The Great Recession happened because we ignored Friedman’s ideas

Patrick Sullivan directed me to a Brad DeLong article on the lessons of the Great Recession:

And yet, as recommendable as Wolf’s proposals may be, little has been done to implement them. The reasons why are found in the second book: Hall of Mirrors, by my friend, teacher, and patron,Barry Eichengreen.

Eichengreen traces our tepid response to the crisis to the triumph of monetarist economists, the disciples of Milton Friedman, over their Keynesian and Minskyite peers – at least when it comes to interpretations of the causes and consequences of the Great Depression. When the 2008 financial crisis erupted, policymakers tried to apply Friedman’s proposed solutions to the Great Depression. Unfortunately, this turned out to be the wrong thing to do, as the monetarist interpretation of the Great Depression was, to put it bluntly, wrong in significant respects and radically incomplete.

The resulting policies were enough to prevent the post-2008 recession from developing into a full-blown depression; but that partial success turned out to be a Pyrrhic victory, for it allowed politicians to declare that the crisis had been overcome, and that it was time to embrace austerity and focus on structural reform. The result is today’s stagnant economy, marked by anemic growth that threatens to become the new normal.

I think this is exactly backwards.  But first let’s get one issue out of the way; Friedman’s proposed 4% rule for M2 growth might well have failed in 2008.  On the other hand, clearly that’s not what DeLong (and Eichengreen?) had in mind.  Monetarism in the sense of the k% rule has almost zero influence today.  If people are claiming that “monetarist” ideas contributed to the failed policy response in 2008-09, they are clearly thinking of monetary policy more broadly—that the Fed can and should steer the nominal economy, and that we should not rely of fiscal or regulatory solutions to problems that are essentially monetary.  So let’s review what happened in 2008:

1.  Two days after Lehman failed, the Fed met and decided the US faced a financial problem, not a monetary/AD problem.  Thus they decided not to ease monetary policy. A few weeks later the Fed decided to pump enormous quantities of liquidity into the banking system.  Under a normal (monetarist) policy regime, that liquidity would have driven short-term rates to zero and increased the broader money supply.  But the Fed did not want that to happen.  They explicitly tried to avoid easing monetary policy, even as they rescued the banks, by implementing a new device called “interest on reserves.”  Paying banks not to move the money out into the economy.  This kept rates above zero until mid-December, when the Fed finally threw in the towel and lowered rates to 0.25%, where they remain today.

2.  In 1997 Friedman warned the profession that they were confusing low interest rates with easy money.  In 2003 Bernanke echoed that warning.  In Frederic Mishkin’s final FOMC meeting (in 2008) he made a heartfelt plea to the Fed not to confuse low rates with easy money.  Unfortunately, over the next few years the Fed (and most of the rest of the profession) did exactly that, assuming that low rates meant an easy money policy.

3.  By March 2009, the data were coming in much worse than expected, and it was clear that monetary policy had been far too tight in 2008 (when we were not at the zero bound), producing the biggest drop in NGDP since the 1930s.  I recall DeLong once expressing dismay that the Fed would acquiesce to such a large drop in NGDP, and do little to repair the damage.  They finally did act in March, with the QE1 program, and a weak recovery began.  But they needed a much more aggressive program, either more QE, or lower IOR, or more aggressive forward guidance, or the sort of level targeting that Bernanke recommended the Japanese undertake in the early 2000s, or all of the above. But it wasn’t until late 2012, when the Fed saw the approaching fiscal austerity that they moved more aggressively on the QE/forward guidance front.  Since the beginning of 2013 the unemployment rate has been falling fast.

I see a profession that wrongly thought the Fed was out of ammo (something Friedman would have never assumed) that wrongly thought low rates meant easy money (something Friedman never would have done), that wrongly thought fiscal stimulus was the answer (something Friedman never would have done), that wrongly thought it was a financial crisis and not a monetary/AD crisis until it was too late (suggesting they put more weight on Bernanke (1983) than Friedman and Schwartz (1963).)

Actually Bernanke was trying to do more, but when the “Fedborg” is hopelessly confused, and when the broader economics profession is hopelessly confused, well then there’s only so much one mild-mannered former college professor can do.

The people most off base in 2008-09 were the conservatives.  Friedman’s voice was dearly missed.

PS.  I hope DeLong doesn’t get annoyed if I tease him on one point.  He calls Martin Wolf a “conservative British journalist” and then spends several paragraphs discussing all sorts of Wolf views on a wide range of issues.  The only common thread I found was that Wolf’s policy views seem consistently left-of-center, at least where there is a clear left/right split (the euro seems ambiguous.)  So why not say “formerly conservative British journalist?”

(That’s not to say Wolf doesn’t have some good suggestions.)


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76 Responses to “The Great Recession happened because we ignored Friedman’s ideas”

  1. Gravatar of Jesse Jesse
    29. January 2015 at 07:16

    Policy makers didn’t try Friedman’s ideas in the modern sense. A quick glance at the Divisia M4 data set will confirm this.

  2. Gravatar of Vivian Darkbloom Vivian Darkbloom
    29. January 2015 at 07:32

    It appears to me that the fiscalists are claiming that government should have done more (spending) and didn’t. Thus, government policy failure caused the Great Recession.

    It also appears to me that the monetarists are claiming that government (the Fed) should have done more (monetary easing) and didn’t. Thus, government policy failure caused the Great Recession.

    Which was it? There seems to be a consensus of government failure (and perhaps even the failure of “the profession”), but given this divide of the nature of that failure, it once again appears that economists, and Joe the Plumber, have about a 50 percent chance of answering the question correctly (and, who knows, Joe might come up with the idea that it was both!). I’m thinking about placing my bets on Joe the next time. 🙂 (Scott, I’m not letting you get by that Joe the Plumber remark easily).

    But, now that we know what errors were made, I’m sure that “next time will be different”.

  3. Gravatar of Njnnja Njnnja
    29. January 2015 at 07:36

    “for countering the crisis…central banks, he argues, should raise inflation targets to 3% or even 4%”

    Which sounds like an ad hoc NGDP targeting regime. So if that is the solution, and monetarists like Friedman were the problem, are people who advocate NGDP targeting, such as Prof. Sumner, not considered to be monetarist in the Friedman tradition?

  4. Gravatar of maxk maxk
    29. January 2015 at 07:42

    I am astonished at the amount of fundamental disagreement between experts that exists in economics. You and DeLong clearly have completely different views on the causes of the recent recession.

    Given the fundamental disagreements, I am equally astonished at how confidently you and DeLong state your opinions. Are you each that sure that the other is just totally wrong? Pretty worrisome to us outside observers. Or is it just too much trouble to be always hedging every statement?

    So, consider this hypothetical. Suppose that the Fed had reacted in 08 exactly as you wished, that they clearly stated their intention to keep NGDP on trend. And suppose that everyone had utterly believed that they would follow through. (Of course, a very far-fetched hypothetical.)

    1. What would have happened?

    2. How sure are you?

    The alternative opinion is perhaps something like this: the collapse of the housing bubble led a substantial fraction of people to feel less wealthy. Those people reduced spending and increased saving, thus reducing demand, leading to recession. This reduction in demand would mainly not be solvable by monetary actions. However much people were convinced that the Fed actions would lead to inflation, and so make it silly for them to save and not spend, they were going to save anyway, because their houses were worth a lot less than they thought, because they were suddenly poorer than they had thought they were. Reference studies showing that the recession was strongest in counties with the largest falls in house prices.

    How is this wrong?

  5. Gravatar of foosion foosion
    29. January 2015 at 07:50

    I’m not sure the disagreement is as fundamental as maxk suggests.

    To me, the solution is both monetary and fiscal stimulus. I’d imagine both DeLong and Sumner could have agreed on a combination that would be effective.

    Scott, would you agree with that?

  6. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    29. January 2015 at 07:54

    Well Maxk, for one thing;

    http://www.nber.org/papers/w15075.pdf

    ‘Models used to guide policy, as well as some empirical studies, suggest that the effect of housing wealth on consumption is large and greater than the wealth effect on consumption from stock holdings. Recent theoretical work, in contrast, argues that changes in housing wealth are offset by changes in housing consumption, meaning that unexpected shocks in housing wealth should have little effect on non-housing consumption. We reexamine the impact of housing wealth on non-housing consumption, employing the Case-Quigley-Shiller data on U.S. housing wealth that have been used in prior studies to estimate a large housing wealth effect. Existing empirical work fails to control for the fact that changes in housing wealth may be correlated with changes in expected permanent income, biasing the resulting estimates. Once we control for the endogeneity bias resulting from the correlation between housing wealth and permanent income, we find that housing wealth has a small and insignificant effect on consumption.’

  7. Gravatar of maxk maxk
    29. January 2015 at 08:05

    More total disagreement!

    On the one hand, Mian and Sufi House of Debt
    On the other hand, the NBER paper that Patrick Sullivan links to.

    I’m with Vivian, let’s just ask Joe the Plumber for his opinion.

  8. Gravatar of maxk maxk
    29. January 2015 at 08:11

    foosion says:
    “To me, the solution is both monetary and fiscal stimulus. I’d imagine both DeLong and Sumner could have agreed on a combination that would be effective.”

    No way they could agree. DeLong would have wanted a fiscal stimulus that was much larger than the one that was passed. I’m guessing Scott thinks the one we had was too big, and totally unnecessary if the Fed has followed his suggestions.

    The disagreements in economics on fundamental facts are enormous. Can we really call this field science?

  9. Gravatar of Charlie Jamieson Charlie Jamieson
    29. January 2015 at 08:17

    Stimulus, be it monetary or fiscal, just doesn’t work anymore, because all the money created flows either directly to the wealthy and the lending institutions (monetary stimulus) or indirectly through the poor and middle class to the wealthy.

  10. Gravatar of Kevin Erdmann Kevin Erdmann
    29. January 2015 at 08:18

    Maxk, Ptolemy and Copernicus strongly disagreed. Do you think the best response to that is to throw up your hands and figure the astrologists are as good a source of information as anyone? Or do you try to approach their work diligently and decide for yourself who is correct?

  11. Gravatar of benjamin cole benjamin cole
    29. January 2015 at 08:34

    Excellent blogging. Exactly—only when the Fed got mildly bold and determined (by prevailing milquetoast standards) in QE3 did they make headway.
    Really, we have reached a time and place when central bankers have to say, “Bubala, we are going to set this house on fire, burning Ben Franklins to the moon.”
    Then run escalating amounts of monthly QE until we see eight straight quarters of 8% NGDP growth.
    Then maybe we think about cooling off.
    Actually, the 1976-9 recession was more robust than what I am calling for.

  12. Gravatar of maxk maxk
    29. January 2015 at 08:41

    Kevin, science doesn’t progress by amateurs like me reading all the papers and then deciding which is correct. Science progresses by the scientists conversing, presenting results, checking, refuting, etc., and eventually forming a consensus.

    Seems like macro economics is very far from consensus, and that’s fine. Must be a very hard problem.

    What worries me is the degree of certainty. If someone is sure about an answer to a hard problem, could be he is right and eventually the rest of the field will come around. But it could be he is an advocate and wants the answer to be a certain way. There’s way too much of that in economics. And I think the advocacy very much gets in the way of the progress of the science.

    Is Scott sure that he is right? Why is he sure? What’s the evidence? If he is right, why can’t he convince DeLong?

    By the way, who do you think is right?

  13. Gravatar of Nick Nick
    29. January 2015 at 08:47

    Maxk and Kevin,
    How about you guys split the difference and say science progresses by cohort replacement?
    As to the ‘why is everyone so sure’ part, it’s basically a product of arguing over lab time. We don’t have enough Large Economy Colliders for nearly anyone to get their projects on the agenda. They have to be advocates for themselves for a long time to ever start getting the data they would need to actually be sure. But, at the same time, once you get the lab time if the early results disappoint you can always start tinkering with the theory then.

  14. Gravatar of maxk maxk
    29. January 2015 at 08:56

    No, they’re not advocates because they’re fighting for research funding; they’re advocates because they have strong priors about government policies. (‘They’ doesn’t necessarily mean Scott and DeLong. I just mean many economists.) That is the advocacy which seems to infect too much economics. Is Scott convinced of his monetary explanations for the Great Recession because of the data or because the prescription (monetary not fiscal solution) better suits his libertarian priors?

  15. Gravatar of joemac joemac
    29. January 2015 at 09:06

    Scott,

    What is the precise difference between a “financial problem” and a “monetary/AD problem” in terms of macro? Theoretically speaking…

  16. Gravatar of maxk maxk
    29. January 2015 at 09:22

    Didn’t mean to single out Scott. Same question about DeLong. Is he convinced that a monetary response to the Great Recession was wrong because of the data or because of his priors?

  17. Gravatar of Nick Nick
    29. January 2015 at 09:27

    Maxk,
    It’s not about funding. No amount of research funding can get a macroeconomist control over the decisions of the central bank of a sizable monetary group.
    I agree that each person is inclined to want to pursue an agenda that he thinks will vindicate a theory which he or she is attracted to for personal reasons. But they would all be advancing their idiosyncratically preferred theories in a more cordial manner of they could do more concurrent tests without them interfering with each other. They effectively have one lab, no matter what they do. Sometimes they can try to run a handful of different programs at once but then they just end up telling each other all their results were actually due to a confounding influence from somewhere else in the lab

  18. Gravatar of Britonomist Britonomist
    29. January 2015 at 09:34

    This whole thing is silly, Keynesians say that policy makers ignored Keynes, that fiscal stimulus was inadequate and too little too late. Monetarists say that policy makers ignored Friedman, that monetary policy was inadequate and too little too late. I feel like both propositions are unfalsifiable, and you will never be able to convince each other.

  19. Gravatar of Doug M Doug M
    29. January 2015 at 09:41

    Maxk

    If you read enough, you will realize that there are many stripes of economists who will vehemently argue opposite sides of the issue. And, after the fact, will look at the same data and conclude that they were right all along.

    The best reading are those that are willing to change their tune as information changes, but are not so wishy-washy as to not take a stand.

    Most of economics is built on a foundation of sand. Models are based on parameters that cannot be measured. The data is noisy. Experimentation is nearly impossible.

  20. Gravatar of Don Geddis Don Geddis
    29. January 2015 at 09:48

    @maxk: “This reduction in demand would mainly not be solvable by monetary actions. However much people were convinced that the Fed actions would lead to inflation, and so make it silly for them to save and not spend, they were going to save anyway

    You’ve given up before you’ve begun, and radically underestimated “however much” inflation the Fed could (in theory) generate. If the Fed flooded the economy with cash, and the price level rose to 10x the current value, and milk was $50/gallon instead of $5/gallon … you’re really so confident that would have absolutely no effect on people’s saving behavior? That seems like an absurd model of consumer reactions.

    Remember: the value of fiat money is completely arbitrary. It is essentially costless, for the Fed to set the monetary base to any level at all. What kind of consumer inertia could possibly withstand arbitrary amounts of money printing?

    DeLong would have wanted a fiscal stimulus that was much larger than the one that was passed. I’m guessing Scott thinks the one we had was too big, and totally unnecessary if the Fed has followed his suggestions.” I agree with your predictions about Brad and Scott.

    The disagreements in economics on fundamental facts are enormous. Can we really call this field science? … If he is right, why can’t he convince DeLong?” That seems to be a social question, not an economics question. Your answers are probably better found in Kuhn. (Kuhn observed, essentially, that old scientists rarely changed their minds; fields as a whole changed, because new young scientists adopted the better theory, and eventually the old scientists died.) Think of it positively: you have the privilege of being present right in the middle of a huge paradigm shift in macroeconomics! Few observers are so lucky as to see such a fundamental advance in a scientific field, in real time.

  21. Gravatar of Ray Lopez Ray Lopez
    29. January 2015 at 10:00

    @everybody – maxk is right, and the rest of you try to bully him into submission. As for Sumner’s disparagement of Friedman’s monetary rule, as having fallen out of fashion, Sumner will find his NGDPLT rule will also look as dated as bell-bottom jeans do today. It would be wise for Sumner and the rest of you Sumnerites to heed these words of Friedman:

    I do not believe anybody here, including myself, knows enough to do any better. Almost everyone is in favor of countercyclical monetary policy. However, when you ask each one what he means by that policy, you find that Mr. Jones’s policy is anathema to Mr. Smith, and Mr. Smith’s to Mr. Robinson. In point of fact, there is agreement only on the glittering generalities that the Reserve System should do the right thing in the right way at the right time. There is no agreement on how you know the right time and the right thing to do. The appearance of agreement dissolves, once you put it to the test.” – “A Program for Monetary Stability”* by Milton Friedman (1965)

  22. Gravatar of maxk maxk
    29. January 2015 at 10:16

    Don Geddis:
    I agree. If the Fed engineered very high inflation as you describe, people would certainly spend their money. But Scott’s prescription is something like a 5% NGDP level rule. I’m saying that even if all of that was inflation, it wouldn’t cause the ‘house of debt’ consumer in 2008 to stop saving and start spending. And if that were the case, would the Fed just keep pushing higher? I say, no way.

  23. Gravatar of maxk maxk
    29. January 2015 at 10:27

    Don Geddis:
    “Think of it positively: you have the privilege of being present right in the middle of a huge paradigm shift in macroeconomics! Few observers are so lucky as to see such a fundamental advance in a scientific field, in real time.”

    I hope that happens. What I fear is that 50 years from now the field will look just the same, Keynesians vs Friedmanites, Sharks vs Jets.

    Nick:
    I think you misread me. I was saying that funding is *not* the explanation. Love your argument that the single real economic world means no opportunity to run independent experiments. Makes sense. However, I would think that progress could happen with the right sort of data analyses, e.g., as described in the new book by Angrist & Pischke.
    The thing that will hold back progress is strong priors & lack of open minds.

  24. Gravatar of SG SG
    29. January 2015 at 10:40

    @Britonomist

    Both positions are surely falsifiable. If the US experienced a sudden surge in unemployment despite stable NGDP (or stable unemployment despite big swings in NGDP), then I think Scott goes back to the drawing board.

    A falsification of krugman-delong-style Keynsianism would looks similar – a big increase or decrease in unemployment (or no change) despite a big increase or decrease in a country’s deficit (or CAPB, or whatever measure you think properly captures the fiscal stance of that country).

    And what do you know, we’ve seen big decreases in both deficits and unemployment in countries at the ZLB over the past couple of years, most notably in the US. Hence Scott’s frequent references to the collapse of the Keynsian model. And if you look more closely at Scott’s recent econlog posts on Keynsian economics (like http://econlog.econlib.org/archives/2015/01/the_keynesian_s.html), you’ll see he’s taken apart the most common excuses that keynsian commentators have made (which tend to obfuscate the measurement of economic growth, “austerity” or both).

  25. Gravatar of Charlie Jamieson Charlie Jamieson
    29. January 2015 at 10:43

    Inflation won’t make people spend rather than save. Somehow there is an idea the consumers are saving rather than spending, which is just not true.
    They might actually spend *less* if prices rise faster than wages, which is very likely.
    Meanwhile, the savers who control most of the money will just find or manufacture investment vehicles that keep up with inflation.
    Their debt instruments will be worth less, which may be the point to this goal.

  26. Gravatar of ssumner ssumner
    29. January 2015 at 10:47

    Vivian, You said:

    “It also appears to me that the monetarists are claiming that government (the Fed) should have done more”

    Not at all. The Australian central bank did much less, a much less contractionary policy. And the outcome was much better.

    Ask Joe the Plumber to respond to that claim. 🙂

    maxk, You said:

    “I am astonished at the amount of fundamental disagreement between experts that exists in economics. You and DeLong clearly have completely different views on the causes of the recent recession.”

    Are you aware of the fact that in multiple previous posts DeLong has accused the Fed of allowing NGDP to be far too low?

    You said:

    “Given the fundamental disagreements, I am equally astonished at how confidently you and DeLong state your opinions.”

    And I’m astonished that someone commenting here has never seen intellectuals express contrasting views with confidence. Have you never read Krugman, Cochrane, etc?

    You said:

    “How is this wrong?”

    That paragraph is wrong on almost every level possible. Unemployment was almost unchanged during the housing collapse of January 2006 to April 2008. You confuse consumption with aggregate demand. There is no counterfactual of the Fed pegging the price of NGDP futures, just for starters. No counterfactual of how level targeting impacts prices in asset markets, and how that impacts wealth. I suggest you read my paper “The Real Problem was Nominal.”

    You said;

    “Can we really call this field science?”

    I’ve pointed out many times that this statement is silly, for two reasons. It’s actually a debate about what the term “science” means (there is no generally accepted definition–not even close.) Sorry, but debates about definitions are silly. And there’s usually the implicit assumption that a science is better than a non-science. Which is even a sillier assumption.

    It’s about as silly as criticizing physics on the following rounds. “Gee physicists claim to be able to explain the motion of particles, but I notice they can’t agree on whether it’s going to rain a month from today.”

    You said:

    “Is Scott sure that he is right?”

    Of course not. I’m not sure about anything. I’d take about 10 to 1 odds on a bet (monitored by God) on whether NGDPLT would have made the 2008 recession milder. But not 1000 to 1.

    Charlie:

    You said:

    “Stimulus, be it monetary or fiscal, just doesn’t work anymore, because all the money created flows either directly to the wealthy and the lending institutions (monetary stimulus) or indirectly through the poor and middle class to the wealthy.”

    This is wrong on so many levels I want to cry. The Fed exchanges base money for T-bonds of equal value. Stop assuming the Fed gives money to the wealthy.

    foosion, You are probably right (say an actual helicopter drop, not a “helicopter drop”), although we would not agree that it was the optimal solution.

    Kevin, Here’s an even better analogy. In 1979 when inflation was 13% economists used to totally disagree on whether central banks could keep inflation fairly close to 2% over long periods of time, if the decided to do so. Given that inflation has averaged 1.99% since 1990, I’d say most economists have come around to the view that they can.

    Nick, That’s obviously wrong. Two drunks in a bar arguing about who should be president, or whether football player X or Y is better, are equally confident. It has to do with human nature, not lab time.

    joemac, A financial problem is a real shock, which can affect real GDP via Arnold Kling’s “re-allocation” mechanism, even if NGDP growth is stable.

    Britonomist, Then how did economists become convinced that central banks could keep inflation close to 2% over an extended period of time, if they chose to do so? The history of economics refutes your claim.

    And bring up the rear is the court jester:

    “Sumner will find his NGDPLT rule will also look as dated as bell-bottom jeans do today.”

    Yes, I’ve made the same point. Let’s see, is that the 147th time Ray has accused me of not know X, when I’ve made the same point in my blog?

  27. Gravatar of ssumner ssumner
    29. January 2015 at 10:50

    Charlie, You said:

    “Inflation won’t make people spend rather than save. Somehow there is an idea the consumers are saving rather than spending, which is just not true.
    They might actually spend *less* if prices rise faster than wages, which is very likely.
    Meanwhile, the savers who control most of the money will just find or manufacture investment vehicles that keep up with inflation.
    Their debt instruments will be worth less, which may be the point to this goal.”

    You do realize that there is essentially no economist in the world that agrees with you. You have the most crazy Keynesian/RBC hybrid model I have ever seen. If money is as neutral as you claim, where does unemployment come from. Why is less spending a problem? Don’t you believe in sticky wages?

  28. Gravatar of Charlie Jamieson Charlie Jamieson
    29. January 2015 at 11:06

    The traditional models are mistaken in they posit that consumer is saving rather than spending. The consumer spends what he earns.
    Traditional economists measure the debt/money that’s being created and wonder why they money isn’t being ‘spent.’
    The answer is that money is being used to buy assets … the excess money creation is just being swapped around in financial markets.

    By the way, the Fed’s action in 2008-2009 — buying distressed mortgage related securities at par certainly did create money for the wealthy. I agree that QE is jut a swap.
    I do believe the Fed creates money for the wealthy with low interest rates, because financial institutions and the wealthy have access to those loans. They also have a greater ability to benefit from asset price increases.

    Economists need to start looking at where the money is flowing rather than just the quantity created.

  29. Gravatar of Vivian Darkbloom Vivian Darkbloom
    29. January 2015 at 11:06

    Yeah, Scott, and now that we’re talking about probability of getting stuff right and the relative abilities of you and Joe the Plumber, what are the chances you’ll come over and correctly diagnose and fix my toilet? I think there may be a leak somewhere between the toilet and the sewer main. 😉

  30. Gravatar of Vivian Darkbloom Vivian Darkbloom
    29. January 2015 at 11:07

    Yeah, Scott, and now that we’re talking about probability of getting stuff right and the relative abilities of you and Joe the Plumber, what are the chances you’ll come over and correctly diagnose and fix my toilet? I think there may be a leak somewhere between the toilet and the sewer main. 🙂

  31. Gravatar of Britonomist Britonomist
    29. January 2015 at 11:09

    “Both positions are surely falsifiable. If the US experienced a sudden surge in unemployment despite stable NGDP (or stable unemployment despite big swings in NGDP), then I think Scott goes back to the drawing board.”

    I think that stable NGDP growth = low unemployment is an entirely different claim to what’s being assessed here regarding the response to the banking crisis. I think both Keynesians and Monetarists would agree stable NGDP = low unemployment.

    “A falsification of krugman-delong-style Keynsianism would looks similar – a big increase or decrease in unemployment (or no change) despite a big increase or decrease in a country’s deficit (or CAPB, or whatever measure you think properly captures the fiscal stance of that country).”

    But Keynesians can always, always say that you’re measuring the true ‘fiscal stance’ of governments wrong. Just like monetarists can always always say that you’re judging the true monetary stance of the central bank wrong.

  32. Gravatar of maxk maxk
    29. January 2015 at 11:09

    Scott:
    “That paragraph is wrong on almost every level possible. Unemployment was almost unchanged during the housing collapse of January 2006 to April 2008. …”
    No doubt my terminology is bad – I’m not an economist! Basically I’m just trying to say, what if Mian & Sufi are correct?
    Quote from their blog:
    “The central argument we make in our book is that the housing bust in combination with excessive household debt burdens were the key drivers of the economic downturn.”
    Sounds like you totally disagree. Can their arguments be refuted just by pointing to unemployment from Jan 06 to Apr 08? Holy Cow, how do Mian & Sufi keep their jobs at Princeton & Chicago? No, obviously there’s a real argument here, even if I don’t know the correct terminology.

    This is what I’m talking about. You don’t seem to address contrary opinions, you just dismiss them. And Krugman does the reverse, and so on. How can this be real field of inquiry?

  33. Gravatar of Britonomist Britonomist
    29. January 2015 at 11:10

    “Britonomist, Then how did economists become convinced that central banks could keep inflation close to 2% over an extended period of time, if they chose to do so? The history of economics refutes your claim.”

    How’s that supposed to convince a Keynesian?

  34. Gravatar of Don Geddis Don Geddis
    29. January 2015 at 11:28

    @maxk: “5% NGDP level rule. I’m saying that even if all of that was inflation, it wouldn’t cause the ‘house of debt’ consumer in 2008 to stop saving and start spending. And if that were the case, would the Fed just keep pushing higher?

    The goal, in your example, would be 5% NGDPLT. Once you achieve that (even if all inflation), you don’t want any additional spending. NGDP is the measure of aggregate demand (total spending), and if it’s on target, then everything (from the demand side) is going as well as it can. So, no, the Fed wouldn’t “push higher”, once it reached its target.

    The “10x” price level hypothetical, was just my response to your question of, if NGDP was below target, then is there any possible way to get more spending (assuming consumers are “scared” and want to “save” instead of spend)? The answer is: yes, by high (5%) inflation, at least, even if for no other reason.

  35. Gravatar of Britonomist Britonomist
    29. January 2015 at 11:29

    @Scott

    Nevermind I misunderstood your claim. Didn’t you say yourself a few years ago that economists agreed about inflation targeting because back then the economy wasn’t at the zero lower bound so there was no controversy about the effectiveness of monetary policy both to Keynesians and monetarists as the interest rate was an effective policy lever. So why wouldn’t they disagree back then?

  36. Gravatar of Britonomist Britonomist
    29. January 2015 at 11:30

    So why wouldn’t they agree back then?*

  37. Gravatar of Adam Adam
    29. January 2015 at 11:30

    I with you, but you lose me a little with “that wrongly thought fiscal stimulus was the answer.”

    For two reasons. First, did the economics profession really think that? It sure seems like there was lots of assertion that austerity was needed and would spur growth.

    Second, was it “wrong” to think fiscal policy was part of that answer? I guess your argument is that we had austerity and easier money at the beginning of 2013, therefore easier money earlier could have done it on its own.

  38. Gravatar of TallDave TallDave
    29. January 2015 at 12:15

    Yes, great points Scott. A lot of people forget what IOR was for. Everyone should re-read the 2008-9 Fed minutes, someday they ought to be required reading for econ majors.

    Wolf suggested to me a few years back that WW II had ended TGD and therefore WW II levels of spending should be considered “a starting point” for fiscal stimulus. (I don’t think the Europeans would appreciate another massive US infantry invasion, but then many didn’t like the first one either.) More problematic is that WW II lowered living standards in the U.S., even as it raised GDP. And that’s before we even start talking about offset.

  39. Gravatar of bill woolsey bill woolsey
    29. January 2015 at 12:20

    maxk:

    Well, it is just bad macroeconmics.

    Yes, if people feel less wealthy it is entirely plausible that they will increase their saving. The supply of saving curve shifts to the right. The “natural” interest rate falls. The quantity of saving supplied falls–some defer saving–and the quantity of investment demanded rises.

    There is a reallocation of demand from consumption to investment–from spending on consumer goods and services to spending on capital goods

    But what if people choose to save by accumulating money? What if the interest rate necessary for saving and investment to be coordinated is negative? Well, that turns out to be the same thing as what if they choose to save by accumulating money, because the only thing keeping the market interest rate above zero is an ability to save by accumulating hand-to-hand currency.

    And so, that is why your story about debt and saving just collapses in to a monetary problem.

    If the demand to hold money rises and the quantity fails to rise match it, then spending on output is going to fall. It did.

  40. Gravatar of TallDave TallDave
    29. January 2015 at 12:25

    Also, man, we really/i> miss Milton Friedman. He was a big voice that the Right would listen to.

  41. Gravatar of Britmouse Britmouse
    29. January 2015 at 12:40

    “I think both Keynesians and Monetarists would agree stable NGDP = low unemployment.”

    Is that really true? I think MMs have a much stronger attachment to the idea that wages are *the* sticky price which matters, whereas Ks would say “that might be right, it depends”.

  42. Gravatar of Jared Jared
    29. January 2015 at 12:57

    But didn’t Friedman support IOR? “Economists, most notably Friedman (1959), have long advocated the payment of interest on reserves at a market rate in order to eliminate the distortions associated with the tax on reserves.”
    http://www.newyorkfed.org/research/epr/02v08n1/0205good.pdf

    And I don’t understand your quibbling about a few basis points. I was under the impression that rate changes didn’t matter much to you (as a cause of anything). If IOR just sets a floor to the FFR, why would keeping rates at 75bps or 25bps instead of 0bps have much of an impact on demand given that the Fed was also pumping in trillions of $ of more base?

  43. Gravatar of E. Harding E. Harding
    29. January 2015 at 12:57

    Interest on reserves at close to 0% has only an extremely minor impact on bank lending, and it may well be expansionary rather than contractionary due to banks being able to repair their balance sheets risk-free. The bigger problems are FRED series USROE and USROA.

  44. Gravatar of Anthony McNease Anthony McNease
    29. January 2015 at 13:37

    Don Geddis: “Think of it positively: you have the privilege of being present right in the middle of a huge paradigm shift in macroeconomics! Few observers are so lucky as to see such a fundamental advance in a scientific field, in real time.”

    That’s exactly describes my opinions since the crisis and also discovering this and other econ blogs. This is a very exciting time to be interested in econ.

  45. Gravatar of Daniel Daniel
    29. January 2015 at 13:38

    maxk

    The disagreements in economics on fundamental facts are enormous. Can we really call this field science?

    Nope, it’s just politics in drag. I’m not being sarcastic.

    Ray Lopez

    You might want to have a look at this

    http://econlog.econlib.org/archives/2015/01/what_is_ray_lop.html

    Congrats. Literally EVERYBODY has noticed you’re a total idiot.

  46. Gravatar of Anthony McNease Anthony McNease
    29. January 2015 at 13:47

    maxk:

    “How can this be real field of inquiry?”

    The fact that historians disagree on the causes of World War 1 does not mean that history is not a legitimate “field of inquiry.” I’m sorry but the bar for “real field of inquiry” does not start at “maxk understands the disagreements in ________.”

  47. Gravatar of Kevin Erdmann Kevin Erdmann
    29. January 2015 at 14:10

    Scott, good point about the 1970s. It’s an example both of economists en masse believing untrue things and also coming closer to the truth over time.

    Maxk, I believe Scott is much closer to the truth than either the Keynesians & left wing populists or the Austrians, hawks, & right wing populists. A big rule of thumb for me is to avoid narrative thinking and especially good guy vs. bad guy thinking. It lowers your IQ by high double digits, and especially these days, it seems like a rampant problem. Anyone slaying villains is very unlikely to be able to move toward truth.

    That’s probably the biggest benefit of using EMH or general assumptions of rationality. They aren’t perfect maps of human activity, but they serve as governors, to keep pulling us back toward a fruitful direction. Without it, we very easily fall into villain bashing. We become unmoored, like walking through a field, blindfolded. It’s even worse than that, actually. If the truth is that the Fed isn’t a part of some conspiracy to funnel cash to fat cats, many people wouldn’t be able to detect it if you glued it to their noses – blindfolded or not. Any economist that puts a lot of effort into announcing who the bad guys are, or announcing their approval or disapproval about income distributions, etc. is probably motivated by unhelpful influences. Of course, we are all the worst judges of our own motivations.

  48. Gravatar of Daniel Daniel
    29. January 2015 at 14:18

    Everybody,

    When you have almost the entire profession (Keynesians and Austrians alike) using models which assume the monetary base is fixed – AND NOT EVEN BEING AWARE OF IT ! – I think it’s pretty safe to say macro has a very long way to go towards becoming an actual science.

    But then again, this is more of a reflection of human nature (man’s innate hypocrisy).

  49. Gravatar of Britonomist Britonomist
    29. January 2015 at 15:22

    (Modern) Keynesians don’t use models with a fixed monetary base, and Austrians have very little presence in academic economics.

  50. Gravatar of Daniel Daniel
    29. January 2015 at 15:31

    (Modern) Keynesians don’t use models with a fixed monetary base

    Yeah, that must be why Keynesians were insisting that the Fed wasn’t out of ammo when interest rates hit zero. Oh, wait.

    Try harder.

  51. Gravatar of Kenneth Duda Kenneth Duda
    29. January 2015 at 17:02

    Scott, thank you for this post. I was perplexed by DeLong’s message, but now I understand it means which Friedman/monetarist ideas we’re talking about.

    Thanks,
    -Ken

    Kenneth Duda
    Menlo Park, CA

  52. Gravatar of Jeff Jeff
    29. January 2015 at 18:12

    Jared,

    Notice that in the paper you quote, “Friedman (1959)” refers to “A Program For Monetary Stability”, in which Friedman also calls for a 100 percent reserve requirement. In that case, interest on reserves is unambiguously interest on required reserves, which is a very different thing from paying interest on both required and excess reserves as the Fed started doing in 2008.

    Paying interest on required reserves has always made sense, and it should have been done long before 2008. In the late 1970’s, the marginal reserve requirement for transactions deposits faced by large banks was 10 percent, and the Fed funds rate was well over 10 percent. 10 percent of 10 percent is 1 percent, so the failure to pay interest on required reserves was effectively a 1 percent tax on transactions deposits. One effect of this tax was to drive financial intermediation out of the taxed banking system and into other financial institutions not subject to the tax.

    Paying interest on excess reserves is another matter entirely. As Scott says, it is paying banks to not move money into the economy. There has to be a substantial difference between what a bank can make on low and medium risk loans versus what it can earn on perfectly safe and liquid reserves if you want to see banks actually supplying credit to private businesses. In a low-rate environment like we’ve seen the last 6 years, you want to maximize that difference by setting the interest rate on excess reserves to zero. The Fed’s reluctance to do so surpasses my understanding.

    Notice that paying interest on required reserves, or not paying it, makes no difference at all to a bank’s decision about whether to loan funds out or keep them as reserves. Required reserves have to be held no matter what, that’s why they’re called that. It is only interest on excess reserves that can incent banks not to lend.

    I have read a lot of Friedman’s stuff, and I’m pretty sure he would agree with what I wrote above. If he didn’t, he’d be wrong, and Milton Friedman was almost never wrong. 🙂

  53. Gravatar of Major.Freedom Major.Freedom
    29. January 2015 at 18:42

    The Great Recession happened because we ignored Friedman’s ideas

    Correct!

    https://www.youtube.com/watch?v=m6fkdagNrjI

  54. Gravatar of ssumner ssumner
    29. January 2015 at 20:36

    Charlie, You said:

    “Traditional economists measure the debt/money that’s being created and wonder why they money isn’t being ‘spent.’

    But traditional economists do know the difference between stocks and flows.

    Vivian, Trust me, you don’t want me fixing your toilet.

    maxk, I can’t respond to a book I have not read, all I can do is respond to your comments. If I am wrong, tell me why. Don’t just say “looks like economists don’t always agree.” We know that! Why discuss the stuff we do agree on?

    Britonomist, They sharply disagreed in the 1970s, even when not at the zero bound. By the early 2000s they agreed central banks could target inflation, when not at the zero bound.

    Adam, A few years ago a University of Chicago poll found only one economist in 50 disagreed with the claim that fiscal stimulus promoted growth.

    Jared, It mattered because T-bill yields were lower than the IOR. But you are right, interest rates are not a good indicator of the stance of policy. But my point was that the decision to implement IOR to prevent rates from falling was a strong signal that the Fed didn’t want to ease policy. And recall that MMs believe Fed signals are very important.

    E Harding, You said:

    “Interest on reserves at close to 0% has only an extremely minor impact on bank lending”

    The reason IOR was harmful has nothing to do with the impact on bank lending, the problem was that it increased the demand for the medium of account, which is deflationary. Banking is a sideshow. Focus on monetary policy, not credit policy.

    And Friedman would never suggest raising IOR in the midst of a depression.

    Daniel, Good to see Ray providing a few laughs for my friend over at Econlog.

    Ken, Glad that helped.

  55. Gravatar of Britonomist Britonomist
    29. January 2015 at 20:51

    Scott, regardless of what happened in the past, I still see no prospect of the two sides agreeing on this particular issue any time soon. I think the only thing that can unite Keynesians and monetarists is doing actual helicopter money as Friedman once suggested: http://www.voxeu.org/article/helicopter-money-policy-option

    What are your thoughts on this?

  56. Gravatar of ChrisA ChrisA
    29. January 2015 at 21:56

    To move the debate forward, lets say that the evidence is not solid for either fiscal or monetary expansion. The question is what should the policy regime be in future to potential shocks like house market crash which forces the economy to low interest rates? To me, a policy of keeping NGDP growth rate stable by monetary expansion seems to be pretty harmless. After-all we are simply replicating the policy that prevailed prior to the crash (by definition). If it turns out to be ineffective in creating demand, well at least we have retired some government debt costlessly. If it does cause unexpectedly high inflation (although evidence is strongly against this), its relatively easy to stop. The alternative policy, of fiscal expansion, seems to me to have some very strong potential downsides. The first is obvious – more debt. If the fiscal expansion takes the form of real projects (as opposed to tax cuts) then you also have the problem that people are now developing careers and lives based on something which is supposed to be temporary. Which pretty much guarantees that it won’t be temporary (see Japan). So in terms of risk/reward, it seems obvious to me that monetary expansion should be tried first, with full intent. If for some reason, with decent NGDP growth, we are not seeing demand come back (i.e. Scott is wrong), then try fiscal expansion via tax cuts paid for by monetary expansion, all the way to paying a Citizens Income. If that doesn’t do the trick, well no matter, as we can all live for free then anyway.

  57. Gravatar of Ray Lopez Ray Lopez
    30. January 2015 at 00:47

    A ool said: “You do realize that there is essentially no economist in the world that agrees with you. You have the most crazy Keynesian/RBC hybrid model I have ever seen. If money is as neutral as you claim, where does unemployment come from. Why is less spending a problem? Don’t you believe in sticky wages?”

    So according to this ool, if facts don’t fit a preconceived theory, a pigeonhole, we throw away the facts and keep the theory! Progress! I wonder how the economy got by without the central bank? After the Second Bank of the US shut down in the Andrew Jackson era?

  58. Gravatar of Daniel Daniel
    30. January 2015 at 01:39

    I wonder how the economy got by without the central bank? After the Second Bank of the US shut down in the Andrew Jackson era?

    The answer is – POORLY.

  59. Gravatar of Nick Nick
    30. January 2015 at 04:09

    Prof Sumner,
    Two drunks in a bar arguing are so sure of every dumb thing they say because they are drunk! Is that what’s going on in Macro? It IS human to disagree, but the level of acrimony and self righteousness is not fixed. If you think professional economists have the same level of discourse as pugnacious drunks for the same reasons then you agree with maxk’s comments more than you are admitting.

  60. Gravatar of ThomasH ThomasH
    30. January 2015 at 06:46

    DeLong called Wolf a “Tory.” From what I know of his writings, that is correct.

  61. Gravatar of Britmouse Britmouse
    30. January 2015 at 07:16

    I laughed at seeing “conservative Martin Wolf” too, I guess if we label radical Post-Keynesians as small-C conservatives then we can label SYRIZA are moderate centre-left, and everybody to the right of Blair/Clinton is a “free market ideologue”, i.e. a dangerous fanatic. Yes, I see what you did there, Brad.

  62. Gravatar of Jared Jared
    30. January 2015 at 07:26

    Jeff, thanks for the clarification on Friedman.

    Scott, what signal does IOR send? It definitely signifies the central bank’s intention to keep rates above 0, but .25 and .75 is still very very low. But it also seems to signal that the increase in the monetary base is permanent, hence, the need to use IOR to adjust rates instead of OMOs. According to MM, shouldn’t that be expansionary?

  63. Gravatar of ssumner ssumner
    30. January 2015 at 08:39

    Britonomist, I’ve often argued that helicopter drops are a horrible idea. You can check out some of my earlier posts.

    We need a new monetary regime. If you want “compromise,” a better solution would be to move to a monetary regime that keeps us out of the zero rate trap. For instance, although I oppose 4% inflation target, I’d support it if it was the only alternative on the table (compared to our current policy.) Krugman also supports it.

    Chris, You said:

    “If for some reason, with decent NGDP growth, we are not seeing demand come back (i.e. Scott is wrong), then try fiscal expansion via tax cuts paid for by monetary expansion, all the way to paying a Citizens Income. If that doesn’t do the trick, well no matter, as we can all live for free then anyway.”

    As far as I’m concerned NGDP is demand. So your comment actually makes no sense to me. Perhaps by “demand” you mean real GDP growth. In that case obviously fiscal stimulus would not help either, you’d need supply side reforms like privatization, deregulation and lower MTRs.

    Or maybe you meant if my scheme fails to boost NGDP, we can use fiscal stimulus.

    Nick, I just meant that it’s human nature to defend your claim as if you are correct, unless perhaps you are discussing something which you admit to having no expertise in (say string theory for me.)

    I should not have said drunk, that wasn’t the point.

    Thomas, No, he called him a small c “conservative.”

    Jared, Good question. I think the signal is that the Fed doesn’t want to loosen. (BTW, I agree the 0.25% rate is low, but it was originally higher.)

    Now here’s where it gets complicated. The Fed saw policy as easy, whereas the markets viewed it as tight. Thus the Fed thought it was preserving an easy, but not too easy policy, whereas the markets thought the Fed was preserving a tight and getting tighter policy when it left rates well above zero in the fall of 2008.

  64. Gravatar of Charlie Jamieson Charlie Jamieson
    30. January 2015 at 09:01

    ‘But traditional economists do know the difference between stocks and flows.’

    Could it be that the economic machine is creating stocks and not flows? And the flows created are flowing into financial assets.
    What we maybe need are more money that flows — more spending by ordinary consumers or more government spending on infrastructure, education, transfer payments.
    More deficit spending would do that. Pick your brand — tax cuts for the middle class, tax rebates for the poor, or create new entitlement programs, or build things. Or send money to the states.
    The trick is to do that in a politically fair manner and without triggering inflation by malinvestment.
    Another alternative would be central bank buybacks of student loan debt, credit card debt, etc.

  65. Gravatar of Britonomist Britonomist
    30. January 2015 at 11:01

    Scott, but you wont convince Keynesians that the market will find a 4% inflation target credible until you provide them the ‘bazooka’ they are after, and that’s helicopter drops. The threat of unlimited QE is not enough to Keynesians, but the threat of helicopter drops might be enough. Nobody is necessarily advocating helicopter drops, only that it becomes part of the Fed’s arsenal so that its inflation targets actually become credible.

  66. Gravatar of E. Harding E. Harding
    30. January 2015 at 14:08

    @ssumner
    “the problem was that it increased the demand for the medium of account”
    -From whom did this increased demand primarily come from?

  67. Gravatar of ssumner ssumner
    30. January 2015 at 20:29

    Charlie, You said:

    “Could it be that the economic machine is creating stocks and not flows? And the flows created are flowing into financial assets.”

    Rivers flow into lakes. Money doesn’t flow into financial assets. Financial assets can’t “hold” money.

    You said:

    “Another alternative would be central bank buybacks of student loan debt, credit card debt, etc.”

    Why not just spend the money on drugs and prostitutes?

    Britonomist, You said:

    “The threat of unlimited QE is not enough to Keynesians”

    OK, so Keynesians believe that if the SNB bought up 100% of the world’s assets, and owned the entire world, the Swiss franc would not depreciate.

    Whatever.

    I can’t imagine you’d find a single competent Keynesian economist who thinks we be at the zero bound with a 4% inflation target. That’s why people like Krugman, Rogoff, Blanchard, etc., propose it. To combine a 4% inflation target with a helicopter drop . . . what would be the point?

    In any case, the Japanese (1997-2012) proved helicopter drops don’t work.

    E. Harding. From IOR? Obviously from banks. No one else gets the IOR.

  68. Gravatar of Britonomist Britonomist
    30. January 2015 at 21:32

    “OK, so Keynesians believe that if the SNB bought up 100% of the world’s assets, and owned the entire world, the Swiss franc would not depreciate. ”

    Central banks can’t legally buy any asset they like, they’re limited in what they can buy. Maybe if the Fed bought 30 trillion in all the assets it can legally buy, and effectively swapped these low interest bearing safe assets with low interest paying reserves at the central bank, it would have some effect on the economy, but I don’t think it would be fundamentally that large: you’re just swapping one low interest bearing asset for another. The more powerful effect would be from the knee jerk reactions on the stock markets and currency markets, or effects on the government deficit (since the increased debt is being held by the central bank, the may just view that debt as meaningless and a deficit as free money which means they increase the deficit, but that would be fiscal policy, while we’re talking about monetary effects).

    I know what you’re going to say: “in that case, just make interest on reserves negative”. The problem is, while this might work, I’ve read many articles on why such a policy is unwise or can cause instability amongst the banking system, or that it might just result in higher banking costs for customers. There’s also concerns that it would lead to an unsustainable credit boom.

    The point is, negative IOR are an uncomfortable proposition for many people. Massive asset purchases combined with negative IOR is a convoluted and unpredictable measure with an ambiguous transmission mechanism. ‘Helicopter drops’ on the other hand are simple and direct, and conform to monetarist/New Keynesian models better which have no special role for the banking system. In which case, why DON’T you support helicopter drops? It’s just more directly implementing policy suggested by the models.

    As for Japan, what did they do that you regard as helicopter drops?

  69. Gravatar of ssumner ssumner
    31. January 2015 at 11:20

    Britonomist,

    “Central banks can’t legally buy any asset they like, they’re limited in what they can buy.”

    What are the limits? Isn’t the ECB buying private debt? Didn’t the Fed buy MBSs?

    Central banks have never had a shortage of assets to buy, not even close.

    You asked:

    “As for Japan, what did they do that you regard as helicopter drops?”

    Japan did a combined fiscal monetary expansions. They massively increased the monetary base and the national debt at the same time. You may not know this, but that’s how economists define “helicopter drops.”

    You said:

    “The point is, negative IOR are an uncomfortable proposition for many people.”

    The SNB just went to negative 0.75%. And you don’t think helicopter drops would make people uncomfortable?

    Sorry to say this, but helicopter drops are a completely moronic idea. There is simply no good argument for helicopter drops. It’s a massive inefficient fiscal policy. There are much better policies. I would do Krugman’s proposed 4% inflation target before I’d do a helicopter drop.

    One final point. How much QE would the Fed have had to do in 2008-09 to hit a 5% NGDP level target?

    ZERO.

  70. Gravatar of Britonomist Britonomist
    31. January 2015 at 12:32

    “What are the limits? Isn’t the ECB buying private debt? Didn’t the Fed buy MBSs?”

    From what I’ve read, only assets with very low risk. Even the MBS are of a low risk class and government backed. It’s also important who the Fed buys from, if the Fed buys from private non-bank owners, it can result in portfolio-readjustment that can increase economic activity (but it’s still mild and indirect).

    “Japan did a combined fiscal monetary expansions. They massively increased the monetary base and the national debt at the same time. You may not know this, but that’s how economists define “helicopter drops.”

    Helicopter drops how they’ve been defined from my reading is specifically government deficit spending financed by brand new money. Now if the central bank aggressively buys government bonds on the secondary market while the government runs a large deficit, this can be thought of as indirect helicopter drops. The problem is, in Japan’s case, which YOU YOURSELF noted, these purchases were coupled with a promise to reduce the monetary base in the future to prevent prices from rising:

    ” the BOJ also hinted that they’d eventually pull the money back out of circulation, to prevent prices from rising.”

    This means, to me at least, this is not a true helicopter drop, since the injections of money are not permanent and comes with an immediate expectation of future tightening. For me, helicopter drops must involve /permanent/ monetary injections, otherwise it’s not staying faithful to Friedman’s analogy.

    Nobody is saying that helictopter drops will be successful if it isn’t coupled with an explicit target by policy makers to boost aggregate demand.

    ” And you don’t think helicopter drops would make people uncomfortable?”

    It would make hyperinflationists and Austrians uncomfortable, but who cares about this. The point here is trying to build a synthesis with Keynesians and monetarists, I don’t think Keynesians would find this uncomfortable.

    “Sorry to say this, but helicopter drops are a completely moronic idea. There is simply no good argument for helicopter drops.”

    That voxeu article I linked earlier by highly regarded economists presents an excellent argument.

    “It’s a massive inefficient fiscal policy. There are much better policies. I would do Krugman’s proposed 4% inflation target before I’d do a helicopter drop.”

    4% inflation target is not an alternative, it’s a complementary or required policy. Again, the problem most Keynesians have is that just because you promise 4% inflation doesn’t mean you can reach it. Keynesians argue that QE is not a powerful bazooka, you argue it is. I’d argue that, both Keynesians and Monetarists should regard helicopter drops as an unambiguously powerful bazooka /if the injections are permanent/, and if added to the Fed’s arsenal, then both Keynesians and monetarists would find any inflation target by the central bank credible.

  71. Gravatar of Charlie Jamieson Charlie Jamieson
    31. January 2015 at 12:57

    Scott, sure ‘money flows into financial instruments.’
    Example:
    I borrow a dollar, meaning a deposit is created in my bank and and buy lemonade from the kid on the street. My deposit flows into his account.
    Good for the economy. A real service and asset was provided, labor was done.
    Or, I borrow a dollar and buy a financial asset like a stock. My deposit flows into the seller’s account.
    Neutral for the economy. No new real good was produced. We’re just exchanging assets.
    Both loans created new money. But one of them created a higher quality of economic activity.
    ….
    Not sure why you oppose helicopter drops on principal, since an expansion of the lending system is in itself a form of helicopter drop — precisely because such expansions are generally permanent. Aggregate lending always increases. If you decrease it, you have a recession. That’s why you have to be careful how fast you let lending expand.
    We let it expand too fast in the 2000s in the real estate bubble, with people borrowing to buy financial assets (money ‘flowed’ into financial instruments).

  72. Gravatar of ssumner ssumner
    1. February 2015 at 09:10

    Britonomist, You said:

    “Helicopter drops how they’ve been defined from my reading is specifically government deficit spending financed by brand new money. Now if the central bank aggressively buys government bonds on the secondary market while the government runs a large deficit, this can be thought of as indirect helicopter drops. The problem is, in Japan’s case, which YOU YOURSELF noted, these purchases were coupled with a promise to reduce the monetary base in the future to prevent prices from rising:”

    I’m not sure if you realize it, but this proves my point. The helicopter drop has exactly the same drawbacks as QE. If one doesn’t work, the other won’t work as well.

    Charlie, I have no idea what you are talking about. Lending is a helicopter drop? Explain. On wait, you did explain, they are both permanent. Death is also permanent, is it like a helicopter drop?

    And no, helicopter drops are not permanent, as the Japanese showed in 2006.

  73. Gravatar of Britonomist Britonomist
    1. February 2015 at 10:41

    “I’m not sure if you realize it, but this proves my point. The helicopter drop has exactly the same drawbacks as QE. If one doesn’t work, the other won’t work as well.”

    But then it doesn’t make sense to oppose helicopter drops when you can oppose QE for exactly the same reason, assuming that’s the only reason QE is ineffective.

    But with QE, not only do you have to worry about future expectations, but you the issue of transmission mechanisms which Keynesians and others need constant convincing of.

    With helicopter drops, issues about transmission mechanisms go away, and the only issue becomes about good old fashioned monetary economic debates regarding the role of expectations etc…

  74. Gravatar of Major.Freedom Major.Freedom
    1. February 2015 at 13:48

    Sumner wrote:

    “Sorry, but debates about definitions are silly.”

    I admit I chuckled.

    NGDP guy saying tight money should not be defined in terms of interest rates or money supply, but should be defined in terms of NGDP, is saying debates about definitions is silly.

    Oh the irony…

  75. Gravatar of ssumner ssumner
    2. February 2015 at 11:25

    Britonomist, Again it does nothing that QE by itself does. If other people can’t understand these issues, that’s not my fault, I’ve explained it 100s of times in this blog. All I can do is keep pointing out that helicopter drops are a bad idea, and indeed even QE is far from optimal. We need NGDP targeting, and if not that then an inflation target high enough to keep us out of an liquidity trap.

  76. Gravatar of Britonomist Britonomist
    2. February 2015 at 12:43

    “Britonomist, Again it does nothing that QE by itself does.”

    It at least prevents endless critiques regarding the transmission mechanism. To me it’s a win win.

    And you can’t keep comparing targets to weapons, those are apples and oranges.

    Suppose the Fed lost the ability to do QE, all it could do was change the federal funds rate, and only to 0 or above. Would you say “no problem, just implement NGDP targeting”? Would the fed have enough ammunition just with the federal funds rate?

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