Karl Smith made the following observation yesterday:

At the same time Scott Sumner provides with a rhetorical tool that might help me convey what is otherwise extremely difficult to convey. That is:

Never reason from a food choice

Tyler Cowen made the following observation yesterday:

Don’t think of the model as “what happens to a restaurant when there is an exogenous increase in the beauty of its women” (recall Scott Sumner “” “don’t reason from a beautiful women [price] change!” ).  Think of the model as “what does lots of beautiful women predict about the place of a restaurant in its product life cycle?”

This leads me to wonder:

1.  Can I copyright this maxim, and collect fees anytime someone uses it?

2.  In 100 years will my market monetarist ideas be completely forgotten?  Will I be a historical footnote—perhaps recalled as the economist who coined the phrase “never reason from a  . . . ?”  (BTW, I would consider myself very lucky if I became a historical footnote.)

It also got me thinking about what else we shouldn’t reason from:

Never reason from an interest rate change and never reason from an exchange rate change don’t count, as they are obvious, and are actually just special cases of prices.

1.  Never reason from a wealth change:  Is wealth falling due to factors that would be expected to reduce GDP (i.e. late 1929, or late 2008) or is wealth falling for reasons that would not be expected to reduce GDP (late 1987, January 2006 to April 2008)?

2.  Never reason from a current account deficit:  Does the current account deficit reflect healthy growth triggered by immigration and neoliberal reforms (Australia)?  Or does the CA deficit reflect reckless government borrowing (Greece prior to the recession)?

3.  Never reason from a price level:  Does the very low price level reflect highly efficient government policies that hold costs down (Hong Kong)?  Or does it reflect very inefficient government policies that keep the country poor (many LDCs)?

4.  Never reason from an increased propensity to save:  An increased propensity to save might cause more actual saving and more growth, or it might not boost actual saving, but rather depress AD.  What determines which will occur?  Monetary policy.  And it turns out that monetary policy also drives AD.  So talking about saving propensities adds nothing to our analysis of aggregate demand changes.

5.  Never reason from an endogenous money claim:  Don’t say; “money is endogenous, therefore . . . ”   Unless the central bank targets money (which is very rare), the money supply will respond endogenously to changes in money demand that occur when some other variable is being targeted (interest rates, exchange rates, inflation expectations, etc.)  But central banks generally target those other variables by changing the money supply in such a way as to stabilize the target variable.  So an observation that money is “endogenous” tells us nothing about the effect of changes in the money supply.

6.  Never reason from an aggregate wage change:  (Yes wages are a price, but I haven’t discussed this one yet.)  Higher real wages could be healthy, reflecting faster productivity growth.  Or they could be unhealthy, reflecting deflation and sticky nominal wages.

Other suggestions?

PS.  Speaking of reasoning from a change in beautiful women:  About 10 years ago my wife brought me to a nightclub in Beijing full of very beautiful young women who seemed anxious to meet me.  If that happens to you then you should feel free to draw the obvious inference—at my age there is no other rational interpretation.  (Oh wait, I might have been dreaming . . . )

I tend to oversimplify complex problems.  So do lots of other people.  It’s only since I started blogging that I realized how often I did this.  That’s because on one day I might passionately believe X was important.  On another day it seemed to be all about Y.  And a week later Z seemed to be the key to everything.  When I’m thinking about one of those things, the others get blotted out of my mind.  But blogging leaves a paper trail, so now I realize that I’ve claimed “It all boils down to X,” with at least 10 different Xs.

In recent days three bloggers have tried to get to the core of the policy failure.  Matt Yglesias has suggested it all boils down to the zero rate bound, Ryan Avent replied that the key problem is the reluctance of central banks to engineer sharply negative real rates, and Steve Waldman has countered that it’s the political power of older savers that is inhibiting monetary stimulus.

It’s pretty easy to show that none of these answers is adequate, nor is any monocausal explanation I’ve previously offered.  So here’s 10 factors that contributed to the “perfect storm,” a list that is itself hardly exhaustive:

1.  Yes, Matt’s right that the zero rate bound matters.  If the US fed funds rate was currently 2%, and all the macro indicators were exactly as they are now, the Fed would cut its rate target. They are slightly more averse to unconventional stimulus.

2.  Ryan’s also right that the need for especially low real rates matters.  The real estate bust means that macro equilibrium requires unusually low real interest rates.

3.  Steve’s right that the savers lobby plays a role.  But I’m a big saver, and I feel that I’d be far better off if money had been much easier in 2008.  Partly because tight money badly hurt the values of stocks and risky bonds.  And partly because the resulting recession made real rates much lower than they’d be at full employment.  It’s not a zero sum game.  The “mistake theory” of policy failure is looked down on by sophisticated intellectuals, but if you think (as I do) that 99% if professional economists “got it wrong” in 2008, how much of a stretch is it to assume that the economists at the Fed also got it wrong?

4.  Nick Rowe is right that interest rate targeting contributed to the problem by making the Fed “mute” at zero rates.  It became harder to signal its future policy intentions.

5.  Larry Ball is right that Ben Bernanke’s personal qualities played a role.  He favored a more democratic decision process than Greenspan or Volcker, and on average that will get you better decisions.  But in this particular case Bernanke’s expertise and instincts are superior to that of the median FOMC voter.  And Bernanke’s not the sort of person who would demand that others follow his lead.

6.  We are suffering partly because we just happen to have chosen rate targeting rather than level targeting, and prices rather than NGDP.

7.  We are in this predicament partly because the public doesn’t understand the concept of “inflation” in the same way as Bernanke does, making for a PR nightmare.  When Bernanke announced the need for more inflation in the fall of 2010 (QE2), he meant more demand-side inflation, i.e. higher real incomes for Americans.  The public read it as more supply-side inflation, i.e. lower real incomes for Americans.  The backlash made the Fed more cautious.

8.  We are in this predicament because the median economist believes in intro textbook “liquidity trap” myths, and hence put no pressure on the Fed to stimulate, as they thought the Fed was out of ammo.  The Fed usually follows the preferences of the median economist, so this cognitive failure was a really big deal.

9.  We are in this predicament partly because the Fed already feels like it has done a lot (as does the profession.)  That’s because they never absorbed Bernanke’s 2003 admonition that NGDP growth and inflation are the “only” way to ascertain the stance of monetary policy.  They don’t know that ultra-tight money drives NGDP so low that interest rates fall to zero, which makes excess reserves surge.  As a result ultra-tight money paradoxically ends up looking like ultra-easy money.

10.  And now I’ll end up with a few cheap shots at liberals and conservatives (no single ideology could create such a monumental mess.)  In America it’s hard to believe that the opposition of conservatives to monetary stimulus is unrelated to Obama being president.  Inflation was higher under Bush, and yet the intensity of conservative Fed bashing was far less.  In Northern Europe, conservatives see the crisis as an opportunity to force the southern tier to shape up.  In both cases there is a fear that easy money could somehow ‘bail out” failed economy policies.  In contrast, American liberals took office in January 2009 with grand dreams that this was a 1933-type opportunity to expand government, just as FDR did.  Hence they mostly ignored monetary policy until the GOP took over the House of Representatives.

OK, what have I missed?  I bet if you went through my nearly 1500 posts you’d find dozens of other explanations, which I can’t recall right now.

PS.  After I wrote this I recalled one more—too much weight on historical inflation numbers  (especially in September 2008), not enough weight on targeting the forecast.

PPS.  I just noticed that Karl Smith has a related post.

Most educated people know about the three women on the Supreme Court, and are certainly aware of Hillary Clinton.  Some may have even heard of Vice Chair of the Board of Governors, Janet Yellen.  I’d like to argue that Cleveland Fed president Sandra Pianalto might well be more powerful than any of those five women, mostly because she appears to hold a swing vote at the FOMC.  Thus it’s interesting to probe the thought process of a Fed moderate:

Sniderman: Let’s talk more directly about current circumstances. If inflation is near our goal right now, why not try to go faster and get that unemployment rate down sooner?

Pianalto: We always have to stay focused on a balanced approach. I would be concerned that if we were to provide even more policy stimulus, given my current outlook, we could risk an unwelcome rise in inflation. On the other hand, if we were to remove our policy accommodation too quickly, I would be concerned that we would risk slowing the economy and causing an unwelcome disinflation. I think we have to strike a balance, and I think we have a good balance with our current policy.

I’m almost certain Pianalto would say I’m mischaracterizing her views, but that answer has “zero fiscal multiplier” written all over it.  Aggregate demand is right about where she wants it.  But what happens if the economy goes off course, growing faster or slower than expected?

Sniderman: If we get into the summer and begin to see another one of these patterns of the economy slowing down, do you think that would be the time to support further easing in policy and maybe be willing to take a little more risk on the inflation side of things in order to get the economy moving again?

Pianalto: Right now my forecast is for the economy to grow a little more than 2.5 percent this year and 3 percent next year, with inflation staying close to 2 percent. My forecast for either economic growth or inflation would have to change for me to want to make a change in the stance of monetary policy. Given my current outlook for the economy, the current stance of monetary policy is appropriate. If my forecast were to change significantly, then I would want to look at the appropriate policy response, and perhaps make an adjustment to my monetary policy stance in response to a change in my forecast.

Again, zero fiscal multiplier.  But that’s not really what interests me about this answer.  Nor is it the implied 4.5% to 5% NGDP growth target, which sounds vaguely market monetarist.  That’s certainly the NGDP growth she expects, but she does not indicate that she puts equal weight on short term deviations in inflation and growth.  And she does not seem to favor level targeting; so although the NGDP forecast looks decent, it’s actually a bit below what most market monetarists would prefer, given the huge undershoot since 2008.

What interests me most is that she talks as if the Fed is still steering the nominal economy, despite near zero interest rates.  Other people may not see it that way, but swing voters at the FOMC certainly talk like they are still “doing monetary policy.”   In one sense that’s reassuring—we’d hate to see those at the controls claiming that the steering mechanism for the economy was stuck.  On the other hand it’s also a bit dismaying, as the marginal crew member of USS Nominal GDP seems happy with the ship’s course; even as Obama, Romney, Bernanke, 14 million unemployed, and the US stock market think it’s obvious that aggregate demand is too low.

PS.  A note to commenters:  Please don’t tell me what Mr. Etch-a-Sketch is saying right now, I’m only interested in his views on monetary policy before he felt he had to kowtow to the Tea Party.

Four days ago I said this:

But interest rate targeting (which underlies all of New Keynesian economics) has been an unmitigated disaster for American workers.  And given that rates are likely to frequently hit the zero bound in future recessions (as trend productivity growth and population growth both slow) NK policy will fail us again and again in future recessions, i.e. when we most need it to be effective.  Our current monetary regime is roughly like a car with a steering wheel that works fine””except when driving on twisting mountain roads with no guard rail.  (emphasis added.)

Today Matt Yglesias said this:

Zero Bound Recessions: Again and Again

Let me just flag this post as something to think about that will play a role in questions I’ll be arguing further. The present economic dilemma in which setting short-term nominal interest rates to zero has failed to revive the economy looks exceptional from our present perspective but will in fact be typical of future recessions. 

That’s because of factors related to population aging, slowing population growth, and eventual population decline.

And he concluded as follows:

Long story short, unless you want to be in a permanent depression you either need to find a way to put nominal interest rates below zero or else to permanently increase the background level of inflation to 4 or 5 percent a year to give yourself headroom.

Those would work (although a cashless society is obviously decades away—if only for political reasons.)  But we don’t need 4% to 5% inflation, just 4% to 5% NGDP growth, level targeting.  We could have avoided this recession with higher trend inflation, but we also could have avoided it with level targeting of NGDP.

PS.  Enjoy your honeymoon in Argentina.

Two months ago I quoted Soros as follows:

To be a little more specific, let me suggest the outlines of a European solution to the euro crisis. It involves a delicate two-phase maneuver, similar to the one that got us out of the crash of 2008. When a car is skidding, you first have to turn the steering wheel in the direction of the skid, and only after you have regained control can you correct your direction. In this case, you must first impose strict fiscal discipline on the deficit countries and encourage structural reforms; but then you must find some stimulus to get you out of the deflationary vicious circle””because structural reforms alone will not do it. The stimulus will have to come from the European Union and it will have to be guaranteed jointly and severally. It is likely to involve eurobonds in one guise or another. It is important, however, to spell out the solution in advance. Without a clear game plan Europe will remain mired in a larger vicious circle in which economic decline and political disintegration mutually reinforce each other.

Here’s how I responded:

Here’s what Soros is right about:

1.  He’s right that countries like Greece must tighten fiscal policy as they are running out of investors willing to lend them money and not be repaid.

2.  He’s right that the eurozone desperately needs stimulus.

What’s the obvious solution?  They need tighter fiscal policy in the periphery and strong monetary stimulus from the ECB to sharply raise NGDP growth in Europe.  But there is no mention of monetary policy at all.  And yet his diagnosis virtually cries out for a market monetarist solution.

Instead Soros seems to imply the deus ex machina of eurobonds saving the day.

Now commenter Steve sent me a new interview, where he does exactly what I suggested:

And he warned that the euro zone fiscal compact, an agreement by 25 EU leaders to prevent another debt crisis and restore confidence, was pushing in the wrong direction because it obliged governments to balance budgets and reduce indebtedness at a time of inadequate demand.

He said that because fiscal stimulus was ruled out, monetary policy remained the only tool available.

I started my blog with a focus on US policy, but I’m actually seeing more signs of market monetarist influence in Europe than the US.  That’s probably because although fiscal stimulus won’t work in either region, the impossibility of fiscal stimulus is more obvious in Europe.  Hence money is the only game in town.

Soros is a HUGE name in Europe—another big win for market monetarism.