The third way

Paul Krugman expresses frustration that “austerians” keep using bad arguments:

[We Keynesians are] not always and everywhere against fiscal consolidation; give me the right economic circumstances and I’ll turn at least modestly deficit hawk. We are, instead, against austerity when the interest rate is against the zero lower bound, because when the economy is in a liquidity trap the contractionary effects of fiscal tightening can’t be offset by monetary expansion.

I don’t agree that monetary policy is out of ammunition at the zero bound, and if you read the entire post it seems even Krugman doesn’t think the ECB is out of ammunition:

Let me venture a guess: it may have a fair bit to do with the ECB’s narrow mandate. In America, the Fed explicitly had a dual mandate, which charges it with achieving full employment as well as price stability; this makes it natural to consider the difference being at the zero lower bound makes. In Britain, for whatever reason, the BOE has proved willing to tolerate above-target inflation for a while, and public policy debate does tend to focus on what the BOE can do to offset austerity. But in Europe, the ECB just doesn’t talk about its responsibility to stabilize the real economy, and how the liquidity trap in the European core may be compromising its ability to do so.

Nor is it just failure to talk; let’s not forget that the ECB actually raised rates in 2011, despite high unemployment, and has consistently refused to cut rates even as Europe slides deeper into double-dip recession “” and as Europe as a whole moves ever deeper into fiscal austerity.

So what I’m arguing, I guess, is that the EC obtuseness on fiscal policy is derived in part from the broader European obtuseness on monetary policy. Still, it’s quite a remarkable thing: we’re five years into this crisis, and key European policy makers still talk as if they were unaware of the central argument their critics have been making from day one.

I strongly agree with all these points:

1.  The ECB has the wrong target (inflation only.)

2.  The ECB raised rates in 2011.

3.  The ECB “has consistently refused to cut rates even as Europe slides ever deeper into double-dip recession”

What I don’t understand is how the inflation-targeting ECB wouldn’t simply offset any additional fiscal stimulus, or at least the demand-side effects of additional stimulus.  Nor do I understand how a central bank that refuses to cut rates could be said to be out of ammunition.  Are PIIGS bond yields at zero?  And even if rates were at zero, is the ECB out of paper and ink?

Yesterday he did a post on a similar issue:

So, start with our big problem, which is mass unemployment. Basic supply and demand analysis says that things like that aren’t supposed to happen: prices are supposed to rise or fall to clear markets. So what’s with this apparent massive and persistent excess supply of labor?

In general, market disequilibrium is a sign of prices out of whack; and most people commenting on our mess accept the notion that one or more prices are for some reason not adjusting. The big divide comes over the question of which price is wrong.

As I see it, the whole structural/classical/Austrian/supply-side/whatever side of this debate basically believes that the problem lies in the labor market. (I know, the Austrians will deny it “” but it doesn’t matter what you say about their position, any comprehensible statement leads to angry claims that you don’t understand their depths). For some reason, they would argue, wages are too high given the demand for labor. Some of them accept the notion that it’s because of downward nominal wage rigidity; more, I think, believe that workers are being encouraged to hold out for unsustainable wages by moocher-friendly programs like food stamps, unemployment benefits, disability insurance, and whatever.

As regular readers know, I find this prima facie absurd “” it’s essentially the claim that soup kitchens caused the Great Depression. But let’s stick with the economic logic for now.

Notice that Krugman doesn’t address the sticky price wage argument at all.  To be fair, lots of conservatives make the “disincentive to work” argument, but it’s certainly not the only justification for believing wages might be at the wrong level to clear the labor market.  Then he switches to an interest rate argument, without explaining what’s wrong with the sticky wage theory:

So what’s the alternative view? It’s basically the notion that the interest rate is wrong “” that given the overhang of debt and other factors depressing private demand, real interest rates would have to be deeply negative to match desired saving with desired investment at full employment. And real rates can’t go that negative because expected inflation is low and nominal rates can’t go below zero: we’re in a liquidity trap.

I certainly do understand this argument, but I find it frustrating how he seems to slide seamlessly from one issue to a completely separate issue.  The first tissue is; “Why do nominal shocks have real effects?”  And I think sticky wages are a pretty reasonable answer.  The second question is: “Why did the Fed allow a large negative nominal shock to occur?”  And the zero lower bound is certainly a plausible theory of Fed Fail.  As readers know I think the zero bound is not truly a “trap;” the Fed can reflate by setting a higher NGDP growth target and committing to buy as much debt is is required to equate market expectations with the target.  Nonetheless, I agree that the actual behavior of the Fed was almost certainly at least somewhat restrained by their queasiness over adopting aggressive unconventional policies.  So the zero lower bound matters in that sense.  But this is wrong:

There are strong policy implications of these two views. If you think the problem is that wages are too high, your solution is that we need to meaner to workers “” cut off their unemployment insurance, make them hungry by cutting off food stamps, so they have no alternative to do whatever it takes to get jobs, and wages fall.

No, if wages are too high, and wages are sticky, then the solution is to raise NGDP.  I favor straight monetary stimulus, but if that won’t work then even a helicopter drop would be preferable to waiting years for wage cuts to restore equilibrium.  You can believe wage stickiness is the root cause of unemployment, and also favor the sort of AD stimulus that Krugman would regard as “progressive.”

At times Krugman seems to suggest there are only two views; his view and that of the right wing crazies.  Of course there are heterodox views on both sides (some leftists also oppose the Fed’s “easy money” policy.)  And there are (monetarist) supporters of monetary stimulus who see sticky wages as the root cause of cyclical unemployment.

I also take exception to this claim:

Oh, and one more thing: no, you can’t say “Well, there may be truth to both views”. Either the economy is supply-constrained or it’s demand-constrained. Of course even the most ardent demand-siders will admit that there are supply constraints in there somewhere, that if we had an economic boom we would, after some period of time, enter a regime where printing money is inflationary and government borrowing drive up interest rates. But not here, not now.

I certainly agree that demand has been the biggest problem since 2008.  But I see no reason why both the AD and SRAS curves can’t shift left at the same time.  And if they do, the drop in employment would be even greater than if only the AD curve had shifted left.

There’s more to life than old-style Keynesian stimulus and austerianism.  In the first post I linked to Krugman expressed frustration that people weren’t paying attention to his views:

So do the austerians reject this argument? No “” they basically fail even to acknowledge that it exists.

As a market monetarist, I know how he feels.

PS.  Just so the post doesn’t seem like a mindless anti-Krugman rant, let me add that I do agree with Krugman’s view that the recent David Stockman column was a sort of mindless rant.  And I’m an expert on rants.   :)


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43 Responses to “The third way”

  1. Gravatar of Pedro Pedro
    31. March 2013 at 16:59

    “Are PIIGS bond yields at zero?” – This summarises my bafflement at the ZLB being invoked in the debate over European austerity time and time again. Just what interest rate is at zero in any of the PIIGS? If that is so, then how can people who profess to only support fiscal policy at the zero lower bound advocate the existence of large multipliers in, say, Greece? I genuinely don’t understand this line of reasoning. Do you have any idea what model it is that underlies that sort of argumentation?

    And if this is so, then quite apart from inflation targeting, ECB purchases of PIIGS bonds in the secondary market would have significant stimulative effects with minimal consequences in terms of failing to meet its inflation target. Am I missing anything?

  2. Gravatar of Geoff Geoff
    31. March 2013 at 17:19

    It’s clear that real side structural issues have been the biggest problem since 2008.

  3. Gravatar of Mike Sax Mike Sax
    31. March 2013 at 17:37

    “I agree that the actual behavior of the Fed was almost certainly at least somewhat restrained by their queasiness over adopting aggressive unconventional policies”

    One good reason to believe this is it’s what Bernanke himself has said:

    “Well, as you point out, we’re at the zero lower bound and that makes further accommodation not impossible but more difficult and harder to predict and with more side effects that are difficult to predict. I’m not sure I understand the whole thrust of your question. We have””as, you know, we have given this guideline for””so we call them signposts for how the funds rate is going to evolve over time. And as a lot of academic research shows, you know, when you’re close to the zero lower bound, by telling markets that you’re going to keep rates low for a significant period, that’s one way to get longer term rates down and to provide more stimulus to the economy. And we think this has been a pretty effective tool. Now, we could go further. We could lower even further say the unemployment that rate number that we hit. We’ve discussed variants and at least one member of the committee has suggested that. But for right now, we find that the thresholds that we have put into that rate guidance seemed to be sufficient to approximate the””what’s called the Optimal Control Path of Interest Rates that it seems to give a path of unemployment inflation that’s about as good we can get with the monetary policy tools that we have. It doesn’t mean we’re satisfied. It just means that we don’t have enough fire power to get the economy back to full employment more quickly.”

    http://blog.supplysideliberal.com/post/46330372038/ben-bernanke-on-why-the-fed-has-an-inflation-target-of

  4. Gravatar of Mike Sax Mike Sax
    31. March 2013 at 17:50

    Nah I wouldn’t say your anti-Krugman rant was totally “mindless.” There was some “mindful” elements in it too.

    If I want a totally mindless Krugman rant I visit Bob Murphy.

    http://consultingbyrpm.com/blog/2013/03/krugman-ignores-massive-human-suffering.html#comments

  5. Gravatar of Justin Rietz Justin Rietz
    31. March 2013 at 17:53

    (Apologies for the long comment)

    1. Re: a liquidity trap – given IOR and the Fed’s commitment to keep inflation at 2%, don’t we have a case of a self-inflicted liquidity trap? Has Krugman addressed this?

    2. A broader question / comment: how much power does the Fed really have in “setting” short term rates? In his autobiography, Greenspan stated that the Fed followed, rather than led, the market. Bernanke in a recent speech said that the Fed “controls” short term rates, but not long-term rates or future short-term rates. http://www.federalreserve.gov/newsevents/speech/bernanke20130301a.htm

    Daniel Thornton at the St. Louis Fed has argued that the Fed, pre-2008, has had little impact on rates. I don’t know if he would argue this in regards to the last 5 years, however, given the Fed’s massive open market ops.

    2b. Per Bernanke’s comment, it seems odd that the Fed would attempt another Operation Twist.

  6. Gravatar of Ben J Ben J
    31. March 2013 at 18:11

    Geoff, I am interested in seeing your evidence for these real side structural issues!

  7. Gravatar of ssumner ssumner
    31. March 2013 at 18:15

    Pedro, I wish I knew.

    Mike, I agree with Bernanke’s claim that a lower unemployment target would be more expansionary than current policy.

    Justin, You are right that the Fed follows the market far more than most people understand.

    But no, if the Fed targets inflation at 2% there is no liquidity trap. Indeed fiscal policy would be almost completely ineffective. In that case the problem is that the Fed has the wrong target.

  8. Gravatar of ssumner ssumner
    31. March 2013 at 18:17

    Ben, Geoff presumably thinks the huge boom of the late 1960s was caused by LBJ’s big government policies, which improved efficiency. He doesn’t seem to think that demand shocks affect output.

  9. Gravatar of Justin Rietz Justin Rietz
    31. March 2013 at 20:51

    I realized I may have mixed two definitions of a liquidity trap and the impact of monetary policy while writing my comment.

    Krugman appears to define a liquidity trap as the inability to lower nominal rates further. Is this correct? I’ve typically defined a liquidity trap to be the inability to increase inflation.

  10. Gravatar of Justin Rietz Justin Rietz
    31. March 2013 at 21:11

    (sorry, hit submit button too soon).

    Does Krugman believe that credibly committing to print money in the future when the ZLB doesn’t hold is b/c it would lower rates, and/or because it would raise inflation expectations? I’ve read several of his articles and didn’t find his position real clear (probably due to my own confusion).

  11. Gravatar of kebko kebko
    31. March 2013 at 21:41

    I’m surprised that you gave him a pass about equating opposition to extended unemployment insurance, etc. with “the claim that soup kitchens caused the Great Depression”. You have a great post on that:
    http://www.themoneyillusion.com/?p=12198
    That kind of cheap shot is really banal and just plain stupid. I don’t know what else to call it. It’s name-calling in the defense of economic illiteracy. Krugman is just taking a s%&t on the shared plate of public discourse with that kind of nonsense.

  12. Gravatar of Max Max
    31. March 2013 at 22:33

    Justin,

    http://web.mit.edu/krugman/www/bpea_jp.pdf

    “How can a country that is in a liquidity trap – that is, where increases in the money supply seem to have no effect – engineer inflation? As we have seen, the problem is essentially one of credibility. If the central bank can credibly commit itself to pursue inflation where possible, and ratify inflation when it comes, it should be able to increase inflationary expectations despite the absence of any direct traction on the economy via current monetary policy. Indeed, if one views monetary policy in terms of nominal interest rates, a credible commitment to inflation can seem to be a pure bootstrap policy: interest rates never actually need fall, all that is required is a promise not to raise them when the economy expands and prices begin to rise.”

    Contrast with Milton Friedman:

    “Now, the Bank of Japan’s argument is, “Oh well, we’ve got the interest rate down to zero; what more can we do?” It’s very simple. They can buy long-term government securities, and they can keep buying them and providing high-powered money until the high powered money starts getting the economy in an expansion. What Japan needs is a more expansive domestic monetary policy.”

    People who believe in “high powered money” tend to attribute the failure of money printing to generate inflation with some breakdown in the banking system.

  13. Gravatar of Ben J Ben J
    31. March 2013 at 23:26

    Max, you said,

    “People who believe in “high powered money” tend to attribute the failure of money printing to generate inflation with some breakdown in the banking system.”

    I would disagree, probably the biggest issue is that central banks who have ‘printed money’, or purchased assets have not done so with a speific target to which they have forecasted that they will hit, and promise to take action until they do. It certainly has had an effect in the US case – to stop deflation in 2009 and halt disinflation in 2010. The Fed was unambiguously clear that it wanted inflation to be positive, but never higher than 2%. That is exactly what it got.

  14. Gravatar of Rajat Rajat
    1. April 2013 at 03:12

    Why do you keep defending him? I tuned out after the first para.

  15. Gravatar of Errorr Errorr
    1. April 2013 at 04:56

    Wouldn’t any supply shortfalls be unknowable while there is a demand shortfall. This is what I think Krugman means, but his blog is so simplified and meant to “change the discussion” that it isn’t always worthwhile. If we had 5% NGDP growth and that was 5% inflation that would suggest a major AS shock, but until inflation is determined (which is impossible ex ante) then there is no point in worrying about traffic ahead when you are out of gas.

  16. Gravatar of ssumner ssumner
    1. April 2013 at 05:18

    Justin, The term ‘liquidity trap’ is used in several different ways, but the term ‘trap’ certainly implies an inability to boost AD and inflation.

    Krugman thinks a higher inflation target would help by reducing real interest rates.

    kebko, Yes, that was a cheap shot, but that’s pretty common in the blogosphere.

    Ben and Max, Keep in mind that when Friedman was alive bank reserves were high powered money. They no longer are. High powered money does not pay interest.

    Errorr, Suppose output fell and inflation stayed constant. That would imply the AD and SRAS curve moved equally far to the left. So I’m not sure it’s “unknowable.”

  17. Gravatar of Errorr Errorr
    1. April 2013 at 05:22

    There is a certain dis-ingenuousness to Krugman (and a little bit among the MM types) about how monetary policy is evaluated. If Krugman truly believes the Fed is impotent then he is clearly wrong, however his statements seem to be contradictory. I would argue that the Fed is politically constrained on what it can buy and how much. Expectations matter, but so do actions and QE3 has been ineffective. If there is fiscal stimulus (say a large deficit financed payroll tax cut) then if the fed refuses to raise rates the extra bond purchases would be expansionary (the Sumner critique doesn’t matter if the Fed fails to change policy). Fiscal policy cannot force the FED to do anything if it wants to counteract the effect but the FED can be complicit in converting the fiscal actions into monetary expansion by refusing to counteract the effects. Now I am just a dilettante but this seems to me QE by proxy to overcome political restraints.

  18. Gravatar of Tyler Healey Tyler Healey
    1. April 2013 at 05:57

    “[C]utting interest rates [distorts] the economy towards borrowing and lending and investment. Given that the recession was caused by excessive and irresponsible borrowing, to encourage borrowing is crazy, unless there is evidence that monetary policy works much faster than fiscal. Is there any such evidence?” – Ralph Musgrave

  19. Gravatar of Ben J Ben J
    1. April 2013 at 06:25

    Tyler, why have you added “distorts” in square brackets? Is that what Musgrave said, or intended to say? Is it from context? The meaning of the paragraph changes dramatically if that word is changed.

  20. Gravatar of o. nate o. nate
    1. April 2013 at 06:29

    Scott, it seems like both you and Krugman are quite similar in your views of how to get out of this mess. You both seem to agree that the best thing would be for the Fed to raise inflation expectations. The only difference is that Krugman adds a plan B, which is if the Fed fails to do that, then he recommends Keynesian-style fiscal stimulus as a back-up. You seem reluctant to go that far, though it’s not clear from your macro model why, given the assumption of a derelict Fed, that Keynesian stimulus wouldn’t work in the current situation. It seems to be more a matter of philosophical preferences about government’s role that leads to the slight difference in emphasis between you and Krugman.

  21. Gravatar of Geoff Geoff
    1. April 2013 at 06:33

    Ben J:

    “Geoff, I am interested in seeing your evidence for these real side structural issues!”

    What would the evidence have to look like if the problems weren’t primarily structural?

    The evidence is consistent with both theories (real and nominal). There are problems in both. But the problems on the nominal side likely isn’t too little inflation, it’s too much inflation, which then affects the real side structure. Just like it is counter-productive to want an individual person’s nominal income to rise 5% per year no matter what he does, so too is it counter-productive to want two or three or more people’s collective incomes to rise 5% per year no matter what they do.

    The knowledge that aggregate spending is going to rise 5% per year is insufficient for investors and consumers to know how that spending can be sustainably distributed and allocated on the side of prices and supply. Forcing aggregate spending to rise 5% per year carries with it influences on the side of relative prices and spending and thus relative supply. It is not something that we can solve by merely adding 5% to prices each year. Individuals don’t spend 5% more on everything when their income rises 5% each year. They spend more than 5% on some things, and sometimes they stop spending on other things. When the CB inflates, individuals do not allocate the additional spending to everything by 5%. As a result, the real side structure is invariably affected. And because the effect is NOT generated by consumer preferences, but rather by money variations, what ends up happening is that the change to the structure doesn’t match the change in consumer preferences. Ergo the prevalence of real side structural problems APART from what fiscal and regulatory policies have brought about.

    Dr. Sumner:

    “Ben, Geoff presumably thinks the huge boom of the late 1960s was caused by LBJ’s big government policies, which improved efficiency. He doesn’t seem to think that demand shocks affect output.”

    The word “presumably” is often invoked to set up a straw man.

    My post does not preclude the possibility of inflation generating a boom, nor does it preclude the possibility of deflation generating a bust. The acknowledgement that deflation can generate a bust does not obligate one to conclude that the problem is insufficient inflation. For you would be ignoring the likelihood that the deflation is itself caused by real side problems, whereby the CB is “caught off-guard” or “caught asleep at the wheel” and other conceptions of CB activity that presumes the cause of busts is insufficient inflation in the now, rather than too much inflation in the past (which cannot be adequately measured, as a proxy for the market, through arbitrary constant growths in price levels or NGDP).

    One can acknowledge monetary policy generated a boom in the 1960s, without making the additional claim that busts are about insufficient inflation.

    If an individual goes on a debt financed consumption binge, and their spending rises over time, but then after some point their lack of real productivity catches up with their profligate spending and higher standard of living, such that their borrowing is reduced, their spending is reduced, and their standard of living is reduced, from what they were before, then it would be wrong to assert that the problem for this individual is insufficient money, insufficient inflation, or insufficient spending. It be right to argue that the problem is structural. Their real side productivity does not line up with the relative money and spending associated with their activity.

    Now, this is not to say that inflation cannot “solve” this individual’s problem. Sure, if his nominal income rises more, then he’ll be able to borrow more, spend more, and continue on as if nothing is problematic. But then the same poison as before will gradually take over once again.

    The solution of inflation will only mask the structural problems. Inflation will not solve the structural problems that can only be fixed by a market generated change to relative spending and prices. Inflation, because it has its own affect on relative spending and prices, it invariably hampers the market process of relative spending and price formation. Thus the structural problems persist, and with persistent inflation, will grow worse and worse over time.

    Most importantly, these structural problems can persist despite falling unemployment, and falling resource idleness generated by inflation.

  22. Gravatar of Geoff Geoff
    1. April 2013 at 06:52

    We glimpse these structural problems in history by the fact that CBs tend to have to accelerate their own activity in order to bring about the same aggregate real side effects. Banker lending of last resort, the original “target”, came to an end, because the structural changes grew such that it “needed” more inflation. So 2% price growth targeting became the new paradigm. It too eventually became insufficient. Now there is a “moderate inflation” plus “employment” dual mandate. It too eventually became insufficient.

    Now there are some monetarists who have convinced themselves that NGDP targeting was the right target all along, when the historical function they are serving is merely to propose an acceleration to existing inflation, since the current inflation isn’t working anymore, given the additional structural side problem buildups which require more.

    With enough time in NGDP targeting land, structural problems will again build up to the point at which the existing paradigm is insufficient. Then we’ll likely see yet another generation of monetarists proposing a new “This is what it should have been all along” inflation rule, which will likely be higher than the existing paradigm at the time.

  23. Gravatar of Ben J Ben J
    1. April 2013 at 06:58

    Geoff,

    So, besides your theory of distortion in the time-structure of capital, spending and prices, no evidence?

  24. Gravatar of TravisV TravisV
    1. April 2013 at 07:14

    Paul Krugman has shamed Martin Feldstein for his terrible column but Prof. Sumner has not:

    http://krugman.blogs.nytimes.com/2013/04/01/bond-bubble-brouhaha

  25. Gravatar of John Thacker John Thacker
    1. April 2013 at 08:15

    o. nate:

    “You seem reluctant to go that far, though it’s not clear from your macro model why, given the assumption of a derelict Fed, that Keynesian stimulus wouldn’t work in the current situation.”

    Because, as the ECB has demonstrated, if the Fed sticks to its current inflation target, they will simply raise rates and neutralize a Keynesian stimulus. The very fact that the ECB raised rates in 2011 is strong evidence *against* Krugman’s Plan B, even if he fails to realize or acknowledge it.

    Plan A is change the target. If Plan A does not occur, then Plan B cannot work. The ECB shows that much.

  26. Gravatar of Tyler Healey Tyler Healey
    1. April 2013 at 08:25

    Ben J,

    Yes, “distorts” is what Musgrave said. He argues that ZIRP is counterproductive, given that the poverty crisis was caused by excessive and irresponsible borrowing.

  27. Gravatar of Michael Michael
    1. April 2013 at 09:12

    Geoff wrote:

    “The knowledge that aggregate spending is going to rise 5% per year is insufficient for investors and consumers to know how that spending can be sustainably distributed and allocated on the side of prices and supply. Forcing aggregate spending to rise 5% per year carries with it influences on the side of relative prices and spending and thus relative supply. It is not something that we can solve by merely adding 5% to prices each year. Individuals don’t spend 5% more on everything when their income rises 5% each year. They spend more than 5% on some things, and sometimes they stop spending on other things. ”

    This is true, but it is a feature, not a bug. Much government intervention in the economy takes the form of either direct purchases or direct adjustments in relative prices (such as the deductibility of health insurance for employer-based coverage). Better to target an overall level of nominal (not real) spending without directly dictating who spends the money, and on what.

  28. Gravatar of Tyler Joyner Tyler Joyner
    1. April 2013 at 09:56

    Michael,

    Just because they’re not directly dictating who spends the money on what does not mean they’re not affecting those things in inequal amounts. Someone can be 120lbs and gain 5 lbs per year, but it matters whether it’s muscle or fat, or some combination thereof. The fact that the policy aims to increase an aggregate and be agnostic to specific industries and players does mean that it succeeds in doing so – and I think Geoff has argued quite persuasively that Fed policy does in fact create winners and losers.

    If anything, this is potentially worse than price controls. At least with price controls the unintended consequences tend to be plain to see and, to some degree, measurable. If you enact a policy with the inherent assumption that there will be no unintended consequences, and the minds responsible for concocting this policy admit no possibility of unintended consequences, it makes it that much harder to objectively evaluate the policy’s effectiveness.

  29. Gravatar of TravisV TravisV
    1. April 2013 at 10:00

    More Krugman on Feldstein:

    http://krugman.blogs.nytimes.com/2013/04/01/financing-the-deficit-more-feldstein

    When will market monetarists shame this terrible column Feldstein wrote?

  30. Gravatar of libertaer libertaer
    1. April 2013 at 10:01

    “What I don’t understand is how the inflation-targeting ECB wouldn’t simply offset any additional fiscal stimulus, or at least the demand-side effects of additional stimulus.”

    This is my key problem with Krugman. Even if he is right about the zero bound, which I don’t think he is, fiscal policy can’t come to the rescue. Fiscal policy can’t work if you keep targeting inflation. Monetary policy is the only game in town. Without the right monetary policy we all turn Japanese.
    Sumner is right, Krugman is wrong.

  31. Gravatar of TravisV TravisV
    1. April 2013 at 10:02

    Prof. Sumner once wrote this about Martin Feldstein:

    http://www.themoneyillusion.com/?p=2311

    “we need a bunch of boring technocrats, people who actually know how the world works, people like Martin Feldstein.”

    Really??? I sure don’t think Feldstein knows how the world works!

  32. Gravatar of Michael Michael
    1. April 2013 at 10:29

    Travis V wrote:

    “Just because they’re not directly dictating who spends the money on what does not mean they’re not affecting those things in inequal amounts. Someone can be 120lbs and gain 5 lbs per year, but it matters whether it’s muscle or fat, or some combination thereof. The fact that the policy aims to increase an aggregate and be agnostic to specific industries and players does mean that it succeeds in doing so – and I think Geoff has argued quite persuasively that Fed policy does in fact create winners and losers.”

    But we have a Fed. And our Fed has a monopoly on the monetary base. If you want to argue against the existence of the Fed, that is one thing. What I don’t understand, arguments in favor of the Fed acting incompetently, rather than compentently.

    As far as winners and losers, as long as there is a Fed with a monopoly on base money, the Fed’s actions – or inactions – will create some winners and losers. There is no such thing as a neutral Fed, since events in the real economy will affect growth and inflation expectations, and thus prices and transactions.

    A Fed with a transparent policy goal that will provide a stable, predictable trend in the purchasing power of the dollar is better than an ad hoc, arbitrary Fed, a Fed that thinks it should force prices down economy wide if there is ever an oil crisis, or a Fed that will choose to reward creditors (and mortgage refi professionals) at the expense of debtors by producing an unexpected period of below target inflation.

    “If anything, this is potentially worse than price controls. At least with price controls the unintended consequences tend to be plain to see and, to some degree, measurable. If you enact a policy with the inherent assumption that there will be no unintended consequences, and the minds responsible for concocting this policy admit no possibility of unintended consequences, it makes it that much harder to objectively evaluate the policy’s effectiveness.”

    I think it would be more accurate to say that NGDP level targeting would minimize, not eliminate, “unintended consequences” relative to many other possible central bank policy goals.

  33. Gravatar of Geoff Geoff
    1. April 2013 at 13:05

    Ben J:

    “So, besides your theory of distortion in the time-structure of capital, spending and prices, no evidence?”

    The evidence is consistent with the theory.

    Oh I get it, you believe that the first theory you stumble upon, or the theory you were taught, if it is consistent with the historical data, then it ipso facto means that theory is right and no other theory is permissible.

    The problem with that view is that economic theories aren’t confirmed or refuted on the basis of historical data. They can’t be, if rival theories that can’t both be right, are nevertheless consistent with the data.

    Easy example:

    Suppose history is one where standards of living have increased alongside an increase in government regulations.

    Two rival theories:

    A. Increased standards of living have occurred BECAUSE of the increased government regulations; and

    B. Increases standards of living have occurred DESPITE the increased government regulations.

    Both of these theories are consistent with the data. They are both at first glance not false. But they can’t both be right. Yet for two people, one who thinks A is right, the other who thinks B is right, they can’t accuse the other of ignoring “the evidence.” They can’t both say that the other is only talking about theory, without evidence.

    The only way to settle the dispute here is by judging and analyzing the two theories on a ground OTHER than the historical data (the evidence).

    The theory I have laid forth is fully 100% consistent with the historical data. You just fallaciously believe that because the evidence is also consistent with your theory, that my theory, and all other rival theories, are ipso facto false as a result. But you can’t do that. You are pretending that my argument is ONLY theoretical, when in reality the theory, while grounded a priori, is nevertheless consistent with the evidence.

    Some of the tell-tale signs that are consistent with my theory are:

    1. Every time there is a bust, the higher order capital goods stages tend to experience a greater relative struggle than the final consumer stage. If the theory that it is aggregate demand that is at fault, we should not keep seeing this pattern, but one where all industries struggle relatively the same.

    2. If inflation did not affect the capital structure of the economy, then we should see every price rise equally with inflation. But since we instead tend to see stocks, durable goods and construction industry prices rise more than consumer goods prices during an inflation, it means the theory that the capital structure isn’t affected, is untenable.

    There are other empirical signs that are consistent with the theory I have laid out, but I want to emphasize that the data isn’t what makes the theory true. It can’t make it true, not when there are more than one rival theories that are also consistent.

    You’re only hurting your own intellectual development by pretending in your own mind that rival theories are only theories, and are not consistent with historical data because your theory happens to be.

    ————————-

    Michael:

    “The knowledge that aggregate spending is going to rise 5% per year is insufficient for investors and consumers to know how that spending can be sustainably distributed and allocated on the side of prices and supply. Forcing aggregate spending to rise 5% per year carries with it influences on the side of relative prices and spending and thus relative supply. It is not something that we can solve by merely adding 5% to prices each year. Individuals don’t spend 5% more on everything when their income rises 5% each year. They spend more than 5% on some things, and sometimes they stop spending on other things.”

    “This is true, but it is a feature, not a bug.”

    Well I guess I should be partially impressed that you are intellectually able to understand and hence honestly admit that inflation does affect the capital structure of the economy in addition to consumer valuations which generate profit and loss signals.

    “Much government intervention in the economy takes the form of either direct purchases or direct adjustments in relative prices (such as the deductibility of health insurance for employer-based coverage). Better to target an overall level of nominal (not real) spending without directly dictating who spends the money, and on what.”

    The absence of targeting relative spending doesn’t mean inflation doesn’t affect relative spending in ways that are counter-productive.

    It would be like arguing the aggregate money supply during the 1920s was not relatively highly inflationary, on the basis that people weren’t looking at M2 or M3 at the time.

  34. Gravatar of Edward Edward
    1. April 2013 at 13:50

    “Every time there is a bust, the higher order capital goods stages tend to experience a greater relative struggle than the final consumer stage. If the theory that it is aggregate demand that is at fault, we should not keep seeing this pattern, but one where all industries struggle relatively the same.”

    No. Industries are different across the board. All that is needed is for the economy as a whole to move in the same DIRECTION, although not necessarily the same rate of downward growth.

    “If inflation did not affect the capital structure of the economy, then we should see every price rise equally with inflation.”
    Not necessarily. Some capital goods industries might be so productive that their prices fall and they still make a profit.

    “But since we instead tend to see stocks, durable goods and construction industry prices rise more than consumer goods prices”
    meaningless. Big Yawn. Sometimes the credit created by the Fed ends up in the capital goods industries, sometimes in the final consumer goods industries, as consumers use their credit to keep on buying… so what?

    “Both of these theories are consistent with the data. They are both at first glance not false. But they can’t both be right.”
    Actually…. :-), you could have a situation, if you’re a utilitarian libertarian, where you believe that some regulation are necessary, and those regulations increased the standard of living, while other bad regulations retarded it, so, in fact both theories, could in theory, be right! :-)

    Yet for two people, one who thinks A is right, the other who thinks B is right, they can’t accuse the other of ignoring “the evidence.” They can’t both say that the other is only talking about theory, without evidence”

    Suppose there is a “natural experiment” where something remarkably similar has occurred in two separate places, where only one or two factors are different.
    Would you not say that those who ignore this are ignoring evidence?

    There has been a series of NE’s about “austerity.” Not necessarily Austrian austerity, but “austerian” austerity, the solution in a depressed economy is to raise taxes and cut spending, because this will somehow inspire “confidence” The delusional fools who still believe this in the EU are certainly ignoring evidence

  35. Gravatar of Edward Edward
    1. April 2013 at 14:12

    Just to clarify. What I meant to say was that a u. libertarian will say that a small amount of regulations helped growth, while growth occurred IN SPITE OF the rest of the bad regulations.

    Example, growth occurred in spite of tariffs. 2nd example, growth was helped by the federal government handing land to settlers after the Civil War.

    Its possible that these can coexist simultaneously, so your viewpoint that its “either one or the other” is wrong.

  36. Gravatar of Ben J Ben J
    1. April 2013 at 14:42

    Geoff,

    “The theory I have laid forth is fully 100% consistent with the historical data.”

    You keep saying this, but you haven’t actually presented a single piece of evidence.

    “The only way to settle the dispute here is by judging and analyzing the two theories on a ground OTHER than the historical data (the evidence).”

    Oh I see, your theory is unfalsifiable.

  37. Gravatar of ssumner ssumner
    2. April 2013 at 04:41

    Errorr, You said;

    “If there is fiscal stimulus (say a large deficit financed payroll tax cut) then if the fed refuses to raise rates the extra bond purchases would be expansionary (the Sumner critique doesn’t matter if the Fed fails to change policy).”

    I understand your reasoning here, but it’s not correct. The key mistake is to equate “change in monetary policy” with “change in interest rate.” They are very different concepts. The Fed recently offset the fiscal austerity of the recent tax increases with a more expansionary monetary policy. And they did so without changing interest rates. That’s why the economy did not slow in Q1.

    Tyler, Bases on that quote, he seems to be equating monetary policy with a change interest rates. A BIG mistake.

    o. nate. I believe the fiscal multiplier is roughly zero, as we’ve seen by the fact that the economy did not react to the recent austerity. In any case fiscal stimulus is something you expect from a banana republic, not a serious country. If Congress feels so strongly that we need more AD that they’ll waste billions on fiscal stimulus, then they obviously ought to just tell the Fed to do it. The Fed gets its mandate from Congress, doesn’t it?

    TravisV, I only read quotes of the Feldstein article, but based on those posts consider him hereby shamed.

    I was referring to his views on taxes when I praised him. I’ve criticized him on monetary policy (he believes in liquidity traps.)

  38. Gravatar of Potpourri Potpourri
    2. April 2013 at 08:59

    […] has a post titled “David Stockman wants to pee in your cornflakes,” Scott Sumner says, “I do agree with Krugman’s view that the recent David Stockman column was a sort of […]

  39. Gravatar of Potpourri « How to Articles Potpourri « How to Articles
    2. April 2013 at 09:50

    […] has a post titled “David Stockman wants to pee in your cornflakes,” Scott Sumner says, “I do agree with Krugman’s view that the recent David Stockman column was a sort of […]

  40. Gravatar of o. nate o. nate
    3. April 2013 at 12:11

    Scott, thanks for the thoughtful reply. I think Krugman would point to other data that supports his view that the multiplier is non-zero: such as the correlation between austerity and GDP stagnation in Europe. I suppose one can always cherry-pick examples that support one view or the other. It’s difficult to prove anything conclusively with these examples, since austerity never happens in a vacuum, and one can always argue that it was offset by other factors, such as monetary expansion or private-sector growth. I guess it’s a matter of debate whether or not Congress could manage to carry out large-scale stimulus without excessive waste and/or corruption (which I think is what you’re implying with the “banana republic” reference). However, there is a case to be made that there is currently ample room for the type of infrastructure investment that government has typically provided and that for whatever reason private capital has difficulty substituting for.

    John Thacker, the Fed is not the ECB and based on the Fed’s own stated policy they would not act to stem a small bout of above trend inflation so long as unemployment remained elevated, so I don’t think that criticism holds in this case.

  41. Gravatar of ssumner ssumner
    3. April 2013 at 16:48

    o. nate, I agree that the multiplier is likely positive for an individual country in the eurozone. But I don’t think the multiplier is positive in terms of the effect on GDP for the entire eurozone.

    My bigger problem with fiscal stimulus is the banana republic argument. It’s a really stupid policy when you have monetary stimulus as an alternative. If the political system will allow one but not the other, then Congress needs to change the system. Is that political impossible? Well then I’d respond that fiscal stimulus is equally politically impossible.

    Since either option is impossible, why not fight for the sensible politically impossible option, not the stupid politically impossible option.

    Don’t take “stupid” literally, I just mean it’s an unwise policy.

  42. Gravatar of Geoff Geoff
    7. April 2013 at 16:30

    Dr. Sumner:

    “Don’t take “stupid” literally, I just mean it’s an unwise policy.”

    Whew, for my sake.

  43. Gravatar of Miles Kimball on the Evils of Public Debt | Last Men and OverMen Miles Kimball on the Evils of Public Debt | Last Men and OverMen
    22. March 2017 at 04:43

    […] favor the sort of AD stimulus that Krugman would regard as “progressive.”      http://www.themoneyillusion.com/?p=20421      The title of this Sumner piece was “The Third Way.” As Kimball is […]

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