About This Blog

Welcome to a new blog on the endlessly perplexing problem of monetary policy.  You’ll quickly notice that I am not a natural blogger, yet I feel compelled by recent events to give it a shot.   By “recent events” I don’t mean the financial crisis, but rather the dramatic fall in aggregate demand since last summer.  Indeed, one goal of this blog is to show that we have fundamentally misdiagnosed the nature of the recession, attributing to the banking crisis what is actually a failure of monetary policy.  The intended audience is professional economists as well as others with a strong interest and background in macroeconomics.

I have spent 25 years researching the Great Depression, liquidity traps, and forward-looking monetary policy (especially policies that utilize market forecasts.)  Last October I noticed that the Fed (and other central banks) had lost credibility, allowing market expectations for growth and inflation to fall far below their implicit target.  In other words, the severe economic slump seemed to be caused by tight money–not tight in any absolute sense (more on that later), but relative to what was needed to meet the Fed’s objectives.  To my great frustration, I found few if any macroeconomists who saw things that way, even though it seemed a logical implication of mainstream macro theory.

A blog is not the place for a lengthy dissertation, and so here I’ll merely list three views that underlie my unusual take on the current recession:

Premise 1: The only coherent way of characterizing monetary policy as being either too“easy” or “tight” is relative to the policy stance expected to achieve the central bank’s goals.

Premise 2:Monetary policy can be highly effective in reviving a weak economy even if short-term interest rates are already near zero.”

Premise 3: After mid-2008, and especially in early October, the expected growth in the price level and nominal GDP fell increasingly far below the Fed’s implicit target.

In plain English, the first premise means the Fed should adopt the policy stance most likely to achieve its goals.  It is a point forcefully advocated by Lars Svensson, who Paul Krugman recently cited as an expert on the role of expectations in monetary policy.  The second is a quotation from Mishkin’s best selling monetary economics text (p. 607), i.e. it’s what we have been teaching our students.  And I have encountered few if any economists who disagree with my third assumption.  Indeed, if this were not so, why would Bernanke be calling for fiscal expansion?

The logical implication of these three premises is that the Fed has the ability to boost nominal growth expectations, and if they let those expectations fall far below target (as they did last fall) the subsequent recession (depression?) is their fault.  Why does almost no one else see things that way?  That’s what I’d like to explore.

At the same time, I assume that a blog must be more interesting than a research paper, so I’ll circle around these issues lightly.  I’d like to mix together observations on current events, commentary on other economic blogs (Krugman, Cowen, Hamilton, Mankiw, etc.) and fun facts from monetary history.  I’ll have plenty to say about misconceptions about Keynes, liquidity traps, the New Deal, and other related topics which have suddenly become highly topical.  Many of my best ideas will pop up early, so if you come to this blog much later, you might check the February 2009 archive.

Thanks for reading.   I welcome any serious comments.

Update, July 2009:    ****FAQS:****

1.  How can I say money was tight in late 2008?

Because markets expected NGDP growth to fall far short of the Fed’s implicit target.

2.  But weren’t interest rates cut to very low levels?

Interest rates are a very misleading indicator of monetary policy.  Both in the early 1930s and late 2008, falling rates disguised a tight money policy.  The rates were actually falling for two reasons.  Expectation of recession led to less borrowing and thus lower real interest rates.  And inflation expectations also fell sharply.

3.  But didn’t the monetary base increase sharply?

Yes, but this is also misleading for two reasons.  During periods of deflation and near-zero rates, there is a much higher demand for non-interest bearing cash and bank reserves.  In addition, last October 6th the Fed began paying interest on reserves, which caused banks to hoard bank reserves.

4.  Wouldn’t charging a penalty rate on excess reserves cause all sorts of problems?

Not if done correctly.  It need not hurt bank profits if it was combined with a positive interest rate on required reserves.  The penalty can also be applied to vault cash, which is a part of bank reserves.

5.  But what if banks cannot find good credit-worthy borrowers?

Then they can use the excess reserves to buy Treasury bonds.  This will put the cash into circulation, and boost aggregate demand through the “excess cash balance mechanism.”

6.  Isn’t the real problem . . . ?

No, the real problem right now is not a “real” problem.  The real problem is a nominal problem.  When the growth rate of nominal GDP falls sharply there is always a severe recession.  We have a severe nominal shock, a problem which has been understood by economists at least as far back as Hume.  At the time, it always looks like the “real problem” was some symptom of the monetary shock, such as financial panic.  Thus in the 1930s people thought the collapsing financial system caused the Great Depression, only later did we discover it was too little money.

7.  Aren’t business cycles caused by a misallocation of capital?

No.  Misallocation of capital does occur, and it can have real effects.  But even a major misallocation of resources such as the housing boom of 2003-06 does not cause a big enough misallocation to create a recession.  That’s why the initial downturn in housing was handled well, with only a minor bump in unemployment between mid-2006 and mid-2008. The big jump in unemployment more recently was caused by a sharp fall in NGDP, i.e. tight money.  By the way, there was no major misallocation of capital before the Great Depression.  In that case the problem was 100% tight money after September 1929.

8.  Have you seen Garrison’s Powerpoint slides?

Yes, several times.  Using his terminology, we now face a secondary depression.  BTW, please don’t ask me to read such and such a book on Austrian economics.  The comment section is where you get to show me how useful ABCT really is, by making thought-provoking comments on the post.  Until I finish my other projects, I won’t have much time to read anything.

9.  How can the solution for this mess be the same thing that got us into this mess in the first place?

The solution is stable NGDP growth at about 5% a year, which is not what got us into this mess.  It would be slightly more accurate to say that it is what kept us out of this mess between 1982 and 2007.  We got into this mess when we stopped providing enough money for modest growth in NGDP.

10.  Won’t your policies lead to high inflation in the long run?

No, but not doing my policies might.  Countries that follow conservative “hard money” policies during deflation (the US in the early 1930s, Argentina 1998-02) end up seeing the government taken over by left-wingers.  And if massive deficits are incurred because of a long recession, that makes higher inflation more likely in the future.  Monetary stimulus reduces the need for fiscal stimulus, and thus reduces the risk that debts will be monetized in the future.

11.  Aren’t market forecasts unreliable?

Yes and no.  Markets are often wrong, but are still about the best forecasts we have.  In this case other private forecasters, as well as the Fed itself, are also forecasting low NGDP growth.  So whatever forecast we use, it still shows the need for further stimulus.

12.  Isn’t monetary stimulus ineffective in a liquidity trap. 

No.  Temporary monetary injections are never very effective.  Monetary injections expected to be permanent are always effective–even in a liquidity trap (according to well-known Keynesian Paul Krugman.)  What we need is an explicit NGDP or inflation trajectory, including a promise to make up for any short term undershoots.  This will increase the credibility of monetary policy.

13.  Don’t we need both monetary and fiscal stimulus?

No.  Monetary stimulus can make NGDP grow as fast as you like, as we saw in Zimbabwe.  Once the Fed has set monetary policy at the level expected to produce on target growth, then there is no role for fiscal stimulus, it can only make things worse.

14.  Isn’t there a risk of overshooting with monetary stimulus, due to the “long and variable lags.”

No.  There are no long and variable lags in monetary stimulus.  Money does have a lagged effect on sticky wages and prices.  But wage growth is determined by inflation expectations.  Thus as long as the Fed targets 12 month forward NGDP or inflation; we don’t need to be worried about damaging inflation.  A temporary blip in inflation may occur from oil prices now and then, but it won’t feed into core inflation, and hence wages.

15.  Isn’t the CPI a bad measure of inflation, because it ignores house prices and stock prices?

Stocks prices should not be included.  House prices should be, and actual inflation was higher than the official rate in 2004-06, but not very much higher.  This is one reason I prefer NGDP targeting, it does include new house prices.

16.  How can I defend the EMH, when so many studies show people are irrational and markets are inefficient?

Market anomaly studies are products of data mining.  At some level this is known by economists, but the problem is far worse than even most economists realize.  These tests are not reliable.  People are often irrational, but it’s not clear that irrationality has much impact on sophisticated financial and commodity markets.  The anti-EMH position has yet to come up with useful public policy advice, or useful investment advice. 

17.  Wasn’t the housing bubble obviously just a big house of cards?  And wasn’t that obvious to any thinking person at the time?

Apparently it wasn’t obvious to the big Wall Street banks who lost billions, and in some cases failed entirely.  Nor to the many highly sophisticated investors who invested in those banks, or more directly in mortgage-backed securities.  I agree that in retrospect this collapse seems like it should have been obvious, but the reality is it was not.  Obama’s proposal for a minimum 5% “skin in the game” rule would not have prevented this crisis, as lots of the villains did have skin in the game, and lost billions.

18.  Isn’t the only solution to get rid of central banking?

And then what?  A gold standard does not stabilize the price level, as the real value of gold fluctuates like any other commodity.  We had depressions under the gold standard.  I think central banking is inevitable, but we do need to reform the system so that central bankers no longer try to out-guess the market.  Monetary policy should be implemented by the market, using a futures targeting system.  The market is best able to stabilize the price level, or NGDP.

19.  Aren’t you just a monetary crank trying to solve all the world’s problems by printing money?

Yes, but like a broken clock the monetary cranks are right twice a century; 1933, and today.  The other 98 years I am a Chicago-trained, libertarian, inflation-hawk.  Twice a century I put on my Irving Fisher super-hero suit, and emerge from my deep underground bunker.

 

Sorry, but I don’t have time to respond to FAQs here.  These are primarily for new visitors who don’t know where I am coming from, and want information to help them better understand a blog post.  There will be plenty of opportunities for visitors to raise these issues in new posts.  They pop up over and over again.  Ad nauseum.


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27 Responses to “About This Blog”

  1. Gravatar of Tom Tom
    25. February 2009 at 04:30

    I am a non-economist, but someone with a deep interest in monetary policy. I’ve just read the post of the General Theory and would heartily endorse the tone and level of the writing. I’m sure there’s more than enough depth to hook in the professional economics community, but it’s also very well written and structured for us keen amateurs. Bravo and thanks.

  2. Gravatar of Ryan Ryan
    25. February 2009 at 08:57

    Dr. Sumner,

    Given your research background dealing with the gold standard, readers may be interested in a brief discussion of your views on that issue. Though it’s not directly related to the current turmoil, I think it would be interesting if you have the time.

  3. Gravatar of ssumner ssumner
    25. February 2009 at 19:24

    Thanks Tom and Ryan, I will try to address the gold standard in future posts. I did talk about it briefly in one of my replies tonight, but I have much more to say. Please be patient as I am in a busy stretch at school, but perhaps spring break would be a good time to work on some gold posts. Would you prefer that I discuss what happened in the 1920s and 1930s, or pros and cons of using it today?
    One of my current posts already suggests why I prefer a CPI (or nominal GDP) target to a fixed gold price.

  4. Gravatar of Harvey Wharfield Harvey Wharfield
    27. February 2009 at 08:24

    Scott,

    I’m sure you’re aware of the growing trend among some states to attempt to return to “sound money.” I’ve been part of this since 2003 and work with the states and the concept’s creator, Dr. Edwin Vieira of Virginia. NH tried it back in 2004 and 2006 but it was tabled. Since then 3 more states, Indiana, Colorado and Missouri are trying to get some form of Dr. Vieira’s concept introduced. Not having the time to explore your theories entirely, do our aims square with some of your views ?

    If you’s like a two-page overview of what we’re doing just email me and I’ll send it to you.

    Thaks,

    Harvey

  5. Gravatar of Harvey Wharfield Harvey Wharfield
    27. February 2009 at 08:26

    Others so interested in the overview of the Sound Money Bill, just ask for it at
    mentor2@gmail.com

  6. Gravatar of Chris Burns Chris Burns
    27. February 2009 at 14:57

    Hi Dr. Sumner,

    Could you elaborate, perhaps in a future article, on mechanisms the Federal Reserve can use to push down long term real interest rates?

    Thanks,

    Chris Burns

  7. Gravatar of James Baker (Uncle Jim) James Baker (Uncle Jim)
    1. March 2009 at 13:30

    Scott:

    Fran and I are thrilled at the recognition you are receiving based on your recent articles and your blog. I know that your mother, Max and Carol and Mark are very proud and happy for you, sentiments that Fran and I share. We are sending all the relevant links to your cousins who will be most impressed.

    We enjoy reading the articles although I must admit to a somewhat less that complete underestanding. So we look forward to the next ocasion for a visit and getting some further explanations from you. Maybe you will be visitng Washington again in the near future?

    Love from all of us to you, Bi and Isabella

    Uncle Jim

  8. Gravatar of ssumner ssumner
    1. March 2009 at 18:33

    Thanks Uncle Jim, It is gratifying that people are paying attention, as I have worked hard on this issue and feel passionate about it. The Tyler Cowen review was especially gratifying as I greatly respect his judgment. If you ever listen to NPR, he is often interviewed.

  9. Gravatar of David Beckworth David Beckworth
    1. March 2009 at 18:39

    Scott:

    You are breath of fresh air in the debate over the appropriate macroeconomic policy. Keep up the good fight.

  10. Gravatar of Harvey Kornicks Harvey Kornicks
    29. March 2009 at 05:50

    Scott: I believe your not digging deep enough to the economics of the mess we are into to. The historic approach/perspective should have much more weight with any discussions on economic plans for the future. For the divergence of real numbers need to come together not only in a STATE government but as a world economy. No big words from me however, I will try to give some bullet points on what I believe to be a control/planned out economy for the world’s population.

    1.) Colonial times-banking systems and money was localize
    2.) Mid- 19th Century same discussion regarding government spending and taxes have already matured in another level. The print during this time made the general population aware of such problems
    3.)Gold along with silver a form of our government to back the paper money it is printed on.
    5.)A small Company AIG (1918 give or take a few years)is founded by an American in CHINA ( Historically I truely believe this is a key..will explain in further notes
    6.) The Printing presses start rolling and prosperity is for all
    7.) The push is now on to invest in our industries through stock,
    8.) Great depression, dreams and the above information is be retracted in the form of Gold coins. (Government wanting them back!)
    9.) WAR, WAR, War, to get our industries back on the move. Putting more money into our hands.
    10.) Now, the big leap in faith which I truly believe is the reason for a good bulk of our problems that we are beginning to face. Nixon taking us off the gold standard.
    a.) Brentwood, IMF, all tied into a world base philosophy. The American financial institutions selling us the way to prosper where all the IRA, any so many other financial vechiles to take our money out of the system.
    11.) Now for a brief summary, AIG…..and China and the gentlemen whom founded AIG…. I do not believe for one moment that when Nixon opened communications to China, it was in the best interest of our Country..

    O.K. what does this have to do with your blogs that I briefly went over? Back in the 50′s when interest rates were give or take around 2% gas was if my memory is correct under 25cents, american cars in the range (generally speaking $2,500-3,500 range, gold at the time under $50.00 ounce, siver, crazy at under $2.00 ounce. My point is there is a formula that is being used to create wealth and the control of the economics of this country and next the world though the IMF. In this formula, Interest rates, Gold, life expentancy, plus geograpical locations will have a play in this formula. The divergence of wealth will be force like any other movement to find a balance until each generation 60+ year cyle takes place. The 60 year cyle will have a spread of time between the life expentancy of each generation.

    The key phase for our generation is ” Past perfomances are no gaurentee for future sucess/gains.” However you as and academician have the oligation to tie the past,and present together to give your student a real world view.

    I will apologize now for any spelling mistakes, however, my ideas….well, nope. I think we might be in the next stage not only of a New World Order, but a New World Financial System base more on the faith of each government. IMF, is trying to place itself as the Bank of Last resorts…

    My gut instinct gold will be used a one source for the balance of payments of debt. If our government values gold held by us (at$50.00 oz. ) to the true market value, then I believe this will help our trade balances and bring our debt done to a realistic number. So, you heard this here..The re-evalution of gold from our government…

    Thank you for your patience and time.

    Thank you for your time.
    If it was not for my son being choosen for the Tomorrow 25 award I probably would not have heard of the college.

  11. Gravatar of claudio claudio
    28. April 2009 at 16:05

    Just to give a reference:

    Is the Austrian business cycle theory still relevant?
    Anthony M. Carilli & Gregory M. Dempster

    It seems to be forthcoming in the Review of Austrian Economics. Despite of many Austrians refusing to use econometrics, the authors tried to have some fun with VAR.

    BTW, amazing blog.

  12. Gravatar of ssumner ssumner
    6. June 2009 at 13:16

    Thanks Claudio.

  13. Gravatar of Carl Lumma Carl Lumma
    9. August 2009 at 16:03

    >18. Isn’t the only solution to get rid of central banking?
    >
    >And then what?

    Decentralized banking, of course:

    http://www.ripplepay.com

    In brief: with digital currency, people can be their own banks, i.e. print their own money in the form of loans. Such a currency system could provide data for real macro analysis, and many indicators which are lagging today could become instantaneous. Likewise, reserve requirements and multiplier ratios could be adjusted in real time. If capitalism is good, why should key parts of it lie outside normal human relationships? Human relationships support rich information flows — compare to ~ 6 bits of information typically available to a bank deciding whether to fund a loan. Infeasible? Consider that credit cards are actually private currency systems, which merely accept greenbacks 1:1 for balance payments. The present proposal may be no more than a credit card with special features. Or, governments may be persuaded to adopt it in place of cash, since taxation could be automatic. We already knew vaults were anachronisms.

  14. Gravatar of Jordi Jordi
    8. September 2009 at 06:54

    Dear Mr. Sumner,

    I am writing to you on behalf of Capital, a spanish business magazine. I
    am working on an article
    about the most influential economy/business bloggers. Would you mind
    answering
    some questions, please?

    1. Which are, in your opinion, the most influential economy bloggers in
    the world?
    2. Which news would you consider to be as the most important news
    discovered by
    economy
    bloggers?
    3. Why did you begin to write your blog?
    4. Which situation would you regard as most difficult? Have you received
    a lot of
    pressure?
    5. Which news would you refer to as most important news
    discovered/written in your
    blog?
    6. Which news has surprised you most?
    Do you remember some news that was more influential than you had ever
    thought even
    before writing about it?
    7. What is your opinion about what are bloggers doing for democracy and
    transparency
    in economy? Which example can you name as most relevant in this case?

    Thank you very much.

    Kind regards,

    Jordi Benítez
    Capital Magazine Journalist

  15. Gravatar of chris mahoney chris mahoney
    7. November 2009 at 10:15

    Grover Cleveland is a hero of the gold standard movement. He resisted pressure to inflate (in fact, to stop deflation). After he left office the Democratic Party embraced silver and bimetalism and nominated William Jennings Bryan, a strong critic of the gold standard. In view of the history of the gold standard, it looks like Bryan was right and Cleveland was wrong.

  16. Gravatar of ssumner ssumner
    7. November 2009 at 10:27

    Chris, You are right–about the gold standard. It should be said that Bryan had a lot of bad ideas as well, he supported the income tax, for instance.

  17. Gravatar of Jeff Watson Jeff Watson
    18. November 2009 at 15:03

    Just stopped by to say that for a self described unnatural blogger, you have one helluva blog. I will stop back often, and you can make book on that.

    Jeff

  18. Gravatar of Stephen Turcotte Stephen Turcotte
    19. November 2009 at 06:52

    Hi Scott, Jim Lapides, sent me a link to your blog and said i should get in touch with you. The phone number the Jim provided for you is of service. Send me an email and we’ll setup some time to chat.

  19. Gravatar of Pandora Pandora
    28. November 2009 at 04:33

    Scott, Just wanted to point something out that’s happened over the last year: you’ve become a blogger. In fact, I think you’re a natural, after all.

  20. Gravatar of ssumner ssumner
    29. November 2009 at 14:34

    Thanks Pandora.

  21. Gravatar of TVHE » Scott Sumner wins TVHE » Scott Sumner wins
    12. October 2010 at 13:02

    [...] excellent blog here, and has been pushing the NGDP target line for the entire crisis.  See the start of the blog in February 2009 – in the depths of the [...]

  22. Gravatar of TVHE » Why QE will lead to inflation past the Fed target TVHE » Why QE will lead to inflation past the Fed target
    18. November 2010 at 15:38

    [...] me, this is incredibly similar to price level targeting (or even in some form of NGDP targeting) albeit an indirect version.  The Fed is implementing a mechanism that makes them take into [...]

  23. Gravatar of Scott Somner の最初のエントリ About this blog – 道草 Scott Somner の最初のエントリ About this blog – 道草
    13. December 2010 at 03:02

    [...] と題されたページがあります。これはブログのいちばん最初のエントリ About this blog (25. February [...]

  24. Gravatar of Appareil Photo Reflex Numerique Appareil Photo Reflex Numerique
    4. June 2011 at 10:18

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  25. Gravatar of Scott Sumner Scott Sumner
    4. June 2011 at 10:56

    Yes, you can quote me.

  26. Gravatar of Financeroll English | Monetary policy: A victory, and a test Financeroll English | Monetary policy: A victory, and a test
    14. September 2012 at 21:38

    [...] voice emerged in a little dilemma of a economics blogosphere. On Feb 2nd, 2009, Scott Sumner launched his blog with a flurry of posts assailing a required knowledge on financial policy. But roughly no one knew [...]

  27. Gravatar of A victory, and a test | She's a Savvy Investor A victory, and a test | She's a Savvy Investor
    15. September 2012 at 08:04

    [...] voice emerged in a tiny corner of the economics blogosphere. On February 2nd, 2009, Scott Sumner launched his blog with a flurry of posts assailing the conventional wisdom on monetary policy. But almost no one knew [...]

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