After my recent trip I was appalled to discover the number of leading conservative voices opposing monetary easing. Even worse, many seemed to assume the Fed was already engaged in monetary stimulus. Before considering their views, let’s examine the thoughts of the greatest conservative monetary economist of all time, Milton Friedman. Here he discusses the zero rate problem in Japan:
Low interest rates are generally a sign that money has been tight, as in Japan; high interest rates, that money has been easy.
. . .
After the U.S. experience during the Great Depression, and after inflation and rising interest rates in the 1970s and disinflation and falling interest rates in the 1980s, I thought the fallacy of identifying tight money with high interest rates and easy money with low interest rates was dead. Apparently, old fallacies never die.
Friedman was absolutely right, near-zero interest rates are an almost foolproof indicator that money has been too tight. Were he still alive, I can’t even imagine what he would think of the views being expressed by his fellow conservatives. Here is Minneapolis Fed president Narayana Kocherlakota:
Monetary stimulus has provided conditions so that manufacturing plants want to hire new workers. But the Fed does not have a means to transform construction workers into manufacturing workers.
Actually money has been tight. And those construction jobs were mostly lost in 2007 and early 2008, when employment was still high. The serious unemployment problem developed in late 2008 and early 2009, and reflected a generalized drop in AD across the entire economy. And manufacturing has also shed lots of jobs.
Update: Regarding 2007-08, I should have specified construction jobs associated with the housing bubble. The subsequent sharp fall in NGDP obviously cost construction jobs in commercial and industrial building. But those were cyclical losses due to tight money, not misallocation problems.
The right seemed to have latched onto the view that since tight money can’t be the problem, it must be some mysterious “structural problem.” Obviously there may be some structural problems, indeed I have argued that some government labor market policies are counterproductive. But there is nothing structural that could explain the sudden dramatic jump in unemployment between 2008 and 2009.
Even worse, we already have a perfectly good explanation for that rise in unemployment; in 2009 NGDP fell at the fastest rate since 1938. You’d expect a massive rise in unemployment from this sort of nominal shock, even if there were no structural problems. Now of course there is a respectable argument that the US currently faces both problems. But economists who make that argument (e.g. Tyler Cowen) correctly note that this means we need more monetary stimulus. They simply warn us not to expect miracles. But unless you are an extreme RBC-type who doesn’t believe monetary shocks matter at all (and most conservatives are not) then how can one not favor monetary stimulus?
I suppose one argument is that we are “recovering,” and hence that no more stimulus is needed. People seem to have forgotten that deep recessions are generally followed by fast growth. Both NGDP and RGDP growth was very fast in the first 6 quarters of recovery from the 1982 recession. But now we are getting only 4% NGDP growth, not the 11% of the earlier recovery, so how can we expect the 7.7% RGDP growth of the recovery from 1982? Even worse, David Beckworth presents data (from Macroeconomic Advisers) that NGDP peaked in April, and actually declined in May and June. We may see the already anemic 2nd quarter numbers revised downward this week. Goldman Sachs expects less than 2% growth in 2011. And a rise in unemployment. That’s no recovery.
If we really were facing structural problems, then on-target NGDP growth would lead to stagflation, as in the 1970s. Conservatives keep insisting that high inflation is just around the corner, and Paul Krugman keeps making them look like fools. This pains me because I like most conservative economists more than I like Krugman.
Friedman and Schwartz noted that in the 1930s the low interest rates and high levels of liquidity (cash and reserves hoarding) lulled people into thinking money was easy. Thus pundits during that era pointed to all sorts of structural problems, which were actually symptoms of the Depression, not causes. So I have been disappointed to read statements like this one from Edmund Phelps:
THE steps being taken by government officials to help the economy are based on a faulty premise. The diagnosis is that the economy is “constrained” by a deficiency of aggregate demand, the total demand for American goods and services. The officials’ prescription is to stimulate that demand, for as long as it takes, to facilitate the recovery of an otherwise undamaged economy — as if the task were to help an uninjured skater get up after a bad fall.
The prescription will fail because the diagnosis is wrong. There are no symptoms of deficient demand, like deflation, and no signs of anything like a huge liquidity shortage that could cause a deficiency. Rather, our economy is damaged by deep structural faults that no stimulus package will address — our skater has broken some bones and needs real attention.
Or William Poole:
More bond buying from the Federal Reserve won’t help the U.S. economy, because purchases can’t remedy the main problem plaguing the U.S., which is fiscal and regulatory uncertainty, former St. Louis Federal Reserve President William Poole said.
While the Fed buying more debt will bring rates down, it won’t inspire spending and lending given uncertainties in the U.S. ranging from tax cuts to health care reforms.
A policy of low interest rates is a textbook response of monetary authorities to the economic weakness brought on by deficient aggregate demand. The policy is justified by pointing to various ways in which money can promote economic activity—including by stimulating investment, discouraging savings, encouraging consumption spending, and allowing individuals to lower their debt burdens by refinancing existing debt. While these effects are theoretically plausible, this textbook policy does not apply to our present situation.
First, our lingering crisis and economic weakness was brought on not by a Keynesian failure of effective demand, but by a Hayekian asset boom and bust. Second, the textbook case for low interest rates treats the policy as one of benefits without costs. No such policy exists.
Yes, Hayek did briefly oppose monetary stimulus in the early 1930s. But in the 1970s he admitted that he had been wrong, as the problem was not simply “misallocation” resulting from an asset boom, but also insufficient nominal spending.
Or the Wall Street Journal:
As the Bible says, we know that our redeemer liveth. And on Wall Street and Washington these days, the economic redeemer of choice is the Federal Reserve. When the Fed’s Open Market Committee meets again today, markets are expecting a move toward easier money that is supposed to prevent deflation, re-ignite a lackluster recovery, revive the jobs market, and turn water into Chateau Petrus.
It’s a tempting religion, this faith in the magical powers of Ben Bernanke and monetary policy, but it’s also dangerous. It puts far too much hope in a single policy lever, ignores the significant risks of perpetually easy money, and above all lets the political class dodge responsibility for its fiscal and regulatory policies that have become the real barrier to more robust economic growth. . . .
As for the current moment, the Fed has maintained its nearly zero interest rate target for 20 months, while expanding its balance sheet by some $2 trillion. By any definition this is historically easy monetary policy, and not without costs of its own.
Not by Milton Friedman’s definition. And then it gets worse:
This is the real root of our current economic malaise—the conceit of Congress and the White House that more government spending, taxing and rule-making can force-feed economic expansion. Now that this great government experiment is so obviously failing, the politicians and the Wall Street Keynesians who cheered the stimulus are asking the Federal Reserve to save the day. Mr. Bernanke should tell them politely but firmly that his job is to maintain a stable price level, not to turn bad policy into wine.
So that’s what it’s really all about. I agree that Obama’s economic policies are highly counterproductive. But unlike some conservatives I am not willing to unemploy millions of workers to win a policy argument. I guess that’s the difference between hard core conservatives and pragmatic classical liberals like Friedman and I. We should do the right thing and then put our trust in the democratic system.
Update: I should clarify that my attack here was not directed at all conservatives–most are well intentioned, but rather the sentiments in the WSJ editorial. On many policy issues I agree with the other conservatives mentioned here.
BTW, when I researched the Great Depression, I was shocked at how the conservative Wall Street establishment hated dollar devaluation, despite the fact that the stock market obviously loved it. I noted (to myself) that “at least the modern WSJ is much better; they often use the market reaction to policy announcements as a way of establishing their likely effects.” I guess the WSJ has reverted back to the primitive pattern of the 1930s. “Yes, the markets are screaming for easier money, probably because it will boost the economy. But we can’t have that because it might make Obamanomics look successful.” Plus ca change . . .
HT: Marcus Nunes, JimP, 123, Ryan Avent.