Archive for the Category Monetary Policy


Cowen and Smith on monopoly and stimulus

In a recent Bloomberg debate, there was an interesting exchange.  First, Tyler Cowen:

But Noah, I have a question for you. You’ve written several columns about how the American economy is becoming more monopolistic. If true (and it is not exactly my view), that implies output could be much higher with current resources, even at full employment. A boost in demand could spur firms to produce more, rather than restricting output so much. So are you now a fan of these Trumpian deficits? They may not be your preferred form of deficit spending, but do you see them still as a net positive?

Then Noah Smith:

As you say, monopoly power could potentially increase the case for stimulus in bad times.

Actually, that’s not what Tyler said, nor is what Tyler said true.  (Now everyone will be annoyed at me.)

One of the fundamental principles of modern macro is that demand-side stimulus cannot solve real problems.  It can overcome problems such as high unemployment caused by sticky wages and prices combined with inadequate spending, but that’s all it can do.  Inefficiencies associated with monopoly are a real problem, and cannot be solved by printing money.  There are actually a number of issues here that need to be disentangled, some of which are quite subtle.

1.   Monopoly is a microeconomic problem, not a macroeconomic problem.  Thus it’s quite possible to have low unemployment rates and high levels of monopolization.  Indeed, I’d argue that’s true in America right now.  Employment in the monopolistic sector is indeed lower than we’d like, but the result of this is not unemployment, it’s workers being employed in the less efficient competitive sector of the economy.  This is important, because the mechanism by which demand stimulus creates growth is by encouraging more employment (not moving workers between sectors).  But we are already at full employment.

2.  Suppose I’m wrong, and monopolization causes the natural rate of unemployment to be higher than otherwise. Say America’s natural unemployment rate rises to French levels, due to monopolization.  Is Tyler correct in that case?  No, demand stimulus is still not called for even if monopolization causes the natural rate of unemployment to be higher than otherwise.  That’s because when you are at the natural rate, demand stimulus basically tricks workers and firms into producing more output than they’d like, by pushing up nominal spending in the face of sticky wages and prices.

So doesn’t that make us better off?  In the short run yes, but only at the cost of being worse off in the long run.  When prices are sticky, demand stimulus can reduce a monopoly’s real price, which is its price relative to NGDP.  But once the monopoly catches on to the higher NGDP, it will raise the real price again.  That might not sound so bad, but it leads to cyclical instability.  Ditto for wage stickiness.  Demand stimulus will give monopolies an incentive to hire more workers, as long as nominal wages are sticky.  That will indeed make the economy more efficient for a short time (this may have been Tyler’s intuition), but at a cost of future instability.

This is why we have independent central banks.  Because our economy is riddled with inefficient policies such as minimum wage laws and taxes on labor, our natural rate of output is suboptimal.  Demand stimulus tricks us into producing more, and we move closer to the optimal position for the economy.  But it’s not sustainable. It’s a sugar rush.  Minimum wages eventually get increased with NGDP, and workers renegotiate contracts.  In the short run, the stimulus really does make us better off as a country (with or without monopoly), but it overheats the economy and leads to a painful recession in future years.  Once mainstream monetarist and New Keynesian economists understood this problem, they decided the best we could do was to keep the economy close to the natural rate of unemployment, and then advocated setting up independent central banks that would be immune from pressure by a corrupt future president that might have a big ego and a short attention span.  (Hmmm . . . . )

Unless I’m mistaken, there is nothing particularly controversial about this post.  Think about a standard NK model, which produces an optimal policy of 2% inflation.  How would the existence of monopoly change the optimal policy?  Make it more expansionary?  But what does that even mean?  In the standard model, money is neutral in the long run.  Going to 3% inflation doesn’t have any long run benefit.  I suppose you could advocate steadily rising inflation, ending up in hyperinflation, but that won’t work if there are any welfare costs of inflation.  In fact, the optimal policy under a NK model is no more expansionary with monopoly than without.

Now I suppose there might be models where the optimal policy is more countercyclical if there is monopoly, and this seems to be what Noah is hinting at.  But that doesn’t help Tyler’s argument, as in that case policy should actually be more contractionary when unemployment is 4.1%.  And I’m not even sure that claim is true; do NK models imply that more weight should be put on output, and lesson inflation, when the economy is more monopolistic? Are there any models that do so?

PS.  Tyler might argue that the monopoly argument was not his view, just the implication of Keynesian models with which he does not agree.  But I’m saying even that’s not true.  The argument he makes is not even an implication of any sound Keynesian model that I’m aware of.

PPS.  I have a new post criticizing proposals to “experiment” with a hot economy, over at Econlog.


Growth in 2017

The 4th quarter GDP numbers were just released.  Here is how I’d summarize the data:

Growth from 2016:Q4 to 2017:Q4 = 4.4% nominal and 2.5% real

Growth from 2015:Q4 to 2016:Q4 = 3.4% nominal and 1.8% real

So what do we know about this data?

1.  Monetary policy was more expansionary during 2017.  That might explain both the increase in inflation and the increase in real growth.

2.  My hunch is that monetary policy alone does not fully explain the increase in real growth, just most of it.

3.  The rest of the increase in real growth is due to some combination of faster global growth and policy changes in the US.

Here’s my guesstimate.  Of the 0.7% rise in RGDP growth, I’d guess 0.4% was monetary stimulus (i.e faster NGDP growth), and 0.2% was global growth, 0.1% was deregulation, and o.1% was expectations of corporate tax cuts.  Yes, that adds up to 0.8%, but I think there was also a 0.1% drag on growth caused by the US approaching full employment.

I think corporate tax cuts will add about 0.2% to 0.3% to RGDP this year.

I don’t have high confidence that any of these numbers are precisely right (and the data itself may be revised), but I do think they are in the ballpark.

PS. I have a new post at Econlog pointing out that monetary policy in 2017 was nearly perfect.

PPS.  Hypermind currently forecasts 4.3% NGDP growth from 2018:Q1 to 2019:Q1.  My hunch is that it will come in just below 4%.  I’m sticking with my frequently made prediction that this will end up being  the longest expansion in US history.


Alternative Money University

I’m pleased to announce that I’ll be teaching in a four day program called “Alternative Money University”, organized by George Selgin. The program will take place July 15-18 at the Cato Institute in Washington DC, and George provides some information about registering in his blog:

Students in or entering their last year of undergraduate or beginning years of graduate studies are invited to apply. Successful applicants will be chosen on the basis of their academic records and demonstrated interest in monetary economics.

Those chosen to take part will attend, free of charge (with hotel and travel expenses covered by the Cato Institute), several thought-provoking academic seminars led by top scholars in the field. This year’s seminars will include:

The Evolution of Money and Banks,” taught by George Selgin, the director of Cato’s Center for Monetary and Financial Alternative and professor emeritus of economics at the University of Georgia.

The Economics of Commodity Money (and Bitcoin),” taught by Lawrence H. White, professor of economics at George Mason University and senior fellow at the Cato Institute.

The Role of Monetary Policy in the Great Recession,” taught by David Beckworth, senior research fellow in the Program on Monetary Policy at the Mercatus Center at George Mason University and host of the Macro Musings podcast.

Monetary Rules vs. Discretion,” taught by, Scott Sumner, Ralph G. Hawtrey Chair of Monetary Policy and director of the Program on Monetary Policy at the Mercatus Center at George Mason University, and professor emeritus at Bentley University.

If you wish to apply, or to learn more about the program, visit Applications are open until January 31, 2018.

St. Louis Fed President James Bullard will be providing a keynote address at the beginning of the event.

I’m not sure about the logistics of doing this, but I’d like to use the unpublished manuscript for my new book as a teaching resource. This book will be called “The Money Illusion: Market Monetarism and the Great Recession”, and will be based on my last 9 years of blogging. If I’m able to do so, then students in my course would be the first to use this book in a class.

I’m really looking forward to this project. I’ve never actually taught a course where most of the students wanted to be there—where most of the students actually want to learn the material. So it will be a new experience for me.

Goodfriend at the Fed?

I’ve consistently advocated the following positions:

1. The Fed should focus on monetary policy and not get into credit allocation.  They should focus on buying Treasuries, not other types of debt (unless they run out of Treasuries to purchase–which is not likely.)

2.  The Fed should rely on policy rules, not discretion.

3.  The Fed should do whatever it takes to hit its policy goals, including unlimited asset purchases and negative IOR, if necessary.

Here’s the FT on the newest pick for the Fed:

Mr Goodfriend was critical of aspects of the Fed’s quantitative easing policies, saying it should be wary of purchasing mortgage-backed securities, and has embraced the use of monetary policy rules to guide a central bank’s thinking.

But the economist, who is known as a free thinker, has not ruled out radical stimulus options. In 1999 he wrote that negative rates were a feasible option, years before central banks started experimenting with them. In 2015 he presented a paper on the subject of negative rates at the Fed’s Jackson Hole symposium in Wyoming.


El-Erian at the Fed?

The Wall Street Journal has a new piece discussing rumors that Mohamed El-Erian might be chosen for the position of vice chair of the Board of Governors:

In recent years, Mr. El-Erian has voiced somewhat hawkish critiques of the Fed’s policy stance, including decisions to hold interest rates at ultralow levels despite signaling plans to raise them. In recent months, he has suggested that the Fed’s inflation target of 2% might be too high given structural forces holding down consumer prices.

A few comments:

1.  We now know that those who offered hawkish critiques of Fed policy a few years ago were wrong.  Inflation has continued to undershoot the Fed’s target.

2.  When “structural forces” hold down inflation, they do so by boosting RGDP growth.  There is no other way by which structural forces can hold down (GDP deflator) inflation.  None.  RGDP growth has actually been at unusually low levels over the past decade.  Thus we now know that structural forces are not holding down inflation.  It was slow NGDP growth.  Those who think otherwise are confusing microeconomic factors (Amazon, China, etc.) with macroeconomic factors.  Yes, Amazon and China hold down specific prices, but only by boosting GDP growth.  And this mistake cannot be excused by pointing to mismeasurement of inflation.  Maybe tech is causing actual inflation to be lower than measured inflation, but the puzzle being discussed is why measured inflation is so low.

Confusion over these sorts of basic macro issues is exactly why we need to appoint world class experts on monetary economics to the Fed.  People like El-Erian tend to assume that a tighter monetary policy would allow the Fed to have a higher path of interest rates going forward.  In truth a tighter monetary policy would result in slower growth and a lower path of the natural rate of interest over time.  (See Trichet, ECB.)  If the Fed didn’t realize this and persevered with their plan to raise rates, they would create a depression.  I’m not predicting a depression because I don’t expect the Fed to do this, just pointing to the logical consequence of this sort of mistaken reasoning.

Higher interest rates should not be a goal of monetary policy, but if it is a goal then you get there by making monetary policy more expansionary, and boosting the trend rate of NGDP growth.

PS.  I have a cameo role in a new MRU video.

PPS.  I was interviewed for this piece in the Commercial Observer.

HT:  Patrick Horan, Vaidas Urba