Paul Krugman is dismayed that the conservatives he pays no attention to are not saying the things he’d like them to say if he did listen to what they said

Or something like that.  As we all know, Krugman likes to brag that he doesn’t read any conservatives, as they have nothing interesting to say.  But that doesn’t prevent him from being dismayed by their lack of intellectual honesty. Here Krugman discusses Allan Meltzer’s repeated warnings that inflation is coming:

Tests in economics don’t get more decisive; this is where you’re supposed to say, “OK, I was wrong, and here’s why”.

Not a chance. And the thing is, Meltzer isn’t alone. Can you think of any prominent figure on that side of the debate who has been willing to modify his beliefs in the face of overwhelming evidence?

Here’s Steve Williamson, who changed his mind about inflation:

Back in days of yore, my concern was that we could indeed get higher inflation. How? I had thought that the Fed had the ability to control inflation, but when push came to shove, they wouldn’t do it. Once people caught on to that idea, we could get on a high-inflation path that was self-sustaining. Of course, since I said that, I’ve continued to work on these problems, and stuff has been happening. In particular, we’re not seeing that high-inflation path.

And here’s an article discussing Arthur Laffer:

And in June of 2009, he penned an op-ed warning excessive quantitative easing would inevitably lead to higher inflation and interest rates.

…we haven’t ever seen anything like this in the U.S. To date what’s happened is potentially far more inflationary than were the monetary policies of the 1970s, when the prime interest rate peaked at 21.5% and inflation peaked in the low double digits …Gold prices went from $35 per ounce to $850 per ounce, and the dollar collapsed on the foreign exchanges. It wasn’t a pretty picture.

Obviously, nothing like that happened.

In an interview with Business Insider from his office in Tennessee, Laffer admitted that he was wrong. The old maxim that dictates increasing the availability of cash through lower interest rates will lead to higher prices, he said, may need to be reexamined.

I frequently meet conservatives who have changed their minds, and I frequently meet conservatives who have not changed their minds.  I also meet Keynesians who didn’t change their minds about market monetarism after the famous 2013 “test.”  In any case, don’t take this as a jab at Krugman; given that he doesn’t read any conservatives he can hardly be faulted for not knowing what they are saying.

Enough fun and games, now let’s focus on the much more important question: whither monetarism?  (That’s the first time in my life I typed the word ‘whither’ and probably the last.  I just don’t like that word.)

There have been lots of good critiques of Meltzer’s op ed, including friendly fire from monetarists like Marcus Nunes and Bob McTeer.  Brad DeLong provides some not so friendly fire.  I’d like to focus on what I see as the big problems, and the resulting implications for monetarism:

1.  Meltzer confuses the monetary base with high-powered money.  High-powered money is base money with a lower yield that T-bills.  The recent injections of money by the Fed are mostly interest-bearing reserves, and hence are not high-powered money.  So contrary to the claim of Meltzer, the Fed is not monetizing the debt.  And that means that all previous cases of monetizing the debt have no bearing on the eventually outcome of QE1, QE2, and QE3.

2.  There is no such thing as long and variable lags.  Monetary policy affects assets prices like stocks and TIPS spreads immediately.  Effects on the broader economy show up very quickly after asset prices change.  A huge literature on long and variable lags grew up based on a fundamental misconception, that interest rates and/or the money supply are useful indicators of the stance of monetary policy. They aren’t.

3.  The low interest rates of recent years represent the effects of a tight money policy by the Fed, not easy money (as Meltzer seems to imply in the op ed.) Milton Friedman understood this.  So did Ben Bernanke (back in 2003, not today.)

On the third point, Keynesians make the same mistake.  Here’s Menzie Chinn discussing the fiscal multiplier:

When output is contracting due to some aggregate demand shock, there is likely to be a lot of slack, such that a Keynesian model is more apt than a Classical model. In addition, monetary policy is likely to be accommodative.

Chinn, Meltzer and about 99% of other economists seem to believe that monetary policy has been accommodative since about 2008.  Ben Bernanke agrees.  But the Ben Bernanke of 2003 would not have agreed:

The imperfect reliability of money growth as an indicator of monetary policy is unfortunate, because we don’t really have anything satisfactory to replace it. As emphasized by Friedman (in his eleventh proposition) and by Allan Meltzer, nominal interest rates are not good indicators of the stance of policy, as a high nominal interest rate can indicate either monetary tightness or ease, depending on the state of inflation expectations. Indeed, confusing low nominal interest rates with monetary ease was the source of major problems in the 1930s, and it has perhaps been a problem in Japan in recent years as well. The real short-term interest rate, another candidate measure of policy stance, is also imperfect, because it mixes monetary and real influences, such as the rate of productivity growth.   .   .   .

Ultimately, it appears, one can check to see if an economy has a stable monetary background only by looking at macroeconomic indicators such as nominal GDP growth and inflation. On this criterion it appears that modern central bankers have taken Milton Friedman’s advice to heart.

I believe old monetarism is effectively dead. The monetarists (including Allan Meltzer) made enormous contributions to our understanding of monetary policy. But their model has reached a dead end. I implore bright young grad students with an interest in monetary economics to take a look at market monetarism. Since 2008 we’ve been more accurate in our predictions than any other school of thought. We have a coherent model that incorporates rational expectations and efficient markets. Our views on policy lags do not conflict with market indicators. We understand the difference between the monetary base and high-powered money. We understand the difference between temporary and permanent monetary injections. We understand the importance of interest on reserves. We have a model that can explain market responses to QE and forward guidance surprises. We can explain the price level, not (like NKs) merely the rate of inflation.

What we don’t have is jobs at elite institutions.  So if you are a bright young academic you have a golden opportunity to lead the movement—to become the next Milton Friedman.  What’s stopping you?

We see one article after another demonstrate that the stylized facts simply don’t support NK sticky price models. This AER paper by Bils, Klenow and Malin is a recent example.  On the other hand models that rely on NGDP shocks and sticky wages are very unlikely to be falsified.  Don’t you want to base your research agenda on a rock solid assumption?  NGDP shocks cause demand-side business cycles.  Period.  End of story.


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57 Responses to “Paul Krugman is dismayed that the conservatives he pays no attention to are not saying the things he’d like them to say if he did listen to what they said”

  1. Gravatar of Edward Edward
    9. May 2014 at 12:52

    Scott,

    You ARE the next Milton Friedman!

  2. Gravatar of Tom Brown Tom Brown
    9. May 2014 at 13:16

    Mark A. Sadowski, O/T: I saw the following today:

    “…borrowing always increases GDP — government or private.”

    with no further evidence presented. What would be the first step in determining the truth or fallacy of that statement?

  3. Gravatar of Dustin Dustin
    9. May 2014 at 14:17

    I don’t quite understand this: “The low interest rates of recent years represent the effects of a tight money policy by the Fed, not easy money”

    Is this meant to say that tight monetary policy in the past required to Fed to lower interest rates in an attempt to reinvigorate the economy because said tight monetary policy dampened the economy… Or that the low interest are the tight monetary policy?

    Something that isn’t apparent to me in all of these analyses of past Fed conduct is what decisions should be made moving forward. Assessing the stance of monetary policy only retrospectively seems all together uninformative with respect to guiding decisions about what steps to take next. Maybe it’s just me.

  4. Gravatar of Dustin Dustin
    9. May 2014 at 14:34

    Also, there are two terms that I often see used interchangeably ‘easy money’ and easy monetary policy’. To me, These are not synonymous.

    Easy money is a market phenomenon, the demand for money relative to its supply.
    Easy monetary policy is a Fed stance, the willingness of the Fed to expand the supply of money base (or high power money may be a better term).

    It is an important distinction I think because too often policy makers judge the stance of policy with respect to past policy and not against the intended effect of policy.

    An analogy would be a car – I press or release the gas pedal to achieve a certain MPH. If there are suddenly steep uphill and downhill sections of roadway, I cannot judge the appropriate supply of gas to the engine by how far I depress the pedal with respect to how far I press the pedal while navigating flat sections of roadway. Rather, I judge the proper supply of gas by what MPH I desire to achieve.

    The downhills would be ‘easy money’ (there is no control over this external phenomenon), while the willingness to press the pedal would be ‘easy money policy’ (it is a decision).

  5. Gravatar of Tom Brown Tom Brown
    9. May 2014 at 14:55

    Dustin, for an MMist, “easy money” means more high power money relative to demand for high power money. MMists also like to fold expectations in there… so temporary changes in the high power money supply do nothing. Interest rates don’t really fit in the picture. That’s my interpretation anyway!… so of your choices, I’m pretty sure low interest rates do not reflect a “tight money policy.” It’s more likely that low interest rates have resulted from half measures to ease the money supply, which perhaps drove down rates but did not increase the supply adequately relative to demand (I’m out on a limb of speculation there a bit… so it’ll be fascinating to see how far off I am). :D

  6. Gravatar of Tom Brown Tom Brown
    9. May 2014 at 14:56

    I should have written this instead:

    “so of your choices, I’m pretty sure low interest rates are not in themselves a “tight money policy.””

  7. Gravatar of Tom Brown Tom Brown
    9. May 2014 at 15:02

    And regarding “tight money” vs “tight money policy” … well since Sumner here is referring to high power money, the central bank has complete control over its balance sheet and the IOR rate: so it thus has complete control over the supply of high power money, and in that way can adjust the supply of it relative to demand for it.

    So in your analogy, perhaps it’s better to assign demand for high power money the role of the hills. That would then leave “tight money” and “tight money policy” as basically the same thing again. Again: I’m guessing here, so don’t take my response too seriously.

  8. Gravatar of Dustin Dustin
    9. May 2014 at 15:48

    Tom,

    I suspect your interpretation is very close. And to be clear – we are talking the FFR or a long term nominal rate?

    I agree that hills = demand, gas pedal = supply, the resulting speed = balance of the 2 (NGDPLT)

  9. Gravatar of Major-Freedom Major-Freedom
    9. May 2014 at 15:57

    “The low interest rates of recent years represent the effects of a tight money policy by the Fed, not easy money”

    Once again, you contradicted yourself. We’re being told that level of interest rate changes can be caused by either the liquidity effect or the inflationary, hot potato effect, where we cannot be certain of which one, and then we’re told that no, it’s definitely caused by “tight money.

  10. Gravatar of benjamin cole benjamin cole
    9. May 2014 at 15:58

    Excellent blogging. A cavil: I think QE monetizes debt but by paying IOER the Fed somewhat neutralized the reserves and banks did not want lend anyway.
    From the point of view of the taxpayer, the national debt has been monetized, if the Fed maintains its balance sheet (which it says, wrongly) it will not do. So the debt has been temporarily monetized.

  11. Gravatar of Major-Freedom Major-Freedom
    9. May 2014 at 16:10

    “There is no such thing as long and variable lags. Monetary policy affects assets prices like stocks and TIPS spreads immediately. Effects on the broader economy show up very quickly after asset prices change. A huge literature on long and variable lags grew up based on a fundamental misconception, that interest rates and/or the money supply are useful indicators of the stance of monetary policy. They aren’t.”

    This is all incorrect, both the initial claim and the supposed justification for it.

    There is indeed such thing as long and variable lags. The prices of goods do not immediately affect stock prices or other asset prices. Prices are set according to supply and demand. Demand is demand from all individuals who are able and willing to buy the asset. The demand is not just from those who receive newly created money first. Demand is also from those who receive the new money after some time has passed whereby nominal incomes of those late receivers finally rises due to the increased spending from the initial receivers.

    Of course, in reality things are a little more complex than a single group of “initial” receivers and single group of “late” receivers of money. There are many more groups of people, each of which wait just a little longer than the group prior in terms of nominal income growth. This is rather easy to understand. When Bthe Fed inflates, it is not the case that the reserves the Fed prints land equally in everyone’s bank accounts. The primary dealet

  12. Gravatar of Jason Jason
    9. May 2014 at 16:12

    “We have a coherent model that incorporates rational expectations and efficient markets.”

    Anyone else find this circular? Efficient markets requires that agents have rational expectations which is defined as expectations that are consistent with the model which incorporates efficient markets and rational expectations??!

  13. Gravatar of Mark A. Sadowski Mark A. Sadowski
    9. May 2014 at 16:19

    Scott,
    Off Topic.

    Antonio Fatas tries to make the Euro Area look good by comparison with other European countries by using resident rather than national working-age population, and by using RGDP rather than NGDP.

    http://fatasmihov.blogspot.com/2014/05/the-uk-makes-euro-area-look-good.html

    May 8, 2014

    The UK makes the Euro area look good.
    By Antonio Fatas

    “…When comparing performance across countries it is quite common to use a variety of indicators: GDP growth, unemployment, productivity,… They all tend to move together but they can sometimes provide a quite different view of the economic performance during a number of years. I decided to look at GDP growth but adjusting is by changes in demographics: GDP divided by working-age population (between 15 and 64 years old, as it is measured by the OECD). What I do is to compare the 2013 number with the 2007 number (which I use as the beginning of the crisis).

    [Graph]

    What I find interesting (and surprising) is the similarities across countries, despite the differences in policies. With the exception of Greece (and possibly Italy) all the other countries are very close to each other. The three countries that originally opted out of the Euro do not look too different from the Euro countries. Yes, Sweden has done great but so has Germany. The UK has grown less than the Euro area (of 18 countries), less than France or the Netherlands and at a rate which is very similar to that of Spain. Same for Denmark. Among the small countries that are still outside of the Euro area some have done quite well, others not so well and, surprisingly, some of these countries manage to do well with a currency pegged to the Euro (Bulgaria and Latvia).

    [Note on data: let me stress that I am using GDP divided by working-age population and this makes a difference for some economies. For example, Latvia's GDP in 2013 is still lower than in 2007 but its working-age population has been declining sharply over these years. Dividing by working-age population allows us to remove potential demographic changes during these years.]…”

    Fatas is doing more than just using working-age population data, he’s using *resident* working-age population data. This matters because although there was a large decline in the working-age population of Latvia, there was an even larger decline in the resident working-age population of Latvia since about 85,000 working-age Latvians, or over one in 20, moved out of the country to look for work between 2007 and 2013.

    Using *national* working-age rather than resident working-age population and including EFTA and EU countries that Fatas left out one gets the following 2013 real GDP (RGDP) per working-age population indexed to 100 in 2007.

    1.Poland 119.0
    2.Romania 111.4
    3.Macedonia 111.1
    4.Bulgaria 110.9
    5.Slovakia 110.8
    6.Lithuania 110.4
    7.Malta 108.7
    8.Germany 104.4
    9.Sweden 103.8
    10.Czech Republic 103.3
    11.Austria 101.7
    12.Latvia 101.7
    13.Switzerland 101.5
    14.Estonia 100.9
    15.France 99.9
    16.Belgium 98.2
    17.Hungary 98.1
    18.Euro Area 98.0
    19.Netherlands 97.5
    20.Norway 96.3
    21.United Kingdom 95.8
    22.Finland 95.6
    23.Denmark 95.4
    24.Portugal 95.3
    25.Iceland 95.0
    26.Croatia 94.5
    27.Spain 94.0
    28.Slovenia 93.7
    29.Ireland 93.0
    30.Italy 90.9
    31.Luxembourg 87.1
    32.Cyprus 82.2
    33.Greece 79.7

    Now Latvia’s performance doesn’t look so great, and Hungary, which has a floating exchange rate, outperforms the Euro Area as a whole. And we also see why Fatas excluded Poland, Romania, Macedonia and the Czech Republic, each of which have a floating exchange rate policy, and consequently their monetary policy is independent from the Euro Area’s. They all outperform the Euro Area average.

    But since the proper way to judge the effectiveness of policies meant to impact aggregate demand is to actually look at aggregate demand, a better measure is nominal GDP (NGDP). So here’s 2013 NGDP per national working-age population indexed to 100 in 2007.

    1.Romania 159.4
    2.Bulgaria 138.3
    3.Poland 137.7
    4.Iceland 132.9
    5.Lithuania 131.5
    6.Macedonia 127.8
    7.Malta 127.4
    8.Latvia 124.2
    9.Norway 120.8
    10.Estonia 119.4
    11.Hungary 119.1
    12.Slovakia 117.1
    13.Sweden 113.8
    14.Germany 113.0
    15.Austria 112.4
    16.United Kingdom 109.8
    17.Denmark 109.0
    18.Belgium 109.0
    19.Czech Republic 108.7
    20.France 108.4
    21.Croatia 108.4
    22.Finland 108.1
    23.Euro Area 105.9
    24.Luxembourg 105.2
    25.Switzerland 104.7
    26.Netherlands 104.4
    27.Slovenia 102.1
    28.Portugal 100.0
    29.Italy 99.7
    30.Spain 97.0
    31.Cyprus 89.8
    32.Ireland 87.0
    33.Greece 85.2

    Now Iceland, Norway, the UK and Croatia, which also all have floating exchange rates, outperform the Euro Area as a whole. In fact *all* of the countries with floating exchanges rates outperform the Euro Area average with the sole exception of Switzerland, which effectively has a one-sided peg to the euro (essentially it only eases if the ECB does).

    What is the chance that all of these countries would have outperformed the Euro Area average if they had instead chosen to peg to the euro or had joined the euro?

  14. Gravatar of ssumner ssumner
    9. May 2014 at 16:34

    Dustin, Interest rates are set in the market. Tight money produced very low NGDP growth which led to low nominal interest rates.

    Ben, Since the Fed is exchanging interest bearing reserves for T-bills, they haven’t really monetized the debt. To do so, you’d have to exchange non-interest-bearing base money for interest-bearing debt. Even if the ERs stay in circulation forever, they would need to pay higher interest rates over time.

    Mark, Interesting, the bottom of the list is completely dominated by eurozone members.

  15. Gravatar of Major-Freedom Major-Freedom
    9. May 2014 at 16:37

    “There is no such thing as long and variable lags. Monetary policy affects assets prices like stocks and TIPS spreads immediately. Effects on the broader economy show up very quickly after asset prices change. A huge literature on long and variable lags grew up based on a fundamental misconception, that interest rates and/or the money supply are useful indicators of the stance of monetary policy. They aren’t.”

    This is all incorrect, both the initial claim and the supposed justification for it.

    There is indeed such thing as long and variable lags. The prices of goods do not immediately affect stock prices or other asset prices. Prices are set according to supply and demand. Demand is demand from all individuals who are able and willing to buy the asset. The demand is not just from those who receive newly created money first. Demand is also from those who receive the new money after some time has passed whereby nominal incomes of those late receivers finally rises due to the increased spending from the initial receivers.

    Of course, in reality things are a little more complex than a single group of “initial” receivers and single group of “late” receivers of money. There are many more groups of people, each of which wait just a little longer than the group prior in terms of nominal income growth. This is rather easy to understand. When Bthe Fed inflates, it is not the case that the reserves the Fed prints land equally in everyone’s bank accounts. The primary dealers experience a rise in cash first, then those the primary dealers buy from, and then those that second group buys from, and so on. This is the long and variable lags of nominal income growth, and thus long and variable lags of demand, and thus long and variable lags to supply and demand, and thus long and variable lags to prices.

    The initial jump in prices you observe after Fed announcements is merely the effect from the demand that exists given not everyone’s income has risen yet due to that inflation. As more and more people’s incomes have risen, the demand for assets and goods is then affected to that extent as well.

    In other words,

    Everyone who offers a demand for assets is affecting the prices of those assets, and because nominal incomes and thus nominal incomes undergo long and variable lags, so do asset prices.

    It is why you don’t see step patterns in asset prices. It is why you don’t see vertical sections due to the effect of Fed announcements, and why don’t see horizontal levels between Fed announcements. What we do see are more gradual changes over time, as more and more people experience a change in their income over time as the initial inflation spreads from person to person over time.

    Why didn’t asset prices rise and then remained on a plateau immediately after the Fed announced $85 billion a month QE all those months ago? It’s because stock prices are also based on corporate earnings, and corporate earnings do not all instantly rise at the same time when the Fed buys treasuries from the banks with its OMOs.

    Now, as regards to the foundation of long and variable lags, in my view it is the logic of the inflationary process. It is impossible for everyone to spend more than what they have, and what they have is a long and variable outcome of past inflation. Thus what they spend is subject to long and variable lags as well.

    The mainstream view has to do with naive reasoning from historical trends. Even the Fed assumes as given that the greater economy is effected by inflation usually with a 12-18 month time lag. The general economic conditions is what determines asset prices at any given time.

    Or going the other way…if we imagine that all but the primary dealers immediately reducing their nominal demand for assets to zero, then it is almost certain that asset prices would collapse. And yet if long and variable lags is false, this should not occur, because asset prices are effected by the inflation, not the incomes of those whose incomes are subject to long and variable lags.

    In other words, if any portion of the nominal demand for assets is a function of long and variable lags, (which we know is true), then it is a logical necessity that prices of assets are subject to long and variable lags.

    Milton Friedman accepted the theory of long and variable lags.

  16. Gravatar of Major-Freedom Major-Freedom
    9. May 2014 at 16:41

    “Dustin, Interest rates are set in the market. Tight money produced very low NGDP growth”

    Another contradiction.

    By claiming that tight money did this or that to NGDP, you are implying that tight money is best defined in terms of money supply or some other non-NGDP metric. And yet you are also on record as insisting that tight money and loose money are only relevant as defined in terms of NGDP.

    So what is it? Contradiction, or tautology?

  17. Gravatar of Mark A. Sadowski Mark A. Sadowski
    9. May 2014 at 17:21

    Scott,
    Off Topic.

    Mian and Sufi demonstrate why Microeconomists should stick to what they know best.

    http://houseofdebt.org/2014/05/08/chicago-and-the-causes-of-the-great-recession.html

    May 8, 2014

    Chicago and the Causes of the Great Recession
    By Atif Mian and Amir Sufi

    “…This generates a very strong relationship between debt growth and the collapse in spending, as can be seen in this scatter plot. Each dot is a zip code, and it shows that zip codes that had the largest increase in mortgage debt during the housing boom were exactly the zip codes that saw the largest collapse in spending on new autos during the bust:

    [Graph]

    We have focused on Chicago just to give one example. The patterns we show here are robust across the country. It is pretty clear that the debt boom and housing collapse are central to explaining the Great Recession (we detail more of the evidence in our new book, now available on Amazon). Can other theories of the cause of the recession explain these patterns? Did neighborhoods on the south and west side of Chicago cut spending because of the collapse of Lehman Brothers? Did these areas suffer because of policy uncertainty? Because monetary policy was too tight? Perhaps these problems exacerbated the recession. But the central role of excessive debt and the housing collapse are immediately obvious in the data.”

    What if we repeated the exercise by looking at international data involving countries with different monetary policies? Would household sector leverage growth in 2002-2006 be correlated with a decline in real household sector consumption expenditures in 2006-2009?

    The best source for such data is the OECD. Household sector leverage can be calculated as the ratio of household sector loan liabilities to household sector Gross Adjusted Disposable Income (GADI) which is equivalent to BEA Disposable Personal Income (DPI). Household Sector Final Consumption Expenditures (FCE) is equivalent to BEA Personal Consumption Expenditures (PCE). To convert it to real consumption it can be adjusted by the Household Sector FCE Deflator.

    Unfortunately this data is only available for ten OECD members with independent monetary policies. The OECD also has this data for 12 out of the 18 Euro Area members (all but Cyprus, Estonia, Latvia, Luxembourg, Malta and Slovenia), so I calculated a weighted averaged for those 12 countries for the Euro Area average.

    Here is the household sector leverage data in percent.

    Country—–2002-2006-Change
    1.Czech Rep-15.8–30.7–14.9
    2.Euro Area-66.1–77.9–11.8
    3.Hungary—15.7–36.5–20.7
    4.Japan—–90.8–88.1-(-2.7)
    5.Korea—-106.0-111.2—5.1
    6.Norway—-97.1-129.0–31.9
    7.Poland—-15.3–23.7—8.4
    8.Sweden—-77.4–99.9–22.4
    9.Switz.—156.2-167.4–11.2
    10.U.K.—–99.8-123.1–23.4
    11.U.S.—–94.3-116.9–22.6

    Here is the change in leverage with the change in real Household FCE from 2006-2009.

    Country–Leverage–RFCE
    1.Czech Rep-14.9—7.4
    2.Euro Area-11.8—0.9
    3.Hungary—20.7-(-6.3)
    4.Japan—(-2.7)-(-0.7)
    5.Korea——5.1—6.4
    6.Norway—-31.9—7.4
    7.Poland—–8.4–13.2
    8.Sweden—-22.4—3.4
    9.Switz.—-11.2—5.3
    10.U.K.—–23.4-(-1.9)
    11.U.S.—–22.6—0.3
    Average—–15.4—3.2

    When one regresses the change in real Household FCE on the change in leverage ratio the R-squared value is 0.0211 meaning that only 2.1% of the variation Household real FCE change can be explained by the change in the leverage ratio. In other words there is almost zero correlation when one considers geographic regions which have differing monetary policies.

    The only countries which had above everage leverage growth in 2002-2006 combined with slower than average real consumption growth in 2006-2009 are in fact the US, the UK and Hungary. Norway and Sweden had above average leverage growth growth in 2002-2006 and above average real consumption growth in 2006-2009, and the Euro Area and Japan had below average leverage growth in 2002-2006 and below average real consumption growth in 2006-2009.

  18. Gravatar of rob rob
    9. May 2014 at 17:42

    The main thing standing between market monetarism and widely held acceptance is the math. Without formal mathematical models to point to, critics will always think of it as primitive. That said, clearly it is not easy to create a mathematical model of market monetarist beliefs or else someone would have made one. Maybe it is a good candidate for a computer simulated model?
    I find this to be a sad part of the modern economics, you can have the logic, you can have the evidence, but few will pay attention to you especially in the lofty heights of the top 7 unless you have the math. Sometimes reality is perhaps too complicated to make a meaningful mathematical expression of every useful theory. Sometimes translating an idea into mathematics sneaks in simplifying assumptions too incongruent with reality, and often it is the case that those using he models become blind to this assumptions. I really don’t have any other explanation for the bizarre belief that monetary policy can be in a situation where it can no longer cause inflation.

  19. Gravatar of Mark A. Sadowski Mark A. Sadowski
    9. May 2014 at 18:06

    Scott,
    Off Topic.

    Paul Gambles argues that QE is bad for the economy because it raises house prices. (Meanwhile Mian and Sufi argue that the economy is driven by house prices and debt and not by monetary policy, so go figure.)

    http://www.cnbc.com/id/101649411

    May 7, 2014

    How QE may be doing more harm than good
    By Paul Gambles

    “…It may even be that QE has actually had a negative effect on employment, recovery and economic activity.

    This is because the only notable effect QE is having is to raise asset prices. If the so-called wealth effect — of higher stock indices and property markets combined with lower interest rates — has failed to generate a sustained rebound in demand for private borrowing, then the higher asset values can start to depress economic activity. Just think of a property market where unclear job or income prospects make consumers nervous about borrowing but house prices keep going up. The higher prices may act as either a deterrent or a bar to market entry, such as when first time buyers are unable to afford to step onto the property ladder…”

    QE does in fact have a strong correlation with certain kinds of asset prices, in particular stock prices. The monetary base Granger causes the S&P 500 and the DJIA at the 5% significance level each. But I’ve conducted Granger causality tests using indices of national house prices at a monthly frequency (e.g. the Case-Shiller 20-City Index) and I can find no sign at all of any correlation.

    However, what I do find is a statistically significant correlation between nominal income and house prices. The BEA has state level nominal personal income data at quarterly frequency, and the FHFA has state level All-Transactions House Price Index data at a quarterly frequency.

    When I regress the year on year change house prices on the year on year change in nominal personal income at the state level it is positively correlated at the 5% significance level.

    The unweighted average of year on year house price changes at the state level is 3.87% in 2013Q4. The unweighted average of year on year nominal personal income changes is 1.47% in 2013Q4. The top eight states in nominal personal income (NPI) growth all have above average growth in the house price index (HPI). The following are year on year changes in percent as of 2013Q4.

    State-NPI-HPI
    1.ND–4.1-11.4
    2.TX–3.3–5.5
    3.OR–3.1–8.4
    4.UT–2.8–8.1
    5.ID–2.2–5.8
    6.WA–2.0–6.5
    7.NV–2.0-20.9

    What I would suggest is that if QE is having any effect at all on house prices, it is through nominal incomes. Which means that Paul Gambles has this amazingly wrong.

  20. Gravatar of Mark A. Sadowski Mark A. Sadowski
    9. May 2014 at 18:09

    “The top eight states in nominal personal income (NPI) growth all have above average growth in the house price index (HPI).”

    should read

    “The top seven states in nominal personal income (NPI) growth all have above average growth in the house price index (HPI).”

  21. Gravatar of Bonnie Bonnie
    9. May 2014 at 18:09

    Edward:

    I agree. Sumner IS the “Friedman” of our time. But referring to him as such probably doesn’t do his ideas justice. Friedman was merely in the ballpark compared to Sumner hitting the triples and home runs. :)

  22. Gravatar of Mark A. Sadowski Mark A. Sadowski
    9. May 2014 at 18:30

    Tom Brown,
    “What would be the first step in determining the truth or fallacy of that statement?”

    The first step is to better define the question. Are we talking nominal or real GDP? I would think it would make much more sense to be talking about nominal.

    What is the time frame? I imagine in the very short run this might be true given the right circumstances. But it’s almost certainly not true over longer periods of time. That’s because leverage is significantly inversely correlated with the velocity of money. So what you will typically find is high leverage levels in countries with very low rate of NGDP growth such as Japan, and relatively low leverage levels in countries with high rates of NGDP growth such as Argentina, Peru or Zimbabwe.

    So the question needs to be better defined first, but I’m fairly confident that no matter how it’s defined a counterexample could be found.

  23. Gravatar of dannyb2b dannyb2b
    9. May 2014 at 19:11

    “a high nominal interest rate can indicate either monetary tightness or ease, depending on the state of inflation expectations.”

    High inflation expectations and a high rate wouldnt be considered easy policy if its cost push inflation?

  24. Gravatar of dannyb2b dannyb2b
    9. May 2014 at 19:23

    I disagree that the ngdp growth rate indicates the stance of policy. With the analogy of a 50cc bike and a formula 1 car.

    A formula 1 car can change speed at a much more rapid pace than a 50cc bike. The change in speed is analogous to the change in growth in an economy.

    The level of potential performance of each vehicle used is the stance. Both vehicles can have the same stance of say maximum performance but get very different rates of acceleration because the f1 car is more efficient. Same goes for the central bank it can go easier (higher performance) but not achieve much growth because it is inefficient.

  25. Gravatar of Ralph Musgrave Ralph Musgrave
    9. May 2014 at 21:43

    Scot says, “Monetary policy affects assets prices like stocks and TIPS spreads immediately.” Not too clever: boosting the wealth of the wealthy does not result in a big or quick increase in spending or demand.

    In contrast, Keynsianism involves, amongst other things, feeding money into Main Street pockets. The effect on demand will be bigger and quicker, I’d guess.

  26. Gravatar of Kevin Erdmann Kevin Erdmann
    9. May 2014 at 22:47

    Mark, you owe me 5 minutes of my life back for linking to that Paul Gambles piece. The singularity will have arrived the day that AI can attract a human following by writing an article that incoherent.

  27. Gravatar of Lorenzo from Oz Lorenzo from Oz
    9. May 2014 at 22:49

    Ralph Musgrave: only if the central bank lets that happen. Remember the Sumner Critique.

    Scott: One sells Market Monetarism to the Friedman-inclined as completing Friedman (which is why his policy recommendations were heading in that direction late in life).
    http://skepticlawyer.com.au/2013/04/15/check-your-expectations-3-milton-friedman-not-going-far-enough/

  28. Gravatar of Lorenzo from Oz Lorenzo from Oz
    9. May 2014 at 22:52

    Mark: Your NGDP figures explain why Malta, when I was there a few years ago, seem remarkably unaffected by the Eurozone crisis.

  29. Gravatar of Ralph Musgrave Ralph Musgrave
    10. May 2014 at 03:15

    Lorenzo,

    Congress is more the obstruction than the Fed. Assuming Congress OK’d more fiscal stimulus, and assuming the Fed thought stimulus was required, it wouldn’t obstruct it. It might even ASSIST it by printing money and purchasing the extra debt: i.e. doing some QE (or more QE than it’s already doing).

  30. Gravatar of Willy2 Willy2
    10. May 2014 at 03:28

    - Meltzer should define what he means with “inflation”. If he means higher interest rates then he’s mistaken.
    - We already have inflation, in the bond & stock market since 2009. What do you mean “no inflation” ?
    - Rising interest rates are actually DEFLATIONARY because it lowers the value of credit (=deflation)
    - Rates are NOT driven by inflation. If that was the case then we would have seen rates rise along side with oil prices (e.g. from 2001 up to 2008).
    - Monetarism don’t understand the world of inflation as well. The monetarists belive that QE should have been followed by higher rates and it didn’t. But the monetarists are right when they say that increasing the money & credit supply leads to some sort of inflation somewhere in the system. Stock & bond market(s) or real estate market(s). But it requires rising (asset) prices to get the money & credit flowing.

  31. Gravatar of TravisV TravisV
    10. May 2014 at 09:24

    Brad DeLong wrote an interesting commentary on 2007 and 2008 here:

    http://equitablegrowth.org/2014/05/10/tim-geithner-stressed-saturday-focus-may-10-2014

  32. Gravatar of ssumner ssumner
    10. May 2014 at 09:26

    Mark, The Mian and Sufi quotation seems to be an example of the fallacy of composition. And the international data is a good point of comparison.

    rob, You said;

    “That said, clearly it is not easy to create a mathematical model of market monetarist beliefs or else someone would have made one.”

    Actually it is easy. If I knew how to do mathematical modeling I could do one easily. The model would involve sticky wages and NGDP/W shocks affecting employment. Monetary policy would drive NGDP. The real problem is that mainstream macroeconomists would not like the model.

    Bonnie and Edward, I appreciate the kind words but the truth is that Friedman is far above me in all aspects of economics.

    Danny, A better analogy is steering. NGDP growth expectations are analogous to the setting of a steering wheel on a ship.

    Ralph, You said;

    “Not too clever: boosting the wealth of the wealthy does not result in a big or quick increase in spending or demand.”

    You are confusing spending with “consumption.” Saving and investment are also spending.

    Lorenzo, I have an article coming out next year on how (late in his life) Friedman was heading toward market monetarism.

    Ralph, The Fed is tapering, they obviously don’t think “more stimulus is required.”

    Willy, In economics the term ‘inflation’ refers to goods and services prices, not stock and bond prices.

    And you are wrong–I did not predict higher inflation.

  33. Gravatar of Mike Sax Mike Sax
    10. May 2014 at 09:48

    “As we all know, Krugman likes to brag that he doesn’t read any conservatives, as they have nothing interesting to say”

    I can’t speak for Krugman but I find this kind of snark tremendously interesting so for him to say that is clearly wrong. I think he might have said this once-and you’ve since referred to it no less than 87,000 times-a conservative estimate. I don’t know that saying it once means he ‘likes saying it.’ You on the other hand clearly like saying he says he doesn’t read conservatives.

    Is it your hope he’s going to breakdown under your snark to say “I’ve seen the light. I read conservatives and I like it. Sumner’s constant snark has made me see this.”

    SW claims he’s not a conservative though I admit that his claim sounds strange. I guess to the extent that being a conservative means Krugman bashing and little else he is the conservative he pretends not to be.

    Politically though SW says he supports Obama and may even kind of support fiscal stimulus-or at least he thinks an increase in public debt could be helpful right now, though admittedly for very complicated reasons.

    On the other hand no question he’s on the ‘Freshwater’ side of the divide-though he claims that such terms are meaningless-but then which Freshwater economist would say they actually are meaningful? Logically if your a Freshwater economist you’re not even going to credit ‘Saltwater’ economists as being economists you’re going to say there are just economists and charlatans who claim to be economists and call themselves Saltwaters.

  34. Gravatar of Tom Brown Tom Brown
    10. May 2014 at 09:51

    Dustin, I was talking about FFR. However, Sumner has responded to you directly since then, so I’d go with his response.

    Mark, thanks. In terms of counterexamples, I was pretty sure one could be found as well… I’m not sure what was intended by the author of that statement. Perhaps it’s not worth pursuing, but when I read it, my first thought was “I bet Mark Sadowski could find a counterexample”… but I was more interested in where you might turn first to find one. Thanks for your response. I hadn’t considered all the qualifications you bring up.

  35. Gravatar of Tom Brown Tom Brown
    10. May 2014 at 10:05

    Mark, “Are we talking nominal or real GDP?” … as you taught me to think, I’m also assuming nominal. I don’t know what the author of that meant.

    Re: time frame… no clue what the author meant (the author was just a random commentator BTW: one that annoys me by making blanket statements like that with no evidence).

  36. Gravatar of Mike Sax Mike Sax
    10. May 2014 at 10:09

    Give Laffer credit but even now his original warnings sound laughably shrill. The trouble with 2013 is many still don’t interpret that year as you do-it’s not widely believed to be a market monetarist victory outside of market monetarist circles.

  37. Gravatar of Tom Brown Tom Brown
    10. May 2014 at 10:32

    Scott, I can see why there might be some confusion about “high powered money” at least for us amateurs (perhaps no excuse for Meltzer), looking in the glossary of Mishkin’s 7th edition (I understand this is your favorite intermediate text on money as well as Mark’s?) we find:

    high-powered money The monetary base.

    monetary base The sum of the Fed’s monetary liabilities (currency in circulation and reserves) and the U.S. Treasury’s monetary liabilities (Treasury currency in circu- lation, primarily coins)

    Nothing in there about a yield lower than T-bills… yet when that was written, surely some nations somewhere had an IOR rate > 0? Or no?

  38. Gravatar of flow5 flow5
    10. May 2014 at 13:21

    Money supply aren’t useful indicators of the stance of monetary policy? Tripe. Even Alan Greenspan pontificated “The historical relationships between money and income, and between money and the price level have largely broken down”

    Dead wrong. Nothing has changed in 100 years. Roc’s in MVt = roc’s in nominal-gDp.

    And it’s always been the case that “Monetary policy affects assets prices like stocks and TIPS spreads immediately”.

    You don’t know what your talking about. You don’t know how to forecast nominal-gDp growth.

  39. Gravatar of flow5 flow5
    10. May 2014 at 13:26

    “The scientific method is a body of techniques for investigating phenomena, acquiring new knowledge, or correcting and integrating previous knowledge. To be termed scientific, a method of inquiry must be based on empirical and measurable evidence subject to specific principles of reasoning” – Wikipedia

    Scientific evidence is evidence (proof), which serves to either support or counter a scientific theory or hypothesis. Such evidence is expected to be empirical evidence and in accordance with scientific method” – Wikipedia

    “a method or procedure that has characterized natural science since the 17th century, consisting in systematic observation, measurement, and experiment, and the formulation, testing, and modification of hypotheses” – Wikipedia

    Monetary policy objectives should be formulated in terms of desired rates-of-change (roc’s), in monetary flows [ M*Vt ] relative to roc’s in real-gDp [ Y ]. Roc’s in nominal-gDp [ P*Y ] can serve as a proxy figure for roc’s in all transactions [ P*T ]. Roc’s in real-gDp have to be used, of course, as a policy standard.

  40. Gravatar of ThomasH ThomasH
    10. May 2014 at 14:30

    “Chinn, Meltzer and about 99% of other economists seem to believe that monetary policy has been accommodative since about 2008″

    But these 99% did not criticize QE or worry about inflation being generated. Perhaps they just assumed the Fed would be politically constrained from using unconventional policies and if so were they not correct in that?

  41. Gravatar of Larry Larry
    10. May 2014 at 22:49

    Time to shift focus from BB to JY. BB needs some time to reset…

  42. Gravatar of Willy2 Willy2
    11. May 2014 at 00:44

    Scott,

    - As long as wage rises are below (official) (price) inflation we won’t see high(er) inflation. And that has been happening since 1981 in both the US & Europe.

  43. Gravatar of Ralph Musgrave Ralph Musgrave
    11. May 2014 at 03:03

    Scott,

    Let’s run thru the argument again. You said “Monetary policy affects assets prices like stocks and TIPS..” Quite right, but my answer (above) was that “boosting the wealth of the wealthy does not result in a big or quick increase in spending or demand….In contrast, Keynsianism involves, amongst other things, feeding money into Main Street pockets. The effect on demand will be bigger…”

    Your answer was that “Saving and investment are also spending.” Well, first that’s not true: what we’re talking about here is the Fed printing money and buying privately held assets. The INITIAL effect of that is that sundry individuals get checks from the Fed, which they lodge at their commercial banks, who in turn lodge the money at the Fed. Now if those individuals do nothing with that money (and they’ll tend not to because they are wealthy) then there won’t be much of the “spending” to which you refer.

    Thus the important question is: what form of stimulus (buying the assets of the rich or net spending money into Main Street) brings the quickest and biggest effect on spending. Since the AVERAGE household has a bigger propensity to spend that wealthy households, then seems to me that Keynsianism beats market monetarism.

  44. Gravatar of Mark A. Sadowski Mark A. Sadowski
    11. May 2014 at 06:04

    Krugman on lowflation:

    http://krugman.blogs.nytimes.com/2014/05/10/already-in-the-lowflation-trap/

    “…And remember, above all, that the risks aren’t symmetric. Controlling inflation may be painful, but we do know how to do it. Exiting deflation or lowflation is really, really hard, which is why you never want to go there.”

    I’m just old enought to think that if Krugman had been around in the 1970s he would have been saying:

    “…And remember, above all, that the risks aren’t symmetric. Exiting deflation may be difficult, but we do know how to do it. Controlling high inflation or stagflation is really, really painful, which is why you never want to go there.”

  45. Gravatar of Mark A. Sadowski Mark A. Sadowski
    11. May 2014 at 09:54

    Scott,
    Off Topic.

    Mian and Sufi responded to my comment at House of Debt:

    http://houseofdebt.org/2014/05/08/chicago-and-the-causes-of-the-great-recession.html

    “There is already serious academic research on this question, and it is pretty definitive. We describe it in our book.

    [http://www.imf.org/external/pubs/ft/survey/so/2012/res041012b.htm]
    [http://econpapers.repec.org/paper/fmgfmgdps/dp175.htm]
    [http://www.frbsf.org/economic-research/publications/economic-letter/2010/january/global-household-leverage-house-prices-consumption/]

    And the long history:

    [http://www.frbsf.org/economic-research/files/wp11-27bk.pdf]

    Elevated levels of private debt are associated with more severe recessions. It is one of the most robust empirical findings in all of macroeconomics.”

    ———————————————————–

    I respond in comments:

    ————————————————————

    Levels of private debt can explain the geographical distribution of the effects of debt-deflation recessions if one controls for monetary policy. But Irving Fisher, the author of the debt-deflation theory of depressions, assigned a pivotal role to monetary policy in causing such recessions and in ameliorating, or preventing them.

    First let’s take a look at some of the supposed empirical evidence presented against this claim.

    1) Jorda, Schularick and Taylor (2012)
    JST examine 67 cases of systemic financial recessions. Of these 50 occured under a gold standard regime. Ten occured in the most recent recession with six of the countries affected either members of the Euro Area or pegged to the euro (Denmark). (The only exceptions are Sweden, Switzerland, the UK, the US.) Of the remaining seven systemic financial recessions, all but Australia (1989) and Japan (1997) involved a fixed exchange rate regime (and it’s also now known that Australia’s recession was largely allowed to occur, in order to achieve significant disinflation). Thus only six out of the 67 systemic financial recessions JST look at involved flexible exchange rate regimes, and consequently occured under circumstances in which monetary policy was totally free to prevent or respond to the recession.

    2) IMF: “Dealing With Household Debt” (2012)
    Figure 3.2 was one of the two things that inspired my first comment. (The other was Figure 4 from Glick and Lansing.) There are 36 countries in the regression and the time period almost perfectly matches what I did above, except that the IMF look at the change in real consumption through 2010. But 14 of these countries were in the Euro Area, and 4 more were pegged to the euro. Thus 18, or half of the observations, involved countries that had the exact same monetary policy.

    One of the whole points of my exercise was to see if the correlation still existed if you replaced the euro members with a single observation. It clearly does not.

    3) Glick and Lansing (2010)
    Figure 4 was the other thing that inspired my exercise. There are 16 countries of which 9 are Euro Area members and one (Denmark) is pegged to the Euro.

    The story is of course the same. Remove the countries in the Euro Area, or pegged to the euro, and replace them with a single Euro Area observation, and the correlation totally vanishes.

    4) Mervyn King (1994)
    Figure 7 has ten countries of which six, or over half, were either part of the European Exchange Rate Mechanism (ERM). Remove those countries and the correlation totally vanishes (and the number of observations becomes ridiculously small).

    An interesting thing about this particular example is that the decline in consumption is calculated through 1992, which happens to be the very year that three of the countries (Norway, Sweden and the UK) abandoned the ERM and significantly devalued their currencies. This was in fact what turned those economies around.

    In Figure 8 on the following page King repeats the exercise with regional UK data, in a fashion very similar to the Chicago diagram. Pointedly, King states that the reason why he used data from the same country was because it “helps to control for differences in national fiscal and monetary and policy shocks.”

    In the conclusion, while paying Irving Fisher homage as the author of the debt-deflation theory of depressions, King notes:

    “I have argued that debt-deflation should be seen as a real business cycle [RBC] rather than a monetary phenomenon.”

    This is certainly not what Irving Fisher hmself thought, who states on page 346 of “The Debt-Deflation Theory of Great Depressions”:

    http://fraser.stlouisfed.org/docs/meltzer/fisdeb33.pdf

    “On the other hand, if the foregoing analysis is correct, it is always economically possible to stop or prevent such a depression simply by reflating the price level up to the average level at which outstanding debts were contracted by existing debtors and assumed by existing creditors, and then maintaining that level unchanged.

    That the price level is controllable is not only claimed by monetary theorists but has recently been evidenced by two great events: (1) Sweden has now for nearly two years maintained a stable price level, practically always within 2 per cent of the chosen par and usually within 1 per cent. Note Chart IV. (2) The fact that immediate reversal of deflation is easily achieved by the use, or even the prospect of use, of appropriate instrumentalities has just been demonstrated by President Roosevelt. Note Charts VII and VIII.”

    It’s a tragic shame that we’re still debating Irving Fisher’s original point 81 years later.

  46. Gravatar of Mark A. Sadowski Mark A. Sadowski
    11. May 2014 at 10:00

    Here’s a link to the Mervyn King paper:

    http://ces.univ-paris1.fr/membre/Pohttp://houseofdebt.org/2014/05/08/chicago-and-the-causes-of-the-great-recession.htmlncet/Paris1/M2/MasterThesis/Article/M.King_1994.pdf

    (Who knew that the debt-deflation theory of depressions was really RBC?)

  47. Gravatar of aretae aretae
    11. May 2014 at 13:35

    Scott,

    You said:
    “Since 2008 we’ve been more accurate in our predictions than any other school of thought. We have a coherent model that incorporates rational expectations and efficient markets.”

    Where do I go for (a) a defense of the above, and (b) a smart math-geek’s introduction to market monetarism…apart from having read you for those parts (most) of the past 6 years when I was paying attention to the blogosphere.

  48. Gravatar of ssumner ssumner
    11. May 2014 at 14:56

    Mike Sax, If I claim he pays no attention to conservatives I get all sorts of pushback from his defenders. That’s why I say that even he admits it, so that only his most diehard defenders waste my time here. People like . . . you.

    Tom, When the 7th edition came out the base was high-powered money. I would have said the same. But it is no longer.

    Thomas, They were not politically constrained, they simply decided not to go that route.

    Ralph, You are making all sorts of fundamental errors, such as confusing saving with the dishoarding of cash. And investment most certainly is “spending.”

    There is no “propensity to spend” in the Keynesian model, only the propensity to consume, which has no important role to play in 21st century macroeconomics.

    Mark, Good comments. It seems plausible to assume that “elevated levels of debt might be associated with bad monetary policy under certain regimes (say the gold standard) although I have not studied the question. And your empirical work suggests even that hypothesis is doubtful.

    aretae, Paul Krugman has been right about more things than most other economists. We’ve been right about the stuff he was right about, and also the stuff he was wrong about. Now it’s possible someone’s been even righter than us, but I don’t know who it is.

  49. Gravatar of J Mann J Mann
    12. May 2014 at 05:04

    Krugman’s reading of conservatives is deeply wierd.

    This latest bit is right on the heels of his post explaining that conservatives have nothing substantive to say about Piketty, which apparently ignores the dozens and dozens of economists working their way through the argument. (I can’t recall finding anything *non-substantive*, although I hear that DeLong was able to cherry pick a couple quotes.)

    What makes it most bizarre is that Krugman demands that he personally be read with maximum charity — you can never assume that Krugman means what he appears to be saying, unless you spend a few hours reading and synthesizing his other stuff, and even then, you are probably not smart enough to understand what he’s telling you.

  50. Gravatar of Wonks Anonymous Wonks Anonymous
    12. May 2014 at 06:04

    I don’t think Williamson has ever identified as an conservative. My understanding is that he’s a center-left pro-Obama Democrat.

  51. Gravatar of Wonks Anonymous Wonks Anonymous
    12. May 2014 at 06:05

    I just recalled perhaps an even better example of an economist changing their mind on monetary policy recently: Narayana Kocherlakota.

  52. Gravatar of Bob Murphy Bob Murphy
    12. May 2014 at 09:48

    I haven’t read all of the above comments, so perhaps someone already brought this up, but anyway:

    Scott, actually Krugman *was* aware of Laffer’s recantation. Krugman wrote a blog post praising Laffer for it when that Business Insider article came out.

  53. Gravatar of Mark A. Sadowski Mark A. Sadowski
    12. May 2014 at 10:37

    Scott,
    Off Topic.

    Mian and Sufi responded to my latest comment at House of Debt and promptly closed the post for further comments preventing me from carrying on my conversation further.

    Mian and Sufi:
    “I don’t think we are that far apart. We believe that excessive levels of debt combined with a collapse in asset prices instigates severe recessions. If monetary policy reacted very strongly to quickly offset the decline in nominal GDP expectations, then that would definitely mitigate the impact. Perhaps we could even avoid the severe recession altogether. If you read our book, you will see our strong support for aggressive monetary easing in the face of a debt-induced shock to the economy.

    Where we disagree is on the ease with which monetary policy can fight against this dynamic. An incredibly bold and confident central banker could perhaps offset the dramatic decline in demand, but we have never seen such a banker.

    We think your focus on monetary factors alone could be strengthened if you accepted the underlying shock that drives the initial decline in demand. A key reason higher nominal GDP expectations could help is by helping to inflate away severe debt burdens.”

    Mian and Sufi obviously believe that the initial shock came from debt. I emphatically believe this is false. The initial shock came from monetary policy.

    The US yield curve became inverted in August 2006 and stayed that way through May 2007:

    http://research.stlouisfed.org/fred2/graph/?graph_id=75581&category_id=0

    Every US recession since WW II has been preceded by an inverted yield curve in the previous 6-18 months. An inverted yield curve is strictly a matter of monetary policy choice.

    Year on year nominal GDP growth in the US fell from 6.5% in 2006Q1 to 5.3% in 2006Q3 to 4.3% in 2007Q1 to 3.1% in 2008Q1 to 2.7% in 2008Q2:

    http://research.stlouisfed.org/fred2/graph/?graph_id=135856&category_id=0

    Anyone who didn’t see a recession coming simply wasn’t paying attention. (I forecast one based on the inverted yield curve and unit labor cost behavior in a monetary policy term paper I wrote in the spring of 2007.) The only question was how severe it would be and whether it would precipitate a financial crisis, which of course was a real possibility given the housing bubble.

    The weird thing is that at research seminars I’ve heard people joking about the dangers of pricking leveraged asset price bubbles, so this is common knowledge at least in some circles. But evidently Chicago is so steeped in RBC these days that recessions can only have real causes.

    Friedman must be spinning like a top.

  54. Gravatar of Scott Sumner Scott Sumner
    12. May 2014 at 11:39

    J Mann, Good point.

    Wonks, I meant someone who Krugman regards as a conservative (Williamson is obviously in that group.) Indeed I’m not a conservative, but I’d guess Krugman regards me as one.

    Wonks and Bob, Thanks for those tips, his statment was then much worse than I imagined. He knew about all these conservatives changing their minds, and still trashed them for not doing so.

    Mark, Their view is overwelmingly prevalent, so I’d cut them some slack. Very few economists that I have met knew that the growth rate of the monetary base slowed sharply in late 2007 and early 2008. Very few know that the Fed sharply raised real interest rates between July and December 2008. They simply relied on news headlines and common sense–it didn’t seem like tight money.

  55. Gravatar of Bill Bill
    13. May 2014 at 06:55

    In Krugman’s defense:

    http://krugman.blogs.nytimes.com/2014/01/03/in-praise-of-art-laffer/

  56. Gravatar of ssumner ssumner
    13. May 2014 at 07:57

    Bill, In his defense? That makes it much worse.

  57. Gravatar of Mark A. Sadowski Mark A. Sadowski
    16. May 2014 at 06:34

    Scott,
    Mian and Sufi have erased the entire conversation with me that took place on their blog save for my initial comment.

    Disappointing to say the least.

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