From the comment section

In the previous post, an excellent comment from “Ram” included this gem:

Krugman is the oddest of the skeptics (though he’s only a quasi-skeptic), because he has said that the way out of the liquidity trap is to raise inflation expectations, and then when the Fed succeeded in doing just that, his response was that the market was overreacting. Overreacting to what? Wasn’t getting precisely that reaction the point?

I wish I wasn’t so long-winded; that’s the sort of short post I’d like to do.  But the rest of his comment is also excellent:

Of course, QE works in Bernanke’s model, otherwise he wouldn’t keep proposing it (first for the BOJ, now for the Fed). Bernanke is hardly a heterodox macroeconomist, which makes me wonder why so many reputable economists have expressed skepticism about QE. Do they work with fundamentally different models from Bernanke, or do they merely disagree about parameter values? Or is there no there there? I thought that Bernanke & Woodford were the foremost representatives of contemporary business cycle theory, prior to Bernanke’s appointment. Why so much dissent now, when there appeared to be so much consensus then?

.   .   .  [the paragraph quoted above]

I understand that economists disagree about a lot of things, but the sense one gets from the pre-crisis literature is that there was a lot more agreement than we’re now seeing. For whatever reason, it seems like the crisis caused everyone to throw everything they believed out the window and revert to their own pet models. Now that the Woodford-style models have turned out to have been the best of the lot, I think what we’re seeing is denial, because it is easier to explain away these apparent successes than to admit that one’s very public deviation from the conventional wisdom proved unnecessary.

My only comment is that I believe the Svensson approach (targeting the forecast) has gained even more credibility than the Woodford approach, although both are far superior to most of the half-baked macro models currently being tossed around.



23 Responses to “From the comment section”

  1. Gravatar of JimP JimP
    8. November 2010 at 08:05

    I think what happens, at least for some people, public figures with established reputations and points of view – is that they get stuck and then just refuse to move. The perma-bears are just that – and they cant move. Both the inflationistas and the deflationistas are stuck – looking for reasons and data to support the idea that we are doomed – no matter what we do. If one model wont produce that outcome they drop it and go to another one. It is not forecasting for them. It is religion.

  2. Gravatar of Ram Ram
    8. November 2010 at 09:43

    Thanks for the kind words. To be clear, I include Svensson in the broader school of thought to which Woodford & Bernanke belong, so I did not mean to suggest that Woodford’s approach has proven superior to Svensson’s. Also, while Svensson pioneered the literature on forecast targeting, Woodford made it to the party before it was too late:

    “I review the long-running debate between proponents of monetary rules and proponents of discretionary monetary policy and argue that inflation-forecast targeting represents a powerful synthesis of the two approaches. I explore some common questions that arise about inflation-forecast targeting and consider how the U.S. Federal Reserve might move toward an explicit policy of inflation-forecast targeting.” (2007)

    The link is here:

  3. Gravatar of libfree libfree
    8. November 2010 at 13:19

    I chalk it up to human nature. Ideas are easy, actions have consequences. When you look backwards you have all kinds of useful data but in the present it’s never so clear. It takes a lot of nerve to do actions you believe are correct in the face of hazy data.

    Think of it like driving a car. No matter how many times you’ve said “It’s better to hit the car in front of me than to swerve into the other lane”, when you actually get there the panic sets in and instincts take over.

  4. Gravatar of Simon K Simon K
    8. November 2010 at 13:40

    Scott – I appreciate your long-windedness. I find macro arguments incredibly hard to follow unless they’re spelled out in great detail, so I find you and Bill Woolsey far more informative than anyone else on these subjects. Aside from my own stupidity, it gives me more confidence you’re not just smuggling your politics into the argument by the back door.

    I suspect that’s what’s going on with those economists who oppose greater monetary ease. Although quite a lot of those opposing the policy are not so much economists as bankers and securities traders, who mostly don’t need to understand macro. Indeed understanding macro is probably an impediment if your job is to make money (or at least appear to make money) from market inefficiencies.

    On the economists, though, I suspect the pre-2008 consensus was an illusion. There were always those on the right who privately preferred to believe the real effects of monetary policy were very small, and those on the left who privately preferred to believe that fiscal policy was more effective, but they were prepared to go along with the consensus view as long as the required macro tweaks to the economy were small. There was, after all, an apparent consensus, and you never get very far in academia going against the current research program – thats certainly true in the hard sciences, so I assume its true in Economics too. With the crisis, though, there’s suddenly a clear motive to go against the grain and try to make a name for yourself – even if all the evidence is actually compatible with the pre-crisis consensus.

    After all, from the right-wing point of view it didn’t make any difference that the Fed was trying to tweak policy it its real effects were very small, and from the left-wing point of view there was nothing much wrong so fiscal interventions weren’t required. If you always private preferred fiscal policy, though, now is the time to try to prove the point, and if you always privately thought monetary expansion was just inflation and nothing else, now is the time to try to stop it.

  5. Gravatar of Shane Shane
    8. November 2010 at 16:33

    But clearly Krugman has a point to some extent–or else why would the Fed’s balance sheet be so bloated?

    Obama shoulda passed the Qualitative Easing Act of 2009, aka the taxpayer bailout, rather than TARP or Wall Street reform. It could have:

    1. Capped size of Fed’s holdings of treasuries.

    2. Allowed it to sell treasuries at that point to support prices in capital markets such as corporate debt and broad-based indexes.

    3. Allowed the fed to shore up return on save investments.

    4. Allowed the fed to decrease the risk of investment in capital markets.

    5. Allowed the Fed to “bailout” the Treasury by adopting a strategy that will increase the value of their balance sheet rather than one that is guaranteed to reduce it.

    Both Krugman and Delong have not only supported such policies, but noted that continued QE at this point is basically deficit spending–it is guaranteed to reduce the money the Treasury will receive from the Fed.

    There are no atheists in foxholes. There are no monetarists in financial panics, because even monetary policy is fiscal policy at some point.

  6. Gravatar of Shane Shane
    8. November 2010 at 16:36

    And don’t say “But we would never have gotten to this point if we just did X,” because we clearly got to that point, and need some strategies for the next time we get to that point.

  7. Gravatar of Morgan Warstler Morgan Warstler
    8. November 2010 at 20:43

    Also from the peanut gallery, I have GREAT NEWS!!!

    Mike “Mish” Shedlock has agreed to a :30 minute debate / discussion with Scott Sumner… on Monetary Policy.

    I suggested Video Skype as I’d like to record and split screen it for – cross posted with the participants.

    I think this is an exciting turn in the debate as both participants cheer free markets, smaller government, and neither believe hyper-inflation is a concern.

    But still they completely disagree on QE.

    The Internet love me, it really, really, loves me!

  8. Gravatar of nyd nyd
    9. November 2010 at 03:29

    1. “most of the half-baked macro models currently being tossed around”

    Such as..?

    2. “targeting the forecast) has gained even more credibility”

    Has it? What is the evidence for this?

  9. Gravatar of scott sumner scott sumner
    9. November 2010 at 06:34

    JimP, That’s right,

    Ram, Thanks for clarification. I can tell by reading your comments that you know more about modern macro than I do.

    libfree, Don’t forget the Fed is always doing an equal amount of “action”. There is no monetary policy that involves significantly more action than any other. They are all just settings of the base. So why not do the “action” most likely to succeed?

    Simon, That’s a good point, and is part of the explanation, but not all. Bernanke is hardly “on the left” but he pushed for fiscal stimulus in 2008. Libfree (above) also has part of the story.

    It’s also odd that right-wingers are more concerned when the Fed is trying to raise inflation to 2%, then when inflation was 2.5% and the Fed was doing nothing about it.

    Shane, Krugman doesn’t understand that the Fed’s balance sheet is bloated precisely because they have run deflationary policies, and because they pay interest on reserves. He is confusing cause and effect.

    If we had done standard easy money policies combined with targeting the forecast, level targeting, we would never have needed to bloat the base. Even now, with the damage done, the Fed could easily stimulate the economy with a much smaller base. Just set a high inflation target and do negative IOR. Those reserves will vanish quickly.

    Morgan, Fine, but someone will have to help me with the technology. Hopefully I can find someone at my university.

    Just so I am not totally caught off guard, is he one of those left wingers who thinks the Fed can’t increase NGDP? Or one of those right wingers who thinks if they do so, it will mean inflation, not RGDP growth?

    nyd, For example:

    1. Models that suggest monetary policy is ineffective once rates hit zero.

    2. Models that suggest a big increase in the base is an inflationary time bomb despite IOR.

    I see these two mistakes all the time. The first is mostly from the left, and the second is mostly from the right.

  10. Gravatar of Morgan Warstler Morgan Warstler
    9. November 2010 at 07:07

    If there’s one thing I think best sums up his own theory it’d be this:

    You both have your own unorthodox system. Its a modern Austrian and Friedmanite.

  11. Gravatar of Mattias Mattias
    9. November 2010 at 07:09

    Quote from Mish that will give you a hint of his views.

    “I define inflation as a net expansion of money supply and credit, with credit marked-to-market. Deflation is a net contraction of money supply and credit, with credit marked-to-market.

    Given that consumer credit is plunging at unprecedented rates, given that credit dwarfs money supply creation, and given that marked-to-market valuations of credit on the balance sheets of banks is again falling, I propose we are back again in deflation.

    My model suggests part of 2007 and all of 2008 were deflationary years. Inflation returned in 2009, and the economy is back in deflation now.”

    See for more.

  12. Gravatar of Shane Shane
    9. November 2010 at 07:13

    Any truth to concerns about downside risk on the Fed’s balance sheet? Or in practice will it all equal out?

  13. Gravatar of Jeff Jeff
    9. November 2010 at 08:44

    Scott, if you debate Mish, the first thing you should do is come to an agreement with him about terminology. As Mattias points out above, Mish uses the word “inflation” to mean something else. You can’t have an intelligent debate if you’re not speaking the same language. Since the word “inflation” has a long history of meaning “growth of the general price level” in economics, you should insist that Mish abide by the conventional definition of it, and he should use the terms “money supply” and “credit” when he’s talking about those things. To do otherwise will only confuse the audience.

    My guess is that Mish will refuse to use the conventional terminology, in which case you should just refuse the debate.

  14. Gravatar of W. Peden W. Peden
    9. November 2010 at 09:31


    Fascinating link.

    On a related note: if we’re ever going to get some real fiscal austerity out of the US, it isn’t going to come in a deflationary period. There just won’t be the political will for it, for one thing. But, with a divided political system that makes big spending programmes difficult (remember the late 1990s?) and an economy that is back on track, the US could really see some positive moves in this direction over the next decade.

  15. Gravatar of Morgan Warstler Morgan Warstler
    9. November 2010 at 09:45


    you are nuts, we’re going to massively cut back on public employees… starting in January.

    The elderly likely voters will be played against the teachers unions… until Public Unions are broken shells of their former selves.

    Teacher strikes and City / State bankruptcies are coming, and none of them end well for the left.

  16. Gravatar of Doug Bates Doug Bates
    9. November 2010 at 10:31

    I think I’m finally less confused about the effects of QE. That it has taken me this long to figure it out helps me to understand all the people who haven’t yet.

    It appears that the creation of credit via QE has pretty much the same effect as the creation of credit via the private banking system. The Fed is essentially stepping in and providing credit because the broken private banking system is constrained by the need to rebuild its capital ratios. Bank credit has basically stalled since Dec07, when the recession began, so the only way to increase credit and boost the circulating money supply is for the Fed to act like a bank, borrowing short and lending long.

    I am concerned that, in doing this, the Fed could crowd out the private banking system, because the Fed is not constrained by the need to optimize profits or maintain capital ratios. But so long as the private banking system remains broken, the Fed is doing no harm, and is helping to keep demand and the money supply growing.

    Although $600bn sounds like a lot of money, it is basically within the norm for the amount of credit that would be created over the next 8 months if the private banking system and the rest of the economy were healthy. So there is no need to be worrying about hyperinflation or collapsing currency, etc. At this level, QE is a lot like training wheels for a private banking system that is relearning how to ride a bike.

  17. Gravatar of Morgan Warstler Morgan Warstler
    9. November 2010 at 11:35

    “It appears that the creation of credit via QE has pretty much the same effect as the creation of credit via the private banking system.”

    If by creating credit, you mean making everyone’s money worth less – then righto!

    Fractional Reserve Currency can be unwound. You might need to have a lower leverage, but there are always hard assets behind the loan.

    I think the thing Scott doesn’t do a good enough job of explaining, at least to me, is how the Fed might get this printed money back out of the system.

    Can’t there be some debt created and placed on books, that allows the cash to be called back in? Retired?

    And another question like Shane’s the assumption is that lots of the crap they have as MBS collateral all marked-to-market.

    What happens when the Fed says “holy shit this is really only worth $300B” – is that like $800B got created, or destroyed?

  18. Gravatar of W. Peden W. Peden
    9. November 2010 at 13:36


    Cutting some employees is one thing. Cutting overall spending in real terms is a task for heroes.

  19. Gravatar of Richard W Richard W
    9. November 2010 at 17:48

    9. November 2010 at 07:13

    ‘ Any truth to concerns about downside risk on the Fed’s balance sheet? Or in practice will it all equal out? ‘

    Although the asset side of the Fed balance sheet is accumulating risk. If they have an indemnity from the US Treasury their risk exposure can’t be higher than the default risk of the US itself. That is why it did not make much sense for the Fed to acquire MBS from other 100 percent state-owned entities. A federal government guarantee on the instruments would have done the same job. The credibility of the Fed price stability mandate is at risk when they are exposed to potential capital losses on securities. However, their solvency is only exposed if they buy foreign-currency denominated securities.

  20. Gravatar of scott sumner scott sumner
    9. November 2010 at 19:15

    Morgan, Thanks for the link.

    Mattias, I don’t like defining inflation as money supply changes. It makes the Quantity Theory into a tautology.

    Shane, Balance sheet risks from QE are relatively small. (Compared to the gains to the Treasury from faster NGDP growth.) I’m not an expert on the unconventional assets that were purchased in 2008, but I’m pretty sure large losses are not expected there either.

    Jeff, If he defines inflation as money, I sure hope he doesn’t provide a “theory of what causes inflation” 🙂

    W. Peden, I hope you are right.

    Doug, Yes, it is relatively small. I don’t like the credit view of QE–I think it mostly works via expectations.

    Richard, Did the Fed save the taxpayers a bit of money by holding GSE bonds rather than T-bonds (given we’d implicitly guaranteed the GSE bonds anyway? The yield was still a bit higher, but shouldn’t have been.

  21. Gravatar of Shane Shane
    9. November 2010 at 19:35

    So the Fed is sound because the Treasury backs it, and the Treasury is sound because, among other things, it controls the Fed. This is how Austrians are made…

  22. Gravatar of scott sumner scott sumner
    11. November 2010 at 06:21

    Shane, No, the Treasury is far from sound. I’m not Austrian, but I’m also not a Keynesian with my head in the sand about the deficit problem.

  23. Gravatar of Yet Another Krugman Kontradiction Yet Another Krugman Kontradiction
    23. November 2010 at 07:13

    […] got that? The market’s expectations responded just the way Scott Sumner hoped, and so QE2 was “working” on that account. But Krugman was a stick in the mud, saying […]

Leave a Reply