Archive for March 2021


Ed Nelson on Milton Friedman

One of my favorite David Beckworth podcasts is his interview of Ed Nelson, who has recently published a book on Milton Friedman (which I plan to read soon.) Here Nelson discusses how Friedman responded to Sargent and Wallace’s Unpleasant Monetarist Arithmetic paper:

And, it’s a good news for monetarists because you can separate monetary and fiscal policy, even with fiscal policy running large deficits. And so Friedman argued that as a practical manner, other than the early 80s, it was the case that US history was characterized by R being lower than little g, growth rate of government spending.  So when you have that, you had a situation in which you can run deficits, you can accumulate debt and you’ll still have debt to GDP, public debt to GDP, often tending to decline. So he regarded that like the practical case. That was his answer to Sargent and Wallace. And in fact, if you look at the Gilder and Fisher textbooks from the 80s, the r less than g edition, and this is something that, has had life breathed into it by Olivier Blanchard’s paper, it’s something that’s been a textbook point for a long time. And Friedman made the point in 1987. And of course it’s basically implicit or explicit in Sargent and Wallace, but anyway, it wasn’t what Sargent and Wallace pushed, but it was what Friedman pushed when he read Sargent and Wallace that, “You will be able to separate monetary and fiscal policy because R is less than G.”

Today, R (interest rates) are even further below g (economic growth.)

A lot of nonsense has been written to the effect that “there is no such thing as a money multiplier”. Nelson sets the record straight:

And the reason he thought an M2 target was feasible is that he thought that the monetary base could be used to manage M2. He believed that there was a ceteris paribus money multiplier relationship between the monetary base and M2. The monetary multiplier is, again, something that gets a lot of trash talking among modern day economists and people who say, “all textbooks are all wrong about the money supply process.”

I think that that is really doing a disservice to the idea of ceteris paribus. Because if you just look at a world without interest on reserves or without a lot of the complications, there is a logic why a change in reserves would lead to a change in deposits. You can add all sorts of bells and whistles to the money supply function, but that’s the basic message that I think is valid.  And so, he was arguing, you should be able to control M2, by offsetting with open-market operations factors affecting the money multiplier. So, you can argue that that was a sense of fine-tuning prescription, the fine tuning would be getting an M2 target, but he believed there was a fairly reliable relationship between the monetary base and M2 and after the 1990s, certainly that was quite accurate.

Friedman used M2 as an intermediate target in roughly the same way as I use NGDP futures prices as an intermediate target. The correct criticism of the money multiplier is that it is not particularly useful, even without IOR, because targeting M2 is not a good idea.

Another common misconception is that monetarists (wrongly) assumed that the actual velocity of circulation was constant. Not so:

Beckworth: And I think he would argue, and correct me if I’m wrong here, he would argue that if the Fed had done this, if the Fed had successfully targeted, say, M2 this whole period, this whole time, then velocity would have been more stable. Is that fair? And therefore this breakdown in the money demand relationship with income would be less of an issue.

Nelson: That’s right. He believed, for example, in the 1930s, particularly that the big fall in velocity, and it was a big fall in the velocity, even though the money and nominal spending had a big relationship. It was a big fall in velocity, but he thought that was due to big uncertainty engendered by the monetary and economic collapse. So he thought that velocity fluctuations often were triggered by monetary instability. And that certainly is something that will be widely shared when it comes to hyperinflation which is well-known in term, inflation engenders big increases in velocity.

PS. In the National Review, David Beckworth pushes back against the view that big deficits will lead to high inflation

PPS. Matt Yglesias has a very clear explanation of why NGDP is a better target than inflation.

PPPS. George Selgin has a very informative post on banknotes during the 19th century. Here’s the image he should have used for government money porn:

Bartenders would hate me

Tyler Cowen directed me to this Adam Ozimek tweet:

When fiscal stimulus is spent in the US then we can expect inflation to average 2% during the 2020s. If fiscal stimulus is spent overseas then we can expect inflation to average 2% during the 2020s.

But interest rates in the US might be a tiny bit lower if the money is spent overseas.

PS. My fellow economists might also find me to be highly annoying.

Back to normal?

A year ago I suggested that we had under-reacted in the early stage of Covid-19 and would overreact at the end of the pandemic. And that seems to be happening.

I recently visited my mother, who lives in an apartment complex that caters to older people. All the people residing there have received both doses of the vaccine, and yet all sorts of restrictions remain in place. People still need to wear masks, and outside visitors are limited to 2 at a time. The front desk kept asking me if I’d recently been out of the country—as if that would have made me more dangerous!

Bryan Caplan is marketing t-shirts to encourage society to get back to normal, once vaccinated:

This story caught my eye:

Biden receives high marks on COVID-19, lags on immigration, guns: POLL . . .

A significant slice of the country also backs how Biden is handling distribution of the COVID-19 vaccines, with 3 in 4 Americans approving.

The evidence suggests that the US government is doing a poor job on vaccine distribution, and also that nothing unusual is happening at the border.

So why the poll results? I suspect it’s because the media is telling the public that the vaccine distribution is going great and the border is a disaster. The narrative is that Trump was tough on the border and incompetent on Covid, so reporters simply look for any scrap of information to confirm their priors that Biden will be weak on the border and more competent on Covid.

It’s like back in 2008, when the narrative said it was a housing/banking crisis, and no one in the media bothered to investigate why the Fed was refusing to cut interest rates after Lehman failed. Not part of the pre-determined narrative.

PS. Yes, most countries are doing even worse on vaccines, but that doesn’t mean we are doing a good job.

Do as we say, not as we do

International relations are full of hypocrisy, but rarely so obvious as in this case:

Secretary of State Antony Blinken publicly called on Paraguay’s government not to switch relations from Taipei to Beijing. 

Decades ago, the US government “switched relations” from Taipei to Beijing. Did we switch back?

Meanwhile, China’s most influential newspaper says Covid-19 may have come from a Chinese lab. I never bought this conspiracy theory, but if a major Chinese newspaper says so . . . well, what should I believe?

And China is making a big deal out of the fact that a retired US military officer suggested that the CIA may want to use Uyghurs to destabilize China:

In a 2018 speech retired US army colonel Lawrence Wilkerson said: “If the CIA has to mount an operation using those Uygurs … Well, the CIA would want to destabilise China, and that would be the best way to do it.”

China’s treatment of the Falun Gong is comparable to its treatment of the Uyghurs. Serious question: Why is the West (rightly) outraged by the treatment of the Uyghurs, but silent on the treatment of the Falun Gong?

Here’s The Economist:

Today it is black radicals in the Bay Area who are most nostalgic for what China once represented. Tyson Amir grew up in East Oakland, the son of Black Panther affiliates. He travelled to China in 2018 to follow in the footsteps of his “elders”, who raced to “beat Nixon” to China in 1971. Sanyika Bryant, another Oakland-based activist, used to keep a photo of Mao and Robert Williams, a black-defence leader, as his screensaver. . . .But “there’s a lot of people, especially younger organisers, who have no clue about this history,” he sighs. . . .

This is partly because China has changed. As authoritarian as it was under Mao, it is now capitalist (albeit with Chinese characteristics), and no longer a wellspring for revolutionary ideas. 

I don’t believe the writers for The Economist have any idea how authoritarian China was under Mao.

PS. This Noah Smith post on China is very good.

MMs, MMTers, Larry Summers, young tweeters, and politicians

Larry Summers sees a roughly equal chance of three outcomes: high inflation, a soft landing, and the Fed slamming on the brakes so hard that the economy falls into recession. That’s a nice prediction, as whatever happens he won’t be wrong. (I’m being sarcastic. I don’t have much better to offer, other than to look at market forecasts.)

Larry now seems viewed as some sort of old fuddy duddy, to be contrasted with hip young pundits who think worry about inflation is as old fashioned as a 70s-era disco music.

Some people associate the “What, me worry?” school with MMTers, which seems kind of strange. As far as I can tell, MMTers are the most likely to believe that inflation is caused by big deficits. If inflation is rising, then the MMTers say that tight money won’t work, as open market sales merely swap one government liability for another, without changing income. That means inflation can only be stopped by tax increases, which means that if you haven’t stopped inflation then that indicates that your budget deficit is too big. Thus in the MMT model, inflation is basically caused by excessively large budget deficits. A very crude fiscal theory of the price level.

But then maybe I’m all wrong, as trying to pin down MMTers is like playing a game of whack-a-mole (as Paul Krugman once observed.) All I know for sure is that if we get a lot of inflation then MMTers will say, “See, we told you to raise taxes”, and if we don’t, they’ll say, “See, we didn’t expect inflation.”

Meanwhile, young tweeters seem to forget the Great Inflation happened, or perhaps that it was caused by some sort of oil shock. How oil shocks cause double digit NGDP growth has never been explained. Everything we learned about unreliable Phillips Curves and shifting inflation expectations seems to have been forgotten. You simply can’t have too much stimulus.

I suppose their ignorance is understandable. If parents expertly adjust the thermostat to keep the house temperature at 71 to 73 degrees for 20 years, with a 72 degree target, can you blame the kids who grew up in that house for thinking that thermostats don’t have much impact on temps? (Let’s hope Powell knows!)

My views are orthogonal to this intra-Keynesian debate. I don’t think the fiscal stimulus is a good idea, but not because I expect much inflation. The inflation rate will be determined by the Fed. Rather it’s a reckless policy because it will lead to higher tax rates in the future and won’t do much to generate growth beyond Q3. (Deficits do cause higher interest rates, but only slightly higher in a country like the US.)

For 250 years of American history, politicians have held the peacetime budget deficit in check because of fears of either inflation or higher interest rates (or perhaps a loss of confidence in the gold standard.) What would happen if they begin to sniff out that the actual risk is not inflation or much higher interest rates next year, rather the risk is higher taxes in 20 years, after they’ve safely retired? How would they respond to this information?

I fear that we are about to find out.