Tony Yates has a fairly extensive discussion of his views on market monetarism. Before dissecting on the specifics, a few general comments:
1. It’s hard for an outsider to grasp the nuances of any macro framework. God knows I’ve been criticized for misstating the views of Austrians, MMTers, Keynesians, and many other groups. Yates does better than most.
2. The views expressed here are my own, and as Nick Rowe indicated in the comment section to Yates’s post, market monetarism is a set of views that share a family resemblance (as is true of Keynesianism, Austrianism, etc.) Nick’s comments are well worth reading.
So the following will sound more negative than I actually intended. Let’s go over Yates’s points one at a time. He starts by listing 10 tenets of market monetarism (these are not his views on policy, but rather his interpretation of our views):
1. Monetary policy is never ineffective at stabilising inflation or the real economy, even at the zero bound.
Nope. Monetary policy may be unable to stabilize the economy when there are real shocks. Monetary policy is pretty good at stabilizing the economy when the instability is due to a combination of sticky nominal wages and fluctuating nominal spending.
2. Fiscal policy is ineffective [at, see above...] always.
Nope. Fiscal policy can work in many different ways. If the central bank is targeting inflation (including indirect taxes) then fiscal policy can boost employment if the government reduces VAT taxes, or employer-side payroll taxes. Under a fixed exchange rate regime the government can boost output with more spending on goods and services. The US in 1940-41. My point was that if the central bank is targeting something like “aggregate demand” (as it should), then it’s silly for fiscal policymakers to attempt to influence “aggregate demand.” That doesn’t mean that certain government projects might not become more desirable at low real interest rates, for standard classical cost/benefit reasons.
3. Fiscal policy is effective [at...], but not desirable.
I mostly agree, with the caveat of the final sentence in my previous comment. I do understand that fiscal and monetary policy are not identical, and hence one can construct models with a role for both. But I don’t find those models persuasive. To call fiscal policy a “blunt instrument” would be an understatement.
4. Those New Keynesian models omit to model money, and so don’t capture why monetary policy is effective.
Yes and no. I happen to think that omitting money makes it harder to see the importance of monetary policy. However on purely theoretical grounds any story told with changes in the supply and demand for money can also be told with a description of the future path of interest rates relative to the future path of the Wicksellian equilibrium interest rate. But I could also create models where the key variable was the difference between the actual price of zinc, and the Wicksellian equilibrium price of zinc (where the latter term is defined as the nominal zinc price consistent with 5% NGDP growth.) How do we know of the price of zinc is above the Wicksellian equilibrium price of zinc? Simple, if NGDP growth is above target.
5. If you look at New Keynesian models carefully, they show that monetary policy is effective, even at the ZLB, which demonstrates why it, and not fiscal policy, should be used for stabilisation purposes always.
I think it’s more accurate to say that those models allow for the effectiveness of monetary policy at the zero bound. You can graft onto the NK models something like Krugman’s “promise to be irresponsible.” Or Lars Svensson’s “foolproof plan” for escaping a liquidity trap. Of course it’s also possible to construct NK models with expectations traps that do not allow for effective monetary policy. I don’t accept the assumptions that underlie those pessimistic versions of the model.
6. Unlike in NK models, monetary policy isn’t just about OMOs, or even buying long dated government securities. Expansions of the money supply can be used to buy all sorts of assets.
Yes and no. I certainly don’t believe that developed countries would need to buy non-government securities to hit a reasonable target, such as 4% or 5% NGDP growth, level targeting. But my deeper objection is that NKs frame the ineffectiveness issue backwards. They start by asking what the central bank can do at the zero bound, when they should start by asking why we are at the zero bound. More specifically, imagine a “do whatever it takes” central bank that keeps buying assets until inflation or NGDP growth expectations are on target. What then? This reframes the debate in a way that focuses on the real “zero bound” problem, the zero bound on the availability of eligible assets for the central bank to buy. When framed this way it becomes apparent that the zero bound on interest rates is not the real issue, as a central bank could theoretically run out of eligible assets even at positive rates.
For example, a few years ago the Australian national debt had fallen close to zero. Nominal interest rates were positive. Now let’s suppose that the RBA were only allowed to buy Australian government debt. That constraint would make monetary policy ineffective. And it would have nothing to do with the zero bound on interest rates, which were (and are) positive in Australia.
Now consider a country at the zero bound like the US. Suppose that the Fed committed to unlimited “QE” in order to raise NGDP growth expectations up to the old 5% trend line. They committed to buy T-securities until there were no more, then agency securities until those were exhausted, then Germany, Japanese, Canadian, British, etc., government bonds until those were exhausted, then AAA corporate bonds until those were exhausted, etc., etc. Is that monetary policy effective? It’s effective if the Fed can create expectations of sufficiently fast NGDP growth before running out of eligible assets. Thus the real zero bound problem is not zero interest rates, but the possibility that the Fed might be legally prevented from buying assets that it needed to buy in order to satisfy the public’s demand for base money when NGDP growth is on target.
NKs tend to assume that since the Fed’s balance sheet has ballooned from 6% of GDP to over 20%, a still higher number would be needed if they had adopted a 5% NGDPLT policy in 2008. Actually just the opposite is true. With that 5% NGDPLT policy, we never would have hit the zero bound, and hence our monetary base/GDP ratio would be much lower (as is the case in Australia–which never hit the zero bound.) NKs are monetary policy pessimists because they see interest rates as the lever of policy, whereas it’s more useful to think of them as the outcome of the policy regime. Yes, NKs are correct that there is a liquidity effect and that easy money today is likely to lead to lower short-term interest rates today. But as Woodford points out easy money today is not at policy at all; a policy is a change in the expected future path of monetary policy from today to the end of time. It’s a policy regime. And an expansionary policy by that criterion may well raise nominal interest rates.
7. Societies should adopt nominal GDP targeting.
8. [And/or] It follows from some combination of 1-6 that societies should adopt some form of nominal GDP targeting.
That’s basically right, although I certainly don’t think NGDP targeting is precisely optimal, just a good, pragmatic, easy to understand target that is superior to IT. I’d prefer something like a nominal total labor compensation target, especially for countries like Kuwait where NGDP can be distorted by commodity price shocks.
9. The crisis was caused by inflation targeting. Following a MM perspective, including a nominal GDP target, would have averted it.
Yes and no, there were many causes. If the Fed had adopted a “target the forecast” approach in their meeting after Lehman failed, monetary policy would have become dramatically more expansionary and the recession would have been significantly milder. Ditto for replacing an inflation target with a price level target. But I believe NGDPLT would have been better yet.
10. Fiscal policy is ineffective away from the ZLB because it prompts an offsetting monetary policy response.
See my response to points 2 and 3. Note that Yates ignores the “market” part of market monetarism.
A few general remarks:
1. I accept the fact that it will never be possible to write down a macro model with microfoundations where NGDP targeting is optimal. However, I also believe that we don’t know enough about the relative importance of price and wage rigidity, or the relative importance of various types of price rigidity, to construct useful models of that sort.
2. It’s a fair criticism of MM to point out that we don’t have much in the way of either sophisticated theoretical models or empirical studies to support our claims. Like Keynes (1936) we rely heavily on a combination of basic economic models (AS/AD for me, where AD is a hyperbola), stylized facts that are highly suggestive, criticism of alternative approaches, and logic. If someone bothered to write down the MM model (at least my version of it), the model would be as simplistic as the Keynesian cross.
3. The real innovation of MM is that we’ve suggested that mainstream economists are thinking about the issues in the wrong way, and we have done so using many concepts that have come from those very same mainstream economists. I tend to endlessly bore my readers with quotes from famous respected economists who used to claim that low interest rates don’t mean easy money, or that monetary policy remains highly effective at the zero bound. In late 2008 these mainstream views were abandoned by the profession (including the famous economists I quote), for all the wrong reasons. For example, many economists simply misread the events in Japan (1993-2012) and become pessimistic about monetary policy. A great deal of MM is simply reminding the profession that if the BOJ does what it did in fact do in 2013, that policy will be effective. Ditto for the Swiss policy adopted a couple years earlier.
4. Speaking for myself, I view MM partly as a sort of Deirdre McCloskey-like critique of modern macro methodology. Milton Friedman (my hero) was famous for not having a well-defined “model.” Or for thinking in partial equilibrium terms. His best ideas were not his “monetarist” ideas such as the 4% rule, but rather his critique of Keynesianism (low rates aren’t easy money, permanent income hypothesis, natural rate hypothesis, etc.) In my view MM is most effective as a critique of mainstream macro since 2008, and least effective when promoting NGDP targeting.
HT: Ben Southwood.