It’s (not) different this time.

In an earlier post I argued that Fed policy almost always reflects the consensus views of economists, and therefore that most economists fail to perceive major monetary policy failures at the time and place they occur.  I applied that conjecture to episodes of inflation and deflation.   Let’s see if we can take that conjecture even further today.

I’d like to argue that almost every American recession shares two characteristics:

1.  Recessions are caused by a slowdown in NGDP growth, which is triggered by tight money.

2.  During every recession most economists fervently deny point 1 applies to the current problem.

That’s a pretty bold claim, but what else would you expect from a blog entitled “The Money Illusion?”

When economists look back at historical US macro data they immediately notice a strong correlation between nominal shocks and real output.  The mainstream view (which is the one I adhere to) is that these recessions represent failures of demand management.  Monetarists have always singled out monetary policy, and in recent decades new Keynesians pretty much adopted that view as well.  (In contrast, Post-Keynesians tend to see the role of monetary policy as being endogenous, i.e. the nominal money supply might be determined by the business cycle.)

Put simply, a recession occurs whenever AD shifts to the left, or at least sharply slows the rate at which it is shifting to the right.  This results in a sharp slowdown in NGDP growth.  Because NGDP growth generally slows sharply in recessions, and because monetary policy can and should try to stabilize NGDP growth, it is not surprising that modern macro focuses on the search for the optimal monetary rule.

There is just one problem with this simple story.  Economists do agree that slowing AD causes recession, and that monetary policy can and should stabilize AD, but they never seem to see the current recession as resulting from a failure of monetary policy.  It is always “different this time.”  Younger readers of this blog may not know this, but every recession produces a torrent of articles arguing that “this one is different; it’s not like past recessions.” And when you think about it, how could it be otherwise?

[Perhaps someone can help me dig up a recent article that gave scary quotations from the news media during the 1990-91 recession; how it was different from all past recessions, and represented the end of capitalism as we know it.]

The Fed reflects the consensus views of mainstream economists, and that consensus is certainly not going to blame themselves for any recession (even economists have egos.)  At the same time economists are aware that the theories in their textbooks suggest that recessions are failures of monetary policy.  Hence the need for some sort of excuse, some rationalization for why this time they (we) are not to blame.  And the “it’s different this time” excuse is perfect—an excuse for all occasions.

How can economists delude themselves in this way?  I see several possibilities.

1.  Nominal interest rates generally fall sharply in recessions.  Even though at an intellectual level economists should know better, I’ve noticed that most economists think money is “easy” at the very moment that tight money is reducing NGDP growth.  Not just this recession, but every recession that I can recall.  I’ve talked endlessly about this issue, so I’ll spare you another lecture.

2.  Recessions are often associated with real shocks (oil, tech, real estate bubbles, etc) that are easier to visualize than the insidious problem of monetary disequilibrium.

What about this recession?  Why don’t economists blame tight money?  If we exclude the lunatic fringe who deny that monetary policy (no matter how expansionary) can impact nominal aggregates, then there are two possible ways in which monetary policymakers could be exonerated:

1.  The recession may be caused by real factors.  In that case an increase in NGDP may simply result in more inflation.

2.  A monetary policy expansionary enough to stabilize NGDP growth may be politically infeasible.

Arnold Kling argues that stimulus may not be all that effective because what we have is not so much an “output gap” as a resource reallocation problem.  I presume that means that any attempt to artificially stimulate the economy with monetary policy would merely produce inflation, or perhaps further asset bubbles.

Paul Krugman seems to argue that monetary stimulus is politically unacceptable because in order to get real interest rates to the appropriate level, we would need to generate unacceptably high expected inflation rates.  In several previous posts I have argued that Krugman seems to contradict himself, as he generally argues from the traditional Keynesian position that the SRAS is relative flat in a deep slump, but then seems to suggest that any significant recovery in real output would require politically unacceptable rates of inflation.  I am still waiting for one of his defenders to explain this seeming contradiction.  (I might add that I have had some very articulate Krugman defenders visit my blog in the past.)

While on vacation I read a book on cosmology that I almost entirely failed to understand.  The author (a Tufts Professor whose name I forget) suggested that the current theory of the origin of the universe is “inflation.”  Among the many bewildering ideas in the book is his view (which he suggests is now almost the standard model) that the “inflation” theory implies that virtually all possible universes exist.  Thus there are billions of universes just like this one, where I am typing out the same blog, and then billions more that are identical in every respect except that Nick Rowe is a Post Keynesian.

[BTW, moral philosophers have long been troubled by the thought that free will might not exist.  What if it turned out that all possible choices are made?]

He also argued that the famous “Anthropic Principle” has recently received some experimental support, by predicting the value of the cosmological constant with at least a rough degree of accuracy.  I don’t have the book with me, but here is a quotation from Wikipedia:

A generic feature of an analysis of this nature is that the expected values of the fundamental physical constants should not be “over-tuned,” i.e. if there is some perfectly tuned predicted value (e.g. zero), the observed value need be no closer to that predicted value than what is required to make life possible. The small but finite value of the cosmological constant can be regarded as a successful prediction in this sense.

I won’t try to explain the anthropic principle, as I am not sure how to do so without making it sound tautological.  But for those familiar with the basic idea, consider whether the following are analogous hypotheses:

The Innocence Principle: The consensus view of the cause or causes of macroeconomic problems will tend to exonerate the economics community from any blame.

Corollary 1:  The economics profession will never blame monetary policymakers for causing recessions, if the monetary authority reflects the consensus of macroeconomists (as in the US.)

Corollary 2:  The economics profession will never predict any problem that could have been prevented by a suitable monetary policy.  This means that the consensus forecast will never predict that a recession will commence at some future date.

Much of the current discussion of “the economic crisis” proceeds with the unspoken assumption that the sub-prime loan fiasco is the cause of our current malaise.  Indeed, most pundits don’t even see a need to defend that assumption, but rather charge right into explaining how they (we?) could have been so stupid as to allow this financial screw-up to have occurred.  After all, it’s obvious that the sub-prime crisis caused the recession, isn’t it?

Actually it isn’t obvious.  Indeed, this assumption is only defensible if once the scale of the sub-prime fiasco became apparent for all to see, it became blindingly obvious that we faced a severe economic crisis.  But the massive sub-prime crisis became apparent to everyone in late 2007 and early 2008, and yet not only did most economists not predict the current recession (which is now widely expected to be the worst since the Depression), but most economists didn’t even predict a mild recession.  All these economists who confidently tell us what we did wrong to get us into the current mess, and even write books about the failures of capitalism, didn’t see “the current mess” coming even when the purported cause was plainly visible to all!

I’ll conclude by repeating a long quotation from the underestimated Paul Einzig, who saw the same mix of incompetence and overconfidence in 1937.  (It was from an early post that some of you may not have seen, and I don’t recall anyone commenting on.)  This quotation perfectly encapsulates my view of macroeconomists and investors, or “supermen and sub-men” as Einzig calls them:

“On June 9, 1937, this veteran monetary expert [Cassel] published a blood-curdling article in the Daily Mail painting in the darkest colours the situation caused by the superabundance of gold and suggesting a cut in the price of gold to half-way between its present price and its old price as the only possible remedy.  He took President Roosevelt sharply to task for having failed to foresee in January 1934 that the devaluation of the dollar by 41 per cent would lead to such a superabundance of gold.  If, however, we look at Professor Cassel’s earlier writings, we find that he himself failed to foresee such developments, even at much later dates.  We read in the July 1936 issue of the Quarterly Review of the Skandinaviska Kreditaktiebolaget the following remarks by Professor Cassel:  ‘There seems to be a general idea that the recent rise in the output of gold has been on such a scale that we are now on the way towards a period of immense abundance of gold. This view can scarcely be correct.’ . . . Thus the learned Professor expected a mere politician to foresee something in January 1934 which he himself was incapable of foreseeing two and a half years later.  In fact, it is doubtful whether he would have been capable of foreseeing it at all but for the advent of the gold scare, which, rightly or wrongly, made him see things he had not seen before.  It was not the discovery of any new facts, nor even the weight of new scientific argument that converted him and his fellow-economists.  It was the subconscious influence of the panic among gold hoarders, speculators, and other sub-men that suddenly opened the eyes of these supermen. This fact must have contributed in no slight degree towards lowering the prestige of economists and of economic science in the eyes of the lay public.” (1937, pp. 26-27.)

When did our economic supermen realize we had a major crisis on our hands?  Not in late 2007 when the sub-prime fiasco became apparent.  Not in early 2008 when Bear Stearns nearly failed.  Not in the summer of 2008 when industrial production and commodity prices began falling rapidly and the real estate crash spread into heartland markets.  No, it was in the fall of 2008 when they noticed their 401k accounts tanking, and when the sub-men on Wall Street told them AD was falling fast, that’s when our supermen woke up to the severity of the crisis.

And now they want to tell us that the fault lies with greedy bankers, or deregulation, or regulation, or Greenspan’s monetary policy, or oil price bubbles.  They are still unwilling to look in the mirror and ask whether the sharp fall in NGDP in late 2008 might have reflected a monetary policy stance far too contractionary for the needs of the economy.  The next generation of economists will look at the appalling NGDP data and have no compunction about pointing fingers where all our macro/money textbooks suggest they should be pointed.



17 Responses to “It’s (not) different this time.”

  1. Gravatar of Alex Alex
    8. June 2009 at 06:37

    Scott. You still have to convince people that the counter factual to the current policies is not 25% unemployment and a 30% drop in GDP. I know your story about the truck and the driver. Well this truck driver just avoided hitting the school bus and killing 50 kids at the cost of destroying his truck. You think that he could have steered the truck in a way that he could have also saved the truck, maybe… I’m just happy the kids are OK and now we have 80 more years in which we can test your maneuver with the confidence that the next time the driver is in the same situation at least he knows how to save the kids.

  2. Gravatar of Chris Chris
    8. June 2009 at 07:10


    What is your theory of boom and bust? You have stated in previous posts that you don’t support the Austrian view of monetary induced malinvestment, but in this post you talk about the Fed causing the latest recession. I’ve enjoyed your blog, so hopefully you could elaborate on this topic.

  3. Gravatar of Jon Jon
    8. June 2009 at 08:02

    It was different this time: the tbill fetish on the part economists returned in force and the duration of the downturn nearly doubled.

    Once the Fed turned to monetizing a mix of instruments–instruments that the market believed could be more difficult to demonetize and hence were more permanent than temporary–voila, signs of recovery appear almost immediately.

    Incidentally, there is very little evidence of ‘quantitative easing’ relative to six months ago. The Fed has wound down its TOMOs in lock-step with its POMOs, thus demonstrating that really large quantities were not needed but a perception that those quantities would not be withdrawal immediately was needed.

  4. Gravatar of Alex Golubev Alex Golubev
    8. June 2009 at 08:31

    Scott, you have probably done this before, but i would love to see a visual or quantified representation of this: “a strong correlation between nominal shocks and real output”. it’s not that i don’t believe you or it doesn’t make sense. but i suspect that something always leads to the nominal shock as well and one might even call it a “cause” and possibly see patterns there. We’re all drunks looking for our keys where the light is.

  5. Gravatar of Alex Golubev Alex Golubev
    8. June 2009 at 08:41

    I’m not the only “drunk”/economist blaming leverage. Mistakes happen, but ((mistakes x33) x all banks) are quite deadly and aka “nominal shocks”:

    “A few days ago, I called Burton G. Malkiel, the Princeton economist, to ask him what he thought of Mr. Grantham’s theories. Mr. Malkiel is the author of “A Random Walk Down Wall Street,” surely one of the greatest popularizers of any academic theory that’s ever been written.

    “It’s ridiculous” to blame the financial crisis on the efficient market hypothesis, Mr. Malkiel said. “If you are leveraged 33-1, and you’re holding long-term securities and using short-term indebtedness, and then there’s a run on the bank “” which is what happened to Bear Stearns “” how can you blame that on efficient market theory?””

  6. Gravatar of Jon Jon
    8. June 2009 at 16:05


    I feel its important to distinguish the implosion of the financial industry from the economy. Anyone wishing to link them needs to show the causality.

    The banking implosion appears as a classic-bank run. Overall delinquencies for diversified institutions are running BELOW prior recessions. AIG was felled not by paying out on losses on MBSs but by collateral calls motivated by a perception that losses might occur in the future. Reckless and fickle statements from the FDIC roiled bank investment by creating uncertainty as to the priority of creditors.

    So why did the economy tank? I suggest monetary policy as an alternative explanation.

  7. Gravatar of ssumner ssumner
    9. June 2009 at 05:35

    Alex, I’m not sure I exactly follow the analogy, but if you steer for 5% NGDP growth you avoid both the children and crashing the truck (high inflation and recession.)

    Chris, My view is that monetary policy errors cause fluctuations in NGDP (or M*V) Because wages and prices are sticky, NGDP fluctuations lead to changes in real GDP, not just prices. In the long run, only prices change. It is actually a pretty standard model.

    Jon, Interesting point. In an earlier post I also noted that the monetary base hasn’t risen all that much this year. The QE may have helped a bit, but I also think signs of recovery in Asia are helping. Your point about the importance of expectations is exactly right. If the QEs are viewed as more permanent, then you may well be correct. But there is one puzzle, why didn’t the all of the positive market reaction come on the announcement? The actual QE has not been more than announced.

    Alex#2, Take a look at Friedman and Schwartz’s Monetary History of the US. Then look at recent recessions like 1982 1991, 2001 and right now—NGDP growth almost always slows sharply. A sufficiently expansionary monetary policy can always generate faster NGDP growth.

    Alex#3, I agree with Malkiel.

    Jon#2m Good point.

  8. Gravatar of Bob Murphy Bob Murphy
    9. June 2009 at 17:00

    Scott wrote:

    When did our economic supermen realize we had a major crisis on our hands? Not in late 2007 when the sub-prime fiasco became apparent. Not in early 2008 when Bear Stearns nearly failed. Not in the summer of 2008 when industrial production and commodity prices began falling rapidly and the real estate crash spread into heartland markets. No, it was in the fall of 2008…that’s when our supermen woke up to the severity of the crisis.

    And now they want to tell us that the fault lies with…Greenspan’s monetary policy…

    Wait a second there, Lex. I tentatively predicted that this would be the worst recession since ’81-’82, and I made the prediction publicly in the fall of 2007. (It was based on a forecast for a bank client I made in July 2007.)

    Now if you’ll excuse me, I have to go fight some villains who escaped from the Phantom Zone.

  9. Gravatar of ssumner ssumner
    10. June 2009 at 06:07

    Bob, I meant “perceived supermen,” not “actual supermen.” I consider you an actual superman.

  10. Gravatar of Alex Golubev Alex Golubev
    10. June 2009 at 07:06

    1. Show causality between bankign and economy?? Did easy credit not stimulate the economy first? Perceived and real losses drive the banks cost of capital, which drives their willingness to lend and the rate they charge. now we get a negative feedback loops.
    2. Perceived vs real losses. Perceived losses based on high EXPECTED losses + high PERCEIVED leverage. Yes perception is reality. AIG didn’t get a chance to REALIZE these high leveraged losses. committing AAA capital to not so AAA collateral is a type of leverage. Repeating that 2-3 times for every loan (securitization, CDO, CDO squared) IS leverage.
    3. EMH, it’s starting to bug me again and Scott hasn’t posted any followups to the original EMH post 🙂 – it’s great that the market is unpredictable, but that has nothign to do with efficiency or rationality of human economic decisions. Half the time people don’t even know that they’re making an economic bet! if 100 people act on feelings(insurance)/short-sample(last 10 years)/agency-problem-ridden reasons EMH holds up, but resources will be misallocated. what use is that? we can’t just look where the light is.

  11. Gravatar of ssumner ssumner
    11. June 2009 at 05:11

    Alex, I don’t think that easy credit stimulates the economy, in fact I think (ceteris paribus) it is exactly the reverse. Easy credit lowers nominal interest rates. This lowers velocity, which lowers NGDP. I think that easy money stimulated the economy. If the money supply grows fast enough so that M*V increases by more than 5% then the economy tends to get overheated. Thats what happened in 2004-05.

    What easy credit (from Asia) did do is to cause relatively more investment and less consumption than otherwise.

    3. I am still waiting for a useful anti-EMH model; one that will help me invest, or help the Fed, or help bank regulators. Do you have one?

  12. Gravatar of Alex Golubev Alex Golubev
    11. June 2009 at 06:27

    3. Scott, i definitely don’t have one. “the market is unpredictable, but that has nothign to do with efficiency or rationality of human economic decisions”. My point is that proving that the market is not predictable doesn’t prove that resources are efficiently allocated by the agents. I’m not arguing against free markets. i’m arguing against the economic assumption of rational agent. It’s not EMH that i have a problem with per se. it’s the rational agent assumptions: “a rational agent is an agent which has clear preferences, models uncertainty via expected values, and always chooses to perform the action that results in the optimal outcome for itself from among all feasible actions”. do you agree that we act this way? I don’t know a single human being that does (not THINKS he does). So my point is, change EMH to UnpredictableMH and undo the rational agent assumption. then model complex systems and reinforcing processes. We have to give up the simplicity of linear reasoning for the reality of uncertainty and irrational decision making.

  13. Gravatar of ssumner ssumner
    12. June 2009 at 05:16

    Alex, That’s fine, but I still want to know what the usefulness of this approach will be. Even if it is not developed yet, what do you foresee as its value after it is developed?

  14. Gravatar of Alex Golubev Alex Golubev
    12. June 2009 at 07:06

    Scott, I cannot argue for it that well or predict useful value before it’s been discovered, yet I cannot see how we wouldn’t have positive developments from modeling an assumption MORE correctly. “The economy is a complex adaptive system. This was grasped intuitively by, among others, Alfred Marshall, John Maynard Keynes and, of course, Joseph Schumpeter” (funny the appeal to intuition and not reason). It’s from this paper and i think this guy will do a better job arguing for complex systems than I:
    Maybe you can post something EXPLORING the application of complex systems to econ? FOR/AGAINST – i don’t really care. it’s interesting and unknown and better than shooting down something dumb from WSJ or Krugman.

  15. Gravatar of ssumner ssumner
    13. June 2009 at 06:25

    Alex, Here’s an example of why I am skeptical. The abstract from the just announced Arrow prize winning paper from last year:


    “The Market: Catalyst for Rationality and Filter of Irrationality”

    John A. List, University of Chicago and NBER
    Daniel L. Millimet, Southern Methodist University

    The B.E. Journal of Economic Analysis & Policy,

    Assumptions of individual rationality and preference stability provide the foundation for a convenient and tractable modeling approach. While both of these assumptions have come under scrutiny in distinct literatures, the two lines of research remain disjointed. This study begins by explicitly linking the two literatures while providing insights into whether market experience mitigates one specific form of individual rationality””consistent preferences. Using field experimental data gathered from more than 800 experimental subjects, we find evidence that the market is a catalyst for this type of rationality. The study then focuses on aggregate market outcomes by examining empirically whether individual rationality of this sort is a prerequisite for market efficiency. Using a complementary field experiment, we gathered data from more than 380 subjects of age 6-18 in multi-lateral bargaining markets at a shopping mall. We find that our chosen market institution is a filter of irrationality: even when markets are populated solely by irrational buyers, aggregate market outcomes converge to the intersection of the supply and demand functions.

    I agree that there is a lot of irrationality in the world, I am not yet convinced, however, that economists will ever be able to do much with that fact. But I’ll keep an open mind.

  16. Gravatar of スコット・サムナーのマネー観、マクロ観 by Scott Sumner – 道草 スコット・サムナーのマネー観、マクロ観 by Scott Sumner – 道草
    7. May 2011 at 23:59

    […] g.  ほとんどの不況が需要不足、従って金融政策の失敗によって起こると考えるところは私も多くの経済学者と同じである。しかしここでも私の見方は多少異なっている。思うに、ほとんどの経済学者たちは昔の不況についてだけそう理解しており、近年の不況については何か特別な要因のためだと誤診している。彼らは「その最中」、波の上部の泡に魅了されてしまい、混乱を引き起こしている水面下の大きな流れを見失ってしまう。   […]

  17. Gravatar of Diego Navarro Diego Navarro
    18. May 2012 at 14:50

    Sumner may well be right if you understand financial “systemic risk” as a feature of how a complex economy emerges from interlocking exposures — not only in finance, but also in the “input-output matrix structure” of the real economy. Sharp contractions in money supplies would be noncausal precursors of such interlocking systems becoming less flexible.

    Think of a sheet of some pliable material that hardens when wet (i.e. liquidity flowing) but flops when dry.

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