Now that the money supply is falling fast . . .

Where are those who warned us that rapid growth in money foretold hyperinflation?  Are they now predicting deflation?  From the Telegraph:

The stock of money fell from $14.2 trillion to $13.9 trillion in the three months to April, amounting to an annual rate of contraction of 9.6pc. The assets of insitutional money market funds fell at a 37pc rate, the sharpest drop ever.

“It’s frightening,” said Professor Tim Congdon from International Monetary Research. “The plunge in M3 has no precedent since the Great Depression. The dominant reason for this is that regulators across the world are pressing banks to raise capital asset ratios and to shrink their risk assets. This is why the US is not recovering properly,” he said.

.   .   .

Mr Summers acknowledged in a speech this week that the eurozone crisis had shone a spotlight on the dangers of spiralling public debt. He said deficit spending delays the day of reckoning and leaves the US at the mercy of foreign creditors. Ultimately, “failure begets failure” in fiscal policy as the logic of compound interest does its worst.

However, Mr Summers said it would be “pennywise and pound foolish” to skimp just as the kindling wood of recovery starts to catch fire. He said fiscal policy comes into its own at at time when the economy “faces a liquidity trap” and the Fed is constrained by zero interest rates.

Mr Congdon said the Obama policy risks repeating the strategic errors of Japan, which pushed debt to dangerously high levels with one fiscal boost after another during its Lost Decade, instead of resorting to full-blown “Friedmanite” monetary stimulus.

“Fiscal policy does not work. The US has just tried the biggest fiscal experiment in history and it has failed. What matters is the quantity of money and in extremis that can be increased easily by quantititave easing. If the Fed doesn’t act, a double-dip recession is a virtual certainty,” he said.

Mr Congdon said the dominant voices in US policy-making – Nobel laureates Paul Krugman and Joe Stiglitz, as well as Mr Summers and Fed chair Ben Bernanke - are all Keynesians of different stripes who “despise traditional monetary theory and have a religious aversion to any mention of the quantity of money”. The great opus by Milton Friedman and Anna Schwartz – The Monetary History of the United States – has been left to gather dust.

Mr Bernanke no longer pays attention to the M3 data. The bank stopped publishing the data five years ago, deeming it too erratic to be of much use.

This may have been a serious error since double-digit growth of M3 during the US housing bubble gave clear warnings that the boom was out of control. The sudden slowdown in M3 in early to mid-2008 – just as the Fed talked of raising rates – gave a second warning that the economy was about to go into a nosedive.

Mr Bernanke built his academic reputation on the study of the credit mechanism. This model offers a radically different theory for how the financial system works. While so-called “creditism” has become the new orthodoxy in US central banking, it has not yet been tested over time and may yet prove to be a misadventure.

Paul Ashworth at Capital Economics said the decline in M3 is worrying and points to a growing risk of deflation. “Core inflation is already the lowest since 1966, so we don’t have much margin for error here. Deflation becomes a threat if it goes on long enough to become entrenched,” he said.

As Sarah Palin might say; “How’s that creditism working out for ya?”  

Looks like Tim Congdon is the Michael Belongia of the UK.  I’m not a pure monetarist, but I’ll take M3 over creditism any day.


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31 Responses to “Now that the money supply is falling fast . . .”

  1. Gravatar of marcus nunes marcus nunes
    27. May 2010 at 05:45

    Bernanke is a fan of “the credit channell of MP”. Back in December 2007 the TAF was launched due to the disfunctionality of credit! It didn´t work – spreads didn´t come down and stayed down. But they kept insisting…

  2. Gravatar of marcus nunes marcus nunes
    27. May 2010 at 05:55

    For a readable exposition of Bernanke´s “creditism”:
    http://www.philadelphiafed.org/research-and-data/publications/business-review/1988/brnd88bb.pdf

  3. Gravatar of scott sumner scott sumner
    27. May 2010 at 06:16

    marcus, Thanks, that 1988 paper shows that he has been thinking along these lines for quite a while.

  4. Gravatar of Mark A. Sadowski Mark A. Sadowski
    27. May 2010 at 06:44

    Scott,
    The fed may no longer pay attention to M3 but they have MZM. MZM was lower on May 10th than it was on February 2nd of 2009. It peaked on December 7th ($9.63 trillion) and fell at an annual rate of 9.3% through April 19th ($9.29 trillion). Like you I don’t have excessive faith in aggregates however this is one more piece of evidence that money is too tight.

  5. Gravatar of Morgan Warstler Morgan Warstler
    27. May 2010 at 06:48

    Scott,

    Can you give us some napkin math idea for how much QE you think we need?

    Is it just $300B + 2%*14.2T in cash printed?

  6. Gravatar of jsalvati jsalvati
    27. May 2010 at 06:50

    Perhaps they will predict hyper-deflation.

  7. Gravatar of scott sumner scott sumner
    27. May 2010 at 07:31

    Thanks Mark.

    Morgan, None. I think they need to stop paying interest on reserves and set a much higher P-level or NGDP target. That would be enough w/o any QE.

    Jsalvati, Somehow I doubt it. :)

  8. Gravatar of Mark A. Sadowski Mark A. Sadowski
    27. May 2010 at 08:46

    More signs of inflation fear dementia at the Fed. Richmond FRB president says he is in favor of tighter monetary policy:

    http://www.marketwatch.com/story/feds-lacker-moving-away-from-consensus-wording-2010-05-26

    Meanwhile corporate bond distress is at its highest level since the credit crunch of early 2009:

    http://www.bloomberg.com/apps/news?pid=20601087&sid=atn4lTDhUcZo&pos=3

    Will somebody please stop the insanity!

  9. Gravatar of Mike Sandifer Mike Sandifer
    27. May 2010 at 09:36

    Scott,

    I have a second question here about the math of falling nGDP. If nGDP falls, say 2% in a $14 trillion dollar economy, is there a sort of reliable rule of thumb computation to be done to predict the economic impact in terms of rGDP?

  10. Gravatar of David Pearson David Pearson
    27. May 2010 at 10:08

    Scott,

    I agree — M3 is telling us something important: creditism has failed in its primary objective, which is restoring velocity through the monetary transmission mechanism. The question is, is the consequence deflationary or inflationary?

    M3 is a decent proxy for the velocity produced by the shadow banking system (as it includes repo’s, which is the primary funding vehicle for shadow balance sheets) as it employs more and more leverage. So M3 is telling us that “creditism” is not “fixing” the shadow monetary transmission channel. In fact, it is broken, and it cannot be fixed. Base money growth merely falls down the sinkhole of collapsing velocity. Which gets us back to the question I pose in the first paragraph (is falling M3 inflationary or deflationary?).

    In the face of a brken transmission mechanism, I think we both agree that to raise velocity the Fed must target expectations directly. The question is, what behavior will this spark on the part of economic actors? You seem to assume that higher inflation expectations lead to higher RGDP growth as actors resume “normal” activities once the threat of deflation recedes. The result is a resumption of “trend” RGDP growth (if I am correctly summarizing your views).

    The other argument is that economic actors are not held back by the specter of deflation, but by the expectation that future income growth is insufficient to support debt service, and that refinancing debt will be difficult given the state of the banking system. If this is the case, then the only way to convince them otherwise is to promise that future income growth will be robust enough to service debt incurred when asset prices were much higher. This requires a more than decent rate of income growth given the leverage accumulated during the bubble years. So actors require some convincing. Is 2-3% enough? Hardly, as it is just the “normal” rate of inflation. To overcome debt service fears, the rate of nominal income growth has to be more robust than normal. Is this a difficult hypothesis to accept?

    So back the question of inflation v. deflation. The more M3 collapses, the more the Fed will have to abandon its reticence and adopt an inflation target. And the more the Fed adopts a “normal” inflation target, the more likely it is that that velocity is unresponsive. The more velocity is unresponsive, the more likelihood that the Fed will raise its inflation target — “temporarily”. And the more the Fed adopts a “temporarily high” target, the more the Fed will risk crashing the markets when it lowers it. That, in a nutshell, is the argument for hedging against high future inflation.

    As an aside, I will note that, while I agree that M3 is important, it was also important in the summer of 2008, when it was screaming higher during a period of what you characterize as “tight money”:

    http://www.nowandfutures.com/key_stats.html

  11. Gravatar of StatsGuy StatsGuy
    27. May 2010 at 11:50

    David…

    M3 is a lagged indicator, not a forward-looking indicator. It is a record of past transactions, sort of like closings in housing.

    Fall 2008 was extremely tricky, because commodity prices (largely driven by speculation and an anti-dollar carry trade, which was largely funded by leveraged hedged funds) were skyrocketing right up until they got frothy then collapsed. In that context, one could argue the Fed’s actions in summer 08 were understandable. They killed the commodity bubble to stop a run on the dollar.

    But the Fed was not nimble, and proved itself slow to react. Or, they saw commodity prices coming down and thought ‘mission almost accomplished’. This goes back to the timing of the crash, which we’ve gone over many times. Risk asset markets didn’t crash seriously till weeks after Lehman; the demand crisis hit the fan not just because of Lehman, but because of the botched and incoherent policy response (fiscal and monetary). And the Fed didn’t follow through with its promises of QE till March, which marked the turnaround.

    The problem with bluffing, is that when someone calls your bluff, you have to follow through. The Fed’s persistent refusal to follow through week after week, month after month, wiped out many buy ‘n hold investors, and shifted massive assets into the pockets of sell side bears.

    If you listen to much of the conversation today, there is no lack of awareness of QE. However, the common riposte is that the Fed does’t have the political capacity to engage in more QE until things get really bad, and therefore the markets should expect deflation until things get so bad the public accepts inflation – and by then, it will be a _real_ inflation.

    For example:

    http://www.zerohedge.com/article/albert-edwards-europe-edge-deflationary-precipice-will-paradoxically-usher-20-30-inflation

  12. Gravatar of Lord Lord
    27. May 2010 at 12:16

    I have reached the conclusion that bankers have no credibility with respect to creating inflation and never will. It would be as counter to their natural instincts as congress running extended surpluses. If something is to be done, it will have to be congress taking monetary policy out of their hands and not borrowing the money to do it. They could simply authorize treasury not to borrow to make up the deficit but merely credit their accounts with any necessary amount to a given amount or for a given period. The bankers would then have a task they would feel comfortable addressing.

  13. Gravatar of Mark A. Sadowski Mark A. Sadowski
    27. May 2010 at 13:36

    Scott,
    I’m getting paid $20 an hour right now to correct the grammatical errors on a good Jordanian friend’s generally well written thesis on the monetary transition mechanism (MTM). It has saved me from working on my own doctoral thesis. However he’s 42 pages into his literature review and in my opinion it’s clear he has failed to develop a single original idea. I was tempted to tell him “hand me the printing press and I’ll have some AD generated before the end of the day.”

  14. Gravatar of David Pearson David Pearson
    27. May 2010 at 14:51

    Stasguy,

    The problem I have with the “crashed expectations” hypothesis is that it is tautological. If you define “too tight” as having caused a “crash”, then any crash will be caused by the Fed being “too tight” by definition. Sure. But what does it tell us about what the Fed should have done? Buy $1tr in mortgages in November ’08 rather than waiting for 1q09? Fine, they could have, but it would have ended up in ER’s just the same. What about penalizing ER’s with negative rates? OK, except trying to figure out what rate to charge that did not impair bank profitability in November of ’09 was a tall order. What about immediately rolling out a 2% inflation target? Again, the markets would have responded, “we thought that was the inflation target already, and yet we still had a crash.” The Fed could have said, “we really mean it this time,” in which case the markets likely would have responded, “prove it”.

    I think the focus on the decline in NGDP expectations in Oct/Nov of ’08 misses something important. Velocity crashed then because the shadow banking system suffered a sudden, unexpected run on its financing (the repo market). Lehman was a catalyst, but the run was inevitable given the amount of AAA-rated repo collateral that was too sketchy to be rolled. Haircuts on that collateral for repo’s (and outright redemptions) caused the crash, and Lehman’s failure was the result — not the other way around.

    So if velocity is crashing in a credit crisis because collateral for overnight repo’s is discovered to be junk, is the Fed CAUSING velocity to crash? Of course not. Now, one might argue that collateral was thought to be junk because the Fed was too tight — it was the Fed’s fault that collateral values were falling! I’d like to see someone make that argument… Or alternatively, one could argue that the Fed could have simply provided short term financing to replace the repo’s, which is exactly what they did. The problem was that by then, the shadow banking system had effectively died a timely death to an over-levered life; a natural, inevitable death given the quality of the securities backing its funding.

    As far as NGDP futures are concerned, I don’t believe that in the Fall of ’08, those futures could have facilitated any more injection of funds into the banking system then the Fed achieved through its s.t. funding facilities. Maybe they could have had a “signaling” effect to other markets, but which market at that time would have had more importance in signaling, the market for overnight bank funding, or a market for 2yr NGDP futures? Had the Fed been able to maintain the futures price at, say, 6% NGDP growth, I would argue the other asset markets would have just looked at that price and concluded, “its manipulated”.

  15. Gravatar of StatsGuy StatsGuy
    27. May 2010 at 15:22

    @David

    All the points you raise are fair, which is why I find it hard to overly criticize the Fed for its summer 08 actions. I believe the financial crisis was real – we suddenly discovered we were poorer. But how much poorer? Not nearly as much as the world asset market crash suggests. The real effect was priced into the stock market when Dow hit 10k, perhaps sooner. The Dow is at 10k today, and today things look a whole lot worse than they were back in september 08, and worse than a lot of people thought they would get.

    But the markets held on a little because – as people like Buffett noted – the Fed would need to inflate to compensate, which meant no one wanted to own too much cash.

    Except the Fed decided to raise its middle finger to all the folks that expected it to act as it had promised it would act. Thus, the market bounced up and down wildly while trying to decide if the Fed would commit to compensate for the private deleveraging that was starting to occur. When the Fed refused to compensate, the markets crashed. Demand crashed in November – literally fell off a cliff – in expectation of the mass layoffs that hit in December (which everyone except the professional economists knew was coming).

    Meanwhile, all we could hear was credit channel, credit channel, credit channel. Recapitalize the banks with federal money so they can lend!

    What we did NOT see was any quantitative easing (mass purchases of govt. securities, or even commitment to mass purchase them), in spite of both expectations and promises. Indeed, we did not see this until the banks had safely offloaded their bad assets onto the Fed or F&M etc. Conspiracy, corruption, incompetence, or ideological failure?

    The world may never know.

  16. Gravatar of StatsGuy StatsGuy
    27. May 2010 at 15:32

    “As far as NGDP futures are concerned, I don’t believe that in the Fall of ‘08, those futures could have facilitated any more injection of funds into the banking system then the Fed achieved through its s.t. funding facilities. Maybe they could have had a “signaling” effect to other markets,”

    OK, let me disagree here – when the deleveraging crisis started, we saw a MASSIVE unwind of the anti-dollar carry trade (of which the commodity bubble was a manifestation). That’s largely why the dollar spiked and US treasury prices jumped to insane levels; think of it as a huge short squeeze on everyone that short dollars (they were short dollars because they were using the dollar as a funding currency for non-dollar asset purchases). At this point, the Fed probably breathed a great sigh of relief – the Dollar is saved!!! The ECB still went full force trying to kill the dollar as reserve currency – as Trichet argued that countries should use more Euros and fewer dollars in their reserve holdings – and so he kept the ECB as tight as a Victorian corset (and man did that backfire!!).

    Partly because the ECB’s refusal to coordinate, the Fed avoided QE until it was damn near too late. However, let me argue – IF THE FED had announced QE in November 2008, the dollar unwind would never have progressed as far as it did. Unemployment should NOT have exceeded 8%. Between Nov 2008 and March 2009, unbelievable damage was inflicted on the US economy. At that time, Krugman and others warned that every month of delay was lengthening the period till we get back to full employment by 6+ months.

  17. Gravatar of Jon Jon
    27. May 2010 at 16:04

    Money aggregates acquired a bad reputation during the 80s. People blamed velocity. Money aggregates were mostly abandoned. Now, I agree that it’s not clear how to use m2, m3 etc, but logic used to ignore quality was very poor.

    My hypthosis about what was really happening is this: it’s all about innovation in finance. Official broad money measures were fixated on the banking system as if banks were the unique source of money substitutes–yes you still read that in almost all of the modern texts. It’s wrong, very wrong. A money substitue can be anything that constitute a trusted claim on money. A basic form of this would be a demand account which is not a money asset but is a claim on money. However the market has innovated many claims on money. A very common one being tbills, but government debt in general, including government backed morgage debt is treated this was too. The biggest newish class of money claim is the derivatives contract. These are not included in official broad money aggregates.

    This goes a long way to explaining the tight money problem in 2008. There is a lot of evidence that liquidity preference was not the issue, but rather counterpart risk meant that derivatives ceased being regarded as secure claims on money.

  18. Gravatar of Mattias Mattias
    28. May 2010 at 00:27

    It seems that inflation paranoia just won’t disappear whatever happens in the real (nominal?) world. Personally I tend to lose interest when people start talking about all the money printing that is supposedly going on and how money is “created out of thin air”. Isn’t all money in a fiat system more or less created out of thin air?

  19. Gravatar of W le B W le B
    28. May 2010 at 04:35

    S
    Thanks for taking the time and care to reply to my earlier comment.
    1. If we can’t use measures of these money aggregates (e.g. M4 lending in the UK) to gauge whether money is tight or lose, are you suggesting we keep an eye on a basket of asset prices?
    2. As we need to accompany fiscal consolidation with monetary easing should we not change the balance in the way the lower PSBR is financed by reducing the proportion made up from the sale of gilts/treasuries and increasing the proportion raised from private bank lending to the public sector? And accompany this with a clear explanation that the aim is to increase NGDP by x% by this means, with the extent of public sector borrowing from the private banking sector changing in future years as dictated by the performance of the economy in relation to the NGDP target?
    W le B

  20. Gravatar of scott sumner scott sumner
    28. May 2010 at 05:06

    Mark, That’s mind-boggling, and even more mind-boggling is that the Democratic leaders who are talking about additional fiscal stimulus don’t even seem to realize that there are top Fed officials who think the economy doesn’t need any more AD, and would try to offset that stimulus through higher rates. How about a clear Fed mandate?

    Mike, It depends on the trend rate of growth in NGDP. If it is 5% (as in the US), then if someone told me that NGDP was going to suddenly fall 2% (7% below trend) I would predict that in the short run inflation would fall 1% below trend and real GDP would fall 6% below trend. That’s because the short run SRAS is fairly flat to the left of the LRAS curve. Given 2% trend inflation and 3% trend real growth, I would expect about 1% inflation and minus 3% real growth.

    David; You said;

    “In the face of a broken transmission mechanism, I think we both agree that to raise velocity the Fed must target expectations directly. The question is, what behavior will this spark on the part of economic actors? You seem to assume that higher inflation expectations lead to higher RGDP growth as actors resume “normal” activities once the threat of deflation recedes. The result is a resumption of “trend” RGDP growth (if I am correctly summarizing your views).”

    It’s not that simple, not just me, but almost all macroeconomists believe that expectations of higher future inflation and higher future NGDP will tend to raise current inflation and current NGDP. How you think that impacts current real GDP depends on slack in the economy, whether you are a Keynesian or a classical economist, etc. But I’d like to unpack those two assumptions so that it is clear what we are debating.

    I favor steady NGDP growth even if I am completely wrong in my assumption about how it is likely to impact RGDP.

    You said;

    “Is 2-3% enough? Hardly, as it is just the “normal” rate of inflation. To overcome debt service fears, the rate of nominal income growth has to be more robust than normal. Is this a difficult hypothesis to accept?”

    Debt holders care about NGDP growth, not inflation. I favor MUCH higher NGDP growth, as we are far below the 5% growth trend line. I don’t want to get all the way back (that’s unrealistic) but at least part way back. That means something like 9% NGDP growth for one year and that would probably mean about 6% RGDP growth and 3% inflation, given the SRAS curve.

    You said;

    “As an aside, I will note that, while I agree that M3 is important, it was also important in the summer of 2008, when it was screaming higher during a period of what you characterize as “tight money”:”

    I didn’t say it was important. I said the hyperinflation worriers who pay a lot of attention to M3 ought to now be forecasting deflation. I look at financial market expectations, not M3.

    I have no idea why a temporarily higher inflation target would crash markets. I think they would like such a policy. They did under FDR.

    statsguy, Excellent comment. But the experience of Japan tells me we may never get the high inflation, just years of suffering under our increasingly burdensome debt load. Or maybe we are not as patient as Japanese voters. Who knows?

    Lord, You said;

    “I have reached the conclusion that bankers have no credibility with respect to creating inflation and never will.”

    Maybe, but they did in the 1960s and 1970s. So never say never.

    Mark#2, I know how you feel. Which program are you in? (Apologies if you already told me, I have a bad memory.)

    David; You said;

    “The problem I have with the “crashed expectations” hypothesis is that it is tautological. If you define “too tight” as having caused a “crash”, then any crash will be caused by the Fed being “too tight” by definition. Sure. But what does it tell us about what the Fed should have done? Buy $1tr in mortgages in November ‘08 rather than waiting for 1q09? Fine, they could have, but it would have ended up in ER’s just the same. What about penalizing ER’s with negative rates? OK, except trying to figure out what rate to charge that did not impair bank profitability in November of ‘09 was a tall order. What about immediately rolling out a 2% inflation target? Again, the markets would have responded, “we thought that was the inflation target already, and yet we still had a crash.” The Fed could have said, “we really mean it this time,” in which case the markets likely would have responded, “prove it”.”

    Believe me, I understand why people feel this way. But there are two parts to my answer.

    1. Under a fiat regime nominal aggregates are under the central bank control, apart from the unlikely case where buying up all $10 trillion in T-debt wouldn’t hit the target. And even then they can move on to agency debt, foreign gov. debt. etc.

    2. The bigger issue you raise is credibility. I agree the QE and negative interest on ERs might not have got the job done. The key is targeting, and especially level targeting. That’s where you are wrong. The market realized in late 2008 that the Fed wasn’t go to do level targeting. I prefer dealing with NGDP, but the same is true of P, but to a lesser extent. The markets realized that NGDP was going to plunge sharply in the short run (and already was beginning to) and much more importantly the Fed signaled that it was OK with that, it wasn’t going to later try to bring it up to the old trend line. This made asset prices crash. In late 2008 the current value of stocks, commodities, and real estate is vastly lower if 2010 NGDP is expected to be 14.6 trillion, as compared to 15.8 trillion. And when those 2010 NGDP expectations downshifted sharply in late 2008, that made current NGDP fall off the table. Does that make sense?
    A commitment to level targeting, preferably NGDP but at least prices, would have made a huge difference. This isn’t just me, this is what the smartest macro people (like Woodford) believe.

    You said;

    “Now, one might argue that collateral was thought to be junk because the Fed was too tight — it was the Fed’s fault that collateral values were falling! I’d like to see someone make that argument… ”

    I just did.

    You said;

    “Had the Fed been able to maintain the futures price at, say, 6% NGDP growth, I would argue the other asset markets would have just looked at that price and concluded, “its manipulated”.”

    In another post I said it was obvious to me that NGDP was falling sharply. Worst case if my idea doesn’t work, I get rich. I don’t think it’s easy to get rich, hence I think my idea would have worked.

    You keep thinking in terms of all the turmoil. I’m not saying my idea would have suddenly stopped all the market turmoil, I’m saying it never would have started up in the first place. Rather, you would have had a much milder crisis, a la late 2007.

    Jon, I don’t know enough about that to comment.

    Mattias, I agree.

  21. Gravatar of ssumner ssumner
    28. May 2010 at 06:45

    W le B, I’m afraid I can’t answer the PSBR question, I simply don’t know enough about the issue.

    Yes, I look at asset prices, though I have strongly recommended that the government set up and subsidize trading in NGDP futures markets, which would be much more informative.

  22. Gravatar of David Pearson David Pearson
    28. May 2010 at 08:59

    Scott,

    I’m afraid I missed the part about how the Fed’s lack of an NGDP target caused market concerns about collateral. You imply that it was the market’s concern over “NGDP plunging sharply” that caused this concern. Let’s ignore the tautology in that for the moment. I think you are missing something important about AAA collateral.

    There are two ways to create the impression that super-safe AAA collateral is impaired. The first fits your view: it is to create the risk of such a depression as to fall outside the range of events that the ratings agency thought probable. In other words, it is to take safe collateral and make it unsafe by virtue of the severity of the recession ahead.

    The second way to impair AAA collateral does not fit your view. It is to produce large amounts of AAA-rated paper that was so egregiously mis-rated as to risk impairment under even a mild recession.

    The timing is important. House prices flattened, delinquencies spiked, a mild recession ensued, and then AAA-collateral became suspect; this caused a banking panic, which in turn crashed NGDP expectations. If this was the sequence then the Fed could only have avoided the impairment of AAA collateral by promising that house prices would always rise, because (and this is critical) this was the assumption built into ratings agency models.

    This crisis was caused by a shadow banking system that levered itself using repo’s backed by AAA collateral that then became suspect. NGDP targeting would not have prevented the collateral from becoming suspect.

    I think one place where we differ the most is in how the system “behaves”. If you adopt an NGDP target, and, as a result, create the impression that nominal price targets will never fall; then this will create enormous financial system leverage on AAA-rate assets, and, eventually, this leverage itself will cause the system to fail. None of this would be “irrational” on the part of the markets, and yet it would also be highly predictable. In fact it is exactly what I predicted and profited from during 2005-2008. The Greenspan/Bernanke asymmetric monetary policy and NGDP targeting will produce the same effect: systemic risk caused by leverage will eventually manifest itself in either case, because both are an artifice, an intervention in market prices that causes false signals and unintended consequences.

  23. Gravatar of Lord Lord
    28. May 2010 at 11:05

    I think the division into fiscal and monetary authorities is the problem because it relies on them to change their behavior with regime. We need a new division, a deflation fighting authority and an inflation fighting authority. Congress always wants to be the good cop and the Fed the bad cop. Demanding that they change roles with the economy simply isn’t functional.

    I for one would not have the slightest doubt the Fed would not counter fiscal stimulus despite what some members may say or feel, for that would take positive action while they are content doing the minimum necessary. To counter it would risk their independence and they would need to see results before acting just as they will do nothing now until they see further weakening.

  24. Gravatar of Mark A. Sadowski Mark A. Sadowski
    28. May 2010 at 15:05

    Scott,
    You wrote:
    “Mark#2, I know how you feel. Which program are you in? (Apologies if you already told me, I have a bad memory.)”

    You’re excused as you deal with so many commenters. I’m at the University of Delaware. We’re proud of our econometrics but my dearest colleagues and I are all in applied macroeconomics. That’s what makes your website so amusing to me.

  25. Gravatar of ssumner ssumner
    28. May 2010 at 18:24

    David, You said,

    “The timing is important. House prices flattened, delinquencies spiked, a mild recession ensued, and then AAA-collateral became suspect; this caused a banking panic, which in turn crashed NGDP expectations. If this was the sequence then the Fed could only have avoided the impairment of AAA collateral by promising that house prices would always rise, because (and this is critical) this was the assumption built into ratings agency models.”

    I don’t agree. I believe NGDP started falling in August, and the subsequent fiancial panic was a result of the falling NGDP.

    And I’m not willing to create recessions so that bankers take fewer risks. We need to address that problem through different regulations. Get rid of TBTF, F&F, etc.

    Lord, Monetary policy can change w/o any “positive action.” It got much tighter throughout 2008 as the Fed funds rate stayed at 2%.

    Mark, Thanks, I’ll try to remember.

  26. Gravatar of Doc Merlin Doc Merlin
    29. May 2010 at 07:35

    Nah, the people who predicted inflation don’t have it happening till around the time the National Debt Crises /really/ pick up. We have to go through some nastyness in the bond market first, and see some more short term contraction due people fleeing to safety.

  27. Gravatar of johnleemk johnleemk
    29. May 2010 at 14:00

    Scott,

    “That’s mind-boggling, and even more mind-boggling is that the Democratic leaders who are talking about additional fiscal stimulus don’t even seem to realize that there are top Fed officials who think the economy doesn’t need any more AD, and would try to offset that stimulus through higher rates.”

    This reminded me of a fantastic Krugman quote from a fantastic Krugman article on monetary policy from the 1990s, attacking “vulgar Keynesianism”: “Indeed, if you want a simple model for predicting the unemployment rate in the United States over the next few years, here it is: It will be what Greenspan wants it to be, plus or minus a random error reflecting the fact that he is not quite God.”

  28. Gravatar of johnleemk johnleemk
    29. May 2010 at 14:03

    The article, by the way is from http://www.pkarchive.org/cranks/vulgar.html

    Interestingly his throwaway discussion of the zero bound at the end reminds me of what you recently wrote about his odd writing predilections: he discusses the zero bound as if it is real, but then adds offhandedly that he doesn’t think it applies to Japan and that they could inflate their way out of stagnation. I don’t remember where he later elaborated on this view, but here is a related and more academic essay he wrote where he basically echoes your views: http://web.mit.edu/krugman/www/japtrap.html

  29. Gravatar of Scott Sumner Scott Sumner
    30. May 2010 at 07:17

    Doc merlin, Some people predicted high inflation this year.

    Johnleemk, Yes, I recall that too. I have read much of Krugman’s stuff on the zero bound, and his attitude towards it is clearly very complicated. At times he sees it as a problem, but more for practical or political reasons than theoretical. He usually acknowledges that a realy determined central bank could get around it.

  30. Gravatar of Mousa Mousa
    27. August 2011 at 13:07

    This is the first post-modern published work on Creditism – how odd that none of these people refer this guy. I just heard him present at the ASA on “Credit Expansion Economies,” I wonder how long it will take for someone to try to claim they created that term as well?
    http://www.net4dem.org/mayglobal/Events/Conference%202004/papers/GregoryMorales.pdf

  31. Gravatar of syoutsai syoutsai
    9. June 2012 at 19:48

    Found this on: netdem.org/mayglobal/Papers/GregoryMorales.doc
    This was taken from page three:

    “Global Credit Economy”

    “Creditism (Morales, ‘Our Null Society’: Creditism)
    ALV
    Cr-Cr*C – Cr *V – Cr *DI = Cr *VA
    AMV

    Looks like he was not only writing about creditism but published a formula as how it was done – and that way back in 2003.

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