Waldman on monetary and fiscal policy

Most economists form their worldviews based on what was going on when they were young.  I teach the Phillips curve as follows:

1.  Phillips Curve “discovered” (actually rediscovered) in 1958. 

2.  US policymakers used the Phillips curve in the 1960s.

3.  People in important positions of power are generally in their 50s.

4.  Policymakers in the 1960s came of age in the Depression.

5.  Unemployment was then seen as a more serious problem than inflation.

6.  In the 60s, policymakers pushed us up and to the left on the PC.

I am a product of the 1970s.  My view of the importance of monetary policy was formed by the world situation in 1980:

 inflation 1980 (yearly basis)   

  CPI Austria  Austria cpi 6.654 % 

  CPI Belgium  Belgium cpi  7.547 % 

  CPI Canada  Canada cpi 11.058 % 

  CPI Chile Chile cpi 31.238 %   

  CPI Denmark Denmark cpi 10.895 %   

  CPI Finland Finland cpi 13.762 %   

  CPI France France cpi 13.733 %   

  CPI Germany Germany cpi 5.540 %   

  CPI Great Britain Great Britain cpi 15.121 %   

  CPI Greece Greece cpi 26.291 %   

  CPI Iceland Iceland cpi 55.738 %   

  CPI India India cpi 9.085 %  

  CPI Indonesia Indonesia cpi 17.057 %  

  CPI Ireland Ireland cpi 18.251 %   

  CPI Israel Israel cpi 132.950 %   

  CPI Italy Italy cpi 19.552 %   

  CPI Japan Japan cpi 7.240 %

  CPI Luxembourg Luxembourg cpi 6.994 % 

  CPI Mexico Mexico cpi  29.845 %  

   CPI Norway Norway cpi 13.477 %  

   CPI Portugal Portugal cpi 13.109 %  

   CPI South Africa South Africa cpi 15.842 %  

   CPI South Korea South Korea cpi 32.202 %   

   CPI Spain Spain cpi 15.213 %

  CPI Sweden Sweden cpi 14.127 % 

   CPI Switzerland  Switzerland cpi  4.426 %   

   CPI the Netherlands The Netherlands cpi  6.650 %   

   CPI Turkey Turkey cpi  75.072 %  

   CPI United States United States cpi 12.516 %

Countries could choose different trend rates of inflation (and hence NGDP growth), just like someone choosing food from a menu.  How did they generate these vastly different trend rates of inflation?  The only answer that made any sense to me then was monetary policy.  And it’s still the only answer that makes any sense to me.  I was reminded of this when reading a new post by Steve Waldman:

Like Andy Harless (but see Sumner’s rejoinder), I think the distinction between fiscal and monetary policy has grown very blurry. Monetary reserves are now interest-bearing obligations, ultimately paid for by the state. Some Fed “liquidity facilities” involved issuing interest-bearing obligations to buy up private sector assets (at prices above those offered in private markets). That sounds like fiscal policy to me. While it can be argued that conventional open-market operations only transform the maturity of government obligations, by anchoring the yield curve and increasing the fraction of debt that can be used directly as a medium of exchange, conventional monetary policy may increase the willingness of private agents to hold US debt, reducing constraints on spending and enabling expansionary fiscal policy. Fiscal policy and monetary policy are intertwined, and it’s not clear to me that either dominates the other. (There’s an aphorism to the effect that “the monetary authority always moves last”, but it doesn’t persuade me. Timing of endogenous phenomena tells one very little about causality. Timing of moves in a game tells us very little about which player has the advantage.) Ultimately, I’ve come to think that the main differences between fiscal and monetary policy are institutional. Decisions about what we call “fiscal” and “monetary” policy decisions are made in different ways by dissimilar entities. Those decisions can reinforce one another, or they can offset and check one another. Some people prefer to emphasize the role of fiscal authorities for “democratic legitimacy”, while others champion action by an “independent central bank”, on the theory that isolation from overt politics will yield technocratically superior choices. You can accept these preferences on face, or more cynically argue that some groups expect one or the other decisionmaking body to execute policy ways that that favor preferred interests. But at a macro level, Sumner’s NGDP targeting monetary policy and MMT-ers’ GDP-supporting fiscal policy look similar to me. Both perspectives arouse my sympathies but provoke misgivings. First, I’m not sure either instrument is up to the task of stabilizing the target over a long horizon, and worry that attempting but failing to stabilize may prove riskier than conventional muddling through. Second, I think the micro-level stuff really does matter. In order to ensure both high quality resource allocation and distributional legitimacy, I think it matters very much what is paid for with fiscal expansion, and precisely how monetary policy is to be conducted. (I offered a proposal a while back that now looks like a bizarre hybrid of Sumnerism and Chartalism, which tries to address micro-level concerns.)

I don’t see any similarity between monetary policy (which is basically a nominal policy) and fiscal policy (which is basically a real policy.)  If a central bank wants to produce a trend rate of NGDP growth of 20%, we know it can do that over time (not ever year.)  Fiscal policy?  I wouldn’t even have a clue as to where to start.  Suppose fiscal policy aims for 20% trend rate of NGDP growth, and the central bank is following Friedman’s 4% M2 growth rule.  What happens? 

The analogy I use is driving with my young daughter.  She’s strong enough to reach over and move the steering wheel.  But if I’m driving, and have some place I want to go, I’ll just grip the wheel tighter and offset her push.  If Bernanke and the Fed want to go somewhere, they can always grip the policy wheel and get (eventually) where they want to go.  Fiscal policy is helpless under those conditions. 

Yes, there are conditions where the central bank is the handmaiden of fiscal authorities (Zimbabwe a few years ago), but that doesn’t describe the US.

The real reason I wanted to link to Waldman is this paragraph from the same post:

For me, the highlight of the meeting by far was lunch with Scott Sumner and Scott Wentland. We had a grand conversation. Readers of both blogs might imagine the authors of The Money Illusion and interfluidity to be on opposite sides of a great divide, but it didn’t feel like that at all. The quality of mind I value in other people and strive for in myself is a kind of nimbleness, a fluidity of mind. The world is too complex for any particular narrative to be perfect. Good judgment, I think, comes from the ability to slip between and among stories, to understand the ways different accounts might be true, to marshall evidence and reasoning on both sides and then apply weights to a superposition of competing, sometimes contradictory ideas, all of which play a role in ones choices. Sumner and I understood one another’s views very quickly, and took them seriously, though we’d probably assign them different weights. Further, though I suspect he will bristle a bit at the characterization, within the economics profession Sumner is an ideologue in the very best sense. There’s both a moral and a methodological component to that. Sumner is driven, scandalized even, by what he sees as a profound and preventable failure of monetary policy. He’s shocked that the rest of his profession (which he’d previously considered himself to be in the middle of) didn’t notice, that economists don’t get in their guts how awful an abdication of policy has occurred. So Sumner has made it his full-time preoccupation for two years to communicate and persuade, working to change his colleagues’ intuitions about what is acceptable and what is not. He has a reasonable (though not unassailable) model of how the economy works, and a coherent vision of a policy regime that would be wise under that model. Recent experience suggests that implementing Sumner’s policy regime, under which the monetary authority both commits to and is able to target NGDP, would be eased by tools that are institutionally or politically unavailable under current arrangements (e.g. an NGDP futures market, negative interest on reserves, perhaps more flexibility with respect to asset purchases). Rather than working within those constraints, he has made lobbying to alter them part and parcel of his campaign to shift the intuitions of his colleagues with respect to the conduct and duties of monetary policy.

Wait, I thought econ was estimating VARs to refute models.

Greg Mankiw’s always talking about how great Harvard is (and I don’t doubt it’s pretty great.)  Someone ask him how many of his grad students think and write as well as this guy, who’s an econ student at Kentucky.

PS.  I know what you’re thinking; “Naturally you think he’s great–he’s praising you!”


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24 Responses to “Waldman on monetary and fiscal policy”

  1. Gravatar of 123 123
    24. January 2011 at 13:42

    If the Fed is doing fiscal policy, why did the Fed’s profits increase?

  2. Gravatar of Benjamin Cole Benjamin Cole
    24. January 2011 at 14:01

    Waldman sounds like the rare gem who can take a position, argue it, and yet see the other side of the coin, and actually enjoy intellectual discussion, not monologue.

    BTW, Dow up 100 today, some recent bank-lending stats look very good. I think the QE debate fades from here, with QE “winning” the debate for perhaps the wrong reasons.

    Nothing succeeds like success. If the economy turns strong, QE can take credit. If the economy had faltered (though had been better than otherwise) QE would have taken blame.

    The anti-QE crowd (the Nipponistas) will look increasingly shrill if they keep honking about the dangers of QE as the economy grows and inflation remains low. I think this is the forecast, btw.

  3. Gravatar of Indy Indy
    24. January 2011 at 15:20

    Interfluidity’s at the top of my charts. He used to post more often, but he’s slowed down awfully in the last few months. Somebody at Kentucky needs to give the fellow more time – or make blogging for an hour a day one of his official duties.

  4. Gravatar of Doc Merlin Doc Merlin
    24. January 2011 at 17:33

    Fiscal policy combined with governmental market restrictions can have an (pretty strong) effect on CPI too, but yes I agree monetary policy is far more dominant.

  5. Gravatar of Doc Merlin Doc Merlin
    24. January 2011 at 17:34

    I should clarify, I mean it can make CPI higher, rarely does increasing restrictions lower CPI.

  6. Gravatar of Morgan Warstler Morgan Warstler
    24. January 2011 at 19:12

    Austan Goolsbee as a debater from Yale had gone Milton Academy and grew up in California, but when he debated, he adopt a full on Deep Texan accent and began virtually every round with some form of “now I don’t know much about x,y,zeee – but it sho seems to me that…”

    Waldman plays a similar game, he just LOVES the end goals of DeKrugman and respects their efforts oh so very much… as he sticks it in them. It’s fun.

    ——

    The only common thing to monetary and fiscal is that they both are a tax on the winners in the current state of things to help the losers.

    Monetary, at its best, defends itself by arguing it is in the mid and long term interests of the winners to accept this.

    Of course the backbone of Monetary, whether it is Keynes, Fisher, Hayek, Mundell, Sumner, or Friedman, is proving that it has a backbone…. not only that is has a solution in weird times, but the same firm grip during normal times.

    Scott talking about his daughter reminded me of this passage from Hunter Thompson:

    “Few people understand the psychology of dealing with a highway traffic cop. Your normal speeder will panic and immediately pull over to the side when he sees the big red light behind him … and then he will start apologizing, begging for mercy.

    This is wrong. It arouses contempt in the cop-heart. The thing to do — when you’re running along about a hundred or so and you suddenly find a red-flashing CHP-tracker on your trail — what you want to do then is accelerate. Never pull over with the first siren-howl. Mash it down and make the bastard chase you at speeds up to 120 all the way to the next exit. He will follow. But he won’t know what to make of your blinker-signal that says you’re about to turn right.

    This is to let him know you’re looking for a proper place to pull off and talk … keep signaling and hope for an off-ramp, one of those uphill side-loops with a sign saying “Max Speed 25″ … and the trick, at this point, is to suddenly leave the freeway and take him into the chute at no less than a hundred miles an hour.

    He will lock his brakes about the same time you lock yours, but it will take him a moment to realize that he’s about to make a 180-degree turn at this speed … but you will be ready for it, braced for the Gs and the fast heel-toe work, and with any luck at all you will have come to a complete stop off the road at the top of the turn and be standing beside your automobile by the time he catches up.

    He will not be reasonable at first … but no matter. Let him calm down. He will want the first word. Let him have it. His brain will be in a turmoil: he may begin jabbering, or even pull his gun. Let him unwind; keep smiling. The idea is to show him that you were always in total control of yourself and your vehicle — while he lost control of everything.”

    The lesson here is that Sumner can’t just say he’ll take over the wheel when his daughter is smiling at the cop with a can of Budweiser in her hand, that will just lead to more car chases.

    REAL backbone, is using the same firm hand to make sure we never get into trouble. We know Friedman had backbone – he fought government over-reach tooth and nail, we know Mundell has backbone – he tricked Greece into becoming sane and legal. They disagree, but we know what both stand/stood for FIRST.

  7. Gravatar of Andy Harless Andy Harless
    24. January 2011 at 22:29

    Suppose fiscal policy aims for 20% trend rate of NGDP growth, and the central bank is following Friedman’s 4% M2 growth rule

    Suppose monetary policy aims for a 20% trend rate of NGDP growth while the fiscal authorities are constantly raising taxes and cutting spending to produce bigger and bigger surpluses. That won’t work either, because we’ll end up in a liquidity trap. Or if you don’t believe in liquidity traps, we’ll end up on the far side of the Laffer curve and the economy will implode.

    Certainly fiscal and monetary policy can put limits on each other, but ultimately they have to cooperate to some extent. The question is which one to give the leading role (while the other just agrees to operate within a set of parameters that are compatible with the strategy). In principle, I think it works either way. If fiscal policy were sufficiently flexible, it could be used to target NGDP while monetary policy holds, for example, a constant short-term interest rate. For political reasons, monetary policy is more effective for controlling excessive NGDP growth, but it appears that monetary policy can become very difficult when NGDP growth undershoots severely. (We can argue about just what “difficult” means in this context, but surely, if it weren’t difficult in some sense, the Fed would have done a better job.) So perhaps one could design a policy that targets NGDP growth by using monetary policy to keep NGDP from rising too quickly and fiscal policy to keep it from rising too slowly.

    monetary policy…is basically a nominal policy…and fiscal policy….is basically a real policy

    Is fiscal policy real? It can be, if it’s defined in real terms (“We’ll pay whatever it costs to build this bridge.”) But what if it’s defined in nominal terms ($1 billion in lump sum tax rebates)? In that case it basically consists of borrowing money on behalf of the rebate recipients. I don’t see how that’s any more “real” than printing new money for them to borrow privately.

  8. Gravatar of Full Employment Hawk Full Employment Hawk
    24. January 2011 at 22:54

    “Policymakers in the 1960s came of age in the Depression.”

    The New Classical Economics and Real Business Cycle Theory could only establish themselves in acadimia after the senior professors and the journal editors who had actually experienced the Great Depression at first hand had retired or died. People who had first hand experience with the Great Depression (unless they were ideolgically committed to some theoretical dogma like Austrian Economics of Schumpeter’s theory of business cycles) knew, from their personal experience, that models of business cycles that assumed that prices and wages were perfectly flexible and that markets continuously cleared, even when the economy was depressed, were nonesensical.

  9. Gravatar of Full Employment Hawk Full Employment Hawk
    25. January 2011 at 01:26

    “I think the distinction between fiscal and monetary policy has grown very blurry.”

    There is a tertium quid here: In addition to monetary and fiscal policy, there is Financial Markets Policy, which subsumes most of the non-conventional policies that the Fed has engaged in (but not buying long-term government securities, which is clearly monetary policy).

    If one accepts the point of view that the most basic, most fundamental function of a central bank is to act as a lender of last resort, financial markets policy is within the domain of the central bank.

  10. Gravatar of A Grad Student A Grad Student
    25. January 2011 at 02:15

    I don’t want to be gratuitously mean to Waldman, but he is much better as a *writer* than a *thinker*. I doubt that many of Greg Mankiw’s students at Harvard are able to write as fluidly as Waldman, but I also doubt that they are confused on such basic points. The “blurriness” between fiscal and monetary policy is only relevant when interest rates are at the zero lower bound, a point that Waldman either fails to understand or bizarrely chooses to omit; the comparison between Chartalism and Sumnerism is just bizarre. (Though it’s not quite as bizarre as taking Chartalism and “MMT” seriously in the first place.)

    In sum: Waldman is a smart guy, but his intuition about money and economics is still rather weak. His reputation as a brilliant thinker stems from his legitimate brilliance at writing, not some special insight into economic matters. Indeed, he’s a perfect example of why formalized economics is so important: it elevates the Woodfords rather than the Waldmans to the top.

  11. Gravatar of Andy Harless Andy Harless
    25. January 2011 at 08:03

    A Grad Student:

    The “blurriness” between fiscal and monetary policy is only relevant when interest rates are at the zero lower bound

    Not so, now that reserves pay interest. OMO’s consist of altering the structure of government debt between T-bills/notes and bank reserves, both of which pay interest at what will presumably be close to market rates for their maturity. Now suppose the Treasury were to fund itself partly with overnight borrowing instead of 3-month bills. (Or suppose, given its current methods, it changes the mix between 3-month and 1-month bills.) Fundamentally, that’s the same thing, but would it be considered monetary policy?

    the comparison between Chartalism and Sumnerism is just bizarre

    Again not so. The two are similar in that they focus on nominal spending as a target and leave aggregate supply as a subsidiary issue, instead of focusing on the empirically questionable concepts of aggregate real growth and the general price level that obsess mainstream macroeconomists.

    I’ll agree that formalized economics is important, but it has the same danger that purely literary economics has: it elevates form over substance. To get the best sense we can of how economic models apply to reality we need to discuss them in both literary and mathematical terms.

  12. Gravatar of Dustin Dustin
    25. January 2011 at 09:03

    Will the word ‘Sumnerism’ appear in future economics textbooks?

  13. Gravatar of scott sumner scott sumner
    25. January 2011 at 09:34

    123, Good question.

    Benjamin, Yes, how many false alarms about inflation before they wise up?

    Indy, I agree.

    Doc, I don’t agree, fiscal policy has little effect on the CPI.

    Morgan, Nice analogy. I’m guessing you’re a PJ O’Rourke fan too.

    Andy, You said;

    “Suppose monetary policy aims for a 20% trend rate of NGDP growth while the fiscal authorities are constantly raising taxes and cutting spending to produce bigger and bigger surpluses. That won’t work either, because we’ll end up in a liquidity trap. Or if you don’t believe in liquidity traps, we’ll end up on the far side of the Laffer curve and the economy will implode.”

    I strongly disagree, no way we’ll have a liquidity trap with anything close to 20% NGDP growth. It’s very easy for the government to run surpluses year after year with 20% NGDP growth. If the Fed runs out of T-Bonds to buy, they can just buy German and Japanese government bonds.

    If the fiscal authorities want to make the economy implode, that’s their business. Nothing to do with monetary policy (recall I ruled out the Zimbabwe case–assumed an independent Fed, which is what we have.)

    Australia has almost no national debt, and the fastest NGDP growth of any developed economy. Even in a liquidity trap a central bank can create 20% NGDP with a crawling peg exchange rate regime.

    BTW, my 20% NGDP growth was not a hypothetical, lots of countries did this in the Great Inflation. And surprisingly, fiscal deficits in real terms were often quite small during the 1970s.

    You said;

    “Certainly fiscal and monetary policy can put limits on each other, but ultimately they have to cooperate to some extent.”

    No they don’t. The Fed does what it wants in our system, and the fiscal authorities must take that NGDP growth rate as a given. When Reagan ran big deficits, Volcker didn’t play ball.

    You said;

    “If fiscal policy were sufficiently flexible, it could be used to target NGDP while monetary policy holds, for example, a constant short-term interest rate.”

    No, a constant interest rate leaves the price level indeterminate, even with active fiscal policy.

    You said;

    “We can argue about just what “difficult” means in this context, but surely, if it weren’t difficult in some sense, the Fed would have done a better job.)”

    I don’t agree, even Bernanke now says the Fed could have prevented the Great Contraction. But they didn’t. Evidence of failure is not evidence of difficulty, it’s evidence of a flawed model.

    I meant fiscal policy is real in the sense that it takes the price level as given, and thus any changes in nominal quantities (taxes, spending) are changes in real quantities. In the long run, it is exactly the opposite for monetary policy.

    I agree about the Great Depression, I don’t really agree about financial policy, although I suppose one can find one or two types of financial policy that cross over the line to become monetary.

    grad student, I hope you aren’t at Harvard. :)

    Seriously, I obviously don’t agree with his views of monetary policy, but when I spoke with him I found him to be completely on top of the issues we discussed. On the other hand many economics professors seemed totally unaware that there were other things the Fed could do once rates hit zero, They kept saying things like the Fed is out of ammo. Or they said money was obviously easy, because rates were low. I was astounded at the things I read coming out of elite institutions. Many macroeconomists didn’t know real rates soared in late 2008. Many didn’t know about IOR back in 2008.

    Andy, You said;

    “Again not so. The two are similar in that they focus on nominal spending as a target and leave aggregate supply as a subsidiary issue, instead of focusing on the empirically questionable concepts of aggregate real growth and the general price level that obsess mainstream macroeconomists.”

    I’m confused by this–I thought Keynesians and monetarists did the same. AD is one issue, and AS another. My only wrinkle is that I define AD as NGDP, while Keynesiasn don’t (although monetarists often do.)

  14. Gravatar of scott sumner scott sumner
    25. January 2011 at 09:34

    Dustin, I hope so.

  15. Gravatar of Morgan Warstler Morgan Warstler
    25. January 2011 at 09:40

    Andy,

    Fiscal stimulus spending can be and often is “dig holes, fill, repeat,” and it creates a debt load that future taxpayers must cover.

    At worst when money is printed by the Fed, it crowds out other bond buyers…. but the entire system is still “trying” to find productivity gains / profits.

    Please explain to me what is blurry about this, other than the fact that in both circumstances someone is making money far too easily (unemployed vs. Goldman).

  16. Gravatar of Mark A. Sadowski Mark A. Sadowski
    25. January 2011 at 12:06

    Scott wrote:
    “Most economists form their worldviews based on what was going on when they were young. I teach the Phillips curve as follows:

    1. Phillips Curve “discovered” (actually rediscovered) in 1958.
    2. US policymakers used the Phillips curve in the 1960s.
    3. People in important positions of power are generally in their 50s.
    4. Policymakers in the 1960s came of age in the Depression.
    5. Unemployment was then seen as a more serious problem than inflation.
    6. In the 60s, policymakers pushed us up and to the left on the PC.”

    Nick Rowe wrote an entry in response to Krugman’s “War on Demand”. Here’s what he had to say about the lingering effects of the 1970s:

    “And, for once, the memories of their parents are actually supporting me in my job. Look what happened in the 1970′s, when demand increased. Printing too much money and increasing demand really did cause inflation. It really didn’t make us all richer. It didn’t reduce unemployment.

    Now, just for once, we have to switch gears. These times are not normal. Just for once, the demand side really is the problem. Just for once, the overly obvious truth your senses are telling you really is the truth. Just for once, your parents’ experience of the 1970′s doesn’t apply. Just for once, it really is OK to have a drink, even though you are a recovering alcoholic.”

    http://worthwhile.typepad.com/worthwhile_canadian_initi/2011/01/the-war-on-demand-and-the-short-side-rule-.html

    Allow me to share my response to Nick here as it seems slightly relevant:

    “There’s an economic side to me I rarely reveal. It’s Medievalian in its faith in cyclicality. I’ve always been intrigued by theories of long waves.

    It’s hard not to believe when you look at a graph of yoy CPI from 1960-2000 and observe an almost symmetric mountain peak ascending and descending as you go from left to right. The preceding 40 years (1920-1960) were of course less symmetric but certainly being punctuated by the Great Depression they present a somewhat inverted picture.

    So in a sense the Medievalian part of me wasn’t surprised by our current demand side economic predicament. And I’m not surprised at all that the biggest problem we have now is convincing those with memories of the 1970s (and early 1980s), as well as their children, that printing money right now really would help.

    Previous generations have had similar struggles. In the 1960s there was a deepseated fear of unemployment by those who had lived through the Great Depression which led them to believe that in the proper management of the demand side lay the solution to all our economic problems. Similarly Benjamin Roth’s Great Depression diary reveals a thinking eerily similar to our own time where fears of inflation lurk around every corner and yet there was none to be found.

    I wonder, how much of these waves are the result of the widespread persistence of irrational fears induced by painful memories that take a good dose of the opposite to finally cure and unfortunately set off the secular cycle yet again?”

    Clearly I was in a philosophical mood.

    P.S. You’ll find some familiar names in Nick’s comment thread.

  17. Gravatar of Andy Harless Andy Harless
    25. January 2011 at 15:59

    Scott:

    It’s very easy for the government to run surpluses year after year with 20% NGDP growth.

    My point is that you won’t get 20% NGDP growth in the first place if fiscal policy is sufficiently tight (and becoming tighter at a sufficiently rapid rate). Spending would collapse in spite of easy credit because disposable incomes would be too low. But you seem to define monetary policy to include exchange rate policy, in which case you may be right. It is my understanding, though, that US exchange rate policy is considered the province of the Treasury, not the Fed.

    a constant interest rate leaves the price level indeterminate, even with active fiscal policy

    Fiscal policy determines the natural interest rate, so it can be conducted so as to determine the relation between the natural and actual interest rate, even if the actual interest rate is set arbitrarily. Thus it can (by definition of natural interest rate) determine the price level. Are you denying that fiscal policy determines the natural interest rate?

    The Fed does what it wants in our system, and the fiscal authorities must take that NGDP growth rate as a given.

    I will cite 2009 as a counterexample, although I know you disagree. But surely you acknowledge that the point is at least controversial among knowledgable people.

    Evidence of failure is not evidence of difficulty, it’s evidence of a flawed model.

    A flawed model is evidence of intellectual difficulty. But in any case, recent conditions make monetary policy objectively difficult because they make current market responses more dependent on future monetary policy, so that the Fed depends more heavily on a difficult commitment technology. Also, they make monetary policy difficult because asset prices are more sensitive when interest rates are low (hence the housing boom-bust, and the tech boom-bust). If fiscal policy were conducted so as to assure a sufficiently high natural interest rate, monetary policy would be easier.

    I meant fiscal policy is real in the sense that it takes the price level as given….In the long run, it is exactly the opposite for monetary policy.

    In the short run monetary policy takes the price level as given too. And we don’t usually think of fiscal policy as a long run phenomenon, but it could be practiced that way, in which case it would no longer take the price level as given. There’s a whole school of thought that argues that fiscal policy is what determines the price level and that monetary policy is obliged to go along for the ride (assuming it can’t let the government default).

    I thought Keynesians and monetarists did the same. AD is one issue, and AS another. My only wrinkle is that I define AD as NGDP, while Keynesiasn don’t

    The wrinkle is critical, because it allows you to do macroeconomics without worrying about aggregate supply, if you choose to do so, and much of the time you do apparently choose to do so. Standard Keynesians can’t do that, because the AD side of the model is inherently incomplete — i.e., the Keynesian AD concept has no meaning independent of AS. (Originally the AS curve was horizontal, but in any case, some assumption about AS has to be explicit in order for the model to make sense.) NMT people (as best I can tell) are similar to you in that feel comfortable ignoring the supply side. I’m a bit unclear on their precise rationale, but I find it easiest to understand their ideas as a theory of nominal income determination.

    Morgan:

    Fiscal stimulus spending…creates a debt load that future taxpayers must cover.

    So does money creation. Cash is merely a government obligation that pays its coupon in the form of liquidity services instead of paying explicit interest. And bank reserves now pay interest eplicitly. Future taxpayers may or may not need to cover explicit government debt, depending on how accepting future bond markets are of the rollovers, and they may or may not need to cover debt in the form of money, depending on how accepting future goods markets are of the money stock. In either case, if markets are not accepting, there is the option of refinancing via inflation.

    And fiscal policy can take the form of tax cuts and transfers, so the system can still be “‘trying’ to find productivity gains / profits.”

  18. Gravatar of Morgan Warstler Morgan Warstler
    25. January 2011 at 22:50

    Andy,

    Cutting taxes is not now, nor has it ever been “stimulus.”

    Fix your definitions so you can respond to the real point.

    Money, property, ownership, profits, etc. as a concept starts exclusively in the hands of the private individual or his interests. That is its primary state.

    Money is taxed/taken by the government. This is its secondary state.

    As such, there is a word/phrase/idea for government deficit spending – BUYING things it has no money to pay for, but may in the future. We call that stimulus.

    There is a also a word/phrase/idea for government agreeing admitting that not taxing/taking money causes economic growth – this is tax cut.

    If you can’t make your argument that Fiscal and Monetary Stimulus are the same without confusing stimulus and tax cuts, then you don’t have an argument, you simply are playing a definitional debate game.

    So now we know, cash is not a government coupon. Cash is how two private parties without any government around will attach value to an intermediate good so that they might trade. You can say that cash gains value if the government will force you to pay taxes with it of they kill you, but that is not the same thing.

    Example: marriage is a thing your church does. The fact that government tried to steal the word to gain authority means nothing – they are two distinct ideas, please treat them as such.

  19. Gravatar of Andy Harless Andy Harless
    26. January 2011 at 08:35

    Morgan:

    Money, property, ownership, profits, etc. as a concept starts exclusively in the hands of the private individual or his interests. That is its primary state.

    Wrong! Property rights are created, defined, enforced, and defended by the government, so at the very least (in the absence of a fiscal stimulus) the government needs to collect enough taxes to fulfill its functions with respect to property rights. If it chooses to defer (perhaps indefinitely) the collection of those taxes, that is a fiscal stimulus.

    Now you have use a general definition of “cash,” but since we were discussing “monetary policy,” what I had in mind was specifically fiat money, which is the usual object of monetary policy (although it’s also possible to have monetary policy in a commodity money regime, but in that case — if it’s a genuine commodity money regime and not simply fiat money temporarily fixed to a commodity standard — it’s just the government operating like a private bank). People choose to hold non-interest-bearing fiat money rather than interest-bearing debt because money provides liquidity services, so the value to the government of issuing debt vs. money depends on the value of those liquidity services.

  20. Gravatar of scott sumner scott sumner
    27. January 2011 at 06:37

    Mark, That’s a good observation. The post-WWI inflations certainly contributed to people yelling “fire fire in Noah’s flood” that was so bizarre in the 1930s.

    Andy, It’s considered the province of the Treasury, but they have no power to control exchange rates, because they don’t control the supply or demand for dollars. The Fed has de facto control over the exchange rate. But even w/o that control, they can create high inflation through QE despite large surpluses. Keynesians look at savings and investment, but those are real variables that don’t anchor the price level. As Nick Rowe always points out, its the supply and demand for money, not savings and investment that anchor prices. In almost all countries NGDP will be somewhere between 5 and 50 times larger than the base. (In the US it’s about 20 times bigger, when not in a liquidity trap. And it’s still about 20 times bigger if you use currency, rather than the base.) Since the Fed can increase the base as much as they want, they can eventually boost NGDP

    I believe fiscal policy influences the natural interest rate, but I wouldn’t say it determines it. In addition, the natural interest rate is only observable indirectly, by noticing whether prices or NGDP are under or over target. So the argument really isn’t whether they can influence the natural rate, they can, but whether they are capable of keeping NGDP and/or prices on target. My answer is not necessarily, although they may for brief periods. They simply don’t have enough ammunition, especially if the natural rate is far off target. Imagine the Fed sets the fed funds are at 2% in 1979, and holds it there,. What fiscal policy would prevent a breakout of hyperinflation? It couldn’t be done.

    I agree there is dispute about my views of fiscal policy.

    You said;

    “A flawed model is evidence of intellectual difficulty.”

    I think it is really important to separate out two types of difficulty, so we are clear what’s being debated. It was really difficult (intellectually) for Friedman and Schwartz to convince the profession that the Fed blew it in 1930-33. But when they did, it was easy for the Fed to prevent M2 from falling 30%. It is really difficult for me to convince the Fed to do NGDP level targeting, but if I did I think the Fed could do it easily, in a technical sense.

    Regarding taking the price level as a given, I should have said the expected future price level. Obviously the current price level is a given, no dispute about that. But when the Fed forecasts inflation in the out years, (at 2%) they are telling us what they expect to do. When the CBO forecasts inflation in the out years, they are telling us what they expect the Fed to do.

    I think it’s also important to consider the context of the post. Waldman was making a general observation about monetary and fiscal policy. Obviously when rates are at zero you’ll find many economists who find his views plausible. But when rates are above zero, base velocity is much more stable, and few economists would argue that fiscal policy plays a major role in determining the rate of inflation–most would argue it is monetary policy, and with lots of empirical evidence to back them up.

    You said;

    “Standard Keynesians can’t do that, because the AD side of the model is inherently incomplete — i.e., the Keynesian AD concept has no meaning independent of AS.”

    I’m confused (but I’m sure it’s my ignorance.) The Keynesian models says if the multiplier is 5, then nominal spending will rise by 5 times the increase in G. The way that gets partitioned between real output and prices depends on the slope of the SRAS. If it’s flat then RGDP increases 5 times. Is that right? (I’m probably wrong.)

  21. Gravatar of Andy Harless Andy Harless
    27. January 2011 at 13:06

    Scott:

    The Keynesian models says if the multiplier is 5, then nominal spending will rise by 5 times the increase in G.

    That’s the way I would like to think about it, but Nick Rowe seems to disagree with me. (See his response to my comment on his “War on Demand” post.) Specifically, he says that, when you write the Keynesian cross model in nominal terms without introducing money illusion, “you can’t determine NGDP unless you already know what P is.” I think most contemporary Keynesians would agree with Nick’s interpretation. And I can see the argument for interpreting the consumption function in real terms: for example, if you take the constant term to represent “necessities,” those necessities aren’t going to change just because their prices change. I do think you need to introduce some sort of money illusion (with which I’m personally comfortable, but most others apparently aren’t) to give the consumption function (and other behavioral equations) a nominal interpretation. If you interpret the behavioral equations in real terms and combine them with a national income identity that is in nominal terms, then you need an explicit aggregate supply equation to connect the nominal and real quantities.

  22. Gravatar of scott sumner scott sumner
    29. January 2011 at 10:30

    Andy, I don’t understand. I thought the Keynesian cross assumed prices were fixed, so a rise in NGDP was also a rise in RGDP. If so, what’s wrong with my suggestion?

  23. Gravatar of Andy Harless Andy Harless
    1. February 2011 at 14:55

    I think that’s correct, but how is one to interpret the Keynesian cross model in world where prices are not perfectly fixed? To make sense of standard Keynesian economics, you need some kind of aggregate supply curve: a horizontal one works fine, but it has proven too unrealistic to be useful. What you share with the Chartalists is that you can make meaningful and useful statements about macroeconomics without having a model of aggregate supply. Thus I felt that A Graduate Student was wrong to declare the comparison bizarre.

  24. Gravatar of ssumner ssumner
    2. February 2011 at 19:42

    Andy, I’m so far away from the Keynesian cross that I may be totally off base. I had thought that as soon as you assumed prices might change, you had to throw out the Keynesian cross, and use some other model (like AS/AD.) But I may be completely wrong. or i suppose you could assume the Keynesian cross determines nominalspending, and then add an SRAS. All this is just off the top of my head, it’s been 35 years since I thought about the Keynesian cross.

    You said;

    “What you share with the Chartalists is that you can make meaningful and useful statements about macroeconomics without having a model of aggregate supply. Thus I felt that A Graduate Student was wrong to declare the comparison bizarre.”

    It’s weird that I am seen that way, as I thought my blog posts have a very definite assumption about SRAS—that the curve is fairly flat right now, but not completely flat. All my assertions about monetary stimulus are based on that assumption. Thus I assume that monetary stimulus will raise expected inflation, but raise RGDP growth by much more.

    I guess you mean that I can make statements about AD, or NGDP, without any assumption regarding SRAS. Is that right?

    I know nothing about Chartalist. I seem to recall someone told me they were post-Keynesians, which is as far away from my views as it is possible to be.

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