Back to the 1960s

It’s been obvious for several years that the field of economics has entered a new Dark Ages.  Here’s another example, from a couple articles discussing Australian monetary policy.  First, James Alexander sent me this gem, discussing the views of RBA board member John Edwards:

“It has never been the view that the target had to be achieved each and every quarter, or for that matter each and every couple of quarters, or year for that matter,” Edwards was cited as saying. Australia’s annual inflation rate has been below 2 percent since the third quarter of 2014.

The RBA’s first rate cut in a year on May 3 came after data showed that some of the disinflationary pressures weighing upon economies from Japan to Europe are also being seen in Australia. The consumer price index dropped for the first time since 2008 in the first quarter, while annual core inflation growth slowed to the weakest on record, prompting the central bank to cut its inflation forecasts.

Some economists have argued that the inflation target should be lowered to reflect global and domestic forces that could keep downward pressure on prices for some time, the WSJ reported. The central bank will be forced to cut interest rates to 1.5 percent by August, according to most economists surveyed by Bloomberg.

This was a widespread view in the 1960s and 1970s.  Inflation was not caused by monetary policy; it reflected other forces. By the 1990s were we out of those Dark Ages, and that view was thoroughly discredited.  Actually, it was more than just discredited, it was widely mocked.  And now it’s back.

Stephen Kirchner sent me another piece on the RBA:

Former Reserve Bank of Australia governor Ian Macfarlane has lashed out at financial markets – particularly those offshore – for effectively forcing the central bank into a wasteful knee-jerk official interest rate cut this month to avoid falling victim to an increasingly erratic global currency war.

In his first public comments about Reserve Bank rates policy since handing over the governorship to Glenn Stevens a decade ago, Mr Macfarlane lambasted currency traders and analysts for assuming the central bank should always adopt a slavish adherence to its 2-3 per cent inflation target.

Describing current monetary policy as “easy” – or stimulatory – he said there was nothing in the central bank’s approach that locks it into making a cut every time a statistical report shows inflation is below the goal.

Here’s the problem.  Financial markets never have Dark Ages—they always understand what’s going on.  So when economics enters a new Dark Ages, the views of economists will be rejected by the financial markets.  Economists will then lash out at the irrationality of markets, when it’s actually the economics profession that has lost touch with reality.  (And yes, I’m also talking about the Fed.) Australia’s economic policy is clearly too tight to hit their targets, and yet they continue to insist that policy is expansionary.

Mr Macfarlane’s intervention – just as Macquarie Bank predicted on Thursday that the lack of fiscal stimulus and need for a weaker currency would see the official cash rate slashed to 1 per cent – indicates a growing desire to re-educate analysts and markets about both the limits of monetary policy and the need for greater flexibility around how the target is used.

“When countries introduced inflation targeting 20 or 25 years ago, they never envisaged a world where inflation was so low that it was below all major countries’ targets,” Mr Macfarlane, who was the first to formally announce the target when it was adopted, said.

That’s right, markets that foolishly believed that the RBA would adhere to its inflation targets need to be “re-educated”.  In fact, it’s Mr. Macfarlane who doesn’t understand what’s going on.  The markets are well aware of the fact that the RBA is willing to let inflation stay below 2%, and that’s precisely why they are putting pressure on the RBA to drive interest rates ever lower.  If markets expected 2.5% inflation going forward (the RBA target), then interest rates would probably be higher than 1.5%.

More confusion:

However, Mr Macfarlane, who is now an ANZ Bank director, suggested that one of the triggers for the surprise May cut was a fear within the central bank that markets would have reacted violently had the board left the cash rate unmoved two weeks ago because the weak inflation figures implied a cut was urgently needed to meet the 2-3 per cent target.

In the lead-up to the May rate meeting – which the Reserve Bank this week indicated was a close call – the Australian dollar traded above US78¢, an uncomfortably high level given the bank’s goal of driving down the currency to help the post-resources adjustment.

Within the board, there would have been a genuine fear that a decision not to cut could have sent the currency shooting dangerously above US80¢.

“Their problem [at the Reserve Bank] is that financial markets, particularly offshore, assume a mechanical application of what they regard as the standard model,” Mr Macfarlane said.

“The inflation targeting approach says that if inflation forecasts are below target, we should run an easy monetary policy – we already have that,” Mr Macfarlane said.

Here’s what’s actually happening:

1.   Australia doesn’t already have easy money; they have tight money.

2.  Global Wicksellian equilibrium interest rates have fallen sharply, and central banks have been slow to accept that fact.  Just as many of my commenters are slow to accept the fact that global productivity growth has slowed to a crawl. Reality’s a bitch.

3.  When the RBA (unexpectedly) holds its policy rate above the equilibrium rate, money is tight and the Aussie dollar appreciates sharply in the forex markets, which drives inflation even further below the RBA target.  The lower inflation then leads to calls for even further rate cuts.

The bond market sees what’s going on:

The benchmark 10-year government bond yield crashed this week to its lowest level in 141 years on financial market predictions that more official interest rate cuts are likely in coming months.

Over at Econlog, I have a post on the new Dark Ages in international trade.



35 Responses to “Back to the 1960s”

  1. Gravatar of Brian Donohue Brian Donohue
    20. May 2016 at 07:05

    Great post, Scott.

    The only sign that monetary policy is worryingly loose is currency debasement- i.e. inflation.

    There is no inflation, so the feverishly inclined perceive “asset bubbles”. These people are wrong. The only risk that assets are overpriced comes from a calamitous future path of monetary policy. It could be a self-fulfilling prophecy of misery.

    I’m not sure monetary policy was better understood in the 1990s. It’s the ZLB that makes people think cray cray.

    I’d love to see developed markets compete with each other to devalue their currencies. Isn’t that the direction Austrailia is going, in the face of the kicking and screaming of the clueless?

    Similarly, I hope Yellen continues to focus on global economic conditions, which argue against a June rate hike, given where the rest of the developed world including China is/ should be going.

  2. Gravatar of marcus nunes marcus nunes
    20. May 2016 at 07:21

    Scott, yes, Australia is becoming “conventional”!

  3. Gravatar of Mike Sax Mike Sax
    20. May 2016 at 07:30

    Somewhat off topic-though I guess related to this dark age of economics theme.

    Just one observation about your recent piece in the Orange County Register regarding the $15 MW.

    I’m not looking to debate the merits of the idea. But you seem a little surprised it has gained resonance.

    I think it’s clearly because many believe their wages are stagnant. I know you’ve also argued this is not the case, but it certainly seems to me at least that many believe that it is whether or not they are right about it.

    If you want to know exactly where the current push for $15 comes from it’s because of a bunch of food service workers formed a movement and demanded it.

    So that’s the genealogy.

    The usual driver of things is not economic theory but politics.

  4. Gravatar of E. Harding E. Harding
    20. May 2016 at 07:40

    “Financial markets never have Dark Ages—they always understand what’s going on.”

    -Given the bizarre (and incorrect) reactions of those presidential nomination prediction markets, I doubt this strongly.

  5. Gravatar of Benjamin Cole Benjamin Cole
    20. May 2016 at 07:48

    Excellent blogging.

    From “market monetarists are winning” to monetary Dark Ages in a few days. Worse, I agree with the moods.

  6. Gravatar of Sleazy P. Martini Sleazy P. Martini
    20. May 2016 at 08:02

    I thought you didn’t make use of the Wicksellian natural rate in your analyses?

  7. Gravatar of CMOT CMOT
    20. May 2016 at 08:12

    There seems to have been a Great Unlearning, not just in economics but across all the public policy related disciplines, of a lot of hard learned lessons.

    The best reason why that I can come up with are a combination of IT technologies that made logistics and production much more efficient, so high quality outcomes are taken for granted, and the rise of social media, where ideologues can cajole, bamboozle, and bully public policy people into believing things that they want to be true are true, evidence and experience be damned.

    But I’d love better answers than that.

    Any thoughts about the Great Unlearning?

  8. Gravatar of ssumner ssumner
    20. May 2016 at 08:26

    Brian, You said:

    I’m not sure monetary policy was better understood in the 1990s. It’s the ZLB that makes people think cray cray.”

    That’s clearly part of it, but Australia’s not even at the zero bound.

    Mike, I agree there was no valid reason for the sudden push for a $15 minimum wage, which was sort of the point of my post.

    Harding, Saying markets are efficient is not the same as saying they have perfect foresight. In any case, the experts were even more wrong about Trump. They said he had no chance, whereas at least the markets said he had a chance.

    Ben, I’m bipolar

    Sleazy, When visiting Paris it’s helpful to know French. When swatting down interest rate fallacies, it’s helpful to speak new Keynesian.

    CMOT, My best theory is that growing inequality and interest rates stuck at zero lead to bad economics.

  9. Gravatar of Mike Sax Mike Sax
    20. May 2016 at 08:35

    E. Harding if you’re looking for a guy who thought Trump had a real chance win the GOP primary early look no further.

  10. Gravatar of Brian Donohue Brian Donohue
    20. May 2016 at 08:52

    @Scott, yeah, not the ZLB I guess, but ‘low’ rates generally. People see ‘low’ rates and automatically think “monetary policy is too loose!”

    I know. I used to think like this. I distinctly recall, in 2004, thinking “The Fed needs to raise rates so they’ll have plenty of ammo when the economy slows down.” Note to 2004 Brian: you’re a dummy.

  11. Gravatar of E. Harding E. Harding
    20. May 2016 at 10:22

    “In any case, the experts”

    -You’re calling yourself an expert these days?

    And I’m not referring to the early stuff. I’m talking about the ridiculous market reaction to Trump’s abortion comments, the market non-reaction to Trump’s Florida victory, and to the ridiculous market assessment of Rubio’s and Cruz’s chances immediately after the South Carolina primary results. Remember, I wrote my Rubio ceiling post in the days between South Carolina and Nevada, as even I, with limited information, could see the dubious foresight of the market reaction.

  12. Gravatar of Sleazy P. Martini Sleazy P. Martini
    20. May 2016 at 10:57


    Not much has changed.

  13. Gravatar of TravisV TravisV
    20. May 2016 at 11:09

    I highly recommend googling “Ray Dalio: It’s A Depression, Not Recession”

    Wow, Dalio was promoting his “long-term debt cycle” model all the way back in October 1992, and he continues to use the same model. One of Dalio’s observations:

    “This time the Fed has eased a lot and the economy has not responded.”

    Ray Dalio is a big deal, considered a macro genius. See here:

    P.S.: In his podcast with Nate Silver, Tyler Cowen said years ago, Dalio had some unique insight about real interest rates, and that’s how his fund performed so well…..

  14. Gravatar of E. Harding E. Harding
    20. May 2016 at 12:42


    -Sumner’s model is superior and Cowen’s Third Law.

  15. Gravatar of Major.Freedom Major.Freedom
    20. May 2016 at 18:22

    Speaking of dark age economics, when is Sumner’s economics ever going to provide an explanation for why there are recurring, widepsread periods of rising cash preference the world over?

    That question has met with Darky McDarksi level dark since day 1.

  16. Gravatar of Oliver Oliver
    20. May 2016 at 18:43

    The funny thing with Australia is that we don’t really have many economists with a big public profile (at least not in my 20-something lifetime, I don’t know what it was like back when you taught here). We have some ex-treasurers and ex-RBA governors, but aside from Saul Eslake all of the independent big name economics “experts”/commentators over here tend to be professional journalists.

    Just the other day I was left dumbstruck by an ABC radio interview with the business editor of some paper, where he sanctimoniously explained to listeners that the RBA might have difficulties generating inflation because “monetary policy has reached it’s limit” so “further easing by the RBA will be ineffective”. He even brought up the ECB’s QE program as an example of easy monetary policy failing to stimulate the broader economy.

    Thankfully the RBA is pretty independent by global standards and our political parties have been very supportive of this independence for at least 25 years.

  17. Gravatar of Matthias Goergens Matthias Goergens
    20. May 2016 at 21:53

    Financial markets can have their dark ages: when they happen, people like Benjamin Graham and Warren Buffett can pick up decent assets for cheap and make a killing. (Profiting from overvaluation is harder, because short selling is more curtailed in lots of jurisdictions than long buying.)

    NGDP level targeting will eliminate recessions. Apart from that, it will not by itself generate lead to any additional productivity.

    However, productivity enhancing political reforms will be easier to push through.

    Right now, when a politician thinks about eg whether to let a big bank fail in a crisis, the consequences might be either a recession boren from financial chaos now, or moral hazard leading to a bigger recession in a few years.

    Under NGDP level targeting recessions are banished, and full employment will be the norm. So the decision about whether to rescue the big bank or let it fail, will come down to “Will this boost rGDP?” And if you guess wrong, all you get is a slight uptink in inflation instead (since the NGDP level is fixed)—but no angry, unemployed, hungry people in the street. (Of course, lobbying and special interests will still play a role, but they will have a slightly harder time, since they can’t just argue that letting the big bank fail will risk a recession.)

    Ordinary workers will have an easier time accepting free trade under this regime: under virtually guaranteed employment, American steel workers won’t mind cheap Chinese steel too much. (More importantly, other lobby groups like the owners of steel works couldn’t hide behind trying to protect the steel workers.)

    Like Scott argued better financial policy in Germany in 1929-1932 would have had very long term real consequences for East Germany—via enabling better politics (ie no Hitler, no war against the western allies). NGDP level targeting today could also make better decisions easier.

    The biggest boon of all in fiscal policy would of course be to eliminate deadweight losses from taxation. The way to do that is to shift taxation to the least elastic economic activities.

    The least elastic economic activity of all is, of course, `supplying land’. Mason Gaffney has a good piece on how Georgism would work in a modern context; also talking about how it would help productivity growth.

  18. Gravatar of Postkey Postkey
    21. May 2016 at 00:01

    “Just the other day I was left dumbstruck . . . ”

    Maybe you should read this?

  19. Gravatar of Oliver Oliver
    21. May 2016 at 01:09


    There’s all sorts of nonsense written online.

    Unlike the rest of the western world, Australia never had any ZLB problems so monetary policy didn’t become a huge talking point over here and we escaped all of the hysteria regarding the risks of 0% interest rates and QE. We entered the crisis with high rates by Australian standards and left it with high rates by global standards, so anyone arguing that the RBA was being irresponsible had no legs to stand on. Most of the concern regarding bubbles was directed towards regulation of the financial sector and government policy, not the RBA.

    Unfortunately we’re now in the position where every rate cut is met with “RBA cuts rates to new record low of X.XX%” by the media. Those statements I heard on the radio left me dumbstruck because prior to the rate cuts in early 2015 nobody was really spouting that nonsense over here (or at least the people spouting it weren’t mainstream business/economics commentators).

  20. Gravatar of Postkey Postkey
    21. May 2016 at 02:28

    Maybe you should try reading:

  21. Gravatar of ssumner ssumner
    21. May 2016 at 05:08

    Brian, You said:

    “Note to 2004 Brian: you’re a dummy.”

    Nope, dummies are people who never learn from their mistakes. I’ve also gotten plenty of things wrong. In 2004, I never anticipated the zero bound in the US.

    Harding, You said:

    “You’re calling yourself an expert these days?”

    Why would you even ask me that?

    Travis, Why does Dalio think “the Fed has eased a lot”?

    Matthias, Yes, I’ve made similar arguments. Indeed I think Friedman’s real agenda in the Monetary History was to promote capitalism.

    Oliver, Yes, several of my Aussie commenters have made those sorts of observations.

  22. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    21. May 2016 at 05:42

    J. Bradford opines;

    My worries are compounded by the fact that the Federal Reserve appears to be working with an outmoded and probably wrong model of how monetary policy affects the rest of the world under floating exchange rates. The standard open-economy flexible-exchange rate models I was taught at the start of the 1980s said that contractionary monetary policy at home had an expansionary impact abroad: the dominant effect was to raise the value of the home currency and thus boost foreign countries’ levels of aggregate demand through the exports channel. But [Blanchard, Ostry, Ghosh, and Chamon (2015)][6] argue, convincingly, that that is more likely than not to be wrong: when the Fed or any other sovereign reserve currency-issuer with exorbitant privilege raises dollar interest rates, that drains risk-bearing capacity out of the rest of the world economy, and the resulting increase in interest-rate spreads puts more downward pressure on investment than there is upward pressure on exports.

    It looks to me as though the Fed is thinking that its desire to appease those in the banking sector and elsewhere who think, for some reason, that more “normal” and higher interest rates now are desirable is not in conflict with its duty as global monetary hegemon in a world afflicted with slack demand. But it looks more likely than not that they are in fact in conflict.

  23. Gravatar of Brian Donohue Brian Donohue
    21. May 2016 at 06:17


    I prefer Trump doesn’t win, but I’m starting to think he will.

    I also think he has at least as good a chance as Hillary of gaining an appreciation of monetary policy and its proper place in the public policy sphere.

    Now you can reject this possibility, but if you entertain it for a moment, can you imagine the treatment the “debt / flim flam king” would get from monetary policy know it all know nothings in media and academia. You may find yourself with the strangest of bedfellows!

    Anyway, I reckon the more clearly you state your distaste for the fellow in the meantime, the more principled and credible your defense of the blind squirrel would be in that curious eventuality.

  24. Gravatar of E. Harding E. Harding
    21. May 2016 at 09:15

    “Why would you even ask me that?”

    -Pundits, as a rule, were not saying there was no chance Trump would win the nomination back in August. You definitely were.

  25. Gravatar of Matthew Waters Matthew Waters
    21. May 2016 at 15:20

    On productivity, this was interesting:

    As Scott has said many times, both inflation and productivity are very hard to measure. The argument from Goldman Sachs’ economist hinges on specialized hardware and software. More buying has gone into special-purpose electronics versus general-purpose electronics, but there has been less study of the deflation factors which feed into productivity.

    It appears the ultimate source is this Fed note:

    There is also a non-zero contribution to productivity from free, ad-supported goods. Facebook and Google have engineers working hard on these services and better targeting ads, but the money spent on advertising does not seem to be included in GDP. Yes, the contribution from free goods is small, but it is non-zero.

  26. Gravatar of Alex Alex
    21. May 2016 at 15:42

    Professor, what about that “The United States as a Banker to the World”
    from David Beckworth

    this from John Taylor

    and this

  27. Gravatar of ssumner ssumner
    22. May 2016 at 19:18

    Everyone, Thanks for all the links.

    Brian, Anything is possible, but it doesn’t really matter what Trump thinks about monetary policy. I doubt he even knows what it is.

    Harding, You said:

    “Pundits, as a rule, were not saying there was no chance Trump would win the nomination back in August.”

    Of course they were. Don’t you follow the news?

  28. Gravatar of rob rob
    22. May 2016 at 22:33

    “Some economists have argued that the inflation target should be lowered to reflect global and domestic forces that could keep downward pressure on prices for some time”
    Weird maybe they should ask Venezuela for advice, they haven’t had too much difficulty.

  29. Gravatar of Andy Andy
    23. May 2016 at 01:40

    This is slightly off topic but I think it’s so surprising that I’ll comment it here.

    Governor of Bank of Finland (also ECB gov. council member) Erkki Liikanen has commented in Bloomberg that ECB should tolerate above 2% inflation for some time before raising rates. Liikanen is in no way a dove and is also always extremely careful in his public statements.

    It’s the first time I’ve heard anyone inside ECB discuss that inflation could be above 2%. To me this tells that ECB are prepared increase the target which would of course be more than we could hope for at this point, and also much better than e.g. helicopter money (I wonder what Germans think hehe).


  30. Gravatar of Blue Eyes Blue Eyes
    23. May 2016 at 03:38

    Great post. Same problem in the UK. We have low “core” inflation, a shocking and worsening current account situation, slowing growth, and so on. Yet the consensus is that money is easy.

  31. Gravatar of TravisV TravisV
    23. May 2016 at 08:40

    Goldman Sachs on Rate Hike Odds: 35% in June, 35% in July


  32. Gravatar of TravisV TravisV
    23. May 2016 at 08:41

    Bullard: rates too low for too long could be risky, Tight U.S. labor market may put pressure on inflation

  33. Gravatar of ssumner ssumner
    23. May 2016 at 14:47

    Andy, That’s very interesting.

  34. Gravatar of James Alexander James Alexander
    24. May 2016 at 13:42

    Matthew, that AEI piece based on Goldman Sachs research is interesting but given we know for sure what nominal GDP is, and that it is growing at very weak at 3% per annum, then the burden of the mismeasurement/understatement of RGDP must fall not on what is missing from output but the gross overestimate of the GDP Deflator. PCE Inflation instead of being a hopelessly low 1% is really <0%.

    And the Fed (and GS) think it right to tighten?!?!

  35. Gravatar of Major.Freedom Major.Freedom
    24. May 2016 at 18:28

    Market monetarism theory asserts that the market fails to accommodate “bad” central bank policy.

    If Sumner believes he is a libertarian, why does he believe the market cannot adjust prices efficiently enough to absorb aggregate spending changes such that widespread unemployment does not arise?

    In a pure laissez faire economy, money production would be private and competitive. It would be possible that new money production slows down for extended periods of time, due to changing environmental, geological and other conditions. In these cases, NGDP might fall to 1% growth for two or more years. It is possible. Given Sumner’s claim that depressions are caused by NGDP not growing at 4.536453727% per year, and given Sumner’s claim that the Fed can permanently prevent depressions with 4.536453727% NGDP growth, it follows that Sumner believes free market capitalism will inevitably result in depressions and that government is the only means to prevent it.

    Libertarian? Even according to his own litmus test, he isn’t.

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