Why a little bit of inflation is good for savers

Will be in Dallas for a few more days.  Just so you don’t think I disappeared, I dug up an old post I wrote but never posted.  I saw the 3rd quarter NGDP was about 4%–surprised by the high deflator (something I can’t explain.)  Looks like final sales (Woolsey’s target) were much lower than GDP growth.  I will try to catch up on comments early next week.  Here’s something to look at until then:

We are taught in basic economics that an unexpected increase in inflation hurt savers.  But I’m a very heavy saver, and I think a bit more inflation would help me.  Partly that’s because I have lots of equities, but I’d still feel this way if I had to live the next 30 years as a retiree surviving on T-bill interest.

You might argue that I am confusing real and nominal interest rates.  Yes, inflation would raise nominal rates, but surely it wouldn’t raise the real yield on T-bills?  In fact, I think a little bit more inflation would raise real T-bill yields.  Maybe not right away, but within two or three more years.

To make this argument we have to remember a few important macro concepts, and also empirical regularities:

1.  Near zero rate traps are associated with very low inflation and a depressed real economy.  The depressed real economy often leads to low real interest rates, even if the economy is growing.  The best example occurred in 1933-40, when real interest rates remained low despite fast RGDP growth.  The explanation was that although RGDP growth was high, the level of RGDP remained low throughout the 1930s—and this led to low levels of real investment, and hence not much demand for credit.  Japan is another example.

2. The economy should be able to fully adjust to an adverse demand shock within a few years, as wages and prices adjust.  However, the adjustment may take longer if various real factors delay the recovery:

a.  A higher real minimum wage, caused by legislation or disinflation.

b.  Extended unemployment insurance, which reduces downward wage flexibility.

c.  Protectionism.

d.  Higher taxes, which discourage investment.

e.  Increased regulations that discourage small firms from adding employees.

These factors cannot, by themselves, explain the current high unemployment.  But they can slow the adjustment to lower unemployment in an economy where the central bank is not providing enough money for the usual recovery–which is normally associated with fast NGDP growth. 

3.  AD shocks can amplify AS problems, and vice versa.  Just as the tight money of 2008 caused Congress to extend UI for 99 weeks, an easier money policy that boosts nominal growth and inflation will cause Congress to reduce the benefits much sooner.  And the real minimum wage would fall.   Some economists say the problem is almost entirely a deficiency of AD.  Other RBC-types say labor market distortions are a big problem.  But since the labor market distortions are mostly a response to the falling AD, the policy implications of each view are the same—we need more AD.

Here’s what people forget.  Monetary policy was far more inflationary in 1990-2007, but savers were also far better off.  The recent disinflation has hurt savers badly because it has lowered the real rate of return on their investments.   Why is the textbook view wrong?  Because it assumes money neutrality, i.e. it assumes inflation is a zero sum game.  In fact, unexpected inflation could cause the economy to recover, after which real returns on investment like T-bills would return to their normal level.  Yes, there may be a “new normal” because of high savings rates in Asia, but it’s hard for me to believe that the current minus 0.50% yield on 5 years TIPS is the new normal.  I think it at least partly reflects the weak economy.  If we get stuck in a long period of economic weakness (as debt markets are now forecasting), then savers will do very poorly, even as they experience the lowest inflation rates of their lives.

So no, I’m not trying to stick it to savers; I’m trying to help them.  And I’m trying to help borrowers as well.  Economics is not a zero sum game.  Right now an extra trillion dollars in NGDP would be more than 50% real, and that’s a lot of extra income to make everyone better off.


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58 Responses to “Why a little bit of inflation is good for savers”

  1. Gravatar of marcus nunes marcus nunes
    29. October 2010 at 13:14

    Krugman continues insisting that MP is quite powerless to push NGDP higher! “WE must have fiscal policy”!
    http://krugman.blogs.nytimes.com/2010/10/29/more-on-friedmanjapan/

  2. Gravatar of ang ang
    29. October 2010 at 13:42

    Ok, I’ve got a political winner: how about a temporary Social Security/Fed matching program, where the Fed will double Social Security checks for one year. Social Security has about a $750bn annual budget so it’s about the right size, it adds nothing to the deficit, and the most feared and respected voting group, seniors, will love it. Plus think of the revival in Nevada.

  3. Gravatar of Jeff Jeff
    29. October 2010 at 13:56

    Scott, the contribution of inventory growth was slightly higher than real output growth itself, i.e., real final sales fell.

  4. Gravatar of Bill Woolsey Bill Woolsey
    29. October 2010 at 14:14

    Jeff:

    Really bad!

  5. Gravatar of Richard Cantillon Richard Cantillon
    29. October 2010 at 14:53

    Scott Sumner is our generation’s John Law. He can convince the average Jose in Latin America that inflation is the right choice and has no consequences. Bravo!

  6. Gravatar of Morgan Warstler Morgan Warstler
    29. October 2010 at 15:27

    Bill,

    TX sales tax receipts are up nicely.

    Scott,

    “Just as the tight money of 2008 caused Congress to extend UI for 99 weeks, an easier money policy that boosts nominal growth and inflation will cause Congress to reduce the benefits much sooner.”

    The logical way to look at it is this:

    Since the Dems increased UI, the smart thing for the Fed to do is tighten money (or be glad inflation is low) and screw them so they lose.

    Then when Republicans come in and tie UI to say tax-deductible worker retraining (great idea morgan!), do some pumping, so they get credit and Obama get tossed our for being a Socialist.

    The Fed cannot write policy, and it is folly to make things better and see what happens when Obama is in office.

    No, the smart thing is to say, “Behave” in Nov. and have Obama sit Ben next to Michelle for his SOTU speech.

  7. Gravatar of Wes Wes
    29. October 2010 at 15:51

    > But I’m a very heavy saver, and I think a bit more inflation would help me. Partly that’s because I have lots of equities…

    This makes you an investor.

    >So no, I’m not trying to stick it to savers;
    >I’m trying to help them.

    I’ve read plenty of stuff that you wrote to understand that you are an inflationist. You are no friend of savers. Please stop pretending.

  8. Gravatar of david david
    29. October 2010 at 16:40

    The political independence of the Fed works both ways; if the Fed violates it, it will rapidly find its autonomy being removed.

  9. Gravatar of Mark A. Sadowski Mark A. Sadowski
    29. October 2010 at 17:46

    Scott,
    One of your best posts yet. Why? Precisely because it’s so contrarian.

    Your points seem to be that unusually low levels of monetary stimulus lead to:
    1)Low levels of ROR.
    2)Public policy factors delaying recovery
    3)AD shocks amplifying AS problems

    How can I disagree. If ROR is reduced by low levels of AD how could investment be otherwise than be reduced? The resulting bad public policy would obviously lead to reduced growth. AS is always reduced by negative AD shocks (see the CBO record).

    Excellent! Capital! Good show as ever!

  10. Gravatar of Morgan Warstler Morgan Warstler
    29. October 2010 at 18:28

    From 1994:

    http://www.time.com/time/magazine/article/0,9171,981879,00.html

    I used to think if there was reincarnation, I wanted to come back as the President or the Pope or a .400 baseball hitter. But now I want to come back as the bond market. You can intimidate everyone.
    –James Carville, Clinton campaign strategist

    “Among other things, investors saw a new threat of inflation in promises by House Speakerin-waiting Newt Gingrich and other Republicans to cut taxes next year without any credible program for restoring lost revenues. “Tax cuts are not always good for the bond market,”said Joseph Carballeira, the head of U.S government- securities trading at Smith Barney. “Initially, there was a sense of optimism when the Republicans won. But now there is the sense that fiscal discipline may be over.” Said Hugh Johnson, chief investment strategist for First Albany: “This has become a nagging fear that bond traders have in the back of their heads. They might not discuss it much, but the fear is there.”

    “That was harsh news to Leedom Kettell, who runs a printing company in Syracuse, New York, with 10 employees. Kettell had been shopping for a new $40,000-to-$50,000 printing machine for his growing business.”But now, with the higher rates, I’m doing all I can to avoid buying,” he says. “Postpone is the key word.”

    James Carville blamed the bond market… not the Fed.

    The Bond Market didn’t want the Republican tax cuts… the Fed was fine with them.

    The AFL-CIO didn’t want the rates raised…too bad!

    Good old Lacy Hunt said, this one is ok… but no more.

    Now back then it seemed to me as a 24 year old political hack, that the Fed was doing the Republicans bidding – raising rates so they could cut taxes – not the unions, not the bond market.

    It still seems to me like that. I don’t know why anyone would think the Fed is autonomous – bankers are Republicans.

    My problem is that we need to Fed to side with Republicans OVER bankers – and that is a tough sell.

  11. Gravatar of W. Peden W. Peden
    29. October 2010 at 19:07

    marcus nunes,

    To Krugman’s credit, at least he’s learnt the different between the monetary base and the money supply. He hasn’t always understood the distinction.

    Krugman makes the assumption that the BoJ was pursuing a policy of boosting M2 to a level necessary for high inflation. This assumption is false, so the inference that central banks cannot control M2 (and presumably other measures of broad money) in a “liquidity trap” (as a faithful reader of Keynes I hate the way that Krugman has co-opted the term) is unsupported by any evidence, or any theory for that matter.

    Let’s consider some of the implications of Krugman’s line of argument here. Is he arguing that an increase in the monetary base (which is a component of M2) has a “crowding out” effect with respect to other compnents of M2? Presumably not, since he doesn’t say so, let alone clarify a causal mechanism for this effect.

    Just pointing at times when the monetary base and the money supply have diverged won’t cut it. Just because, say, consumer spending has fallen, it doesn’t mean that national income has fallen. Consumer spending and national income can diverge, because consumer spending is a component of national income.

    If the monetary base is a component of M2, then it’s absolutely insane to say that increases in the monetary base, ceteris paribus, do not result in increases in the money supply. But boosting the money supply using the monetary base would necessitate a sustained, considerable increase in a tight-money situation.

    A classic example of how one can start from false premises and end up in Bedlam.

    I still don’t see, however, why Krugman puts any stock in increasing the money supply. It makes no sense from a Keynesian perspective, as far as I can see. One you reject the quantity theory of money and think of the money supply as reflecting inflation rather than causing inflation, I don’t see why you would be interested in the money supply. One might still be interested in interest rates, to some degree, but what possible reason could Krugman have for caring one jot about quantitative easing, especially since now he doesn’t even think it can boost the money supply?

  12. Gravatar of Shane Shane
    29. October 2010 at 22:39

    Fantastic post. But I’m just wondering. Krugman grudgingly says that monetary policy *might* work. And yet Sumner is consistently ICE COLD to the fiscal stimulation, while he gets mad when Krugman is wishy-washy on monetary. We will help you fight the inflation hawks, but why are you not throwing down the gauntlet against the deficit hawks? Last time I checked, some serious deficits were a great way to create inflation. Why doesn’t that kind count? Will the Fed, barely willing to counteract disinflation now, actually seek to counteract the Tea Party Deflation? I guess I’m asking, Scott, why aren’t you putting out the red carpet for the only political party capable of creating inflation? Unless you think that will be the agenda of a Republican Party relaunched by Ron Paul supporters.

  13. Gravatar of Joe Joe
    30. October 2010 at 00:18

    Professor Sumner,

    If the money supply is increased, this will initiate the hot potato process. But any firm that experiences new demand from this new money, once they’re doing more business, their demand for money will go up, since their income is up. New employees they hire will have more money demand. Their suppliers will have more income from them and thus more demand. So, wouldn’t this process be negated right away by the increased money demand? I suspect the answer is “yes, once their income and prices have gone up enough the process will end, but in the meantime there will still have been new economic activity.” Right?

    Thanks,

    Joe

  14. Gravatar of W. Peden W. Peden
    30. October 2010 at 04:59

    Shane,

    If big deficits are a great way to get inflation, then why does Japan have such a big deficit and national debt, yet no inflation?

    A government deficit only leads to inflation if the government funds its borrowing in a certain way. For example, in the UK the government can fund its borrowing by selling short-term bonds to the banks. Because repayment is almost certain within a short period, the banks can regard these as part of their reserves, so the selling of these bonds essentially is an increase in the money supply.

    In a system of discretionary monetary policy, any fiscal effects on monetary conditions can be compensated for by a sufficiently determined central bank. So the Japanese government can run deficits as large as they want; as long as the Bank of Japan is pursuing a tight-money policy, the Japanese government is powerless to create inflation.

    The same is true in the US. There is no party in the US capable of changing monetary conditions, unless that party is willing to change the Fed’s mandate. The Democrats could run a deficit that is 100% of GDP, fund it through borrowing from banks, and the Fed could still create deflation if they wanted.

    I can’t speak for Sumner, but my personal opposition to fiscal stimulus is that-

    (a) I don’t think there is any sound reason to think that it will stimulate the real economy. The empirical evidence that it will work is slim to non-existent, which is the main reason why the first fiscal stimulus was defended with counter-attack (e.g. “You’re exposing the Treasury View!” or “We have to do SOMETHING!”) rather than a solid empirical case.

    (b) as a nominal stimulus, it can be totally counteracted by the Fed, as explained above.

    If, as you say, the Fed is unwilling to counteract deflation, there is precious little that even a 100% Democrat Congress could do, UNLESS it changes the Fed’s mandate in a profound way or at least puts tremendous political pressure on the Fed to pursue a vigorous monetary stimulus.

    The best argument for fiscal stimulus is this-

    (1) We have to do something.

    (2) Fiscal stimulus is something.

    Therefore, we have to pursue fiscal stimulus.

    Both premises are true, but the inference is the fallacy of the undistributed middle. This seems to be the same fallacy that Krugman makes when he is defending monetary stimulus-

    (1) We have to do something.

    (2) Monetary stimulus is something.

    Therefore, we have to pursue monetary stimulus.

    I see no reason why fiscal stimulus will not simply add to the US national debt. Even if combined with a loose monetary policy from the Fed, it would just be roundabout monetary policy with unnecessary consequences.

  15. Gravatar of Doc Merlin Doc Merlin
    30. October 2010 at 05:34

    @W. Penden:
    WRT fiscal stimulus, couldn’t agree more.

  16. Gravatar of JimP JimP
    30. October 2010 at 06:53

    The case against the stimulus – and why Tuesday will not be a good day for the Dems.

    http://www.realclearmarkets.com/blog/519.pdf

  17. Gravatar of marcus nunes marcus nunes
    30. October 2010 at 10:24

    And Krugman keeps on drumming about more Fiscal “Stimulus”!
    http://krugman.blogs.nytimes.com/2010/10/30/the-moral-equivalent-of-stagflation/

  18. Gravatar of marcus nunes marcus nunes
    30. October 2010 at 10:35

    According to this (again from Krugman!) all that has been discussed, proposed and critized in themoney illusion over the past 21 months is “bollocks”.
    http://krugman.blogs.nytimes.com/2010/10/30/sex-and-drugs-and-markets-role/

  19. Gravatar of W. Peden W. Peden
    30. October 2010 at 10:45

    “Increases in the monetary base would fail to increase broad monetary aggregates, let alone boost the economy.”

    - Krugman.

    I would be fascinated to read where he wrote this before the crisis. I suppose, in one interpretation, its not an interesting prediction at all (sometimes, an increase in a part will not result in a whole) but on another interpretation it’s a fascinating piece of theory that has absolutely to do with the standard literature about (Krugmanite, not Keynesian) liquidity traps.

    His challenge at the end is worthwhile, of course: we should all ask, re: our favourite theory, what would make us think it was wrong?

  20. Gravatar of W. Peden W. Peden
    30. October 2010 at 10:47

    Also, I just remembered Sumner’s point that an increase in the monetary base can be symptomatic of a contraction in broad money, which makes Krugman’s point even more dubious.

  21. Gravatar of Morgan Warstler Morgan Warstler
    30. October 2010 at 14:26

    1. Increases in the monetary base would fail to increase broad monetary aggregates, let alone boost the economy
    2. Despite large monetary base expansion, the economy would slide toward deflation, not inflation
    3. Despite large budget deficits, interest rates would stay low, because short-term rates would stay pinned at zero

    Forgive me but ALL this says is:

    With a “bad shock” the Fed / Treasury can stack money at the banks – and they will not loan it, they will stack the money at the Fed Reserves… and since the economy isn’t growing the Fed won’t have the cojones to raise rates.

    Meanwhile Scott says:

    The Fed isn’t stacking enough money with the banks and is encouraging them to stack what they get back in Fed Reserves.

    I will give Krugman at least this:

    He’s honest in his desire to rob savers with QE, because why not?!? He’s also willing to rob them with Fiscal policy and taxes and any other way he can.

  22. Gravatar of Shane Shane
    30. October 2010 at 15:35

    As Professor Sumner always notes, we don’t have to change the Fed’s mandate–it is currently abdicating responsibility to stabilize prices by allowing disinflation by permitting less than full employment. In the meantime, the political climate seems like it is becoming much less supportive for any kind of stimulus, monetary or fiscal. Does anyone think the coming election will fill the Fed with confidence for additional monetary stimulus, especially if it brings in a new congress itching to investigate all and sundry, particularly the Fed itself, that old bugaboo of the radical right. I hate to simplify things, but I really don’t see a lot of room for nuance in politics right now. As far as some are concerned, stimulus is stimulus; fed spending is big government spending like the stimulus, the bailouts, health care, and all the rest. My point is simply that expending effort to discredit this or that type of stimulus because you prefer some other type sends the message that it’s all wasteful and pointless, and it all does more harm than good.

    (http://www.nytimes.com/2010/10/11/us/politics/11fed.html?_r=1&scp=1&sq=federal%20reserve%20tea%20party&st=cse)

    @JimP–thanks for that article. It was quite informative. And I certainly agree that the stimulus as it was designed was of dubious value. Advocates of monetary stimulus often respond to criticism by using the phrase “a sufficiently determined central banker can certainly create inflation/raise the price level/raise NGDP.” I guess I would respond to the article by saying “don’t you think a sufficiently determined treasury can crowd out private investment (or lack thereof, in this case)”? And in the current environment, where that investment is basically stuffing money between mattresses, isn’t this crowding out a good thing? This is not to say that fiscal stimulus can literally “prime the pump” of the economy and return it to a self-perpetuating cycle, but it certainly can create some real investments, and the Fed cannot fire the workers hired as a result. It seems absurd to argue that a central bank cannot create inflation or rising NGDP, and this would have to have some positive impact—thus it is absurd to say that monetary policy cannot do anything; by the same token, it seems absurd to argue that the Treasury cannot directly create real GDP growth, when government spending is one of the major components of it by definition. Sustained QE will eventually have to have some kind of effect; ditto for continuous spending.

    I actually don’t think the major rationale is “well, we have to do something!” It simply makes sense to do QE when unemployment is high and inflation is declining—there is basically no cost, and it will no doubt have some positive effect. The same goes for spending on public-sector capital projects—it will basically have very little cost, and it will no doubt have some positive effect, even if that is limited to locking in lower interest rates right now. Furthermore, in a real sense, there is no net borrowing taking place, just as there is no net borrowing taking place when the social security trust fund runs a surplus and the general fund “borrows” it. We are “lending” ourselves idle capital right now, but if we put it to a productive use, then it will not really cost anything—just the reverse is true, it would be more expensive to let it sit there and do nothing. It’s not that it will pay for itself a la the Laffer curve—all we’re actually doing in real terms is putting idle resources to work, and if that work is something productive, or something that we would have to do anyways, then we save money by doing it now. Saying that this seems politically unworkable, or that it would be better to focus on monetary policy, is a lot different from saying that it cannot work. A central bank can always create inflation if it wants to; a government can always put idle resources to work if it wants to.

    Thanks for the great discussion y’all!

  23. Gravatar of Lorenzo from Oz Lorenzo from Oz
    30. October 2010 at 19:10

    I cannot take comments such as Richard Cantillon and Wes’s seriously, since Scott is advocating about the level of inflation we have down here in Australia: which is perfectly livable with.

    There are also huge differences between hyperinflation a la Latin America or Weimar Germany, high inflation a la 1970s and what Australia, for example, has experienced since 1992. If you cannot make such basic distinctions, you cannot comment intelligently on public policy.

  24. Gravatar of ang ang
    30. October 2010 at 19:38

    @david:

    Clearly the Fed does and should consider maintaining their political independence. It can’t be truly apolitical because it’s actions shape and distort markets, having asymmetric effects on citizenry and therefore having political nature. (Permament) Quantitative Easing is convenient because it supports government debt, and therefore question of how to distribute the AD is essentially decided by the political process. However, if the government is not creating enough debt, this process would seem to have limited effect for realistically sized QE programs.

    I really think one the biggest problem in our current political discourse is “the money illusion”, which leads to extreme confusion with how to think about debt and deficits. If the government issues debt and the Fed buys it on the secondary markets (permanently), this does not raise the government’s debt burden, but would “increase the national debt” and would therefore be “stealing from our children”. If the Fed just wrote the government a check and immediately forgave the debt, same net result on the debt burden, however you’d have a much harder time explaining to the lay-person why this was a bad thing.

    Bottom line is, we need to find a way to get the Fed to pump some more AD into the economy. Easiest way is to support Federal spending; failing this “unorthodox” measures are called for. Prof. Sumner wants to see the Fed buying stocks; while this may have the desired effect on NGDP and benefit everyone, I fail to see how this is apolitical, as certainly more of the benefits would accrue to current stockholders. This is why I suggested boosting Social Security, as it is pretty much the most popular government program and garners bipartisan support. Seriously, if the Fed said “we’d like to write every senior a check, if only congress will let us”, who’s going to oppose that? But at this point I’d support almost any measure to boost AD.

    –ang

  25. Gravatar of Mark A. Sadowski Mark A. Sadowski
    30. October 2010 at 19:39

    Oz,
    Unfortunately Richard and Wes’ are the kind one usually reads in the U.S. these days.

    I’m almost ready to move to the land down under, but not quite. If you could see my backyard you’d understand why I can’t leave.

    This battle needs to be fought on, under, and over, my own turf.
    Mark

  26. Gravatar of Mike Sandifer Mike Sandifer
    31. October 2010 at 06:31

    ang, you raise a good question, in my mind. Why not put the monetary stimulus directly in the hands of consumers?

    Sure, there may be moral hazard problems, but maybe our new financial regulations will help tamp down associated issues. Anyway, perhaps the most important thing is just to get the economy moving right now.

  27. Gravatar of Stephen Stephen
    31. October 2010 at 08:11

    Banks make more efficient capital allocation decisions than Congress. Banks must make loans to lowest credit risk, or else they will fail..if not supported by the government…
    I don’t trust congress to distribute the money fairly instead of banks. At least banks have some kind of market discipline to punish bad decisions.

  28. Gravatar of Jon Jon
    31. October 2010 at 09:09

    Scott: You’re really practicing a slight of hand when you hypothetically discuss someone who has saved via treasury bills.

    As you know, Bills, Demand Accounts, and other vehicles of similar duration do just fine during unexpected inflation in ways that a longer duration note or bond will not.

    Tilting the scale a bit much?

  29. Gravatar of JimP JimP
    31. October 2010 at 10:11

    http://macromarketmusings.blogspot.com/2010/10/qe-has-worked-before-my-reply-to-paul.html?utm_source=feedburner&utm_medium=feed&utm_campaign=Feed:+MacroAndOtherMarketMusings+(Macro+and+Other+Market+Musings)&utm_content=Google+Reader

    A comment says there is an article in the National Review favoring NGDP targets – but no link. Anyone have one?

  30. Gravatar of Doc Merlin Doc Merlin
    31. October 2010 at 13:32

    @Mike Sandler:

    That is what the Bush stimulus did (roughly). The consensus was that it wasn’t terribly effective because people just went and paid down their debt instead of spending.

  31. Gravatar of Morgan Warstler Morgan Warstler
    31. October 2010 at 17:22

    “If the Fed just wrote the government a check and immediately forgave the debt, same net result on the debt burden, however you’d have a much harder time explaining to the lay-person why this was a bad thing.

    ang, are you an academic?

    are you familiar with the whiskey rebellion? in the hinterlands, whiskey basically functioned as currency for trade.

    this was an instance where the political system didn’t understand they were actually taxing money… but the rubes did.

    the rubes ALWAYS know. and they totally understand that somebody prints money, and their money buys less.

    government debt gets paid back. its far more confusing to find out the Fed can buy it “permanently”- and it seems like you are more concerned with solving for the rubes, so maybe stick with that.

    Also, please show me some examples of the Fed over-riding the wishes of the Republican party where bankers weren’t the reason.

  32. Gravatar of Mike Sandifer Mike Sandifer
    31. October 2010 at 19:48

    doc, that may be a good point, but granting more money could work better. Remember also, that the inflation would decrease real debt, help spur demand and exports, and create a temporary disincentive to save.

  33. Gravatar of Mike Sandifer Mike Sandifer
    31. October 2010 at 19:53

    morgan, you may as well bring up the Luddites.

    I’d argue that average people don’t understand monetary policy, and really no one does. There is uncertainty about the effectiveness of monetary stimulus near the zero bound, but using different transmission mechanisms, such as sending money to the people directly, could help tremendously.

    But, politically feasible? I’m guessing the Fed and president would be accused of usurping congress.

  34. Gravatar of Doc Merlin Doc Merlin
    31. October 2010 at 23:54

    “But, politically feasible? I’m guessing the Fed and president would be accused of usurping congress.”
    The fed can literally send money to whoever they want. They wouldn’t do this however, as it undercuts their stockholders. Second of all, it is a very difficult task, something that the IRS is already geared to do, but the Fed most definitely isn’t.

  35. Gravatar of JTapp JTapp
    1. November 2010 at 05:47

    The Economist just posted a decent article on the pros cons of price level targeting.

    “Research by the Bank of Canada suggests that if more than 40% of people base their expectations on rules of thumb or past inflation, price-level targeting loses its edge.” Interesting.

  36. Gravatar of Mike Sandifer Mike Sandifer
    1. November 2010 at 05:57

    doc, do you really think that the deficit hawk, small government, audit the Fed congress would tolerate stimulus checks going out that they oppose?

  37. Gravatar of Mike Sandifer Mike Sandifer
    1. November 2010 at 06:02

    Scott, I know you reject this idea in general, but how about in depressed economies?

    I wonder if it would be a good idea for the Fed to up its purchases of government debt and start retiring it. This could provide more stimulus and perhaps begin to satisfy the deficit hawks as well.

    If this is as inflationary as you indicated in the past, it may be just what the doctor ordered right now. The Fed can begin slow, if they want.

  38. Gravatar of W. Peden W. Peden
    1. November 2010 at 06:38

    I’ve just had a thought about Krugman and the liquidity trap (Mark XII): if what is important is the fall of nominal interest rates to zero, then why was Britain able to escape the liquidity “trap” in 2010?

    A monetarist explanation would point to a 12-month growth rate of broadly defined money (M4) from December 2008 to December 2009. In other words, the quantitative easing programme of the Bank of England was sufficient to keep M4 chugging along and as a result Britain has got well clear of inflation (CPI inflation is about 1.1% ABOVE target in 2010).

    A Keynesian explanation might point to the fiscal stimulus of the 2009 budget. However, the net fiscal stimulus spending, per se, in the UK was about £20 billion (according to wikipedia) while the budget deficit was £175 billion, which is only 12.4% of UK GDP.

    In other words, the UK experience from 2008-2010 constitutes a definitive refutation of the Krugmanite liquidity trap. Monetary stimulus proved to be sufficient to bring an economy with nominal interest rates of 0.5% back from deflation into significant deflation. So the Krugmanite liquidity trap is not only problematic in theory; the empirical evidence contradicts it, insofar as I understand what Krugman proposed.

  39. Gravatar of Morgan Warstler Morgan Warstler
    1. November 2010 at 06:44

    Mike,

    How about this one: The Fed pays the personal taxes of people who own small businesses with 2-20 employees.

    There is no such thing really as a deficit hawk, there is a point where we’re so far in debt people get sick to their stomach – as such Republicans have learned since Reagan to get us right up to that line, so Dems can’t buy votes.

    Being a deficit hawk really means you are advocating spending cuts to traditionally Dem supported spending, so your plan doesn’t satisfy them.

    Instead, try to invent a method of printing money that goes exclusively to the “deficit hawks,” dress it up, create any old rationale for it – and you’ll finally have found a politically acceptable approach to QE.

  40. Gravatar of Morgan Warstler Morgan Warstler
    1. November 2010 at 07:38

    http://www.nytimes.com/2010/11/01/opinion/01krugman.html?_r=1

    This post from Krugman never once mentions “Hard Assets,” or “Ownership.”

    Its like academics are so focused on the happy insight of The Money Illusion, that they absolutely forget that money/debt/credit is all just a function of trade… but that behind the trade are hard assets that people own.

    There are PRIZES: Land, cars, houses, commodities – real ATOMIC things and ATOMS have owners.

    That’s why I think Krugman is a liar and Scott is just an egghead.

    I think Scott really doesn’t care who owns the hard assets, he just likes to think about the derivatives.

    Meanwhile Krugman talks and talks about the derivatives because he’s really after the hard assets.

    Krugman writes:

    “Real estate speculation ran wild in Florida and Nevada, but also in Spain, Ireland and Latvia. And all of it was paid for with borrowed money.

    This borrowing made the world as a whole neither richer nor poorer: one person’s debt is another person’s asset. But it made the world vulnerable. When lenders suddenly decided that they had lent too much, that debt levels were excessive, debtors were forced to slash spending.”

    Real Estate, got it. A nice hard asset. Then gobbledygook… let’s print and borrow more!

    NO dude, let’s take the hard assets away from the debtors give them to the creditors and be done with it.

    How hard is it? GET OUT OF THE HOUSE. GET OFF OF THE LAND.

    If we have some moral nagging about it, use MERS to clean up the debtors credit record, and get a decent nights sleep.

    I think there is a horrible side effect of people not talking about the ownership of the hard asset behind the derivative: it forgets the underlying reality of economics: scarcity.

    If you own it, I don’t.

    You see this when people talk about digital theory as well. There is no true ownership possible of the digital, because it is infinitely copyable, efforts to treat it like atomic goods – undermine the the very premise of ownership. People talking about piracy of digital music, like it is theft of food, undermines our notion of owning food, it makes stealing food, a little more justified – it doesn’t protect music.

    If oil was infinitely copyable, we’d riot if someone said you can’t copy it. Music is copyable, so we should not allow it to be sold, lest we demean ownership.

    Somehow, money which functions exclusively to allow the trade of ownership of atomic things, has a bunch of theorists NOT PISSED OFF when the king’s mint is adding quicksilver to the gold.

    Krugman we know wants to steal the gold, Scott just seems to believe in alchemy.

  41. Gravatar of Doc Merlin Doc Merlin
    1. November 2010 at 08:50

    @ Mike Sandifer
    “doc, do you really think that the deficit hawk, small government, audit the Fed congress would tolerate stimulus checks going out that they oppose?”

    Well, Bush’s congress did it. Keynesianism is bipartisan. I don’t like it, but the republicans seem to support it. The fed also spent lots of money buying up private assets.

  42. Gravatar of Jeff Jeff
    1. November 2010 at 08:54

    My comment way up above is wrong. Real final sales were up, but only at a 0.6 percent annual rate. In other words, inventory growth accounted for 70 percent of the growth in output.

  43. Gravatar of Justin Justin
    1. November 2010 at 10:19

    “I saw the 3rd quarter NGDP was about 4%–surprised by the high deflator (something I can’t explain.)”

    The high deflator appears related to a sharp decline in import prices.

    The deflators for the various domestic components of GDP were quite low (PCE price index up 1.0% annualized, and investment/government each up 0.4%). Import prices, on the other hand, fell at a 7.9% annualized pace. Since we subtract imports from GDP, falling import prices put upward pressure the GDP deflator Put another way, falling import prices restrained the growth rate of the price level for what we buy.

    This happened in 2008Q4 (deflator was ‘only’ down 1.2% at an annual pace despite plummeting prices across much of the economy, because import prices fell at 32.1% rate) and in reverse in 2008Q2 (deflator ‘only’ rose 3.2% despite higher inflation across much of the economy because of a 16.6% surge in import prices).

  44. Gravatar of Morgan Warstler Morgan Warstler
    1. November 2010 at 12:40

    Why do so many UChicago Economists want to do Labor:

    http://economics.uchicago.edu/pdf/2010_11_vitas.pdf

    Or is that the most common?

  45. Gravatar of scott sumner scott sumner
    1. November 2010 at 13:50

    Marcus, That graph he provides is intentionally misleading. The Japanese monetary base fell in 2006–he ends at December 2005. Krugman knows this. It shows that temporary currency injections are not inflationary–but we already knew this.

    ang, That might work, but there are much cheaper ways to get the job done–which don’t balloon the deficit.

    Jeff, Yes, that doesn’t bode well for Q4.

    Richard. Was John Law in favor of NGDP futures targeting, level targeting?

    Morgan, Actually, the next Fed decision occurs AFTER the election.

    Wes, You said;

    “This makes you an investor.”

    No that makes me a saver. Saving equals income minus consumption–whether you buy stocks or bank CDs.

    Mark, You said;

    “Scott,
    One of your best posts yet. Why? Precisely because it’s so contrarian.”

    Thanks. I’m tempted to say “aren’t all my posts contrarian?” :)

    W. Peden, Reserves are not part of M2, but are a part of the base. But I certainly agree that the Fed can increase M2 if it really wants to.

    more to come . . .

  46. Gravatar of marcus nunes marcus nunes
    1. November 2010 at 14:07

    Really bad reasoning can come from thinking in terms of what you once named “Gross Deceptive Partition”. Thoma goes that route only to find that “what can you say…”. Likely QE will lower real rates, but will C and or I go up?
    http://economistsview.typepad.com/economistsview/2010/11/qeii-even-if-real-rates-fall-and-expected-inflation-increases-will-frims-and-households-beinduced-to.html?utm_source=feedburner&utm_medium=feed&utm_campaign=Feed%3A+typepad%2FKupd+%28Economist%27s+View+%28typepad%2FKupd%29%29

  47. Gravatar of Morgan Warstler Morgan Warstler
    1. November 2010 at 14:27

    Scott my point is the Fed by waiting has said “Behave!”

    Otherwise they would have acted quicker.

  48. Gravatar of JimP JimP
    1. November 2010 at 14:40

    Krugman admits he was wrong all along about MP – without admitting it of course. Standard Paul.

    http://krugman.blogs.nytimes.com/2010/11/01/the-end-of-western-civilization/

  49. Gravatar of scott sumner scott sumner
    1. November 2010 at 14:51

    Shane, There are two reasons I don’t advocate fiscal stimulus:

    1. It’s not very effective.
    2. It increases the national debt, and future tax liabilities.

    Joe, Yes, that’s exactly right.

    JimP, Thanks for the Miron piece.

    Marcus, That sex and drugs post is idiotic. Is Krugman saying he agrees with that commenter?

    W. Peden, The key is whether the MB increase is temporary or permanent.

    Lorenzo–Indeed I’m advocating roughly the actual inflation the US had during the previous two decades–about 2.5% for a few years, then 2% thereafter.

    ang, You said;

    “Prof. Sumner wants to see the Fed buying stocks; while this may have the desired effect on NGDP and benefit everyone, I fail to see how this is apolitical, as certainly more of the benefits would accrue to current stockholders.”

    No, I have advocated they buy government bonds, not stocks. So the premise of your long post is completely wrong.

    Mike, QE does put money into the hands of consumers.

    Stephen, I agree.

    Jon. Yes, but I also think longer term bond yields would rise with a more robust recovery. Obviously I wasn’t arguing that the standard argument is wrong about inflation hurting savers–there is some truth to it. Existing bonds become worth a bit less. It’s just that right now the positive benefits to savers might outweigh the costs.

    more to come . . .

  50. Gravatar of JimP JimP
    1. November 2010 at 15:25

    Krugman goes the whole way – calling for a price level target:

    http://krugman.blogs.nytimes.com/2010/11/01/if-i-were-king-bernanke/

  51. Gravatar of JimP JimP
    1. November 2010 at 15:32

    from the above Krugman post:

    begin quote
    It’s also crucial to understand that a half-hearted version of this policy won’t work. If you say, well, 5 percent sounds like a lot, maybe let’s just shoot for 2.5, you wouldn’t reduce real rates enough to get to full employment even if people believed you — and because you wouldn’t hit full employment, you wouldn’t manage to deliver the inflation, so people won’t believe you.
    end quote

    So I guess that means MP (if done right) can lower real rates eh Paul? So where is the liquidity trap then?

    And the above quote is then followed by a dig at NGDP targeting.

    You have to give the guy credit – he never does stop being a real s**t.

  52. Gravatar of scott sumner scott sumner
    1. November 2010 at 15:55

    JimP, I was sent a copy of the NR article–it does mention my name, along with David Beckworth. David was also mentioned by the WSJ.

    JTapp, But what The Economist overlooks is that how people form expectations depends on the type of monetary regime. It’s different under fiat money than it was under the gold standard, and it would be different under price level targeting than it is under inflation targeting.

    Mike Sandifer, I’m not quite sure what you mean by “retiring debt” Do you mean the Fed would tie its hands so that it could not reduce the money supply in the future? That would be too effective–leading to high inflation.

    W. Peden, Actually, even Krugman doesn’t really believe in the liquidity trap–he just thinks central banks are usually too conservative to do what it takes to escape the trap.

    Justin, Thanks for the info on the deflator. But that still implies that the prices of what we produce are going up at 2%, which surprises me.

    Morgan, You sure dig up obscure info. I think Chicago has always been strong in labor.

    Marcus, Yes, that sort of reasoning always makes it look like monetary policy can’t do much. It’s true that in a recession the Fed can’t lower rates very much more then they have already fallen–but monetary policy works primarily through other mechanisms.

    Morgan, OK, but now that the election is here can I have your permission to advocate easy money?

    JimP, The funny thing is that all sorts of gold bugs believe exactly that theory–that Bernanke is bringing the end of Western civilization.

  53. Gravatar of Morgan Warstler Morgan Warstler
    1. November 2010 at 18:29

    Well wait… here are the steps:

    Win the house OR wait till 2012.

    If we win, scream gut the public employees! and liquidate the houses! Many posts on these subjects will aid in your good cause.

    The point being with a firm 2% target and $100B+ a month – the more deflationary productivity driven effects we cause – the more QE you get from the Fed.

    What will be disappointing is if you are not picking fights over gutting public employees with Krugman and just keep talking about QE. After all, shouldn’t my logic be Krugman’s logic too?

    IF you are’t getting Fiscal and Monetary is set in stone.
    THEN aren’t you required to promote policy that tries to un-stick wages and prices?

    At some point don’t you have to care more about the suffering unemployed than your liberal conscience?

  54. Gravatar of TheMoneyIllusion » Will it work? TheMoneyIllusion » Will it work?
    3. November 2010 at 14:31

    [...] and thus real rates would return to normal at a slightly faster pace.  That was the thesis in my recent post about why a little bit of inflation might actually help savers. (Not quite so far-fetched as many [...]

  55. Gravatar of scott sumner scott sumner
    4. November 2010 at 16:40

    Morgan, Intellectuals are very good at equating their policy views with their consciences.

  56. Gravatar of Mark A. Sadowski Mark A. Sadowski
    4. November 2010 at 19:43

    Scott,
    Do I take it you don’t count yourself as an intellectual? Or are you just qualifying your point of view?

  57. Gravatar of scott sumner scott sumner
    6. November 2010 at 11:18

    Mark, No one is capable or providing a dispassionate critique of their own values, are they?

  58. Gravatar of This is How Inflation is Confusing «  Modeled Behavior This is How Inflation is Confusing «  Modeled Behavior
    25. November 2010 at 21:45

    [...] Sumner has a post about how inflation is, counterintuitively, good for savers. The thrust of it is that raising NGDP [...]

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