Cardiff Garcia has an excellent article discussing the differences between various types of demand-side economists.  (BTW, I’m both a supply-sider and a demand-sider; both sides matter.)

It’s very hard for reporters to get all the nuances right, but Garcia did an outstanding job here:

Scott Sumner is the Godfather of the modern NGDP level targeting movement and generally a monetary policy purist. By “purist” I mean simply that he believes monetary policy, applied correctly, is fully capable of hitting its targets without the aid of fiscal stimulus, and it can also safely ignore the banking and credit channels.

Still, he pragmatically writes that unless monetary policy is primed to offset it, fiscal policy can indeed raise NGDP. It’s just that fiscal policy can’t deliver the same “ooomph” (not a technical term, unfortunately) as monetary policy. He also thinks fiscal policy can help on the supply side and specifically cites payroll taxes.

When reading Sumner, the point gets across that he just doesn’t think counter-cyclical fiscal policy matters all that much “” or more to the point, would not matter if monetary policy were done right. More on this below.

And as far as I can tell he also did an excellent job with the others.  A brief comment on his conclusion:

So long as your side has a plausible case, and there is agreement that trying the other side’s ideas alongside your ideas would have no effect at worst, then it seems callous to argue against doing both.

If only your ideas are tried and it turns out that you were wrong, an awful lot of people will have suffered for that newfound knowledge about macroeconomics.

Better to try everything at once, and then worry later about deciphering the causal mechanisms, post hoc.

As for whether my arguments are “callous” I think it depends whose making them.  I happen to think that fiscal stimulus does a modest amount of harm, in a couple ways.  It increases the level of future distortionary taxes, and it makes it less likely that effective monetary stimulus will occur, by muddying the waters.  But I also recognize that lots of people who are smarter than me (Krugman, DeLong, Yglesias, Avent, etc) disagree.

Here’s my bottom line. If I was someone like Abe, I’d look at the intellectual dispute and make the same pragmatic decision that FDR made; try a little of everything.  So I agree with Garcia that it would be “callous” of policymakers to ignore any tool with widespread support among economists.  That doesn’t mean they must do everything recommended by economists, but at least they should give the argument serious consideration, if widely held.  (Even if I disagree.)

My role is different.  I’m not a policymaker; I’m inside the academic debate.  I see my role as telling the truth as I see it, and let the chips fall where they may.  If my arguments convince other academics and pundits to come over to my side, that’s great.  If not, then I’ll just be one small input into a vast policymaker apparatus, which is as it should be.

I’m playing a longer game—hoping that if my view eventually prevails then in the future we will DEMAND that central banks stabilize the expected path of NGDP.  My fear is that if we use fiscal policy today, we’ll have to use it in the future.  But the best outcome is an expected NGDP growth path where fiscal policy is never even called for.  That’s my long term goal, and it’s why I maintain my “purist” stance.  (Which given that I favor employer-side payroll tax cuts, is actually not all that pure.)

PS.  The Godfather?  Well every time I decide to stop talking about the need for monetary stimulus, the annoying central banks pull me back in.

PPS.  I wish an investment bank would make me an offer I can’t refuse.

HT:  Saturos

Here we go again:

“The trend is still in principle a sell-off in markets, a sell-off in riskier assets on the expectations that the Fed might signal further readiness to maybe slow down the rate of purchases,” said Daiwa Securities economist Tobias Blattner.

“So all eyes are on the FOMC meeting next week. There is very little else that matters at the moment”

There is very little else that has mattered for the past 5 1/2 years.

Younger readers might wonder how many times the Fed can keep making the same mistake.  Removing the punch bowl before the party even begins.  Unfortunately, the evidence suggests that the answer is “quite a few.”  In the 1966-81 period the Fed had 15 straight years of continually making the same mistake.  Continually refusing to tighten money because the inflation bubble was “temporary,” and would soon pass.  Respectable opinion said that those foolish monetarists who blamed it on printing too much money just didn’t understand that the real problem was a bad food harvest, or higher oil prices, or a union wage contract.  And those problems were easing.  And in any case, interest rates were high, so how could monetary policy be considered “expansionary.”

Let me guess, we just have a mild growth pause, but we’ll get that vigorous recovery in 2010, er 2011, make that 2012, 2013?  I just picked up an issue of The Economist, and they assure us that although US growth this will will be only 2%, next year it will speed up to 2.8%.  European growth in 2013 and 2014?  You don’t want to know.  Let’s just say that my rule of thumb that Europe’s about 75% as rich as America is going out the window.  By 2015 it will be about 70% as rich.  Soon we’ll need a new development category—upper middle income, mixing Greece and Portugal with Chile and Poland.

When you have central bank officials that see inflation everywhere, even as we experience the lowest core PCE inflation in history, then it’s pretty hard for them to change their ways.  Eventually a younger generation of policymakers arrives.  They’ve noticed that the old folks running the show were wrong, wrong, and wrong again.  Inflation?  What are those old farts talking about?  A new regime takes over, and (after a relatively good period) a new set of mistakes start getting made.

Japan’s been making the same mistakes for 20 years, and the ECB is determined to follow in Japan’s footsteps.

This is what happens when a political system delegates power without responsibility.  Central banks have the power to determine the path of NGDP, but don’t get blamed when the path disappoints.  That’s a recipe for disaster.

Question:  If German savers hate low interest rates, why do they insist on a monetary policy that will insure near-zero interest rates for the next 20 years?   Wouldn’t faster NGDP growth lead to higher interest rates?

And here’s another question for you hawks at the ECB; did you see what 20 years of near-zero NGDP growth did to the Japanese public debt/GDP ratio?

PS.  Matt Yglesias has a great new post quoting an EU official making not one but two mind-bogglingly stupid errors in a single sentence.  I didn’t even think that was possible.

Long time commenter Mark Sadowski has two excellent posts over at Marcus Nunes’s blog.  The first is here, and the second is here.  He makes lots of good points; here’s an example from the second post:

So why are Krugman’s results so different from mine? In nominal terms both exports and imports soared during 2003-07. But thanks to a sharp increase in the average price of Japanese imports only exports increased dramatically in real terms.

This is fine from the standpoint of real growth accounting, but the issue at hand was, and is, aggregate demand, which is measured strictly in nominal terms. To claim that net exports drove Japan’s growth during this period is to claim that the source for the increased aggregate demand came from abroad when in fact it came from the Japanese QE, which succeeded by not only stimulating foreign nominal demand for Japan’s exports through a reduced real effective exchange rate, but also by dramatically increasing Japan’s nominal demand for imports.

Mark also shows that Japanese growth correlates more strongly with monetary policy than fiscal policy.  Highly recommended.

David Price sent me an interesting article that he wrote for the Richmond Fed.  This caught my eye:

If banks believe that they can earn more by reducing their excess reserves, and if they appear likely to use their excess reserves to expand their activities faster than the economy is growing, the Fed can avoid the torrent of money simply by raising the interest rate that it pays on reserves. That is why high excess reserves do not necessarily set the stage for high inflation.

But is there a risk of the Fed getting the timing wrong? If it doesn’t act quickly enough to raise IOR, or if it doesn’t raise the rate enough, an unwanted rise in inflation or inflationary expectations could be the result.

For some economists, the likelihood of such a sequence of events is remote. “The FOMC [Federal Open Market Committee] meets every six weeks,” says Stephen Williamson of Washington University in St. Louis. “You’re not going to have a huge inflation instantaneously. They can head it off if they’re willing to tighten at the appropriate time.”

Ennis and Wolman of the Richmond Fed suggest, however, that high excess reserves create a greater timing challenge for the Fed than it normally faces. “Absent the excess reserves, banks would have to raise funds to make new loans,” Wolman says. “People argue about whether the large quantity of reserves materially changes the sensitivity of the economy to the Fed messing up.”

The issue is that with high excess reserves on tap, banks can increase lending quickly “” “without having to sell assets, raise deposits, or issue securities,” Ennis and Wolman wrote. Thus, they suggested, high excess reserves mean that an expansion can take place more quickly, perhaps before the Fed is ready to act on signals that it is happening.

Williamson’s right, it’s not a problem.  And the mistake Ennis and Wolman make is an interesting one.  Individual banks are not constrained in making loans in the short run, as they can always borrow needed reserves in the fed funds market.  If they do so that will put upward pressure on interest rates, and the Fed will supply the needed reserves to maintain their fed funds target.

In the long run banks are constrained, as the Fed will adjust the monetary base to prevent economic overheating.  The endogenous money folks, who are right about the period between Fed meetings, overlook this longer run problem with their theory.  Six weeks is not a long enough period to have major macroeconomic consequences.  But in the very short run the banks are not constrained by a lack of reserves, if the Fed is targeting the short term interest rate.  The base is endogenous during that period.

I was also struck by Price’s description of the onset of IOR during the fall of 2008.  Before quoting from the paper, let me explain my mindset.  Suppose you found the following account of someone’s day:

I got up and had eggs for breakfast.  Got in the car and went to the grocery store to buy some milk.  While driving down Elm Street I pulled out a AK47 and shot 3 children on a playground.  Then I went to the dry cleaners, to pick up my shirts.  I pointed out that the shirts were still a bit wrinkled, and one had a stain that had not been removed.  Then I got an oil change at Valvoline . . .

Most people would go “Whaaat!?!?!” when they read about the shooting.  That was roughly my reaction when I read Price’s matter of fact description of the Fed’s decision to pay interest on reserves, made in early October 2008:

In the Financial Services Regulatory Relief Act of 2006, Congress authorized the Fed to begin paying IOR on Oct. 1, 2011. In May of 2008, however, in the midst of the financial crisis, the Fed asked Congress to move up the effective date. During the crisis, the Fed had been carrying out emergency lending to financial institutions on a large scale. The Fed neutralized this process in monetary terms by “sterilizing” the money that it was creating; that is, as it created money, it sold the same amount of Treasury bonds from its holdings to absorb an equal amount of money. (Technically, the New York Fed, acting on behalf of the Federal Reserve System, would sell the bonds and the reserve account of the trading counterparty would be debited, causing those reserves to, in effect, disappear.) The Fed was selling off its supply of Treasury securities quickly, however, and it was foreseeable that it would run out of sufficient Treasuries with which to sterilize its lending.

“The Fed had sold so many securities that most of those left in its portfolio were encumbered in one way or another,” says Alexander Wolman, a Richmond Fed economist who co-authored a 2012 working paper on excess reserves with colleague Huberto Ennis. “Given that the Fed wanted to continue expanding its credit programs without lowering market interest rates, the answer was to start paying interest on reserves.”

Yes, given they wanted to continue expanding credit without lowering interest rates (which were at 2% at the time.)  But we are talking about October 2008!  To me that like saying; “Given I had decided to eliminate those three little children, the solution was to pull out my AK47.”

Is it any surprise the stock market crashed in early October?  I mean if you are having to go to Congress for emergency powers because the economy is going down the toilet, I’m not sure “below target interest rates” is the number one thing the Fed should have been worrying about.

PS.  I should say that despite my lame attempts at humor, the Price article itself is fine.

The BoJ disappointed investors by failing to offer further stimulus.  The yen soared in value.  No surprise there.  And Japanese stocks fell sharply–no surprise there.  European and American stock futures also fell on the news.  That would be a surprise if you believed the phony hype about “currency wars.”  In fact, macro is not a zero sum game, as I keep emphasizing.  What’s good for Japan is good for the world.  What’s good for Germany is good for the world.  What’s good for China is good for the world.  What’s good for the US is good for the world.  Indeed what’s good for Zimbabwe is good for the world.

So what should the BoJ do?  Is 2% inflation the right number?  (Put aside the fact that they should be targeting NGDP, not inflation.  Let’s say they insist on inflation.)

For the moment, Japan could restore full employment with 1% inflation, perhaps even zero percent (using the GDP deflator.)  That’s because wages are very well behaved.

On the other hand Japan needs an inflation rate that is high enough to keep them away from the zero bound.  Yes, if they had NGDPLT then the zero bound would not be a problem.  But if they inflation target it is a big problem.  So maybe the inflation target should be even higher than 2%.

There is also this ominous warning:

To encourage more investment, the government plans to draw up plans for tax reform by the autumn, when it is due to decide whether the recovery is strong enough to endure the blow to demand from sales tax hikes due in 2014 and 2015.

The tax increases are needed to cope with a growing public debt that already is more than twice the size of Japan’s economy.

While Abe’s “Abenomics” economic policies have helped boost share prices and raised hopes for a sustained recovery, the central bank remains far from its target of achieving 2 percent inflation within the next two years.

I can tell them right now—the recovery is not “strong enough to endure the blow,” and indeed a 5% hike the sales tax would likely cause a recession, unless Japanese inflation rises more rapidly than most people expect.  The new BoJ policy has clearly helped, but Japan is far from being out of the woods.

Japanese stocks have fallen as the yen has recently risen from 103 to 96 to the dollar.  That’s still better than the exchange rate of 80 last year, but 96 is not going to get the job done.  Try 120.

PS.  Unfortunately my first link seems to have changed.