Reply to Matt Yglesias
Matt Yglesias has a new post challenging my views on monetary offset:
Scott Sumner became famous in the world of popular economics writing with the bold contention that even at the “zero bound” the Federal Reserve both could and should bring the economy back to full employment even in the face of contractionary fiscal policy. But he’s always paired this with a stronger claim, namely that the Fed does in fact bring about exactly the level of Aggregate Demand that it wants to have regardless of the tightening or loosening of fiscal policy.
And he’s become pretty testy about people like Larry Summers who think that looser fiscal policy would be a helpful means of restoring full employment more swiftly.
A curious issue that in my opinion he and other proponents of the full monetary offset thesis haven’t fully grappled with is that Federal Reserve officials keep saying it’s not true.
Those three paragraphs are a bit misleading, but that’s partly my fault. It’s a complex and subtle topic, and I’m sure I’ve occasionally taken shortcuts in some of the things I’ve said, which left those impressions. I’ve probably said the Fed is satisfied with this crappy economy—out of sheer frustration. First a few clarifications, and then what I actually do believe:
1. In 2009 NGDP growth was clearly far below what the Fed wanted, in 2010-13 it was modestly lower than they would have wished. So the first paragraph is not really accurate.
2. The second paragraph is accurate but slightly misleading. I did get testy, and Summers did argue that fiscal stimulus would help boost employment. But what I was testy about was his other claim, that he’d favor fiscal stimulus even if monetary policy (by itself) led to on-target AD. Summers argued that the private sector would waste resources when interest rates were low, and hence the government should be more heavily involved in allocating resources. Matt Yglesias once characterized those views as “socialist”, and I made the mistake of also using that term in the post he links to. I apologized in my next post. What can I say; I pick up terminology from blogs I like. Matt’s encouraging me to talk like Rush Limbaugh.
3. I have done several posts discussing the fact that Fed officials don’t seem to believe in monetary offset. So the third paragraph is also inaccurate. But I suppose most of the discussion has been in comment sections that few people read.
Here are a few thoughts that come to mind:
1. One has to be careful interpreting the statements of Fed officials. First of all, monetary offset can sound unpatriotic if framed one way, and not doing monetary offset can sound unpatriotic if framed another way. Thus Fed officials sometimes say that that they take fiscal policy as a given, and do what’s best for the country given the stance of fiscal policy. That implies offset. They say that QE3 and forward guidance were done partly in order to offset the effects of fiscal austerity in 2013. On the other had if you ask Ben Bernanke “If Congress does fiscal stimulus to boost employment, will you sabotage their effort with higher interest rates?” Then I’m sure he will answer no. But that’s also the answer to that question that he would give when interest rates are positive, and even Matt Yglesias agrees that monetary offset is the right model in that case. Framing effects. Now of course none of this proves there is complete monetary offset, and I’ve always acknowledged that fact. But much of the analysis of fiscal stimulus in the blogosphere, including at the highest level (i.e. Krugman) simple assumes there is no monetary offset.
2. In the 1970s Fed officials said they could not be expected to offset the inflationary effects of budget deficits. We now know those protestations were incorrect. Were they untrue at the time? Depends on your theory as to what caused the Great Inflation. But we know that when Reagan dramatically boosted the budget deficits the Fed did offset. They also offset the LBJ tax increase of 1968, which therefore failed to reduce inflation. The BOJ offset fiscal stimulus for more than a decade. They presumably denied doing so.
3. Matt also discusses a theory that I first heard from Andy Harless, that the Fed views unconventional monetary stimulus as costly, and hence fiscal stimulus might not lead to 100% offset. This is a very logical theory, and might be true. But it’s not as self-evident as one might assume. For instance, the fact that the Fed has fallen short of its goals for AD might well reflect bad forecasting. I seem to recall Yglesias pointing out that GDP growth has consistently underperformed Fed forecasts. So perhaps they tried to offset and failed. Another possibility is that the Fed would prefer not to do monetary stimulus, and favors fiscal stimulus for that reason. But that doesn’t mean they won’t act if necessary, just that they would prefer someone else deal with the complaints from the Ron Paul’s of the world. There are many occasions when I hoped someone else would do something unpleasant, but when they didn’t I went ahead and did what I thought needed to be done. Like taking out the trash.
I’ve also argued that the Fed tends to overestimate the impact of conventional policy tools (such as interest rate changes), and underestimate the impact of unconventional tools such as forward guidance. Suppose the Congress had done no stimulus in 2009. Would Bernanke have said to himself; “Oops, looks like I’m going to go down in history as the worst Fed chairman since 1930, as another depression is on the way.” Or might he have decided to do some of the things that he had earlier recommended the Japanese do, such as level targeting? I happen to think level targeting is much more powerful that the Fed itself probably believes. If they had done level targeting in 2009 to make up for a lack of fiscal stimulus, in my view the recovery would have been even faster. So more than 100% monetary offset is perfectly possible. As long as we are in the realm of irrational behavior, anything is possible. I’ll wager that if you asked the average Fed official whether the recent decision to taper would turn out to be expansionary, approximately 100% of them would have said no. But it was! That’s because they “offset” the taper with more extended forward guidance, and the forward guidance turned out to boost AD more than the taper reduced it. Stocks rose on the news.
4. At this point we are left with a few basic facts:
a. Monetary offset is the standard assumption at positive interest rates.
b. Monetary offset should be the baseline assumption when rates are zero. Alternative assumptions require explanations. They might be true, but they require Fed stupidity.
c. It’s an empirical question as to how actual, real world central banks will behave, when faced with shifts in fiscal policy.
As I look at the empirical evidence several points seem clear. First, the Fed would have done more monetary stimulus back in 2008 and 2009 if they knew then what they know now. They are perfectly willing to boost the balance sheet by many trillions. They did not do so in 2009 because they thought their earlier actions were enough. They were wrong. But if the Congress had done less the Fed would have done much more QE and much more forward guidance in 2009. Second, several Keynesians including Paul Krugman said that 2013 would be a test of monetary offset. When the results came in exactly as the market monetarist predicted, they changed their minds. There was no test. Yes, it was far from a decisive empirical test, but where are the empirical tests in the other direction? Are we to spend hundreds of billions of dollars on fiscal experiments that (by assumption) doesn’t pass conventional cost-benefit tests because there are theories out there that fiscal policy can work if the Fed officials are incompetent, and although we don’t have any empirical evidence to back that up other than public statements which may be little more than CYA, we’ll go ahead anyway? Remember that Congressmen are the lunatics and Fed officials are the “grownups” in the policymaking realm. My opponents want to base stabilization policy on a regime that ASSUMES the lunatics know better than the grownups how to stabilize the economy. How likely is that to work in the long run?
I’ve argued that estimates of the fiscal multiplier are nothing more than estimates of central bank incompetence. A point in Matt’s favor is that central banks are in fact somewhat incompetent. But to make fiscal stimulus work they have to be incompetent in a very specific and peculiar way. In the end we will never have an answer to the interesting policy counterfactuals. By the time we get there, central bank behavior will have changed, and the reaction function will be different. The Fed of 2014 is not the same as the Fed of 2008. The search for “the multiplier” is futile; it’s a chimera. Monetary offset in the purest form is also probably false, in the sense that all social science theories are false. But it seems to me to be the most useful place to begin the analysis.
And finally, my crusade for monetary offset is both positive and normative. Obviously fiscal stimulus is a moot point in the US anyway; Congress isn’t going to do any. But if I can convince other people that monetary offset is the most natural thing in the world, and also that not only is monetary stimulus not risky, but that not doing monetary stimulus can be highly risky, then monetary offset will be much more likely to be true in the future. Even if my theory is false, it should be true, and we need to make it true. We don’t do that with defeatist talk about monetary impotence that you hear from the world’s most famous blogger, rather we get there with a coalition of market monetarists and progressives like Yglesias who keep insisting the Fed can and should do more.
I suppose one can argue that it’s a mistake to mix up positive and normative analysis. But then I’m not the only one who makes this mistake. Here’s Matt Yglesias sounding very monetary offsetish:
Conventional wisdom in DC is that not only would the full expiration of the Bush tax cuts make people grumpy as they find themselves needing to pay more taxes, it would also provide the macroeconomy a job-killing dose of fiscal drag. . . . I don’t buy it.
The problem is that this chart ignores what I think we’re now going to call the Sumner Critique. In other words, it assumes that the Federal Reserve is somehow going to fail to react to any of this. You can probably construct a scenario in which the Fed is indeed caught unawares, or is paralyzed by conflicting signals, or is confused by errors in the data, or any number of other things. But Ben Bernanke knows all about the scheduled expiration of these tax cuts. . . . Maybe he and his colleagues won’t do anything to offset this drag on demand, but if they don’t as best I can tell that’s on them. This is the very essence of a predictable demand shock, and the policymakers ultimately responsible for stabilizing demand are the ones who work at the Fed.
Tags:
16. January 2014 at 15:37
You have two number 3’s.
16. January 2014 at 16:20
“Summers argued that the private sector would waste resources when interest rates were low, and hence the government should be more heavily involved in allocating resources. Matt Yglesias once characterized those views as “socialist”, and I made the mistake of also using that term in the post he links to.”
How is it not socialist to argue that the government will allocate resources more efficiently, lower bound or no lower bound? What makes the government suddenly better at allocating resources than the private sector when interest rates reach zero? Why is the government not subject to the same risks of mis-allocation when credit is cheap?
Even though it may have offended some people’s sensibilities, I believe you got it right in your other post when you said that the people who want more fiscal stimulus want more socialism.
16. January 2014 at 16:47
I wonder how forward guidance works when you have FOMC board members rhapsodizing about deflation (Plosser) or in sweat-drenched hysterics about the “rot of inflation” (Fischer).
I can tell you institutional real estate investors place little faith that Fed policies are a foundation for investing.
I think QE works as bondholders who sell have the option of placing an immediate claim on output or investing in other asset classes.
If we eliminate the FOMC maybe forward guidance would have some effect…forward guidance and transparency are good government…
16. January 2014 at 16:49
My problem with Keynesianism…. well not my only one…
The Keynesian theory is based on the idea that:
Consumer demand is very sensitive to changes in income and Consumer demand is the primary driver of aggregate demand.
In my experience, neither of these things is true. Perhaps over the long term, consumer spending is a function of income, but in the short-term people are going to spend what they are going to spend regardless of there current levels of income. Consumers spending does not significantly drop when we go into recessions.
Consumer spending does not drive demand. While consumer spending is the largest fraction of AD, it is stable. The big changes in demand come from investment spending.
My problem with the monetary offset… It isn’t even a problem with the offset per se. The way that it comes across in the initial description is that the Fed is actively trying to undermine the fiscal policy. But the Fed doesn’t even have to try to do the offset, it just happens.
16. January 2014 at 16:54
Prof. Sumner,
Great reply, thanks. I’m a huge fan of both you and Yglesias and I’m inclined to agree with you here.
16. January 2014 at 17:13
“Another possibility is that the Fed would prefer not to do monetary stimulus, and favors fiscal stimulus for that reason. But that doesn’t mean they won’t act if necessary, just that they would prefer someone else deal with the complaints from the Ron Paul’s of the world.”
That’s right, they’re just complaints. They’re not arguments. They’re not derived from sound economic principles. No economist has ever made a case against additional inflation even during a recession. They’re just…complaints. Empty yammering. An obstacle standing in the way of a proud and honorable inflationary nation.
Ever wonder why the “Ron Paul’s of the world” know they have you intellectually beaten? You won’t dare seriously engage their arguments either in formal debate, or informal blogosphere back and forth. They are the ones showing you that the Emperor isn’t wearing any clothes…
16. January 2014 at 17:14
WC, Thanks, I fixed it.
Carl, Well I didn’t really intend it as an insult, but what happened is that I seemed to imply that anyone who favored fiscal stimulus is a socialist, and that wasn’t my intention. I agree with you that Summers’s justification is slightly socialistic, but I should stay away from those terms as it just clouds the debate. Better to stick to bland descriptions of the policy views of my opponents. Then people can focus on the issues. Of course the Limbaugh comment was a joke.
Doug, You said;
“My problem with the monetary offset… It isn’t even a problem with the offset per se. The way that it comes across in the initial description is that the Fed is actively trying to undermine the fiscal policy. But the Fed doesn’t even have to try to do the offset, it just happens.”
Yes, I’ve noticed that problem too, and I think that’s why people have trouble accepting it. It happens in a counterintuitive way, almost without the Fed realizing what it is doing.
Thanks Travis.
16. January 2014 at 17:18
Geoff,
You wrote:
” You won’t dare seriously engage their arguments either in formal debate, or informal blogosphere back and forth.”
What on Earth are you talking about? See here: http://www.youtube.com/watch?v=ZuSIFisFEis
16. January 2014 at 17:29
” If they had done level targeting in 2009 to make up for a lack of fiscal stimulus, in my view the recovery would have been even faster.”
So you consider this recovery to have been fast?
16. January 2014 at 17:48
I think Yglesias is the most interesting blogger I read. He writes very clearly and often has an new insight on the topics he covers. His quixotic quest for up-zoning aside, I share his values on most issues. I’m glad he asked you to expand on Monetary Offset, since I also wondered what your real views were. Some of your posts make it appear that you have a less nuance view than you actually have. You have been very good about responding to reader comments and to other blogs. Reading and responding to opposing blogs is a great example and I wish other bloggers (like Krugman) would do more of this instead of just looking for cheap shots.
16. January 2014 at 18:47
TravisV:
I meant debates with other “Ron Paul” type economists. Sorry, should have been more clear.
16. January 2014 at 18:49
Jim:
“I think Yglesias is the most interesting blogger I read.”
“I share his values on most issues.”
I love myself too.
16. January 2014 at 19:43
“Chinese Stocks Tumble On Contagion Concerns From First Shadow-Banking Default”
http://www.zerohedge.com/news/2014-01-16/chinese-stocks-tumble-contagion-concerns-first-shadow-banking-default
16. January 2014 at 20:59
“And finally, my crusade for monetary offset is both positive and normative. Obviously fiscal stimulus is a moot point in the US anyway; Congress isn’t going to do any. But if I can convince other people that monetary offset is the most natural thing in the world, and also that not only is monetary stimulus not risky, but that not doing monetary stimulus can be highly risky, then monetary offset will be much more likely to be true in the future. Even if my theory is false, it should be true, and we need to make it true. We don’t do that with defeatist talk about monetary impotence that you hear from the world’s most famous blogger, rather we get there with a coalition of market monetarists and progressives like Yglesias who keep insisting the Fed can and should do more.”
Forget Rorty, Scott. Meet Leo Strauss.
17. January 2014 at 00:45
Summers might well be right to say the private sector wastes resources at a zero interest rate: i.e. that the rate should be raised and a bit of fiscal stimulus implemented. (Though I don’t agree that that stimulus should necessarily be in the form of more government spending.)
Reason is that having the Fed buy government debt results in an artificial cut in interest rates (even if that’s not market monetarists’s central aim). And interest rates should be at their free market rate, not any sort of artificial rate.
MMers might answer that by claiming that fiscal stimulus is also “artificial”. My answer to that that the basic purpose of the economy is to produce what people want (both as expressed by what they do with their dollar bills, and the types of public spending they vote for at election time). So given a recession, people should be given more of the stuff that enables them to purchase what they want (i.e. more money), plus (possibly) government spending should rise.
17. January 2014 at 00:53
Doug M,
Where’s your evidence that household spending is not influenced by household income? There’s plenty of research been done into that question, and the evidence is that given a rise in income, or some other form of windfall, households spend very roughly half of it and save roughly half of it. See:
http://onlinelibrary.wiley.com/doi/10.1111/j.1745-6606.1984.tb00322.x/abstract
http://www.nber.org/digest/mar09/w14753.html
http://www.kellogg.northwestern.edu/faculty/parker/htm/research/johnsonparkersouleles2005.pdf
http://finance.wharton.upenn.edu/~rlwctr/papers/0801.pdf
http://www.eea-esem.com/files/papers/eea-esem/2012/1382/chz1a.pdf
http://www.newyorkfed.org/research/current_issues/ci7-11/ci7-11.html
17. January 2014 at 02:22
One argument I would have is that our prominent paleo-Keynesians do not base their argument on incompetence of FED or on some pragmatic result of how reality unfortunately is. They use idealized models.
If Paul Krugman and others were honest they should always and everywhere say that fiscal stimulus is only the second best option to “promising to be irresponsible” or any other way of boosting aggregate demand by more expansionary monetary policy. They should be like Cato the Elder and add “and FED needs to be more expansionary now” at the end of every single speech. Because it is that important.
Instead what we see is that they pay just lip service to more expansionary monetary policy – possibly to hedge their predictions – and go on with their own fiscal expansion idea. Even when given chance – like when the they were faced with results of supposed market monetarism test – they rather said “other things” instead of “Forward guidance was more expansionary than we thought. FED clearly made it, it has now more credibility to be irresponsible and we are happy for it”
17. January 2014 at 02:22
What’s really interesting about the Yglesias post is the new narrative that “those instruments (primarily QE and “forward guidance” ..) carry risks to financial stability….at the zero bound…”
Matt didn’t quite get the narrative right. In Summers words, “interest rates significantly below growth rates for long periods virtually ensures the emergence of substantial financial bubbles..”
So now we have gone from monetary policy doesn’t work at the ZLB….to monetary policy causes bubbles at the ZLB interest rates below growth rates…eerr.. aahh…umm whatever.
This is a lot more fun than watching a contortionist at a circus.
17. January 2014 at 02:43
Don’t you think that Krugman’s opposition to monetary offset is normative as well as positive? Where would he be if he had to concede it was true.
17. January 2014 at 02:43
I actually think monetary offset is pretty simple. A big increase in government spending should boost the inflation rate other things being equal and a central bank that is targeting this would have to tighten to stay on target. On the other hand if they spent less, the Fed would have to loosen to compensate.
The idea that the Fed could ever be out of ammo, which seemed to be the view among policy makers like Sumner and Obama is ridiculous. Try telling anyone that if the Fed started charging banks 10% to hold excess reserves at the Fed and committed to buying a trillion dollars in assets a month. I don’t think people would say that monetary policy was impotent then.
17. January 2014 at 04:56
Hi scott,
this passage: “I’ve argued that estimates of the fiscal multiplier are nothing more than estimates of central bank incompetence”.
How would you then qualify the ECB ???
17. January 2014 at 05:30
Doesn’t monetary offset depend to some extent on the monetary regime?
If the Fed has an NGDP level target, then it’s pretty clear that for every dollar that fiscal stimulus adds to nominal income, the Fed will subtract $1 from nominal income. Not instantaneously, but certainly over time.
But isn’t this less clear if the Fed has a flexible inflation rate target? Any fiscal policy-related change in NDGP will be composed of real growth (not a policy target) and inflation (the target). Unless we assume that the Fed keeps the inflation rate exactly where it wants it, wouldn’t monetary offset be less than complete? Particularly with a rate target that lets bygones be bygones.
17. January 2014 at 05:43
I’m surprised this is one area where you barely mention the market reaction to FMOC announcements. If full monetary offset were in fact inevitable, wouldn’t the market reactions be more subdued? Or is the uncertainty of timing alone enough to trigger the large responses? It seems to me the reaction indicates that these important announcements, which are responsible for the majority of the offset, are not inevitable. This leads me to believe that full offset is certainly possible, but far from the “baseline assumption.”
PS It’s clear that an NGDP futures market would provide a better measure of this, but in fact in the world of full offset you may not get the test you prefer, the reactions to announcements should be small because the announcements should be expected. (Be careful what you wish for).
PPS. This sentence seems to be the stronger form of your argument. “Even if my theory is false, it should be true, and we need to make it true.”
17. January 2014 at 06:07
Scott:
“In the 1970s Fed officials said they could not be expected to offset the inflationary effects of budget deficits. We now know those protestations were incorrect. Were they untrue at the time? Depends on your theory as to what caused the Great Inflation. But we know that when Reagan dramatically boosted the budget deficits the Fed did offset. They also offset the LBJ tax increase of 1968, which therefore failed to reduce inflation.”
The delusion that fiscal deficits were one of the primary causes of the Great Inflation is still very widespread. This delusion can often be cured with the simple facts.
True, fiscal policy was expansionary in fiscal years 1964 through 1968. The cyclically adjusted Federal budget balance was reduced from (-0.5%) of potential GDP in fiscal year 1963 to (-4.4%) in fiscal year 1968, and the deficit was increased annually during that time:
http://www.cbo.gov/sites/default/files/cbofiles/attachments/43977_AutomaticStablilizers3-2013.pdf
But a 10% income surtax was enacted in 1968 and remained effective through 1970. The cyclically adjusted budget balance rose to (-1.1%) by fiscal year 1970 and remained in the relatively narrow range of (-2.7%) to (-1.3%) from fiscal year 1971 through 1982. In fact despite the image of a deficit prone decade the 1970s were one of the most fiscally responsible decades on record with gross Federal debt setting a post WW II record low of 32.5% of GDP in fiscal year 1981 (President Carter’s last budget).
True between 1963 and 1968 NGDP growth averaged 8.1% and core inflation (to strip out the effects of energy prices) accelerated from 1.3% in 1963 to 4.4% in 1968:
http://research.stlouisfed.org/fred2/graph/?graph_id=155542&category_id=0
But NGDP growth was double digit every year from 1976 through 1979, peaking at 13.0% in 1978, and core inflation accelerated to 9.2% by 1980.
Then, under Reagan, cyclically adjusted Federal budget balance was reduced from (-1.5%) in fiscal year 1981 to (-4.6%) in fiscal year 1986 (the largest cyclically adjusted budget deficit since 1960 prior to the Great Recession). And yet from 1981 to 1986 NGDP growth averaged 7.4% and core PCEPI fell to 3.4% by 1986.
The Great Inflation and the Great Disinflation are perhaps the greatest examples of monetary offset of fiscal policy away from the zero lower bound in US history, because fiscal policy was relatively tight during the height of the Great Inflation, and became exceptionally loose during the Great Disinflation, exactly the opposite of what fiscalists predict.
17. January 2014 at 06:22
Scott:
“The BOJ offset fiscal stimulus for more than a decade. They presumably denied doing so.”
The following is from my guest post at Historinhas “Richard Koo also misinterprets Japan´s lost decades (Part II)” on June 11, 2013:
“…In my opinion the most objective way of judging fiscal policy stance is the change in the general government structural balance. The structural balance is adjusted for the business cycle and thus any changes should represent policy rather than the state of the economy. The IMF provides estimates of Japan’s general government structural balance from 1994 on so we can compute the changes from 1995 on:
http://thefaintofheart.files.wordpress.com/2013/06/sadowski2b_4.png
With the exception of calendar years 1997 and 2001 fiscal policy was expansionary during 1995-2003. Do we know anything about the fiscal policy stance prior to 1995? An excellent summary of the Japanese discretionary fiscal stimuli programs is Anita Tuladhar and Marcus Bruckner’s “Public Investment as a Fiscal Stimulus: Evidence from Japan’s Regional Spending during the 1990s” (IMF Working Paper No. 10/110, April 2010). Appendix Table 8 lists two fiscal stimuli for 1993 and one each for 1992 and 1994, so fiscal policy was obviously expansionary for the entire 1992-96 period. It also lists nine fiscal stimuli and three tax cuts during 1995-2002, but none during 2003-07. The fiscal tightening in 1997 is explained by the fact that Japan raised its consumption tax from 3% to 5% on April 1, 1997. The fiscal tightening in 2001 seems to have been passive. The expansionary fiscal policy of 2003 represents a carryover of the effects of the 2002 fiscal year, which ended on March 31, 2003.
Considering that the BOJ’s call rate wasn’t lowered below 1% until July 1995 and didn’t get below 0.25% until November 1998, Japan’s fiscal policy seems a bit backwards. Away from the zero lower bound there’s absolutely no rationale for doing fiscal stimulus unless one wants to see the spectacle of competing policy levers cancel each other out, and yet Japan did eight fiscal stimuli and three tax cuts during 1992-98. On the other hand, if one truly believes in the Keynesian concept of the liquidity trap, then one would want to do fiscal stimuli when the policy rate is pinned to the zero lower bound, and yet Japan practiced five consecutive years of consolidation during fiscal years 2003-07, a time when the policy rate was never as high as 0.5%.
So with that background out of the way, and recalling that Japan’s QE was announced in March 2001 and didn’t really kick into gear until December 2001, how did the Japanese economy do? Here’s a graph of Japans’ annual CPI inflation and harmonized unemployment rate:
http://thefaintofheart.files.wordpress.com/2013/06/sadowski2b_5.png
Note that aside from the consumption tax induced increase in 1997 Japan’s inflation rate dropped nearly every year from 1991 through 2002 and then edged upward until there was consecutive years of consumer price inflation in 2006-07 for the first time in nearly a decade. Unemployment increased nearly every year through 2002 and then dropped in 2003 for the first time since 1990, and then continued to drop every year through 2007. And it’s worth noting that even the Nikkei 225 gave its thumbs up during 2003-07, with the index rising from less than 7900 in April 2003 to over 18,000 in June 2007, which is still by far the greatest stock market rally in Japan since the beginning of the Lost Decade(s)…”
So once again, the Japanese disinflation proceded unimpeded during the time fiscal policy was exceptionally expansionary, and came to an end when fiscal policy became contractionary. This is another excellent example of monetary offset of fiscal policy, however in this case, the latter half took place at the zero lower bound, precisely when Keynesians predict monetary policy is impotent.
17. January 2014 at 06:46
Scott,
Off Topic.
John Williams mentions NGDPLT in a recent speech at the Brookings Institution on page 16:
“…Looking ahead, there remain a number of key unresolved issues related to the ZLB. Three come immediately to mind. First, should central banks change their policy frameworks from inflation targeting to one of price-level or nominal-GDP targeting in order to better anchor expectations of future policy actions? One lesson from the recent past is the difficulty in anchoring policy expectations when the short-rate is at the ZLB. Although quantitative forward guidance has proven a useful tool, it suffers from a number of limitations. Experience has shown that it is impossible to convey the full reach of factors that influence the future course of policy. As a result, forward guidance ends up being overly simplified and prone to misinterpretation. Moreover, forward guidance several years in advance may not be credible, especially in light of the change in policymakers over time. In theory, alternative frameworks such as nominal GDP targeting, if fully understood by the public, could help resolve these communication difficulties (Williams 2006; Woodford 2013), but at some potential cost…”
http://www.brookings.edu/~/media/research/files/papers/2014/01/16%20monetary%20policy%20zero%20lower%20bound/16%20monetary%20policy%20zero%20lower%20bound%20williams.pdf
17. January 2014 at 06:48
Somewhere in the sky Adam Smith is chuckling.
Here we have the “experts” arguing about what the central bank can and cannot do and what it should do and whether it should do it and so and so forth. Meanwhile, the 100 year legacy of the Federal Reserve is that it does no better, and many would argue it has done worse worse, at keeping the national economy out of the gutter.
Scott, can you appreciate how far from the ideal, frictionless, economic system our nation currently is? In theory your ideas could work. But the real world is nothing like your theoretical model. I make the same criticism of the Keynesianists. The economy is over-regulated, over-legislated and over-litigated. A full reset is needed yet no one wants to have it happen on his watch.
WWII rationing created a huge buildup in unmet consumer demand. Voila, subsequent aggregate demand grew at a rapid pace. Technology drove the securitization rage of the 1980s and ’90s. Credit rapidly expanded. Voila, aggregate demand increased at a decent pace.
Now those two cards have been played. Unless you have another card I don’t see how this year should be any better than the last.
17. January 2014 at 06:50
Mark,
At the entrance to headquarters of a Japanese religious cult (not Zen…something newer), it says “Where there is truth, there is proof.” Nice job of again illustrating this principle.
BTW – I think the only people still questioning the effectiveness of monetary policy at the ZLB are Cochrane and PK.
17. January 2014 at 07:02
The Fed can achieve even if it doesn’t believe.
Just like I can stop my car using the brake pedal alone, even if I’m quite certain that the Chant of Halting is also required.
17. January 2014 at 07:07
“Obviously fiscal stimulus is a moot point in the US anyway; Congress isn’t going to do any.”
This is ‘austerity’, right?
http://www.usdebtclock.org/
17. January 2014 at 07:26
‘I agree with you that Summers’s justification is slightly socialistic, but I should stay away from those terms as it just clouds the debate.’
I’d argue that accurate labeling clarifies the debate. But then, I’m writing from Kshamaland.
17. January 2014 at 07:33
Thanks Jim, I actually agree with Matt on zoning.
dtoh, I like the contortionist metaphor.
Rajat, I try not to judge people’s motives, as I don’t like it when people judge mine.
JohnB, Don’t you mean Summers and Obama?
Erwan, Hard to say, but you also need the right kind of incompetence. Does ECB policy get worse or better when fiscal policy changes?
Michael, Sure that’s possible, but not certain. It seems clear that policy is somewhat forward looking, as when the Fed announced QE3 partly in response to expected future austerity. But it does depend on the regime, and thus I’d expect fiscal stimulus to be more effective under fixed rates.
Adam, Very good question. My sense is that the Fed doesn’t always set policy at the right level, and that’s what the markets respond to. But that’s a different question from whether or not they respond to fiscal stimulus. Basically your point is related to Harless’s critique of my argument.
Mark, Great comments, and I’d add that inflation rose even further in 1969.
Dan, You said;
“Scott, can you appreciate how far from the ideal, frictionless, economic system our nation currently is? In theory your ideas could work. But the real world is nothing like your theoretical model.”
I hope this is some sort of weird joke, because if you still don’t know that I assume a sticky wage economy with involuntary unemployment then I hardly know what to say.
17. January 2014 at 07:37
Dan W
I do believe you are confusing Adam Smith with Mises (or some other pseudo-scientific sadist).
Also
http://en.wikipedia.org/wiki/Obscurantism
They’re talking about you.
17. January 2014 at 08:05
Scott,
Wages might be sticky but incomes are not. Many people can and do choose to work more hours or less depending on their preference. Recent employment numbers imply that the current trend is for many people opting not to work. If labor markets were sticky how can it be that so many are leaving it? If people really wanted to work the unemployment rate would be higher. It’s not. You yourself recognize that the unemployment rate is a poor predictor of the economy. In some ways I agree. But at the same time, if less people are working there is going to be less economic activity and thus less aggregate demand. Over the long term, is it possible to have more AD with less people working?
Current central bank policy is to drive long term interest rates lower. The return to savers is thus reduced. This means their income is reduced. To claim that monetary offsets work is to believe the economy efficiently compensates these savers by taking from one hand and giving back with another. Most savers will tell you they are not seeing the other hand giving back.
Adam Smith saw all of this in his day and what he said then applies just as well to today. The central bank may say it is working for the good of the nation but it meets and greets with bank CEOs and politicians would crave low cost debt. One would have to be a fool to think they don’t care more for the smaller, known, group than for the large, amorphous, unknown group.
“People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise prices.” – Adam Smith
17. January 2014 at 09:05
is it possible to have more AD with less people working
So if the population is halved while NGDP increases 10 times, you have less aggregate demand.
I guess all sort of wonders are possible in bizarro world.
Current central bank policy is to drive long term interest rates lower
So you’ve independently come to the conclusion that tight money harms savers.
17. January 2014 at 09:20
“Summers argued that the private sector would waste resources when interest rates were low, and hence the government should be more heavily involved in allocating resources.”
This is a caricature of Summers’s view. If you read his ideas closely (http://www.nber.org/reporter/2013number4/2013no4.pdf), he’s saying that the government should be spending more because of technological change in the private sector. He thinks high-productivity sectors (e.g., manufacturing) are adopting labor-substituting technology at a fast pace and will therefore need fewer and fewer workers. The low-productivity sectors (e.g., education and healthcare) will therefore need to employ the excess labor in the years ahead, if we are to get back to normal employment rates. However, many of the low-productivity sectors are tied closely to the government. Thus, if we want to employ those displaced by new labor-substituting technology, the government will need to spend more structurally, perhaps more than the 20%-to-GDP or so that we’ve gotten accustomed to.
I don’t necessarily agree with this view, but you should at least present it honestly, rather than crying “socialist”.
17. January 2014 at 10:07
Scott, I have been reading your blog for years now, and after reading this post, I think I finally understand your views on monetary policy. I’m exaggerating a little, but I would suggest that you save a link to this post and send it to anyone who doesn’t seem to grasp your views.
18. January 2014 at 08:49
Dan, You said;
“But at the same time, if less people are working there is going to be less economic activity and thus less aggregate demand. Over the long term, is it possible to have more AD with less people working?”
You’ve completely lost me here. Have you ever checked out Zimbabwe circa 2008?
And you are making my head spin. First you mock the idea of a frictionless economy, then you suggest the labor market is frictionless. Which is it?
You said;
“Adam Smith saw all of this in his day”
No, Smith was talking about relative prices, not the price level. Completely unrelated. You are accusing central banks of reducing the price of the product they produce, not increasing it.
JSeydl, If it’s a caricature of his views, it’s one shared by Matt Yglesias and Brad DeLong. Have you criticized Matt for crying socialist. And by the way, citing something else Summers believed in no way refutes my claim. That’s logic 101. He most certainly did express exactly the views I claimed he expressed.
And by the way, I thought it was considered tacky to criticize someone for saying something after they’ve already apologized.
And government spending is more than 35% of GDP in America, so we are already doing what Summers wants. Where did you get the 20% figure?
Thanks Matt.