Do monetary shocks matter? And what is a monetary shock?

Mark Sadowski recently discussed a study by Harald Uhlig on the effects of monetary shocks on RGDP.  Uhlig didn’t find much effect.  I suggested that there is a severe identification problem, and that NGDP fluctuations are the best indicator of monetary shocks.  Mark replied as follows:

Scott,
Well if all NGDP shocks were treated as monetary shocks then we’re assuming that AD shocks are purely monetary in origin. Obviously that would result in much larger estimates for the proportion of RGDP variation attributable to monetary policy shocks.

That also seems like too strong an assumption to me. That is, I think that it is implicit that monetary policy is ultimately responsible for the level of NGDP at any point in time, but that doesn’t necessarily mean monetary policy is solely responsible for every shock to AD.

I don’t think there is any question that the vast majority of economists would agree with Mark and not me on this issue.  Let me try to explain why this stuff makes me a bit uncomfortable.  Here are some possible definitions of monetary shocks:

1.  Unexpected changes in the fed funds target

2.  Deviations of the fed funds target from the Taylor Rule value

3.  Unexpected changes in the monetary base

4.  Unexpected changes in M2

And there are many more.  For each proposed definition of a “monetary shock” you will get a different answer to the question; “How much impact do monetary shocks have on real output?” That makes it all seem quite arbitrary.

It might be helpful to return to the fiscal multiplier question as a point of comparison.  The multiplier might be defined as the impact of federal spending shocks on RGDP, holding both private investment and S&L spending fixed.  In fact, as far as I know economists tend to hold state and local spending fixed but not investment spending, which is allowed to vary for “crowding out” reasons when estimating the multiplier.  This makes no sense to me.  Federal authorities have no control over S&L spending.  Almost everyone agrees that the multiplier should be estimated holding monetary policy fixed, but no one seems to know what that means.

I have a completely different view.  I’m a pragmatist.  For me “the” fiscal multiplier is what happens when the federal fiscal authorities change federal spending, and all other sectors of the economy (S&L, the Fed, private investment) respond to that action in the way they actually do respond in the real world.  In other words, I want to know the counterfactual change in RGDP with or without that federal action, holding nothing constant.

Now let’s return to the puzzling problem of identifying monetary shocks.  To me the only interesting question is how much more volatile is RGDP as compared to an economy where the Fed has adopted the optimal policy.  That’s a pragmatic way to define the real effects of monetary policy.  It’s a definition with policy implications.  It tells us how much we can hope to improve things.  So if I knew how much more unstable RGDP has been over the past few decades, as compared to the volatility of RGDP in a policy regime that pegs the price of NGDP futures contracts to rise at 5% per year (assuming that policy is optimal), then that seems to me to be the most useful definition of the contribution of monetary shocks to the business cycle.  It’s a bit arbitrary, but every other definition I can think of is essentially 100% arbitrary.

Mark might reply that NGDP targeting cannot prevent all fluctuations in NGDP, which is true.  This is another reason why we need an NGDP futures market.  That market would provide a very good estimate of the amount of NGDP variation that was predictable, and hence preventable.  If we had that market, and if it was not targeted (and hence was volatile) it would be the ideal monetary shock indicator to put into these VAR studies.


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47 Responses to “Do monetary shocks matter? And what is a monetary shock?”

  1. Gravatar of Michael Byrnes Michael Byrnes
    3. February 2014 at 07:24

    Would you call a sudden increase in the demand to hold base money a monetary shock – regardless of what caused it?

  2. Gravatar of Marcelo Marcelo
    3. February 2014 at 07:31

    Scott,

    I am wondering if you think latest Fed language/policy action (decreasing rate of bond purchases) is the Fed tightening policy (despite ~4% NGDP growth last year)?

    Thanks,
    Marcelo

  3. Gravatar of Nick Rowe Nick Rowe
    3. February 2014 at 07:51

    Good post Scott. I have been thinking about a closely related question: http://worthwhile.typepad.com/worthwhile_canadian_initi/2014/02/separating-real-from-nominal-shocks.html

  4. Gravatar of ssumner ssumner
    3. February 2014 at 08:10

    Michael, Not if both the money supply and NGDP remained unchanged.

    Marcelo, I don’t see much change in policy in the most recent statement. Maybe slightly tighter. If they had not tapered further I would regard that as a loosening of policy.

    Thanks Nick, I’ll take a look after class.

  5. Gravatar of Don Geddis Don Geddis
    3. February 2014 at 09:38

    What frustrates me about the questions, is the obsession about “origin”. E.g. Sadowski says “…assuming that AD shocks are purely monetary in origin…” And one of our resident trolls always complains that, yes, money demand skyrocketed in 2007/2008, and the Fed didn’t accommodate, but why did it rise?

    The thing is: monetary policy is capable of screening off the nominal effects of real shocks. As Rowe says in his post, “What we … want … is a monetary policy that ensures that real shocks are purely real shocks, and never also nominal shocks.”

    It shouldn’t matter whether the origin of AD shocks is “purely monetary”, or not. If monetary policy can buffer the nominal effects of any real shock (perhaps this “if” is debatable), then every AD shock is a monetary shock.

    So I find the end of Sadowski’s comment exactly wrong: “monetary policy is ultimately responsible for the level of NGDP at any point in time, but that doesn’t necessarily mean monetary policy is solely responsible for every shock to AD.” Sounds to me like it does indeed “necessarily mean” that monetary policy is responsible for all AD shocks, even according to his own macro theory.

  6. Gravatar of John Brennan John Brennan
    3. February 2014 at 10:41

    Scott,
    When you say you are a pragmatist, what do you mean? Is it something philosophical or just practical?

  7. Gravatar of Jason Jason
    3. February 2014 at 11:20

    Even if the underlying model in the link is incorrect, a function P(MB, NGDP) fit to the empirical data (inflation, ngdp, monetary aggregate of your choice, e.g. mb) should allow one to begin to get a handle on resolving the components:

    http://informationtransfereconomics.blogspot.com/2013/07/extracting-nominal-shocks.html

    The functional form of the fit will determine e.g. how much is nominal vs real, but then you have a test of that functional form … the fit to the 3D surface P(MB, NGDP):

    http://informationtransfereconomics.blogspot.com/2014/01/it-really-does-seem-to-be-about-size-of.html

  8. Gravatar of ssumner ssumner
    3. February 2014 at 11:25

    Don, I think what Mark is trying to do is dintinguish between shocks that the monetary authority could not offset until it is too late, with those that it could. Or at least that would be one way of viewing his comment. Other interpretations are possible. Interestingly, level targeting might reduce the severity of shocks that are widely viewed as “non-monetary.” Such as velocity shocks.

    Rorty, Someone once said “that which has no practical implications has no philosophical implications.” I’m not well versed in philosophy, but I believe that I am somewhat of a philosophical pragtmatist, based on what little I know (which is very little.)

  9. Gravatar of TravisV TravisV
    3. February 2014 at 11:27

    Yikes! Bad for the market?

    “Bombshell Report From The New York Fed Suggests The Labor Market Is Tighter Than People Think”

    http://www.businessinsider.com/employment-to-population-ratio-is-misleading-2014-2

  10. Gravatar of ssumner ssumner
    3. February 2014 at 11:39

    jason, Interesting. I’d say the part of RGDP growth not predicted by NGDP shocks is the real shock portion.

    Thanks Travis.

  11. Gravatar of James in London James in London
    3. February 2014 at 12:05

    Travis. The “papa swamp” comment on the story at Business Insider makes it pretty clear that baby boomers retiring is a non-event. The lower participation rates are solidly in the 25-55 year old segment. One could argue that it is the “little princes” children of the baby boomers who are leaving the workforce. The spoiled brats in other words, forcing their parents to work. But that is too fantastical, even if we all have a few stories like that!

  12. Gravatar of James in London James in London
    3. February 2014 at 12:12

    Scott. How far will equity prices and bond yields have to fall before you revise your view “slightly tighter” view of monetary policy last week? That “heartless” statement and unanimous vote was surprising.

    Perhaps the markets are just testing Janet Yellen’s leadership abilities? If you are right about Ben Bernanke doing as much as he could given the circumstances then the market may be right to regard the very fact of his leaving as de facto tightening until Yellen shows she is both as dov’ish AND as in charge as Bernanke.

  13. Gravatar of TravisV TravisV
    3. February 2014 at 14:23

    Thomas Piketty forgot a major factor: land!

    http://www.slate.com/blogs/moneybox/2014/02/03/piketty_and_land_ricardo_s_return.html

  14. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    3. February 2014 at 15:05

    Interesting take on sticky wages in Europe. Who would have thought the Germans were more flexible!

    http://www.voxeu.org/article/german-resurgence-it-wasn-t-hartz-reforms

    ‘We argue that in the early to mid-1990s, the specific governance structure of the German system of industrial relations allowed for an unprecedented increase in the decentralisation (or localisation) of the process that sets wages, hours, and other aspects of working conditions, from the industry- and region-wide level to the level of the single firm or even the single worker. This process of wage decentralisation helped to bring down wages, in particular at the lower end of the wage distribution, and ultimately improved the competiveness of the German economy.

    ‘Germany’s system of industrial relations is not rooted in legislation and is not governed by the political process, but instead is laid out in contracts and mutual agreements between the three main labour-market parties: trade unions, employer associations, and works councils (the worker representatives who are typically present in medium-sized and large firms).

    ‘This allowed for an unprecedented decentralisation of the wage setting process….’

  15. Gravatar of Philo Philo
    3. February 2014 at 15:26

    You write: “For me ‘the’ fiscal multiplier is what happens when the federal fiscal authorities change federal spending, and all other sectors of the economy (S&L, the Fed, private investment) respond to that action in the way they actually do respond in the real world. In other words, I want to know the counterfactual change in RGDP with or without that federal action, holding nothing constant.” I think the italicized phrase is unwarranted, for you are holding constant *the behavioral dispositions of all the agents (other than the federal fiscal authorities in their professional capacity)*.

    Note that the fiscal multiplier, so defined, can be expected to change over time, since behavioral dispositions change. An estimate of the federal fiscal multiplier should not be expected to be valid for more than a particular moment: it is not some sort of universal constant.

    A different point: My impression is that your clarity about what you mean by ‘monetary shock’ is unusual in the economics profession, and is practically nonexistent among financial journalists.

  16. Gravatar of Mark A. Sadowski Mark A. Sadowski
    3. February 2014 at 15:49

    Scott,
    This is perhaps unseemly of me to go off topic on a post addressing my views of what constitutes a monetary policy shock, however Krugman has a habit of saying things about monetary policy that really tick me off. Here’s the latest:

    “Now, there are a couple of points that will predictably come up here. Some people will argue that the Fed coulda and shoulda and maybe even did make up for its inability to lower short-term rates with other policies. My view would be that making monetary policy truly effective at zero rates, if it was possible at all, would have required more radical action than the Fed was willing or politically able to take.”

    http://krugman.blogs.nytimes.com/2014/02/03/changing-circumstances-graphed/

    This is all the more reason why it might have been very important for those with highly visible bully pulpits on economic policy (ahem) to have spent as much time as possible making the case for more radical monetary policy action, and forcefully pointing out the need for the President not to leave three out of seven seats on the Board of Governors of the Federal Reserve empty without nominees from January 2009 to April 2010 and waiting to make those nominations after it was virtually impossible to get nominees who might have taken more radical action confirmed by the Senate. Evidently for those people there were other issues that were far more pressing than improving the conduct of monetary policy in the middle of the worst recession in 80 years.

    Oops, missed opportunities and all that.

  17. Gravatar of Michael Byrnes Michael Byrnes
    3. February 2014 at 17:40

    I have a different take on Krugman’s column…

    “My view would be that making monetary policy truly effective at zero rates, if it was possible at all, would have required more radical action than the Fed was willing or politically able to take.”

    I think this is as close to conceding the point as Krugman is ever going to get. I mean, he will obviously never write a post with the title, “Sorry! Sumner was right the whole time! Oops…”

    But, remove one little clause from his post, and you get…

    “My view would be that making monetary policy truly effective at zero rates XXXXXXXXXXXX would have required more radical action than the Fed was willing or politically able to take.”

    … you get something that Scott Sumner might have said or at least agreed with.

    Of course, he did throw in the “if it was possible at all” bit, but that might just be Krugmanese for “I was wrong, but I don’t want to say so outright!”

  18. Gravatar of Tom Tom
    3. February 2014 at 18:12

    The 2008 ‘monetary shock’ was actually a 2006-2008 slow at first and then sudden realization that most homeowners had just lost 100-400k that they thought they had “in the (home equity) bank”.

    Home equity wealth is neither 3. money base, nor 4. M2, but until it is included as central to the Great Recession macro/money analyses, such analyses will be weak.
    50 mil x 200k is about $10 trillion in equity wealth that (somewhat) unexpectedly disappeared in market value. Millions were acting like their equity was money in the bank. When the equity was gone, they acted like they had lost savings, and started consuming a bit less, which spiral added up rapidly to a big macro decrease.

    Japanese banks and companies, after their 1989 real estate bubble pop also were much, much poorer, and it has been showing for 25 years now.

    So NGDP targeting and futures markets are fine, but “shocks” are all basically some sort of mal-investments. The decision makers are shocked to find out their expectations are wrong.

  19. Gravatar of Jim Glass Jim Glass
    3. February 2014 at 19:29

    Krugman has a habit of saying things about monetary policy that really tick me off. Here’s the latest:

    “…My view would be that making monetary policy truly effective at zero rates, if it was possible at all, would have required more radical action than the Fed was willing or politically able to take.”

    If he’s saying that for some reason the Fed didn’t do more than it did, so the recession was worse than it might have been, that’s true enough.

    But as a purported criticism of the effectiveness of monetary policy per se, well … it seems to give away the entire game.

    I mean, can we imagine Krugman accepting the same criticism of fiscal policy?

    “…My view would be that making fiscal policy truly effective at zero rates, if it was possible at all, would have required more radical action than the Congress and President were willing or politically able to take.”

    Thus fiscal policy was ineffective, and an inferior alternative to pursue. QED.

    (Especially as, with the key challenge being to convince a group of people to take action, it woulda been *so much* easier to convince a majority of a four-of-seven FRB governors who were focused on the issue and supposedly disinterested, than 535 elected politicians answering to countless interest groups.)

  20. Gravatar of Saturos Saturos
    3. February 2014 at 21:51

    Yes but now you’re begging the question and assuming the conclusion with regard to the correctness of your own views on optimal monetary policy, which is not going to convince any other economists.

  21. Gravatar of Saturos Saturos
    3. February 2014 at 23:07

    Nick Rowe’s excellent reply to this post: http://worthwhile.typepad.com/worthwhile_canadian_initi/2014/02/separating-real-from-nominal-shocks.html#more

  22. Gravatar of J.V. Dubois J.V. Dubois
    4. February 2014 at 02:03

    Scott: I more or less agree with you with only two quibbles

    1) As far as I understand in the past you expressed opinion that even NGDP is not an ideal measure to target. Supposedly there are theoretically some better options for target like for instance wage income.

    2) Another thing is that how much do we want to study changes in RGDP as opposed to changes in unemployment. Recent British experience shows that there may be some productivity issues involved. My point is that if there is a supply shock that lowers RGDP but does not impact unemployment as much.

    Or to say it in another way if Okun’s law does not hold very well then impact of two “monetary shocks” as defined by one set of monetary policy rules on RGDP may be very similar, while impact of these shocks on unemployment may vastly differ. Even then I would say that even if comparing two different policies with somewhat similar effect on RGDP the one that produces lower unemployment is superior.

  23. Gravatar of Squarely Rooted Squarely Rooted
    4. February 2014 at 04:04

    Here is a question:

    http://www.npr.org/blogs/money/2014/01/31/268350791/episode-514-how-bernanke-set-off-tomato-protests-in-brazil

    This is the latest episode of NPR’s Planet Money, and they theorize that the primary impact of QE was to give money to major US financial institutions who then proceeded to invest it abroad, causing booms and inflation in the emerging markets that received the inflows but only indirectly affecting the United States.

    Does this matter?

  24. Gravatar of ssumner ssumner
    4. February 2014 at 05:56

    James, I revise my views every time the markets change, even a single point. I don’t revise the model I use to revise my views when the market changes.

    It’s possible that monetary policy is tighter than 6 months ago, but I doubt it. The evidence is weak. Stocks are higher than 6 months ago, so there is nothing in the stock market that indicates money is tighter than 6 months ago.

    If you are asking whether money is tighter than one month ago, I’d say the answer is probably yes, but only slightly tighter. Stocks are far more volatile than monetary policy, because many other factors also affect stock prices. Of course that’s why we need a NGDP futures market. Then we would know.

    Patrick, Very interesting.

    Philo, I agree.

    Mark and Michael, Good points.

    Tom, Don’t forget the sharp slowdown in the growth of the monetary base in late 2007 and early 2008. That’s what triggered the recession.

    Jim Glass, I like the fiscal comparison.

    Saturos, I think you misunderstood the purpose of the post. I was not trying to argue for a particular monetary policy as being optimal. I just used my preferred target as an example. The point was that the definition of monetary shocks ought to be the difference between optimal policy (however defined) and the actual policy.

    JV, Good points, we could define monetary shocks in terms of either Y or U. It’s arbitrary. I don’t have strong views, as I don’t think any policy implications hang on the estimated size of monetary shocks.

    Squarely, The US economy would be far better off if the QE had been invested overseas, but alas it is almost all sitting in ERs.

  25. Gravatar of ssumner ssumner
    4. February 2014 at 05:57

    Squarely, I should have added that an outflow of funds would boost US exports.

  26. Gravatar of Tom Brown Tom Brown
    4. February 2014 at 15:43

    Scott, Mark, OT: what’s your reaction to this short Forbes article:

    http://www.forbes.com/sites/louiswoodhill/2014/02/03/the-great-federal-reserve-fallacy/

    Scott, he specifically mentions you and NGDPLT in there: saying it’d be better than what we have now (but only if done with a futures market), but overall arguing that the gold standard would be better still.

  27. Gravatar of Mark A. Sadowski Mark A. Sadowski
    4. February 2014 at 16:25

    Tom Brown,
    I used to comment on Louis Woodhill when his articles were featured at Real Clear Economics. I’ve wasted far too many words on him already.

    Louis Woodhill:
    “This is because gold has maintained a reasonably constant real value over the centuries, and because gold is considered by many to be the ultimate and true “money.””

    Note that Woodhill puts scare quotations around the word “money” because some of the things that people call “money” aren’t real money backed by real gold.

  28. Gravatar of Tom Brown Tom Brown
    4. February 2014 at 16:46

    Mark, thanks. That was exactly the quote that caught my eye… I almost repeated it here, but didn’t want to scare you away. 😀

    Is he in the same league as John Tamny?

    Plus his repeated use of dog whistles turned me off.

  29. Gravatar of Squarely Rooted Squarely Rooted
    4. February 2014 at 16:55

    Thanks, that makes sense.

  30. Gravatar of Major_Freedom Major_Freedom
    4. February 2014 at 18:42

    It isn’t the aggregate spending increase that is helping the economy grow in the short term, it’s the effects the cause of NGDP growth, i.e. monetary inflation, has on relative spending, prices, and interest rates

  31. Gravatar of Major_Freedom Major_Freedom
    4. February 2014 at 19:21

    The reason why “sufficient” NGDP growth looks like the main cause for (short term) recovery (and why “insufficient” NGDP looks like the main cause for (short term) recession) is that “sufficient” NGDP is associated with higher relative price, spending and interest rate changes, ceteris paribus.

    After all, if for some miraculous reason spending on everything except watermelons collapsed to zero, with $14 trillion plus 5% spent on watermelons, then as compared to a previous period of $14 trillion spending in a division of labor, the real outputs of the two scenarios would be, needless to say, vastly different. This trite example is only meant to illustrate the point that it isn’t NGDP that matters, it’s where spending takes place that matters.

    When MMs call for higher NGDP, they are actually relying, unintentionally, on the other effects of the cause of higher NGDP (i.e. inflation of the money supply), in order to bring about the (short term) effects they desire. They believe they want more NGDP, but what they need is a sufficiently changed trajectory of relative prices, relative spending, and relative interest rates, to bring about the boom.

    Less spending on wages and capital goods, and more than offsetting spending on pizzas, such that NGDP grows, is not going to grow the economy. The HOPE is that more NGDP will be allocated properly among all the various competing uses of dollars. But that hope is misplaced, because investors need an unhampered market in money in order to know where to allocate spending, capital resources and labor, to be in line with market preferences.

  32. Gravatar of Mark A. Sadowski Mark A. Sadowski
    4. February 2014 at 22:56

    Tom Brown,
    Both Woodhill and Tamny abscribe to Austrian Business Cycle Theory. They are very similar in their personal outlooks on life, being largely self educated, anti-empirical, libertarian goldbugs. It’s the anti-empirical aspect that by far bothers me the most.

    What Woodhill says about gold maintaining a constant value is of course totally false, but his anti-empirical nature means he is immune to the exposure of data.

    However, for what it is worth here’s some things I dug up from my notes.

    First of all, it’s not at all clear that that gold has a deflationary bias (which would be a plus in Woodhill’s eyes).

    The nominal price of gold fell from $850 an ounce in January 1980 to $272 an ounce in July 2000. A gold standard might have committed the US to a more inflationary monetary policy over that time period.

    It’s not even clear that gold is even a good hedge against inflation over extremely long periods of time. For example gold was 0.89 English pounds an ounce in 1257. By 1999 it had risen to 172 UK pounds an ounce or an increase of just over 193 fold. But historical estimates of the Retail Price Index (RPI) by Gregory Clark have it rising from 0.144 in 1257 to 74.0 in 1999 or up by nearly 514 fold. The real value of gold went down by 62.4% over 742 years.

    The real problem with a gold standard is not the deflationary bias, it’s the price volatility.

    There or those who blame gold’ recent price variability on the demand for gold ETFs. But gold ETFs have only been in existence since March 2003. There’s no evidence of greater gold price variability since their introduction:

    https://research.stlouisfed.org/fred2/graph/?graph_id=118123&category_id=0

    In fact gold prices appear to have had far higher variability during 1973-1983.

    And annual data on internal gold demand from the UK during 1858-1914 (when the price of gold was fixed) shows extraordinary fluctuations:

    http://research.stlouisfed.org/fred2/graph/?graph_id=118124&category_id=0

    Other than the supposed emergency use of fiat currency by the Spanish in a siege in 1491 during the Conquest of Granada there’s no known record of fiat currency in the West before 1661. So currency consisted almost entirely of gold or silver coins.

    The historical Retail Price Index (RPI) by Gregory Clark is continuous from 1264 to present. The 396 inflation rates computed on the basis of that index from 1264 through 1660 show double digit inflation in 57 years and double digit deflation in 42 years. There are three years where prices rose by more than 30% and six years where prices declined by more than 20%. So there is little evidence of stable prices before the introduction of fiat currency.

    Gregory Clark also estimates of average annual real earnings covering the same period of time. Real earnings fell in 197 years or nearly half fo the time. There are 59 years where real earnings fell by more than 10%, ten by more than 20% and one where real earnings fell by 30.8%. Through the entire 396 year period real earnings increased by 4.4% or at an average annual rate of increase of 0.011%. In short, real earnings were highly volatile but essentially stagnant prior to the introduction of fiat currency.

    Goldbugs often credit the rise of the US as a world economic power to the fact the US dollar was backed by gold and silver in the 1800s.

    The occupation of a lightly populated continent by a technologically superior civilation was bound to lead to some economic growth, no? But if I had to pick one reason for why the US grew from being a medium size power (it was already large enough to win its independence from one of the greatest powers on the earth) to being the world’s leading economy the last thing that would cross my mind is a silver and gold backed currency.

    The United States had five major deflations during the 19th century: 1801-1802, 1814-1821, 1822-1824, 1841-1843, and 1865-1878. Four of these are associated with “panics”: the Panic of 1819, the Panic of 1837, and the Panic of 1873. The average rate of real GDP per capita growth during these five deflations was 0.6%. The average rate of real GDP per capita growth during the the 19th century as a whole was 1.4%.

    Since the beginning of the 20th century the US has only had one major deflation: 1920-33. This was of course associated with the Great Depression. The average rate of real GDP per capita growth was (-1.0%) during those 13 years. Real GDP per capita growth has averaged 1.8% since the beginning of the 20th century (including the Great Depression) but has been even higher since we gave up the medieval practice of using specie as currency.

    All data comes from Measuring Worth.

  33. Gravatar of Bill Woolsey Bill Woolsey
    5. February 2014 at 03:45

    I don’t think “actual policy” to “optimal policy however defined” works at all. Consider all the discussion above of the gold standard. While I don’t consider the gold standard optimal, others do. There are a variety of ways that a gold standard will lead to monetary shocks.

    As for my preferred policy, targeting a growth path of spending on output, there are a variety of ways that monetary disturbances are possible. The exact inverse proportionality of real output to the price level in the face of supply shocks would lead to some monetary disequilibrium that shifts real GDP from potential. Of course, that is not the same as keeping minimizing real GDP variability, which I don’t see as the goal.

    Maintenance of a nominal anchor can entail some monetary disturbance as well.

    But I do favor a nominal anchor and think stabilizing the growth path of spending is on the whole a good idea.

    Think about an advocate of the gold standard. Monetary disturbances can occur in many more circumstances. But some might think the gold standard is still better.

  34. Gravatar of ssumner ssumner
    5. February 2014 at 07:10

    Tom, The Fed does not assume any long run tradeoff between inflation and unemployment, which is why they target inflation at 2%.

    Mark, I believe that there were many debasements of money under the old commodity money regime. Indeed a British pound used to be one pound of silver, but was much less by 1900. Under a true gold standard there is no long run trend up or down.

    Bill, But what is a monetary shock, in your view?

  35. Gravatar of Mark A. Sadowski Mark A. Sadowski
    5. February 2014 at 07:29

    Scott,
    “Mark, I believe that there were many debasements of money under the old commodity money regime. Indeed a British pound used to be one pound of silver, but was much less by 1900. Under a true gold standard there is no long run trend up or down.”

    But I’m not looking at the price of gold in British pounds am I? I’m looking at the real price of gold. And in any case, as I point out, the main problem with gold is the fact that its real price is enormously volatile, so the long run trend is totally immaterial.

  36. Gravatar of ssumner ssumner
    5. February 2014 at 07:53

    Mark, Sorry, I misread your post.

  37. Gravatar of Tom Brown Tom Brown
    5. February 2014 at 10:05

    Mark & Scott, thanks for the replies… especially you Mark. A lot of material there, thanks.

  38. Gravatar of Tom Brown Tom Brown
    5. February 2014 at 10:18

    Mark, you write:

    “The occupation of a lightly populated continent by a technologically superior civilation was bound to lead to some economic growth, no?”

    Whenever the goldbugs bring up how wonderful the 19th century was under the gold standard, that’s my first thought. Low hanging fruit, right? But much thanks for the additional info!

    What about the meat of the Woodhill’s Philip’s curve argument though?

  39. Gravatar of Louis Woodhill Louis Woodhill
    5. February 2014 at 11:34

    Yes, gold has had violent ups and downs in real value. One of them, in 1930, caused the Great Depression.

    As I have written in a number of my Forbes articles, the use of gold *as* money (i.e., a monetary control system where the size of the monetary base is constrained by the physical supply of gold) guarantees a deflationary collapse at some point. This is because using gold *as* money creates a new and potentially unlimited demand for a scarce commodity, and permits no substitution in that application. Combine this with fractional reserve banking, and you have a recipe for disaster.

    Also, if you think about it, if you use gold *as* money, and if things progress to where money is the main use of gold, the real value of both the monetary unit and gold become indeterminate. You are defining something in terms of itself. This, I believe, was the deep cause of the credit/business cycle under the “gold is money” gold standards.

    H.R. 1576, which I drafted for Congressman Ted Poe (TX-02) would simply define the value of our fiat dollar in terms of the value of gold. Under H.R. 1576, monetary operations would have no impact upon the supply of, or the demand for, gold itself. Under these conditions, I believe that the real price of gold would be very stable. After all, the markets know everything about the supply and demand pictures for gold, and there is an enormous inventory of the stuff, expressed as years supply for consumptive uses (e.g., jewelry).

    I would also be happy with monetary reform that forced the Fed to target its Open Market operations against the CRB index. The point is that “the dollar” is our unit of market value, and all units of measure are defined as “so much of something that has the property that you are seeking to measure.”

    There are enormous costs to trying to operate the economy with a unit of measure that changes every millisecond. We need to stabilize the real value of the dollar and then turn our attention to other economic reforms.

  40. Gravatar of Mark A. Sadowski Mark A. Sadowski
    5. February 2014 at 12:06

    Tom Brown,
    “What about the meat of the Woodhill’s Philip’s curve argument though?”

    Woodhill’s history of the Phillips Curve doesn’t seem to go much beyond 1958, does it? It’s a strawman argument.

    Nobody today believes in a stable exploitable relationship between unemployment and inflation, and its debatable that anybody ever really did. Certainly by 1968, when Friedman delivered his famous speech on the role of monetary policy, that idea had been pretty effectively debunked by the reality of accelerating inflation in the US and in other advanced countries.

    Furthermore a lot has happened to the Phillips Curve in half a century. It’s undergone a major bifurcation into the Gordon’s Trangle Phillips Curve and the New Keynesian Phillips Curve. The first one has a much better empirical record than the latter one, although a hybrid version of the latter one has been incorporated into the economic models of most contemporary central banks.

    So which Phillips Curve is Woodhill talking about? Obviously not any of the Phillips Curves that exist today. His argument is with something that hasn’t existed in over half a century, if it ever existed at all.

  41. Gravatar of Mark A. Sadowski Mark A. Sadowski
    5. February 2014 at 16:13

    Scott,
    “Mark, Sorry, I misread your post.”

    Actually it occurs to me that in my response I may have been too flip. Inflation was highly volatile during the pre-fiat years (1264-1660) but how much of that was due to revaluations. There were 24 changes in the official price of gold during those 396 years.

    The longest time period without a revaluation was from 1265 to 1342 or 77 years. in that time there were 14 years with double digit inflation and 15 years with double digit deflation. In short I don’t think revaluations were responsible for the lack of price stability in the pre-fiat years.

  42. Gravatar of Mark A. Sadowski Mark A. Sadowski
    5. February 2014 at 16:23

    Louis Woodhill,
    “Under H.R. 1576, monetary operations would have no impact upon the supply of, or the demand for, gold itself. Under these conditions, I believe that the real price of gold would be very stable. After all, the markets know everything about the supply and demand pictures for gold, and there is an enormous inventory of the stuff, expressed as years supply for consumptive uses (e.g., jewelry).”

    US monetary operations have had relatively little impact upon gold supply and demand for the last 40 years. Nevertheless the real price of gold has been highly volatile during this time period. What makes you believe this would change under H.R. 1576?

  43. Gravatar of Mark A. Sadowski Mark A. Sadowski
    5. February 2014 at 16:27

    Tom Brown,
    Do you see what happens when you ask me for my opinions? 🙂

  44. Gravatar of Tom Brown Tom Brown
    5. February 2014 at 16:38

    Louis, it sounds like you are describing a gold standard, but minus the direct convertibility to gold via the central bank. Correct?

    I.e. just replace the target: instead of the every shrinking (~2% / year) slice of the CPI basket of goods instead use a fixed fraction of an oz of gold to define the dollar.

    Anybody: thoughts?

  45. Gravatar of Tom Brown Tom Brown
    5. February 2014 at 16:40

    “Do you see what happens when you ask me for my opinions?”

    Yeah!… that’s awesome. 😀

    Thanks for taking some time to wade in.

  46. Gravatar of Tom Brown Tom Brown
    6. February 2014 at 11:32

    Mark, your comment became the basis of a post:

    http://pragcap.com/debunking-the-myth-that-a-gold-based-monetary-system-coincides-with-higher-growth

  47. Gravatar of Mark A. Sadowski Mark A. Sadowski
    6. February 2014 at 12:46

    Tom Brown,
    If I had known that was going to happen I would have spent a little more time checking it for grammar and spelling. (I put together that comment at an odd hour and didn’t think Scott or Marcus would put any of that into a post.) Fortunately the substance is all correct.

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