Neo-Fisherism, missing markets, and the identification problem

I’ve done recent posts on Neo-Fisherism, and the problem of identifying the stance of monetary policy.  I’ve also pointed out that if we can’t identify the stance of monetary policy, we can’t identify monetary shocks.

This is going to be a highly ambitious post that tries to bring together several of my ideas, in a Grand Theory of Monetary Policy.  Yes, that’s means I’m almost certainly wrong.  But I hope that the ideas in this post might trigger useful insights from people who are much smarter than me and/or better able to handle macro modeling.

NeoFisherians argue that if the Fed switches to a policy of low interest rates for the foreseeable future, this will lead to lower inflation rates.  Their critics claim this is not just wrong, but preposterous—and undergraduate level error.  I think both sides are right, and both sides are wrong.

All of mainstream macro (including the IS-LM model) is built around the assumption of a “liquidity effect”.  That is, because wages and prices are sticky in the short run, a sudden and unexpected increase in the money supply will lower short-term nominal interest rates. Interest rates must fall in the short run so that the public will be willing to hold the larger real cash balances (until the price level adjusts and the real quantity of money returns to its original equilibrium.)

One thing that makes this theory especially persuasive is that it’s not just believed by eggheads in academia.  Pragmatic real world central bankers often see nominal interest rates fall when they inject new money into the economy.  It’s pretty hard NOT to believe in the liquidity effect if you see it in action after you make a policy move.

So the NeoFisherians have both the eggheads and the real world practitioners against them.  And yet not all is lost.  Over any extended period of time the nominal interest rate does tend to track changes in trend inflation (or better yet trend NGDP.)  If I had a perfect crystal ball and saw the fed funds rate rise to three percent and then level off for twenty years, I’d expect a higher inflation rate than if my crystal ball showed rates staying close to zero for the next 20 years.  NeoFisherians are smart people, and they wouldn’t concoct a new theory without some good reason.

In previous posts I’ve found it useful to illustrate where NeoFisherism works with a thought experiment.  I’ll repeat that, and then I’ll take that thought experiment and use it to develop a general model of monetary policy.  Here’s the thought experiment:

Suppose Japan wants to raise their inflation rate to roughly 8%/year.  How do they do this?  This requires two steps.  They need a monetary regime that produces 8% steady state trend inflation, and they need to make sure that the price level doesn’t undergo a one-time jump upwards or downwards at the point the new regime is adopted.

To get 8% trend inflation, they’d need to shift the trend nominal interest rates to a much higher level.  To make things as simple as possible, suppose the US Federal Reserve targets inflation at 2%, and the BOJ has confidence that the Fed will continue to do so.  In that case the BOJ can peg the yen to the dollar, and promise to depreciate it at 6%/year, or 1/2%/month.  The interest parity theory (IPT) assures us that Japanese interest rates will immediately rise to a level 6% higher than US interest rates.  (Note, I’m using the near perfect ex ante version of the IPT, not the much less reliable ex post version.)

We’ve already gotten a very NeoFisherian result.  Currency depreciation is an expansionary monetary policy, and the IPT assures us that this particular expansionary monetary policy will also produce higher interest rates.  And not just in the long run, but right away. Although Purchasing Power Parity is widely known to not hold very well in the short run, expected inflation differentials do tend to reflect the expectation than PPP will hold.  So under this regime not only will Japanese nominal interest rates rise almost exactly 6% above US levels, Japanese expected inflation rates will also rise to roughly 6% above US levels.

Of course actual PPP does not hold all that well (although it does far better under fixed exchange rate regimes, or even crawling pegs like this system, than floating rates.)  But that doesn’t really matter in this case; just getting 6% higher expected inflation is enough to pretty much confirm the NeoFisherian result.

Unfortunately, the immediate rise in interest rates might reduce the equilibrium price level in Japan.  But even that can be prevented with a suitable one-time currency depreciation at the point the regime is adopted.  How large a currency depreciation? Let the CPI futures market tell you the answer.  Make your change in the initial exchange rate conditional on achieving a 1 year forward CPI that is 8% higher than the current spot CPI.  Thus the CPI futures market might tell you that the yen should immediately fall to say 154.5 yen/dollar, and then depreciate 1/2% a month from that level going forward.  Whatever amount of immediate currency depreciation offsets the immediate impact of higher interest rates.

Notice that monetary policy has two components, a level shift and a growth rate shift. This idea will underpin my grand theory of monetary policy.  In this case the level shift was depreciating the yen from 120 yen/dollar to 154.5 yen/dollar.  The growth rate shift was going to a regime where the yen is expected to gradually appreciate against the dollar, to one where it is credibly expected to depreciate at 1/2%/month.

Now think about the expected money supply path that is associated with that new policy regime for the yen.  My claim is that if the BOJ simply adopted that expected money supply path, all the other variables (exchange rates, interest rates, inflation, etc.) would behave just as they did under my crawling peg proposal.

So far I’ve been supportive of the NeoFisherians, but of course I don’t really agree with them.  Their fatal flaw is similar to the fatal flaw of Keynesian and Austrian macro, using the interest rate to identify the stance of monetary policy.  But in some ways it’s even worse than the Keynesian/Austrian view.  Those two groups correctly understand that a Fed rate cut is a signal for easier money ahead.  The NeoFisherians implicitly assume the opposite.

People say that the longest journey begins with a single step.  But what the NeoFisherians don’t seem to realize is that central banks generally signal an intention to go 1000 miles to the west by taking their very first step to the EAST.  (Nick Rowe has much better analogies.)  Thus when Paul Volcker decided that he wanted the 1980s to be a decade of much lower inflation and much lower nominal interest rates, the very first thing he did was to raise the short term interest rate by reducing the growth rate of the money supply.

As soon as you realize that central banks usually use changes in short term nominal interest rates achieved via the liquidity effect as a signaling device, then the NeoFisherian result no longer makes any sense.

But now I’m being too hard on the NeoFisherians.  Look at my crawling peg for the yen thought experiment.  And what about the fact that low rates for an extended period do seem associated with really low inflation, in places like Japan.  That suggests there’s at least some truth to the NeoFisherian claim, and at least some problem with the Keynesian/Austrian view.

In my view the two views can only be reconciled if we stop viewing easy and tight money as points along a line, but rather as multidimensional variables:

Monetary policy stance = S(level, rate)

A change in monetary policy reflects a change in one or both of these components of the S function.  You can have a rise in the price level, but no change in the trend rate of inflation.  You can have a rise in the trend rate of inflation, with no change in the current (flexible price) equilibrium price level.  The beauty of the thought experiment with the yen is that it makes it much easier to see this distinction.  You can imagine once and for all change in the exchange rate, as when the dollar went from $20.67 an ounce to $35.00 an ounce in 1933, and then stayed there for decades.  Or you can imagine a change in the trend rate of the exchange rate, as in my crawling peg example.  Or you can imagine both occurring at once.

When NeoFisherians are talking about higher interest rates leading to higher inflation, they are (implicitly) changing the “rate” component of my monetary policy stance function.  Keynesian and Austrians tend to (implicitly) think in terms of changes in levels, once and for all increases in the money supply that depress short-term interest rates and have relatively little effect on long-term interest rates or long run inflation.

In previous posts I’ve expressed puzzlement as to why easy money surprises lower longer-term interest rates on some occasions, and at other times they raise long-term interest rates.  The “perverse” latter result occurred in January 2001, September 2007, and (in the opposite direction) December 2007.

Indeed the December 2007 FOMC meeting produced the most NeoFisherian (i.e. “rate”) shock that I have ever seen in my entire life.  A smaller than expected rate cut (contractionary shock) led to a huge stock market sell-off (no surprise) but also lower bond yields for 3 months to 30 years T-securities (a big surprise.)  This policy announcement had an unusually large “rate shift” component, whereas most US policy announcements are primarily “level shifts”.  The markets (correctly) saw the Fed’s passivity in December 2007 as indicating that inflation and NGDP growth might be lower than normal going forward.  And not just in 2008, but indefinitely.

Unfortunately, while exchange rates nicely capture the rate/level distinction, they are not ideal for developing a general monetary policy theory, as the real exchange rate is too volatile.  And that brings me to the missing market, NGDP futures.  If this market existed we would have all the tools required to describe the stance of monetary policy in the multidimensional way necessary to sort through this messy NeoFisherian/conventional macro debate.  Suddenly we could clearly see the distinction between level shifts and rate shifts.

Unlike exchange rates, NGDP responds to monetary policy with a lag.  But we could use one-year forward NGDP as a proxy for levels.  Thus if one year forward NGDP rose and longer-term expected NGDP growth rates were unchanged then you’d have a level shift.  If the opposite occurred, you’d have a rate shift.  Or you might have both.  The response of interest rates to the monetary policy shock would largely depend on the response of NGDP futures to the monetary policy shock.

In a richer model there would be more than two dimensions, indeed the expected future NGDP at each future date would tell us something distinct about the stance of monetary policy, and thus more fully characterize any monetary shocks that occurred. But I see great benefits of using the simpler two variable description, levels and growth rates.  This simpler version is enough to address many of the perplexing features of monetary policy, such as why economists can’t seem to come up with a coherent metric for the stance of monetary policy, and why the NeoFisherians reach radically different conclusions than the Keynesians.

Ideally we’d create highly liquid NGDP and RGDP futures market, and then we could easily identify the stance of monetary policy, in both dimensions.  This would also allow us to ascertain the impact of policy shocks on both NGDP and RGDP. NeoFisherians could say, “A monetary policy that raises expected inflation rates and/or expected NGDP growth rates will usually raise nominal interest rates.”  That’s a much more sensible way of making their claim than “Raising interest rates will raise expected inflation and/or expected NGDP growth.

PS.  I’ve benefited greatly from discussions with Daniel Reeves (a Bentley student), and Thomas Powers (a Harvard student).  They understand NK models better than I do, and bouncing ideas off them has helped me to clarify my thinking.  Needless to say they should not be blamed for any mistakes in this post.


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45 Responses to “Neo-Fisherism, missing markets, and the identification problem”

  1. Gravatar of benjamin cole benjamin cole
    19. May 2015 at 09:20

    Interesting post. So if the Fed lowered, or eliminated IOER, the NeoFisherians expect…what?

  2. Gravatar of benjamin cole benjamin cole
    19. May 2015 at 09:27

    Add on: Does NeoFisherianism fall apart near ZLB? That is central banks can go to negative interest rates to bring inflation even lower, but people move to cash, thwarting the intended effect?

  3. Gravatar of Matt McOsker Matt McOsker
    19. May 2015 at 10:02

    I may need to re-read this post several times, but my first question is how the forward pricing formula is in play (and when it might not be in play) This is where the spot price of a commodity and its price for delivery any time in the future is the same based on short rates? Where does this fit into neo-Fisherism (or Fisherism)? With a near zero-rate policy, the spot price of a commodity and its price for delivery any time in the future is about the same – with most of the price increases we are seeing stems from say storage costs, carry financing costs, and small wage growth. Now there are other factors that come into play. With this said can the Fed raise rates causing some inflation and still carry out loose monetary policy under our current circumstances?

  4. Gravatar of Matt McOsker Matt McOsker
    19. May 2015 at 10:24

    Couple more items item to add to my above. How would you factor in a scenario where the propensity to spend of borrowers exceeded that of savers – or does not exceed. Second the Yen has been strong despite extended low rates in Japan, and mainly pushed down by specific intervention against specific currencies.

  5. Gravatar of Scott Sumner Scott Sumner
    19. May 2015 at 10:47

    Ben, Good question, and I don’t know. Maybe someone else can tell us what the NeoFisherians think about IOR.

    Matt, Very good question. It seems like the spot/forward price spread on commodities is an example the NeoFisherians could point to in support of their theory. The lower the interest rate, the lower the expected rate of commodity price inflation.

    As far as Fed policy, they have two options. They can try to raise the spot price level, or they can try to raise the trend rate of inflation (or obviously both.) These are two very different policies calling for very different techniques.

    On your second comment, I’d ignore saving and spending propensities, they don’t affect nominal variables like inflation and NGDP growth.

    Again, the strong yen “despite” low interest rates is a point in support of NeoFisherism. Japan has had tight money, which has produced a strong yen (obviously until the recent QE) and also low inflation. Having said that, I still think the NeoFisherian model is highly flawed, as they seem to ignore the liquidity effect, which is used by central banks as a signal of monetary policy shifts.

  6. Gravatar of Anthony McNease Anthony McNease
    19. May 2015 at 11:29

    Scott,

    “That is, because wages and prices are sticky in the short run, a sudden and unexpected increase in the money supply will lower short-term nominal interest rates. Interest rates must fall in the short run so that the public will be willing to hold the larger real cash balances (until the price level adjusts and the real quantity of money returns to its original equilibrium.)

    One thing that makes this theory especially persuasive is that it’s not just believed by eggheads in academia. Pragmatic real world central bankers often see nominal interest rates fall when they inject new money into the economy.”

    Is this really more complicated than an injection of money requires the Fed to buy bonds which MUST lower yields?

  7. Gravatar of Jose Romeu Robazzi Jose Romeu Robazzi
    19. May 2015 at 12:12

    Prof. Sumner
    This is a paralell to interest rate term structure. Since rates are a bad indicator, let’s use the best indicator, but also use a term structure.

    I would add curvature to level and slope to discribe fully the monetary policy stance needed in order to stabilize AD, curvature would tell you the expected length of stimuli expected by the market to have an effect …

  8. Gravatar of Brian Donohue Brian Donohue
    19. May 2015 at 14:02

    This sounds like a breakthrough. Very good post. Lots to think about here.

  9. Gravatar of Jose Romeu Robazzi Jose Romeu Robazzi
    19. May 2015 at 15:55

    Off topic
    Found this very interesting
    http://johnhcochrane.blogspot.com.br/2015/05/feldstein-on-inflation.html
    This fits the bill for MM, does not it, RGDP > NGDP, inflation is overtaded, growth undertated, no need to raise rates … no need to have more inflation either …

  10. Gravatar of Jason Smith Jason Smith
    19. May 2015 at 16:28

    Hi Scott,

    I did a post awhile ago that captured the differences between rate and level changes that pretty much lined up with your assessments back then:

    http://informationtransfereconomics.blogspot.com/2014/01/strange-new-monetary-worlds.html

    The most serious difference was that the observed “stance” of policy can change sign depending on the relative size of the monetary base and NGDP. You get a more monetarist view of the stance of policy in the 1970s when inflation is high and a more Keynesian view of the stance of policy today when inflation is low.

    The basic model is:

    log(P) ~ (k-1) log(M/m0)
    log(PY) ~ k log(M/m0)
    log(r) ~ a log(b PY/M)

    k = log(c PY)/log(c M)

    where a, b, c and m0 are constants.

  11. Gravatar of Scott Sumner Scott Sumner
    19. May 2015 at 17:21

    Anthony, You asked:

    “Is this really more complicated than an injection of money requires the Fed to buy bonds which MUST lower yields?”

    Yes, it’s far more complicated. The fall in interest rates (if it occurs, and it might not) is going to be almost identical if the Fed buys gold instead of bonds. It has almost nothing to do with what they are buying, it’s all about what they are selling.

    Jose, Yes, a more sophisticated model would include curvature.

    Thanks Brian.

    Jason, Not sure I understand that . . .

  12. Gravatar of Scott Sumner Scott Sumner
    19. May 2015 at 17:49

    Jose, I’m not sure why Cochrane assumed inflation might be negative 1.5%. That would require some truly bizarre hedonics.

  13. Gravatar of Jose Romeu Robazzi Jose Romeu Robazzi
    19. May 2015 at 19:47

    @Prof Sumner,
    Aparently Feldstein speculate on something along those lines, I believe Prof. Cochrane speculate on the impacts on monetary policy if he is right …

  14. Gravatar of Major_Freedom Major_Freedom
    19. May 2015 at 20:23

    “Their fatal flaw is similar to the fatal flaw of Keynesian and Austrian macro, using the interest rate to identify the stance of monetary policy.”

    Bzzzt.

    You have already been refuted on this linguistic prescriptivism fallacy.

    A definition is not a factual or objective claim. If one defines monetary policy “stance” according to interest rates, then they are not making a flawed argument by associating lower rates with tighter policy.

    But this is nether here nor there, since it so happens that Austrians do not even define the stance of monetary policy according to see interest rates. They know full well that highly inflationary economies tend to have higher interest rates, while modestly inflationary economies tend to have lower interest rates.

    Austrians in fact by and large define the “stance” of monetary policy according to the money supply and its main component of credit expansion created money.

    Don’t you remember? Back when you were debating Murphy about the 1920s? When he said the Fed was inflationary as defined by the money supply and you denied that the basis that the Fed was not tracking M2 or M3 at the time?

    Of course, if we want to get Misesian Austrian level, then we would regard “inflation” as a political concept only, not an economic one. Mises wrote:

    http://libertarianpapers.org/wp-content/uploads/article/2009/lp-1-43.pdf

  15. Gravatar of Major_Freedom Major_Freedom
    19. May 2015 at 20:24

    More here:

    http://mises.ca/posts/blog/on-mises-definition-of-the-term-inflation/

  16. Gravatar of Major_Freedom Major_Freedom
    19. May 2015 at 20:46

    When you read Austrians say something like “The Fed lowered rates during the 1990s and 2000s thus fueling an economic boom”, they are not “defining” or “equating” or even “associating” low rates with easy money.

    What they are actually saying is that the monetary inflation and credit expansion during the 1990s and 2000s caused the economic boom, and the reason there was a boom is because it just so happened that all that credit expansion during that particular time period pushed interest rates below what they otherwise would have been, and that the proximate cause for the malinvestment.

    Moreover, if the Federal Reserve System engendered even more credit expansion that what took place, then interest rates may very well have been higher than they actually were. Or they may have been even lower.

    Regardless, to assert that the Austrians are wrong because they allegedly define the extent of inflation in terms of interest rates, is like a Christian asserting an atheist is wrong because the atheist allegedly defines Satan’s wrath as a true evil curse rather than a welcomed possession of the unfaithful: Not only is the Christian off for claiming the atheist is wrong on the basis of definitional choice, but they are also wrong for even assuming the atheist defines Satan’s wrath in that way in the first place.

    Sumner continues to engage in linguistic prescriptivism, not a week after he was shown that he does this, and yet he keeps doing it. It is pathetic.

  17. Gravatar of Kenneth Duda Kenneth Duda
    19. May 2015 at 21:33

    Anthony:

    > Is this really more complicated than an injection of
    > money requires the Fed to buy bonds which MUST
    > lower yields?

    Yes, it is more complicated. If the markets view the Fed’s money injection as part of a general loosening of monetary policy (relative to prior expectations), say, tolerance of more inflation than before, then long-term bond yields will rise, not fall, based on the Fed’s purchases. It all depends on expectations.

    The genius of market monetarism is the recognition that there is no simple “do A and the markets must respond by doing B” here, that the market response will always depend not just on A, but also the market’s expectations of future policy. Market monetarism harnesses this fact, rather than struggling against it the way the Fed does today, exploiting (rather than getting defeated by) the Lucas critique.

    My favorite blog post making this point is from Nick Rowe:

    http://worthwhile.typepad.com/worthwhile_canadian_initi/2015/04/var-vs-wtf.html

    Nick lays out four scenarios where the central bank raises the policy rate, and gets four completely different reactions depending on expectations. Brilliant stuff.

    -Ken

  18. Gravatar of Kenneth Duda Kenneth Duda
    19. May 2015 at 21:37

    I should have quoted the key passage from http://worthwhile.typepad.com/worthwhile_canadian_initi/2015/04/var-vs-wtf.html :

    > Imagine the exact same increase in the overnight rate with 4 different
    > explanations:
    >
    > a) “Our new model shows the economy is much stronger than our old model says it was.”
    >
    > b) “We decided to increase the inflation target from 2% to 3%, figured
    > expected inflation would rise very quickly to the new target, and didn’t
    > want real interest rates to drop too much.”
    >
    > c) “We’ve turned Swedish, and decided to raise the overnight rate to
    > reduce asset prices, even if it means inflation drops below the 2%
    > target temporarily.”
    >
    > d) “The person responsible has been fired, and normal monetary policy
    > will resume shortly.”

    In all cases, the Fed is raising overnight rates (presumably by selling off short-term treasuries). What do you think would happen to 30-year bond yields in each of these cases?

  19. Gravatar of dtoh dtoh
    19. May 2015 at 22:34

    @Scott,
    As I have said several times before, the easiest way to model this is a graph showing the exchange (by the non financial sector) of financial assets for real goods and services over some period. Price of financial assets is on the y axis. Quantity of financial assets exchanged in the on the x axis. The higher the price of financial assets, the more assets that are exchanged. More assets exchanged equals higher AD.

    The curve shifts left or right depending on expected future NGDP (or you can do it in 3 dimensions with expected NGDP on the z axis.)

    Fed action can cause either movement along the curve and/or the curve to shift. The change in asset prices (i) is indeterminate and depends on whether movement along the curve or the shift dominates.

    This is both obvious and trivial. Maybe you’re saying the same thing with levels and rates, but it seems like you’re making it a lot more complicated than it needs to be.

  20. Gravatar of Prakash Prakash
    19. May 2015 at 23:11

    Good post. I will need to read it once more.

    Are NGDP/RGDP futures the only missing market?
    Isn’t a nominal wealth/networth futures market (whether total or percapita) also needed for a better overall picture ? To better understand/model expected income and expected savings.

  21. Gravatar of Scott Sumner: Neo-Fisherism, missing markets, and the identification problem « Economics Info Scott Sumner: Neo-Fisherism, missing markets, and the identification problem « Economics Info
    20. May 2015 at 01:00

    […] Source […]

  22. Gravatar of MFFA MFFA
    20. May 2015 at 03:13

    So the cries about the ECB “blowing bubbles” have started :
    http://www.marketwatch.com/story/5-bubbles-that-draghis-qe-is-already-blowing-2015-05-20?dist=beforebell

  23. Gravatar of Jose Romeu Robazzi Jose Romeu Robazzi
    20. May 2015 at 05:15

    @MFFA
    Despite the misleading headline (I think the word “bubble” is misplaced), what the article is describing is the “hot potato” effect, isn’t it? Something that should be expected, given QE. What is clear to me, is that there is “Cantillon effects” as well, otherwise there would be no “hot potato” effect at all…

  24. Gravatar of Market Fiscalist Market Fiscalist
    20. May 2015 at 06:32

    Great post. I hope you are planning more of these longer, more theoretical posts.

    If all prices were perfectly flexible then neo-Fiscerism would be true. The only way a CB could raise interest rates would be to increase the money supply. If they announced an increase in the interest rate target people would immediately factor that into their business plans leading to a increase in the demand for money that the CB would need to satisfy if it were to meet its IR target and this would drive an immediate increase in inflation.

    Even in a world where prices are not perfectly flexible a smart CB could make neo-Fisherism true by saying “we plan to set a higher interest rate target and the way we plan to achieve this is to increase the money supply until inflation is sufficient to sustain the new IR”. Interest rates may initially dip but would quickly rise to hit the target.

    It therefor seems odd to me that if the CB just says “we are raising the interest rate target (above the natural rate) and will adjust the money supply to hit it” that this will (as non neo-Fisherites appear to think) lead to an endless deflationary spiral where the economy stays perpetually in the short-term and never gets to the new equilibrium of higher interest rates and higher inflation.

    It seems that something must be being missed – and perhaps neo-Fisherites are on to something ?

    One thought I have is that if a CB commits to an interest rate target (above the natural rate) then it may indeed initially fire off deflation. But to sustain this deflation it will have to sell off more and more assets and pay higher real rates of interest on them (plus prices will have to increase relative to the deflation to reflect the higher interest rates) – and this will in the long term turn the deflation into inflation and lead to the eventual higher inflation equilibrium.

  25. Gravatar of Anthony McNease Anthony McNease
    20. May 2015 at 07:55

    Kenneth, I think under current conditions in all four of those cases the 30 yr bond yields drop.

  26. Gravatar of Anthony McNease Anthony McNease
    20. May 2015 at 07:58

    Scott,

    ” It has almost nothing to do with what they are buying, it’s all about what they are selling.”

    Ok the Fed is selling dollars which increases the supply of base money and with that increase thereby the credit rates drop.

  27. Gravatar of Anthony McNease Anthony McNease
    20. May 2015 at 07:59

    Kenneth,

    Thanks for the link. That was helpful and informative.

  28. Gravatar of ssumner ssumner
    20. May 2015 at 13:04

    dtoh, I think it needs to be complicated.

    Prakash, What value would that market have? Would it help determine policy?

    MFFA, Thanks.

    Jose, Technically yes, but I believe the hot potato effect is important, but not Cantillon effects. The former is based on what the Fed sells, the latter on what it buys. It’s far weaker.

    Market Fiscalist, Thanks. Rather than say they might be on to something, I’d prefer to say they are beginning to catch up to where Friedman was in 1997.

    Anthony, As long as prices are sticky, and as long as it’s a one-time increase.

  29. Gravatar of dtoh dtoh
    20. May 2015 at 19:48

    @scott,
    But it’s not complicated. It’s trivial.

  30. Gravatar of dtoh dtoh
    21. May 2015 at 00:27

    @scott

    Humour me and tell me what my model doesn’t explain.

  31. Gravatar of Jose Romeu Robazzi Jose Romeu Robazzi
    21. May 2015 at 05:02

    @ Prof. Sumner
    Thanks for the clarification. Reading about your views I was puzzled by what you said about Cantillon effects. But now I (think I) get it. The benefits of stabilizing AD by far outweight the cost of wealth transfers.

  32. Gravatar of ssumner ssumner
    21. May 2015 at 05:49

    dtoh, You said:

    “The higher the price of financial assets, the more assets that are exchanged. More assets exchanged equals higher AD.”

    I don’t follow this logic. A record amount of assets were exchanged on October 19, 1987, and yet stock prices fell by 22.8%. Why?

    And I don’t see your model addressing the distinction between level shifts and growth rate shifts.

  33. Gravatar of dtoh dtoh
    21. May 2015 at 20:15

    @scott,
    Might want to read my comments carefully – “exchange (by the non financial sector) of financial assets for real goods and services”. (It has nothing to do with trading volumes).

    Regarding growth rate shifts – again, read my comment. “The curve shifts left or right depending on expected future NGDP.”

  34. Gravatar of ssumner ssumner
    22. May 2015 at 05:22

    dtoh, I don’t understand why a higher price for financial assets causes more financial assets to be exchanged for goods.

  35. Gravatar of dtoh dtoh
    22. May 2015 at 20:47

    @scott

    “I don’t understand why a higher price for financial assets causes more financial assets to be exchanged for goods.”

    If the price of a home loan goes up (interest rate goes down), more people will exchange homes loans for homes.

    If the price of car loan goes up, more people will exchange car loans for cars.

    If the price of credit card debt goes up (rate on my card goes down), I’ll buy more stuff on credit.

    If the price of corporate bonds goes up, more corporations will issue bonds and buy factories.

    If the price of potatoes goes up relative to applies, more potatoes will get exchanged for apples.

    Etc., etc., etc.

  36. Gravatar of ssumner ssumner
    23. May 2015 at 14:33

    dtoh, You said:

    “If the price of potatoes goes up relative to apples, more potatoes will get exchanged for apples.”

    Why do potato prices rise? Is it because there is more demand for potatoes? in that case, why exchange them for something else?

  37. Gravatar of dtoh dtoh
    23. May 2015 at 20:00

    @Scott,
    If we are going to using a comparable analogy to monetary policy, then potato prices rise when the Potato Reserve Board decides to buy more potatoes. Unless of course the market believes PRB action will drive up the future supply of potatoes, in which case, potato prices may actually go down.

  38. Gravatar of dtoh dtoh
    24. May 2015 at 05:16

    @scott,
    but more to the point…do you disagree that a rise in financial asset prices will result in an increased exchange (by the non financial sector) of financial assets for real goods and services assuming no change in NGDP expectations.

  39. Gravatar of Don Geddis Don Geddis
    24. May 2015 at 09:52

    @dtoh: you’d first need a causal explanation of some economic situation where financial asset prices rise but NGDP expectations are unchanged. I bet you can’t come up with a plausible one.

  40. Gravatar of ssumner ssumner
    24. May 2015 at 12:14

    dtoh, It just seems so hopelessly vague that it adds nothing to the analysis. Use Occam’s razor. The hot potato effect with new cash is enough, why make it more complicated? You aren’t going to convince any liquidity trappers, they’ll just deny that monetary policy affects asset prices. They are hopeless.

  41. Gravatar of dtoh dtoh
    24. May 2015 at 17:17

    @Scott
    To be effective, monetary policy doesn’t need to affect asset prices. It only needs to cause a marginal increase in the exchange of financial assets for real goods and services.

    As I have said, the problem with the HPE is that it defies causality. As you readily admit, Bill Gates doesn’t buy a new car because he has more cash. Rather, he acquires cash in order to buy a new car. Monetary policy works the same way. Through expectations and/or asset purchases the CB induces the non-financial sector to exchange financial assets for real goods and services. The non-financial sector acquires money as an intermediate medium to effect this exchange. I think the reason you have a hard time understanding this is because you use the analogy of a bumper potato crop (or helicopter drop)… but monetary policy does not work this way. It’s done through an exchange of money for assets, which is fundamentally very different than a helicopter drop.

    If we are looking for a simple model, then we should be seeking one that looks directly at what causes a change in AD, i.e. marginal changes in the quantity of financial assets exchanged for real goods and services.

  42. Gravatar of dtoh dtoh
    24. May 2015 at 17:35

    @don geddis
    Medium and long term, of course asset prices will reflect the expected growth rate. Short term no. A Treasury trader with a hangover can impact asset prices. When I was in the business, we used to regularly do trades that would cause a 1 to 2% jump in the equity market indices. Had absolutely nothing to do with NGDP expectations.

    Also over time the shape of the curve will change depending on various factors including tax rates on capital, etc.

  43. Gravatar of ssumner ssumner
    29. May 2015 at 09:09

    dtoh, I don’t see any relationship between a bumper crop of potatoes and a helicopter drop. The farmers don’t give the potatoes away.

    Your other comment suffers from the fallacy of composition. You cannot explain the hot potato effect at the individual level, you need to bring in the fallacy of composition to fully explain the process. When you do that financial markets are an unneeded complication.

  44. Gravatar of dtoh dtoh
    30. May 2015 at 04:15

    @scott,

    I think you over-rely on the fallacy of composition to compensate for the lack of an explanation for how the HPE mechanism actually works.

    In most cases we CAN infer conclusions about aggregate (composite) results or properties from individual properties. Not always…but in the unusual cases where it’s claimed that composite inference is fallacious, then the burden of proof should be to show or explain why the inference is invalid. Simply claiming that because some composite inferences are fallacious that therefore all composite inferences are fallacious is in itself fallacious.

    Further, even if we were to assume (incorrectly I believe) that the fallacy of composition were applicable in regards to HPE and that therefore HPE causality at the aggregate level can not be refuted by observation at the micro-level, that still leaves you in the logically even less tenable position of arguing that the LACK of causality at the micro level somehow through composition infers the EXISTENCE of causality at the aggregate level…you certainly have offered no other credible argument for how the HPE mechanism actually works. Your sole argument seems to be that correlation equals causality and that any arguments to the contrary are wrong because of the fallacy of composition.

    I’ll respond more fully regarding potatoes crops and helicopter drops later.

  45. Gravatar of Browsing Catharsis – 07.10.15 | Increasing Marginal Utility Browsing Catharsis – 07.10.15 | Increasing Marginal Utility
    10. July 2015 at 04:04

    […] “Neo-Fisherism, Missing Markets, and the Identification Problem,” by Scott Sumner. […]

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