Don’t waste time looking for Ratex alternatives

Noah Smith has a new post discussing the current fad of looking for alternatives to the rational expectations model.  The motivation seems to be that we need to explain the collapse of bubble expectations and the rise in the propensity to save (although not actual saving?) during the 2008 recession.  I understand why people want to do this, but it would be a very big mistake.

I’ve always thought that it was patently obvious that the Fed caused the Great Recession with a tight money policy that allowed NGDP expectations to collapse in late 2008. But other people apparently don’t see it as being at all obvious.  They look for alternative explanations.  And yet when you ask them why, they tend to give these really lame “concrete steppes” explanations, such as, “The Fed didn’t raise interest rates on the eve of the Great Recession, so how can you claim that tight money caused the recession?”  Or they show themselves to be completely ignorant of actual Fed policy, and claim that the fed funds target was at zero when NGDP expectations collapsed in 2008.  It wasn’t.

Fortunately, neither of those apply to the ECB, which had positive target interest rates throughout 2007-2012, and which took “concrete steppes” in both 2008 and 2011, tightening money and triggering not one but two plunges in NGDP growth, which led to two recessions.  If there has ever been a more perfect example of the monetary policy/AS/AD model that we teach in our textbooks, I’d like to see it. (OK, maybe 1929-32.) And yet last time I did one of these rants almost no economists were blaming the ECB’s tight money policy for the double dip recession.

Now, I’m seeing progress.  I’m seeing more and more mainstream economists accept the MM claim that the monetary tightening of 2011 caused the second dip in Europe.  In a few more years economists will realize that the ECB tightening of 2008 (which was also “concrete”) caused the 2008 recession as well.

Then economists may begin to notice that the 2008-09 recession in the US was oddly similar to the eurozone recession, which was clearly caused by tight money. The only (minor) difference was that in the US it was “passive tightening”, if the fed funds rate is your preferred policy indicator.

A few economists don’t buy the “nominal shocks have real effects due to sticky wages and prices” model of demand side business cycles.  I don’t agree with them, but it’s fine if people like John Cochrane don’t accept my claim that the ECB didn’t caused the eurozone depression. But as for the rest, the overwhelming majority who think nominal shocks do matter, I’m mystified.  Take the AS/AD model that you see in McConnell, Mankiw, Krugman, Cowen and Tabarrok, Hubbard, or any of the other textbooks.  Why do we even teach this model if confronted with an almost perfect example of a depression caused by tight money, we simply don’t believe it?

Update: John Cochrane informed me that I mischaracterized his views.  He does believe that nominal shocks have real effects, and that wage and price stickiness do exist.  Mea culpa.

I was inspired to do this post by an excellent recent paper on the eurozone depression, by David Beckworth.

HT: Gordon

 


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81 Responses to “Don’t waste time looking for Ratex alternatives”

  1. Gravatar of Sam Sam
    27. July 2015 at 15:25

    Having not followed 2011/2012 econ blog discussion that closely, I found myself as mystified as this person about the origin of the “concrete steppes” pun. What’s your gloss on Rowe’s meaning behind the term? Something to do with Mongols riding automobiles instead of horses?

  2. Gravatar of Lorenzo from Oz Lorenzo from Oz
    27. July 2015 at 16:14

    I presume you mean this excellent paper:
    http://people.wku.edu/david.beckworth/ecb_eurocrisis.pdf

  3. Gravatar of E. Harding E. Harding
    27. July 2015 at 16:14

    “If there has ever been a more perfect example of the monetary policy/AS/AD model that we teach in our textbooks, I’d like to see it. (OK, maybe 1929-32.)”
    -1937 (now that you’ve mentioned the Great Contraction).

  4. Gravatar of Lorenzo from Oz Lorenzo from Oz
    27. July 2015 at 16:16

    “But as for the rest, the overwhelming majority who think nominal shocks do matter, I’m mystified. Take the AS/AD model that you see in McConnell, Mankiw, Krugman, Cowen and Tabarrok, Hubbard, or any of the other textbooks. Why do we even teach this model if confronted with an almost perfect example of a depression caused by tight money, we simply don’t believe it?”
    The bone-deep worship of “the real” (and therefore non-monetary) in mainstream economics?

  5. Gravatar of E. Harding E. Harding
    27. July 2015 at 16:24

    @Sam
    -I was mystified by that, too, but the meaning is clear in this post. “Concrete steppes”=”concrete steps”=”Fed raising rates to cause recession”. I think the addition of the extra “p” and “e” was jut due to humorous misspelling.

  6. Gravatar of E. Harding E. Harding
    27. July 2015 at 16:25

    @ Lorenzo
    -“Low rates and $1 trillion in money-printing means easy money”.

  7. Gravatar of Britonomist Britonomist
    27. July 2015 at 16:33

    “I’ve always thought that it was patently obvious that the Fed caused the Great Recession with a tight money policy that allowed NGDP expectations to collapse in late 2008.”

    I will not (and nor will most other economists who’ve specifically done work on the banking/finance sector) find anything obvious or compelling about this until you provide a model that shows this to be possible, and no the smallest models in the world (http://econlog.econlib.org/archives/2015/06/the_worlds_thre.html) are not enough, because it doesn’t show how base money can offset a huge credit/banking shock, as I explain in the comments – nor does it really capture how the base is in fact endogenously determined for interest rate targeting central banks.

    I’m not saying the fed couldn’t have done anything, but it /is/ in fact important to distinguish between failing to actively undergo highly unconventional policies in order to offset a huge shock to the economy, and actively causing the huge shock itself. Economists want to know what caused the shock, and if the Fed merely failed to react the right way to the shock, it is enormously uninformative to describe this shock as being “caused by the fed”.

  8. Gravatar of E. Harding E. Harding
    27. July 2015 at 16:41

    “Or they show themselves to be completely ignorant of actual Fed policy, and claim that the fed funds target was at zero when NGDP expectations collapsed in 2008.”
    -Who does this?!

  9. Gravatar of E. Harding E. Harding
    27. July 2015 at 16:46

    “because it doesn’t show how base money can offset a huge credit/banking shock,”
    -Quantity has a quality all to itself.
    “as I explain in the comments – nor does it really capture how the base is in fact endogenously determined for interest rate targeting central banks.”
    -In relation to those CBs’ target, which is exogenous. When a central bank hits the ZLB, it ceases to be “interest rate targeting”.
    “I’m not saying the fed couldn’t have done anything, but it /is/ in fact important to distinguish between failing to actively undergo highly unconventional policies in order to offset a huge shock to the economy, and actively causing the huge shock itself.”
    -Sumner calls this “methodologically vacuous”. I don’t entirely agree, but when an institution like the Fed has as much power as it does in NGDP-related affairs, the distinction ceases to have significance. Just like it is pointless debating as to whether God supposedly caused sin or simply failed to react to its rise.

  10. Gravatar of John Hall John Hall
    27. July 2015 at 17:05

    I think the Fed 2008 tight money policy argument is hard for a lot of people to understand at first. It was definitely hard for me to grok for a time. I think part of the confusion is a lack of data of NGDP expectations and the fact that the fall in expectations was coincident with what many were taught to believe was expansionary policy.

    Nevertheless, when it comes to criticizing the Fed, I feel like it’s very easy to go from saying the Fed should have done X differently to saying it’s their fault. In fact, you basically do that when you say the Fed caused the great depression. If I’m accused of being at fault and I feel I made a best effort at something, I tend to get defensive. I imagine that’s how many more influential people at the Fed or high levels of academia would probably feel upon hearing the argument. It’s probably not convincing to those people.

    Rather, I find the more convincing argument is that nominal GDP expectations fell, for many reasons that could be fleshed out in more detail by someone else, the Fed did many things to try to halt the decline in expectations. However, it did not do enough, and it should have done more. I think that’s completely consistent with your beliefs. Perhaps it is a more limited claim than the Fed caused the Great Recession, but I think it’s convincing.

    The part of the whole the Fed caused the Great Recession argument that I find weakest is that the Fed didn’t cause the initial decline in NGDP expectations. Moreover, Fed supporters can easily point to all these extraordinary things that the Fed did and the clear impact they had on markets. No one could argue that the Fed twiddled it’s thumb. Thus, saying they caused the Great Recession is hyperbole. At best, you could make the more limited argument that better Fed action would have resulted in a milder (or non-existent) recession.

  11. Gravatar of Kevin Erdmann Kevin Erdmann
    27. July 2015 at 17:26

    Another avenue toward the monetary cause I recently noticed is that, in defense of the GSE’s, economists on the left note that the GSE’s couldn’t have been the cause of the boom and bust because there was a similar boom and bust in commercial real estate. Here, Krugman acknowledges that if GREs and the CRA were not responsible, predatory lending also wasn’t responsible.

    http://krugman.blogs.nytimes.com/2010/01/07/cre-ative-destruction/

    He still refers to it as a bubble, but getting past the politically partisan claims for bubble causes is a big first step to getting to an interpretation that doesn’t blame a bubble for the bust at all. Leave it to Krugman to help nudge us past our petty political biases.

  12. Gravatar of Britonomist Britonomist
    27. July 2015 at 17:55

    “Quantity has a quality all to itself”

    Meaning?

    “In relation to those CBs’ target, which is exogenous. When a central bank hits the ZLB, it ceases to be “interest rate targeting”.”

    Actually, even under the ZLB the size of the base might still vary depending on the demand for reserves from banks. Not that this matters, at the ZLB changes in the base have very little significance at all other than possibly signalling the path of interest rates in the future.

    “but when an institution like the Fed has as much power as it does in NGDP-related affairs”

    Except the extent of this power is not obvious or fully agreed upon. Plus, the government also has exactly the same power if not more, in fact it is the government that ultimately determines the Fed’s mandate and who runs it. So by extension it is also true (using this logic) that the government caused the great recession (after all it could have forced in a new NGDP target mandate and authorized permanent money injections, or thousands of other potential actions); is saying the government caused the recession an informative useful diagnosis of what actually happened, or just a red herring?

  13. Gravatar of Scott Sumner Scott Sumner
    27. July 2015 at 18:28

    Sam, I just took it as a joke.

    Lorenzo, That’s right.

    Britonomist. Lots of problem there. You are confusing cause and effect. The eurozone debt crisis is clearly the effect of plunging NGDP, not the cause. And we know from 1933 that monetary policy can easily produce rapid NGDP growth in the midst of a horrible banking crisis.

    I must have 100 posts that answer all the objections in your comment.

    I don’t know why you keep insisting on asking if there was anything the Fed could have done to offset the crisis. THEY CAUSED THE RECESSION. It’s the things they DID that caused the Great Recession.

    E. Harding, Who thinks interest rates were at zero in 2008? Almost everyone I talk to.

  14. Gravatar of E. Harding E. Harding
    27. July 2015 at 18:34

    “Not that this matters, at the ZLB changes in the base have very little significance at all other than possibly signalling the path of interest rates in the future.”
    -LOL. Given that the Fed plans to raise rates while not actually winding down the base to past trend, I see this as ridiculous. Come on, man. You know printing money causes NGDP growth. QE is printing money. Therefore, QE causes NGDP growth.
    “Meaning?”
    -Exactly what it says on the tin.
    “Except the extent of this power is not obvious or fully agreed upon.”
    -Zimbabwean CB: “We can’t help this hyperinflation!”
    U.S. CB in the 1970s; “We can’t help this double-digit inflation!” U.S. CB officials in 2012: “We can’t help this fiscal austerity!”
    “Plus, the government also has exactly the same power if not more”
    -Not with Congress being this gridlocked. The fed has discretion and is basically a small oligarchy, which is much harder to gridlock. Congress being gridlocked makes it difficult for it to exercise godlike control over NGDP.

  15. Gravatar of Scott Sumner Scott Sumner
    27. July 2015 at 18:39

    John, There is simply no justification in economic theory for distinguishing between the Fed doing something and doing nothing. Or between errors of omission and commission. The Fed’s duty is to steer AD along a steady path. They either do their duty of they don’t. Holding rates fixed at 2% at a meeting is every bit as “active” as cutting or raising rates.

    Kevin, What I’ve never understood is why people insist that the housing boom had only one cause. Why not 17 causes, including GSEs and stupid banks and FDIC and TBTF and CRA and tax deductibility of interest?

  16. Gravatar of E. Harding E. Harding
    27. July 2015 at 18:41

    “Almost everyone I talk to.”
    -Name three(!). The Federal Funds Rate first hit under .25% on Halloween, 2008. I first began looking at economic statistics in late 2007 and 2008, and predicted the price of oil would soon stabilize (though not collapse) in May 2008, when gold stopped rising in price.

  17. Gravatar of E. Harding E. Harding
    27. July 2015 at 18:42

    “Kevin, What I’ve never understood is why people insist that the housing boom had only one cause. Why not 17 causes, including GSEs and stupid banks and FDIC and TBTF and CRA and tax deductibility of interest?”
    -Too many causes makes one’s theory less easy to support, since you have to provide evidence for each cause.

  18. Gravatar of Major.Freedom Major.Freedom
    27. July 2015 at 19:06

    Disagreements between people are sufficient evidence that Rational Expectations is false.

    So called “Rates” is a fudge factor that was ad hoc’d into orthodox positivist empiricism to make the theory self-contained and bounded.

    There are individual investors who have been systematically wrong. There are those who have been systematically correct.

    There is no one “market” expectation. All prevailing prices are founded upon disagreements between buyers and sellers. Buyers dem the price cheap, sellers deem them expensive. It is why they buy and sell.

    Price defined booms and busts neither falsify nor confirm Ratex. Both parts of the cycle are due to disagreements among investors, and when booms occur, the sellers were wrong and the buyers were right, and when the bust occurs, the sellers were right and the buyers were wrong.

    There is no one “market expectation” for prices. It is impossible for such a thing to exist, and even if for argument’s sake we postulated such an absurd thing, then the implication would be a collapse of the market, since every investor would be standing there waiting on the same “side” waiting for the same “price”.

    It is because Ratex is false that we even have exchanges and prices.

  19. Gravatar of Major.Freedom Major.Freedom
    27. July 2015 at 19:08

    Don’t waste time trying to defend Ratex. It is untenable.

  20. Gravatar of Major.Freedom Major.Freedom
    27. July 2015 at 19:09

    The question of whether “investors” can be systematically right to wrong must be accompanied by the corrolary question “Which specific investors?”

  21. Gravatar of Britonomist Britonomist
    27. July 2015 at 19:19

    @Scott

    “The eurozone debt crisis is clearly the effect of plunging NGDP, not the cause.”

    I agree, but that has nothing to do with anything I said, I wasn’t talking about Europe.

    ” And we know from 1933 that monetary policy can easily produce rapid NGDP growth in the midst of a horrible banking crisis.”

    The monetary system was in fact different then, as you’re well aware; countries were in a golden straitjacket (as Nick Crafts says – locking them “into a deflationary spiral that kept real interest rates high, prevented independent use of monetary policy, and made the arithmetic of tackling budget deficits much more unpleasant”), much like Eurozone countries are today, as you’re well aware. It’s not a comparable situation to the monetary regimes of the UK and US today.

    “I must have 100 posts that answer all the objections in your comment. ”

    And I must have 100+ comments with objections to many of these posts. I don’t remember ever really getting a satisfying answer.

    “THEY CAUSED THE RECESSION. It’s the things they DID that caused the Great Recession.”

    Again, I’m going to need a model better than “the world’s smallest model” to show the process in detail to find that claim compelling.

    @ E.Harding

    “LOL. Given that the Fed plans to raise rates while not actually winding down the base to past trend, I see this as ridiculous. Come on, man. You know printing money causes NGDP growth. QE is printing money. Therefore, QE causes NGDP growth.”

    Any stimulus from QE at the ZLB is not through base growth. The Bank of England explicitly makes clear that the increased base held by the banking sector is just an irrelevant byproduct.

  22. Gravatar of TravisV TravisV
    27. July 2015 at 20:59

    Brad DeLong: “Must-Read: Brink Lindsey: Low-Hanging Fruit Guarded by Dragons: Reforming Regressive Regulation to Boost U.S. Economic Growth”

    http://equitablegrowth.org/2015/07/27/must-read-brink-lindsey-low-hanging-fruit-guarded-dragons-reforming-regressive-regulation-boost-u-s-economic-growth

  23. Gravatar of Rajat Rajat
    27. July 2015 at 21:17

    This is an old theme, but I think the problem is more recently illustrated by the frequent use – by Yellen and many/most economics commentators – of the term ‘normalization’ to refer to increases in the FF rate (eg http://www.federalreserve.gov/newsevents/speech/yellen20150327a.htm)

    People in the US and elsewhere still see zero/low official interest rates as abnormal, as artificial, as an aberration. So of course when you see things that way, a failure to lower rates (or lower them by more) when faced with asset prices plunging etc is not regarded as an explanation for anything. Until current interest rates are seen as no more or less ‘normal’ than the rates of the mid-late 90s were, the nonsense will continue.

  24. Gravatar of Kevin Erdmann Kevin Erdmann
    27. July 2015 at 21:40

    Well, Scott, I mean, to the extent that something like FDIC exists, it’s always going to be a cause in a banking related shock. But I think you’re taking it in the wrong direction. There are fewer causes, not more. Any supposed cause that identified a bubble in 2001 is not a cause, because nobody’s house is ever going to be worth anywhere close to what it was worth in 2001. For that matter, there were never too many houses. So any cause that is based on there having been too many home buyers couldn’t be a cause. There were never too many mortgages. There was never a bust in the rental market. Those might all be terrible laws, but they weren’t causes of the bust. The CRA seems like terrible governance, but as far as I can tell, it ushered a few million marginal households into capital gains windfalls. And, if it caused a few more homes to be built, all the better.

    I suppose all of those supposed causes were actual causes, since the fake causes meant the consensus wouldn’t let the Fed even begin to accommodate a housing recovery. So, the fake causes led to the real cause, I guess.

    Think about this…Housing starts collapsed at the beginning of 2006 – and rent inflation shot up just as that happened because this was a supply shock. Home prices started collapsing at the beginning of 2007, and by August 2007, prices were down nearly 10% and funds of MBS were starting to implode because MBS market prices were collapsing (defaults were just starting to rise in the youngest cohorts of mortgages). In their August meeting statement, the FOMC described the housing collapse as ongoing….ONGOING! While they announced that they were keeping the FFR at 5.25% because of inflation fears! Core CPI inflation was 2.1%. But, get this. Core minus shelter inflation was 1.2%. Shelter inflation was 3.4%. We were well into disinflation except for the housing supply shock – in August 2007, with FFR at 5.25%. This was the first of at least 3 times when they tried to keep the Fed Funds rate above expectations and rate markets immediately went bonkers.

    But, can you imagine the howls that would have gone out if they had announced that they were dropping FFR to 4 1/2% in order to accommodate a housing recovery? There are way too many “causes”. There were 3 causes which was really 1 problem: (1) constrictions in housing supply led to (2) wrong ideas about demand problems which led to (3) disastrous Fed policy.

    If you back shelter inflation out of the CPI, the Fed hasn’t been above its target inflation rate for 20 years. Guess where we are now? Shelter inflation 3%, Core minus Shelter 0.9%, housing starts are flatlined, and Robert Shiller, Arnold Kling, and a thousand other economists are talking about a housing bubble while the Fed debates a rate hike. If they do it again and they tighten and the economy goes in the tank next year, is it really because of the FDIC or CRA? People are talking about asset bubbles, just like last time. There is one thing and only one thing that makes the difference between us having our own double dip recession or not. As much as I’d get rid of the FDIC, that ain’t it.

    OK. I’ll give you Detroit. Detroit has too many houses. There is a housing bubble there. But everywhere else, there is one cause.

    Man, I’m starting to feel like Morgan. I even used all caps. Morgan, is there a free, virtual, digital URL I can contact for help?

  25. Gravatar of TravisV TravisV
    27. July 2015 at 21:40

    Is anyone else surprised that this man is Unilever’s CEO?

    “Commercial agriculture accounted for 71 percent of tropical deforestation in the last 12 years. That translates into the loss of 130 million hectares (321 million acres) of forests. In fact, that loss contributes about 15 percent to global greenhouse gas emissions, more than the entire transport sector. These are the inconvenient facts.”

    In other words, the massive companies that grow our food are in part responsible for aiding and abetting practices that are slowly killing the earth by recklessly tearing down forests to grow crops.”

    http://www.businessinsider.com/unilever-ceo-speaks-on-climate-change-2014-12

  26. Gravatar of Kevin Erdmann Kevin Erdmann
    27. July 2015 at 22:04

    Here’s a thought. Households and financial intermediaries in this country were treading so carefully and were managing their risk profiles so well that, even though home prices had never dropped more than a couple percent before in the modern era, it took a 25% drop in home prices to create an economic disruption. Before 2007, nobody would have guessed that our financial system was that solid.

    Even with FDIC, CRA, TBTF, it took a 25% drop in the single most important asset used for household leverage and collateral to break us.

    Considering that since then public pressure has only been to keep banks from issuing mortgages, even today, it looks to me like if households and the banks had been so well managed that they could have withstood a 40% drop in home values, then we would have seen a 45% drop before it was over.

    The farther it dropped, the more everyone said, “Yep. See. I told you those speculators were going to cause this to happen. This is what happens when you let credit flow.” Nobody was going to let the Fed loosen money without a crisis.

  27. Gravatar of James in London James in London
    27. July 2015 at 22:22

    Britonomist:
    Never reason from a price change. Or from “a huge crediting/banking shock”. What caused the “shock”?

  28. Gravatar of Mark A. Sadowski Mark A. Sadowski
    28. July 2015 at 02:27

    Off Topic.

    The conclusion of a 12 part series (see numbered links at bottom of this post) using Vector Auto-Regression (VAR) analysis to study the effects of the US Quantitative Easing (QE) on output and prices.

    https://thefaintofheart.wordpress.com/2015/07/27/the-monetary-base-and-the-channels-of-monetary-transmission-in-the-age-of-zirp-conclusion/

  29. Gravatar of Scott Sumner Scott Sumner
    28. July 2015 at 05:05

    Britonomist, If we are no longer in a golden straightjacket, then today it would be even easier to boost NGDP expectations than in 1933.

    Rajat, OK, but then why did our textbooks say exactly the opposite, that low rates don’t mean easy money? Why have we been teaching our students a model that we don’t believe?

    Kevin, I think you misread my comment. I was just trying to list some things that increased housing construction. I was not suggesting that I know the appropriate amount of construction, or that those factors caused a crisis. Obviously I think the Fed caused the crisis.

    Thanks Mark, We need more of this sort of empirical analysis.

  30. Gravatar of Dustin Dustin
    28. July 2015 at 05:17

    It is clear that you feel there is a mistake in using Ratex alternatives to explain away bubble collapses, but are you also saying the search for Ratex alternatives would itself be a mistake?

    So I guess my question is this, are market-based NGDP futures a Ratex alternative? A futures market doesn’t seem altogether dissimilar from what Noah references in the link you provide, “Greenwood and Shleifer measuring expectations with surveys.” Perhaps the distinction is the use of expectations to guide current policy.

  31. Gravatar of Jean Jean
    28. July 2015 at 05:22

    Britonomist – the shock was endogenous AND exogenous. The dollar was too tight, and the euro was extremely tight. The periphery of Europe went into recession in the second quarter of 2007, and the US followed in Dec. Once the ECB raised rates in July of 2008 european banks didn’t want to hold euros, as they thought the damn thing wouldn’t survive, so they sought to hold Bunds AND dollars. Thus, a too tight currency was made even tighter.

  32. Gravatar of Vivian Darkbloom Vivian Darkbloom
    28. July 2015 at 05:29

    “Kevin, What I’ve never understood is why people insist that the housing boom had only one cause. Why not 17 causes, including GSEs and stupid banks and FDIC and TBTF and CRA and tax deductibility of interest?”

    “I’ve always thought that it was patently obvious that the Fed caused the Great Recession with a tight money policy that allowed NGDP expectations to collapse in late 2008.”

    The former sounds quite reasonable; however, I’ve never understood why people insist that the Great Recession had only one cause. Why not 17?

  33. Gravatar of Floccina Floccina
    28. July 2015 at 06:14

    “I’ve always thought that it was patently obvious that the Fed caused the Great Recession with a tight money policy that allowed NGDP expectations to collapse in late 2008.”

    That is no fun. It is much more fun (and satisfying to) to blame rich bankers if you are a democrat and foolish borrowers if you are a republican.

  34. Gravatar of Vivian Darkbloom Vivian Darkbloom
    28. July 2015 at 06:27

    @Floccina

    That is quite true. But, again, the tendency is to assign, depending on one’s ideological predilections or one’s favorite project, one cause to the exclusion of all others. Your observation is consistent with that. Should you add to your list that it is much more “fun” (and satisfying, too) to blame the Fed if one is a monetarist?

  35. Gravatar of Ray Lopez Ray Lopez
    28. July 2015 at 06:32

    Sumner: “Thanks Mark, We need more of this sort of empirical analysis.” says the man who refuses (because he can’t find one?) to cite any econometrics article that supports the hypothesis the Fed causes any change in the economy.

    And BTW Sadowski says his results “Granger -cause”. It’s like saying the price of butter in Bangladesh ‘Granger causes’ world GDP, since the two variables are correlated, with a lag (GDP increases as the price of Bangladesh butter is increased).

  36. Gravatar of Tom Brown Tom Brown
    28. July 2015 at 07:07

    Speaking of rationality and expectations, I see Krugman is hedging his bets on a Trump nomination.

  37. Gravatar of Ray Lopez Ray Lopez
    28. July 2015 at 07:20

    @myself – check out the prior Sumner post to this one comments section where I just tore a new hole in Sadowski’s argument re the one paper he claimed proves monetarism (Christiano et al). Yet no less than the Dallas Fed specifically calls out errors in the seminal Christiano et al paper (when it was in pre-published form in 1994, but essentially the same paper as published a few years later) in a Balke et al paper titled “Understanding the Price Puzzle” (and the ‘prize puzzle–Google this–makes a monkey out of monetarism).

  38. Gravatar of David de los Ángeles Buendía David de los Ángeles Buendía
    28. July 2015 at 07:51

    Dr. Sumner,

    Before 2008 people invested rather than saved because investing paid profits than savings or paying down debt. After 2008 investing paid considerably less profits and thus saving and paying became more profitable than investing. The economy rewarded investments before 2008 and punished them afterwards and people responded accordingly.

    It is not complicated.

  39. Gravatar of benjamin cole benjamin cole
    28. July 2015 at 08:10

    Central banks, under the banner of “fighting inflation” are instead suffocating economies.

    Even Singapore is now in a deflationary recession.

    Central bankers need to seek robust economic expansion for several years.

  40. Gravatar of TravisV TravisV
    28. July 2015 at 08:16

    At Vox, Ezra Klein interviews Bernie Sanders:

    http://www.vox.com/2015/7/28/9014491/bernie-sanders-vox-conversation

  41. Gravatar of Andrew_FL Andrew_FL
    28. July 2015 at 08:23

    You’ve got a double negative I don’t think you intended there, Scott.

  42. Gravatar of Britonomist Britonomist
    28. July 2015 at 08:40

    @James

    “Never reason from a price change. Or from “a huge crediting/banking shock”. What caused the “shock”?”

    I highly doubt it was monetary policy, as Sumner claims. There is no reason in 2007 for bankers to have suddenly expected the price of acquiring reserves to have significantly increase then or in the future. The lending/finance shock was just full blown hysteria initiated by the decline in the value housing and in turn of mortgage backed securities (whether you believe it was actually a bubble or not, the market certainly believed and reacted as if it were a bubble by then).

  43. Gravatar of marcus nunes marcus nunes
    28. July 2015 at 09:29

    @Britonomist
    Evidence for the “monetary policy caused the shock”:
    https://thefaintofheart.wordpress.com/2011/04/14/the-crisis-from-an-ad-perspective/

  44. Gravatar of Miguel Miguel
    28. July 2015 at 11:22

    So, you continue believing no bubble, nor burst, previous the deceleration of NGDP? My God, forgive their offense, because they don’t see the evidence… Amen

  45. Gravatar of Doug M Doug M
    28. July 2015 at 13:04

    Of course nominal shocks have real effects.

    Any model that doesn’t account for this is clearly wrong.

    Money is not neutral.
    Or there is malinvestment that causes both the real and the financial to collapse simultaneously.
    Or A higher cost of capital (lower equity prices) kills new investment.

  46. Gravatar of James in London James in London
    28. July 2015 at 14:19

    Britonomist
    There was no house price shock in 2007. House prices fell with increasing severity during 2008 and into 2009 – as monetary policy tightened and tightened.
    http://www.nationwide.co.uk/~/media/MainSite/documents/about/house-price-index/downloads/monthly.xls

    In the U.S. it was largely the same. Tightening monetary policy turned the drama of flattening HPI growth into a crisis.

    The lack of response to falling NGDP growth expectations in 2007 was a monetary tightening. The modest upwardly moving bias of rate setters in most of 2008 dramatically compounded the first error.

    Countries with independent and more relaxed and flexible monetary policies in relation to IT saw the HPI flattening, but no collapse. Australia, Sweden, Canada, Israel.

  47. Gravatar of Doug M Doug M
    28. July 2015 at 16:09

    James in London,

    While home prices may not have fallen in 2007 there was already a mortgage crisis underway.

    Novastar and New Century — two large sub-prime lenders declared bankruptcy in March of 2007. 1 full year before Bear Stearns. 15 months before Lehman brothers. Merrill Lynch famously lost 8 billion dollars in the month of August of 2007.

  48. Gravatar of Major.Freedom Major.Freedom
    28. July 2015 at 18:20

    Sumner wrote:

    “The Fed’s duty is to steer AD along a steady path.”

    No, the Fed’s duty is not what it currently does not do but you want it to do.

    The Fed’s duty is to protect the politically connected banks from bankruptcy and to facilitate a general credit expansion from each bank without resulting in overextended banks being called by non-overextending banks.

    The academic front, the flag bearing intellectual duty, is to “steer aggregate prices along a steady path”.

    This is not the same thing as steering AD.

    Sumner is in lala land.

  49. Gravatar of Major.Freedom Major.Freedom
    28. July 2015 at 18:23

    The argument that the Fed’s duty is to target AD on the basis that it just doesn’t know it yet, but such a duty is “implied” by another intention such as minimizing large downward swings in employment, then by that logic, the duty of the Fed must really be to shut its doors and plead to Congress to liberalize money across the board.

  50. Gravatar of Bob Murphy Bob Murphy
    28. July 2015 at 19:26

    Scott, I think the biggest stumbling block that “normal” (not people like me) economists have with your view is your insistence on calling it “tight money” instead of calling it “incredibly loose money that’s not loose enough.”

    I understand your perspective on this, but it is somewhat tautologous and I think that’s what throws most economists. It’s not your policy recommendations or even diagnosis, it’s your vocabulary.

  51. Gravatar of Don’t waste time looking for Rational Expectations alternatives « Economics Info Don’t waste time looking for Rational Expectations alternatives « Economics Info
    28. July 2015 at 20:00

    […] Source […]

  52. Gravatar of Tom Brown Tom Brown
    28. July 2015 at 20:14

    @Bob Murphy, perhaps Scott measures tightness & looseness by the NGDP level relative to the long term extrapolated trend? If I’m correct, are you saying that’s not normal? :)

  53. Gravatar of Miguel Miguel
    28. July 2015 at 23:46

    If MM were right, in one moment before de bubble there is a point were NGDP growth was too high. So ther is a moment where the fed had to rise interes rate. It is impossible to think that all the moments are accurated just to low interest rate. So, in your opinion, when interest rates were too low between 2000 recession and 20011? Never?

    Seriously, MP is insufficient to control both real economy (NGDP) and financial. The control of NGDP alone will never stabilize the economy for ever, as Minsky taught.
    And is really difficult to believe that ther is not financial cicle.

  54. Gravatar of Dustin Dustin
    29. July 2015 at 06:08

    Miguel

    “If MM were right, in one moment before de bubble there is a point were NGDP growth was too high. So ther is a moment where the fed had to rise interes rate.”

    MM has nothing to do with this.

  55. Gravatar of Andrew_FL Andrew_FL
    29. July 2015 at 07:50

    @Tom Brown-If it was normal then most people would be Market Monetarists. They aren’t, therefore, it’s not normal.

    Scott may not like that most people think of monetary policy in terms of nominal interest rates and unstated assumptions about where they should be, and he may have very good reasons for not liking that most people think that way. Heck, I don’t especially like that either. But that is what is normal, in the sense that that is how most people think of the tightness/looseness of monetary policy.

  56. Gravatar of o. nate o. nate
    29. July 2015 at 10:53

    I wonder how much of the idea that the Fed caused the 2008 recession is caused by perfect hindsight. It’s easy now to say that the Fed should have thrown everything it could at boosting AD much earlier, but how apparent was that at the time? GDP statistics have undergone some pretty significant revisions from the initial releases. Would it really have been possible to steer the economy with perfect foresight using contemporaneous NGDP figures? Base money seems to be even less useful as a guide, since changes in its trend-rate of growth seem to be fairly uncorrelated with NGDP.

  57. Gravatar of Kevin Erdmann Kevin Erdmann
    29. July 2015 at 13:16

    o. nate:

    https://www.youtube.com/watch?v=SWksEJQEYVU

    Jim Cramer is a character, and in August 2007 when this happened I discounted it as the rantings of a TV clown. But, man, he earned himself lifetime cred with that. Now, maybe it takes hindsight to appreciate that.

    But, so many people argue that letting Lehman fail a year later was the problem. I disagree. But, if people are going to argue that, then you can’t argue that it takes hindsight to look at the Fed, in a scheduled meeting the day after the Lehman failure, still holding rates above market because they see inflation as the main problem. And most of the collapse in NGDP, employment, and even home defaults happened after September 2008.

    If anybody forgets that Cramer rant, it’s worth a watch. Chilling in retrospect.

  58. Gravatar of Morgan Warstler Morgan Warstler
    29. July 2015 at 14:25

    Hear, hear!

    “Scott, I think the biggest stumbling block that “normal” (not people like me) economists have with your view is your insistence on calling it “tight money” instead of calling it “incredibly loose money that’s not loose enough.””

    She’s an incredibly loose woman, who is not loose enough.

    is not

    She’s a prude.

    ——

    The tech is readily available for Scott to auto replace every mention of “tight money” on his blog.

  59. Gravatar of Michael Byrnes Michael Byrnes
    29. July 2015 at 14:27

    Yglesias with a good post on inflation and productivity

    http://www.vox.com/2015/7/28/9057149/wages-productivity-inflation

  60. Gravatar of Dustin Dustin
    29. July 2015 at 14:56

    o. nate:

    Contemporaneous NGDP wouldn’t be the driver of policy, but rather NGDP expectations. By definition, market expectations are highly reliable as, at an individual level, they guide consumption/savings/investment decisions.

  61. Gravatar of Scott Sumner Scott Sumner
    29. July 2015 at 15:25

    Dustin, I see the NGDP futures approach as being completely consistent with Ratex, and see no reason to search for alternatives.

    Vivian, Because the monetary explanation is a necessary and sufficient explanation for the stylized facts of 2007-09.

    Ray, The price puzzle has nothing to do with monetarism.

    David, Saving is exactly equal to investment, so saying people saved rather than invested is meaningless gobbletygoop.

    Andrew, Thanks, I corrected it.

    Bob, People need to stop acting like it’s my definition. I’m just using Bernanke’s definition of easy and tight money.

    Miguel, No, NGDP percent is not the real economy.

    O.nate, I was obvious to both me and the asset markets that the Fed was making a catastrophic mistake in 2008. Data lags are not the issue, the NGDP market forecasts were falling fast.

  62. Gravatar of Scott Sumner Scott Sumner
    29. July 2015 at 15:33

    Michael, That’s a great Yglesias post.

  63. Gravatar of Major.Freedom Major.Freedom
    29. July 2015 at 21:12

    “I’m just using Bernanke’s definition of easy and tight money.”

    Bernanke has proposed more than one mutually exclusive definition. He mentioned nominal GDP what, once as a possible new target?

    And that suddenly means your “NGDP guy” target is based on Bernanke’s definition?

    In his blog post “Should monetary policy take into account risks to financial stability?”, Bernanke wrote:

    “In response to the Great Recession, the Federal Reserve has kept the short-term interest rate (the federal funds rate) near zero since December 2008 and taken other steps (like purchasing longer-term Treasury securities) to strengthen the recovery and avoid deflation of wages and prices. Although the recovery has not been as fast as hoped””in part because of “headwinds” arising from fiscal policy, the after-effects of the financial crisis, and other factors””today the jobs situation in the United States is much better than a few years ago, and the risk of deflation is very low. Fed policies have had a lot to do with that.

    Despite the substantial improvement in the economy, the Fed’s easy-money policies have been controversial. Initially, detractors focused on the supposed inflation risks of such policies. As time has passed with no sign of inflation, that critique now looks rather threadbare.”

    Here Bernanke defines what the Fed did after the crisis of 2008, as NGDP was collapsing, as LOOSE monetary policy.

    Loose based on what? In the same post, Bernanke continues:

    “But Lars found little support for his position at the Riksbank and ultimately resigned. In the event, however, the rate increases were followed by declines in inflation and growth in Sweden, as well as continued high unemployment, which forced the Riksbank to bring rates back down. Recently, deflationary pressures have led the Swedish central bank to cut its policy rate to minus 0.25 percent and to begin purchasing small amounts of securities (quantitative easing).”

    To Bernanke, in this blog post, easy money means reducing interest rates.

    http://www.brookings.edu/blogs/ben-bernanke/posts/2015/04/07-monetary-policy-risks-to-financial-stability

    Then, in his post titled “Why are interest rates so low? – part 4”, he wrote:

    “After lowering short-term interest rates nearly to zero in December 2008, the Fed sought to ease policy further by buying large amounts of longer-term securities (quantitative easing). Quantitative easing increased the demand for longer-term government securities, thereby lowering the term premiums on them.”

    Here Bernanke defined easy money as lowering interest rates and as increasing the monetary base. And, that the reason, according to Bernanke’s definition, of what long term yields fell was not because of your definition of tight money, but because of Bernanke’s definition of loose money.

    Try engaging what Bob wrote this time.

  64. Gravatar of jamesxinxlondon jamesxinxlondon
    30. July 2015 at 03:57

    Doug M
    2007 was not a housing crisis. It was a crisis for some housing financiers, both in the US (the ones you mentioned) and in the UK (Northern Rock). These failures and flattening HPI were signals of falling NGDP growth expectations. The monetary policy response should have been to ease, but US and UK monetary authorities did nothing practical (and therefore tightened monetary policy) or talked about tightening (thereby tightening even more).

    Monetary policy is always relative to NGDP Growth expectations. Monetary policy can include moving interest rates around, but only against expectations about those moves. Monetary policy is not an absolute thing and this a commmon mistake we see all the time in the comments here.

    Tight money can mean cutting rates to zero, and even having QE, if NGDP Growth expecations keep falling – calling it “loose but not loose enough” is both confusing and wrong.

    A lot of comment on the site here is from people with little background in financial markets. The obsession with the future is everything in financial markets, expectations are everything.

  65. Gravatar of Ray Lopez Ray Lopez
    30. July 2015 at 06:23

    @ssumner who says: “Ray, The price puzzle has nothing to do with monetarism.”

    St. Louis Fed paper, Oct. 2006: “A fundamental tenet of monetary policymaking is that a surprise increase in the short-term interest rate will lower price inflation from what it otherwise would have been. Thus, it has been disconcerting to macroeconomists that many empir- ical estimates of the relationship between the federal funds rate and inflation have suggested that a surprise interest rate hike is followed immediately by a sustained increase in the inflation rate. This result has become known as the “price puzzle,” starting with Eichenbaum (1992). Hanson (2004) showed that it is not easy to explain away the price puzzle, especially in the pre-1980 period.”

    Dr. Sumner, you’re old enough to remember To Tell The Truth. Will the real Scott Sumner please stand up? This trolling of yours for the sake of winning the argument is getting ridiculous. We’re both middle-aged men, and you’re acting like a pre-teen. Your daughter is more mature than you.

  66. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    30. July 2015 at 07:07

    The conclusion of that Yglesias Vox article deserves more pondering;

    ‘Real wages really have risen much too slowly over the past 40 years. But while Clinton’s version of the chart makes it look like rising productivity isn’t part of the solution, looking at the divergent price indexes clarifies that it is crucial. For real wages to rise, we need the things middle-class families spend the bulk of their income on to get cheaper. That means more productivity in the big housing, health, and education sectors “” not more pessimism about the potential of productivity.’

    All three of those sectors are heavily regulated by governments.

  67. Gravatar of Tom Brown Tom Brown
    30. July 2015 at 07:10

    O/T: Scott, what do you think of this statement from John Cochrane:

    “I am a big euro fan. … I am also a big meter fan. I don’t think each country needs its own measure of length, or to shorten it when local clothiers are having trouble and would like to raise cloth prices.”

    So why not just one world currency (and one CB?)? It works for meters.

  68. Gravatar of Don Geddis Don Geddis
    30. July 2015 at 07:19

    @Major.Freedom: You’ve confused the concepts of “tight money” and “loose money”, with the concepts of “tighter money” and “looser money”. The first pair is an absolute measure, the second pair is a relative measure.

    If a central bank takes an action to make money “looser”, that has essentially no bearing on whether money then becomes “loose”.

    The one confusion has made the bulk of your comment irrelevant, to the question of whether money is “tight” or “loose”, in an absolute sense.

  69. Gravatar of o. nate o. nate
    30. July 2015 at 09:29

    Dustin wrote: “Contemporaneous NGDP wouldn’t be the driver of policy, but rather NGDP expectations. By definition, market expectations are highly reliable as, at an individual level, they guide consumption/savings/investment decisions.”

    Hmm, so if I understand this correctly, we are not very good at telling what NGDP recently was, but we are highly accurate at predicting what it’s going to be?

  70. Gravatar of TravisV TravisV
    30. July 2015 at 13:02

    Patrick R. Sullivan, thanks for that Yglesias link.

    Tom Brown, thanks for that Cochrane link.

  71. Gravatar of Major.Freedom Major.Freedom
    30. July 2015 at 16:14

    You have falsely divorced a movement towards an absolute measure, from the absolute measure, to the point of presuming that moving towards an absolute measure is possibly synonymous with the absolute measure becoming relatively further away from the starting point all else equal.

    Plus you are ignoring the crucial point that was made, which is that Bernanke in the blog posts I cited, did not define loose AND loosening, nor did he define tight AND tightening, in terms of NGDP. He defines them in terms of interest rates and the monetary base.

    Sumner on the other hand defines loose AND loosening, and tight AND tightening, in terms of NGDP. Loose of it is above his arbitrary non-market ideal absolute level, loosening if the absolute level is increasing or becoming less negative, tight if it is below his arbitrary non-market ideal absolute level, tightening if it is decreasing or becoming less positive.

    The analogue to what Bernanke wrote, if you want to separate the two sets too far, would be that Bernanke would define loose as interest rates being absolutely low (corrected for savings gluts and whatever other factor he has in mind), tight as interest rates being absolutely high (again corrected for other factors), loosening as interest rates (corrected for various factors) becoming lower, and tightening as interest rates (corrected for various factors) becoming higher.

    I never said or implied that loosening is synonymous with loose. If Bernanke’s definitions from his blog are to be used, then it we would say that if money were to be loosening, in terms of interest rates and monetary base expansion, then it is possible for money to still be tight absolutely, in terms of interest rates and monetary base.

    Your entire post was nothing but a straw man, so it can be dismissed with as little mental effort as went into your writing of it.

  72. Gravatar of Major.Freedom Major.Freedom
    30. July 2015 at 16:21

    Geddis:

    This passage is the giveaway:

    “Despite the substantial improvement in the economy, the Fed’s easy-money policies have been controversial. Initially, detractors focused on the supposed inflation risks of such policies.”

    Here Bernanke is separating easy money, I.e. loose money absolutely, from (price) inflation.

    It cannot be said, given this passage, that Bernanke would logically come to believe that lowering interest rates may be loosening, but monetary policy might still be tight absolutely if prices are not rising much.

  73. Gravatar of Ray Lopez Ray Lopez
    30. July 2015 at 18:30

    @Don, MF: don’t we all feel silly here arguing over 3.2%? Ben S. Bernanke in a 2003 paper found that the effects of monetarism on the economy is about 3.2% (see below). Why can’t we just get along? We are like the two Scotsmen, econ professors, (Sumner has a thing over Scotsman I recall) fighting over a copper penny who by pulling it invented wire. Why did they argue so hard? Because so little money (3.2%) was at stake.

    RL

    Measuring the Effects of Monetary Policy: A Factor-Augmented Vector Autoregressive (FAVAR) Approach * Ben S. Bernanke et al (2003) Apart from the interest rates and the exchange rate, the contribution of the policy shock is between 3.2% and 13.2%. This suggests a relatively small but still non-trivial effect of the monetary policy shock. In particular, the policy shock explains 13.2%, 12.9% and 12.6% of capacity utilization, new orders and unemployment respectively, and 7.6% of industrial production

  74. Gravatar of Major.Freedom Major.Freedom
    31. July 2015 at 03:51

    Ray,

    It is impossible to scientifically calculate the effects of anything that spans an economy, since we will never observe the counterfactual needed to compare the observable world with.

    If the world was a free market in money, for 100 years say, then the same limitation would apply. We would not be a lr to scientifically calculate the effects of central banking, since it would be unobservable.

    And Bernanke was wrong about everything. Google Bernanke was wrong.

  75. Gravatar of Ray Lopez Ray Lopez
    31. July 2015 at 07:43

    @MF – who says: “It is impossible to scientifically calculate the effects of anything that spans an economy, since we will never observe the counterfactual needed to compare the observable world with.” – you don’t need a counterfactual for FAVOR, it is internally driven. The model is saying that a monetary policy shock (such as a large rate increase or decrease) only accounts for a small percent of the economy’s output, compared to other variables. If in your alternate universe we would have 300%/yr growth instead of the 3%/yr growth that is typical, this conclusion would not change the FAVOR analysis, which only takes the data you input into it.

  76. Gravatar of Ray Lopez Ray Lopez
    31. July 2015 at 07:48

    Sumner says: “Update: John Cochrane informed me that I mischaracterized his views. He does believe that nominal shocks have real effects, and that wage and price stickiness do exist. Mea culpa.”

    Sumner, you have lots of ‘mea culpa’ to do. You seem to have reading comprehension problems. If you misread your friend and colleague Cochrane, who is somebody who you pay close attention to as you respect his views, imagine how much you must misread me or MF or your other blog critics, who you don’t even respect? Or is Cochrane as obscure as you are when writing, so you don’t know top from down? If so, he’s a clever economist.

  77. Gravatar of Major.Freedom Major.Freedom
    31. July 2015 at 16:34

    Ray:

    “MF – who says: “It is impossible to scientifically calculate the effects of anything that spans an economy, since we will never observe the counterfactual needed to compare the observable world with.” – you don’t need a counterfactual for FAVOR, it is internally driven.”

    That is precisely a limitation that prevents it from doing what you believe it can do.

    Scientific predictions require external considerations, which is only possible in the tightest of controlled localized experiments, such as in a physics lab.

    There is no way to go external to the economy as a whole, because even the testing itself becomes a part of it.

  78. Gravatar of ssumner ssumner
    1. August 2015 at 06:15

    Patrick, That’s a good Yglesias post.

    Tom, The analogy doesn’t hold because wages and prices are sticky.

  79. Gravatar of AnotherAnon AnotherAnon
    3. August 2015 at 10:20

    Scott,

    Somewhat offtopic but what are the pros and cons of more people using flexible wage contracts to alleviate downward nominal wage rigidity? The obvious pro is that when aggregate demand falls, both wages and inflation fall as well, diminishing the rate of increase in layoffs. At the same time a con could be that a fall in wages causes a fall in spending and so on, but people may very well just work more to alleviate their fall in wages. Employers have more to spend, and theoretically the quantity of labor demanded may increase.

    The reason this isn’t the case is probably because of things like money illusion and poorer worker morale.

    Of course we don’t live in a world where everybody can suddenly shift towards flexible wage contracts, but are there any great downsides in doing so?

  80. Gravatar of ssumner ssumner
    4. August 2015 at 07:09

    Anotheranon, We shouldn’t expect much from increased wage/price flexibility, but it would be a slight plus. Consumer spending is not determined by wages, it’s determined by NGDP (and hence monetary policy)

  81. Gravatar of TravisV TravisV
    8. August 2015 at 07:00

    “John Cochrane informed me that I mischaracterized his views. He does believe that nominal shocks have real effects, and that wage and price stickiness do exist. Mea culpa.”

    Cochrane recently wrote the following about nominal shocks and real effects:

    http://johnhcochrane.blogspot.com/2015/07/mankiw-and-conventional-wisdom-on-europe.html

    I couldn’t help but think of Glasner’s analysis of Ludwig von Mises’s “crocodile tears for the working class”

    And this classic by Austrian Bob Murphy:

    https://dajeeps.wordpress.com/2012/08/12/greg-mankiws-debate-with-liquidationists-in-2009

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