It’s the policy regime that needs fixing

In a recent post I argued that there is no answer to the question of whether money was too easy in 2004-06.  Or more precisely the answer depended on what the Fed had in mind for 2007-17.  This is actually not that strange a view—modern macro theory suggests that the conversation should not be about which policy is appropriate for a given period, but rather which monetary regime is optimal. Without a coherent regime, attempts to fine tune the economy will usually end badly.

Unfortunately, we don’t have a coherent policy regime. We don’t know what the Fed is trying to do to NGDP. More importantly, we don’t know what they’ll do if they fail. That is an important part of a regime. Will they act as they did in 2008-09? Or will they have learned something, and act more appropriately (with some catch-up.) I hope it’s the latter, but the honest truth is that we simply don’t know.

With this level of uncertainty is not obvious what sort of monetary policy is appropriate today, even for people who believe in something like 4.5% NGDPLT. And that’s because even if you decide to adopt that policy, you need to also decide where to start the trend line.  Right here?  Or after a bit of catch-up?  That’s discretionary.  Good policy is rules-based, but first you must use discretion to decide the optimal rule.  But we never actually do pick a rule, and hence the frustration of us rules proponents, we are always seeing the wrong debate take place.

We are inappropriately mixing a debate over day-to-day policy with a fight over what rule we should be on.  Imagine a cross-country road trip where there are constant disputes over which road to take because the two passengers aren’t sure exactly where they are, and also because one wants to go to LA and the other to San Francisco.  I’m saying we should at least agree on the destination, and then we can figure out which road is best (or better yet let the market figure it out.)

Evan Soltas has an excellent post explaining why current Fed policy is appropriate. Tyler Cowen agrees. Ryan Avent and Cardiff Garcia have excellent posts explaining why current policy is too tight. It’s not clear who’s right.  Policy in the US and the UK and Japan is defensible.  In contrast, policy a few years ago in those three countries was indefensible, and indeed policy in the eurozone continues to be indefensible to this day.

In the US, the optimal policy right now depends on what the Fed contemplates doing later.  Does the US plan to adopt a 4.5% NGDPLT regime in late 2015, when they exit the zero bound?  Then I’m with Soltas, I’m fine with current policy.  Does the Fed intend to continue its discretionary growth rate targeting after 2015?  Then I’d support a higher path of NGDP, for reasons explained by Avent—it makes the zero bound problem less likely.

Over at Econlog I have a new post arguing that the interest rate increase of late 2015 caused the Great Recession (a much more interesting post than this one, BTW.)  Given that assertion, it might seem odd that I think Soltas’s preferred policy is defensible.  The problem is that it was expectations of this 2015 policy that caused the Great Recession, and unfortunately that horse has already left the barn. Contrary to Krugman’s expectations trap argument, the problem wasn’t that the central bank couldn’t commit to being irresponsible, or that it wouldn’t be believed if it chose to commit, the problem is that the central bank simply didn’t want to. There’s no doubt in my mind that a Fed commitment to return 65% of the way back to the old trend line would have been believed. For the Fed, the costs of reneging on a promise would be an order of magnitude greater than the benefits. (BTW, contrary to what you read in the press, the Fed never reneged on its promise to not raise rates before unemployment fell to at least 6.5%, or inflation rose above 2.5%. Nor would they be reneging if they lowered the threshold to 6.0%)

The dispute between Soltas and the doves is certainly an interesting one, and both sides are making great arguments.  But as important as it is, the far more important debate is over what sort of monetary regime we should have.  Going forward, that should be the focus of our attention.  Solve that problem, and the day-to-day worries about the current stance of monetary policy will dissipate like the morning mist on a hot day.

PS.  If you don’t understand why current eurozone policy is indefensible, go back to my road analogy.  Imagine there is a debate over whether the car should go to LA or SF, and they are currently closing in on Moose Jaw, Saskatchewan, from the south. That’s the eurozone.  In contrast, Soltas and Avant are in a car near Kansas City heading west.  That’s the US (and Britain and Japan.)

PPS.  I decided not to take a stand on the debate because I thought that doing so would distract from the purpose of this post.  I can do that elsewhere.



26 Responses to “It’s the policy regime that needs fixing”

  1. Gravatar of Morgan Warstler Morgan Warstler
    13. March 2014 at 07:15

    “Does the US plan to adopt a 4.5% NGDPLT regime in late 2015, when they exit the zero bound? Then I’m with Soltas, I’m fine with current policy. Does the Fed intend to continue its discretionary growth rate targeting after 2015?”

    We need to be looking at 4% NGDPLT and headed lower.

    We’ve got RGDP that is going unmeasured because of digital deflation.

    There can be no more safe investments, instead of worrying about people holding cash, we should be trying to break investors expectations that anything over 0% is risk-less.

    Digital economies don’t do debt, they do equity.

    We should be structuring our MP towards an equity based economy as fast as possible.

  2. Gravatar of Ilya Ilya
    13. March 2014 at 07:32

    I think you have a typo when you write “2015”.

  3. Gravatar of Ilya Ilya
    13. March 2014 at 07:35

    Never mind.

  4. Gravatar of Chuck E Chuck E
    13. March 2014 at 08:18


    What moves would you recommend to structure MP towards an equity based economy?

  5. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    13. March 2014 at 08:45

    Scott, and others, you may find the exchange between Britmouse and Menzie Chinn of interest, here;

  6. Gravatar of Daniel Daniel
    13. March 2014 at 08:48

    Morgan Warstler – always with a solution in search of a problem.

  7. Gravatar of ssumner ssumner
    13. March 2014 at 09:05

    Morgan, It’s about the labor market, productivity is irrelevant to monetary policy.

    Patrick, They never seem to learn.

  8. Gravatar of Willy2 Willy2
    13. March 2014 at 09:37

    Money certainly was too easy. But the timeframe in wich money was too easy was much longer. I would argue it was the timeframe from say 1995 up to 2008. In that timeframe the US CA was larger than the US budget deficit.

  9. Gravatar of Willy2 Willy2
    13. March 2014 at 09:39

    Correction: “US CA” should be “US CA deficit”.

  10. Gravatar of Morgan Warstler Morgan Warstler
    13. March 2014 at 09:58

    There is no labor market problem:

    The fact is we as tax payers pay the “salaries” for 30M+ able bodied non-workers via welfare payments and have reduced consumption poverty to it’s lowest levels ever.

    That we DO NOT require people to work for that welfare by treating it as a wage subsidy IS A ECONOMIC PROBLEM: it reduces consumption in poor areas (that welfare $ could buy EVEN MORE).

    But we do not have an labor market problem.


    Monetary Policy is a terrible band-aid for our CORE economic problem (that we do not treat welfare as a wage subsidy).

    That doesn’t make MP worthless.

    NGDPLT is genius bc it keeps us from having economic crises, it silences the voices of MOAR GOVERNMENT SPENDING!

    As such NGDPLT is good conservative political economy, it is the smarter son of Friedman’s Monetarism.


    The move towards a equity based economy is unavoidable, as near as I can tell.

    Deals based on atoms have underlying collateral that can be borrowed against.

    Digital literally cannot be owned, it cannot be “third party titled” – see BitCoin.

    It cannot sustain a government large enough to enforce property rights on something copyable.

    As Andreesen says “Software is eating the world.” We won’t need 80% of govt. buildings or 80% of public employees 30 years out.

    As Jurvetson says everything physical eventually costs $1 a lb.

    These are unavoidable forces. You see Summers stumbling around trying to imagine WhatsApp’s $19B with 57 workers = we need more high priced government employees building roads!!!

    Uhm, Larry… no What’sApp means we need less roads. We need turn the entire global government into a bunch of What’sApp that people access on their free smartphones, and we run with 57K total employees – all super coders for the entire globe’s government.

    The MAGIC of NGDPLT is that as Woolsey notes it works at 3%. He doesn’t want any inflation.

    Inflation isn’t the concern. We can fight inflation anytime. But, we CANNOT stop the shift from debt to equity, slowing it down, slows down the shift to digital.

    The concern is that all the capital is debt based and it has to be UNWOUND humanely.

    The smaller the NGDP the smaller the returns, the more likely people are to put money into equity plays – buy lottery tickets into the digital future.


    And that Scott is my point:

    DIGITAL = REAL PRODUCTIVITY but we can’t measure correctly because so much of it is free consumption.

    SO MP that SLOWS DOWN the move to digital is LESS PRODUCTIVE.

  11. Gravatar of TravisV TravisV
    13. March 2014 at 10:00

    Dear commenters:

    Fascinating old post below:

    Could someone please explain why “a fall in the U.S. gold ratio is the expected consequence of an expansionary policy”?

  12. Gravatar of benjamin cole benjamin cole
    13. March 2014 at 11:42

    What I feared seems to be coming…the Fed or econ community migrates to NGDP targeting…but being modern econ types, pick a terget too low…I woikd rather have a 4 percent inflation target than a 4.5 percent NGDP target…

  13. Gravatar of Mattias Mattias
    13. March 2014 at 12:45

    And the Swedish Riksbank was in Nevada but turned back in fear of overshooting into the Pacific?

  14. Gravatar of Morgan Warstler Morgan Warstler
    13. March 2014 at 12:45

    Benji, just treat every web ad served and every comment made like a 47 cent stamped letter sent via USPS, but charge 100X for getting it there instantly.

    Now how big is GDP?!?

  15. Gravatar of Morgan Warstler Morgan Warstler
    13. March 2014 at 12:51

    My point is, you LONGING for a $1 to be worth $.96 just to convince money guys to INVEST IT…

    Really props up old silly things like the postal service, which delays the internet.

    Just take your 4% NGDP headed to 2% over 20 years, and cheer the absolute end of the physical bricks and mortar economy, for govt. and private offices, schools, and malls.

    All that’s left is houses, data centers and restaurants and various entertainment social clubs complexes.

    Don’t slow down our glorious future Benji!

  16. Gravatar of Mark A. Sadowski Mark A. Sadowski
    13. March 2014 at 13:05

    Patrick R. Sullivan,
    Menzie Chinn’s post contained material from two previous posts that I had already commented on. This was fortunate because my desktop computer is down today. Thus I mostly just cut and paste two older comments to his new post.

  17. Gravatar of Matt C Matt C
    13. March 2014 at 13:16


    Unrelated question. Do you have an update for when The Midas Curse: Gold, Wages, and the Great Depression is being released. I know you have been working on it for awhile and I am looking forward to reading it.

  18. Gravatar of Mark A. Sadowski Mark A. Sadowski
    13. March 2014 at 13:45

    Off Topic.

    The BOE’s recent paper on how money is created has created a firestorm among endogenous money enthusiasts. However the manner in which is is being covered ranges from blatantly wrong, to somewhat nuanced but wrong, to basically right.

    Lars P.Syll evidently fails to get the memorandum that the Fed, BOJ and BOE are currently doing QE, which is tantamount to central banks increasing the monetary base by ad hoc amounts:

    “This article has discussed how money is created in the modern economy. Most of the money in circulation is created, not by the printing presses of the Bank of England, but by the commercial banks themselves: banks create money whenever they lend to someone in the economy or buy an asset from consumers. And in contrast to descriptions found in some textbooks, the Bank of England does not directly control the quantity of either base or broad money…”

    Philip Pilkington goes nuanced but still manages to be his usual obfuscatory self:

    “…It is fantastic that the BoE has finally decided to lay its cards on the table and be honest with the public about how money is created. Unfortunately though, the report is not willing to make certain concessions. For example, it largely paints the Quantitative Easing programs as being effective “” which they were not “” and it also claims that the BoE still sets the variable that has the most influence on money creation; that is, the interest rate. This latter point ties into the whole debate surrounding the so-called ‘natural rate of interest’ (which I have dealt with extensively here).

    With regards to the central bank’s power to control lending the BoE authors insist that the “ultimate constraint on lending” is monetary policy. They explain how this functions as such,…Now, the functionality of the mechanism that the BoE authors describe is perfectly in keeping with Post-Keynesian endogenous money theory “” it is also perfectly in keeping with recent innovations (if we can call them that) in the New Keynesian literature by the likes of David Romer who replace the vertical-sloping LM curve in the ISLM model with a Taylor interest rate rule. But to a Post-Keynesian the characterisation of the setting of interest rates as being the “ultimate constraint on lending” is complete nonsense. Just to get a sense of the BoE authors’ belief in the borderline omnipotence of the central bank let us once again quote them in the original,…Actually no. The amount of money created in the economy is ultimately dependent on the demand for credit!…”

    Meanwhile, Cullen Roche manages to get it mostly right:

    “…They also do a good bit of explaining on QE and its operations. I personally think they overstate the case with regards to how the central bank “ultimately” determines the amount of money created, but I think they’re trying to emphasize the fact that the Central Bank is the regulator and price setter of reserves. But don’t mistake this for the BOE implying that the Central Bank controls loan creation directly. I might have said it a bit differently, but their point is totally consistent with Monetary Realism’s views…”

  19. Gravatar of Kevin Erdmann Kevin Erdmann
    13. March 2014 at 14:01

    I worked with the numbers a little bit on one of Chinn’s previous posts.

    Here, I found that the low growth and fiscal consolidation were more likely both the result of beginning structural deficits. The negative correlation between growth and fiscal consolidation came entirely from the countries that entered the recession with highly negative structural fiscal balances.

    Here, I found that the relationship came from the Euro countries. The non-European countries all had positive GDP growth from 2008-2012, which was positively associated with fiscal consolidation. The only non-Euro countries that had negative growth were non-Euro, European countries. These four countries had negative growth and fiscal consolidation. All other countries had GDP growth that tended to rise in association with austerity in the structural fiscal budget.

  20. Gravatar of Tom Brown Tom Brown
    13. March 2014 at 15:36

    Mark A. Sadowski, JKH has his own treatment of it, plus he and Nick have a thread going on Nick’s review of the paper.

  21. Gravatar of Steve Steve
    13. March 2014 at 16:58

    “Imagine there is a debate over whether the car should go to LA or SF, and they are currently closing in on Moose Jaw, Saskatchewan, from the south.”

    The bad news is, they’ve already passed through Killcareer.

    But the good news is a westward turn will take them through Swift Print.

  22. Gravatar of ssumner ssumner
    14. March 2014 at 05:09

    Travis, It means more money is being printed for any given quantity of gold backing up that money. The gold ratio is the central bank’s only truly exogenous policy lever.

    Ben, The key is whether they do level targeting.

    Mattias, Good analogy.

    Matt, C. Still no update, hopefully soon.

    Thanks Kevin.

    Thanks Mark, I did a post.

  23. Gravatar of Lorenzo from Oz Lorenzo from Oz
    15. March 2014 at 02:21

    Sort of off topic: Larry Summers as the Rasputin of the Obama Administration.
    Not such a silly analogy …

  24. Gravatar of Major_Freedom Major_Freedom
    15. March 2014 at 10:38

    “It’s the policy regime that needs fixing”

    Actually, it is the idea that we need a “policy” (read: central planning) at all that needs fixing.

  25. Gravatar of Major_Freedom Major_Freedom
    15. March 2014 at 10:40

    “It’s not clear who’s right.”

    That’s because we can’t observe a free market in money.

  26. Gravatar of ssumner ssumner
    15. March 2014 at 12:39

    Lorenzo, Not at all.

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