Joan Robinson wins

Has there ever been a more complete intellectual breakdown in our profession?  Economists of both the left and the right have been disdainful of the idea that the Fed and ECB adopted ultra-tight monetary policy in late 2008.  When I ask economists why, they often point to the low nominal interest rates.  When I point out that for many decades nominal interest rates have been regarded as an exceedingly unreliable indicator of monetary policy, they shrug their shoulders and say “OK, then real interest rates.”  At that point I explain that real interest rates are also an unreliable indicator, but if you want to use them it’s worth noting that between July and late November 2008, real rates on 5 year TIPS rose at one of the fastest rates in US history, from just over 0.5% to over 4%.  Then they point to all the “money” the Fed has injected into the system (actually interest-bearing reserves.)  I respond that the people who pay attention to money (the monetarists) don’t regard the base as the right indicator, as it also rose sharply in 1930-33.

Their best argument has been “OK, but M2 fell sharply in the Great Depression, and M2 has risen briskly in this crisis.”  At that point I am usually stumped, and merely remind people that the profession no longer paid attention to M2 after the early 1980s, regarding it as “unreliable.”  But now I have a better answer.  I was reading a post by Justin Irving and came across this very interesting graph:

At first glance it doesn’t look like much of interest has happened to the eurozone money supply.  But remember that growth tends to be exponential, and so please visually follow the red euro M2 line upward.  Notice the break in growth in 2008.  Where would the money supply be if the ECB had maintained steady eurozone M2 growth?  Justin also supplied me with the actual seasonally adjusted data.  Here are some data points:

Date                                    M2          growth from 27 months earlier

April 2004                      5339999               14.9%

July 2006                       6372397              19.3%

October 2008                8014245              25.8%

January 2011                8413040                5.0%

So after rising at fairly rapid rates for years, M2 growth slows to barely over 2% annual rate over the past 27 months.  What would Milton Friedman say about that?

If pressed, Keynesians will usually point to real interest rates as the right measure of monetary ease or tightness.  By that criterion the Fed adopted an ultra-tight monetary policy in late 2008.  Monetarists will usually say that M2 is the best criteria for the stance of monetary policy.  By that criterion the ECB adopted an ultra-tight monetary policy in late 2008.  And yet it’s difficult to find a single prominent macroeconomist (Keynesian or monetarist) who has publicly called either Fed or ECB policy ultra-tight in recent years.  Maybe tight relative to what is needed, but not simply “tight.”

I’m calling out my profession.  Do they really believe what they claim to believe about good and bad indicators of monetary tightness?  Or in a crisis do they atavistically revert to the crudest measure of all, nominal rates.  Joan Robinson is famous for once having argued that easy money couldn’t possibly have caused the German hyperinflation, after all, nominal interest rates in Germany were not low during 1920-23.  Have we advanced at all beyond Joan Robinson in the 73 years since she made that infamous remark?  I used to think the answer was yes; now I’m not so sure.

[BTW, modern monetarists like Michael Belongia and William Barnett advocate use of a divisia index for money.  I saw a paper by Josh Hendrickson that showed by that measure money became very tight in the US during 2008.]

Justin’s post also contains another interesting idea.  Notice how much more slowly Danish M2 grew as compared to Swedish, or even eurozone M2.  Sweden has a floating exchange rate and devalued sharply in late 2008, Denmark’s currency is fixed to the euro, and Denmark’s economy is much weaker than Sweden’s (in terms of NGDP and RGDP growth.)  Here’s Justin:

I am examining this issue in my Masters Thesis and it just occurred to me that it might be interesting to see how Denmark and the ECB compare to Sweden on Milton Friedman’s favored measure of monetary policy-M2 growth.  M2 is a standard measure of how much money there is in the banking system of an economy.  It is beyond the point of this post, but there is good reason to think that if M2 drops precipitously, that spending will fall and that the economy will grow below its potential.  Unfortunately we cannot see M2 for Finland alone as there is no real way of distinguishing between the stock of Euros within the Finnish economy, and those in the broader world.  The Danish crown however is something like that radioactive dye physicians inject into peoples veins so that they can see the circulatory system on an x ray.  The Danish currency is essentially the Euro, except that we can track it by the fact that it has pictures of Viking longships on it if it is currency, or a DKK currency ID next to it if it is electronic money.

Because Denmark fixes the price of the Danish Crown in terms of Euro, the central bank is constrained in how it can stabilize M2.  Central banking is, at the end of the day, pretty simple (no to be confused with easy).  The only thing the bank can really do is change the quantity of money and see how the market reacts.  Most of the time, central banks pick an interest rate they think appropriate and print money or pull it from circulation (by selling financial assets or foreign currency they have accumulated) until the interest rates moves where they want it.  When interest rates fall to zero, central banks need to pick other variables to guide their money printing decisions, such as stocks, exchange rates, consumer prices or nominal GDP.  In the case of Denmark, the central bank targets the exchange rate against the Euro by buying and selling the Danish crown in currency markets so that its rate against the Euro never changes.  As Denmark is an open economy with free capital flow, this means that they have essentially no control over their monetary policy.  Danish interest rates and money supply have to adjust to whatever is necessary to keep the Euro rate stable.

I love Justin’s radioactive dye analogy; it reminded me of something I noticed in the Great Depression.  In the US the monetary base fell 7% between October 1929 and October 1930, under the Fed’s tight money policy.  Then it rose substantially after October 1930.  But money didn’t become easier, rather the Fed was partially accommodating the hoarding of cash and reserves during banking panics.  But not fully accommodating the demand, as NGDP continued falling sharply after October 1930.  How could we know if this explanation is correct?  One answer would be to look for a similar economy, without banking panics.  In Canada there were no bank panics, and cash in circulation continued falling throughout 1929-32, if my memory is correct.  Because the US deflation was transferred to Canada via the international gold standard, they had no choice but to deflate their own currency.  Canada in the early 1930s is like Denmark in the past three years.

There’s an old fairy tale where a beautiful princess looks in the mirror and sees her true self, which looks more like an ugly witch.  The US monetary policy looked beautiful in the early 1930s, if one just focused on the base.  But all one had to do was look to the north to see just how ugly it really was.  If the ECB wants to take a look in the mirror, I suggest they take a look at the contrast between Swedish and Danish M2 growth.  The Danish policy it what their policy really looks like.  It’s not a pretty sight.

BTW, Justin’s blog post is more valuable than most master’s theses that I have seen.

PS.  I believe Canada may have done a small devaluation in late 1931, but not enough to prevent deflation.



43 Responses to “Joan Robinson wins”

  1. Gravatar of Britonomist Britonomist
    24. March 2011 at 08:11

    Did Joan Robinson really say that? o.O I didn’t actually know about that.

  2. Gravatar of Scott Sumner Scott Sumner
    24. March 2011 at 08:23

    Britonomist, I discussed it in this post, but don’t have a source. I wonder why not?

  3. Gravatar of flow5 flow5
    24. March 2011 at 08:31

    Very mis-leading. (1) System membership wasn’t compulsory; (2) there was an insufficient volume of eligible Federal Debt to “prime the pump”; (3) before 1933 one FRB could be conducting operations of the buying type — expanding credit, creating bank costless legal reserves and laying the foundation for a multiple expansion of money, while another FRB was doing the opposite, — conducting open market operations of the selling type; (4) it was not until 1933 that we began to unshackle our paper money from the numerous and unnecessary restrictions pertaining to its issuance. With the numerous types of paper money in circulation at the time, this would seem to have been a non-problem. Here is the list: gold certificates, silver certificates, national bank notes, United States notes, Treasury notes of 1890, Federal Reserve Bank notes, and Federal Reserve notes. With that array of paper money there should have been plenty to meet the liquidity demands placed on the banks by the public. But the volume of each type that could be issued was so circumscribed by restrictions that even the aggregate group could not begin to meet the panic demands of the public…These are operational problems, not “tight” money.

  4. Gravatar of flow5 flow5
    24. March 2011 at 08:37

    From the standpoint of monetary authorities, charged with the responsibility of regulating the money supply, none of the current definitions of money make sense. The definitions include numerous items over which the Fed has little or no control (e.g., M2), including many the Fed need not and should not control (currency). The definitions also assume there are numerous degrees of “moneyness”, thus confusing liquidity with money (money is the “yardstick” by which the liquidity of all other assets is measured). The definitions also ignore the fact that some liquid assets (time deposits) have a direct one-to-one, unvarying , relationship to the volume of demand deposits (DDs), while others affect only the velocity of DDs. The former requires direct regulation; the latter simply is important data for the Fed to use in regulating the money supply.

  5. Gravatar of Gabe Gabe
    24. March 2011 at 08:50

    The dollar fell to 1/38th of an ounce today. Do you think it is possible the speculators and hoarders are helping facilitate a mania that is essentially using mob tactics to accomplish what the Hunt brothers tried to do? corner the silver market?

    Obviously the Fed and ECB are not engaging in enough easy monetary policy, so why else would these barbaric relics be appreciating against our modern scientifically managed currencies? should we outlaw the hoarding? or try to enlighten the masses that precious metals are neolithic?

  6. Gravatar of Rien Huizer Rien Huizer
    24. March 2011 at 08:51


    Looking at the graph I suggest that Denmark joins the Euro: almost the same M2 path as Sweden (and Sweden is back at the original parity). Of course that would not tell us anything about Danish M2, but who cares in an area with highly integrated economies. However, Mr Irving (I hope his speculative instincts are generally more sound, because after Sweden’s sharp appreciation, maybe he is running behind) would not have been able to write this unremarkable post, and you would not have been able to put it on your blog.

    Both Sweden and Denmark have problematic relationships with the Euro. Sweden is committed (the Maastricht Treaty) to join, Denmark is obliged to behave like a currency board system (and hence share the pain of the Euro system without all of the benefits) because of it’s exception status under Maastricht and its decision to shadow, but not adopt the Euro. Finland is a better benchmark (a EUR member), but it has a very specialized economy.

    If a country with a large external sector has the foreign policy space to depreciate, and it expects that consumers will absorb the likely shock to their budget constraints (in foreign currency terms; swedish consumption on tradeables is mainly imported, the mirror image of its production) without much political action, a democracy (captive to well organized producer interests and their union allies) will always prefer devaluation over nominal pay cuts (as are happening in several EUR countries now).

    If your yardstick for successful economic policy (macro plus micro) is purely NGDP, the Swedish approach wins. Unavailable to the Finns, and voluntarily abandoned by the Danes. However, the Swedish authorities were probably more mercantilistically inspired than is suggested here.If your neighbour cannot retaliate, you can beggar him with impunity. In a democracy, that then becomes the imperative. In Sweden’s case, there are even elements of virtue, apparently.

  7. Gravatar of Mark Mark
    24. March 2011 at 09:23

    I’m not sure where this would enter into measures of money supply (M3??), but it is certainly the case that in 4Q08 all sorts of financing of investment positions pretty much went away for a good while, in terms of investors’ inability to use the repo markets to finance positions. Financing just went away, and as a result caused forced liquidations of large amounts of formerly levered positions in all kinds of securities, up and down the credit quality spectrum. This created all kinds of extreme mispricings which were opportunities for those who could step up and provide liquidity (though the few who were capable were mostly paralyzed by fear). (A personal favorite of mine were the many paired risky debt plus CDS positions that one could buy locking in cash flow returns far above risk-free rates as the basis between the bonds and CDS completely disconnected as a result of forced liquidations.) In any case, at some level all of this would seem to be one sign of extremely tight money, despite what nominal short term rates may have been.

  8. Gravatar of Joe Joe
    24. March 2011 at 09:31


    This discussion you make of the base, M1, and M2. Does there exist any good readings of this historical debate on the measurement of money and its use and meaning, etc.


  9. Gravatar of ssumner ssumner
    24. March 2011 at 10:46

    flow5, I never said M2 made sense, I said others thought it made sense. I don’t focus on M2.

    Gabe, I thought the dollar was 1/1400th an ounce. I don’t pay attention to gold, so I have no opinion on the subject. But I doubt anyone is cornering the market–that didn’t work out too well for the Hunt brothers.

    Rien, I’m confused, Denmark is already effectively in the eurozone. How would formally joining help their situation. I’d expect exactly the opposite.

    I don’t care about motives, but it’s clear to me that Svensson’s motives were pure. In any case the Danes made a mistake not following Sweden.

    Mark, Yes, money was definitely too tight.

    Joe, I’m not certain, as that’s not my area. I would read the stuff by Friedman and Schwartz on both the US and UK monetary history. That might have a good discussion.

  10. Gravatar of Gabe Gabe
    24. March 2011 at 11:02

    1$ per 1/37th ounce of SILVER. The Hunt Brothers were involved in silver more than gold.

    Well I do hope we get some more quantitative easing soon. When do you think your peers will wake up and start pumping up bubbles again? I’m getting tired of waiting for a QE3 announcement. I guess we just need the stock market to go down a couple weeks and then we can count on the Bernanke to give the markets a good goosing. Any insight on timing?

  11. Gravatar of Valentine Gersbach Valentine Gersbach
    24. March 2011 at 11:31


    I have a quick question for you on my new blog which I’d love for you to take a look at:

    In short, I’m wondering in response to this post and your previous post why so many conservatives seem opposed to current Fed policy/QE2? Folks like Kudlow are arguing that we don’t need inflation right now — we need a stable dollar to promote growth (along with better tax and regulatory policy). Now I don’t know what they would say about 2008, but I’d love to get your opinion on the whole debate related to NOW — is QE2 still necessary and/or what about CURRENT inflation worries?

  12. Gravatar of OGT OGT
    24. March 2011 at 11:38

    Prof. Sumner-I don’t quite get why the fall of the M2 ratio in Denmark necessarily points to ECB policy being too tight. (I am not arguing that ECB policy is not too tight, I think it is). All it seems to be saying is that it is too tight for Denmark, and that it’s a bad idea for them to peg (Good to know they make some policy mistakes!)

    If we showed the same index of M2 in China, which is virtually peged to the USD, or Saudi Arabia what does that show us about the appropriateness US Fed monetary stance? I would argue very very little.

  13. Gravatar of Mark A. Sadowski Mark A. Sadowski
    24. March 2011 at 12:00

    It’s interesting to note that M2 growth has fallen more sharply in Denmark than in the Eurozone. Thinking naively one might reason that being pegged to the euro the change in trend growth would be similar. However, this very pattern is repeated in all the other countries with euro-pegged currencies during this period: Bulgaria and the Baltic States.

    What I suspect is that this is simply a story of exchange rate risk. Capital flows for these countries shifted, in some cases dramatically, necessitating a tightening of monetary policy in order to defend the exchange rate. The flow to safety greatly hurt these countries’ economies.

    This is a cautionary note for those contemplating entry into the Eurozone. These countries would have been better served by allowing their currencies to float during the crisis, and resetting their entry dates to a later time.

    I think W. Peden’s observation concerning Denmark somewhat misses the point that the damage is already done. Estonia entered the Eurozone in January, but its economic prospects are not expected to be any better than the remaining two Baltic States that have yet to join.

    It also raises the question of why Denmark is so committed to its peg given they have no clear intention of adopting the euro.

  14. Gravatar of Mark A. Sadowski Mark A. Sadowski
    24. March 2011 at 12:03

    Whoops, when I said “W. Peden” I should have said “Rien Huizer.” Sorry, wrong European.

  15. Gravatar of effem effem
    24. March 2011 at 12:25

    Oddly enough the UK has had perhaps one of the highest M2 growth rates yet has had mediocre GDP growth. And if you look at consumer confidence surveys (since GDP in and of itself is meaningless) the UK is performing terribly.

  16. Gravatar of W. Peden W. Peden
    24. March 2011 at 12:47


    In recent decades, the preffered aggregate amongst monetary economists in the UK has been M4, though even this often has to be adjusted to prevent it being extremely misleading and of course velocity is variable. M4 growth has undergone a “double dip” in the UK recently-

    – which is one reason why UK NGDP growth has slowed down again and this has been reflected in a slowdown of RGDP growth.

  17. Gravatar of Scott Sumner Scott Sumner
    24. March 2011 at 13:53

    Gabe, Yes, we need QE, but we probably won’t get any more.

    OGT, It doesn’t prove anything. But it suggests that in a country where financial crisis hasn’t driven up the demand for M2 (in real terms) monetary policy is tight enough to reduce M2.

    I admit that there are other possible interpretations, but I see an analogy to Canada in the early 1930s.

    The Balassa-Samuelson effect explains China. But Denmark is a slow-growing European country not too different from other European countries.

    Mark, I’d be surprised in there is much exchange rate risk in Denmark. But that’s a possibility.

    Effem, I agree that M2 is not the most reliable indicator. But it is popular with monetarists. My point is that it is not clear why Keynesians and monetarists don’t see money as being tight. I use NGDP as the metric, so its an easy call for me.

  18. Gravatar of flow5 flow5
    24. March 2011 at 14:09


    “Does there exist any good readings of this historical debate on the measurement of money and its use and meaning, etc.”

    Try Wikipedia’s “money supply”.

  19. Gravatar of Rien Huizer Rien Huizer
    24. March 2011 at 14:52


    If Denmark had been in the Eurozone, it’s M2 qould have been the Zone’s M2, which as the graph shows, is not all that different from Sweden’s. Not that it would benefit Denmark, but observations of this type (I would consider them rather questionable) would not be possible. I though my comment made that clear.

    As to Sweden’s motives: I am sure that monetary virtue and mercantilist expediency found a happy marriage in the Swedish case, but of course, there cannot be any proof.

  20. Gravatar of The Numeraire The Numeraire
    24. March 2011 at 14:55

    “So after rising at fairly rapid rates for years, M2 growth slows to barely over 2% annual rate over the past 27 months. What would Milton Friedman say about that?”

    M2 growth results primarily from financial intermediation (lending), so much of broad money supply growth is a function of economic growth. Of course then, M2 would tend to slow as the economy recedes. That is why Friedman’s M2 explanation of the Great Depression is poor — falling M2 is more likely to correlate than cause economic contraction.

    One would righfully expect Sweden to have faster M2 growth than regions which have slower NGDP growth, but as I asked you before: what portion of Sweden’s faster RGDP growth is a function of the supply-side tax cuts that Sweden put in place in late-2008.

    Interestingly, the U.S. broad money aggregates grew relatively rapidly during the financial crisis period of 2008-09 and slowed thereafter. This is almost certainly a function of the huge increase in dollar demand as the financial crisis unfolded — investment assets in other countries were dumped and those cuurencies were exchanged for U.S. dollars as investment capital returned to the relative safety of the U.S. financial system. The soaring exchange rate of the dollar and the relatively increase in U.S. M2/M3 support this view and provide some evidence of how money in the U.S. was tighter than all other countries (with the exception of Japan, which also invests a lot of capital abroad and is thought to be susceptible to carry trade dynamics).

  21. Gravatar of Silas Barta Silas Barta
    24. March 2011 at 15:05

    When I ask economists why, they often point to the low nominal interest rates.

    Some of them point to ease with which they could get business loans (for *non*-cocaine-influenced business plans) from credit unions for however much they wanted. Or the numerous ads from responsible financial institutions saying that “we’re still lending” at that time. Or non-ceasing of credit card offers in our mailboxes.

  22. Gravatar of W. Peden W. Peden
    24. March 2011 at 17:44

    The Numeraire,

    Your account lacks any mention of expectations of future broad money growth, especially with regard to expectations following the announcement and introduction of IOR in late 2008.

    Also, isn’t Friedman’s position that the fall in M2 was indeed a product of the financial/stock market problems in 1929-1930 and then this supply side factor was allowed (through bad monetary policy) to turn into a nominal crisis?

  23. Gravatar of Richard W Richard W
    24. March 2011 at 19:53

    W. Peden
    24. March 2011 at 12:47

    ” In recent decades, the preffered aggregate amongst monetary economists in the UK has been M4, though even this often has to be adjusted to prevent it being extremely misleading and of course velocity is variable. M4 growth has undergone a “double dip” in the UK recently-

    – which is one reason why UK NGDP growth has slowed down again and this has been reflected in a slowdown of RGDP growth. ”

    That chart is from 2010. Q4 was probably an outlier. The BoE favoured measure broad money M4 is growing at an annualised 4.9%. Velocity should rise with negative real interest rates. With trend RGDP of 2.5%, they really need M4 to be growing under 4% in order to achieve 2% CPI. Seems unlikely that velocity would slow with CPI currently at 4.4%. If Q1 GDP figures does show Q4 to be weather related as seems likely from PMI’s, the Bank will be forced to raise rates.

  24. Gravatar of Bryan Willman Bryan Willman
    24. March 2011 at 22:02

    I think all of these measures of “money” are wrong for the purposes studied here.

    It’s not at all about how how much money is in the banking system, or the shadow system, nor about what households or investors have already borrowed, if also spent (the normal case.)

    The real quantity of concern is some tiered shape, where each tier is defined by the size, nature, creditworthiness, capital base, of the acting entity, and the size of each tier is “how much money could they spend tomorrow on a project, using unencumbered capital on hand and borrowed money, if they thought the project would make money or otherwise serve them well?”

    When we say the housing market is “soft” in financial terms we are saying that the pool of buyers x the money they can lay hands on is small compared to the inventory of RE.

    So let me suggest a very important measure is MLHO – Money People Can Lay Hands on. This is current deposits – sums needed for operations (free cash or discretionary cash) + what a bank might actually lend + what a broker or hedge fund might lend + what an equity partner might commit. In the current economy in the US, for many entites (many households and businesses) MLHO appears very restricted, and that will throttle growth. (That’s a very conventional point of view – what I’m really suggesting is a different measure of money supply for study of this problem.)

    From my own experience, part of what the RE market is seeing now is the triumph of players with unusal funding sources – margin accounts, credit lines, amassed cash, etc. anything but a historically normal loan from a bank.

  25. Gravatar of thruth thruth
    25. March 2011 at 07:51

    Scott, this talk of broader money measures to include credit like instruments begs the question of what role do you see for the Fed when it comes to lender or last resort and liquidity provision? Based on your previous disparaging remarks about Bernanke’s “creditism”, I’m assuming you think the Fed should not have these powers. The challenge is convincing people that the Fed can offset the impact of collapsing credit relationships with the remaining tools (cutting the short rate, QE).

  26. Gravatar of Is Scott Sumner Reality Based ? | Bear Market Investments Is Scott Sumner Reality Based ? | Bear Market Investments
    25. March 2011 at 09:14

    […] 25, 2011 by admin  Scott Sumner wrote If pressed, Keynesians will usually point to real interest rates as the right measure of monetary […]

  27. Gravatar of mmj mmj
    25. March 2011 at 09:30

    “Rien, I’m confused, Denmark is already effectively in the eurozone. How would formally joining help their situation. I’d expect exactly the opposite.”

    because then they would (in theory only, of course) have input to monetary policy.

    as to mark’s comment about why DK is committed to the peg – perhaps b/c its been in place so long. ditto HK.

  28. Gravatar of flow5 flow5
    25. March 2011 at 09:47

    Bryan Willman:

    “The real quantity of concern is some tiered shape”. Money’s measurement & rate-of-utilization is uncontroversial. It’s always been the same. This was analyzed & reported thus:

  29. Gravatar of flow5 flow5
    25. March 2011 at 09:54

    Nominal gDp just took a hit:

    2010 jan ,,,,,,, 0.13 ,,,,,,, 0.538
    feb ,,,,,,, 0.056 ,,,,,,, 0.507
    mar ,,,,,,, 0.072 ,,,,,,, 0.558
    apr ,,,,,,, 0.056 ,,,,,,, 0.552
    may ,,,,,,, 0.067 ,,,,,,, 0.477
    jun ,,,,,,, 0.038 ,,,,,,, 0.474
    jul ,,,,,,, 0.078 ,,,,,,, 0.499
    aug ,,,,,,, 0.031 ,,,,,,, 0.49
    sep ,,,,,,, 0.045 ,,,,,,, 0.542
    oct ,,,,,,, -0.01 ,,,,,,, 0.386
    nov ,,,,,,, 0.041 ,,,,,,, 0.321
    dec ,,,,,,, 0.099 ,,,,,,, 0.32
    2011 jan ,,,,,,, 0.089 ,,,,,,, 0.155
    feb ,,,,,,, 0.089 ,,,,,,, 0.23
    mar ,,,,,,, 0.118 ,,,,,,, 0.307
    apr ,,,,,,, 0.088 ,,,,,,, 0.218
    may ,,,,,,, 0.098 ,,,,,,, 0.19

    First column rate-of-change in the proxy for real-output.
    Second column rate-of-change in the proxy for inflation.

  30. Gravatar of flow5 flow5
    25. March 2011 at 10:00

    Only price increases generated by demand, irrespective of changes in supply, provide evidence of inflation. There must be an increase in aggregate monetary demand, which can come about only as a consequence of an increase in the volume and/or transactions velocity of money. The volume of money flows must expand sufficiently to push prices up, irrespective of the volume of financial transactions, and the flow of goods & services into the market economy.

    In the current environment, price increases attributable to supply shocks as applied to specific commodities, even if of temporary duration (transitory as Bernanke says), create price distortions that foster stagnation, & unemployment, & generally lower prices, if not “validated” by an offsetting expansion of monetary flows. But “validation” in the present mix of economic forces will give us stagflation (since the consumer’s balance sheet is already full blown).

    Distortions now exist which diminish the prices and demands for substitutable products. In other words, the economy ceases (to the extent monopolistic and/or supply side shocks penetrate the system), to be self-regulatory. A massive diversion of purchasing power from non-petroleum & food prices increases, will weaken most sectors of the economy, lowering overall business activity.

    The essence of a free self-regulatory) capitalistic system is price flexibility, downward as well as upward (think sticky prices). Lacking this flexibility, downswings in the economy are not self-correcting. Unemployment causes more unemployment. Bank & other business failures beget more failures. Since the economy lacks the capacity to rejuvenate itself, additional government intervention is inevitable (perhaps leading to command economy).

  31. Gravatar of ssumner ssumner
    25. March 2011 at 10:05

    Valentine Gersbach, Sorry I missed you last time. I don’t understand the conservative view on monetary stimulus, I have to assume they have mixed up (Keynesian) fiscal stimulus with (monetarist) monetary stimulus.

    Rien, You said;

    “If Denmark had been in the Eurozone, it’s M2 qould have been the Zone’s M2, which as the graph shows, is not all that different from Sweden’s.”

    No, it’s M2 would have been exactly the same as it actually was. The reason eurozone M2 did better is because the real demand for M2 rose by more in the eurozone than in Denmark. Eurozone monetary policy was much tighter than in Sweden, and the Sweden/Denmark comparison probably shows that better than the Eurozone/Sweden comparison, as the Swedish and Danish economies are fairly similar. The money supply is endogenous under an open economy fixed exchange rate regime.

    Numeraire, I not sure you understand Friedman’s argument. He agrees that M2 and NGDP are closely correlated, which is precisely why he argued the Fed should not have allowed M2 to fall sharply. They don’t control M2 directly, but if they had injected enough base money they could have prevented M2 from falling. The only interesting debate there is whether or not that would have required the US to abandon the gold standard, which is unclear.

    BTW, I am not in favor of M2 targeting, but it certainly would have been much better than what they actually did in the early 1930s.

    I agree with your points about 2008 in the US, and indeed have made the same argument here. I don’t know enough about Swedish tax cuts to comment, but certainly monetary policy played a role, as evidence by the faster NGDP growth in recovery.

    More to come . . .

  32. Gravatar of Merijn Knibbe Merijn Knibbe
    25. March 2011 at 10:45

    Let’s look at Swedish and Danish unemployment, (industrial)production and GDP, 2010

    Sweden: unemployment is falling (fast!), production is up (in fact: in 2010 the best performing economy of the EU).

    Denmark: unemployment is rising (fast!), production is down (in fact: in 2010 the worst performing of the smaller economies ‘around Germany’: Belgium, the Netherlands, Poland, Denmark, the Czech Republic, Switzerland, Slovakia).

    Denmark is in the middle of growing economies – and declining (‘real’, PPP prices are indead high, the highest of the EU, by the way).

    Source: Eurostat

  33. Gravatar of johnleemk johnleemk
    25. March 2011 at 13:51


    I don’t think there is a good way to model conservative understanding of monetary policy, but I think conservatives believe:

    1. Inflation is never good
    2. Good supply-side policies can lead to a free lunch, independent of monetary policymakers’ stance

    Devilish supply-side economics has led to the conservative bench abandoning all use for monetary policy, except when it can lead to even worse outcomes, like deflation. The Marshallian scissors of supply and demand don’t seem to exist in the macroeconomy for conservatives. Krugman actually wrote an op-ed about this in the 90s, I think.

  34. Gravatar of Lorenzo from Oz Lorenzo from Oz
    25. March 2011 at 15:04

    The discussion of the various monetary aggregates has always confused me. Scott’s focus on NGDP makes much more sense to me: the use of money in actual transactions for goods and services, not how folk might have shifted between various forms of money.

  35. Gravatar of Scott Sumner Scott Sumner
    25. March 2011 at 17:38

    Silas, Those would be the economists who don’t know the difference between monetary policy and credit policy.

    Bryan, For me, the best definition of money is the base, as that’s the money actually produced by the Fed. It indirectly affects other aggregates.

    thruth, I don’t really object to the discount window (very much), but I assumed that creditism when far beyond discount loans. I object to focusing on propping up banks instead of trying to prop up NGDP.

    flow5, I agree that supply shocks can tend to reduce NGDP.

    Merijn Knibbe, Thanks for that info–very persuasive.

    johnleemk, Yes, I think they put too much weight on inflation, and not enough on NGDP. Thus if inflation falls to zero, and NGDP falls into negative territory, that’s good because it’s “price stability.”

    Lorenzo, Monetary aggregates may have made sense in a world of policy lags, but not in a world of “target the forecast.”

    mmj, OK, they’d have a bit of input, but not enough to significantly affect policy.

  36. Gravatar of Lorenzo from Oz Lorenzo from Oz
    25. March 2011 at 18:43

    Scott; Yes, but did the world change or merely our understanding of it? 🙂

  37. Gravatar of ssumner ssumner
    26. March 2011 at 17:42

    Lorenzo, Probably our understanding of it.

  38. Gravatar of ジョーン・ロビンソンの勝利 by Scott – 道草 ジョーン・ロビンソンの勝利 by Scott – 道草
    29. March 2011 at 06:15

    […] Scott // スコット・サムナーのブログから “Joan Robinson wins“(March 24th, 2011) […]

  39. Gravatar of Oh,SoTheTestWasToday? Oh,SoTheTestWasToday?
    30. March 2011 at 12:33

    The Fed’s policy with regard to M2 seems less tight:

  40. Gravatar of ssumner ssumner
    31. March 2011 at 06:48

    Yes, regarding M2 the ECB is much tighter.

  41. Gravatar of Postkey Postkey
    7. April 2011 at 05:49



    Joan Robinson was a well known apologist for the Mao regime and its actions in Tibet.

    Something like – Tibet is historically part of China.

  42. Gravatar of Andrew Lainton Andrew Lainton
    26. May 2011 at 02:34

    I think you are being slightly unfair on Joan and you know it.

    The reference is from a 1937 review of a book setting out a quantity theory view of inflation.

    In the review JR does not deny that changes in interests rates can cause inflation – through a quantity theory view. But doubted that this was what occurred.

    She presented her own post-keynsian view that always and everywhere inflation is cause by rises in real wages. In the Weimar context balances of payments deficits eroded real wages, workers pushed for wage rises, the cost push driven distributional rebalancing required firms to increase real cash balances – it required at least a partially endogenous view of money which the German central bank then supported through printing money. In this theory the printing presses played a role but a passive one – and one where the government was complicit as it had the byproduct of monetarising the wage induced increase in the national debt.

    Though flawed the theory has a number of interesting components – and any theory that neglects real wages and balance of payments is doomed.

    A sounder theory is that from Bortkiewicz (1925) ‘One need not turn the quantity theory of money on its head in order to explain the disproportional growth of money supply and inflation at a certain stage of the inflation process. Instead, the theory needs to be re-interpreted in a way that allows for the fact that the price level is not exclusively determined by the money supply but also by the expectation of the level of further emissions.’
    ‘lack of confidence in the domestic currency, the
    expectation of further emissions and devaluation, has direct bearing on the level of prices and therefore magnifies the effect of an increase in the money supply. As a corollary, the proportionally higher rise in the price level compared to the supply of money creates a monetary scarcity, which actors are trying to overcome by accelerating expenditure thereby raising the velocity. This adaptation process might eventually lead to a substantial acceleration of the circulation of money.’

    Hjalmar Schacht was monetary commissioner and introduced policies which ended the crisis. In his 1967 text ‘The Magic of Money’ blamed monetarising the debt, causing easy credit, used by speculators to naked short sell against the mark. It should be remembered that the bank was privately owned and operated a ‘real bills’ policy. The allied powers had insisted on a loosening of control by the german government.

    Don’t forget also that following the allied occupation of the Ruhr following debt default the programme of ‘passive resistance’ saw the workers on strike, but still being paid by the government money printing. Think about this. T=o, so prices must rise and real wages fall, even without the presses running, profits are eliminated, as are government revenues, so debts rise and the currency falls, a self reinforcing cycle develops. As soon as such a cycle unfolds the future becomes predictable and expectations come into play. The Schacht and Bortkiewicz effects drive up velocity of money and we have exponential hyperinflation.

    From such an approach we can see that even if monetary expansion were no more than to maintain the ‘real’ value of the government fiscal position, we could still have a mechanism for hyperinflation, in that sense JR was right. But she was wrong in that without the presses running the cycle could not repeat, and running them faster than to maintain a real fiscal position could worsen inflation.

    Modern theories of hyperinflation offer complex explanations melding monetary, balance of payments and expectations elements with transmission mechanisms and the different roles of endogenous and exogenous money. In particular they look at feedback mechanisms from price to money as well as money to price.

    All Robertson was doing was critiquing the simplistic mono causal helicopter view of inflation. For that she deserves praise.

  43. Gravatar of ssumner ssumner
    26. May 2011 at 04:53

    Andrew, You’ve made lots of comments, some of which I agree with and others I do not. Here’s a couple reactions:

    1. Nothing you say relates to my assertion that JR thought easy money meant low interest rates. My claim is valid, and not misleading.

    2. The insulting tone of your comment is uncalled for. If you disagree, that’s fine, but don’t question my motives. I have nothing against Joan Robinson. Why would I intentionally mischaracterize her views?

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