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:
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!”