John Cochrane on money/macro

Tyler Cowen pointed me to a excellent interview with John Cochrane.  As usual, I agree with Cochrane on most things.  He makes excellent points about finance, regulation, health care, etc.

But not money.  Here are a few examples:

I’ve been searching all my professional life for a theory of inflation that is both coherent and applies to the modern economy. That might sound like a surprising statement, especially from someone at Chicago, home of MV=PY. But although MV=PY is a coherent theory, it doesn’t make sense in our economy today. We no longer have to hold an inventory of some special asset — money — to make transactions. I use credit cards. We pretty much live in an electronic barter economy, exchanging interest-paying book entries, held in quantities that are trillions of dollars greater than needed to make transactions. The gold standard is a coherent theory too, but it doesn’t apply today either.

Several problems here.  MV=PY is not a coherent theory, because it’s not a theory at all.  It is a definition of velocity.  V is the ratio of NGDP to money.  That’s all it is, a definition.  Now let’s cut Cochrane some slack and assume he meant something more like a monetary theory of prices.  Thus I might argue that the Fed can target inflation at 2% by offsetting shifts in V and Y.  I take it that Cochrane is opposed to that view, and has an alternative fiscal theory of the price level.

But even in that case the argument is very weak.  Unless I’m seriously mistaken Cochrane does believe the gold market theory of the price level worked under the gold standard.  But his objection to MV=PY (that some people use currency substitutes such as credit cards) was equally true under the gold standard. During the early 1900s, gold was actually used even less frequently than cash is used today.  So if the gold market model worked during the gold standard period, despite gold substitutes, why don’t simple MV=PY (i.e. monetary) models work in an economy where currency is the medium of account?

Despite the existence of credit cards, currency demand remains very strong, and indeed is rising. By adjusting the supply of base money the Fed can control its value, at least when not at the zero bound. Even at the zero bound they can do so, but it’s a bit trickier.  (I believe Cochrane supports my futures targeting approach.)

I think we’ve left the point that we can blame generic “demand” deficiencies, after all these years of stagnation. The idea that everything is fundamentally fine with the U.S. economy, except that negative 2 percent real interest rates on short-term Treasuries are choking the supply of credit, seems pretty farfetched to me. This is starting to look like “supply”: a permanent reduction in output and, more troubling, in our long-run growth rate.

In one sense he’s right.  Growth is slow despite a falling unemployment rate.  We are in the Great Stagnation.  But surely the fall in unemployment from 10% to 7% suggests that there was some demand deficiency when it was 10%. I think even Cochrane would agree on that point, as he suggests we’ve “left the point” where demand deficiencies could be blamed.  But have we?  Isn’t it very likely that unemployment will continue falling even as inflation stays below 2%?  That’s what most forecasters believe.  If we had futures markets for unemployment I’m pretty sure they would indicate that this is also what the market believes.  The demand shortfall is smaller than before, probably smaller than many Keynesians believe, but it’s still there.

Later in the interview Cochrane criticizes European policies that pay prime age able-bodied males not to work.  And yet America adopted just such policies in 2008, and only ended them over the weekend.  There are good arguments both ways on extended UI, but surely everyone would agree that the best policy is to eliminate the need for extended UI, by having unemployment return to its natural rate.  And if you think we are there now, does that mean you disagree with the consensus view that unemployment will continue falling over the next year or two, even as inflation stays low?

So I don’t think the theory suggests QE can have a big effect. What about the evidence? Most of it comes from announcement effects. Even there, it’s pretty weak: a 15-or-so basis point change in interest rates in return for a pledge to buy trillions in Treasuries.

.  .  .

If the Fed announces more QE or delayed tapering of QE and bond prices rise on that announcement, is that because QE itself is moving the markets? Or is it because bond investors think, “Wow, the Fed is scared, so it will keep interest rates low for a lot longer than we expected”? Without a solid economic reason to believe QE on its own has much of an effect, the latter interpretation seems more likely.

This is Paul Krugman’s view as well.  Two problems here.  First, the response of nominal interest rates tells us nothing about how expansionary QE will be, as the liquidity and income/inflation effects go in opposite directions.  More importantly, the Fed can only hold rates lower for longer by a more expansionary monetary policy down the road.  So all Cochrane is actually saying is that QE might work, but only because a part of it is expected to be permanent.  Krugman makes the same argument.  To me that would be like saying:

“Yes, I suppose you could argue that pushing the gas pedal to the floor of the car makes it go forward, but only because the other foot is not simultaneously depressing the brake.”

Yup, that’s why cars move.  And monetary stimulus works, if it works at all, only if it is not expected to be withdrawn in the near future.  That’s even true when rates are positive.

Long-term growth is like a garden. You have to weed a garden; you don’t just pile on fertilizer — stimulus — when it’s full of weeds. So let’s count up the weeds.

I really like John Cochrane.  For his sake I hope Krugman doesn’t see this comment.   :)

PS.  People asked for a link to my posts over at Econlog.  I added it to the right column, under “Sites I Visit.”  So far I have only one post.  I expect to add a second one tomorrow.  Because Econlog is shared with three other bloggers, I will post less frequently there than here.

Update:  Mike Freimuth asked a good question:

I’m confused by this:

“the Fed can only hold rates lower for longer by a more expansionary monetary policy down the road”

Since low rates often indicate tight monetary policy, how is it that the Fed couldn’t keep them lower for longer with more contractionary monetary policy down the road. If they tried to shrink NGDP by 10%/year, wouldn’t interest rates be very low for a long time? I think I’m missing something important…

And I responded:

Mike, Yes, my mistake. I was reacting to Cochrane’s comment about Fed signaling. So if the Fed is actually signaling an intent to have a higher future price level than investors currently believe (which seems to be the implication of his comment) then it would also involve a higher long run money supply. But yes, low rates can also be achieved via a tight money policy, a la Japan. I interpreted Cochrane as saying that it would be a signal of both lower future short term rates and a central bank intention to push the price level higher, but I should have made that clear. I.e. the central bank would wait longer to exit the zero bound, because they would wait until NGDP and prices rose by more than previously expected.


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55 Responses to “John Cochrane on money/macro”

  1. Gravatar of David R. Henderson David R. Henderson
    2. January 2014 at 09:29

    Excellent post.

  2. Gravatar of Philo Philo
    2. January 2014 at 09:56

    Cochrane opposes “[t]he idea that everything is fundamentally fine with the U.S. economy, except that negative 2 percent real interest rates on short-term Treasuries are choking the supply of credit . . . .” But, disappointingly, he’s just playing the game of *demolishing the straw-man*. Even before the recent depression it would be hard to find anyone who would say that *everything* was fine (perfect, optimal) with the U.S. economy. But how much stronger a recovery would we have, *even without removing the hindrances to supply, some of which, admittedly (e.g., extended unemployment compensation), have been added since the depression began*, if the Fed produced better “generic demand”?

    I like Cochrane’s metaphor of *weeding your garden* and *supplying fertilizer*. We should do both; but however much weeding we’re going to do–even if we aren’t going to do *any*–let us supply the optimal amount of fertilizer–more than we’re supplying now!

  3. Gravatar of Doug M Doug M
    2. January 2014 at 10:15

    I think you are putting words into Cochraine’s mouth.

    As I read the interview, it seems to me that he doesn’t think the prevalent theories adequately explain the linkages between money and the price level. But, it does not seem to me like he is suggesting a theory of is own, merely that he is unconvinced.

  4. Gravatar of ssumner ssumner
    2. January 2014 at 10:50

    Thanks david.

    Philo, Good point.

    Doug, I’m saying that we do have an adequate theory, and it’s not the fiscal theory of the price level, which he says he favors.

  5. Gravatar of Max Max
    2. January 2014 at 11:01

    Isn’t any theory of the price level a theory of a broken monetary system? I mean, the price level is not supposed to depend on anything, if the central bank is doing its job. Not quantity of money, not fiscal policy, not phase of the moon…

  6. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    2. January 2014 at 11:33

    Whether you call MV=PY a theory, a definition, or an algebraic identity, the existence of credit cards or other electronic means of payments doesn’t invalidate it.

    Financial innovation has made it more difficult to conduct monetary policy by focusing on monetary aggregates, that’s all. Though I believe Alan Greenspan in his latest book noted that M2 had lately been a pretty good indicator of monetary policy.

    If anything, financial innovations make NGDP targeting more attractive.

  7. Gravatar of SG SG
    2. January 2014 at 12:27

    Patrick Sullivan nails it.

    Finance-types have every right to think hard about things like systemic risk, liquidity, financial stablity, etc., because they are clearly important things that affect V and M.

    They just need to realize that the Fed’s total control over M means that the Fed is in the driver’s seat.

    The problem is that finance people (and modern central bankers, sadly) like to think that there is no possible way to overcome the technical problem of making fine-tuned monetary adjustments to systematically, precisely, determine NGDP.

    And when Scott comes around with an idea on how to overcome the technical challenge by using NGDP futures, they just ignore him and keep walking. It’s almost as if they don’t want to solve the problem.

  8. Gravatar of Mike Freimuth Mike Freimuth
    2. January 2014 at 14:12

    I’m confused by this:

    “the Fed can only hold rates lower for longer by a more expansionary monetary policy down the road”

    Since low rates often indicate tight monetary policy, how is it that the Fed couldn’t keep them lower for longer with more contractionary monetary policy down the road. If they tried to shrink NGDP by 10%/year, wouldn’t interest rates be very low for a long time? I think I’m missing something important…

  9. Gravatar of Dan W. Dan W.
    2. January 2014 at 15:26

    SG:

    Could you be more precise about the technical problems you say finance types see that Scott’s theory solves?

    Scott:

    Is rigidly defining economic terms necessary for your theory to work (ie bubbles do not exist, Bitcoin is not money)? If so is this not evidence that NGDP is ill equipped to work in a world that is much more gray and not black & white?

    You are correct that “money does not go into the market”. What does happen is the market facilitates the exchange of money to those who want it now to those who are willing to get it later. What is negotiated is the exchange rate. Variables are the supply of assets for sale, the demand for those assets, the demand for money and the expectation of the future value of money the buying of assets will provide.

    Those are a lot of variables and the expected value of money itself is just one of them. It follows that despite the stout claims that NGDP is the best monetary tool it may in fact be a very ineffective one. A point that Cochrane and Kling and many others much more capable than me are making.

  10. Gravatar of Geoff Geoff
    2. January 2014 at 15:46

    “As usual, I agree with Cochrane on most things. He makes excellent points about finance, regulation, health care, etc.”

    “But not money.”

    That is exactly my assessment of this blog.

    So if the gold market model worked during the gold standard period, despite gold substitutes, why don’t simple MV=PY (i.e. monetary) models work in an economy where currency is the medium of exchange<b??

    That’s better

  11. Gravatar of Matt Waters Matt Waters
    2. January 2014 at 16:47

    Mike,

    Let’s say the Fed adjusts interest rates with a constant function of inflation. Since inflation is a proxy to NGDP, a constant function for interest means higher NGDP growth means higher interest rates. In this model, QE can raise interest rates because the expected future NGDP growth is higher. Therefore expected inflation is higher and therefore the Fed is more likely to raise rates.

    The Fed can also change the underlying function for how they respond to inflation. If they are less likely to raise rates in response to moderate inflation, rates will go down and future NGDP growth goes up.

    I know this all sounds like a confusing contradiction, but there are really only two variables here. Inflation itself and how the Fed responds to inflation. Depending on which variable is changing, an interest rate change in either direction can mean a monetary policy change in either direction.

  12. Gravatar of Mike Freimuth Mike Freimuth
    2. January 2014 at 17:25

    Matt Waters,

    I don’t think this addresses my question. I’m not sure about that because I seem to be missing something and I’m not sure what that thing is so it’s possible that it does and I’m just not getting it. Mainly, I don’t know what this means:

    “a constant function for interest means higher NGDP growth means higher interest rates.”

    What constant function are we talking about? Any constant function? That doesn’t seem right. I understand that QE can raise interest rates, that’s not my question. This is how I am interpreting the quote by Scott that I mentioned previously: (It’s possible my confusion comes from misinterpreting it.)

    The statement seems to be regarding forward guidance about interest rates (not about QE) and it seems to claim that promising to keep rates low in the future forces the Fed to follow an expansive policy in the future (this could be QE).

    Now I get that being less likely to raise rates in response to inflation is more expansionary but this assumes that inflation will increase. Surely, inflation is determined by the stance of policy not independent. When rates are near zero, the Fed seems to have to do something else to get inflation going (QE). If it gets enough inflation going, rates should rise and this would be a sign of more expansionary monetary policy. But how is it that just promising low rates does this?

    For instance, if the Fed did no QE and just promised that it would keep rates at zero forever, wouldn’t that be like promising to offset any increase in the real rate by a corresponding amount of deflation? Wouldn’t that be radically contractionary?

  13. Gravatar of dtoh dtoh
    2. January 2014 at 19:16

    Cochrane’s argument is very simple (and correct), i.e. that at the ZLB, entities may simply hold money rather than spend it. Essentially rather than exchanging financial assets for money with the intention of spending the money, they make the exchange with the intention to hold the money. AND THIS IS EXACTLY WHAT HAS BEEN HAPPENING.

    The problem with current monetary policy is that while engaging in OMP (asset purchases, QE or whatever name you choose to give it), the Fed is simultaneously allowing and encouraging the banking sector to hold larger amounts of money (in the form of ER).

    What Cochrane fails to realize (or acknowledge) is that the amount of ER held by the banking sector is entirely at the discretion of the Fed and that therefore the Fed can easily solve the problem.

    [If the non-banking sector chooses to hold more money that is a separate issue. But that is not the cause of the current problem and moreover, it it were a problem it would be as easily preventable as it is to prevent the banking sector from increasing the amount of ER which they hold.]

    Cochrane is either being stupid or dishonest for not acknowledging this.

  14. Gravatar of Don Geddis Don Geddis
    2. January 2014 at 19:27

    Mike Freimuth: there are two different ways to get low interest rates. One is to ruin the economy with extremely tight money, wind up with essentially no growth, and then allow interest rates to settle to their natural level. In this scenario you would observe low interest rates together with low inflation (or deflation).

    The second approach would be to have a healthy growing economy, where perhaps a typical Taylor rule would suggest interest rates around 5%. In such an economy, the Fed could choose to force interest rates down to 1% anyway, despite the healthy economy. This would result in overheating, and large and growing inflation.

    It’s pretty clear when the Fed promises low rates for a long time, their goal is not to crash the economy in order to achieve low rates. Instead, what they are signalling, is that they will be willing to tolerate a little higher inflation than usual in the future (“overheating”), as the economy begins to recover.

    Basically, there are two opposite solutions to the macro equations when there are long term low interest rates. Deflation is one, but hyperinflation is another.

  15. Gravatar of Mike Freimuth Mike Freimuth
    2. January 2014 at 19:41

    Don Geddis,

    OK but my whole is regarding the “only” in this sentence.

    “the Fed can *only* hold rates lower for longer by a more expansionary monetary policy down the road”

    What you just said seems to contradict the “only.” And the whole point of that sentence seems to depend on the only since the point seems to be that promising to keep interest rates low in the future is expansionary today because it forces the Fed to be expansionary in the future. But if it’s possible to get low rates with “tight” monetary policy then I don’t see how this is the case.

  16. Gravatar of Mike Freimuth Mike Freimuth
    2. January 2014 at 19:44

    correction: my whole *issue* is regarding the “only”…

  17. Gravatar of Geoff Geoff
    2. January 2014 at 19:47

    I’ve been searching all my professional life for a theory of inflation that is both coherent and applies to the modern economy.

    Why not the original definition of inflation as aggregate money supply? It is both coherent and applicable to a “modern” economy (which of course will be ancient in the distant future, so it shouldn’t be called “modern” at all. It dates the statement like idiosyncratic expressions date a novel.)

    The definition of inflation as aggregate money supply is the most useful definition, and the one least prone to encourage misguided thinking about money in particular, and the economy in general.

  18. Gravatar of Geoff Geoff
    2. January 2014 at 19:50

    Don Geddis:

    “Mike Freimuth: there are two different ways to get low interest rates. One is to ruin the economy with extremely tight money, wind up with essentially no growth, and then allow interest rates to settle to their natural level. In this scenario you would observe low interest rates together with low inflation (or deflation).”

    An economy is also ruined with loose money, such as what we have been imposed with for many decades. Tight money later on after each loose money episode reveals that ruin that was before covered up by the illusion of prosperity through higher nominal profits and incomes.

  19. Gravatar of Don Geddis Don Geddis
    2. January 2014 at 21:11

    Mike Freimuth: I agree with you that “only” is technically incorrect. But your interpretation is basically confusing an instrument with a target. The situation is not that the goal is low interest rates, and we imagine the Fed might take any steps to achieve that goal (including crashing the economy). Instead, the obvious goal is a strong and healthy economy, and the manipulation of interest rates is nothing more than a tool to achieve that goal. You’re asking for the tail to wag the dog.

  20. Gravatar of Don Geddis Don Geddis
    2. January 2014 at 21:19

    Geoff: I used to think that you really knew nothing, and your huge volume of comments here were random, totally uncorrelated with the truth.

    But I now appreciate that you have been far more subtle than I realized. Your comments are almost perfectly negatively correlated with the truth. A person could learn a lot of good macro from your comments … but only by taking the opposite of everything you say. If there’s a macro issue, you can be reliably counted on to pick the wrong side of it.

    I apologize for underestimating you. You are indeed a wonder of consistency to behold.

  21. Gravatar of Mike Freimuth Mike Freimuth
    2. January 2014 at 21:26

    Don,

    I don’t think I am confusing an instrument with a target, the statement I don’t understand is making a claim about what you need to do in order to maintain lower rates for longer. I’m not asking for the tail to wag the dog, I’m just trying to figure out what that statement means. The more I look at it the more I believe I am misinterpreting the meaning of it (he is actually talking about QE not forward guidance) but I still don’t get what the meaning actually is.

  22. Gravatar of Mike Freimuth Mike Freimuth
    2. January 2014 at 21:29

    Let me take another crack at this. If low rates today don’t imply expansive monetary policy, how is it that “lower rates for longer” implies “more expansionary monetary policy down the road?”

  23. Gravatar of JohnB JohnB
    2. January 2014 at 21:47

    I think Murray Rothbard’s definition of inflation as “an increase in the supply of money beyond any increase in specie” is still relevant today-even though it was obviously written under the influence of the gold standard. It is a type of compulsory exchange similar to taxation.

    I still think that while this definition is not technically relevant today; it provides the clearest illustration of the point that to inflate means to create money based on nothing but ink and paper. It is also a coherent and useful definition because it makes it clear that only the government (and Fed as part of the government) has the legal authority to make money. Therefore, the government bears total responsibility for inflation over the years and all attempts to blame other things like greedy businessmen are misleading.

    The movements of a price index (any version of the CPI) are irrelevant to a definition of inflation. At any given point, there are a variety of factors that affect the exchange value between money and all other goods in the economy. All that economists can truly say on the subject is that other things equal, an increase in the supply of money will cause its purchasing power to fall (and prices to rise).

    I still think it is important for everyone in the world to understand that rising prices come from the government and their printing presses. Think of all the suffering that just this little piece of knowledge could have saved in places like Venezuela, Zimbabwe, and Argentina. Venezuela today is going down the deadly path of printing tons of money and trying to stop rising prices with price controls. As a result, they are experiencing severe shortages. Stop the madness!! It is so frustrating that educated people can sell other educated people on such self-immolation.

    Inflation definition from Murray Rothbard’s book “Man, Economy, and State with Power and Market” page 990.

    Most recent story I could find about Venezuela’s continuing shortages due to economic idiocy. The government identified 11 causes of the shortages. Guess what? Zero of them had to do with printing money or price controls.

    http://english.eluniversal.com/economia/140101/shortage-prevailed-despite-increased-agriculture-production-in-venezue

  24. Gravatar of Don Geddis Don Geddis
    2. January 2014 at 21:49

    Mike Freimuth: Because it is widely expected that te economy (and in particular, inflation) will pick up and accelerate in the near future. The Fed is communicating that, even when that happens, it has already decided not to immediately raise rates (unlike, e.g. The ECB, or Japan for the last 20 years).

    You’re right: current low rates with current low inflation are not particularly expansionary. But future low rates, assuming future inflation is significantly higher, would be expected to be expansionary.

    (And the confusing self-referential piece is: if it is believed that the Fed will be expansionary in the near future, that increases economic activity today. Resulting in the very immediate inflation that you’ve been looking for. A self-fulfilling prophesy. Or perhaps easier to understand as a complex system with multiple stable solutions, and the economy can jump from the current consistent low-growth one, to a different consistent higher growth one.)

  25. Gravatar of JohnB JohnB
    2. January 2014 at 21:56

    I have a question for the commenters. Does anyone else feel like the different economic schools of thought (Keynesian, Monetarist/Market Monetarist, MMT, Austrian) are so different that you have to change your entire way of thinking about economic issues in order to speak in language that they understand? For instance, having learned my economic base from reading von Mises and Rothbard, at this point I have read enough Sumner to make arguments I don’t really believe about why the Fed should end paying interest on reserves and targeting NGDP, but I feel like I have to think about the economy in a different way to do it. Specifically, the Austrian way is based on individual action while Monetarist or Keynesian ways of thinking are based on aggregation. Does anyone else have this problem?

  26. Gravatar of Mike Freimuth Mike Freimuth
    2. January 2014 at 22:42

    Don,

    I guess my problem is with the premise that “it is widely expected that the economy (and inflation) will pick up in the near future.” Surely this depends on the stance of monetary policy and cannot be used as a starting point for judging the effect of that policy. It’s like saying “assuming that monetary policy is expansionary, low rates will be expansionary.”

    I feel like we keep wandering off track because we are not addressing this in MM terms (nod to JohnB). So think about it this way. The policy tool isn’t the interest rate, it is the monetary base. So when we talk about “policy” we are talking about changes in the base (OMO, QE, etc.) and interest rates are a result of that. Now consider the claim in question.

    “the Fed can *only* hold rates lower for longer by a more expansionary monetary policy down the road”

    So let’s accept your premise and say that RGDP and inflation pick up in the near future but the Fed has promised to keep rates low. What do they have to do? It’s possible that they could lower rates by expanding the base if the liquidity effect dominates but isn’t it also true that this could raise rates if the Fisher/Income effect dominates? If that’s the case, wouldn’t it take a more contractionary policy to maintain low rates?

  27. Gravatar of Mike Freimuth Mike Freimuth
    2. January 2014 at 22:47

    JohnB,

    Yes I agree they all think about it in very different ways (though differing degrees of difference and Austrians are by far the most different from everyone else). But the difference is not between individual action and aggregation. You can’t have a MACRO theory without dealing with aggregates and you can’t have an economic theory without dealing with individual action. The issue is how to think about the aggregate effects of individual action.

  28. Gravatar of Mabuse Mabuse
    3. January 2014 at 00:56

    Hi Scott,

    This is quite off topic, but I have a few questions for you. What do you think of indexed units of account like the Chilean Unidad de Fomento or the World Currency Unit? Do you think that Market Monetarists should be in favour of, against, or indifferent towards such units? And how do you think the universal adoption of such a unit by an economy would affect an NGDP level targeting monetary regime in same?

  29. Gravatar of J.V. Dubois J.V. Dubois
    3. January 2014 at 01:20

    Mike: I was also a little bit perplexed by Scott’s statement that ““the Fed can only hold rates lower for longer by a more expansionary monetary policy down the road”

    However knowing what Scott’s arguments are the correct interpretation of this sentence would be that that the interest rates a little bit longer will have a price in terms of higher inflation and NGDP growth – assuming that economy will get into a normal equilibrium.

    But I agree with you that it is not the “only” way FED can do this. It can also do the Bank of Japan thing and have tight money for 2 decades along with low interest rates. So ultimately I think that Scott did make a slight mistake here.

  30. Gravatar of Daniel Daniel
    3. January 2014 at 02:34

    the Austrian way is based on individual action while Monetarist or Keynesian ways of thinking are based on aggregation. Does anyone else have this problem?

    That being said, the Austrian School tends to be a sort of intellectual abyss that sucks in reasonably bright people and essentially takes them out of the fight. It gets ahold of people when they are sophomores in college and essentially tells them that everything they don’t understand about mainstream economics in fact doesn’t make sense because of a few supposed fundamental flaws underlying it.

    From here

    http://realfreeradical.com/2013/02/24/diminishing-marginal-utility-again/

    But hey, if you’re into unfalsifiable pseudo-science – be my guest.

  31. Gravatar of Benjamin Cole Benjamin Cole
    3. January 2014 at 04:48

    When John Cochrane applies classic economics to specific issues—health care, for example—yes, he makes sense (though I notice the issue is always healthcare or social welfare, and never the USDA, or VA benefits or a cost-benefit look at Iraqistan).

    But Cochrane has simply blown a fuse (like many right-wingers and for that matter, many left-wingers) when it comes to monetary policy.

    The right-wing has been driven nuts by the fact the Fed is being moderately aggressive but we have declining rates of inflation. We have open-ended QE at $75 billion a month, and inflation is below 1 percent and sinking.

    So Cochrane and others have been entertaining increasingly esoteric, exotic, shrill, strained or peevish explanations as to why that is happening, or even concluding that QE causes deflation (and I guess that means we can pay off the national debt and fight inflation at the same time, a great idea).

    Cochrane has been reduced to stating that MV=PT is not true. A tautology that is not true to itself?

    As for fiscal foundations of inflation—please explain what happened after 2008. We ran some of the largest deficits in history. The debt-to-GDP ratio rose. Inflation went south.

    Please explain Japan, where they ran huge deficits to the moon for decades and have the debt-to-GDP ratio to prove it. They cannot get inflation up to 1 percent, even by trying!

    You know, sometimes you gotta look at what is happening on the ground.

    And to top it all off: If Cochrane is so acutely concerned about deficit and debt-fueled inflation, and if he thinks QE has a deflationary impact, then why doesn’t he throw down his cards and call for steady state QE for 10 years? We can tame prices and pay down the national debt.

    I find Cochrane is illogical.

  32. Gravatar of dtoh dtoh
    3. January 2014 at 05:53

    Benjamin Cole,

    Yes, but Cochrane has been making the same wrong arguments from even before the Fed got aggressive on QE. I tend to think he’s just being stupid or intellectually lazy.

  33. Gravatar of Dan W. Dan W.
    3. January 2014 at 06:53

    Benjamin,

    Most sensible thinkers should be dismayed at the ineffectiveness of Ben Bernanke’s policy. The damning evidence of his futility is not that inflation is low but that real economic growth is so uninspiring.

    Right-wingers, to borrow your term, have every right to be critical of Bernanke and his apologists. Clearly QE is a boon to the 1%. It has lifted the financial markets to record highs. Never have the world’s rich been so wealthy. Yet the 99% are seeing little of these gains. Incomes are stagnant and job growth is well below what is “normal” for an economic recovery.

    Perhaps what is really needed is some Austrian therapy. Instead of propping up bank balance sheets they need to be torn down so real assets can be acquired by those with an ECONOMIC INTEREST IN DEVELOPING THEM!!! The truth about low interest rates is that they enable banks to hold onto stale assets. This procrastination is exactly the OPPOSITE of what is needed for economic growth.

    Macros have a point that the level of money is a factor yet it doesn’t help their cause when they cannot agree on what money is! More importantly economic theory that ignores individual motivations is incomplete. The world is not one aggregate supply & demand curve where every input and output is some homogenous widget. Economic activity happens because of individual decisions and those decisions depend on many factors with the perceived value of money being just one of them.

    The philosophical contention between Macros and Austrians exists because Macros insist on making bold claims about their theories that are simply not true in practice. No central authority has the ability to control, especially with any degree of accuracy or timeliness, societal expectations or perceptions. The Invisible Hand is called that for a reason.

  34. Gravatar of Daniel Daniel
    3. January 2014 at 06:58

    not that inflation is low but that real economic growth is so uninspiring.

    If you understood the implication of “stickiness”, you’d see the correlation. But since you don’t, you spout austro-liquidationist boilerplate.

    Blablabla, “individual action”, yadda yadda yadda.

  35. Gravatar of Dan W. Dan W.
    3. January 2014 at 07:21

    Daniel,

    The doctrine of “stickiness” is like the doctrine that “bubbles do not exist”. Such definitions are necessary for the tautology of macro to function. But the real world does not agree with those definitions. In fact individuals are remarkably agile and not sticky. And in fact large numbers of people can be collectively wrong about the future. Whether or not we call that error a bubble or simply the market being right and the public being wrong is the consequence not the same? The forecasters were wrong and the financial models failed.

    What confidence should anyone have in a theory that is so rigid in defining a world that does not really exist?

  36. Gravatar of Daniel Daniel
    3. January 2014 at 07:32

    http://graphics8.nytimes.com/images/2013/03/05/opinion/030513krugman2/030513krugman2-blog480.png

    Wait, didn’t the axiom of human action disprove the existence of such a thing ?

  37. Gravatar of ssumner ssumner
    3. January 2014 at 07:53

    Max, If the Fed is doing its job and targeting NGDP, the price level will depend on RGDP growth.

    Mike, Yes, my mistake. I was reacting to Cochrane’s comment about Fed signaling. So if the Fed is actually signaling an intent to have a higher future price level than investors currently believe (which seems to be the implication of his comment) then it would also involve a higher long run money supply. But yes, low rates can also be achieved via a tight money policy, a la Japan. I interpreted Cochrane as saying that it would be a signal of both lower future short term rates and a central bank intention to push the price level higher, but I should have made that clear. I.e. the central bank would wait longer to exit the zero bound, because they would wait until NGDP and prices rose by more than previously expected.

    Dan, I haven’t seen either Cochrane or Kling make any effective arguments against NGDP targeting. If they have, send them to me and I will respond. NGDP is not defined precisely. But that’s true of lots of aggregates. The definition is certainly precise enough to be a useful policy target.

    dtoh, No, Cochrane is arguing that the use of credit cards in transactions somehow weakens monetary models of the price level. It doesn’t. That’s not a zero bound argument.

    JohnB, You can define inflation as the speed at which the tree in your front yard is growing, if you wish. But if want want to communicate with others, and to be understood, then you’ll stick to “rising prices.”

    If you insist on your definition, then the cause of inflation is inflation. Is that useful?

    You said:

    “I have a question for the commenters. Does anyone else feel like the different economic schools of thought (Keynesian, Monetarist/Market Monetarist, MMT, Austrian) are so different that you have to change your entire way of thinking about economic issues in order to speak in language that they understand?”

    Yes.

    Mabuse, I don’t have any objection to people using indices, but I believe that with NGDP targeting they would not be necessary.

  38. Gravatar of ssumner ssumner
    3. January 2014 at 07:56

    Everyone, I added an update in response to Mike’s question.

  39. Gravatar of Chaz Chaz
    3. January 2014 at 08:04

    I don’t know much about anything, but I do know that long-term growth ain’t nothing like a garden.

  40. Gravatar of ssumner ssumner
    3. January 2014 at 09:00

    Dan The real world doesn’t agree that wages are sticky? So hourly wage rates bounce up and down every five seconds just like pork bellies at the CME? If you say so.

  41. Gravatar of Mike Freimuth Mike Freimuth
    3. January 2014 at 11:22

    Scott,

    OK, I think I’m with you, thanks for the response.

  42. Gravatar of Mike Freimuth Mike Freimuth
    3. January 2014 at 11:33

    Daniel,

    When I read that about Austrian Economics, I wish I had managed to find a softer tone.

    JohnB,

    That’s still basically correct about Austrian Economics though (and I’m a hard core libertarian). Just try to keep an open mind about “mainstream” economics, it’s not perfect but it’s not nearly as off base as Austrians seem to believe. It just takes a lot of effort to figure out what things mean.

  43. Gravatar of dtoh dtoh
    3. January 2014 at 14:39

    Scott,
    Cochrane’s response to the question on the effectiveness of QE starts off, “In my opinion, QE has essentially no effect. Interest rates are zero, so short-term bonds are a perfect substitute for reserves.”

    That sure sounds like a ZLB argument to me!

  44. Gravatar of Benjamin Cole Benjamin Cole
    3. January 2014 at 22:11

    dtoh:

    I just can’t figure Cochrane out. Unless he is just a wolf in wolf’s clothing. That is, he just argues the GOP positions, and then finds intellectual foundations for doing so. (Many Dems do the same thing, ala Krugman).

    Dan W:

    One aspect of Austrianism I like is the questioning of who gets bank loans (the new money created). So a bank creates money and gives it to someone. Usually collateral is pledged. That is how I got a loan to buy a warehouse in 2001. I put down 20 percent, and they (the bank) created the money to buy the rest.

    So I benefitted from this (and the seller), and really benefitted when prices went up.

    And not everyone can get this new money. You had to meet conditions, have connections. Neil Bush got a bunch of new money back at Silverado, for example.

    It does raise interesting questions.

    That said, I think inflation is not a concern. I prefer to worry about real growth. Fiat money helps real growth in a modern economy.

    And anyone who wants to can convert their money into gold, we have a free market now. Or silver. I do not know why gold is better than silver. Can you explain that? If one really think cash is a bad bet, or there are bubbles, then buy gold. You can convert it back to cash when you plan to spend it.

    But I think gold was in a bubble up to 2011, and will go down for years from here. So who knows?

  45. Gravatar of ssumner ssumner
    4. January 2014 at 06:35

    dtoh, I was referring to his later argument about credit cards. Cochrane does not believe the monetarist model is useful even when rates are positive.

  46. Gravatar of dtoh dtoh
    4. January 2014 at 08:55

    Scott,
    As to credit cards…. He’s being stupid about that too. (And BTW, that’s another argument you could easily rebut if you use an asset exchange model for the transmission mechanism instead of HPE.)

  47. Gravatar of Brano Brano
    5. January 2014 at 12:59

    Scott,
    I think you are closer to Woodford, when speaking about credit card economy and importance of medium of *account*. Pages 31-37 : http://press.princeton.edu/chapters/s7603.pdf

  48. Gravatar of ssumner ssumner
    5. January 2014 at 18:46

    Brano, I don’t agree with Woodford on the credit economy, I think the monetary base is crucial.

  49. Gravatar of dtoh dtoh
    5. January 2014 at 18:56

    Scott,
    You said, “I don’t agree with Woodford on the credit economy, I think the monetary base is crucial.”

    Aren’t they the same thing? If you hold ER constant, won’t a change the base always be accompanied by increased credit to the non-banking sector.

  50. Gravatar of ssumner ssumner
    6. January 2014 at 05:29

    dtoh, I don’t see why.

  51. Gravatar of dtoh dtoh
    6. January 2014 at 08:20

    Scott,
    If the Fed engages in OMP and does not allow reserves to rise, then the ultimate counter-party to OMP has to be the non-banking sector, and the trade (OMP) by definition is an exchange of financial assets for money. You can not increase money holdings by the non-banking sector without a simultaneously decrease in the net amount of financial assets held by the non-banking sector.

  52. Gravatar of ssumner ssumner
    7. January 2014 at 08:15

    dtoh, That’s a very different claim (credit does not equal net about of financial assets.) So by your definition are bonds not credit? After all, they net out to zero.

  53. Gravatar of dtoh dtoh
    7. January 2014 at 09:13

    Scott,
    It’s a “slightly” different claim, and not in the way you describe.

    If the non-banking sector issues bonds and the banking sector buys the bonds, than this is both a reduction in net financial assets as well as an increase in credit. Same applies to mortgages, credit card balances, commercial paper issuance, line of credit draw-down, etc.

    If the non-banking sector sells securities out of portfolio to the banking sector, then from a purely nomenclature perspective you are correct (there may be no increase in credit per se), but functionally the effect is identical.

    If the non-banking sector issues equity, which is purchased by the banking sector then you are definitely correct that there is a decrease in net financial assets but no increase in credit. However, the amount of equity issuance is very small in the overall scheme of things, especially in the context of the non-banking sector’s response to OMP, so….. credit is a pretty good proxy for financial assets.

    I think you’re aware that I am painfully persistent in always talking about “financial assets” and “asset prices” rather than “credit” and “rates.” In this case, my use of “credit” was simply for the convenience of lexical consistency in responding to a comment.

    You are right that credit and financial assets are not the same thing, but in the context of monetary policy, they’re close enough that’s it’s sloppy but nevertheless accurate to claim that changes in the base (net of reserve changes) are intrinsically accompanied by changes in the level of credit for the non-banking sector.

  54. Gravatar of ssumner ssumner
    8. January 2014 at 06:21

    dtoh, OK, so I sell the Fed a bond for some $100 bills. Why does that matter? We don’t even know whether it causes bond prices to rise or fall. Either outcome is possible.

  55. Gravatar of dtoh dtoh
    8. January 2014 at 08:08

    Scott,

    It doesn’t matter whether bond prices rise or fall. What matters is why you sold the bond to the Fed. If you have been induced, by either lower bond rates (higher bond prices) OR higher expected NGDP, to sell the bond in order to increase your purchases of goods and services, then there will be a marginal increase in AD.

    (Of course it’s also theoretically possible that you’re doing it just because you want to hold more cash and have no intention of spending the cash, but that’s not what’s happening…. or at least not very much of it is happening).

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