Archive for the Category Monetarism


Are recessions about employment?

I’d say yes, but Nick Rowe disagrees.  He recently tweeted an old post from 2015, which ends as follows:

Recessions are not about output and employment and saving and investment and borrowing and lending and interest rates and time and uncertainty. The only essential things are a decline in monetary exchange caused by an excess demand for the medium of exchange. Everything else is just embroidery.

First I’m going to tell you why I disagree, and then I’ll explain why my disagreement is not very important, at least for the US economy.

I don’t believe that terms like “monetary exchange” and “excess demand” are clearly defined.  In my view, the most useful definition of a recession is a slowdown in employment growth that is sudden, significant and in some sense “anomalous”.  By that I mean a slowdown in employment growth that seems unrelated to fundamental factors such as demographics or preferences.

As this graph shows, slowdowns in employment growth are extremely strongly correlated with “recessions”, as defined by the NBER.   (The end of WWII was a bit weird. But that was an unusual period, with women entering the labor force during the war, then leaving, and soldiers returning home.)

Screen Shot 2019-01-20 at 4.42.40 PM

Thus in an accounting sense, recessions are mostly about employment, not factors such as productivity.  And most economists believe the reduction in employment during recessions is non-optimal, that it does not reflect preferences.  So what causes this slowdown?

In my view (and I think Nick agrees), these recessions are caused by sharp declines in NGDP growth in an economy with sticky wages and prices.  Here is some data on NGDP growth:

Screen Shot 2019-01-20 at 4.39.07 PMOnce again, the correlation is quite strong.  At the same time, I could easily imagine other factors causing a recession.  A government might institute an extremely high minimum wage rate, and then later remove this wage floor.  This would temporarily depress employment growth, without impacting NGDP.  So I don’t see how recessions can always be caused by an excess demand for money, unless they are defined that way.  But since we cannot directly measure excess money demand, that’s not a useful definition.  All we can do is look at various macro variables and infer that there was an excess demand for money.

Nor can we solve the problem by looking at the other part of Nick’s definition, a “decline in monetary exchange”.  If monetary exchange suddenly falls in half, and all wages and prices are cut in half by administrative fiat, there may not be a recession.  Indeed something like this occurs during a currency reform.

[Please don’t misinterpret this observation.  I am not claiming that making wages and prices flexible is a good way of avoiding recessions, it isn’t.  Rather the thought experiment shows that a recession is not identical to a decline in monetary exchange.  And keep in mind that NGDP is only a tiny fraction of “monetary exchange”, which is dominated by the exchange of money in the financial markets.]

Let’s look at the recession that is generally regarded as the least monetary of all post-WWII US recessions, November 1973 to March 1975:

Screen Shot 2019-01-20 at 4.38.19 PMThat graph is actually pretty good for Nick’s claim, as even the least monetary of all recessions looks quite monetary.  NGDP growth slowed significantly during the 1974 recession.

On closer inspection, we can see why this is viewed as the least monetary recession.  The slowdown in NGDP growth was fairly mild compared to other recessions, whereas the fall in employment growth and RGDP was relatively severe, at least for the post-1965 period.

Many economists would attribute this to 1974 being an adverse “supply shock”, caused by soaring oil prices.  I’m not so sure, as the equally severe 1979-80 oil shock produced a boringly normal recession; that double-dip recession was about as severe as one would expect from the size of the NGDP growth slowdown in early 1980, and then again in 1981-82.  So even that double-dip “oil shock” recession looks quite monetary.

Instead, I believe the unusual severity of the 1974 recession reflects a “wage shock” caused by the removal of wage controls.  These same controls had artificially boosted output during 1972 (when Nixon just happened to be running for re-election), and we paid the price in 1974 (when Nixon was fittingly removed from office.)  As a result, wage growth actually rose during the 1974 recession.

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Rather than define a recession as a negative monetary shock that causes less monetary exchange, I’d rather say that a recession is a sudden, sizable, and anomalous slowdown in employment growth.  And then I’d say that US recessions are virtually always caused by monetary shocks that reduce NGDP growth, but in other countries (such as Venezuela and Zimbabwe) recessions are often caused by real shocks–usually bad (interventionist) government policies.

PS.  I understand that the correlation between NGDP and recessions doesn’t prove causation, but we have a mountain of other evidence suggesting that causation goes from monetary variables such as NGDP to employment.

Allan Meltzer, RIP

I was sad to hear that Allan Meltzer passed away today, at the age of 89.  I always thought of him as one of the leaders of monetarism, along with Milton Friedman, Anna Schwartz and Karl Brunner (with whom he frequently collaborated on research.)  Unfortunately I didn’t meet Allan until he was in his 80s, but he was still quite energetic and passionate about both monetary economics and classical liberalism more broadly.  As recently as last year he participated in the Mercatus colloquium on the effect of low interest rates, and also spoke at one of our events.

My views on monetary policy were shaped by many different influences, but none more important that the monetarist revolution of the 1960s and 1970s, in which Meltzer played a key role. He also wrote a very interesting book on Keynes, whom he argues has been widely misunderstood.

Although market monetarism is somewhat different from traditional monetarism, in my view we are carrying the torch forward, with updates that are very much in the monetarist tradition (i.e., the view that markets are more efficient than bureaucrats.)  I would hope that future monetarists improve upon some of our ideas.

I met Meltzer at 3 or 4 conferences over the past 8 years, and he was always very nice to me.  I’ll miss him.


Japan hasn’t yet run out of ink and paper

Here’s Noah Smith at Bloomberg:

Japan’s great monetary policy experiment is drawing to a close, and the results may change the way the world thinks about central banking. The Bank of Japan’s recent quarterly report says, in effect, that the central bank has done all it can do to raise growth and inflation, and that fiscal policy needs to step in and help. The BOJ admitted that monetary policy alone won’t be enough to hit its 2 percent inflation target, now or ever.

This is very troubling for monetarists (as those who think that monetary policy is the key to macroeconomic stabilization are sometimes called). If central banks can’t control the rate of inflation, what hope do they have of affecting the economy?

I was surprised to read that the BOJ’s quarterly report had said that the BOJ had done all it could, particularly since the head of the BOJ frequently says exactly the opposite.  So I followed the link to the “quarterly report” and found . . . another Bloomberg article:

Many economists interpreted a BOJ policy shift in September as preparation for a sustained fight to generate inflation. Shirai said the central bank would maintain the status quo on policy unless the yen surges or economic data deteriorate.

And what will it do to policy if the yen “surges”?  Let me guess, it will ease policy. So why not ease policy today?

In fact, the BOJ denies that it is out of ammo.

Market monetarists have been more accurate in their Japan forecasts than any other group.  I believe that I was the first western blogger to comment on Abenomics, and I consistently predicted that the policy would raise inflation, but not all the way up to 2%.  That’s been my view all along, and that’s exactly what’s happened.  The actual inflation rate has averaged closer to 1.0%, but even that is a dramatic improvement over the deflation that preceded Abenomics (and this occurred during a period of rapidly falling oil prices, when even US inflation underperformed).  I also pointed out early in 2016 that the BOJ was moving to a more contractionary policy, and we now see the effects of that policy switch on Japanese inflation, which has fallen.  Even so, the impact of Abenomics on NGDP is clearly positive.  It began rising almost immediately after Abenomics was announced in late 2012:

screen-shot-2016-11-10-at-8-43-04-pmThe rest of the article makes the usual mistakes, confusing low interest rates and QE with easy money, whereas they are usually reflective of the fact that the central bank policy is too contractionary.  The market monetarist solution now is the same as it always was—NGDPLT—combined with a “whatever it takes approach” to monetary stimulus.  If you want a smaller central bank balance sheet, then aim for a higher NGDP growth target.  This is not rocket science; we know how to do it, we just need to get real world central banks to try.

But don’t let the perfect be the enemy of the good.  Abenomics really was much better than what came before, and we can do still better.  Instead of abandoning monetary policy, why not improve it?

There’s another thing I don’t understand about all these “monetarism has failed” articles—where are all the “Keynesianism has failed” articles? Didn’t Japan do massive fiscal stimulus, causing it’s debt to balloon to 250% of GDP?  Why isn’t fiscal stimulus viewed as a failure?  I suppose a Keynesian would say, “well they should have done even more”?  OK, but why doesn’t that also apply to monetary stimulus?  After all, fiscal stimulus is far more costly. In contrast, there’s no limit to how much money can be printed.  And why do we get this:

If Japan is out of the monetary easing game, other countries will doubtless follow. The era of bold monetary policy experimentation that began with the global financial crisis is now drawing to a close. More and more, economic policy makers will look to fiscal initiatives and to deeper structural reforms to boost growth and stop deflation.

Why not say the failure of fiscal stimulus in Japan means that governments are “out of the fiscal game”?  In fact, governments can never be out of the monetary policy game, unless they revert to barter.  As Nick Rowe likes to point out, there is no such thing as not doing monetary policy.  The only question is where are you going with that policy.  If you have a policy that delivers low NGDP growth rates and near zero interest rates, then you will end up with a big central bank balance sheet. There’s no way to avoid that except by aiming for a higher NGDP target.  Fiscal policy doesn’t create any short cut to success, as the Japanese case already showed. In January 2015, the Swiss tried to “get out of the monetary policy game” so they could shrink their balance sheet, and the balance sheet is now bigger than ever.  If you are going in the wrong direction, then switch policy.

If any central bank was going to fulfill the dreams of monetarists, it was Kuroda’s BOJ.

Actually, Australia’s much closer to what monetarists have in mind, unless you consider letting the yen appreciate from 125 to 100/dollar to be a monetarist “dream”.

Here’s another article on the BOJ, from last month:

“We are buying government bonds to achieve the 2% price target,” Kuroda said.

Kuroda said that he doesn’t expect the BOJ to run out of JGBs to purchase.

He said that the BOJ’s easy policy would not lead to hyper-inflation.

PS.  Stephen Kirchner sent me to this. Great idea, do massive fiscal stimulus when unemployment is 4.9% and the Fed is raising rates to prevent an overshoot of 2% inflation.  Why didn’t I think of that? I often say that talking about politics takes 30 points off a person’s IQ (including me).  I have a new one.  The zero bound takes 30 years of progress away from macroeconomics.  It took macro 30 years to recover from the Great Depression, and it’ll probably take 30 years to recover from the Great Recession. I won’t live that long.



Was the so-called “monetarist experiment” ever tried?

Jim Glass left this response to my (italicized) claim:

1. The Fed said it would start targeting the money supply, but it did not do so …. 1979-82 told us essentially nothing about the long run effect of money supply targeting. It wasn’t even tried.

I don’t understand you here. Certainly money supply targeting wasn’t tried over a long run, so one can’t see any long-run effect of it. But why do you say money supply targeting wasn’t adopted at all?

Volcker in his 1992 memoir “Changing Fortunes” explained why the Fed in 1981 had to change policy to money supply targeting from interest rate targeting, and went into considerable detail about the political resistance from the Reagan Administration that he had to overcome to do it, and the political ploys he used to do so. I don’t see why he’d make up such a detailed story about something that never happened.

Plus, looking at the M1 numbers for the period from Fred, one sees that after rising steadily pretty much from beginning of time, M1 peaked at $429 billion on 4/20/81, three months before the start of the recession, then went down a little bit, then bounced down a tiny tad and back up again repeatedly to hit pretty much exactly $429b again on 7/6, 8/10, and 10/12 thru 10/26 without ever going at all over $429b (or going below $423b). So on the dates three months before the recession started and then three months after it started, M1 was $429b, exactly unchanged. If the money supply wasn’t being targeted during that period, all those $429b numbers are a heck of a coincidence.

It’s certainly possible that the Fed was paying more attention to M1 than before.  I agree with that claim.  But there can be no dispute that they did not adopt Friedman’s proposal of a steady 4% growth rate in the money supply.  Indeed money growth actually became much less stable during 1979-82, which shows that Volcker moved policy even further away from Friedman’s ideal.  Now of course in a different sense you could say monetarism was adopted, as he used a tight money policy to control inflation.  That policy was a success.

But a money growth rule?  It’s never even been tried.  (And I hope it never will be tried, as it’s probably a lousy idea.)


Krugman suggests that New Keynesianism has disappeared (in the long run all theories are dead)

Here’s Paul Krugman:

Brad DeLong asks why monetarism — broadly defined as the view that monetary policy can and should be used to stabilize economies — has more or less disappeared from the scene, both intellectually and politically.

That’s not just a description of monetarism; it also describes New Keynesianism, as DeLong pointed out in 1999.  Is New Keynesian economics actually dead?  Here’s an example of New Keynesianism, from the same year that DeLong wrote the article:

What continues to amaze me is this: Japan’s current strategy of massive, unsustainable deficit spending in the hopes that this will somehow generate a self-sustained recovery is currently regarded as the orthodox, sensible thing to do – even though it can be justified only by exotic stories about multiple equilibria, the sort of thing you would imagine only a professor could believe. Meanwhile further steps on monetary policy – the sort of thing you would advocate if you believed in a more conventional, boring model, one in which the problem is simply a question of the savings-investment balance – are rejected as dangerously radical and unbecoming of a dignified economy.

Will somebody please explain this to me?

Yes, I’d say that NK view from 1999 (expressed by Paul Krugman, BTW) is essentially dead.  I’m not sure what we have now: new, new Keynesianism, old Keynesianism, or as many Keynesianism as there are Keynesians.  (I vote for the latter.) Just as old monetarism is mostly dead, having been replaced by market monetarism.

Krugman also suggests that monetarism is dead because real world governments don’t implement our policies, exactly as we sketch them out.  (He forgets that market monetarists invented negative IOR).  Which of course means that Krugman’s Keynesianism is also dead, as governments are certainly not doing the sort of fiscal stimulus that he recommends.  Indeed the Japanese recently combined fiscal austerity with monetary stimulus, and he seemed to think the Japanese were doing a pretty good job when he met with them recently:

We are all very much wishing, I am a great admirer of the policy moves that have been made by Japan, but they are not good enough, partly because all of the rest of us are in trouble as well.

Yes, he would have preferred they not raise taxes, but the tax increase did not cause a setback to the labor market:

Screen Shot 2016-04-16 at 12.51.44 PMAnd monetary stimulus did get them out of deflation:

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However the BOJ needs to do much more if they don’t want to slip back into deflation.

PS.  Ramesh Ponnuru also has a reply to Paul Krugman.

HT:  James Elizondo