Crazy like a fox

Over at Econlog I pointed out that Ted Cruz asked some rather market monetarist sounding questions to Janet Yellen, during her recent testimony in the Senate.  I think it’s fair to say Cruz easily came out ahead on the exchange.  But that doesn’t fit the press corps’ pre-conceived ideas of their relative expertise, and David Beckworth points out that the WSJ reporter who was live blogging the event initially thought Cruz had his facts wrong, especially the claim that the Fed tightened in the second half of 2008.

The Washington Examiner claims that Ted Cruz’s questions reflected some diverse intellectual influences:

Mundell, known as one of the intellectual architects of supply-side economics, said at a Reagan Foundation event in 2011 that tight money caused the financial crisis. “The Fed did some tightening, and the dollar started to soar,” Mundell told Wall Street Journal editorial page editor Paul Gigot.

The dollar rose by 10 percent between the Fed’s rate cut in April 2008 and the December meeting, against a broad range of currencies.

Furthermore, Cruz was right to note that the major declines in inflation and stock prices, both alternative indicators of monetary policy, occurred during the same period.

“Sen. Cruz basically gave a Market Monetarist critique of the Fed policy in 2008,” Western Kentucky University economist and former Treasury official David Beckworth, one of the economists cited by Cruz’s office, told the Washington Examiner. “The essence of this argument is that the failure of the Fed to respond properly in late 2008 turned an ordinary recession into the Great Recession. Ditto for the Fed’s response in 1929-33.”

That case was laid out in greater length in a 2009 study by Federal Reserve Bank of Richmond economist Robert Hetzel. In his paper, Hetzel wrote that “restrictive monetary policy rather than the deleveraging in financial markets that had begun in August 2007 offers a more direct explanation of the intensification of the recession that began in the summer of 2008.”

Hetzel argued that financial markets were “reasonably calm” as late as summer 2008. “The intensification of the recession,” he wrote, “began before the financial turmoil that followed the Sept. 15, 2008, Lehman bankruptcy.”

Widely overlooked was an exchange on interest on reserves (near the end), where Cruz again bested the Fed chair.  Cruz first asked how much interest had been paid since 2008.  Janet Yellen was not sure, but added:

.  .  . It is a critically important tool of monetary policy . . .

Cruz then asked:

So what has the impact been paying billions of dollars to those banks in the last seven years?

Yellen responded:

It’s helped us to set interest rates at levels that we thought were appropriate for economic growth and price stability.

To say this is misleading would be an understatement.   Everyone, including the Fed, agrees that raising the interest rate on reserves is a contractionary policy. The Fed sharply raised interest on reserves in October 2008. Just think about that. Now it’s true that the Fed was also doing some expansionary “concrete steps” during the same period. But Cruz was not asking about those other steps, he specifically asked about interest on reserves.

During 2009, Janet Yellen said, “we should want to do more.” She clearly meant that it would be better if interest rates were lower. That means that the (positive) interest on reserve program was actually moving the US economy farther away from the Fed’s economic growth and price stability objectives.

At the time, there was some concern about the stability of money market funds. Given the widespread adoption of negative interest on reserves in other countries, the Fed is no longer afraid of reducing IOR to zero, or even below. But concern over the stability of money market funds is very different from meeting the Fed’s economic growth and price stability objectives. There is no question that this policy has pushed the economy further away from those objectives, and Sen. Cruz was quite right to raise the issue with the Fed chair. It’s a pity she didn’t have a persuasive response.

A correct answer from Janet Yellen would have been.

1.  When we instituted IOR (at a time of 1.5% interest rates) we made a serious mistake.  As Ben Bernanke pointed out in his memoir, monetary policy was too tight during this period.

2.  We also erred in continuing the program in 2009, and after.  We thought that zero short-term rates were a threat to financial stability, and later discovered that this was not true.  In retrospect we neither should have initiated the program in late 2008, nor continued it after 2008.

Central banks are really good at admitting mistakes made by their predecessors (i.e. the Great Depression, the Great Inflation, etc.)  But they are not good at admitting mistakes that they themselves made.  That needs to change, which is why we need much more Fed accountability.  Senator’s Cruz’s questions were almost a model of what that accountability should look like.  The Fed needs to be much more upfront about admitting its mistakes.

Update:  George Selgin has an excellent new post that provides incisive analysis of how the Fed ended up sterilizing its monetary injections during 2008.

Update#2:  Chad Reese and I have a piece on policy rules in American Banker.

PS.  I doubt that either Paul Krugman or Ted Cruz would support a 4% NGDP target rule, level targeting.  Krugman might think it’s too low to deal with the zero bound problem.  But the level targeting factor would make a huge difference at the zero bound.  Senator Cruz might prefer something with a role for gold; I seem to recall he mentioned Bretton Woods at one point.  But I think he underestimates how much better NGDP targeting would be at making capitalism look good—making bailouts of auto companies and banks and fiscal stimulus seem unneeded.  If two people that far apart were to ever support NGDPLT, its momentum would be unstoppable.

PPS.  James Alexander has a very good post on the growing interest in NGDP targeting within the eurozone.

HT: Caroline Baum


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69 Responses to “Crazy like a fox”

  1. Gravatar of CA CA
    4. December 2015 at 11:00

    Is Beckworth advising the Cruz campaign?

  2. Gravatar of JP Koning JP Koning
    4. December 2015 at 11:24

    “I doubt that either Paul Krugman or Ted Cruz would support a 4% NGDP target rule, level targeting…. Senator Cruz might prefer something with a role for gold; I seem to recall he mentioned Bretton Woods at one point. ”

    Maybe Fisher’s compensated dollar plan where the dollar’s gold content is administered in order to hit an NGDP target.

  3. Gravatar of Capt. J Parker Capt. J Parker
    4. December 2015 at 11:47

    CNBC has Cruz saying during the GOP debate: “I think the Fed should get out of the business of trying to juice our economy, and simply be focused on sound money and monetary stability, ideally tied to gold,”
    When I heard this I cringed. I could hear Dr. Krugman saying Cruz wants Francisco D’Aconia for Fed Chair. My instinct is to think “tied to gold” and “monetary stability” are not compatible. Am I right? Or, is there a role for gold that market monetarists would embrace?
    (PS I intend to read “Midas Paradox”, Haven’t got to it yet)

  4. Gravatar of Chuck Chuck
    4. December 2015 at 13:34

    Bernanke is responsible for interest on reserves. Check out this Bloomberg article from May 2008.

    http://www.bloomberg.com/apps/news?pid=newsarchive&sid=a_ne91Qe_Pkw

    IOR was slated to be available by 2011, but Bernanke requested that it be advanced.

    Why did Bernanke implement an undeniably contractionary measure in the teeth of the worst financial crisis since the Great Depression?

    I haven’t read his book. Does he mention IOR? Has anyone confronted him about it?

  5. Gravatar of ssumner ssumner
    4. December 2015 at 14:31

    CA, I have no idea.

    JP, Yes, the Fisher CDP is one way to sell the idea to gold bugs.

    Captain, I don’t know.

    Chuck, Yes, he explains it was to prevent interest rates from falling to zero. The Fed target was 1.5% at the time.

  6. Gravatar of Gordon Gordon
    4. December 2015 at 15:10

    Scott, if I understand Selgin’s article (and as a lay person I reserve the right to have misunderstood it by a large amount), when the Fed ran out of ammunition to sterilize its monetary injections, it turned to IOR. I take this to mean that IOR also has the effect of sterilizing money. If so, doesn’t this mean that the Fed’s plan to raise the federal funds rate by 25 basis points by increasing IOR to .5% may be riskier than the normal means by which the Fed raises the fed funds rate? I would prefer that the Fed tighten by unwinding its QE rather than trying to raise the fed funds rate. Also, I still question the need to tighten given that PCE core hasn’t budged from 1.3%.

  7. Gravatar of Bernhard Bernhard
    4. December 2015 at 15:53

    Columnist of German magazine “Der Spiegel” Wolfgang Munchau says he is a follower of NGDP targeting in his latest column.

    Article in German: http://bit.ly/1TIiKyx

  8. Gravatar of Major.Freedom Major.Freedom
    4. December 2015 at 15:55

    “The essence of this argument is that the failure of the Fed to respond properly in late 2008 turned an ordinary recession into the Great Recession.”

    The “essence” of that argument has always been wrong. What is being casually referred to as “an ordinary recession” was itself caused by inflation and credit expansion prior, so it makes no sense to believe that the problem was that the Fed did not inflate enough after. To have done so would only have set the economy up for an even deeper crash later on.

    It is vain to believe we can strip money completely from real goods in such a way that money statistics can be targeted, and then ignored and forgotten, while all focus then turns to how to improve the real side of the economy as stripped from the money side. That is not how human valuation and activity works. You cannot strip away money planning and production from the market process, and expect to have a market process determined real economy. That is impossible.

    It is an error to believe that because there has been central banking in the past, that we are all compelled to not only “choose” – and I use that word lightly – a rule for inflation, but to actually believe in it and attack all genuine market based criticisms of it. That turns you from a peddler of lies to a dangerous fool who peddles lies.

    It makes no sense to believe that one is better off believing in the lie, as compared to not believing in the lie and be willing to reject the legitimacy, morality, and effectiveness of central banking.

    If everyone here finally woke up from their sleep, and rejected central banking entirely, absolutely nothing would be lost from you. The economy would still become as distorted as before, but you would gain by teaching the new generation that there is a better way. The new generation would not care that you were opportunistic in the short run by catering unintentionally to psychopaths who lead the biggest mafia in the land.

    Nothing good has ever come out of monetarism. It is and always has been an intellectual exercise in exploitation and social conflict. It is not a harmonious, welcoming philosophy or body of work. It is a tool for coercion, that’s it.

  9. Gravatar of Benjamin Cole Benjamin Cole
    4. December 2015 at 16:30

    The Fed, and central banker culture globally, is still focused on inflation. They are fighting the last war.

    Central bankers may also be choosing their battles: they know they can whip inflation, so make that the organizational goal.

  10. Gravatar of E. Harding E. Harding
    4. December 2015 at 18:12

    Given MR being a dangerous space for my comments, Scott, if you have any questions on the ancient history presented in Eric Cline’s book, ask me anything. I know a good deal about this topic.

    I’m thinking of launching a blog called Marginal Counterrevolution.

    And I honestly don’t think Cruz knows much about either monetary or foreign policy. Both are half-good, half bad, and seem to contradict themselves. How can Cruz be pro-Gaddafi and Assad, but also anti-Iran and Russia? It’s nuts.

  11. Gravatar of Ray Lopez Ray Lopez
    4. December 2015 at 18:41

    Sumner is bipolar. Compare his response yesterday to me and today on this blog post.

    Yesterday (in comments):

    Ray: “If Sumner is right, there should have been some interest rate sensitive industries that suffered a decrease in revenues during the Great Recession more so than suffered historically.” [and there was not says the PhD dissertation by Arsenios Skaperdas , see yesterday’s link in comments section – Skaperdas: “In the absence of the zero bound, and given previous Federal Reserve behavior, the federal funds rate would have troughed in the range of -2 to -5% since 2009. If unconventional policy failed to bridge this gap, this deficit should represent a very large contractionary monetary shock. I create a measure of historical industry interest rate sensitivity. Estimates from this measure imply that interest rate sensitive industries, such as construction, should have suffered a 4 to 10% decrease in revenues, since 2009, in comparison to insensitive industries. I do not find that this is the case”]

    Sumner: “Have you learned NOTHING in all the time you’ve been reading this blog? How many times do I have to tell you that monetary policy is not about interest rates?”

    Today (in blog post):

    Sumner: “Everyone, including the Fed, agrees that raising the interest rate on reserves is a contractionary policy. The Fed sharply raised interest on reserves in October 2008. Just think about that.” – everybody, except Sumner yesterday.

    How to square this circle? Oh I’m sure Sumner or his minions will think of a metaphysical way. Perhaps in Sumner’s mind interest rates on reserves is not the same as the federal funds rate, even though Wikipedia informs us they are identical.

  12. Gravatar of E. Harding E. Harding
    4. December 2015 at 18:58

    Tay, you are so wrong here. There’s no point in me explaining.

  13. Gravatar of E. Harding E. Harding
    4. December 2015 at 20:33

    *Ray
    And I have launched the Marginal Counterrevolution. Click the link at my name. Hopefully, it’ll help bring balance to both the Against Jebel al-Lawz blog and Tyler’s blog.

  14. Gravatar of Steve Steve
    4. December 2015 at 20:38

    Scott, I’m really glad you did a post on this exchange (even though you didn’t HT: me) 🙂 🙂 🙂

    Ted Cruz views himself as the only “true conservative” in the race, at least that’s what I get from the campaign literature. He’s also an intensely brilliant person. In that light, it’s not surprising that he is toying with both gold and market monetarism.

    I suppose in one sense its a weakness, that he’s tempted by alluring old fashioned ideas like gold, but also a strength that he reads widely and is willing to experiment with new ideas that are pragmatic and conservative.

    That’s my take anyway, and one of the reasons I regard him as a strong sleeper candidate despite his detractors. I think even more than Romney, Cruz would be likely to adopt a pragmatic market monetarist view if elected president.

    I suspect if you follow him in other areas of social and economic policy you will see he searches for principled ways to limit government while preserving liberty.

    Anyway, I’m not explicitly endorsing Cruz, but he definitely got the better of Yellen who responded with disingenuous platitudes.

  15. Gravatar of TravisV TravisV
    4. December 2015 at 21:20

    Kocherlakota: Toward a Better Monetary Policy Reaction Function

    http://economistsview.typepad.com/economistsview/2015/12/toward-a-better-monetary-policy-reaction-function.html

  16. Gravatar of Ray Lopez Ray Lopez
    4. December 2015 at 23:40

    @E. Harding – the red background of your blog is annoying…is that intentional? Also I don’t want to ‘register’ with WordPress. Can you turn that off and allow anonymous comments? If you get traffic, your site could potentially get you around 10-20k USD a year I’ve read….you know TC makes at least this much (probably four times this much) and our host here probably makes the upper range. BTW, do explain “Tay” and why I’m wrong…if it’s so easy it shouldn’t be hard.

  17. Gravatar of MFFA MFFA
    5. December 2015 at 00:35

    “analysis of how the Fed ended up sterilizing its monetary injections in late 2008”

    I’ve taken a class with Randall Kroszner a couple of years ago and he was pretty open about this being an explicit goal of the policies that were being put in place. The focus (I’m speaking based on my memories) was on injecting as much money as needed in the banking system to stabilise it, but making sure at the same time that is does not get out and create a burst of inflation. I’m surprised the current fed chair seems to have forgotten that

  18. Gravatar of Benjamin Cole Benjamin Cole
    5. December 2015 at 04:17

    Add on: I have predicted the American right would embrace an expansionary monetary policy should they ever recapture the Presidency. Perhaps this is an initial salvo in that direction, that is by Cruz. Also we are seeing discussions on the American right that the federal government has an obligation to provide safe assets for investors, and so must run a deficit.

    So, run big deficits, run easy money and vote GOP!

  19. Gravatar of ssumner ssumner
    5. December 2015 at 06:37

    Gordon, I’m not sure whether it’s riskier, but I would also prefer they unwind the QE first.

    You are right that there is probably no need to raise the target rate, although I doubt it will do much harm either. The important decisions come later.

    Thanks Bernhard.

    E. Harding, No politician in all of world history has known much about monetary policy. Why should Cruz be different?

    Ray, How does a higher fed funds rate impact base velocity? How does a higher IOR affect base velocity? Hint, they are in the opposite direction—so no, they aren’t the same.

    Steve, Sorry, when lots of people send me something I often forget to acknowledge them.

    I disagree with Cruz on many issues, but yes, he does seem more like a principled conservative than the other candidates. But with politicians can you ever really know for sure?

    MFFA, That’s right. Market monetarists were complaining about this at the time, but everyone else was ignoring it, as they were ignoring monetary policy in general.

  20. Gravatar of ssumner ssumner
    5. December 2015 at 06:46

    Ray, Link for the Wikipedia mistake?

  21. Gravatar of Brian Donohue Brian Donohue
    5. December 2015 at 07:05

    I agree that Cruz is smart and seems to be groping toward an understanding of monetary policy, but then he swerves toward a gold standard ideas and I think he really doesn’t understand the issue at all.

  22. Gravatar of Julius Probst Julius Probst
    5. December 2015 at 07:08

    Somewhat unrelated, but highly interesting. A recent speech by Kocherlakota in which he claims that the FED’s policy was too contractionary in 2008, and the that the FED created the slow recovery!!!

    https://www.minneapolisfed.org/news-and-events/presidents-speeches/monetary-policy-renormalization

    Some key highlights:

    “So the FOMC was not forced to pursue a slow recovery because of constraints on its tools. Rather, the FOMC chose to pursue a slow recovery. In my view, this choice can be traced back to the Committee’s reliance on the Taylor Rule as a key baseline in its thinking.”

    “Put more bluntly, the Taylor Rule required the Committee to forgo the timely creation of hundreds of thousands—perhaps millions—of jobs in order to get interest rates back up to normal more rapidly.”

    And most importantly:

    “Some observers have suggested that the FOMC should target the price level rather than the inflation rate. Still others have suggested that the FOMC should target the level of nominal income.

    I see merit in all of these suggestions, and I welcome explorations of their consequences.”

  23. Gravatar of Vaidas Urba Vaidas Urba
    5. December 2015 at 08:58

    ” When we instituted IOR (at a time of 1.5% interest rates) we made a serious mistake.”

    Suppose they did not institute IOR, and the committee voted for 1.5 fed funds target without ability to pay IOR. The end result would be much more contractionary.

  24. Gravatar of Andrew_FL Andrew_FL
    5. December 2015 at 09:00

    “I think he underestimates how much better NGDP targeting would be at making capitalism look good”

    A revealing statement, implying keeping up appearances about a system one believes is not very good in point of fact.

    Whatever NGDP targeting makes look good, it’s not actually “capitalism.”

    You should give Cruz more credit. The difference between what you know and what he knows isn’t that he’s just a bit shy of your position. It’s that he’s realized the above fact and you either haven’t, or don’t see a problem with it.

  25. Gravatar of TravisV TravisV
    5. December 2015 at 09:52

    Brad DeLong praises Matt Yglesias:

    http://equitablegrowth.org/must-read-matthew-yglesias-thoughtful-opponents-of-the-welfare-state-have-generally-avoided

  26. Gravatar of jonathan jonathan
    5. December 2015 at 10:16

    I’m curious about Mundell’s comments. My own view is that the rise in the dollar was due to global flight to quality during the financial crisis. In any event, the result was that the dollar rose about 14% from 2008 Q3 to 2009 Q1, while real exports fell 13%.

    Plausibly, a lot of the fall in exports was due to the rise of the dollar (the rest being falling global demand). Since exports were about 12% of GDP in 2008 Q3, the fall in exports alone amounted to ~1.5% reduction in real demand. Overall, real GDP fell 3.5% over this period, so 40% of the reduction in demand was due to falling exports (assuming no multiplier).

    This calculation suggests that, had the Fed had chosen to stabilize the dollar during this period (e.g., by buying foreign currency), they could have reduced the fall in output significantly, potentially by as much as 40% (or more, with a multiplier).

    Consider this a concession to the “monetary policy was too tight” view.

    (Obviously buying foreign currency would have been terribly controversial.)

  27. Gravatar of TravisV TravisV
    5. December 2015 at 10:26

    Dear Commenters,

    Does anyone have a theory for the strange behavior of the 30-year U.S. Treasury yield on Thursday (soared) and Friday (collapsed)?

    Given the behavior of stocks, I would have expected the opposite (collapsed then soared)…..

  28. Gravatar of E. Harding E. Harding
    5. December 2015 at 10:28

    Andrew, disagree wholeheartedly. A system may look bad even if it is quite good.

  29. Gravatar of Bob Murphy Bob Murphy
    5. December 2015 at 12:44

    Does anyone know what Cruz is specifically referring to, when he says the Fed told markets in the summer of 2008 that it was shifting to tighter money? I don’t think he merely meant, “NGDP growth collapsed.”

  30. Gravatar of Andrew_FL Andrew_FL
    5. December 2015 at 13:47

    @E. Harding-Maybe so, but anyone shaking their head wondering how anyone as smart as Cruz (having just discovered he’s smart because he’s said something they agree with!) could be in favor of such a dumb idea (the sentiment around here) as the Gold Standard, clearly doesn’t think capitalism only appears to be not very good. No, in fact he clearly thinks it actually works pretty bad, so the government needs to step in and fix things.

    What does one call the sort of person who wants to “make capitalism look good” by using the power of the government to paper over perceived short comings? Especially if one really holds them to be merely perceived shortcomings? I’m struggling to come up with something that wouldn’t be rude.

    The whole “Cruz almost gets it, he’s finely agreeing with us, so why is he still an idiot?” vibe around here is really offputting, all the more so because it’s wrong.

  31. Gravatar of Michael Byrnes Michael Byrnes
    5. December 2015 at 15:29

    Andrew_FL wrote:

    “anyone shaking their head wondering how anyone as smart as Cruz (having just discovered he’s smart because he’s said something they agree with!) could be in favor of such a dumb idea (the sentiment around here) as the Gold Standard, clearly doesn’t think capitalism only appears to be not very good. No, in fact he clearly thinks it actually works pretty bad, so the government needs to step in and fix things.”

    What is “capitalist” about the Gold Standard?

  32. Gravatar of E. Harding E. Harding
    5. December 2015 at 15:38

    @Ray Lopez
    No; the red background is not meant to be annoying; it’s just what fits best with the blockquote and normal font shades, which I can’t change.

    And I have allowed anonymous comments. “Tay” was a spelling error. And Scott has refuted your point a thousand times; there’s no need to go over it here.

    @Andrew_FL

    “I’m struggling to come up with something that wouldn’t be rude.”

    -Why?

    “all the more so because it’s wrong”

    -How?

  33. Gravatar of Andrew_FL Andrew_FL
    5. December 2015 at 16:01

    @Michael Byrnes-How is a state privileged monopoly issuer of state privileged money capitalist?

    And don’t demand I answer your question first, since you’re attempting to avoid my point by asking me to explain something I didn’t claim. If you want to claim you believe in capitalism you have to explain why you favor central banking and how that’s not, you know, in obvious contradiction to claiming to like capitalism.

    @E. Harding-1. Because I don’t want to be rude 2. Because “Herp Derp everyone who favors a Gold Standard is dumb” is, you know, wrong?

    99% of MI readers thought process on the Gold Standard seems to consist of “Gold Standard means tight money. I hate tight money. I don’t need to know anything about the Gold Standard.”

  34. Gravatar of George Selgin George Selgin
    5. December 2015 at 16:18

    Selgin’s law of gold standard criticism: “The more smugly confident an economists’ dismissal of the gold standard, the greater the odds that he or she knows very little about it.” (Yes, there are outliers; but having taken many observations over the years, I can affirm that the R-squared is high nonetheless.)

  35. Gravatar of Negation of Ideology Negation of Ideology
    5. December 2015 at 16:53

    Andrew_FL –

    “What is “capitalist” about the Gold Standard?”

    “@Michael Byrnes-How is a state privileged monopoly issuer of state privileged money capitalist?”

    I’ll answer both questions. First, the Gold Standard is a state privileged monopoly issuer of state privileged money. The only difference is the price of gold (in those notes) is set by government fiat under the Gold Standard. Neither is either capitalist or non-capiltalist. Harding and Stalin both returned to the Gold Standard in the 1920’s’s. Both also had state issued money before and after. The US was capitalist and the USSR was communist during this time.

    Whether having state issued notes exchangeable for gold (or defined as a share of CPI or GDP) is a prudent idea or not is a good debate to have, but it has absolutely nothing to do with capitalism.

  36. Gravatar of Andrew_FL Andrew_FL
    5. December 2015 at 17:16

    “the price of gold (in those notes) is set by government fiat under the Gold Standard”

    The kind of thing frequently said by someone who doesn’t know how a Gold Standard actually works

    “Whether having state issued notes exchangeable for gold (or defined as a share of CPI or GDP) is a prudent idea or not is a good debate to have, but it has absolutely nothing to do with capitalism.”

    Of course state issued notes have nothing to do with capitalism. Are you under the impression that only states can theoretically issue notes?

    You said you’d answer both questions, and yet you fairly transparently dodged my question. Perhaps it would have been better to remain silent.

  37. Gravatar of Michael Byrnes Michael Byrnes
    5. December 2015 at 17:40

    Andrew_FL wrote:

    “How is a state privileged monopoly issuer of state privileged money capitalist?

    And don’t demand I answer your question first, since you’re attempting to avoid my point by asking me to explain something I didn’t claim. If you want to claim you believe in capitalism you have to explain why you favor central banking and how that’s not, you know, in obvious contradiction to claiming to like capitalism.”

    My question was badly phrased. But you initially asked:

    “anyone shaking their head wondering how anyone as smart as Cruz (having just discovered he’s smart because he’s said something they agree with!) could be in favor of such a dumb idea (the sentiment around here) as the Gold Standard, clearly doesn’t think capitalism only appears to be not very good. No, in fact he clearly thinks it actually works pretty bad, so the government needs to step in and fix things.”

    Has Ted Cruz disavowed a central bank or is he pushing a gold standard central bank, such as the Fed was during its early years? If the latter, are you suggesting that Ted Cruz himself “clearly thinks capitalism actually works pretty bad, so the government needs to step in and fix things.”

  38. Gravatar of ssumner ssumner
    5. December 2015 at 17:41

    Vaidas, No, any policy that increases the demand for the MOA is contractionary. And raising the IOR from 0% to 1.5% increases the demand for the MOA.

    Andrew, You do realize that I’m a big fan of capitalism, don’t you?

    Jonathan, You don’t need to buy foreign assets to prevent a strong currency.

    Bob, I’d guess he’s responding to Fed statements that they were increasingly worried about inflation, and likely to tighten in the future. (Which of course they did.)

    Andrew, You said:

    “What does one call the sort of person who wants to “make capitalism look good” by using the power of the government to paper over perceived short comings?”

    Not sure who you are refering to, but obviously those are not my views.

  39. Gravatar of Ray Lopez Ray Lopez
    5. December 2015 at 18:53

    @Sumner – thanks! I’m 12 hours ahead of you so apologies for the late response, I hope you read this.

    Sumner: “Ray, How does a higher fed funds rate impact base velocity? How does a higher IOR affect base velocity? Hint, they are in the opposite direction—so no, they aren’t the same.” – cite please, or, if no cite, just tell me you derived this or it’s part of your theory? (not trying to be argumentative–in this post–I’ll do that later when I understand your views better). The closest I got to this view, that velocity is different on IOR vs fed funds, is reading in-between the lines this (ironically) ‘Fed is weak’ article at Econlog by San Jose econ prof Hummel http://www.econlib.org/library/Columns/y2013/Hummelinterestrates.html (“Whether the new equilibrium level of real interest rates is exactly the same as the old depends partly on whether the economy is responding to a one-shot increase in the money stock or to an increase in money’s rate of growth”) – apparently velocity is different in money stock (which goes to IOR) vs money rate of growth (Fed fund rate)? Is this what you are saying? Thanks in advance.

    Off-topic to Sumner: ever heard of the McCallum rule as a Fed framework? Is it closer to Taylor’s rule or NGDPLT? A paper online suggests a ‘modified’ McCallum rule performs like Taylor’s rule in a simulation.

    @E.Harding – did you already know what I wrote Sumner above? I doubt it. What Sumner is saying, about two different velocities, one for base money kept at banks on reserve and one for money injected into the economy via the Fed funds rate, appears novel to this blog (or anywhere on the internet!). If not, then please direct me to one blog post that suggests otherwise. And but for my question you never would have known about this esoteric aspect of Sumner’s theory.

    @G. Selgin – if you’re reading this, perhaps you can comment on C. Romer’s suggestion–as indicated in an email from T, Cowen–that output under a gold standard was roughly the same as today’s output under a fiat standard. Perhaps not in crisis mode? Or maybe even then? Since money is neutral long-run, it makes sense that a gold standard is just as good as any other medium, long term. BTW I love physical gold btw, my net costs are only $400 USD/ounce.

  40. Gravatar of Ray Lopez Ray Lopez
    5. December 2015 at 19:04

    @ Off-topic to the poster–derivs I think–that makes a big deal about whether you are talking about domestic US money or US dollars held overseas. You may be onto something as this 1997 paper says targeting the domestic, not total, US money supply is the correct metric: http://www.federalreserve.gov/pubs/feds/1997/199721/199721pap.pdf

  41. Gravatar of Ray Lopez Ray Lopez
    5. December 2015 at 19:21

    PS–from the Hummel paper, which is very good, I post this for lazy readers who don’t want to click the link, it’s a killer paragraph that supports Sumner’s views the Fed has not really expanded since 2008, due to offering interest on reserves. In fact the Fed has only expanded $0.5T, not $2.5T (though I might add 0.5T is still a big increase from the 0.8T of pre-2008 Fed balance sheet reserves):

    Hummel: “Even the dramatic explosion of the monetary base initiated by Ben Bernanke in September 2008 in response to the financial crisis is not the exception that it might appear to be. As the Fed increased bank reserves and currency in circulation by $2.5 trillion over the five years since, it also was, for the first time, paying banks interest on their reserves deposited at the Fed. Although the 0.25 percent rate it pays is quite low, it has consistently exceeded the yield on Treasury bills, one of the primary securities in the Fed’s balance sheet. Thus, at least $2 trillion of the base explosion represents interest-bearing money that, in substance, is government or private debt merely intermediated by the Fed. This may have noticeable impacts on some implicit bid-ask spreads within financial markets and on the allocation of credit. But because it involves no net increase in loanable funds or any major, temporary increase in the net portfolio of people’s real wealth, it should have no liquidity effect on interest rates through either channel. The Fed can have no more impact on market rates through pure intermediation—borrowing with interest-earning deposits in order to purchase other financial assets—than can Fannie Mae or Freddie Mac. The remaining $500 billion increase in non-interest-bearing money (what economists call “outside money”) represents only a slightly more rapid increase than in the decade before the crisis, and nearly all of that has been in the form of currency in the hands of the public. “

  42. Gravatar of George Selgin George Selgin
    5. December 2015 at 20:54

    Ray, no reason to think long-run output would be much different under gold. In fact U.S. output/capita was lower in gold standard era than in post WWII period. But there are way too many determinants involved to draw any conclusions about gold vs. fiat money from that bare fact.

  43. Gravatar of Joe Eagar Joe Eagar
    5. December 2015 at 22:33

    Mr. Sumner, IOR is a very important instrument in the long run. It breaks this incessant link between the transmission of monetary policy and the size—and, crucially, the *structure*—of the money supply. It is much easier for central banks to control interest rates than it is for them to control the supply of money, most of which is privately created anyway.

    Yes, yes the IOR should have been instituted at a negative rate, not a positive one. But it very much deserves to exist as a policy instrument. Can you imagine the capital losses the Fed would incur if goes through a complete tightening cycle without IOR, and has to sell all those assets?

  44. Gravatar of Joe Eagar Joe Eagar
    5. December 2015 at 22:58

    Professor Selgin, you’ve written a lot about free banking. I’m curious how that relates to the gold standard. I like to cite free banks as an alternative to the modern trifecta of an externally floating exchange rate, an internally fixed currency area, and a strong fiscal authority to paper over regional disequilibria.

    On the other hand, I’m also one of those people who think Milton Friedman should be given a medal for breaking the U.S. of the sort of fixed exchange rate mania that has done so much damage to European social cohesion (yes, yes, in the long fixed and floating economies perform roughly the same economically, but there are other consequences).

    If I remember correctly, there were times in history when a free banking system produced a gold standard without state intervention and it worked just fine. I guess my question is there: can free banking work under a state-mandated gold standard, or does it have to be “naturally occurring,” so to speak?

  45. Gravatar of Andrew_FL Andrew_FL
    6. December 2015 at 00:36

    “You do realize that I’m a big fan of capitalism, don’t you?”

    I’m disputing that, so obviously not. It’s very strange indeed to speak of wanting to make a system look good, if you are a fan of it.

    “Not sure who you are refering to, but obviously those are not my views.”

    I don’t find it to be terribly obvious at all. Again that particular line, about making “capitalism look good” was very bizarre if those are “obviously not” your views.

    @Joe Eagar-I believe this would be George’s answer to your question.

    (Small point, a “natural” gold standard arises prior to banking, free or otherwise)

    @Michael Byrnes-“Has Ted Cruz disavowed a central bank or is he pushing a gold standard central bank, such as the Fed was during its early years? If the latter, are you suggesting that Ted Cruz himself “clearly thinks capitalism actually works pretty bad, so the government needs to step in and fix things.””

    Your if the latter answers your own question, does it not?

    I don’t know exactly what Cruz’s position is. But from what I can recall having read, the way he phrases things he has said about the Gold Standard imply it’s instead of the Fed, not administered by the Fed. But as you say, if the latter…

  46. Gravatar of Negation of Ideology Negation of Ideology
    6. December 2015 at 02:55

    Andrew_FL – You are quite amusing. Your question was:

    “@Michael Byrnes-How is a state privileged monopoly issuer of state privileged money capitalist?”

    I answer “Neither is either capitalist or non-capiltalist.”

    Then you agree “Of course state issued notes have nothing to do with capitalism. ”

    Then you say I didn’t answer your question! You agree with my answer and simultaneously claim it doesn’t exist.

    So I will answer you question in more detail. The form of money the government uses for taxes, fines and spending has nothing to do with capitalism. The government can choose to use its own securities, some commodity like gold or tobacco, private banknotes. No form is any more capitalist than any other.

    When it comes to “state-privileged money”, the government has to make some decision as to what it will accept. You arbitrarily want that privilege to be given to gold miners. Why not other commodities? If people started paying their taxes in pork bellies and live alligators, the government wouldn’t be able to manage it. So which form of money is “state-privileged” is a matter of prudence, not capitalism.

  47. Gravatar of Vaidas Urba Vaidas Urba
    6. December 2015 at 03:35

    Scott, the Fed was fully committed to the 1.5 fed funds rate target. Sterilization was a recurring topic in FOMC discussions, and some of the participants were always concerned about fed funds trading below the target. Yes, raising IOR increased demand for MOA, but discontinuing other sterilization tools decreases demand for MOA by the equivalent amount. Then there is supply of MOA, IOR is the sterilization tool which allowed the Fed to increase supply of MOA more compared to other sterilization tools. Switch to IOR was good news.

  48. Gravatar of Tom Brown Tom Brown
    6. December 2015 at 08:48

    I’ve got one in moderation (with some Cruz quotes on inflation and the gold standard)

  49. Gravatar of Andrew_FL Andrew_FL
    6. December 2015 at 09:52

    “You arbitrarily want that privilege to be given to gold miners.”

    Can you point me to where I said that? No, you can’t, because I didn’t. You didn’t answer my question, you presumed to know what I want and then ducked my question.

    Although we have yet more evidence you don’t know how a gold standard works, which is always nice.

  50. Gravatar of Scott Sumner Scott Sumner
    6. December 2015 at 10:45

    Ray, I don’t have time to teach you EC101

    Joe, IOR in no way prevents capital losses if rates rise sharply, as they’d also have to rise on IOR.

    IOR is a solution looking for a problem. The previous monetary regime was far superior.

    Andrew, You said:

    “It’s very strange indeed to speak of wanting to make a system look good, if you are a fan of it.”

    That’s really bizarre. Is that a typo?

    Vaidas, They wanted a 1.5% fed funds rate, but without IOR they would not have been able to achieve it. The monetary injections were driving rates below their target, which is why they asked for IOR.

  51. Gravatar of Major.Freedom Major.Freedom
    6. December 2015 at 10:51

    George Selgin:

    “…no reason to think long-run output would be much different under gold. In fact U.S. output/capita was lower in gold standard era than in post WWII period. But there are way too many determinants involved to draw any conclusions about gold vs. fiat money from that bare fact.”

    Then why cite it? And why choose the arbitrary time of WW2?

    The main reason real growth was higher after WW2 was that there was a significant shift from wartime consumptive activity to civilian productive activity. The capital base of the US was also not destroyed during the war. This significant change has the capability of drowning out any temporally observable difference pre and post gold.

    More to the point, there are very good reasons to believe that all else equal, total output would be higher today under a pure gold standard as compared to under fiat. That is, if we think in terms of counterfactuals we can surmise very good reasons. You won’t be able to find any good reasons if you think in terms of timelines.

    There are many unseen factors with fiat money, some of which include an absence of constraining the size and scope of government activity which reduces capital formation; the lost and wasted capital due to malinvestment, and most insidiously, encouraging the psychological belief among the populace that the government is a source of money and wealth, rather than being fully dependent on producers who sustain the entirety of the government, which rewards idleness and encourages the public to become childlike adults.

    If you truly believed there are NO good reasons to think production would be lower with socialist money, then you would have to logically believe there is no good reason to think production would be lower with socialist commodity production, socialist land ownership and control, socialist food production, indeed under full fledged communism.

    If you dispute this logical implication, because of some heretofore unstated factor that somehow applies to every production except money production, then you need to give a good reason why socialism in money does not reduce total productivity whereas socialism in commodities does reduce total productivity, which will require an explanation of why you are presuming the laws of economics which applies to every other good does not apply to money.

    There is no good reason to believe economics stops when money starts.

  52. Gravatar of George Selgin George Selgin
    6. December 2015 at 12:14

    Major Freedom: “hen why cite it? And why choose the arbitrary time of WW2?”

    Because I am responding to Ray Lopez, who raised the matter. The rest of what you say is also beside the point, as my comparison is of the pre-WWI and post WWII eras. Transition from wartime to peacetime economy obviously plays no part in such a comparison.

    But it is so much easier to criticize someone if one doesn’t bother much about what that person has said, or why!

  53. Gravatar of George Selgin George Selgin
    6. December 2015 at 12:24

    Joe Eager: Free banking systems don’t “produce” monetary standards. The banks accept whatever standard is in place. Free banking can work with any sort of standard, but if the standard ks itself bad, the banking system cannot make up for its flaws. The pre-WWI gold standard was actually pretty darn good, no matter what a million economists, most of whom know nothing about it, opine. But it was good partly because governments had little to do with its administration. A central-bank administered gold standard, like any central-bank fixed-exchange rate commitment, is not robust. That’s why I put my own faith in disciplining the fiat dollar using some sort of strictly-enforced, and preferably automatic, quantity (as opposed to convertibility) rule.

  54. Gravatar of Joe Eagar Joe Eagar
    6. December 2015 at 13:22

    Thanks for the reply, Professor Selgin, that makes a lot of sense. I find free banking a fascinating idea. From everything I have read, the economic system we have today is fundamentally incompatible with multi-ethnic societies (which may explain why ethnic states have become the norm). Free banking seems to offer a way out, an internal adjustment mechanism that doesn’t require the sort of political integration that can be hard to sustain in a diverse society.

  55. Gravatar of Vaidas Urba Vaidas Urba
    6. December 2015 at 15:25

    “They wanted a 1.5% fed funds rate, but without IOR they would not have been able to achieve it. The monetary injections were driving rates below their target, which is why they asked for IOR.”

    Before IOR, the Fed was using other tools to sterilize liquidity injections, and during some days the effective fed funds rate was below the target, during other days it was above the target. What really matters here is what markets were telling about future rates at that time, and they were actually signaling us that on average the effective rates will be above fed funds target.

  56. Gravatar of Ray Lopez Ray Lopez
    6. December 2015 at 18:40

    @Sumner – you claim you don’t have time to teach me “Econ 101” but you reply to everybody else, and yet this is hardly ‘Econ 101’: “Ray, How does a higher fed funds rate impact base velocity? How does a higher IOR affect base velocity? Hint, they are in the opposite direction—so no, they aren’t the same.” – cite please, or, if no cite, just tell me you derived this or it’s part of your theory?

    I suspect you have not thought through what you are saying very well, so you wish to dodge answering. Nobody in your field is saying there are two velocities, acting in opposite directions. At best what they are saying is what is suggested by San Jose econ prof Hummel, and that is that offering IOR gives a disincentive for banks to lend base money to the public. However, this does not mean there are two base velocities, each acting “in the opposite direction”. It just means not as much money is being lent as you might think, if there was no IOR (but that is not ‘opposite’, a poor choice of words).

    Keep up the ‘good’ work Scott. If you muddy the waters enough, and your fame continues, policymakers (who are indifferent to logic, they just court popular opinion) might start listening to you. Already you have the ear of liberals who think printing money leads to prosperity (a popular fallacy that was even believed in W. J. Bryan’s day). Happily, money is largely neutral so unless your proposals are taken to the hyperinflation extreme, you’re harmless. I do think however that Americans are just as likely to adopt Selgin’s ideas as yours, and I find Selgin’s ideas more sound, as they offer an anchor (gold) which by definition will never potentially lead to hyperinflation, as your ‘open-ended’ framework could arguably lead to (when asked what to do if NGDP targets are not reached in Sumner’s framework, Scott irresponsibly replies: ‘just print more money until they do!). Not only that, Selgin is a nice guy, unlike you, as you see that he replies to long-suffering poster MF, even when MF is off-topic.

  57. Gravatar of Andrew_FL Andrew_FL
    6. December 2015 at 21:36

    “That’s really bizarre. Is that a typo?”

    No, it’s not. I don’t go around insinuating I need to cover up the flaws in things I’m a fan of, and I wouldn’t thank anyone who is a fan of anything would do so.

  58. Gravatar of Joe Eagar Joe Eagar
    7. December 2015 at 00:08

    Major.Freedom, if the gold standard were capable of restraining statist ideology, why are the U.S. and Britain (both floaters) more economically liberal than continental Europe?

    Keep in mind statists make these sorts of arguments too. If you read the policy debates surrounding the collapse of Bretton Woods, as well as the ones about the eurozone today, you’ll find a lot of big government types who are great fans of fixed exchange rates, because it shifts the balance of economic power from the central bank to the fiscal authorities.

  59. Gravatar of Joe Eagar Joe Eagar
    7. December 2015 at 00:16

    @Sumner: Naturally IOR rates would rise, that’s what they’re there for. The question is, would bond prices increase at a slower rate with IOR than if the Fed simply sold its holding on the open market in order to bring interest rates up? I guess I don’t know the answer to that.

  60. Gravatar of Joe Eagar Joe Eagar
    7. December 2015 at 00:32

    What am I saying, higher interest rates means lower bond prices, not higher ones. And I guess the question is really whether the use of IOR can slow the fall of bond prices fast enough the central bank can swap out assets and still make IOR payments.

    Now that I actually say it, that does seem unlikely. Being able to raise interest rates without having to fiddle with the money supply still strikes me as a useful tool to have, though.

  61. Gravatar of George Selgin George Selgin
    7. December 2015 at 05:38

    Ray Lopez, you are wrong in thinking that I favor a return to gold. Although I think most criticisms of the classical gold standard mistaken, I also doubt that we can ever revive it–and have said so in numerous places.

    Also, Scott is in fact much nicer than me.

  62. Gravatar of TravisV TravisV
    7. December 2015 at 10:31

    Krugman on Ted Cruz vs. Janet Yellen: “The Passive-Aggressive Monetary Two-Step”

    http://krugman.blogs.nytimes.com/2015/12/07/the-passive-aggressive-monetary-two-step

  63. Gravatar of Negation of Ideology Negation of Ideology
    7. December 2015 at 16:27

    If Cruz is a market monetarist, someone forgot to tell the heads of his economic 527 group:

    “Spearheaded by a trio of economic buffs, the Lone Star Committee roots its mission in defending Cruz against critics of his economic agenda, particularly his support of the gold standard and flat tax. Those “big ideas . . . separate him from the rest of the field,” said co-founder Rich Danker in the statement, “and we’re going to do everything to make sure voters in Iowa, New Hampshire and South Carolina know it.”

    http://www.nationalreview.com/article/428159/ted-cruz-527-group-economic-policy-early-states

  64. Gravatar of Scott Sumner Scott Sumner
    7. December 2015 at 17:01

    Vaidas, You are making things too complicated. The Fed committed to injecting money before they got permission for IOR. The effect of IOR, ceteris paribus, was contractionary. That’s all I am saying, and that’s all Cruz is saying.

    Ray, Two velocities? What are you talking about?

    Andrew, You said:

    “No, it’s not. I don’t go around insinuating I need to cover up the flaws in things I’m a fan of, and I wouldn’t thank anyone who is a fan of anything would do so.”

    I never said anything of the kind, read it again. I never said there were any flaws in capitalism.

    Negation, I certainly don’t think Cruz is a MM.

  65. Gravatar of Gary Anderson Gary Anderson
    8. December 2015 at 23:52

    I would not be against stopping IOR, or even a small negative IOR, with the rule that the banks could not pass that negativity to anyone else! Make the banks lend, but don’t panic the banks either. But I repeat what I have said elsewhere, the banks bet on low rates and the Fed is afraid to disturb that bet with a heated economy requiring raising rates aggressively.

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    9. December 2015 at 14:27

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    16. December 2015 at 16:52

    […] When I asked Scott Sumner to defend that, he wrote, “Bob, I’d guess he’s responding to Fed statements that they were increasingly worried […]

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    13. May 2016 at 01:35

    […] survival tier of Littlefinger. You even exceed Mr. Master of Coin Lord Baelish in possessing a tolerably competent grasp of monetary policy. No ticket to Palookaville for you; you’re a contender. Top seed in the […]

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