I’m still trying to figure out the MMT view of monetary policy. It’s not easy for me, because MMTers seem to think that “monetary policy ” and “changes in interest rates” are pretty much the same thing. I view that as reasoning from a price change, but even some conventional economists make that mistake.

For a brief moment on page 406 of Macroeconomics (by Mitchell, Wray and Watts) it seemed like they understood this distinction:

In a growing economy, it is likely that aggregate demand conditions will improve at times when the market rate of interest rises as the central bank often raises its target rate in an expansion.

Yes! Interest rates are largely endogenous, mostly reflecting changes in output and inflation expectations. When the economy is booming and/or inflation is rising, then market interest rates will also tend to increase. My only quibble is that the authors need not have added, “as the central bank often raises its target rate in an expansion”, as this relationship is true even in an economy that doesn’t have a central bank (say the US prior to 1913.)

But that minor quibble contains the seeds of a major problem, as I don’t know if MMTers even recognize the income and Fisher effects. At times they seem to assume that all changes in interest rates are “monetary policy”, i.e. the liquidity effect.

MWW continue:

[W]e would not observe investment falling when the market interest rate rose because the IRR of each project could also be increasing

So far so good. The internal rate of return will rise with inflation and/or output growth. But then this:

Thus, it is important to avoid applying a mechanical interpretation of the concept of the [Marginal Efficiency of Capital]. Keynes, in fact, did not think investment would be very responsive to changes in the market rate of interest, especially when the economy was in recession or boom.

Woah! The term “Thus” is mixing up two unrelated issues. First, the fact that because interest rates are largely endogenous you often observe interest rates move procyclically. The second (and more dubious) claim is that this is evidence that the economy is not very responsive to interest rate changes. But that doesn’t follow at all. As an analogy, it is true that budget deficits are usually high when the economy is very weak, but even a monetarist like me would never argue that this proves that exogenous increases in deficit spending are contractionary.

In fact, if interest rates decline due to a highly expansionary monetary policy, then it will have a big impact on aggregate demand. On the other hand, if interest rates decline due to the income and/or Fisher effect, then you should not expect an expansionary impact.

In mainstream economics, this can all be easily explained by referring to the gap between the target interest rate and the natural interest rate. But I’m told that MMTers don’t believe the natural interest rate matters, or they think it’s always zero, or something. (BTW, Do they think the real or nominal natural interest rate is zero?)

On the next page (407):

The extreme optimism that typically accompanies a boom also would reduce the sensitivity of investment to changes in the market rate of interest. With high expected returns, firms would be prepared to pay higher borrowing costs.

That seems to confuse shifts in the MEC with changes in the elasticity of demand for investment (as a function of interest rates), unless I’m misinterpreting their claim. The fact that interest rates are higher during a boom doesn’t mean that investment is less sensitive to changes in interest rates.

On page 464, you can see where MMTers’ confused ideas about endogeniety cause them to really go off the rails:

The fact that the money supply is endogenously determined means that the LM schedule will be horizontal at the policy interest rate. All shifts in the interest rates are thus set by the central bank and funds are supplied elastically at that rate in response to the demand. In this case, shifts in the IS curve would not impact on interest rates. From a policy perspective this means the simple notion that the central bank can solve unemployment by increasing the money supply is flawed.

No, no, a thousand times no!!! The final two sentences absolutely do not follow from the first two sentences, which leads me to believe that MMTers misunderstand the concept of endogeniety.

It’s cheating to claim the money supply is “endogenous” and then completely ignore the fact that the interest rate is also endogenous. In the second sentence they mention that central banks “shift” the interest rate. Yes they do, and they do so to prevent shifts in the IS curve from destabilizing the economy. As a result, shifts in the IS curve absolutely do impact interest rates. A rightward shift in the IS curve right after Trump was elected caused interest rates to go up. I could cite 1000 similar examples. Central banks are like the child that runs out in front of a parade and then has the delusion that he is determining the route of the parade.

So the third sentence is wrong; IS shocks do affect interest rates. But the fourth sentence is even worse. The facts cited in the first two sentences absolutely do not imply that the central bank can’t address unemployment by increasing the money supply.

Go back to the late 1970s or the early 1980s, when interest rates were in the 10% to 15% range. Does anyone seriously believe that a huge increase in the money supply would have failed to boost employment, at least until sticky wages caught up?

MMTers would say a big increase in the money supply is impossible because it would push interest rates to zero. But that completely misses the point. Let’s say the Fed just increased the money supply enough to push rates from 12% to 2%. Does that not boost employment?

Another argument I’ve heard is that lower rates don’t matter because interest payments are a zero sum game. Some people pay less interest but others earn less interest. Yes, they may not matter for consumption in a simple Keynesian cross model, but they certainly do matter for investment, even in the simple Keynesian model. Of course I think that the Keynesian cross model is wrong, but excess cash balances also drive NGDP in the monetarist model, so either way (exogenous and permanent) money creation is expansionary, at least when rates are positive (and in reality even when they are zero.)

Just to be clear, I don’t agree with the Keynesian view that easy money lowers interest rates, nor do I agree with the NeoFisherian view that easy money raises interest rates. Both are reasoning from a price change. But even using the flawed Keynesian model (where easy money lowers interest rates), the MMT people are mistaken about endogenous money, unless I’m missing something. And after three weeks of arguing with commenters, I’m finding it harder and harder to imagine that I’ve missed some brilliant MMT insight that explains all of this.

Because they get monetary policy wrong, they also get fiscal policy wrong. Thus on page 506 we are told that one reason why “fiscal deficits do not place upward pressure on interest rates” is because “The official interest rate is set by the central bank”.

Thus in the MMT world, the interest rate is not subject to macroeconomic shocks like other macro variables, it’s just an arbitrary number set by the central bank. IS shocks and fiscal stimulus don’t raise rates because the rates are set by the central bank. And the central bank has no discretion to change the money supply, because doing so would cause interest rates to change. And that would be bad because . . .

Again, I don’t believe “endogenous” means what MMTers think it means.

PS. I have a related critique of MMT over at Econlog.

This will raise a few eyebrows:

Trump Cheers ‘Terrific’ Rise in COVID Cases During Off-The-Rails Vaccine Summit . . .

But after a few minutes of touting the success of Operation Warp Speed, his address morphed into an unspooling of grievances over the election outcome as well as an unfounded assertion that the rising number COVID-19 cases across the country was, in fact, a “terrific” development.

“I hear we’re close to 15 percent. I’m hearing that, and that’s terrific,” Trump said of the percentage of Americans who have contracted COVID-19.

Yes, it’s “terrific” news that the death rate from Covid has shot up to 3,000/day right before the vaccine is being rolled out.

“Horrific” hasn’t changed over the centuries. It was first recorded in English in 1653, the OED says, and still has its original meaning: “causing horror, horrifying.”

But “terrific” is a different story. This adjective originally meant “causing terror, terrifying; terrible, frightful; stirring, awe-inspiring; sublime.”

I recently published a 55-page Mercatus paper arguing that we should not equate interest rates and monetary policy. I’m not sure if anyone actually read the paper, but people do read Twitter. Thus I was glad to see these tweets from Nick Rowe:

Here’s Alex Tabarrok, reacting to news that Operation Warp Speed was more like Operation Warped Values:

In our discussions, we were talking about at least a $70 billion dollar program and optimally double that and we continually faced the sticker shock problem. Investing in unapproved vaccines seemed risky to many people despite the fact that the government was spending trillions on relief and our model showed that spending on vaccines easily paid for itself (the mother of multipliers!). I argued that this was the world’s easiest cost benefit calculation since Trillions>>Billions. But it was hard to motivate more spending—not just in the United States but anywhere in the world. For reasons I still don’t understand anything out of the ordinary–big spending on at-risk vaccines, spending on testing and tracing, challenge trials–was met with a kind of apathy and defeatism. As I said in July:

“Multiple people [in Congress] have told me that things move slowly, no one is stepping up to the plate, leadership is absent. “Who is John Galt?,” they sigh. Ok, they don’t literally say that, but that sigh of resignation is what it feels like in the United States today at the highest levels of government.”

(The entire post is excellent. Tyler’s post is also highly recommend.)

This all seems so familiar. During late 2008, I kept thinking that for reasons I still don’t understand, the Fed remains strangely passive in response to the Great Recession. Why haven’t rates been cut to zero? Why don’t they adopt level targeting, an idea that Bernanke had previously recommended for the Japanese? Why not a “whatever it takes” approach to QE? How about negative interest on reserves? There was this strange passivity that was completely incommensurate with the scale of the disaster.

In retrospect, I suspect the problem is that big bureaucracies cannot turn on a dime. The only way to make this work is to have the system in place before the disaster strikes. Average inflation targeting is a small but important step toward being more proactive. I hope the Fed doesn’t stop there; we’ll know much more 12 months from now. Indeed I suspect the next 12 months will determine whether Powell’s tenure will be a success or a failure.

PS. Should the Pfizer vaccine be given in one dose or two? Please answer the question from a utilitarian perspective.

I favor fiscal relief for the unemployed and small businesses, but not fiscal stimulus. But what sort of fiscal policy do Fed officials favor? Most people assume that the Fed wants more fiscal stimulus, and perhaps that’s true. But I’m not so sure.

Tim Duy directed me to a curious statement by SF Fed President Mary Daly:

The U.S. economy is likely to slow and perhaps even stall in coming months amid the surge in coronavirus cases, San Francisco Federal Reserve Bank President Mary Daly said on Tuesday, but the central bank should not respond, as it typically does to slowdowns, by pulling out more stops.

“It is not the time to stimulate the economy aggressively and get people out in the economy because that would be unsafe,” Daly told reporters on a call after a talk at Arizona State University, held virtually. “I judge policy as in a good place.”

So an increase in aggregate demand would be unwise because it would be unsafe. And yet on October 15 Daly said this:

Monetary policy, including interest rates and the pace of asset purchases by the Federal Reserve are in a good place, but more fiscal stimulus may be needed to ensure that households and state and local governments are able to recover, San Francisco Fed President Mary Daly said Thursday.

And in a November 10 interview, Steve Liesman asked her, “If the fiscal side does less does that mean the Fed needs to do more?” As in almost every single case where Fed officials are asked this question, Daly didn’t directly answer the question. (BTW, it’s a worrisome sign when policymakers don’t answer questions.) Instead, Daly strongly emphasized that fiscal stimulus was needed to support unemployed workers and small businesses. I.e., fiscal relief was needed, not “stimulus”.

We don’t need to send $1200 checks to professionals making $100,000/year.

She also indicated that the Fed had the option of making policy either more expansionary or more contractionary. That’s also my view.

In a normal recession, Fed officials (or at the very least Fed doves) would favor more monetary stimulus. They are not doing so today because they believe the recession is mostly caused by Covid-19. The virus caused spending to suddenly shift from people-oriented services toward the purchase of goods, creating mass unemployment. Tim Duy points out that other doves such as Charles Evans are also opposed to additional monetary stimulus. Here’s Duy:

Ok, so maybe you don’t trust Daly’s signal. She’s newer. She’s on the west coast. I’m on the west coast too. What do we know about what’s going on? Let’s pull another dove then, this time Chicago Federal Reserve President interviewed after the labor report and via Nic Timiraos at the Wall Street Journal. Evans very clearly says they don’t need to revisit the asset purchase program until 2021:

And then Duy quotes from the WSJ article:

“The risk characterization has improved,” Chicago Fed President Charles Evans said on Friday…

…“As we see progress each and every week and month, that really sets the pace for a better recovery in 2021,” said Mr. Evans. “We’re still looking to see how things are going to work themselves out” before making decisions about whether to provide additional stimulus, he said.

So Evans also sees no current need for additional stimulus. That doesn’t mean he is opposed to fiscal “stimulus” (as in relief), but I suspect his views are closer to Daly’s views than to those who want to goose the economy with a flood of free money.

This post is in response to all those people who tell me I don’t know what I’m talking about, and that all the cool people favor more stimulus. Well, I’d say Mary Daly is pretty cool.

Daly was born in Ballwin, Missouri. Her father was a postal worker and her mother was a homemaker. She said, “we were not poor, but we weren’t very wealthy, either. And at some point my family just, sort of, imploded. And my siblings went to live with my grandparents and I went to live with friends. And I dropped out of high school.” At the time, she was 15 years of age. By age 16, she was living on her own working at doughnut shops and retailer Target, struggling to scrape together a full-time salary.

Daly went on to earn a general educational development (GED) and eventually a bachelor’s degree in economics and philosophy from the University of Missouri-Kansas City in 1985. She later received a master’s degree from the University of Illinois Urbana-Champaign in 1987 and a Ph.D in economics from the Maxwell School at Syracuse University in 1994. She completed a post-doctoral fellowship at National Institute of Aging at Northwestern University in 1996.

PS. Patrick Sullivan directed me to a WSJ article that mentions a Mercatus paper I did back in 2013:

They don’t work. “Why the Fiscal Multiplier is Roughly Zero” is the title of a 2013 paper by Scott Sumner for George Mason University, summarizing the Obama stimulus. The key line is that “estimates of fiscal multipliers become little more than forecasts of central bank incompetence,” meaning the Federal Reserve’s job of maintaining stable monetary conditions should actually require it to fight against stimulus.