy problems.”

    Not only is monetary policy not the answer to structural economic problems but I believe all too often, and as currently is the case, monetary policy is used to disguise the extent of the structural flaws that exist. An economy goosed on overly loose money may indicate an improving macro condition while in fact the internals are lousy and getting worse. Consider two reports today (links below): (1) More people are receiving “welfare” than working full-time and (2) Three out of five workers are accruing debt faster than they are adding retirement savings.

    Giving morphine to someone suffering appendicitis will relieve suffering but without surgery his condition will likely deteriorate until he dies. This does not mean morphine should be withheld, but it does mean that disguising pain should be temporary and done with the intent of allowing a real cure to be administered.

    All approaches to Monetarism amount to pushing on a string. This does not make such methods invalid but it does make them ineffectual if the string is limp and otherwise snagged.

    Taken at face value your NGDP prescription is for the central bank to force prices higher in order to maintain desired NGDP targets. You may not say it this way but in fact that is what must happen if structural flaws are snagging or otherwise preventing economic transactions from occurring. Of course higher prices may have the adverse affect of lowering economic confidence further. Can you not see that in the presence of structural flaws that NGDP targeting may worsen the economic condition?

    NGDP targeting may be a better tool than others in the Monetarist’s bag but it is only a tool. An economy with structural flaws cannot be fixed until misalignments in economic incentives are corrected. Attempts to fix an economy solely through monetary activity will only mask structural problems and allow them to grow larger and more intractable.

    http://cnsnews.com/news/article/terence-p-jeffrey/census-bureau-means-tested-govt-benefit-recipients-outnumber-full

    http://www.washingtonpost.com/business/economy/many-americans-accumulating-debt-faster-than-theyre-saving-for-retirement/2013/10/23/b7a9c85e-3b3e-11e3-b6a9-da62c264f40e_print.html

  21. Gravatar of TravisV TravisV
    25. October 2013 at 11:01

    Dan W.,

    Here is the relevant question:

    Imagine that (1) there will be gridlock and no major reforms in Congress for the foreseeable future and (2) you had the ability to control the monetary policy of the United States.

    What would your monetary policy be? Describe it.

    Read this post: http://www.themoneyillusion.com/?p=24378

    I suspect that you are the kind of progressive Prof. Sumner talks about in that post.

  22. Gravatar of TravisV TravisV
    25. October 2013 at 11:15

    Dan W.,

    Consider this paragraph by Prof. Sumner:

    “What many people don’t grasp is that there is no such thing as “not using monetary policy.” A commenter recently noted that most progressives don’t favor using monetary policy because they see it as favoring the rich. I think that’s right, but it actually shows muddled thinking on two different levels. Progressives care a lot about inequality. If they thought monetary policy was worsening inequality then they should care a lot about monetary policy. But it’s even worse; many progressives seem to think there’s such a thing as “not doing monetary policy.” Yes I suppose there is but only in the sense that there’s such a thing as not steering the ship, just letting the steering wheel float around at random. But even that’s a policy decision, isn’t it?”

  23. Gravatar of Dan W. Dan W.
    25. October 2013 at 11:56

    TravisV,

    My monetary policy would be the Thoreau Doctrine. To quote: “if one advances confidently in the direction of his dreams, and endeavors to live the life which he has imagined, he will meet with a success unexpected in common hours.”

    In other words, if I was a benevolent dictator of the sort that chaired the Federal Reserve I would persuade the governors that the best monetary policy would be the one that imagined the economy was running fine.

    In this imagined economy the value of the dollar would be stable and strong relative to other currencies and to this end short term interests rates would be well above zero – thus making the first point real and not imagined! I would advise Wall Street banks that if such a policy hurt their performance they ought to recapitalize. I would advise DC politicians that if they did not like losing the “free lunch” of cheap borrowing provided by QE that they had the power and responsibility to get their fiscal house in order. I would also tell them that if they did not like the unemployment situation that they had the power to lower regulations and make it more attractive for businesses to hire.

    BTW, one of the truths Scott ignores is that unemployment is a micro-economic problem. Employers don’t hire nameless people. They hire individuals and each hiring choice is based on the simple question of whether that individual will increase profitability. Artificially inflating prices does little to change the answer to the question of profitability. In fact if it does anything it hurts it as the uncertain expectation of higher prices usually leads people, ie business owners, to retrench, rather than to invest.

    The greatest beauty of my plan is this: The plan IS THE EXIT STRATEGY!!!! You see, Bernanke does not have an exit strategy. He knows he cannot taper without causing a large negative shock to GDP. But because he believes GDP is the end-all measurement of prosperity he is beholden to it.

    But my plan has an exit strategy since what is targeted, the short term interest rate, is both the short term and the long term goal.

    Now you can say that my plan would cause severe deflation. So be it. Deflation helps everyone except the over-leveraged lender. Deflation rewards saving, frugality and all those wise traits our grandparents knew and taught. Inflation rewards debt and short-term, compulsive consumption. Why would anyone think a world where goods and services got less expensive was bad? Getting more for less is what has created the middle class. Inflation, getting less for more, destroys it.

  24. Gravatar of rbl rbl
    25. October 2013 at 13:04

    The only way I can really make intuitive sense of 1 and 2 is via analogy. The economy is a car, the rate of gasoline consumption is monetary base, and the speed of the car is the size of the GDP. If the driver presses down further on the gas, that is going to increase gasoline consumption and make the car go faster (#1). Even if the car is idling, however there is going to be gas consumption, even though the car is standing still, so the gas use/speed ratio is going to be infinite. If the driver steps on the gas a little bit, the ratio is going to fall, and as the driver gets closer to the optimal cruising speed the gas use/speed ratio will get lower and lower(#2). Obviously the analogy doesn’t explain everything, like what happens if the Fed just redlines the vehicle, but I hope I’m understanding 1 and 2 correctly.

  25. Gravatar of ssumner ssumner
    25. October 2013 at 14:03

    Carl, The Fed determines the base and the public determines the base/GDP ratio. Expansionary policies are a tax on the holders of base money, hence they choose to hold a smaller share of their income as base money when the tax is higher.

    Mike, Yes, any policy that reduces the demand for base money is expansionary.

    Mark, Thanks for that info.

    jknarr, Because what matters is NGDP, not the ratio of MB/NGDP. The gold standard did not lead to a stable NGDP.

    Bob, Regulation should be handled separately from monetary policy. If the optimal regulation leads to less lending, any effect on GDP can be offset with monetary stimulus.

    Michael, That’s right, but I was trying to make the contrast sharper.

    Rob, That’s right.

    Dan, I’m afraid you need to read my article again, as you have not characterized my views at all accurately. And the claim that there are as many getting welfare as working is an absurd falsehood. Don’t believe what you read in the press.

    rbl, I don’t know enough about cars to comment–maybe someone else can.

  26. Gravatar of Geoff Geoff
    25. October 2013 at 14:15

    4. is right or wrong depending on the definition of “generally”. What does that mean? 51 times out of 100? 99 times out of 100? What if the exception persists for longer than expected period, say for 10 or 20 years? What good is 4. if it is useless for a half or full generation of individuals?

    6. is right or wrong depending on the definition of “expansionary monetary policy.” Only if you define monetary policy in terms of total spending, will this statement be true. But there is no reason to define “expansionary” in terms of NGDP. One could rightly claim that NGDP is an arbitrary, non-actionable, abstract statistic. The only rebuttal to this is “Well, you have your definitions, and I have mine.” If one defines “loose” and “tight” money in terms of aggregate money supply, than guess what? If you assume that the aggregate money supply is the primary driver for NGDP, then if you assert that tight and loose are to be defined in terms of NGDP, then there is no logic against defining it in terms of the aggregate money supply.

    It is only during periods of significantly changed holding periods of money that these two will clearly differ. But then we aren’t getting anywhere if we say “Aha! We have a depression because NGDP fell.” For we could argue, rightly, that we have a depression because the previous aggregate money supply inflation, and thus the previous NGDP, were too high. That is why the market forces pushed NGDP lower, and put the central bank in a position of having to decide to let it fall as a consequence of past inflation, or to inflate and reverse this consequence.

    But then re-inflating will just set into motion the same distortions that have as one consequence a market force determined NGDP deflation.

    Contrary to the claim that understanding monetary economics requires one to accept the above two propositions, it is instead the case that these propositions themselves show its author to have a muddled grasp of monetary economics, clouded by Orwellian word weaponry, which of course masks a lack of understanding.

  27. Gravatar of Daniel Daniel
    25. October 2013 at 16:07

    Dan W

    Deflation helps everyone except the over-leveraged lender.

    http://en.wikipedia.org/wiki/Sticky_%28economics%29

    Edumacate yourself, bro

  28. Gravatar of Ben J Ben J
    25. October 2013 at 18:15

    Dan W, you said

    “BTW, one of the truths Scott ignores is that unemployment is a micro-economic problem.”

    We don’t ignore this premise, we just disagree with it. Don’t waste your time arguing that all the unemployment is structural, Casey Mulligan is doing a much better job than you are, and most of the people here will still (partially) disagree with him, even if his hypothesis gets more correct as time goes on.

  29. Gravatar of Gordon Gordon
    25. October 2013 at 18:44

    Nick Rowe

    “We really need a better metaphor.”

    I do like fermented beverages which may explain why my metaphors relate to drinks. Let’s suppose you’re the host of a party and you’re concerned about the ratio of the bottles of alcohol you’ve provided versus the number of bottles provided by guests. You have 2 bottles on the drinks table and only one guest has provided one bottle. The fact that you only provided 2 bottles is a sign to the party goers that the party may not go anywhere so the guests are afraid to commit any of their own bottles to the party. So you put out 2 more bottles as a signal of commitment to the party. The ratio of host to guest bottles is now 4 to 1. But now guests see that the party is likely to take off and be fun so more guests now commit their own bottles to the drinks table and the ratio of host to guest bottles drops dramatically.

  30. Gravatar of Carl Carl
    25. October 2013 at 19:37

    I appreciate the answers, but I think I better move to the back of the class, because I still don’t get it.

    “The Fed determines the base and the public determines the base/GDP ratio. Expansionary policies are a tax on the holders of base money, hence they choose to hold a smaller share of their income as base money when the tax is higher.”

    So, are we only able to evaluate whether a policy is expansionary after we witness its results. For example, if the Fed injects a trillion dollars into the economy right before a supply shock (let’s say a massive outbreak of avian flu) drives GDP down, would the Fed’s policy have been contractionary? Should the Fed follow up by decreasing the money supply to decrease the contractionariness of its policy (Here I am using contractionary, I think, as defined in item 2).

    In a situation where GDP is decreasing, is there any way to run an expansionary monetary policy that isn’t contractionary? According to principle 1, I would be conducting an expansionary monetary policy if I were increasing base money, but at the same time if GDP were decreasing relative to the money supply I would be running a contractionary monetary policy.

  31. Gravatar of Morgan Warstler Morgan Warstler
    26. October 2013 at 01:10

    As long as we admit deflation can be a joyous time:

    http://www.nytimes.com/2003/06/05/business/economic-scene-deal-with-deflation-that-depends-what-causing-prices-fall.html?src=pm

    If there is no scarcity, we’re going to want to keep our eyes on the late 1800′s.

  32. Gravatar of "How to Tell if you Understand Monetary Economics: There’s an easy way … If you understand why all of the following six seemingly contradictory sentences are true, and can clearly explain why … then you are all set. « Economi "How to Tell if you Understand Monetary Economics: There’s an easy way … If you understand why all of the following six seemingly contradictory sentences are true, and can clearly explain why … then you are all set. « Economi
    26. October 2013 at 04:01

    [...] Source [...]

  33. Gravatar of Morgan Warstler Morgan Warstler
    26. October 2013 at 04:30

    More evidence Yellen might NEED NGDPLT just to be credible:

    http://www.businessinsider.com/did-the-fed-miss-its-chance-to-taper-qe-2013-10

  34. Gravatar of ssumner ssumner
    26. October 2013 at 06:06

    Carl, You said;

    “So, are we only able to evaluate whether a policy is expansionary after we witness its results. For example, if the Fed injects a trillion dollars into the economy right before a supply shock (let’s say a massive outbreak of avian flu) drives GDP down, would the Fed’s policy have been contractionary?”

    You are confusing nominal and real GDP. You evaluate monetary policy with NGDP.

    Don’t feel bad if you are confused, 95% of professional economists don’t get it.

  35. Gravatar of Benoit Essiambre Benoit Essiambre
    26. October 2013 at 10:16

    I like Rowe’s broomstick metaphor. Maybe the inventors of Segways should be hired to run central banks since they are specialists of solving complex inverse pendulum problems.

  36. Gravatar of Negation of Ideology Negation of Ideology
    26. October 2013 at 12:28

    TravisV -

    “Rand Paul threatens to hold nomination of Janet Yellen to Fed chair”

    Maybe he’s opposed to her because she’s still alive:

    http://www.businessweek.com/articles/2013-08-08/rand-paul-on-republicans-voter-appeal-and-the-federal-reserve

  37. Gravatar of Carl Carl
    26. October 2013 at 12:33

    Thanks again, Professor Sumner. I would say that I am solidly in the 95% based on how I’m doing on your quiz.

    If I only evaluate monetary policy with NGDP am I at risk of not knowing what effect it has on the real economy? And, if I use some factor such as CPI to figure that out, then am I guilty of just not finishing the equation when I stopped at NGDP?

    Also, I can see how focusing on NGDP can protect against the debt default problem whereby keeping the money flowing while the read GDP is tanking will allow debtors to pay off debts with devalued money. I wonder, however, about the other side of the ledger where creditors do not get to see their savings appreciate as much as they otherwise would during difficult times. Is the key argument for focusing on NGDP that the net deleterious effect of debt defaults has historically outweighed the net benefit of incenting frugality?

  38. Gravatar of ssumner ssumner
    26. October 2013 at 13:07

    Carl, One argument is that it’s fairer to share the pain between lenders and borrowers. Another is that the pie is bigger if we stay close to full employment, and hence it’s not a zero sum game.

  39. Gravatar of Mike Freimuth Mike Freimuth
    26. October 2013 at 13:34

    Carl,

    When evaluating monetary policy, you have to hold things not related to monetary policy constant (like bird flu) but you can’t hold things that are influenced directly by monetary policy constant (like NGDP).

    Also, I think there is some confusion about the line between “contractionary” and “expansionary.” Notice that Scott talks about “more contractionary” and “more expansionary.” If, for some reason not related to monetary policy RGDP is falling, we can still compare two monetary policy regimes and say that one is more or less expansionary than the other based on their relative affects on the demand for base money (M/NGDP). This does not require us to label policy as “expansionary” or “contractionary” in an absolute sense based on the rate of change in NGDP.

  40. Gravatar of Carl Carl
    26. October 2013 at 22:00

    Thanks again Professor Sumner. That makes sense to me. I take it you don’t put much stock in Kondratiev wave-like theories where positive parts of the sine wave are the result of having learned from past excesses and then downward trends have to do with the old people who remember the excesses dying off.

    Mike: I think you’re right that I am jumbling up my real and nominal variables, but in my defense, principle 2 up above is Base/GDP not Base/NGDP.

  41. Gravatar of ssumner ssumner
    27. October 2013 at 07:03

    Carl, That’s right, I’m an EMH guy.

  42. Gravatar of flow5 flow5
    27. October 2013 at 10:33

    LOL. Are MMDA accounts & travelers checks reservable?

    “In consumer banking, “Regulation D” often refers to §204.2(d)(2) of the regulation, which places a limit of six withdrawals or outgoing transfers per month from savings or money market accounts via several transaction methods. Transactions counted against the limit include “preauthorized or automatic transfer, or telephonic (including data transmission) agreement, order or instruction, or by check, draft, debit card, or similar order made by the depositor and payable to third parties.” Transactions not counted against the limit include “mail, messenger, automated teller machine, or in person or when such withdrawals are made by telephone (via check mailed to the depositor).”

    “The law was amended in 2009 to allow greater freedom for the depositor: beforehand, the limit was six withdrawals per month if the funds remained within the same institution (e.g., transfer to checking), but was only three drafts where the funds left the institution (e.g., check, ACH, or card based purchase).[1]

    …The number of deposits or incoming transfers into savings or money market accounts is not limited.” So hypothetically, will savings accounts eventually reflect the creation of new money?

    Go fish.

  43. Gravatar of flow5 flow5
    28. October 2013 at 07:19

    “to think of monetary policy in terms of money and interest rates, not NGDP growth”

    Exactly: Remember that St. Louis Fed’s technical staff surmised: “Although the evidence is mixed, the MSI (monetary services index), overall suggest that monetary policy WAS ACCOMMODATIVE before the financial crisis when judged in terms of liquidity. —Richard G. Anderson & Barry Jones.

    Actually not so. The roc’s in MVt (in Dec 2007) undeniably pointed to a recession beginning in the 4th qtr of 2008.

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