Never reason from a quantity change (unless you coined the phrase)

Here’s an interesting claim:

Trillions upon trillions of dollars have been pumped into the financial system by the Federal Reserve, European Central Bank and the Bank of Japan. Five years ago, if you knew how much stimulus central banks would push, would you have guessed that we would be in a disinflationary environment characterized by continuous deflation pulses? Would you have thought gold would be below $2,000? Most likely, no one five years ago could have possibly thought that deflationary pressures would remain as strong as they have been in the system today.

No one?  What about Paul Krugman and I?  It’s discouraging when the people who got it wrong don’t pay any attention to the people who got it right.

If you had told me in 2009 that the Fed would still be doing massive QE in 2014, I would have realized that one of two events had occurred:

1.  The Fed had decided it was a good time for hyperinflation.

2.  The economy remained weak, nominal rates remained stuck at zero, and hence the Fed was still trying to use unconventional stimulus.

After about 2.8 seconds of deep thought, I would have concluded that the second outcome was more plausible, and of course I would have been right.  Am I reasoning from a quantity change? Check the post title.

Because people were wrong about QE, they try to make up for it with even wronger explanations of what went wrong:

But accommodative policy has not been enough. The ultra-bearish argument is simple: deflation takes hold in developed economies, and no amount of central bank action can counter it, as Japan knows all too well. If central banks can’t reverse deflationary pressure and unlimited money printing is not enough, then the hard work is on commodities. Should industrial commodities perform well and increase in price, cost-push inflation could reverse disinflationary behavior.

No amount of action?  As Japan knows too well?  Ever hear of Abenomics?  What about the sort of “action” we see in Argentina, Venezuela, India, Iran, Turkey, etc?  Closer to home, isn’t Australia continuing to hit its (2% to 3%) inflation target?

I suppose you could argue that the eurozone is falling below its inflation target. But surely it must be doing all it can:

European Union statistics office Eurostat estimated on Friday that consumer prices in the 18 countries sharing the euro rose an annual 0.8 percent this month. That was the same rate as in January and December, after readings of 0.9 percent in November and 0.7 percent in October.

Economists polled by Reuters had forecast inflation would slow to 0.7 percent. Fears the bloc may be at risk of deflation as it struggles to recover from its debt crisis have raised expectations the ECB will use interest rates or other policy tools to give the economy further support.

“The higher than expected inflation numbers reduce the chances of an ECB rate cut at next week’s meeting, and we maintain the view that … the central bank will keep rates on hold,” said Nick Kounis, head of macro research at ABN AMRO.

So no rate cut in the eurozone.  Even though unemployment is 12%, and even though inflation is 0.8%, and even though the inflation target is 1.9%, they decide current policy is just fine.

What about Germany?  Wouldn’t monetary stimulus be bad for Germany?

Figures on Thursday showed annual inflation in Germany, the euro zone’s economic powerhouse, easing to its lowest level in 3-1/2 years in February at 1 percent.

But what about German unemployment, isn’t that quite low?  Wait a minute, I thought you completely insane eurozone hawks told me unemployment doesn’t matter, and that the ECB should focus like a laser on 1.9% inflation.  So doesn’t that mean money is too tight for even Germany?  Make up your minds.  If you are going to be crazy, at least be consistently crazy.  No one likes an unpredictable crazy person.


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25 Responses to “Never reason from a quantity change (unless you coined the phrase)”

  1. Gravatar of Larry Larry
    28. February 2014 at 12:17

    Off topic:

    “Fiscal devaluation”?

    http://www.bloomberg.com/news/2013-02-06/harvard-s-gopinath-helps-france-beat-euro-straitjacket.html

  2. Gravatar of Chuck E Chuck E
    28. February 2014 at 12:28

    The only commodity that I am intimately knowledgeable about is steel. In 2006, flat rolled steel averaged about $.29/lb., spiking to about $.48/lb. in 2008. It has receded to $.36/lb. currently. We saw a spike in oil which has retreated by a similar percentage. I’m not sure how commodity prices do the “heavy lifting” in monetary policy.

  3. Gravatar of Jason Jason
    28. February 2014 at 12:48

    There is a fairly direct connection between the monetary base and interest rates (graph at link):

    http://twitter.com/infotranecon/status/437114750611111936

    The currency component controls long rates (e.g. 10-year) and currency+reserves (i.e. QE) controls short rates (e.g. 3-month). There are “business cycle” fluctuations, but the overall trend is given by c log r = log NGDP/MB – k.

  4. Gravatar of benjamin cole benjamin cole
    28. February 2014 at 13:08

    Tapering too quickly poses unforeseeable and unintended but potentially catastrophic economic risks and threatens permanent corrosion of future economic output.
    And aluminum is cheaper today than 20 years ago. Maybe an aluminum-standard is a good idea…

  5. Gravatar of Rajat Rajat
    28. February 2014 at 13:49

    Nice final line, Scott – linking back neatly to your title! One can see the frustrated artist in you…

    Of course you’re not reasoning from a quantity change, you’re guessing probabilistically from a given future policy measure.

  6. Gravatar of Tom Brown Tom Brown
    28. February 2014 at 14:12

    Scott, O/T: you probably address this somewhere, so maybe you have a link:

    Why 5% NGDPLT?

    What goes wrong with 3%?

    What goes wrong with 7%?

  7. Gravatar of Don Geddis Don Geddis
    28. February 2014 at 14:37

    @Tom Brown: 5% is a convenient match to the monetary success in the three decades of the Great Moderation, which averaged (in the US) 2% productivity growth, 1% population growth, and 2% inflation. When proposing an entirely new monetary framework, NGDPLT, Sumner suggested a growth rate target to be similar to the historical averages that people were already happy with in 1980-2005. No need to confuse a new monetary framework, with also a change in the NGDP growth rate. It’s a reasonable balance between the dangers of too low growth (= missing real wealth), and the costs from too high inflation.

    That said, NGDPLT with 3% or 7% would probably work essentially just as well.

  8. Gravatar of Don Geddis Don Geddis
    28. February 2014 at 14:42

    Scott: “the ECB should focus like a laser on 1.9% inflation. So doesn’t that mean money is too tight for even Germany?

    To be fair, there is some segment of the population that thinks that any inflation is bad, and so the goal of a central bank is to “focus like a laser” on keeping inflation below 1.9%. Not exactly at 1.9%. For these people, less is better. (I’m not sure why they don’t think the target should be 0%. Probably they don’t believe the central bank has the power to hit a 0% target. So, “below 2%” is thought of as a reasonable attempt to do the best job the bank can.)

    Just want to point out that it seems pretty obvious that these other econ commentators are not “crazy”. They just see no benefit in ever deliberately raising inflation.

  9. Gravatar of Major_Freedom Major_Freedom
    28. February 2014 at 14:51

    “Am I reasoning from a quantity change? Check the post title.”

    This blog is a gold mine for how not to think.

    Stalin coined the phrase “5 year plan”. Anyone else who tries to do it is wrong, but he’s right about it because he coined it.

    There are endless examples of analogies that show this thinking to be evidence of someone who’s losing his marbles.

  10. Gravatar of ssumner ssumner
    28. February 2014 at 14:58

    Larry, That’s not a new idea, odd that it’s treated as one. But it does make sense. I’ve discussed employer-side payroll tax cuts, the VAT makes it revenue neutral.

    Thanks Rajat, but you give me too much credit.

    Tom, I have other posts that discuss that issue, there are many factors involved, pros and cons of going each way. For instance, the excess tax on capital rises with NGDP growth, and the sticky wage problem shrinks. The optimal rate depends on the country and time period.

    Don, I’m talking about people who used to complain when I advocated monetary stimulus in the eurozone. They’d say “can’t do that, the ECB has a 1.9% target.” Where are these people now?

    Yes, if low inflation is better then high inflation than obviously 10% deflation would be still better. Of course they’d deny that. But do they have a good explanation of why?

  11. Gravatar of Tom Brown Tom Brown
    28. February 2014 at 15:23

    Don, Scott, thanks.

  12. Gravatar of Tom Brown Tom Brown
    28. February 2014 at 15:47

    Don,

    “I’m not sure why they don’t think the target should be 0%. Probably they don’t believe the central bank has the power to hit a 0% target. So, “below 2%” is thought of as a reasonable attempt to do the best job the bank can.”

    I realize you’re trying to surmise how other people are reasoning here… but if 0% were the target, that would be tough to hit, wouldn’t it? Would it be easier/more practical to attempt to do so if there were no cash?

  13. Gravatar of lxdr1f7 lxdr1f7
    28. February 2014 at 16:01

    Stocks at record highs in US. Still inflation, UE and ngdp are at innadequate levels. This is evidence of innefective transmision channel of QE. Does the s & P 500 need to go to 4000 to reach adequate inflation ngdp and employment?

    In another correction the stock market gyrations will get more extreme as the current transmission mechanism becomes more imbalanced because assets are more and more concentrated. This means the wealth effect is felt by less people with greater wealth and appreciation of asset prices have less effect on spending.

  14. Gravatar of Major_Freedom Major_Freedom
    28. February 2014 at 17:56

    “This is evidence of innefective transmision channel of QE. ”

    All inflation is “QE”.

    QE is the Fed buying assets from primary dealers and other special interest groups with money made out of thin air.

    Every other “monetary policy” entails the same activity by the Fed.

    The cumulative $10 trillion in loans, and other bailouts, has significantly contributed to the economy stagnating, and why we see such large doses of inflation goosing the stock market disproportionately compared to voluntary real savings.

    The cognitive dissonance is so deep that we’re being told to understand the (publicized) $75 billion a month…$75 billion a month…to be another day at the office, because of what’s happening to NGDP.

    It is beyond ludicrous.

  15. Gravatar of Major_Freedom Major_Freedom
    28. February 2014 at 18:02

    Inflation does not affect all prices and expenditures equally. Targeting an aggregate spending statistic means to distort relative spending statistics and thus relative real investment. The distortions to real investment, temporally and cross sectionally, builds over time.

    This is wreaking havoc, RIGHT NOW, in Europe, the US, and emerging markets. But dimwitted theorists looking at “simple to use” aggregates are totally missing it.

    Let it be know that they had absolutely no excuse for this, and that they cannot accurately claim in the future “We didn’t know, we’re sorry.”

  16. Gravatar of ssumner ssumner
    28. February 2014 at 18:10

    lxdr, Why stocks? Why not focus on the price of zinc? What are we supposed to learn from the price of stocks?

  17. Gravatar of lxdr1f7 lxdr1f7
    28. February 2014 at 21:49

    ssumner

    Asset prices in general (including zinc), ngdp and inflation rise ceteris paribus if you increase base. I just chose stocks to simplify a point.

    How much they rise and ngdp, inflation depends on how money is deployed into system and fed counterparties. It’s not as simple as increase base by x and you get x ngdp or inflation or asset price level.

    For example when and if banks rebalance portfolios from the MBS they lose in QE they move into other asset markets.

    This affects asset prices and through the wealth effect spending.

    Fed counterparties don’t spend much they just invest so expectations of higher NGDP wont really move up much. Asset holdings aren’t broad enough to have a strong effect on spending through the wealth effect. Expectations are based on what is expected to happen from an increase in base given how it will work through the system.

    Banks shouldn’t get the money in exchange for treasuries or whatever other asset. If general public were counterparties money would go to spending alot more than simply asset purchases.

  18. Gravatar of anon anon
    1. March 2014 at 01:24

    Nothing of substance, but the first link have double http:// prefixes.

  19. Gravatar of ssumner ssumner
    1. March 2014 at 06:31

    lxdr, You said;

    “How much they rise and ngdp, inflation depends on how money is deployed into system and fed counterparties.”

    No it doesn’t, as I’ve pointed out numerous times.

    Thanks anon.

  20. Gravatar of lxdr1f7 lxdr1f7
    1. March 2014 at 07:13

    “How much they rise and ngdp, inflation depends on how money is deployed into system and fed counterparties.”

    “No it doesn’t, as I’ve pointed out numerous times.”

    Where?

  21. Gravatar of ssumner ssumner
    1. March 2014 at 08:05

    lxdr, Here’s a recent one.

    http://www.themoneyillusion.com/?p=26213

    In the past I have much longer ones.

  22. Gravatar of lxdr1f7 lxdr1f7
    1. March 2014 at 16:29

    In that article you say “a change in M causes a change in NGDP for supply and demand reasons”. But a change in M isn’t going to affect S or D if it doesn’t actually get used for spending. The money needs to be used for it to affect demand.

    Even if it goes towards buying assets then it will have a limited effect on spending by increasing the price of assets and hence wealth because assets are too concentrated in ownership.

  23. Gravatar of lxdr1f7 lxdr1f7
    1. March 2014 at 17:44

    For expectations to adjust people have to expect a change in M is going to affect S or D. If people expect that a change in M wont actually get used for spending or not much then expectations wont shift much.

  24. Gravatar of ssumner ssumner
    2. March 2014 at 06:03

    lxdr, I meant supply and demand for money. In any case your comment has no bearing on what we were discussing, counterparties.

  25. Gravatar of lxdr1f7 lxdr1f7
    2. March 2014 at 15:05

    “if you knew how much stimulus central banks would push, would you have guessed that we would be in a disinflationary environment characterized by continuous deflation pulses?”

    Counterparties are relevant to this discussion because the current counterparties don’t effectively employ the stimulus into the system. Different counterparties would utilize the stimulus funds differently and the result would be different in terms of inflation and ngdp. How and if money is used is vital.

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