No we can’t

I’m so depressed I just want to give up on this pointless crusade, but I suppose I’d better say something about Bernanke’s “pep talk” today in front of Congress.  In the Q&A he argued that “no one” can dispute the aggressive nature of monetary policy today:

“Senator I think it’s important to preface the answer by saying that monetary policy is currently very stimulative as I’m sure you are aware.  We have brought interest rates down close to zero, we have had a number of programs to stabilize financial markets, we have language which says we plan to keep rates low for an extended period. And we have purchased more than a trillion dollars in securities.

“So certainly no one can accuse the Fed of not having been aggressive in trying to support the recovery. That being said, if the recovery seems to be faltering then we will at least need to review our options.

I guess that makes me “no one.”  In the 1930s everyone seemed to think Fed policy was expansionary.  They cut rates close to zero, they dramatically increased the monetary base, they encouraged banks to hold on to more reserves.  Hoover set up a fund to help the banking system.  I’m not disputing that the Fed has done more this time.  But Bernanke himself admitted that we now know Fed policy was actually contractionary during the 1930s.  By what benchmark can the economics profession say it was contractionary then, but is highly expansionary now?  I’ve asked the question 100 times of my fellow economists and still haven’t received an answer.

The broader aggregates? OK, I admit they fell in the 1930s.  But I thought the monetary aggregates were discredited as policy indicators in the 1980s?  Now you have economists who had dismissed monetarism as a washed up doctrine suddenly clinging to the aggregates as the one piece of evidence that money was easier this time than in the 1930s.  This crisis makes economists look like a bunch of atheists who suddenly accept the Lord on their deathbed.  Well it’s too late for that, even M3 is falling now.

Here’s the problem.  The Fed’s “effort” only matters if one policy stance is more costly than another.  That may be true for fiscal policy, but it isn’t true of monetary policy, at least for any plausible policy stance.  Krugman talks about how massive QE could expose the Fed to some price risk.  But there are three things the Fed could do with minimal price risk; lower the interest rate on reserves, set a price level target, and do several trillion in QE with T-bills and short term T-notes.  In practice, the Fed would never go beyond those three steps, so it makes no sense to talk about the Fed having “given it the old college try.”  The correct metaphor is a steering wheel.  Is the steering wheel set at a position where they expect to reach their goal?  That’s the only sense in which one can talk about “easy” or “tight” money.

Here’s what Bernanke says about the prospects for reaching their goals:

The unemployment rate is expected to decline to between 7 and 7-1/2 percent by the end of 2012. Most participants viewed uncertainty about the outlook for growth and unemployment as greater than normal, and the majority saw the risks to growth as weighted to the downside. Most participants projected that inflation will average only about 1 percent in 2010 and that it will remain low during 2011 and 2012, with the risks to the inflation outlook roughly balanced.

Bernanke’s lucky that Congress doesn’t have a clue as to how to interpret Fed-speak, because he is basically saying the following:

1.  The Fed has reduced its implicit inflation target below 2%, indeed below even 1.5%.

2.  The Fed sees more downside risk on jobs, but puts a zero weight on jobs in its policy deliberations.

Bernanke has frequently suggested that the dangers of missing the inflation target are not symmetrical, with deflation being a far more serious problem than modestly higher inflation.  If the Fed is forecasting 1.25% inflation in 2012, and if they also think the inflation risks are balanced, then we know the hawks have won.  Especially given the downside job risks.  Last year Janet Yellen said “we should want to do more.”  Today Bernanke basically said the Fed has options, but doesn’t want to do more.  As I noted earlier, I suspect his actual views are slightly more dovish, but he may feel obligated to paper over differences at the Fed when testifying to Congress.

Oh, and one other thing.  Bernanke told Obama that he better plan on running for re-election in 2012 with the same unemployment rate George Bush faced in 1992.  You remember, the Bush that presided over a big foreign policy success in the Gulf War, and then got 38% of the vote two years later.

Bernanke also noted that the Greek crisis had increased the demand for dollars, causing NGDP growth forecasts to fall below levels expected in April:

One factor underlying the Committee’s somewhat weaker outlook is that financial conditions–though much improved since the depth of the financial crisis–have become less supportive of economic growth in recent months. Notably, concerns about the ability of Greece and a number of other euro-area countries to manage their sizable budget deficits and high levels of public debt spurred a broad-based withdrawal from risk-taking in global financial markets in the spring, resulting in lower stock prices and wider risk spreads in the United States.

Oddly, he did not indicate any Fed plans to respond to the increase in demand for dollars.  Instead, the Fed is content to see the Greek crisis further depress the already pathetically weak NGDP growth forecasts.  But they do plan to keep an eye on the situation:

We will continue to carefully assess ongoing financial and economic developments, and we remain prepared to take further policy actions as needed to foster a return to full utilization of our nation’s productive potential in a context of price stability.

And what might those further actions be?  Returning to the Q&A link above:

“We have not fully done that review and we need to think about possibilities. But broadly speaking, there are a number of things we could consider and look at; one would be further changes or modifications of our language or our framework describing how we intend to change interest rates over time — giving more information about that, that’s certainly one approach. We could lower the interest rate we pay on reserves, which is currently one-fourth of 1%. The third class of things has to do with changes in our balance sheet and that would involve either not letting securities run off — as they are currently running off — or even making additional purchases.

Here’s how to tell if the Fed is serious, if and when it moves.  If they take one of those three steps, it will merely be a desultory action aimed at mollifying the markets.  If they are serious, and really want to turn around market sentiment, then they will use the multi-pronged approach I recommended last year; eliminate interest on reserves, major QE, and some sort of quasi-inflation targeting language.  As Bernanke indicated, the best we could probably hope for regarding inflation targeting is a vague mention that rates would be left low until some collection of macro indicators rise much more substantially—i.e. no early exit.  Those three steps might not be enough for a fast recovery, but it would almost certainly get things moving again. 

At a personal level I do get some satisfaction from seeing Bernanke finally mention reducing the IOR as a possible expansionary policy option.  My very first blog post (after the intro) was on this issue.  Even earlier I mentioned it in a short paper in The Economists’ Voice.  Even before I set up my blog, people like Jim Hamilton were warning of the contractionary nature of IOR.  But I do think I pushed the idea a bit further, especially with my suggestion of negative rates on ERs.  (An idea later adopted in Sweden, but with lots of loopholes.)  In the early days I took a lot of grief for focusing on this issue, although I always thought other steps like inflation/NGDP targeting were more important.  But with Bernanke mentioning it as a policy option, I think the Hall/Hamilton/Sumner view that IOR was contractionary has been vindicated.  Bernanke would not mention reducing IOR as one of three possible expansionary steps, if the program itself was not contractionary.

Despite this minor personal vindication, today fills me with gloom.  It will be interesting to hear what you commenters think.  How about it JimP?  Did Bernanke exhibit the sort of “Rooseveltian Resolve” that (in 1998) he insisted the Japanese needed in order to get out of their Great Recession?  Did he show the “yes we can” spirit?  The Rooseveltian/Kennedyesque/Reaganesque determination that we won’t put up with high unemployment for as far as the eye can see?  Or did he blink? 

PS.  Yes, there might be some “recalculation” problems out there.  But how can we know that without first boosting NGDP growth, which is currently only one half the pace of the recovery from the 1982 recession?

Update:  Torgeir Hoien has a nice piece on monetary policy at the zero rate bound.


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83 Responses to “No we can’t”

  1. Gravatar of JimP JimP
    21. July 2010 at 18:35

    Scott

    I still don’t get it. What does Bernanke think he is doing? He must understand the effect of his sadness – his communication of low expectations.

    He is not supposed to tell us of his sad expectations. He is supposed to set ours. He understands this.

    It really is as if he really does want what we are now getting. He could actually stop this. Just by speaking in the right way. Just by promising somewhat higher inflation. And he refuses to do so.

    As Paul Krugman says:

    “Ben Bernanke’s testimony today, as expected, lacked all sense of urgency. Hey, the economy’s a bit disappointing, and maybe someday we might think about doing something about it”

    http://krugman.blogs.nytimes.com/2010/07/21/the-fedfail-index/

  2. Gravatar of StatsGuy StatsGuy
    21. July 2010 at 18:57

    Buck up, Don Quixote!

    Besides, you gotta ask yourself why the stock market isn’t flipping out even more than it has, given the ECRI readings and such…

    I suspect this is why:

    http://www.automatedtrader.net/real-time-dow-jones/6653/us-senator-dodd-hopes-to-have-panel-vote-on-fed-nominees-before-august

    So there is still hope…

    Of course, it was Nietzche who said “Hope is the worst of evils, for it prolongs the torment of man”.

    Peter Diamond is NOT a wimp. Janet Yellen is taking the #2 spot, and she’s a Berkely ex, and you gotta imagine she occasionally talks with Brad DeLong. And Sarah Raskin… well, I don’t know a darn thing about her really. Still, it’s quite possible Diamond might tell Plosser to go stuff it.

  3. Gravatar of Benjamin Cole Benjamin Cole
    21. July 2010 at 20:12

    Again, a terrific blog from Scott Sumner. There is no more important economics commentator right now in America than Scott Sumner.

    Boy, talk about lowered expectations. Yes, we should stand idly by while economic prosperity is slowly strangled. I guess we will derive substantial psychic income from a 1 percent inflation rate–enough to balance the real income we are losing. At least the Fed thinks so.

    I still think Bernanke is a smart guy. He did not “refudiate” (a new word coined by Sarah Palin) QE, in fact he left that option on the table.

    My guess is we sink into deflation (by some measures we are there already), and then Bernanke pulls off the fighting gloves. But we have to suffer first.

    If you are Irish, Jewish, Catholic, Puritan, Nordic, Chinese, Japanese or from many other groups, you know you have to suffer first, and this may make a little sense. But I never thought that ethnic eccentricities would come to form the basis of monetary policy. (Apologies to all).

  4. Gravatar of Joe Joe
    21. July 2010 at 20:35

    Professor Sumner,

    Fantastic post! I continue to learn so much.

    But, I want to make sure I’ve understood you.

    To get out of the liquidity trap, Bernanke has to announce publicly that he is aiming for X % inflation or Y price level, and that he will hence fourth engage in QE of trillions of dollars until the “people” get their butts moving and we hit the target, and then he will do it again and again and again until aggregate demand is able to increase on its own….

    correct?

    Joe

  5. Gravatar of Bonnie Bonnie
    21. July 2010 at 21:18

    Prof. Sumner:

    I am perplexed. I don’t understand why Bernanke would say that monetary policy is highly accommodative. I notice that he didn’t use the word “expansionary”. Are the two terms interchangeable or are there technical differences? Like does accommodative mean loose credit, but not necessarily easy money? What is he seeing that the rest of us aren’t?

    I saw inflation falling in the last half of 2007 and into 2008 though the commodities and wage reports. I honestly cannot tell where it came from, but thinking about Friedman’s saying that inflation is always and everywhere a monetary phenomenon isn’t the reverse more true than not?

    What could possibly justify a ~1% inflation target when the consequences of getting there are so dramatically bad? The longer they go without at least explaining it, the skeptic in my really starts to swing into full gear. I really don’t like having the Fed relieve themselves on us and try to tell us it’s raining.

    Anyone care to join me in a letter writing campaign? Our Congress critters need to wise up and make the Fed do its job.

  6. Gravatar of Mikko Mikko
    21. July 2010 at 21:56

    I’ve been wondering about the asymmetry between deflation and inflation. Could it be that deflation is especially harmful because it makes the recalculation of the economy as a whole a difficult job?

    After all, we know that optimizing an economy is information theoretically hard (NP-complete) problem. Hence, anything that throws the economy off a solid track where we can use local optimization heuristics to get further, might be very bad indeed.

    Is there any work on this area you’re aware of?

  7. Gravatar of Bonnie Bonnie
    21. July 2010 at 21:59

    I didn’t mean to ask you to defend the indefensible. That’s Bernanke’s problem. Most of the questions in my last post are rhetorical, except for the ones about interchangeable terms and Friedman’s theory of inflation. I understand you are likely as puzzled as I and that you think a ~1% inflation target is insane.

    I don’t know what to do about this situation except try to get it circulating through the political sphere. I have a few connections, but most are no longer in congress. Would it be too much to ask for a simplified version, sort of an elevator speech, of what the problem is and what needs to be done about it so I can shop it around? If it’s too much I’ll try to compose something. Would you be willing to give it a look before I let it fly?

  8. Gravatar of Mikko Mikko
    21. July 2010 at 22:03

    Just to continue very shortly. I come from a computer science background and for me, recalculation would be any event that shocks the economy in such a way to force a major economy wide recalculation. What I am suggesting is that perhaps deflation (or big drop in NGDP / NGDP expectations) could be sufficient to cause such recalculation.

  9. Gravatar of JKH JKH
    21. July 2010 at 23:33

    I was thinking of you, listening to the testimony live, at the precise point of your first quotation, for the reason you explain.

    It’s understandable you would have mixed feelings for his late in the day zero IOR policy option consideration.

    I think I asked you once if you’d seen anything said or written by the Fed on their reason for paying 25 basis points. I still haven’t. It’s only recently I’ve heard more in general about the dangers of compressing money market industry margins even more than they already are. That’s an argument that goes back a long way, well before we got down into this rate territory.

    BTW, there was apparently quite a brouhaha of anticipation in the stock market about the 25 basis point issue for the couple of days prior to the testimony. Maybe that’s more vindication for you than Bernanke actually mouthing the words.

    Have you seen any good analysis done about the effectiveness of what the Riksbank’s done?

  10. Gravatar of Luis H Arroyo Luis H Arroyo
    21. July 2010 at 23:40

    Mikko: I think you are right, wheen you say:

    “I’ve been wondering about the asymmetry between deflation and inflation. Could it be that deflation is especially harmful because it makes the recalculation of the economy as a whole a difficult job?”

    the main problem with deflation is the lack of any information about what the rest is doing. To recalculate the price an wages accurately is impossible.

    I supppose Bernanke is speaking cautiously for political reasons. Remember he don´t initiated his QE expansion until Lehman brothers was down. Perhaps if… Lehman could have been saved -or at least the crisis would have been less hard.
    It is as he need some dramatic facts to act. As any constitutional prosecutor, he need more than cirscunstantial proves to jail the criminals…

  11. Gravatar of Doc Merlin Doc Merlin
    22. July 2010 at 00:00

    @Mikko:
    I’m not Scott, but I will try to answer anyway.

    Recalculation isn’t necessarily bad.
    During the early nineties for example there was massive recalc as businesses tried desperately to find more programmers and engineers, but it was a boom time.
    Also, I wouldn’t say that deflation causes a negative recalc, but rather that a drop in NGDP expectations in a country with some very sticky variable would cause it. Scott believes the main contributing factor is wage and price stickiness, I think its mostly a result of contracts and long term debts.

    I have a physics background and like your computer science background, I also tend to see the economy in a very Hayekian framing… as massive distributed cellular automata computation.

    “After all, we know that optimizing an economy is information theoretically hard (NP-complete) problem. Hence, anything that throws the economy off a solid track where we can use local optimization heuristics to get further, might be very bad indeed.”

    The only ones I know of who look at this directly are the Austrians, but unfortunately they completely lack mathematical rigor. :-( It is an approach that really deserves more looking into, and is approach that I am most interested in (now that computational mathematical theory has advanced!). Its great to see someone else who is!

  12. Gravatar of Mikko Mikko
    22. July 2010 at 01:50

    Of course, recalculation isn’t necessarily bad. It’s actually a good thing when it comes from new needs. I view Scott’s push for stable NGDP growth as a method to ensure that monetary policy does not cause shocks that cause major (in a sense useless) recalculations in real economy.

    I share your feeling that it’s not just about wage stickiness but also about all kinds of long term contracts. Those contracts relay information that _was_ useful in a world with solid NGDP expectations. It no longer is and it takes a whole lot of “recalculation” to figure out the changes. And since economy is an evolutionary distributed computing machine, finding even a reasonably good local optimum can take a lot of time.

  13. Gravatar of JL JL
    22. July 2010 at 02:04

    Dear Prof. Sumner, Doc. Merlin and Mikko,

    My background is in Math, Physics and Computer Science. I am not an economist by trade, but I do intuitively grasp concepts like Pareto Efficiency.
    I do not think it is a coincidence that many of your readers are similar, I think many of us, at least myself, would recognize ourselves as an “autistic economist”.

    “I also tend to see the economy in a very Hayekian framing… as massive distributed cellular automata computation.”

    Me too: I quickly became an Austrian when I first became interested in macroeconomics, but eventually I did some math and it just didn’t add up.

    Anyway, what irks me, aside from the gloom, is the following:

    1 year T-bond yields are 0.27%. (6 month: 0.19%, 1 month: 0.16%).
    Anyone can buy a T-bond.

    The Fed pays 0.25% on excess reserves, which can be withdrawn at any time.
    Only an elite club of banks can deposit money at the Fed.

    Why are we accepting this? This is obviously not “Free to Choose” free market economics.
    It’s a giant government subsidy, where elite banks get an artificially high interest, above the market rate, paid for by the Fed, which is a government institution, backed by tax payers.

    If banks want to deposit money with the US government, let them buy T-bonds like everybody else.
    Or, alternatively, if the Fed wants to pay interest on excess reserves, it should pay a rate that is strictly less than the 1 month yield on T-bonds, e.g. half a percentage point less.

  14. Gravatar of Doc Merlin Doc Merlin
    22. July 2010 at 02:31

    @Miko:

    :-)

  15. Gravatar of Bill Woolsey Bill Woolsey
    22. July 2010 at 03:53

    Scott:

    Please quit with the “inflation” targeting.

    Return money expenditures to the growth path of the
    Great Moderation.

    I know I have been promoting some disinflation (an approach which you criticized as crazy,) but if you really want to get back to the 5% growth path, that is $17.7 trillion in the second quarter of 2011.

    That “they” all talk about inflation, so you need to as well, is not working.

  16. Gravatar of OGT OGT
    22. July 2010 at 05:01

    JimP- The best thing about Krug’s Fed fail index is that it makes the dreaded amorphous ‘dual mandate’ into one easier to understand number. It’s always been my observation that assigning a number to any observation or prediction tends to give people a much stronger (sometimes false)belief in its validity.

    I think he should invert it though, negative numbers and downward graphs are much scarier. Remember how happy we all were when the Case-Schiller index was going up, up, up?

  17. Gravatar of Doc Merlin Doc Merlin
    22. July 2010 at 05:08

    Bill Woosley:

    Agreed! NGDP (or cash expenses) or some other flow makes far more sense to target than inflation!

    Anyway, tshirts with NGDP targeting!

  18. Gravatar of Fed Chairman Bernanke’s Tepid Testimony | EmpirestateFX.com Fed Chairman Bernanke’s Tepid Testimony | EmpirestateFX.com
    22. July 2010 at 05:21

    [...] could do with additional monetary stimulus left several dismal scientists discouraged, including Scott Sumner and Paul Krugman, who wrote the Fed head’s commentary “lack all sense of urgency” [...]

  19. Gravatar of rob rob
    22. July 2010 at 05:31

    Why doesn’t the White House get it? I can understand the Fed willing to err on the side of… failure, since they won’t be viewed a failure unless they go against conventional wisdom AND fail, but Obama has much more to lose here. Do you think the administration is simply clueless? I can understand that fiscal stimulus seems like the more pro-active solution to liberals–but aren’t they politically savvy enough to realize they are going to be judged next election season by the results not the means?

  20. Gravatar of Daily Digest for July 22 » New Deal 2.0 Daily Digest for July 22 » New Deal 2.0
    22. July 2010 at 05:50

    [...] We Can’t (The Money Illusion) Bernanke says the Fed’s response to the recession has been aggressive, but Scott Sumner [...]

  21. Gravatar of Indy Indy
    22. July 2010 at 05:58

    I think I understand the Fed’s thinking here, but it’s almost a sort of speculative Kremlinology at this point. Odd, in a transparent democracy, that we have purposefully organized one of our most important institutions into something like the Kremlin, where, despite ‘regular testimony’ we really can only guess at the hidden motives and ideas of the insiders of a secretive cabal.

    Anyway, I’m thinking that, at this point, they are of opinion that “the financial system crisis / banking collapse” has become a more-or-less ordinary slump, or at least continues to get closer to an ordinary slump every day.

    A few more quarters of zero-rates, slow but steady growth, low (but not negative) inflation, absorption of excess capacity, and a gradual winding-down of unemployment, and we’ll be able to get back to “normal” in a few years, after all the baby-boomers retire and need to be replaced.

    They probably think that is they do extraordinary things in this environment, they will set a precedent and be asked to do them in every ordinary slump. So, in addition to whatever risks they see for policy, they also don’t want it to become seen as standard policy.

    What can I expect, really, but near-recessionary conditions for the next two years?

  22. Gravatar of scott sumner scott sumner
    22. July 2010 at 07:10

    EVERYONE, The other comments in previous posts will be answered this evening. (If I have time! The comments are very numerous today.)

    JimP, Yes, Krugman had a good post.

    Statsguy. D*** You! You’ve given me renewed hope. Now I’ll have my heart broken once again. Seriously, Those are good observations, but isn’t it amazing that we have to wait until August when the two seat lay empty for 18 months.

    Benjamin, I am 3/8 Nordic and 5/8 Puritan, so I take great offense at your ethnic stereotyping! Seriously, you are right, there is this Puritan instinct in policy-making. If you go back to February 2009, you will find a whole post on the Puritan instinct in Fed policy.

    Joe, He needs to watch the TIPS markets (which shows inflation expectations) for guidance as to how much QE is needed. This won’t work perfectly, but it will be better than current policy. If they remove interest on reserves and set an inflation target, I don’t think they need significant QE.

    Bonnie, You said:

    “What could possibly justify a ~1% inflation target when the consequences of getting there are so dramatically bad? The longer they go without at least explaining it, the skeptic in my really starts to swing into full gear. I really don’t like having the Fed relieve themselves on us and try to tell us it’s raining.”

    That last sentence is a gem. You are a natural born blogger.

    The public doesn’t understand why higher inflation is needed. It might be better to fight for getting back to a 3% of 4% growth rate in national income from the 2008 base. We are currently far below that trajectory, so we need faster catch up growth in the short run. The public can understand why falling national income is bad, even if they are confused about inflation.

    Mikko, I have always thought it was because wages were very sticky in the downward direction. But in this particular crisis the worsening debt problem is also an issue.

    Bonnie#2, Again, I think that the nominal national income (NGDP) variable is an easier sell to people. Talk about how national income fell at the fasted rate since 1938, and how the Fed is responsible for (Nominal) national income through monetary policy.

    Mikko, By definition recalculation is a real shock that can’t be fixed through monetary policy. If monetary stimulus solves the problem, it is garden variety AD shortfall, not recalculation.

    JKH, Good to hear from you again. The Riksbank action had some loophole (for day time or overnight reserves, I forgot) that made it largely ineffective. But that was their choice, it could have been written without that loophole. But I’ve come to believe that the Fed has the tools to get the job done w/o negative IOR, so I use it more as a debating point than as a serious policy recommendation. I doubt they would do it. Zero IOR plus large QE plus a higher inflation target would definitely be enough to get things moving, in my view.

    Luis, I agree that institutional factors push Bernanke into caution, and also you point about wage adjustment.

    Doc Merlin, My general take is that the Austrians are right to be skeptical of trying to model the economy with a complex set of equations. That’s why I like looking at market prices; it is a very Hayekian way of thinking about macro, in my view. The markets are already doing the calculations, and telling us what is likely to happen to inflation and other variables.

    JL, I agree about the IOR being unjustified. Also see my previous answer to Doc.

    Bill, I always try to mention NGDP (I hope I didn’t forget), but right now the Fed is more likely to commit to higher inflation, then when we get out of this recession let’s work on converting the profession to NGDP. Inflation didn’t give anywhere near as clear signals as NGDP during this entire business cycle. We need to convince the profession, then the Fed will follow along. Right now a bit higher inflation target is the best we can hope for.

    OGT, I think there is one flaw in the Fed fail index, he should not use absolute values. If you have a supply shock you might have low growth and high inflation, but the Fed may still be doing a good job with AD. If it were done right it would look almost exactly like deviation of NGDP from trend. I should be:

    2*(U – 5%) + (2% – infl.)

    That would be pretty close to deviations of NGDP from trend

    rob, The White House is getting bad advice from a very self-confident economist who shall go nameless.

    Indy, But why didn’t those conventional steps work in Japan? Surely the Fed knows there is a risk that we fall into the same low growth trap?

  23. Gravatar of Mike Sandifer Mike Sandifer
    22. July 2010 at 07:16

    Scott,

    Do you find it maddening that Bernanke today called for continuing fiscal stimulus?

  24. Gravatar of Lee Kelly Lee Kelly
    22. July 2010 at 07:57

    Scott,

    Maybe you can reframe nominal expenditure targeting as a special type of inflation target, i.e. an inflation target adjusted for real growth. Perhaps that will make it more palatable to those you wish to win over. I have (like Bill?) been perplexed by your sudden shift into inflation-speak, when it is not inflation per se that you care about.

    On the other hand, perhaps I have no idea what I am talking about.

  25. Gravatar of Defennder Defennder
    22. July 2010 at 08:02

    This is an interesting take by the WSJ econs blog on why they think eliminating interest paid on excess reserves won’t help.

    http://blogs.wsj.com/economics/2010/07/21/ending-interest-on-reserves-wont-help-economy-much

  26. Gravatar of David Beckworth David Beckworth
    22. July 2010 at 08:09

    JKH:

    Nice to see you hanging back around us mainstreamers again! Your comment mentions how the stock market viewed the dropping of the IOR as good news. Presumably, that is because such a move was viewed as stimulative by the stock market. Given our past conversations on the money multiplier, how do you interpret this reaction by the stock market? Does it not lend itself to the traditional money multiplier story?

    BTW, I have done some empirical work where I look at the effect of unexpected increases in non-borrowed reserves (i.e. bank reserves coming from open market operations that were not expected given the economic conditions). What I find is that the unexpected increase in non-borrowed reserves leads to an increas in deposit and loans and ultimately a boost to the economy. I have thought about blogging these results but it’s probably too technical for a blog post (uses a vector autoregression with a number of economic variables). I would like to write it up, though, and get feed back from some Post-Keynesians on it.

  27. Gravatar of Indy Indy
    22. July 2010 at 08:32

    @sumner:

    “Indy, But why didn’t those conventional steps work in Japan? Surely the Fed knows there is a risk that we fall into the same low growth trap?”

    Your read my mind. When I finished that comment, I thought, “Oh, I should have said they believe we’re somehow inherently different and won’t fall into a Japanese perma-sluggish deflation.”

    I not sure if the Fed believes this, or if they do, why they do. I can only guess, but hear goes. I would guess at two things that makes us different.

    1. Plenty of Land, Natural Resources and “Factor Endowments”. Growth, at least in the new use of these unused resources, *can* resume because there’s room to grow. Japan is left with expensively paving over the hilly and tiny portion of their islands that remain unpaved and unfarmed. I hope they don’t!

    2. Our rate of population growth, especially workforce population. Japan’s population was 122.6 million in 1988, and 127.7 in 2008 – only a 4% increase in two decades, or only 0.2% annualized – basically flat, except, there’s been a huge movement in their population composition from young to elderly. Their total workforce is projected to contract rapidly in the next decade. There’s no “natural” real growth and ability to soak up and absorb excess capacity, passively, as it were.

    Now, compare the US with our 25% growth over 20 years, and our 1.2 million extra households per year, from immigration and our replacement birthrate. Calculated Risk estimates that there are still 1.7 to 2 million excess housing units in the US. But building is only at 600K, and demolitions at around 200K. So, net improvement in the excess could be as much as 800K (or nearly a 50% drop in a single year). We’ve already brought down excess units by over a million since the beginning of the housing bust, but there’s still a lot of overhang.

    So, construction will remain in a depression in the short-term, but house construction should begin to pick up in 18 months or so, and in “only” three years, we should return to normal and be building well over a million housing units a year just to keep up with our natural growth. And in the past, growth in house construction has helped lead us out of recessions. Japan simply doesn’t have this.

    Now, I’m sure you can argue that “population growth didn’t help in the depression”, but that’s not the question. The question is “what makes us different from Japan”, and I see these two things, but especially our population growth, as an enormous advantage over them.

    Again, all I can do is speculate, but I would bet that the Fed essentially thinks something like this:

    “Look, it seems bad out there, we know, but it’s actually not *that* bad (not Great Depression / total economic collapse bad) from our perspective. The banks are saved. The system is now mostly secure. Bailouts all around, and all that. Global Policymakers are now on the case of their troubles (ECB, Greece, Austerity, etc..) The markets have bottomed, or, at least, are close. The stock market (EMH!) is telling us not to despair, maybe to be a little optimistic. China’s growing fast enough to resupply AD to the world, etc, etc…

    Look, the next few quarters are going to be tough as the boost from the stimulus fades, but not so extremely tough we can’t survive it. We can provide transfer payment safety-nets to those who are suffering in the mean time, but the conditions are now established for normal growth to return, as we expect it, inevitably, will.

    “Our role now, therefore, is only to do what we would do in a normal slump. Keep rates very low, provide as much support and liquidity to the banking system as they want, and mostly, to *play for time* and breathing space, as the economy naturally recalculates, adjusts, deleverages, and the population grows to suck up all that excess out there.

    And when the baby boomers all retire or depart this mortal plane, it will create a lot of headroom and need of replacement workers. In a few years, unemployment will be heading downward, growth will resume, and rates will gradually but inevitably climb not just above zero but to their normal healthy in the mid single digits.”

    “In the meantime, we should be prudent, cautious, patient, and, most of all, careful to preserve our credibility and reputation for our steadiness and anti-inflation discipline, even in the face of harsh adversity. The trust that creditors place in our unflinching restraint and self-control is truly our most previous asset.

    “It only takes the slightest departure from our normal behavior to destroy that trust, and so we will not depart from that pattern unless absolutely compelled by catastrophic events to do so, let it create a perception of new precedent, or a weakening of our resolve, or the politicization of our acts.

    “There will be times in the future just like this. High unemployment, slower-than-normal growth, excess to work off, but without actual panic as to the system’s very integrity or widespread suspicion of the fundamental corruption of our economic order. We must preserve the expectation that we will deal with those situations in our normal, typical way, and not impulsively result to extraordinary and reckless ad hoc improvisations the minute we encounter distress! We are reasonable men! We are very prudent persons! We are bankers, by God!”

  28. Gravatar of Dilip Dilip
    22. July 2010 at 09:16

    Someone may have already posted this in this comments section since I didn’t read through it completely. Here is Joseph Gagnon, echoing most of your views here:
    http://www.huffingtonpost.com/joseph-e-gagnon/time-for-a-monetary-boost_b_654944.html

  29. Gravatar of Benjamin Cole Benjamin Cole
    22. July 2010 at 10:16

    Scott-

    I went back and read your 2009 Feb. post on Puritanism and monetary policy.

    I think I have died and gone to heaven—finally, a real-world Phd. in economics I agree with!

    Now, when you post your views on Pigou and consumption taxes, I will enter some sort of euphoric nirvana afterlife.

    Seriously, I am on old-hack finance reporter who took a lot of economics in college, and even worked briefly at the Congressional Budget Office. So I love the field, love public policy questions, but never got deeply into monetary policy.

    Your column, and your overall views, are a wonderful departure from the worn-out nostrums of both political wings.

    Some sort of seminal book is needed from you.

  30. Gravatar of Mikko Mikko
    22. July 2010 at 10:23

    Scott, as I said, I come from computer science background. If by definition recalculation is something that cannot be fixed with monetary policy, then you are lacking a word.

    The economy, as a distributed information processing system, is on normal times involved in a kind of a genetic algorithm searching for higher local optimums. A real shock to an economy can change the landscape on which the computation takes place and force a recalculation. But monetary shock can render the _information_ carried in prices meaningless (because those prices where useful with a particular NGDP expectations). When expectations change, all those prices need to be rethought. And since the race to search the new local optimum _is_ a search, there’s no guarantee that the result looks anything like the original situation.

    Hence, a monetary shock should be able to cause a real recalculation in the economy. Consider an extreme: hyperinflation causes the price signals to basically break down – almost all information that price system relayed vanishes. This means that the relative prices of things change depending on how dependent they are on money as a medium of exchange.

    I don’t buy the wage stickiness theory as the whole reason. I believe it’s part of the problem, but part of the problem might be about the fact that changing the medium of information (money) causes problems for the genetic algorithm we are running.

  31. Gravatar of OGT OGT
    22. July 2010 at 10:58

    Sumner said: “If it were done right it would look almost exactly like deviation of NGDP from trend. I should be:

    2*(U – 5%) + (2% – infl.)

    That would be pretty close to deviations of NGDP from trend”

    I hadn’t actually looked at the formula with any seriousness, in general it’d be an improvement to have some widely accepted measure of Fed performance. I know you’d say that number should be NGDP! But a more direct derivative of their current legal mandate might have more political traction.

    BTW, when I plugged your formula in it gave the Fed better marks for allowing 1% deflation along with 9.5% unemployment than the current 1.1% inflation. Let’s not enourage them!

  32. Gravatar of marcus nunes marcus nunes
    22. July 2010 at 11:34

    Bob Solow testifying before Congress on DSGE models(!)
    “…The point I am making is that the DSGE model has nothing useful to say about anti-recession policy because it has built into its essentially implausible assumptions the “conclusion” that there is nothing for macroeconomic policy to do. I think we have just seen how untrue this is for an economy attached to a highly-leveraged, weakly-regulated financial system. But I think it was just as visibly false in earlier recessions (and in episodes of inflationary overheating) that followed quite different patterns. There are other traditions with better ways to do macroeconomics.
    One can find other, more narrowly statistical, reasons for believing that the DSGE approach is not a good way to understand macroeconomic behavior, but this is not the time to go into them. An interesting question remains as to why the macroeconomics profession led itself down this particular garden path. Perhaps we can come to that later”.

  33. Gravatar of StatsGuy StatsGuy
    22. July 2010 at 12:31

    “Seriously, Those are good observations, but isn’t it amazing that we have to wait until August when the two seat lay empty for 18 months.”

    Well, yes. JimP nearly had a coronary about this a few weeks ago.

  34. Gravatar of azmyth azmyth
    22. July 2010 at 12:52

    Mikko: I don’t think that economic calculation is NP complete because solutions cannot be verified. The economy is comprised of individual agents, each of which is searching for a local maximum for their (utility, satisfying goals, happiness, etc). No outside observer can determine whether they have satisfied their own optimization criteria, since no one fully knows what someone else’s goals are. Nor can anyone determine if society as a whole has reached an optimum, because of externalities and path dependence and other real world details. Finally, the possibilities for the way the economy could be organized are infinite and rapidly changing. An optimum allocation of resources a year ago is already out of date, due to changing technology.

    I would recommend Hayek’s Use of Knowledge in Societyas a good starting point. You are right on target with prices and information. It really is amazing the economy does as well as it does. I suppose you could think of the job of monetary policy is to minimize the noise to signal ratio of price changes. Prices need to change to reflect supply shocks, but economy wide demand shocks don’t add any useful information for agents trying to figure out how to use their resources to satisfy their goals.

  35. Gravatar of Liberal Roman Liberal Roman
    22. July 2010 at 13:00

    ““Seriously, Those are good observations, but isn’t it amazing that we have to wait until August when the two seat lay empty for 18 months.””

    What are the chances that Shelby blocks this? 80%? 90%? 100%?

  36. Gravatar of Karen Karen
    22. July 2010 at 13:15

    It is not very stimulative when cash is now also being used as collateral for loans http://online.wsj.com/article/SB10001424052748703792704575366992490339102.html?mod=WSJ_hps_sections_smallbusiness

    Not only is the Fed paying interest on reserves, but banks are now actively working to contract to the money supply by neutralizing the money they would create through the loan process by requiring the lendee to hold cash as collateral on it. (I’m not sure who’s the brilliant risk strategy analyst who came up with the policy that businesses seeking loans because they need liquidity, need to have adequate liquidity to get it.)

  37. Gravatar of Matthew Yglesias » The Change We Need Matthew Yglesias » The Change We Need
    22. July 2010 at 13:25

    [...] here’s Scott Sumner with much the same points. Paul Krugman has [...]

  38. Gravatar of JKH JKH
    22. July 2010 at 13:45

    David,

    I mentioned the stock market because of the point you raise. The traditional money multiplier story remains quite alive in popular perception as well as the academy. The Post Keynesian steamroller either hasn’t been heavy enough, or has missed the target completely. On the contrary, the idea of the banks doing something with their excess reserves is a story that’s been building steadily in the popular business media, even before recent days. But this was the first time I’d heard of the stock market becoming excited about it. I’m not sure it’s the multiplier story per se; it’s more the elementary idea that the bank’s are “sitting on” the reserves as opposed to “lending” them out on a first go around. The idea that the Fed might do something to encourage more activity was taken as bullish by the stock market.

    (I won’t bore you or Scott with a rehash of the anti-theory. I haven’t changed my view. Although, someday I may bore with a more personal theory of how the mere existence of volatility belies the EMH.)

    Anyway, I think the idea that Bernanke has responded with a sort of contingency plan for eliminating the 25 basis points is something I should acknowledge here. More importantly, Scott’s idea that the Fed really has been too tight is starting to make more sense to me, at least as a point of view that should have been taken seriously all along. There’s no question it’s become a legitimate risk at this juncture, which vindicates anybody who was pounding the table previously about such a risk. I’ll be interested to see how it plays out.

    Regards,

    JKH

  39. Gravatar of Dustin Dustin
    22. July 2010 at 13:52

    “I’m so depressed I just want to give up on this pointless crusade, but I suppose I’d better say something about Bernanke’s “pep talk” today in front of Congress. ”

    —————————————————————-

    I’m depressed too. But don’t give up your “pointless” crusade. Or, at the very least, don’t give up writing this blog.

    I love your ideas and I’ve found myself coming here several times a day to get my Sumner fix (i.e. your views of money and monetary policy and economic events in general).

  40. Gravatar of Travis Travis
    22. July 2010 at 14:00

    Seriously this is just sick. I mean it’s one thing to look at the curent situation and think that this is the best we could do, or to imagine we’ve done to much. That is not the views expressed here, they think things are crap, they have tools available that may improve things, and these tools can be turned off when things have improved. They speak with such flippancy, it makes me want to throw up. What would it take, how many people put out on the street, how much life and treasure before they feel we have suffered enough to deserve help?

  41. Gravatar of Doc Merlin Doc Merlin
    22. July 2010 at 16:07

    @Scott:
    “The markets are already doing the calculations, and telling us what is likely to happen to inflation and other variables.”

    Very true, its just good to be careful to not read more into them than they actually say.

    For example a 4% yield on a 30 year bond and 2.93% yield on a 10 year, doesn’t mean the market expects low inflation over the next 30 years and 10 years. It just means that the market expects low inflation between now and the time enough participants can unload their bonds.

    Anyway, don’t get discouraged and keep up the NGDP targeting fight. We are backing you.

  42. Gravatar of Indy Indy
    22. July 2010 at 16:58

    More Japan stats, pretty bleak:

    http://contrarianedge.com/2010/02/23/japan-past-the-point-of-no-return/

  43. Gravatar of Benjamin Cole Benjamin Cole
    22. July 2010 at 18:30

    The word is getting around.

    Reuters–

    Former Federal Reserve board member Lawrence Lindsey said on Thursday it will be “obvious” by the end of this year that the U.S. economy has entered a “deflationary trap.”

    “We know from (Fed) Chairman (Ben) Bernanke’s recent comments that it is now at least a concern … By the end of this year I think it will be quite clear,” Lindsey said in an economic forum in Tokyo.

    “I would expect by December we will see further quantitative easing” by the Fed, he said.

    Scott Sumner to the rescue!

  44. Gravatar of Richard Richard
    22. July 2010 at 19:04

    Scott,

    What do you think of the argument that US inflation is being understated through the presence of owners’ equivalent rent (OER) weight in the CPI basket, exerting a drag on inflation measures. For example, using the harmonized index of consumer prices (HICP) methodology used in the EU and UK. US HICP inflation would have been an annual 3.5% in April as opposed to 2.2%. Should OER,where no cash transaction takes place be a component of the CPI basket? The drag on the inflation measure through a decline in rents is a lagged consequence of the housing slump. Even US core inflation in April would have been 2% versus the official 0.9% using the HICP methodology.

    Here is a link to Simon Ward who is an excellent UK market monetary economist. He often blogs on the US economy and strongly believes US inflation is understated through OER.
    http://www.moneymovesmarkets.com/

  45. Gravatar of perfectlyGoodInk perfectlyGoodInk
    22. July 2010 at 19:22

    “The broader aggregates? OK, I admit they fell in the 1930s. But I thought the monetary aggregates were discredited as policy indicators in the 1980s?”

    My impression is that they were not discredited per se, but they became less useful over time as more and more complex financial instruments were introduced and it became harder to decide which ones should count as money.

  46. Gravatar of Morgan Warstler Morgan Warstler
    22. July 2010 at 20:13

    @Richard, yah I love you.

    When you toss rents (which need to go down 20% more), we’ve got a nice clip of inflation going don’t we?

    http://www.bls.gov/cpi/cpid1006.pdf

  47. Gravatar of Bernanke Post Mortem Bernanke Post Mortem
    22. July 2010 at 20:52

    [...] doubt about the stance of monetary policymakers. Swift reaction came from Mark Thoma, Paul Krugman, Scott Sumner, and Joe Gagnon. Simply put, an incipient second half slowdown and fears of an outright double dip [...]

  48. Gravatar of Fed Up Fed Up
    22. July 2010 at 21:42

    “Update: Torgeir Hoien has a nice piece on monetary policy at the zero rate bound.”

    Read it. Not impressed. IMO, the idea of negative interest rates is just plain wrong. Very little to no mention of the actual difference between currency and debt.

  49. Gravatar of Doc Merlin Doc Merlin
    22. July 2010 at 23:46

    @Morgan: Slightly off topic, but wrt rents:
    I think rents are going to deflate even faster coming soon. If Palin wins in 2012, she will try very hard to open up federal land, it is a huge issue in Alaska as the vast majority of Alaska is owned by the federal government.

    Also, building technology is about to undergo a massive leap forward. Within the next 20 years, I expect house building costs per sq ft to drop by at least a factor of 3. Due to a few technologies that are on the horizion.

  50. Gravatar of Lorenzo from Oz Lorenzo from Oz
    23. July 2010 at 00:31

    Scott: keep up the good work. I enjoy your blog a great deal and you are doing what taxpayers pay for universities to do, surely. Disseminate serious ideas.

  51. Gravatar of MW MW
    23. July 2010 at 02:15

    For anyone interested, here is Marvin Goodfriend commenting on Bernanke’s testimony: http://www.bloomberg.com/news/2010-07-22/bernanke-s-unusually-shows-deflation-concern-goodfriend-says-tom-keene.html.

  52. Gravatar of Luis H Arroyo Luis H Arroyo
    23. July 2010 at 03:35

    “Zero IOR plus large QE plus a higher inflation target would definitely be enough to get things moving, in my view.”
    That is cuasi religion for me.
    Seriously. I am delighted with this blog, where every day I learn a lot about economics.
    I think it is because I am conservative and skeptical about fiscal policy. For me NGDP has been a discovery, though I remember there was talk of it in the 80s. In any case, your analysis of Bernanke’s testimony is very good, and I agree that a 1% inflation is very low for U.S..

  53. Gravatar of Jaap Jaap
    23. July 2010 at 07:06

    http://paul.kedrosky.com/archives/2010/07/hatzius_the_us.html?dbk

    looks like Goldman Sachs agrees with you Scott. page 18 shows that they think money is tight.
    keep up the good work: “Only dead fish go with the flow.”

  54. Gravatar of Morgan Warstler Morgan Warstler
    23. July 2010 at 07:26

    @Doc,

    With rents factored out, I’m wondering actually wtf scott is talking about on deflation. To me, energy prices drove our last bout of inflation, it was noticeable immediately in 2008, items across the board went up. Menu’s got reprinted.

    And energy prices went up directly because we were printing god damn money, the house of Saud refused to let us buy oil with printed money.

    Then energy prices dropped, and thank god some prices actually came back down.

    Ultimately, Scott’s entire “benefit” of building in inflation is some silly promise that socialists wont take over.

    Meanwhile, I’m 100% totally comfortable with the Fed trying to get inflation target down to 1% or less for the rest of my life…. and winning all the arguments on debt, and Tea Party / center-right nation thinking. We aren’t our idiot socialist grandparents.

    The trick is getting limiting the boom / bust with far less levered fiat currency and a far higher cost of credit.

  55. Gravatar of Doc Merlin Doc Merlin
    23. July 2010 at 07:36

    @Morgan
    Yah, I think thats why the fed tightened money in 2008 despite the housing issues. Gold, oil, copper, etc were skyrocketing in price, and they got scared. You have to admit though that the tightening was particularly painful, especially because it came at the same time as certain supply side problems (increase in min wage for example).

  56. Gravatar of Benjamin Cole Benjamin Cole
    23. July 2010 at 07:37

    Morgan-

    Did you look at that BLS report? What meager inflation there is was supposedly caused by rising used car and truck prices, and apparel.

    Everyone knows clothes are cheaper than ever. Used vehicles are recovering from a plunge.

    One other rising category was transportation services, which I assume was a lag from higher energy prices, or maybe cities raising mass transit fees to try to run balanced budgets.

    Mr. Inflation has cement shoes on. He is sitting in the back of black car owned by Mr. Deflationitino. It is a dark and rainy night–near the docks. Abandoned docks. This is the picture on inflation.

    On the big stuff, unit labor costs are going down, and commercial, industrial and retail rents are going down, and everybody is hunting business–and cutting prices to get it.

    When even former Fed officials say we are looking at deflation, I would pay attention.

  57. Gravatar of johnleemk johnleemk
    23. July 2010 at 08:33

    Morgan/anyone else who thinks 0 to 1% inflation is a great idea:

    Japan is the only developed country I know of that has pursued/is pursuing a policy of zero/close to zero inflation. My father used to buy a bento set for lunch in 1990 or 1991 at about 1200 Yen; he went back a couple years ago, and bought the same set for 800 or 900 Yen.

    We all know how Japan’s turned out. Even my father could intuitively grasp that if prices have fallen, something terrible’s happened to the economy. Maybe we need more stories like these to wake people up.

  58. Gravatar of Fed Up Fed Up
    23. July 2010 at 09:18

    If the major “entities” are all experiencing “positive real earnings growth” and interest rates get too low, shouldn’t they borrow and cause price inflation?

    If they borrow and there is not price inflation, does that mean one of the entities is experiencing “negative real earnings growth”? Is it the “negative real earnings growth” entity that needs help?

  59. Gravatar of Fed Up Fed Up
    23. July 2010 at 09:19

    Price deflation when there is enough supply is easy to fix.

    The problem is the spoiled and the rich along with their banking buddies will NOT like to solution.

  60. Gravatar of Fed Up Fed Up
    23. July 2010 at 09:30

    “Bernanke’s lucky that Congress doesn’t have a clue as to how to interpret Fed-speak, because he is basically saying the following:

    1. The Fed has reduced its implicit inflation target below 2%, indeed below even 1.5%.

    2. The Fed sees more downside risk on jobs, but puts a zero weight on jobs in its policy deliberations.”

    I’d say it is more like as long as the stock market is going up and there are more people being employed in china who cares about those overpaid Americans unless they have jobs in finance or economics.

  61. Gravatar of Fed Up Fed Up
    23. July 2010 at 09:35

    At 9:19 EDIT: “like to solution” to “like the solution”

  62. Gravatar of Benjamin Cole Benjamin Cole
    23. July 2010 at 10:03

    BTW–In China, they have blown the money doors open, blowing up money supply by more than 20 percent y-o-y, and running huge fiscal deficits to build infrastructure. Their economy is growing by double digits.

    And their inflation rate?

    Under 3 percent. The horrors! Three percent!

    http://www.tradingeconomics.com/Economics/Inflation-CPI.aspx?Symbol=CNY

  63. Gravatar of Morgan Warstler Morgan Warstler
    23. July 2010 at 12:39

    @johnleemk

    As I have said repeatedly, since we can ALWAYS inflate (just ask Scott or Krugman), let’s try it my way first:

    1. Liquidate the foreclosed housing inventory – improve the balance sheets of the the guys sitting on dry powder.
    2. Let the value of homes drift back to what it was sans the Fed’s easy money policy.
    3. Let rents go down, so that the lower middle class spend a smaller percentage of their income on housing for years into the future.
    4. Push mark to market, so we find out how many banks are really insolvent.
    5. Let the cost of credit increase.
    6. Use this crisis to unwind the death grip the Public Employees have on our fiscal policy.

    And then, with everything right on the moral side, with the bankers paired back and beaten, with a nation of mobile renters, with the dry powder getting their down cycle payday – THEN, if it isn’t working – we can go target NGDP.

    No matter what Scott moans about, the cost of housing is the thing killing us. The banksters are bound and determined to minimize losses on those foreclosed assets. Their ONLY HOPE is Scott, and Scott has no reason to help them – he doesn’t even call them banksters. They are zombies, let’s kill them quickly. There has to be consequences to risk, or the whole system breaks down.

    On Japan, they are a nation of savers. We’re not.

  64. Gravatar of Morgan Warstler Morgan Warstler
    23. July 2010 at 12:39

    @johnleemk

    As I have said repeatedly, since we can ALWAYS inflate (just ask Scott or Krugman), let’s try it my way first:

    1. Liquidate the foreclosed housing inventory – improve the balance sheets of the the guys sitting on dry powder.
    2. Let the value of homes drift back to what it was sans the Fed’s easy money policy.
    3. Let rents go down, so that the lower middle class spend a smaller percentage of their income on housing for years into the future.
    4. Push mark to market, so we find out how many banks are really insolvent.
    5. Let the cost of credit increase.
    6. Use this crisis to unwind the death grip the Public Employees have on our fiscal policy.

    And then, with everything right on the moral side, with the bankers paired back and beaten, with a nation of mobile renters, with the dry powder getting their down cycle payday – THEN, if it isn’t working – we can go target NGDP.

    No matter what Scott moans about, the cost of housing is the thing killing us. The banksters are bound and determined to minimize losses on those foreclosed assets. Their ONLY HOPE is Scott, and Scott has no reason to help them – he doesn’t even call them banksters. They are zombies, let’s kill them quickly. There has to be consequences to risk, or the whole system breaks down.

    On Japan, they are a nation of savers. We’re not.

  65. Gravatar of scott sumner scott sumner
    23. July 2010 at 13:40

    Mike, I’ve been planning on doing a post on that for a couple days. But I have too many comments to respond to — don’t have time now.

    Lee, I’ll try to remember to talk more about NGDP in the future. I tend to switch to inflation talk went entering policy discussions–just as I’d speak Spanish while in Mexico (if I knew how.)

    Defennder, I don’t follow that at all. He says the banks will reduce their demand for bank reserves, but it won’t work because they’ll demand T-bills instead? Where will the reserves go?

    David, My fear is that they will do the IOR elimination in such a way that its effect is neutralized. I hope I am wrong and the Fed tries to present it as a stimulative measure, if they do it at all.

    Indy, Those are good points, which I have also thought about. Because the “natural” real interest rate is probably a bit higher here, I think it unlikely that we fall into outright deflation. But we still could have a longer than necessary stretch of high unemployment.

    Thanks Dilip, That’s a good piece.

    Benjamin. Thanks. I need to get my first book published before thinking about the second.

    Mikko, I agree, I think we are talking past each other. Yes, monetary shocks can cause something that looks like recalculation. But when the recalculation folks disagree with my monetary approach, and say there are real problems that cause unemployment, they clearly have something else in mind. So to make terminology clearer, it is better to sharply discriminate between monetary shocks and recalculation, otherwise the debate becomes horrible confused.

    I have always hated it when people talk about the Fed “fixing the economy’s problems.” Any and all problems that the Fed is capable of fixing were, ipso fact, CAUSED BY THE FED ITSELF. I think I disagree with most people on that point, but it might better help you understand where I am coming from. The Fed should target NGDP. Problems that it can fix are problems due to changing NGDP. It can’t fix problems that occur when NGDP is on target. So it’s either the Fed’s fault, or there is nothing the Fed can do about it.

    OGT, That doesn’t sound right—did you miss the double negative in the inflation term?

    Marcus, I agree with the DSGE part. His discussion of policy seems very old-fashioned. The Fed is always doing something, the question isn’t whether the Fed should “do something” but rather what it should be doing.

    Statsguy, Yes. I find it interesting how bloggers on the left only recently noticed this problem.

    Liberal Roman, I haven’t followed politics recently. Is that likely? I hope not, even if those weren’t my first, second, third, or fourth choices.

    Karen, I wish every macroeconomist spent a year of graduate school studying 1933. FDR knew how to create higher AD when credit was hard to get. It seems we have forgotten.

    JKH, Just to be clear, I don’t use the traditional money multiplier approach, which is the MB causes M2 which causes NGDP. My view is that long run expected changes in MB cause long run expected changes in NGDP, which causes current NGDP, which causes current M2. So there is some endogenous money in my view, if it makes you feel any better.

    I appreciate your comments on monetary stimulus, as you always seemed the most knowledgeable commenter with your point of view.

    Dustin, Don’t worry, I will continue. But the rest of the summer will be a bit slower because of travel.

    Travis, Good questions.

    Doc Merlin, By the time they want to unload, it will be too late.

    Indy. Yes, the Japanese situation looks bleak. Even worse, I have some money invested there (Asian mutual fund.)

    More to come . . .

  66. Gravatar of scott sumner scott sumner
    23. July 2010 at 14:14

    Benjamin, I hope so.

    Richard, I had a post on that just about a month ago. I said the current numbers are slightly less bad then they look because of the OER problem, but the deflation of 2008-09 was much worse than it looked for the same reason. I did not hear the inflation hawks pointing that out in late 2008-09, so I don’t have much sympathy for them now. But yes, technically inflation is slightly understated right now. But it is too low either way.

    perfectlyGoodink, My point was that in the mid-1980s most well known economists said the monetary aggregates are not reliable policy indicators, for whatever reason. So why are they suddenly now reliable again? There are improved indices out there, like the divisia index, which I know little about. But people aren’t relying on those indices.

    Doc Merlin, Alaska doesn’t have many people, and I’ve heard about new building technology my whole life. I’ll believe it when I see it.

    Thanks Lorenzo.

    MW, Thanks, that’s good to hear–especially since I recall that he is a bit on the conservative side.

    Fed up, I like negative rates on excess reserves.

    Thanks Luis.

    Thanks Jaap,

    Regarding the multi-person discussion of 1% inflation, I would just add that 1% inflation itself is fine, but don’t move there in the midst of the worst financial crisis since 1933.

    Fed up, I sometimes wonder how many unemployed people the top officials actually know personally.

    Benjamin, Yes, although of course we wouldn’t grow that fast even with good monetary policy.

  67. Gravatar of Doc Merlin Doc Merlin
    23. July 2010 at 14:23

    @ I agree with this statement of yours, Scott!
    ‘I have always hated it when people talk about the Fed “fixing the economy’s problems.” Any and all problems that the Fed is capable of fixing were, ipso fact, CAUSED BY THE FED ITSELF. I think I disagree with most people on that point, but it might better help you understand where I am coming from. The Fed should target NGDP. Problems that it can fix are problems due to changing NGDP. It can’t fix problems that occur when NGDP is on target. So it’s either the Fed’s fault, or there is nothing the Fed can do about it.’

    Hear! Hear!

  68. Gravatar of Fed Up Fed Up
    23. July 2010 at 14:50

    scott sumner said: “Fed up, I like negative rates on excess reserves.”

    Aren’t reserves redeemable 1 to 1 for currency?

    What if the banks take excess reserves (which I consider overnight gov’t debt in disguise and someone else called 1-day T-bills) and cash them in for currency?

    What if the banks buy some other extremely short-term instrument that they think won’t default on them?

  69. Gravatar of Fed Up Fed Up
    23. July 2010 at 15:01

    scott sumner said: “Fed up, I sometimes wonder how many unemployed people the top officials actually know personally.”

    I’d like to know how many unemployed they know personally along with how many they know who make $40,000 a year or less. Maybe they should have to check out the budgets (balance sheets) of these people. Maybe they should have to check out some of the mortgage modifications programs showing people spending more than 55% of their income on the interest payments (idea from CalculatedRisk’s posts).

  70. Gravatar of Fed Up Fed Up
    23. July 2010 at 15:06

    scott sumner said: “Regarding the multi-person discussion of 1% inflation, I would just add that 1% inflation itself is fine, but don’t move there in the midst of the worst financial crisis since 1933.”

    IMO, price inflation needs to be high enough to get interest rates high enough so that speculation in financial assets is unprofitable and so that any entity experiencing “negative real earnings growth” does NOT go into debt to make up the difference and keep on spending.

  71. Gravatar of Fed Up Fed Up
    23. July 2010 at 15:21

    scott sumner said: “I have always hated it when people talk about the Fed “fixing the economy’s problems.” Any and all problems that the Fed is capable of fixing were, ipso fact, CAUSED BY THE FED ITSELF. I think I disagree with most people on that point, but it might better help you understand where I am coming from. The Fed should target NGDP. Problems that it can fix are problems due to changing NGDP. It can’t fix problems that occur when NGDP is on target. So it’s either the Fed’s fault, or there is nothing the Fed can do about it.”

    It seems to me that the fed has never considered the difference between price inflating with currency and price inflating with debt.

    If you are going to talk about NGDP, please include your medium of exchange whether currency or debt (FUTURE demand brought to the PRESENT). What if NGDP has been growing at a certain % level over time because of debt that should have NOT been produced then the debt goes bad. Could supply and demand start “spiraling” backwards in time towards their lower level(s) of the past?

  72. Gravatar of Larry Larry
    23. July 2010 at 18:57

    Two items:

    - I think the stock market is doing better than the overall economy because of micro factors. Larger, public companies are more nimble than before, in part because they have outsourced many functions (often to smaller, non-public and/or foreign firms) and can rescale themselves without taking big losses. Wages are less sticky than before, partly because of the salutary examples of the car companies. Public company sales aren’t growing rapidly, but profits are because they can control expenses much more easily. Asian economies are growing more rapidly than ours, and bigger companies can play in those markets more easily. Productivity is also increasing more rapidly, because it keeps getting cheaper to do.

    - Sometimes I have a pleasant dream. In it, the Fed covers 50% of the costs of real estate short sales up to the median price. It “prints” the money and divides it between lender and borrower based on the original percent down. This encourages banks to allow short sales to go through, and gives former homeowners money to resettle. In my dream market clearing happens much faster, and the monetary loosening is popular because it visibly helps lots of people. It’s much more salable than the somewhat mysterious QE that sounds like it’s only helping fat cats. It’s a bit like “helicopter money”, except that it is well-targeted at the still most-damaged sector. The policy is also adjustable, both in duration and in degree of subsidy (lower percentages and payout ceilings are both possible.) It even helps with the “recalculation”, because people can escape underwater mortgages and get the heck to the Midwest (ND, SD, NE, KS, IA, MN, OK are in the top 10) where they might find work.

    I don’t want to live in Japan.

  73. Gravatar of marcus nunes marcus nunes
    23. July 2010 at 21:16

    Buttonwood reflects the wrong and conventional view especially that Japan expanded MS, G, and got nowhere…
    http://www.economist.com/blogs/buttonwood/2010/07/monetary_policy_and_markets

  74. Gravatar of Morgan Warstler Morgan Warstler
    24. July 2010 at 04:00

    scott sumner said: “Regarding the multi-person discussion of 1% inflation, I would just add that 1% inflation itself is fine, but don’t move there in the midst of the worst financial crisis since 1933.”

    “IMO, price inflation needs to be high enough to get interest rates high enough so that speculation in financial assets is unprofitable and so that any entity experiencing “negative real earnings growth” does NOT go into debt to make up the difference and keep on spending.”

    Um, if we KNOW homes prices are going to fall, say because we are told that 1M+ foreclosed homes are going to be sold at auction over 90 days, (no F&F support here) interest rates can be raised immediately.

    Even with a bump in interest points, if you sell enough houses cheap, real buyers with 30% down – are going to borrow at higher rates to buy them. And we have fields of fallow housing we can sell to them, right now, out of the back of a truck.

    The mission of low rates has been to desperately try and keep the air in the balloon. Scratch that, reverse it. Let the balloon drop, so you can raise rates.

    The problem isn’t that we’re at 0% and can’t stimulate the economy, the problem is that we’re at 0%. Period. The end.

    It isn’t up to the Fed to manage the upside gains of the players from the last round, the GOAL of the Fed to be a reliable umpire (like a Supreme Court Justice) – to GET the best deals for the bears, as often as the bulls.

    Because markets only work when both sides of the bet think it is a fair bet. As such, they can’t have wild card government action picking winners and losers – because its no longer chess, it isn’t a sporting match, its a debate – in a debate both sides want to convince the judge to pick them. The economy is not a debate, it is a sports match where impartial referee is held to the highest regard, because the referee is not the judge…. the buyers are, we’re the judge. The score is weighted by price, and the bears make money when price goes down, because they took money out or bet against the market, before it crashed, and now they have money to spend to buy deflated assets.

    Inflation is cheating to favor one side in the betting pool. The best gamblers flock where the the house take is the absolute smallest.

    At the end of this whole boom, we have no more equity stored in our real estate, we have only more debt, we own less (as a %) of our property, the banksters own more.

    Scott refuses to see how the very absoluteness of his “x will cause y,” MEANS LOGICALLY we might as well stick it to the banksters first, deflate the value of the homes – we’ll still have our equity in real dollar terms, we’ll just own a bigger piece – we’ll owe them less.

    If we see a spike of banks going under, and each time FDIC covers everybody, explains whats going on, and unwinds them, and sells their assets cheap, and then doe sit again, and again… prices are down, so interest rates are up. We don’t have to freak out, we can cheer liquidation, and get a chance to buy cheap stuff.

    Assets are supposed to move around like poker chips on ESPN2. We’re not supposed to not be lulled to sleep with minimum bets, while the guys with piles slow play until Scott calls an audible. Why would he be so willing to charge banks for not spending money, but not instead force banks to liquidate… because the houses on their balance sheets are not worth what they claim.

  75. Gravatar of scott sumner scott sumner
    24. July 2010 at 09:22

    Thanks Doc Merlin.

    Fed Up, If currency is held by a bank, then it is part of reserves. If they buy T-bills, then they reduce their demand for base money, which is the whole point of the proposal.

    The Fed has control over currency (and the base), not debt.

    Larry, You might be right, but don’t forget that stocks have fallen from their peak by much more than GDP has fallen from its peak. Stocks are forward-looking and rose in late 2009 as it became clear the recession was less severe than first thought.

    Morgan, You post leaves the impression that you are quoting me, when you are actually quoting a Fed Up post.

    I doubt we will ever KNOW home prices will drop. Asset prices tend to be unpredictable.

  76. Gravatar of Morgan Warstler Morgan Warstler
    24. July 2010 at 11:11

    Scott, that’s wrong. We knew homes prices would fall when the $8K incentive ran out. They did.

    But it wasn’t a sure thing, this is a sure thing:

    1. Only private buyers.
    2. No Fannie Freddie – that kicks 90% of current “buyers” out.
    3. 30% cash down.
    4. Auctions starting at $1.
    5. Sell 1M+ homes in foreclosure in a short 90 day auction.
    6. Make this the standard approach to foreclosures… and we’ll get off Fannie Freddie price inflation.

    Again, we’re not artificially reducing home prices, we’re removing artificial price supports.

    Scott, what possible reason could you have for not wanting 1M currently foreclosed homes to be sold to private investors at deep discounts? It’s the most natural thing in the world.

    Immediately after this right footed policy, if we still need to target NGDP, then we can. Why would we do you thing first? it makes no sense.

  77. Gravatar of Fed Up Fed Up
    24. July 2010 at 18:45

    scott sumner said: “Fed up, I like negative rates on excess reserves.”

    scott sumner said: “Fed Up, If currency is held by a bank, then it is part of reserves.”

    Exactly how do you put a negative rate on currency?

  78. Gravatar of Fed Up Fed Up
    24. July 2010 at 18:47

    scott sumner said: “If they buy T-bills, then they reduce their demand for base money, which is the whole point of the proposal.”

    I thought the whole idea of the proposal was to increase lending (with the fact that T-bills already yield close to zero).

  79. Gravatar of Fed Up Fed Up
    24. July 2010 at 18:51

    scott sumner said: “The Fed has control over currency (and the base), not debt.”

    Yep! And in a wealth/income inequality world, is it the entity (the lower and middle class) who is experiencing negative real earnings growth and goes into debt the one that “drives” real GDP? What if that entity wises up and refuses to go into debt and the economy becomes demand constrained instead of supply constrained?

  80. Gravatar of Fed Up Fed Up
    24. July 2010 at 18:55

    scott sumner said: “The Fed has control over currency (and the base), not debt.”

    Not debt, OK.

    Central bank reserves, a good bit.

    Currency, maybe? What if people don’t want to hold demand deposits?

  81. Gravatar of ssumner ssumner
    25. July 2010 at 18:24

    Morgan, I don’t favor government support of the housing market, and never have.

    Fed Up. You can’t put a negative interest rate on cash held by the public, but cash held by banks is part of reserves, and you can put a negative interest rate on that aggregate.

    Fed Up, No, I must have said 100 times I’m not trying to encourage lending. I’m not blaming you, as you are new to the blog. But it is a common misunderstanding. This blog doens’t focus on banking at all. My focus in monetary policy.

    Fed up, There are lots of countries that don’t borrow as much as we do, and they don’t seem to have AD problems. So I don’t worry about what happens if American don’t go into debt. And I don’t think debt has anything to do with income distribution.

    Fed up, If people don’t want to hold DDs, it depends what they do want to hold. But the Fed can offset any shifts in money demand.

  82. Gravatar of Fed Up Fed Up
    26. July 2010 at 11:33

    ssumner said: “Fed Up. You can’t put a negative interest rate on cash held by the public, but cash held by banks is part of reserves, and you can put a negative interest rate on that aggregate.”

    How does that work?

    And, “Fed Up, No, I must have said 100 times I’m not trying to encourage lending. I’m not blaming you, as you are new to the blog. But it is a common misunderstanding.”

    Well you might not be encouraging it, but I believe the fed sure is.

    And, “This blog doens’t focus on banking at all. My focus in monetary policy.”

    In a wealth/income inequality world, lower interest rates are usually about attempting to create more private debt (excess savers like at goldman don’t spend more although they might be tempted to buy a riskier asset). It seems to me that trying to create more private debt involves some focus on banking. If more private debt is not created, then it could be gov’t debt. Then it is time to talk about how gov’t debt works.

    And, “Fed up, There are lots of countries that don’t borrow as much as we do, and they don’t seem to have AD problems.”

    Which ones, and do they have a trade deficit?

    And, “So I don’t worry about what happens if American don’t go into debt. And I don’t think debt has anything to do with income distribution.”

    I’m taking the other side of that although it could turn into a long conversation. Here is a good place to start. “The origins of the economic crisis”

    http://bilbo.economicoutlook.net/blog/?p=277

    And, “Fed up, If people don’t want to hold DDs, it depends what they do want to hold. But the Fed can offset any shifts in money demand.”

    Currency because the bad debt is being “hidden” and asset prices are too high.

  83. Gravatar of Mikko Mikko
    26. July 2010 at 22:09

    Scott, thanks for the clarification. I definitely agree with you.

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