Not much time today . . . initial market reaction to headline, and subhead:

That’s the sweet talk I was asking for a couple days ago.

I have an open mind on this question, but so far I don’t see much evidence that it is.  Let’s break this down into two parts:

1.  Does finance have an important impact on the path of NGDP.

2.  Does finance have an important impact on RGDP, through mechanisms other than its impact on NGDP?

A whole lot of miscommunication could be prevented if people would at least briefly frame their arguments in terms of these two questions, even if they prefer to spend 98% of their time ignoring these two questions.  That’s because it makes it much easier to understand what they are talking about.  For instance, consider a big drop in lending.  Is that a supply or demand shock?  Is it something that impacts RGDP directly, or only via it’s impact on AD?  It could be either, or both, and it’s often hard to tell from a person’s blog post which channel they are talking about. (Kudos to Arnold Kling for being crystal clear.)

Finance certainly has an impact on NGDP under a gold standard, as does drug smuggling, and also under a poorly run fiat regime, especially at the zero bound.  It’s not at all clear that finance has any impact under a well run fiat regime.  For instance, NGDP took off like a rocket after March 1933, even as much of the US banking system was shutdown.

Finance certainly might have an impact on RGDP, even if NGDP is well behaved, but I haven’t seen much evidence for that proposition.  At least not in the US.  For instance, RGDP took off like a rocket after March 1933, even as much of the US banking system was shutdown.  And no, I’m not repeating myself.

This post is partly in response to a recent post by David Glasner, which contains this observation:

Now, as one who has written a bit about banking and shadow banking, and as one who shares the low opinion of the above-mentioned commenter on Kaminska’s blog about the textbook model (which Sumner does not defend, by the way) of the money supply via a “money multiplier,” I am in favor of changing how the money supply is incorporated into macromodels. Nevertheless, it is far from clear that changing the way that the money supply is modeled would significantly change any important policy implications of Market Monetarism. Perhaps it would, but if so, that is a proposition to be proved (or at least argued), not a self-evident truth to be asserted.

Market monetarists have differing views of money.  For myself, I don’t find the aggregates to be at all interesting, and hence pay no attention to “money multipliers.”  I know there are people out there who are obsessed by the supposed implications of certain accounting relationships, but I try to avoid the subject as much as possible.  If it does arise I simply refer to Krugman’s brilliant dismissal of one pesky blogger—Krugman said “it’s a simultaneous system.”  In other words, accounting tells you nothing about causation.

Finance certainly looks important.  But that’s mostly because monetary policy has a huge impact on finance.  Since 99.999999% of people don’t know how to identify monetary shocks, they reverse the causation—assuming finance is impacting NGDP.  Remember 1931?  I thought not.  But how about 2008?

The focus on finance may have a downside that many people overlook.  Here’s a small passage from my Depression manuscript:

Enthusiasm for Hoover’s proposal was not confined to the NYT.  The June 27 [1931] issue of the CFC (p. 4635) enthused “President Hoover has electrified the whole world and possibly turned the tide of business depression”.   A “Hooverstrasse” was proposed for Berlin.  The British compared the proposal to a new armistice and suggested that the move ranked in importance with the U.S. entry into World War I.  Of course Hoover’s debt moratorium was subsequently shown to be ineffective in arresting the ongoing depression.  Nevertheless, the financial community had great hope for the plan, which indicates they saw the debt crisis as inhibiting recovery.

Between June 2 and June 27the Dow soared by almost 29 percent, and the next day’s NYT (p. 7N) suggested that “War Debt Plan Aids Commodity Prices. . . Sharpest Advance Since Last Summer Shown in Most Groups in Fortnight”.  Although the reaction of financial markets to the moratorium was unquestionably enthusiastic, the reasons are unclear.  Perhaps it was felt that the moratorium would reduce gold flows to countries with a high propensity to hoard (i.e. the U.S. and France.)  The June 27^th CFC (p. 4653) suggested that Hoover’s goals were limited and that it was hoped that the agreement could lead to a climate of “international good will”.

On June 30^th the NYT (p. 1) quoted a bank official as indicating that “it would be a mistake to over-emphasize the proposed debt adjustment as an economic factor in itself”.  Unfortunately, Hoover strongly opposed two initiatives that might have provided meaningful help for Germany; a coordinated international policy of tariff reduction, and a coordinated attempt to lower the world gold ratio through expansionary monetary policies.[1]  Those who have followed the recent events in Europe will see an obvious parallel.  The Europeans have worked hard to develop a debt relief plan for countries on the periphery, but have failed to take the one step that could actually make a big difference, an ECB policy aimed at faster nominal growth in the eurozone.

When I present my talk on the 2008 recession there are always questions about my claim that money was tight in 2008.  Smarter questioners will often say it doesn’t matter whether you call it loose or tight.  It’s just semantics.  I sympathize with this view, but I think it’s wrong.  If monetary policy was widely seen as being highly contractionary in late 2008, the recession would have been far milder.  That’s because people would have demanded an easier monetary policy.  As a counterfactual, imagine the same degree of tightness achieved with an 8% nominal interest rate.  Don’t you think that when unemployment soared to 10% there would have been a chorus of demands that rates be cut?  Everyone would agree that money was tight if we had 8% nominal rates and deflation in early 2009.  So words do matter.

Here’s Ryan Avent:

So why is tapering being discussed at all? A good question. Some of those in favour of tapering are of the view that the size of the Fed’s balance sheet, rather than the pace at which it is growing, is the right gauge of the stance of monetary policy (at least where QE is concerned).

OK, a question is being raised.  Which is the better way of characterizing the stance of monetary policy. Let’s think about this logically . . .

.  .  .

.  .  .

.  .  .

Um, what exactly does ‘stance’ mean?  Further down I put the definition of ‘stance’ that I found on the internet. But that definition isn’t really helpful.  So what does ‘stance’ mean?  I don’t doubt that somewhere you can find a definition where it refers to the level of interest rates.  But there are two problems with that definition:

1.  It’s wrong; no one except Joan Robinson thinks high rates during hyperinflation represent tight money.

2.  It’s not really a definition of ‘stance,’ it’s an example of how the term might be applied to the level of interest rates.  But it doesn’t tell us what ‘stance’ actually MEANS.  Why are high interest rates viewed as tight money? And hence it’s not helpful in figuring out how to characterize a non-interest rate-oriented monetary policy like QE.  Is it the level, or the rate of change in bond holdings that matter?  We can’t answer that question without knowing what ‘stance’ means.  And there is no definition that makes any sense.

Actually there is one definition that is logical, Ben Bernanke’s definition:

The imperfect reliability of money growth as an indicator of monetary policy is unfortunate, because we don’t really have anything satisfactory to replace it. As emphasized by Friedman  . . . nominal interest rates are not good indicators of the stance of policy . . .  The real short-term interest rate . . . is also imperfect . . .  Ultimately, it appears, one can check to see if an economy has a stable monetary background only by looking at macroeconomic indicators such as nominal GDP growth and inflation.

But since Ben Bernanke and I are the only two people in the world who believe that this is the “right” definition (i.e. most sensible), it’s not very helpful in communication.  Make that one, Bernanke has stopped believing this.

For the rest of the population, it makes about as much sense to argue whether the level or change in bond holdings best measures the phluggeratiousness of monetary policy as it does to argue which best measures the stance of monetary policy.  Of course everyone except Steve Williamson agrees that doing more QE is as expansionary or more expansionary than not doing more QE.  But the absolute stance?  First we’d have to come up with a definition of ‘stance.’

Here’s stance defined on the internet:

1. the way in which someone stands, esp. when deliberately adopted (as in baseball, golf, and other sports); a person’s posture.

   “she altered her stance, resting all her weight on one leg”

   synonyms:

   posture, body position, pose, attitude More

   • the attitude of a person or organization toward something; a standpoint.

     “the party is changing its stance on the draft”

     synonyms:

     attitude, stand, point of view, viewpoint, opinion, way of thinking, outlook,standpoint, position, angle, perspective, approach, line, policy More

2. 2.

   CLIMBING

   a ledge or foothold on which a belay can be secured.

If you google the phrase: “stance of monetary policy definition,” the first item is from a Federal Reserve publication:

There is no clear consensus about the appropriate definition of a “neutral interest rate” to be used to evaluate whether monetary policy is “easy” or “tight.”

Yikes, that’s not very helpful.

[Update:  Rajat pointed out that Google searches are tailored to the browsing habits of the searcher.  So please ignore the rest of this embarrassing post.]

So let’s go to the second item:

When I started blogging I kept claiming that the steep recession of 2008-09 was caused by ultra-tight Fed policy.  I had the distinct impression that almost no one agreed with me. Even some who favored NGDPLT preferred to call the mistakes “errors of omission,” not tight money causing a recession.

Oh wait, that’s from TheMoneyIllusion.  The one that contains the Bernanke quotation.  I’m using Google to try to find out what a word means, and it brings up my own rambling blog post.

Moving on we have Investopia’s definition in the 3rd and 4th spot:

When a central bank (such as the Federal Reserve) attempts to expand the overall money supply to boost the economy when growth is slowing (as measured by GDP). This is done to encourage more spending from consumers and businesses by making money less expensive to borrow by lowering the interest rate. Furthermore, the Federal Reserve also has the authority to purchase Treasuries on the open market to infuse capital into a weakening economy.

Also known as an “easy monetary policy”.

At least it’s a definition.  But “attempts?”  The Fed cut rates in 1930 in an “attempt” to boost the economy. Was that easy money?  Not according to the most respected book on monetary history ever written.

Number 5 is some EU article.  Number 6 is something I wrote for Cato Unbound.  Number 7 is a David Beckworth post.

So 40% of the top 7 items dredged up by Google are written by market monetarists.  I guess that makes us the experts.

Matt Yglesias has a good post showing one more reason why income is meaningless:

One issue this poses is that analysis of political issues in terms of “income” quartiles can get pretty misleading. A married couple where dad earns $65,000 a year and mom works part time bringing home $15,000 a year is in the fourth quartile of the American income distribution. A 70 year-old widower whose $2 million in savings bring him an annual income of approximately $80,000 is also in the fourth quartile. But their policy-relevant economic interests are unlikely to have very much in common since in reality their financial situations are entirely dissimilar.

That’s right—and let’s go a bit further.  Suppose the old guy with $2 million earned $200,000/year for 40 years, and was a high saver.  Suppose his twin brother had the exact same income, but spent all his money. The twin brother lives on Social Security.  Who is better off?  Neither.  Both had the same lifetime wage income, and hence equal resources.  Economists take a “lifetime consumption” perspective. The only difference between these brothers is one chose to spend the money when young and the other chose to spend it when old.  It’s as if one lived by himself in a house and the other lived with roommates in an apartment.  No sensible person would say you are better off (than someone who choses to live alone) because you share an apartment with others and thus pay less rent.  These are consumption CHOICES.

[Now of course people might be better or worse off because of the way their brains are wired, but that’s far outside the scope of public policy—even far beyond Mankiw’s “tax the tall” reductio ad absurdum.  At least you can measure tall people; you can’t measure brain wiring.]

The guy with $2 million has already been fully taxed on that wealth, and should of course pay no tax on his capital income.  That’s why smart progressives like Yglesias favor progressive consumption taxes, at least where it’s possible to clearly identify and separate wage and capital income, as with someone surviving on their 401k mutual funds.

In all probability the guy with $80,000 in retirement income earned far more wage income when younger than the hypothetical family discussed by Yglesias, where each member made an average of $40,000/year. So on utilitarian grounds he should have paid a higher rate of wage tax during his earning years than the hypothetical family making a total of $80,000 in wage income.

PS.  There was some discussion of marriage penalty at the end of a recent post.  A few points.  I am aware of the “progressivity/treat households as a single unit” dilemma, except that it has no bearing on the marriage penalty.  If that was a valid argument, it would call for applying the marriage penalty to any two people who live together, and it would not apply to married people who live at separate addresses.  But it doesn’t.  It’s a tax on marriage, and has nothing to do with the claim that “two can live as cheaply as one” which is of course false.

And even if the argument were true, it would be irrelevant.  People who eat dog food have more money to spend on other stuff than people who consume human food, but that DOESN’T mean they should have to pay a higher percentage rate of income tax.  That’s a lifestyle choice.  Single people who live alone presumably enjoy it more than single people who share an apartment with others.  It makes no sense to assume the latter group is better off because they have more income after paying rent, and tax them more. I preferred to live alone when single, and didn’t ask for a tax break.  So I had this view even when it went against my interests.

And even if you wanted to argue the tax system should try to figure out who’s better off by virtue of consuming more wisely, the marriage penalty ignores an even greater inequality.  Even with a flat tax, and no formal marriage penalty at all, a family with two people each making $100,000 is much worse off than a family where one makes $200,000 and the other is a homemaker.  That’s because the homemaker’s output is completely tax free.  Or if you prefer, the two income household would have to hire a maid to duplicate the consumption bundle of the one income household.  The marriage penalty takes this existing unfairness to double income households, and makes it even worse by making the tax system progressive.

There is no justification for the marriage penalty.  None.  I suspect many Dems would joins the Swedes in allowing people to file separately, but maintain progressivity.  I suspect the GOP would agree to eliminate progressivity.  But the two parties cannot agree on a solution, so we end up with a monstrous absurdity—a tax on marriage.

PS.  As usual, I will not defend the claim that capital income should not be taxed. If you have taken a course in public finance and understand the reason but don’t accept it, I’ll listen to your concern.  If you say; “why shouldn’t all income be taxed” your comment will be ignored.  In other words consider this a “wonkish post” addressed to other economists or well-informed amateurs.

  James in London sent me the following:

Sweden‘s central bank cut its main interest rate for the first time in a year and signaled it won’t tighten policy until the start of 2015 to combat deflation in the largest Nordic economy.

.   .   .

“Inflation has been unexpectedly low and, despite the recovery, inflationary pressures over the coming year are expected to be much lower than in the most recent forecast in October,” the bank said. “Slow increases in the repo rate are not expected to begin until the start of 2015.”

.   .   .

“The credibility of their inflation target has started to chip away at the edges so it would have been weird if they didn’t do anything about that,” said Mikael Grahn, an analyst at Danske Bank A/S in Stockholm. “The changed repo rate forecast feels more reality-based but there’s a risk they may have to delay the timing of their first rate increase even further.”

Investor Survey

A survey by SEB AB published last week showed a majority of investors and traders thought the bank’s perceived reluctance to cut was harming its inflation target. More than 25 percent also said the bank’s underlying inflation forecast wasn’t credible, while half urged the bank to introduce a tolerance band.

It must be a nice feeling for Lars Svensson to be able to say “I told you so” every time he runs into his former colleagues at the Riksbank.  And there was never really any serious doubt that he was right and they were wrong.

This also made me smile:

Central bank easing will coincide with laxer fiscal policy. The government has said it will cut income taxes next year for a fifth time since coming to power in 2006. Prime Minister Fredrik Reinfeldt says the cuts are designed to boost domestic demand.

I know I shouldn’t say this because the Swedish government has done a good job on supply-side issues.  I like many of their policies.  Even the income tax cut may be wise.  But to cut income taxes in order to boost aggregate demand at a time when the central bank is not at the zero bound is just beyond clueless.  We truly live in a period of mass ignorance.  Everything macroeconomists have learned over the past 100 years has gone right out the window.  Policymakers are hopeless. Even in enlightened Sweden.