Joseph Stiglitz and the Tea Party

Randall sent me a perplexing Financial Times piece by Joe Stiglitz.  He begins by comparing the proponents of monetary stimulus to the monetarists of the 1980s:

A quarter-century ago proponents of monetary policy argued, with equal fervour, in favour of monetarism: the most reliable intervention in the economy was to maintain a steady rate of growth in the money supply.

In fact, a better comparison would be with the Keynesians of the 1980s, or the Keynesians of today.  It is Keynesians that favor monetary stimulus in recessions, monetarists advocate stable money growth.  Stiglitz knows this, which makes me wonder why he is warning his fellow progressives that monetary stimulus is a dangerous monetarist idea.

This was followed by the discredited pushing on a string idea:

Traditionally, monetary authorities focus policy around setting the short-term government interest rate. But, leaving aside the fact that with interest rates near zero there is little room for manoeuvre, the impact on the real economy of changes in the interest rate remains highly uncertain. The fundamental reason should be obvious: what matters for most companies (or consumers) is not the nominal interest rate but the availability of funds and the terms that borrowers have to pay. Those variables are not determined by the central bank. The US Federal Reserve may make funds available to banks at close to zero interest rates, but if the banks make those funds available to small and medium-sized enterprises at all, it is at a much higher rate.

Then there is this:

It should be obvious that monetary policy has not worked to get the economy out of its current doldrums. The best that can be said is that it prevented matters from getting worse. So monetary authorities have turned to quantitative easing. Even most advocates of monetary policy agree the impact of this is uncertain. What they seldom note, though, are the potential long-term costs. The Fed has bought more than a trillion dollars of mortgages and long-term bonds, the value of which will fall when the economy recovers – precisely the reason why no one in the private sector is interested. The government may pretend that it has not experienced a capital loss because, unlike banks, it does not have to use mark-to-market accounting. But no one should be fooled.

So the Fed might suffer some modest capital losses if QE works, and promotes a faster than expected recovery.  Wouldn’t that be a tragedy!  And he ignores tax revenue gains to the Treasury from a fast recovery.  And what makes Stiglitz think he can predict the future movements of bond prices better than the market?  Is he telling me I’ll get rich if I short T-bonds right after QE2?  Should I believe him?

But all this is nit-picking.  Here’s what really bothers me about Stiglitz’s article.  It’s not that he favors a different monetary policy than I do; it’s that he seems to oppose the Fed having any monetary policy at all.  (Hence the connection with those “abolish the Fed” elements within the Tea Party.)  I defy anyone to read the article and find any monetary policy being advocated.  Indeed I don’t see any evidence that Stiglitz even knows what monetary policy is.

There is no discussion of any nominal target, whether prices, the Taylor Rule, or NGDP.  He seems to think of policy in terms of interest rate changes, but interest rate targets are not Fed policy, they are a tool to implement Fed policy.  If you use interest rates as THE policy, the price level becomes undefined–it shoots off to zero or infinity.  For instance, he indicated interest rates were too low back in 2002-03.  That suggests to me he thinks money was too easy.  Maybe so.  But inflation was below the Fed target at that time.  This suggests that if money had been tighter, inflation might have slowed even more, and a dangerous deflationary spiral could have developed.  That’s why most economists support something like the Taylor Rule, or inflation targeting. Interest rates aren’t enough.

Here ‘s how modern macro works.  Economists assume the Fed has some policy goal or goals.  They choose a nominal target to help implement those goals.  Then they set their various monetary policy tools (such as fed funds rate, IOR, QE, etc) at a level most likely to achieve that nominal target.

But Stiglitz seems oblivious to all this.  He doesn’t advocate a different monetary policy; he suggests we shouldn’t be relying on monetary policy at all.  But the Fed can never be “doing nothing.”  Any policy is an affirmative decision.  The Fed can set policy at a level expected to succeed, or it can set policy at a level expected to fail.

I anticipate some people will argue that Stiglitz does favor more AD, he just wants to “use” fiscal stimulus.  Fair enough.  But once fiscal stimulus is done, what is the Fed supposed to do with monetary policy?  And this is hardly an academic question, in all of American history fiscal policy has never been more “done.”  Even this Congress can’t pass more fiscal stimulus—just imagine the next one.  So it comes down to a basic decision about monetary policy; what is to be done?  And Stiglitz dodges the question, or perhaps implies he’s happy with a monetary policy that is likely to leave unemployment in the 9% to 10% range for several years.  I can’t quite tell.

I have no objection to people criticizing the Fed; I do it all the time.  But then suggest an alternative policy.  What is your nominal target?  How do you think the Fed should try to improve the macro economy?  My problem with Stiglitz is not that I disagree with his answer; it is that I suspect he doesn’t understand there is a question that needs to be answered.


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28 Responses to “Joseph Stiglitz and the Tea Party”

  1. Gravatar of Nick Rowe Nick Rowe
    21. October 2010 at 07:36

    Yep. Given that the government is in the money business, it must, by definition, be doing *something*. The funny thing is, Stiglitz reminds me here of those right-wingers who argue that all monetary policy is just interfering in the market. The only people who can make that argument in a logically consistent manner are those who advocate total de-nationalisation of money.

  2. Gravatar of Nick Rowe Nick Rowe
    21. October 2010 at 07:38

    Just another way of saying what you are saying, of course.

  3. Gravatar of Gregor Bush Gregor Bush
    21. October 2010 at 07:42

    “There is no discussion of any nominal target, whether prices, the Taylor Rule, or NGDP. He seems to think of policy in terms of interest rate changes, but interest rate targets are not Fed policy, they are a tool to implement Fed policy.”

    Exactly. The same thing can be said of Rajan, Kocherlakota and a surprising number of “Wall St” economists who like to talk about the “side effects” of low interest rates and QE. They seem oblivious to the fact that we live in a fiat money world and that AD is a nominal concept. Many economists cite “weak consumer demand” for their forecasts of high unemployment rates and very low inflation for years to come. But if you tell them that their forecasts imply that the Fed should be doing more because they are missing their target badly, they’ll tell you that monetary stimulus is not a good idea and, besides, that there’s nothing the Fed can do anyway.

    You mentioned a couple of weeks ago that the crisis has shown that the majority of economists never really grasped all of the implications of New Keynesian inflation/price level targeting (fiscal policy becomes impotent, ect). This column by Stiglitz, in conjunction with all of the recent hyperventilation about the Fed stating ‘currency wars”, is further evidence of that.

  4. Gravatar of Wimivo Wimivo
    21. October 2010 at 07:42

    It should be obvious that monetary policy has not worked to get the economy out of its current doldrums. The best that can be said is that it prevented matters from getting worse.

    Replace “monetary policy” with “fiscal policy” and it also checks out. Why? Because both the stimulus package and monetary policy have been half-assed. And because of this, suggesting that we should engage in further fiscal stimulus because “monetary policy has not worked to get the economy out of its current doldrums” is highly dubious, if not outright hypocritical in the case of Stiglitz.

  5. Gravatar of Wimivo Wimivo
    21. October 2010 at 07:43

    Totally messed up that html tagging. Sorry.

  6. Gravatar of Morgan Warstler Morgan Warstler
    21. October 2010 at 07:45

    I wish you’d spend more time working through the CPI Futures market….

    The idea that the pay-off on new dollars goes into or come out of the hands of the investor directly, rather than the Fed buying Treasuries seems genius.

    The reason it appears so great, is that it likely diminishes outright demand for T-Bills…. which should push up the Government cost of borrowing, right?

    Which forces us sooner than later to make heavy austerity cuts, right?

    To me this is where you get all mushy… your distinction with DeKrugman isn’t just that new Fiscal is bad, you can carry your monetarism all the way through to “cutting government,” to win over the Tea Party crowd.

    And that’s very very important.

    Afterall, how much QE2 do you think you are going to get if Tea Partiers are howling to Audit the Fed?

    You should make nicey with them, show them your musket as it were.

  7. Gravatar of MikeMcK MikeMcK
    21. October 2010 at 07:50

    Additional wrinkle:

    (a) Monetary policy is a problem because it will decrease the value of the fed’s assets…
    (b) A reduction in the value of assets is bad because it will increase the debt…
    (c) Fiscal policy that increases the debt is okay.

    I’m missing something, I’m sure.

  8. Gravatar of Morgan Warstler Morgan Warstler
    21. October 2010 at 08:41

    http://www.cnbc.com/id/15840232/?video=1614756246&play=1

    Krugman says $8-10T.

    rofl. “Audit the Fed” – here it comes. I warned ya.

  9. Gravatar of Morgan Warstler Morgan Warstler
    21. October 2010 at 08:44

    @MikeMcK

    I actually have been advocating this since I got here. The Fed should push to LIQUIDATE the hard assets underlying the MBS they hold.

    Take the hard assets, and put them into the hands of those with cash…

    Suddenly, the GUYS WITH CASH have a better outlook, they become more willing to take on risk… they just bought three super cheap houses for 20% of last sale price.

  10. Gravatar of andrew andrew
    21. October 2010 at 09:11

    Modest capital losses? On a $2tln portfolio with negative convexity? I’m not so sure about that…..

  11. Gravatar of ssumner ssumner
    21. October 2010 at 10:00

    Nick, Yes, and hence the Tea Party reference. These are actually right wing views (in some regards, not all.)

    Gregor, Good point.

    Wimivo, Yes, he has a double standard.

    Morgan You said;

    “Afterall, how much QE2 do you think you are going to get if Tea Partiers are howling to Audit the Fed?

    You should make nicey with them, show them your musket as it were.”

    I’ll address the Tea Party in a post later today. The last remark you made reminds me of Brett Favre for some odd reason.

    MikeMcK, Good point, I wish I had mentioned that.

    Morgan, Krugman’s just pulling those numbers out of the air. If expectations changed rapidly it’s possible that no QE would actually be needed.

    Andrew, Fair point–I was too cavalier. But I stand by my argument. Despite the Krugman quotation Morgan linked to, no one is seriously suggesting the Fed buy up more than half of all T-bonds. Remember that the Fed and Treasury are actually a consolidated unit. Any Fed profits go to the Treasury. And they’ve made big profits recently.

    Now suppose the Fed is highly successful, rates soar, and the value of T-bonds falls. Any losses to the Fed would be more than offset by gains to the Treasury, as it is still a much bigger net debtor than the Fed is a net creditor. So I still think a successful stimulus program would be a net plus for the consolidated US government balance sheet.

    There is another issue here. The Fed has inside information about its future policy intentions. If it plans to stimulate the economy more than the market currently expects, it should buy foreign bonds, and benefit as the dollar falls. Or it should communicate its intentions to the public, so any expected economic changes are incorporated into bond prices before the Fed buys the bonds.

  12. Gravatar of Nick Rowe Nick Rowe
    21. October 2010 at 10:12

    If QE2 worked, the actual amount of quantitative easing needed would presumably be negative. The Fed’s balance sheet would shrink and go back to its normal composition, just as soon as people expected QE2 to work. It’s not just partly the “communications strategy”; it’s probably more than 100% communications strategy.

  13. Gravatar of ssumner ssumner
    21. October 2010 at 10:25

    Nick, Yes, I forgot to mention that point as well. I agree 100%.

  14. Gravatar of Jeff Jeff
    21. October 2010 at 11:35

    It seems pretty obvious that Stiglitz, like a certain NYT columnist, does not want anyone to think that monetary policy could be effective. If it were, there’d be no reason for more government intervention via regulations, nationalizations, and higher spending. And these guys care a lot more about politics than they do economics.

  15. Gravatar of Ted Ted
    21. October 2010 at 12:05

    I think the thing is Stiglitz leans heavily on the credit-channel on monetary policy. I remember him advocating a sort-of loanable funds theory of the real effects of monetary policy. You can see him getting at this a bit with his discussion of banks and borrowing in that line. I suspect this is why he doesn’t talk about a monetary aggregates.

    But the problem is, quantitative easing can indeed increase lending dramatically in the sort-of monetary-credit model he likes. Let’s say banks have a limited supply of loanable funds (either because they are risk averse given growth expectations or because they are getting interest on stocking their reserves), then the demand for collateral will be high and lending will be low. However, when you inject large amounts of liquidity into the sector, the loanable funds expand dramatically. Banks then lend out, which pushes up collateral values, and then more bank lending etc etc. So even if you assume a credit-channel of monetary policy, like Stiglitz likes, you see a very important role for quantitative easing.

    An interesting paper that gets at the model Stiglitz likes that shows quantitative easing can be effective at extracting bank loans (so long as search costs exist) is Benmelech and Bergman’s “Credit Trap” ( http://www.nber.org/papers/w16200 ). There paper also argues a tax on bank reserves would work as well. Also, interestingly, in their model, it calls for tax cuts to increase lending. Since by cutting corporate tax rates and introducing investment tax credits you increase collateral values which allows firms to extract liquidity from the banks.

    So, it appears in the credit-channel model of monetary policy that Stiglitz likes policies he very much dislikes – quantitative easing and corporate tax cuts – are both optimal policy! As a minimum Stiglitz should be screaming about the interest-on-reserves policy since it limits the credit channel of monetary policy that he feels is the most important.

    (By the way, I don’t necessarily agree with the credit trap model, but it’s exactly the type of thing Stiglitz is talking about and it’s in the monetary framework he likes).

  16. Gravatar of Randall Randall
    21. October 2010 at 12:15

    Scott, what is your view on his point that central banks rates are not driving lending by banks?

  17. Gravatar of Randall Randall
    21. October 2010 at 12:24

    morgan, Fed can’t convert to hard assets. They mostly own only a traunch or small part of a larger instrument placed in baskets of pooled asset ie (MBS). Also many of these instruments are “synthetic”, so they are more of an index or proxy than a hard asset itself, they can be swapped, traded to meet the traunch’s criteria. Also as CDO they can loans, credit cards, life insurance ect. Thats one of the problem with market to market, its hard to value some of these underlying assets and find a price. Which then serves to only reinforce the markets movement and exacerbate the problem.

  18. Gravatar of Randall Randall
    21. October 2010 at 12:32

    Ted, your summary of this point is spot on- but as he also points out, banks are not lacking for capital, (which is true) what they lack is qualified borrowers. The problem is the criteria for credit is set by regulators and does not get impacted by changes in interest rates which is why giving more capital to banks is not likely to work. What would work is if the feds were loosen up the rules on credit. FDR implemented taxes on banks for excess capital, they may work, but banks still have other options to put capital to work without lending. The Volker Rule/ Glass Stigle era rules would put a firewall on the banks balance sheet preventing them from making money from non-lending activities.

  19. Gravatar of Randall Randall
    21. October 2010 at 12:39

    morgan, Fed can’t convert to hard assets. They mostly own only a traunch or small part of a larger instrument placed in baskets of pooled asset ie (MBS). Also many of these instruments are “synthetic”, so they are more of an index or proxy so they can be swapped, traded to meet the traunch’s criteria. As CDO the underlying assets could be loans, credit cards, life insurance ect. Thats one of the problem with mark to market, its hard to value some of these underlying assets and find a price. Which then serves to only reinforce the markets movement and exacerbate the problem.

  20. Gravatar of Yglesias » Endgame Yglesias » Endgame
    21. October 2010 at 14:30

    […] know you won’t listen to me: “” It’s not possible to not have a monetary policy, the only question is which policy would be […]

  21. Gravatar of Mark A. Sadowski Mark A. Sadowski
    21. October 2010 at 14:44

    This reminded me of paper by Brad DeLong called the “Triumph of Monetarism?” in which he summarized the New Keynesian belief system:

    “Twentieth century macroeconomics ends with the community of macroeconomists split across two groups, and pursuing two research programs. The New Classical research program walks in the footprints of Joseph Schumpeter’s (1939) Business Cycles, holding that the key to the business cycle is the stochastic character of economic growth. It argues that the “cycle” should be analyzed with the same models used to understand the “trend” (see Kydland and Prescott (1982), McCallum (1989), Campbell (1994)).

    The competing New Keynesian research program is harder to summarize quickly. But surely its key ideas include the five propositions that:

    1. The frictions that prevent rapid and instantaneous price adjustment to nominal shocks are the key cause of business-cycle fluctuations in employment and output.
    2. Under normal circumstances, monetary policy is a more potent and useful tool for stabilization than is fiscal policy.
    3. Business cycle fluctuations in production are best analyzed from a starting point that sees them as fluctuations around the sustainable long-run trend (rather than as declines below some level of potential output).
    4. The right way to analyze macroeconomic policy is to consider the implications for the economy of a policy rule, not to analyze each one- or two-year episode in isolation as requiring a unique and idiosyncratic policy response.
    5. Any sound approach to stabilization policy must recognize the limits of stabilization policy–the long lags and low multipliers associated with fiscal policy; the long and variable lags and uncertain magnitude of the effects of monetary policy.”

    http://www.j-bradford-delong.net/Econ_Articles/monetarism.html

    It’s useful to remind people what most New Keynesians seemed to believe until recently:

    “…nominal shocks are the key cause of business-cycle fluctuations in employment and output”

    “…monetary policy is a more potent and useful tool for stabilization than is fiscal policy”

    And most importantly in terms of the policy implications of the current recession:

    “The right way to analyze macroeconomic policy is to consider the implications for the economy of a policy rule, not to analyze each one- or two-year episode in isolation as requiring a unique and idiosyncratic policy response.”

    I tend to view fiscal stimulus as an idiosyncratic response to ZIRP but NGDP targeting as its natural policy implication.

  22. Gravatar of Morgan Warstler Morgan Warstler
    21. October 2010 at 15:25

    Randall, I get the unwinding complexities, I will note that in the commercial market, where support was not forthcoming, there have been market solutions to get the underlying assets themselves.

    And I PREFER mark-to-market, but there are other mechanisms that achieve my ends:

    One would be getting rid of the “loss sharing” agreements in the take down of FDIC insured banks. Just let investors at the assets directly at auction.

    Another is my pet hobby – allow MERS violations to justify removal of Foreclosures from consumer Credit Reports.

    http://biggovernment.com/mwarstler/2010/10/19/foreclosure-fraud-can-save-us-economy/

    The trick is identifying any politically viable mechanism that gets the homes vacated and put onto the market ASAP…. we need to liquidate the inventory and end TBTF – ultimately this is about who’s going to eat the losses.

    I vote the big banks and public employees.

  23. Gravatar of Randall Randall
    21. October 2010 at 16:36

    Morgan- interesting, along the same lines, have you considered the ramifications of banks taking charges on assets written down due to m2m. They realize balance sheet improvements, BUT in many cases the asset write down is driven by a thinly traded asset sub class that has few transactions, and the actual asset owned has not seen any real change in cash flow. The net result is the bank gets a charge, a balance sheet adjustment but continues to get the same cash flows. A good way to kick start the economy is to require the principle charges written down to be passed down to the debtor, the would achieve price adjustment and asset value adjustment. As it stands now the tax payer covers the charge, the debtor has to service an inflated asset and the holder improves its margin off the same cash flows. Some things stinks here, Ive spoken to politicos on the hill and they dont get it or want to get it.

  24. Gravatar of Bonnie Bonnie
    22. October 2010 at 00:45

    There seems to me to be public mood of heightened skepticism of government, period, particularly where money is concerned and we know the Fed is at the epicenter. I sympathise with those feelings, but cannot excuse the stoking of public fear and mistrust in prusuit of political points either intentionally or unintentional.

    What we need is a real leader who understands what’s going on to explain it so that ordinary people can understand that, yes, we need a little more nominal GDP, and we can do it in a way that keeps inflation under control. It is that control piece, I think, that they do not understand and they are fearful because gold sellers and the like who have everything to gain from public panic have beat the drums of hyper-inflation being just around the corner if the Fed does any QE at all, just to increase their own profits FROM the downturn. They are modern day Jay Goulds and its sad and disgusting.

    Perhaps it should be pointed out that the Tea Party movement isn’t compatible with Jay Gould style corruption either, and anyone who wishes to stoke pubic fear in order to benefit from it is no friend of theirs.

  25. Gravatar of Bonnie Bonnie
    22. October 2010 at 00:54

    Haha! My typo made a funny. I meant, public fear, not pubic fear.

  26. Gravatar of scott sumner scott sumner
    22. October 2010 at 15:15

    Jeff, But note that Krugman favors monetary stimulus and Stiglitz oppose it. That’s a pretty significant difference.

    Ted, Those are all very good points. I never give the credit channel much thought, but you are right that monetary ease does facilitate more borrowing.

    Randall, Ted probably answered your question better than I could. I don’t see the credit channel as being essential. But I also think any policy that significantly boosts NGDP will boost lending as a side effect. The number of “qualified borrowers” is very sensitive to expectations of next period’s NGDP.

    Mark, I agree on the new Keynesians, but I have to think that DeLong would argue the zero rate trap was a game changer–requiring fiscal stimulus. Or at least in 2008 and 2009 he would have. Now he wants the Fed to act.

    Morgan, What’s your take on the foreclosure mess?

    Bonnie, Yes during economic bad times the public becomes more skeptical.

  27. Gravatar of Doc Merlin Doc Merlin
    25. October 2010 at 04:56

    @Scott:
    I’m not Morgan, but I think that the delay and the foreclosure mess will slow the recovery. Assets in legal limbo is bad-bad-bad.

  28. Gravatar of ssumner ssumner
    25. October 2010 at 07:08

    Doc Merlin, I tend to agree, I would think Morgan would strongly agree.

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