Or else there are two Scott Sumners.  Here’s Nick Rowe:

Not many people know this, but there were actually two James Tobins.

The first James Tobin (pdf) said that there cannot be an excess supply of money, because if anyone did have an excess supply of money he would immediately run to the bank to get rid of it.

The second James Tobin said that people hold positive average stocks of money for the same reason anyone holds positive average stocks of any inventory: because it is too costly to keep running back and forth to the bank to get rid of inventory immediately and then get it back the moment before you need it again.

Nick is forcing me to do something I thought I’d never do—defending Tobin.  That’s because I also hold both views, and see no contradiction.  Here’s what I believe:

1.  At any given set of prices there can be an excess supply of money.  That’s why there is a hot potato effect and that’s why adding more base money raises the price level.

2.  However, in the short run asset prices adjust to prevent an excess supply of money.  The higher asset prices make people willing to hold larger cash balances whenever the monetary base increases.  Thus the money market remains in equilibrium.  That’s really what Tobin is assuming when he talks about the ability to go to the bank.  The banker is a person standing ready to buy base money (on demand) from the public, and supply financial assets like CDs in exchange.  However very little base money actually stays in the banking system during normal times, so it’s actually asset markets more broadly that adjust to the monetary inflow.

So here’s what’s going on.  The public determines how much cash they want to hold, and adjusts how often they go to ATM machines to restock. Tobin’s second point refers to the fact that the opportunity cost of holding cash affects the Cambridge k, or ratio of cash to income.  Higher rates lead to a lower k ratio.  But these adjustments occur almost instantly, as people restock every week or so.  You make a mental note; “start going to the ATM every six days instead of every seven.”  Done.  Almost instantly.  The lags (or “monetary disequilibrium”) before the first adjustment is less than a week, and of no macro significance. Here’s what is significant; the broader level of wages and prices take a long time to adjust.  So in a sense there is macro disequilibrium, but it’s labor market disequilibrium, not money market disequilibrium.  (It would be monetary disequilibrium at original asset prices.)

Now here’s where I part company with Keynesians who might have been with me so far.  Although short term interest rates are one of those “asset prices” that cause the money market to achieve near instantaneous equilibrium, even as the goods and labor markets are in disequilibrium, they actually have very little role in moving NGDP and prices to the level necessary to restore long run macro equilibrium (and to move interest rates back to their original level.)  In my view 60% of the heavy lifting is done by what Keynes called “confidence” and I call “expectations of NGDP growth” and Ford Motors economic forecasters call “expected nominal incomes in 2014 available to buy Ford cars.”  Another 35% of the transmission is done by asset markets like stocks, forex, commodities, real estate prices, junk bond yield spreads, etc.  And maybe 5% by risk-free short term rates.  At most.

That’s why I call interest rates an “epiphenomenon.”  I hope Nick and I can at least agree on that point.

PS.  Recall that the hot potato effect is the only explanation for the long run change in NGDP.  If expectations of higher NGDP growth do 60% of the heavy lifting, then the HPE provides 60% of the transmission mechanism even though the instantaneous adjustment of interest rates prevents any instantaneous HPE.  That’s what Keynesians can’t get through their heads.  How (expectations of) the HPE can even work at zero rates.

Here’s a new article in Slate by Allison Benedikt:

People get defensive when I make fun of the view that low interest rates mean easy money.  They insist that; “all good economists understand that rates are strongly impacted by real growth and inflation expectations, and that the liquidity effect is just one factor.”  OK, let’s look at the NGDP growth rates for Australia in the late 1980s and early 1990s, and then see how one leading Australian Keynesian responded to this data.  I use Q4 to Q4 growth rates:

1986:4 to 1987:4:  14.1%

1987:4 to 1988:4:  13.3%

1988:4 to 1989:4:  11.2%

1989:4 to 1990:4:  3.5%

1990:4 to 1991:4:  1.1%

Now what would you expect to happen to Australian interest rates, just on the basis of that dramatic slowdown in NGDP growth, which represented Australia’s “Paul Volcker moment?”  I’d guess you’d expect a dramatic fall in interest rates, comparable to what we saw in 1982 in America.  And that’s what happened.  Here’s John Quiggin:

A commenter on the previous post raised the idea, promoted by the “market monetarist” school, that monetary policy is so effective as to make fiscal policy entirely unnecessary, at least when interest rates are above the zero lower bound. My views on this issue were formed by the experience of the late 20th century, and in particular, the recession that began in 1990, following steep increases in interest rates. Having planned a “short, sharp, shock”, the RBA started cutting rates in January 1990.

They didn’t go for 25 basis point moves in those days. Over the period to December 1992, rates were cut by more than 12 percentage points, from 17.5 per cent to 5.25 per cent. Over the same period, unemployment rose from 6 per cent to 10.9 per cent, a record for the period since the Depression. As I said in the previous post, tight monetary policy can reliably cause recessions, but expansionary monetary policy in a deep recession is “pushing on a string”.

Where does one begin?  A critique of market monetarism using interest rates as an indicator of the stance of monetary policy?  Perhaps he doesn’t know what market monetarism is.  But why in the world would anyone assume that this sort of drop in interest rates was related to easy money?

Later (in comments) Quiggin mocks anyone who believes low rates might reflect tight money:

OK then, I’ll make some points on the data. First, the starting point for the cash rate was 17.5 per cent, as I said in my post, not 15.8 per cent. So, to restate, the cut was about 12 percentage points. If you can call this a contraction, I think you are in Humpty Dumpty territory.

This leaves me speechless.  I had thought everyone agreed that the bigger the change in interest rates the LESS LIKELY it was due to the liquidity effect. I could do some cheap shots here and talk about how the number one money textbook in America, written by respected moderate and former Fed official Ric Mishkin believes in Humpty Dumpty, or that Ben Bernanke does, or Milton Friedman.  Or that Quiggin seems to align himself with Joan Robinson, who famously insisted in 1938 that the German hyperinflation couldn’t be due to easy money because interest rates were not low.

But I have to admit that Quiggin is right.  Most economists do equate low rates with easy money.  That is the accepted definition.  How that occurred, how the lunatics took over the asylum, is beyond my comprehension.  But it happened, and that’s one reason for the policy failures of the past 5 years.

Keynesians are the worst, but conservatives these days are almost as bad.

PS.  Of course I’m not claiming Quiggin is a lunatic, just a conventional Keynesian.  It’s the ideas of this group that seem crazy to me.

PPS.  Mark Sadowski has an interesting debate with Quiggin in the comment section.

PPPS.  The Australian central bank actually wanted a sharp slowdown in demand, so in no sense was this a failure of monetary stimulus.  Central banks generally get what they ask for.  The Fed current thinks 1.8% first half RGDP growth is adequate, so they are about to taper.  The economy is right on target (in the Fed’s view). Fiscal austerity offset.  Mission accomplished.

There are so many great Krugman posts while I was away that I hardly know where to begin:

But there’s a funny point I hadn’t thought of until Matt O’Brien pointed it out. The alleged justification for chain-linking is that the conventional consumer price index overstates true inflation; it might overall, but probably not for seniors. In any case, however, as Matt points out, the very same Republicans who claim that Social Security benefits should be cut because the CPI overstates true inflation also insist that the Fed must stop quantitative easing, despite the absence of any visible inflation threat, because the real inflation rate is much higher than the official statistics indicate.

And all you commenters and emailers should keep this in mind:

Just to be clear, I’m not saying that there’s nothing there; there may well be, and maybe it’s even profound. But neither I nor most economists are going to make the effort of puzzling through difficult writings unless we’re given some sort of proof of concept “” a motivating example, a simple and effective summary, something to indicate that the effort will be worthwhile. Sorry, but I won’t commit to sitting through your two-hour movie if you can’t show me an interesting three-minute trailer.

Well, it depends on the director.  But you get the point.

And this:

So, why should you care? Well, Fatas and Mihov have it right: if the business cycle is a matter of the economy falling below capacity, rather than fluctuating around potential output, the costs of recessions are much bigger than often portrayed, and focusing on “stabilization” greatly understates the importance of good macro policy.

And this on the emerging markets crisis:

We more or less know the story here. First, advanced countries plunged into a prolonged slump, leading to very low interest rates; capital flooded into emerging markets, causing currency appreciation (or, in the case of China, real appreciation via inflation). Then markets began to realize that they had overshot, and hints of recovery in advanced countries led to a rise in long-term rates, and down we went. (I don’t think QE has much to do with it, although your mileage may vary.)

And this:

And about being a team player: this is really bad, because it’s contrary to the whole concept of the Fed. The Federal Reserve chair is not supposed to be part of the administration’s team “” he or she is supposed to be an independent force, and independence of intellect is a plus, not a minus (especially when, once again, you’ve been right, as Yellen has).

Cardiff Garcia mocks the WH position as being that they want a pushover who would be fun to have a beer with during a crisis “” and there’s enough truth there to make it sting.

All in all, this whole episode is not making anyone think better of Obama’s judgment.

For the following I’d put “bubble” in scare quotes, both otherwise agree:

Now, the thing you need to realize is that the whole era since around 1985 has been one of successive bubbles. There was a huge commercial real estate bubble (pdf) in the 80s, closely tied up with the S&L crisis; a bubble in capital flows to Asia in the mid 90s; the dotcom bubble; the housing bubble; and now, it seems, the BRIC bubble. There was nothing comparable in the 50s and 60s.

So, was monetary policy excessively easy through this whole period? If so, where’s the inflation? Maybe you can argue that loose money, for a while, shows up in asset prices rather than goods prices (although I’ve never seen that argument made well). But for a whole generation?

The following is good, but where are the NYT editors!  After four days the typo still hasn’t been corrected (it should be inside money):

Banks are just another kind of financial intermediary, and the size of the banking sector “” and hence the quantity of outside money “” is determined by the same kinds of considerations that determine the size of, say, the mutual fund industry.

I love this, but interpret it very differently from Krugman:

Simon Wren-Lewis is deeply annoyed at the IMF, and understandably so. How can you publish a paper about fiscal adjustment that explicitly takes no account of monetary policy, and claim that it has any relevance to current problems?

It would be like claiming that fiscal austerity produced the eurozone double dip recession without taking any account of the ECB’s monetary tightening in 2011. Fortunately no good Keynesian would ever do such a thing!

And this:

Finally, sheer nominal stickiness / money illusion doesn’t seem to play any role in the Hall/Farmer formulation. Yet we now have overwhelming evidence of the presence of such stickiness, in the form of a large (and increased) share of wages that exhibit precisely zero change from year to year:

And here it’s even worse than Krugman asserted:

Whoa! They apparently imagine that QE was an intuitive reaction by Bernanke, one that academic macroeconomics would never have suggested. Nothing could be further from the truth. By the time 2008 came along, the issue of how to conduct monetary policy at the zero lower bound had been extensively discussed, notably in Krugman 1998 (pdf), Eggertsson and Woodford (2003), and, yes, Bernanke-Reinhart-Sack 2004 (pdf). Indeed, the Fed’s QE policies initially followed the latter paper closely; its more recent shift to a greater emphasis on forward guidance is a move in the direction of the Krugman-Eggertsson-Woodford approach.

Herbert Hoover did QE in 1932.  FDR moved toward forward guidance in 1933, under the influence of Irving Fisher and George Warren.

And from the same post:

No, the problem lies not in the inherent unsuitability of economics for scientific thinking as in the sociology of the economics profession “” a profession that somehow, at least in macro, has ceased rewarding research that produces successful predictions and rewards research that fits preconceptions and uses hard math instead.

And this:

The first thing you want to say is that all the crisis economies “” even Indonesia, which had by far the worst time in the beginning “” eventually bounced back strongly:

Total Economy Database

This is in stark contrast to the experience of the countries that seem like the closest parallel to SE Asia this time around, the troubled euro area debtors. Here’s a comparison of Indonesia after 1997 and Greece after 2007, with the later years for Greece being the current IMF projections; the number of years after the pre-crisis peak is on the horizontal axis:

Total Economy Database, IMF

By this point in the aftermath of the Asian crisis, even Indonesia was well on the road to recovery; Greece, Spain etc. are still sinking.

What’s worth remembering is that everything people say about why Greece can’t bounce back “” structural problems, corruption, weak leadership, yada yada was also said about Indonesia. So why could Indonesia come back while Greece can’t?

Well, two obvious reasons: Indonesia had a currency that it could devalue, and did, massively. This caused a lot of short-term financial stress, but paved the way for export-led growth.

Look at how well Indonesia did during the global crisis of 2008-09.  Now explain to me how a 1.2 percentage point rise in US ten year bond yields are somehow devastating their economy.  I don’t deny there’s some link (markets show this), but surely the problems are much deeper.

So stop whining that I’m always picking on Krugman.

My trip to Australia started off at a Centre for Independent Studies conference outside of Brisbane.  It’s a classical liberal think tank where business people, pundits and policymakers meet to discuss ideas.   I presented the MM message and lots of people seemed interested.  Francis Fukuyama also spoke there.  It was the first time I’ve met him, although I’m a fan of The End of History and Trust.

As of today, it looks like the center-right coalition in Australia is likely to win the election in 10 days, joining similar parties in New Zealand, Canada and Britain.  Because America does not current have a center-right party, I don’t expect to see a center-right victory here in the near future.

I was particularly impressed with the talk given by the representative from the New Zealand government (Bill English) but will admit to knowing little about that place, other than that that their people live in Hobbit-style dwellings.

On a more serious note, the people at CIS were excellent, and seemed somehow more “reasonable” than similar groups in the US.  I was really impressed with the talk given by Stephen Kirchner.  Stephen is sympathetic to many of the ideas espoused by market monetarists, but has a slightly different take on the success of the RBA:

The new market monetarists argue Australia was a poster child for NGDP stabilisation during the financial crisis, but I interpret things differently. Prior to the onset of the financial crisis, inflation was out of control (CPI inflation running at 5%) and nominal GDP growth was running in the double-digits. The financial crisis saved the RBA from having to induce a domestic recession to bring inflation under control. The RBA was most successful when international conditions were doing the work for them.

No wonder they call it the lucky country.  I’ve added Stephen’s blog to my blogroll, and recommend that you take a look at it.

Then it was on to Sydney where I almost gave a talk at the RBA.  At least I was in the same building, and some RBA people attended.  But the talk was actually sponsored by the Economic Society of Australia.  (I’d like to thank Zac Gross for inviting me.)  I had a very productive conversation afterwards with some of the RBA people, including one who had worked at the Fed and knew a lot about it.  I was vigorously challenged by some really smart people, but I came away more convinced then ever that I am on the right track.  I’m pretty sure that there are no hidden flaws in my argument, rather that even Ben Bernanke himself would likely defend current policy against my criticism on the basis of arguments that I’ve considered and found non-persuasive.   BTW, the RBA’s (dual) mandate is literally carved in stone on the marble wall of their lobby.

I was told that Australia had 20 good years for policymaking, under both parties (in my view it was mostly Labour), but that the current government squandered some of the successes over the past 6 years.  Their fiscal stimulus was completely unnecessary, even using Paul Krugman’s criterion (don’t use fiscal stimulus until rates hit zero.) Fortunately for Australia, the current Labour government took office with almost no public debt, and thus the gross debt is still only 30% of GDP.  The likely new center-right government has promised a maternity leave benefit that is so absurdly extravagant (up to $75,000) that even the Labour Party is opposed.  A bit of “compassionate conservatism” is on the way.

Overall I was very impressed by Australia.  The airports seem very convenient (no horrible TSA system, just a few friendly blokes that wave you through.) Returning to American airports I felt I was in a third world country.  At Dallas I almost missed my connection despite the fact that there was a 2 hour layover. Australia surely has the highest living standards among all countries with more than 20 million people, perhaps 10 million.  It’s third on the Heritage free market list, trailing only Singapore and HK.

It’s nice to see countries with relatively low tax levels do well (Australia, Singapore, Switzerland, etc.) even using the standard criteria of liberalism.  It makes me think that many of the problems liberals attribute to America’s low tax ideology (failed areas like Detroit, etc), are actually caused by unrelated public policy mistakes.  I saw one blogger recently imply that Singapore was some sort of conservative dystopia because it has “inequality.”  This is a country with essentially no slums, excellent public education, great environmental policies, universal health care, etc, etc.  But because 17% are millionaires there is more “inequality” than some place where everyone is dirt poor.  Liberals used to care about poverty back in the 1960s, the change in emphasis to “inequality” (between the middle class and rich) is really a disgrace.

PS.  My first taxi driver said he was from the South Island of New Zealand.  So did my second taxi driver.  Then I took a bus and started chatting with the driver—yup, the South Island.  American taxi drivers usually come from some sort of hellhole in central Asia or Africa, where there is a civil war going on. God help the people of the South Island.  (Yes, I know about the earthquake.)

PPS.  Back in 2010 I pointed out that the Australian housing “bubble” still hasn’t burst.  That’s still true today.  Also true in New Zealand, Britain and Canada.  America is the outlier; bubbles usually don’t burst over a time frame where bubble predictions would be useful.  Yes, prices will eventually fall, as free markets always move up and down.  Even markets with no bubbles.