Krugman on monetary and fiscal stimulus

My recent working paper on the “Princeton School” of macroeconomics discussed two interpretations of Paul Krugman’s 1998 paper, which had suggested that a “liquidity trap” is actually more accurately viewed as a sort of expectations trap.

In what I called the old Keynesian interpretation, monetary policy is ineffective at the zero lower bound because central banks cannot credibly “promise to be irresponsible”. In the new Keynesian interpretation of Krugman’s paper, monetary policy is still effective if the central bank promises a future path of inflation that is high enough to generate a robust recovery in aggregate demand. Thus the effectiveness of monetary policy is not a purely technical question, it also depends on the politics of central banking.

A “Straussian” reader might have noticed that I was writing this paper in part to boost my own view of monetary policy, which is closer to the new Keynesian interpretation of Krugman’s 1998 paper. Now Krugman has a new working paper that comes down squarely on the old Keynesian side of the issue; monetary policy cannot be counted on going forward, and aggressive fiscal stimulus is the best option for maintaining full employment when there is insufficient aggregate demand. Here Krugman explains why he is skeptical of a purely monetary approach:

The seemingly natural answer would be to raise the inflation target. But central bankers are firmly opposed, and conventional wisdom among those willing to take any of this seriously seems to have migrated toward the use of persistent fiscal stimulus to raise r* sufficiently that monetary policy can do the job with the existing inflation target.

It’s important to be clear that relying on a fiscal solution rather than a higher inflation target is, in effect, a choice to pursue higher public spending at the expense of lower private investment. As I said, a liquidity-trap economy in effect “wants” inflation; choosing not to accept that inflation is a decision to impose lower private investment than the free-market economy would choose on its own.

The main reason to engage in this de facto policy of crowding out is the suspicion that there are significant costs to inflation, even if it is in the low single digits, combined with the belief that the social costs of crowding out some private investment are low.

Here’s how Krugman concludes his paper:

Nonetheless, at the moment the case for a fiscal response to the threat of a liquidity trap, as opposed to a higher inflation target, is stronger than the “Princeton School” envisaged in the early 2000s. Maybe central bankers don’t need to be credibly irresponsible after all.

As is generally the case, Krugman’s paper is very well written and he’s good at clearly explaining the intuition behind his analysis.

Clearly Krugman doesn’t believe that a 2% average inflation target (AIT) is enough to get the job done in the modern world of very low equilibrium interest rates. While I don’t view a 2% AIT policy as optimal, I’m much more optimistic than Krugman about its effectiveness. I suspect that our differing views are based on differences in how we visualize the role of monetary policy in the business cycle. I’ll try to describe Krugman’s views to the best of my ability, and then explain where I disagree.

Krugman sees the economy being hit by occasional demand shocks, mostly due to instability in the investment sector of the private economy. Events such as the housing boom and bust of 2006 lead to a sharp fall in the equilibrium interest rate, at which point conventional monetary policy is largely ineffective. Even an average inflation targeting policy, which might call for a couple years of 3% inflation after a deep slump, is not enough. You need aggressive fiscal stimulus.

In my view, the private economy is not inherently unstable. Unlike most economists, I view the 2008 slump as being caused by an inappropriately tight monetary policy that allowed NGDP expectations for 2009, 2010 and 2011 to fall well below the previous trend line, and well below the levels expected in 2007. A level targeting policy (P or NGDP) that committed to do whatever it takes to get back to the previous trend line would have allowed the US to largely avoid the post-Lehman banking crisis, and would have prevented the equilibrium interest rate from falling nearly as far as it fell when NGDP expectations collapsed in 2008. I don’t take the fall in the equilibrium interest rate as a given; I see it as mostly reflecting an excessively tight monetary policy.

Krugman sees the private economy as a sort of arsonist, with the Fed playing the role of an ill-equipped fireman, and the fiscal authorities being a better-equipped fireman. I see the Fed as being an (unwitting) arsonist, which carelessly causes fires that are then inappropriately blamed on the private sector. (The ECB was even more careless in 2008-11, almost criminally negligent.) Unlike the ECB, the Fed didn’t raise rates in 2008. But it did not cut them fast enough, and more importantly it failed to credibly promise some sort of level targeting make-up policy.

My view is certainly more counterintuitive, and is clearly the minority view within the economics profession. In 2008, it certainly looked like the private sector was at fault. But that’s why I started this blog. Indeed my recent book was written to persuade people that my view should be taken more seriously.

In the end, I’ll probably fail to persuade the rest of the profession. But I won’t abandon my view unless people can provide good reasons why my analysis is wrong. Thus far, I have not seen a persuasive rebuttal.

PS. Krugman also covers other issues related to fiscal policy, such as the importance of r < g, the role of housing in the business cycle, and the efficiency cost of various approaches to stabilization policy. (The whole paper is well worth reading, even if you don’t agree with Krugman.) Thus I don’t mean to suggest that the issue I raised here is the only factor explaining why Krugman and I differ on the relative merits of monetary and fiscal policy, but I believe our differing views on the cause of recessions is the decisive factor.

PPS. At one point Krugman discusses what he views as the instability of the private sector:

I’ve written this paper largely as if r* were a constant or at least slowly moving number. In reality, however, a low-inflation economy appears to be subject to large fluctuations driven by private-sector overreach and retrenchment: the commercial-real-estate-driven cycle of the late 80s/early 90s, the tech boom and bust of the late 1990s, the monstrous housing bubble of the mid-2000s.

Those familiar with Kevin Erdmann’s research know that there was no “monstrous housing bubble” during the 2000s. Housing construction was not abnormal for an economic expansion, and in most areas house prices were not far out of line with fundamentals.


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61 Responses to “Krugman on monetary and fiscal stimulus”

  1. Gravatar of anon anon
    2. January 2022 at 20:36

    Correct me if I’m wrong, but surely if the goal is simply to “raise r* sufficiently”, investment subsidies would do this rather more directly and efficiently than traditional fiscal spending, and not crowd out private spending to the same extent?

  2. Gravatar of Matthias Matthias
    3. January 2022 at 01:03

    Anon, and the simplest investment subsidy would be to drop the capital gains tax (especially in times of crisis). Less likely to be abused than an outright subsidy.

  3. Gravatar of Rajat Rajat
    3. January 2022 at 02:47

    That extract really made me wonder. It’s quite provocative, in that Krugman is indicating that *he* is someone who believes or agrees that (1) there are significant costs to low single digit inflation and (2) the ‘social costs’ [welfare costs?] of crowding out some private investment are low. Another thing is if you take the view that the private economy is inherently unstable and adopt his suggested approach of using fiscal stimulus to boost AD when inflation is below its (presently low) target, it seems that that government spending as a % GDP must ratchet up over time – because monetary policy is used to lower private demand to hit the current (low, 2%) IT when private demand increases (or recovers) and fiscal stimulus is used to raise AD to hit the IT when private demand falls. Although fiscal stimulus could involve tax cuts, that would not tend to ‘crowd out’ private investment in the way he describes (or would to a much lesser extent – because lower taxes plus higher rates might generate the same private investment as higher taxes and lower rates). If his approach would lead to continually rising government spending over time, then one would have to believe not only that marginal private investment today is of low value, but that marginal private investment will be of low value in the next recovery, when private demand begins to recover after a dip but government spending has already been used to meet the shortfall in AD. That doesn’t seem plausible.

  4. Gravatar of Rajat Rajat
    3. January 2022 at 03:10

    Another query I have is based on Krugman’s conclusion: my understanding is that the early 2000s ‘Princeton School’ didn’t believe a higher inflation target was necessary so long as a central bank could credibly promise to allow the price level to ‘catch up’ to its target path by allowing inflation to exceed its target for a period. Is Krugman now saying that such a promise loses credibility in an environment where the natural real rate is so low (or negative) that the nominal policy rate needs to be at the ELB much longer than before? And as a result it becomes harder for investors to believe that the central bank will ever be in a position to make good on its promise of irresponsibility?

  5. Gravatar of Henry Henry
    3. January 2022 at 03:43

    You are so sweet.

    Such a little snowflake.

    Krugman is not “well-written”. Btw, most people with a inkling of intelligence would say “writes well”, or “doesn’t write well”, or perhaps “well-read” – yeah, bit weird to say “well-written”. But anyhow, he’s a moron who continues to think that forcing future generations to live in abject poverty (or go to war over debt they can’t pay) is the best way to ensure that his generation doesn’t experience any hardship for the credit card they maxed out.

    And you think that is brilliance? To give yourself a credit card that increases credit indefinetly, until the entire banking system collapses because nobody can pay the debt? Amazing. Real smart.

    I’ll hire you to sweep floors and clean my toilet, because there is no way your managing my investments.

  6. Gravatar of Willy2 Willy2
    3. January 2022 at 07:54

    There certainly was a “monstrous housing bubble”. Just look at the amount of housing starts. That kept going higher throughout the 1990s and up to the year 2005. The amount of housing starts was in 2005 the highest EVER since the recording of housing start started in the late 1960s

    There was another sign of the US housing bubble between 1990 and 2008. In the 1990s both 1) (real) median household income and 2) real estate prices kept rising. Households can’t “print” money (like banks) but they have to earn it. Paying interest & principal must come out of their (household) income. In that regard the housing boom in the 1990s was a solid and sound real estate boom.

    Between the year 1999 and 2008 (real) median household income remained flat but at the same time real estate prices kept rising between the year 1999 & 2006. So, there was a divergence between real estate prices and household income in the timeframe 1999 – 2006 (= housing bubble).

  7. Gravatar of ssumner ssumner
    3. January 2022 at 08:55

    anon, Another option is a debt financed sovereign wealth fund to buy stocks, combined with QE to soak up the new bonds.

    Rajat, I actually don’t think Krugman is convinced on the cost of 4% inflation. Rather I think he’s saying that real world policymakers look at things that way, and that takes monetary policy off the table.

    Krugman does suggest that private investment, at the margin, is relatively unproductive. He cites the tax subsidy of housing, but ignores the NIMBY issue (which suggests we are building too little housing.)

    He doesn’t say much about AIT, which I found to be puzzling. I would have thought he’d want to take a victory lap.

    Willy2, You said:

    “The amount of housing starts was in 2005 the highest EVER since the recording of housing start started in the late 1960s”

    False.

    https://fred.stlouisfed.org/series/HOUST

    And adjusting for population growth it was even less impressive. Please read Erdmann’s book—you’ll learn something.

  8. Gravatar of XVO XVO
    3. January 2022 at 09:13

    As far as I can tell, having read Krugman off and on for the last decade plus, he is a shill of the democratic party. Whatever position the mainstream Democratic party takes is the position his economics takes and he will justify that position no matter what the facts are. If they’re pro union, he will justify pro union positions. If they’re pro raising minimum wage, he will find a way to justify raising the minimum wage. Deficit/debt too high, well you fool, don’t you know that fiscal stimulus is necessary at the zero lower bound?

  9. Gravatar of Willy2 Willy2
    3. January 2022 at 10:00

    Nope. See here:

    https://www.calculatedriskblog.com/2021/10/housing-starts-decreased-to-1555.html

  10. Gravatar of Don Geddis Don Geddis
    3. January 2022 at 10:55

    @Willy2: If you’re attempting to reference this graph in particular: ( https://1.bp.blogspot.com/-1OwFiYL0Ktw/YW67pw4Y6MI/AAAAAAAA7K8/LJEE_VUNqbsnWEHCul1uJj5MRk6AqFuAgCLcBGAsYHQ/s1020/StartsSept2021.PNG ) then you need to add the red (“one unit structures”) and blue (“2+ unit starts”) together, in order to compare “total amount of housing starts”.

    It’s not especially interesting to merely note that the red line may have been at a historical high in 2005. You need to understand what the red line means. The comments were about the sum of your two lines, not about each line individually.

  11. Gravatar of Carl Carl
    3. January 2022 at 13:09

    What do you suppose makes the two of you differ on whether the private economy is inherently unstable?

  12. Gravatar of vince vince
    3. January 2022 at 13:09

    Krugman wants more inflation and fiscal stimulus? Two comments:

    1. Inflation–too much money chasing too few goods–cannot be a good thing. Why aspire to attain it at all? Instead of trying to fix causes, we trade one economic problem for another?

    2. Fiscal stimulus for what? Who will do the work? Unemployment was 4.2 percent last month.

  13. Gravatar of vince vince
    3. January 2022 at 13:13

    ssumner wrote: “there was no “monstrous housing bubble” during the 2000s.”

    Maybe not monstrous, but it only takes a pin to pop a bubble.

  14. Gravatar of Effem Effem
    3. January 2022 at 14:28

    Off topic I know.

    But I know you’re a fan of EMH. The world has had a dramatic increase in the NPV of future cash flows (aggregate asset values) since COVID. How can that be? We’ve lost lots of people, shrunk the labor force, etc. How can that possibly be positive for wealth assuming markets are efficient?

  15. Gravatar of ssumner ssumner
    3. January 2022 at 15:04

    Willy, Nope, it’s you that is uninformed. I’d read Erdmann so that you stop making these mistakes. My data series is more comprehensive than yours, as it includes all housing starts.

    Get your act together!

    Carl, It’s partly a question of differences in how we view errors of omission vs. errors of commission in monetary policy. To Krugman, the distinction matters. To me, it doesn’t.

    His view is not unreasonable, but I believe my approach is more useful for policy purposes. With NGDPLT, the private economy will do fine.

    Vince, You said: “Krugman wants more inflation and fiscal stimulus? A”

    Not right now.

    Effem, Interest rates have fallen. The cash flows have not increased, but they are being discounted at lower rates.

  16. Gravatar of Effem Effem
    3. January 2022 at 15:17

    Scott, the 30y treasury yield is 2.02%. On 12/31/2019 it was 2.39%. Global wealth was up 7.4% in 2020 and i’m guessing a greater amount in 2021 (don’t have the numbers yet). 37bp cannot get you there.

  17. Gravatar of vince vince
    3. January 2022 at 15:30

    Effem wrote: “37bp cannot get you there.”

    Get you to 7.4%? It does better. Capitalizing the two rates, I get a value increase of 18.3 percent.

  18. Gravatar of vince vince
    3. January 2022 at 15:42

    ssumner wrote: “Vince, You said: “Krugman wants more inflation and fiscal stimulus? A”

    Not right now.”

    My take on the article is Krugman supports more inflation, but since central bankers are reluctant, they resort to fiscal stimulus. He seems to suggest either one (or both) are good alternatives.

  19. Gravatar of Benjamin Cole the Tin-Foil Hat Economist Benjamin Cole the Tin-Foil Hat Economist
    3. January 2022 at 16:52

    It’s important to be clear that relying on a fiscal solution rather than a higher inflation target is, in effect, a choice to pursue higher public spending at the expense of lower private investment–SS

    Larger fiscal deficits can be obtained by tax cuts, such as a holiday on Social Security taxes.

    For reasons that I do not understand even the MMT crowd, with which I have a great deal of sympathy, seems to advocate more spending rather than tax reductions.

    Losses to the Social Security fund could be made up by the Federal Reserve buying Treasuries and placing them into the fund.

    Monetary policy must be considered in a global context, and interest rates are set in globalized capital markets. The expectations fairy may be a gossamer of fantasy, when an economy is entering a recession.

    Lastly, the orthodox macroeconomics profession still has not answered the question whether a central bank building up a balance sheet is inflationary or anti-inflationary.

  20. Gravatar of vince vince
    3. January 2022 at 17:29

    Benjamin Cole wrote: “It’s important to be clear that relying on a fiscal solution rather than a higher inflation target is, in effect, a choice to pursue higher public spending at the expense of lower private investment–SS”

    ssumner was actually quoting Krugman. Not everyone agrees with the Krugman statement. If we pretend fiscal expansion were productive, the money supply could (should?) expand with it.

  21. Gravatar of Kevin Erdmann Kevin Erdmann
    3. January 2022 at 19:00

    The stuff about crowding out mainly applying to residential is interesting, and it makes sense, as far as it goes, on the housing side of the ledger. But, I wonder, do the relatively high real interest rates of the late 1990s, coinciding with fiscal surpluses, create any doubts about the relationship between fiscal stimulus and r?

  22. Gravatar of Mike C. Mike C.
    3. January 2022 at 19:03

    I agree that there was not a monstrous bubble in terms of house prices, but what do you think about the big rise and fall of measures like mortgage debt as a percent of GDP as tracked by Calculated Risk? https://www.calculatedriskblog.com/2021/11/five-economic-reasons-to-be-thankful.html?m=1

  23. Gravatar of Effem Effem
    4. January 2022 at 07:16

    Considering federal deficits basically flow directly into corporate profits, I wonder if Krugman realizes he is advocating for another upward jump in wealth inequality?

    My hunch on Krugman: when Team Blue is in power, low federal spending will be a problem. When Team Red is in power, inflation will be a problem.

  24. Gravatar of Jeff Jeff
    4. January 2022 at 08:24

    “It’s a dirty little secret of macroeconomics that business investment appears to be relatively insensitive to the cost of capital…Instead, interest-rate policy works mainly though housing.”

    Dirty little secret indeed. So the Fed deliberately turned shelter into a casino? Not only that, it is the primary means they have chosen to bail-out the economy when it needs a pick-me-up? House price swings of many times the average income year-to-year, house flipping and levered slumlording, massive mortgages and rent payments….all that is a feature, not a bug? After the great human tragedy that was the first housing boom, they are doing the same thing all over again? Ironic that Krugman doesn’t see any of these things as “a major problem for planning”.

    Words from the Eichengreen paper that he links seem telling now:

    “Contemporaries unfortunately found it impossible to break out of the established mindset even when this radical change in circumstances rendered ineffectual and even perverse the application of conventional remedies.”

  25. Gravatar of ssumner ssumner
    4. January 2022 at 08:52

    Effem, Haven’t real interest rates fallen even more sharply? In any case, I never claimed that interest rates are the only factor that affects stock prices.

    Vince, I don’t think so. Check out his new interview with David Beckworth.

    Kevin, Certainly the relationship is pretty weak, and many other factors matter too.

    Mike, There was a lot of mortgage debt, but I don’t see how that relates to the business cycle.

    Jeff, The Fed has no ability to target specific sectors. They just need to keep NGDP on a stable path.

  26. Gravatar of Spencer Bradley Hall Spencer Bradley Hall
    4. January 2022 at 09:21

    re: ” that allowed NGDP expectations for 2009, 2010 and 2011 to fall well below the previous trend line”

    Preposterous. Sumner doesn’t know a credit from a debit.

    Milton Friedman: “There is no way of slowing down inflation that will not involve a transitory increase in unemployment, and a transitory reduction in the rate of growth of output”

    Either Friedman’s right or Sumner’s right (N-gDp targeting). I suspect that Sumner is right.

    Most of the boom / busts in housing are the result of disintermediation of the nonbanks / shadow banks (including investment banks), either by a mis-match (narrowing of the margin), between short-term funding liabilities (having nothing to do with government guaranteeing), and long-term earning assets, an interest rate inversion, or else a deterioration in the value of those assets (or some combination thereof).

    But the FED’s policy is to freeze short-term funding. What in effect that represents is an attempt to throw most funding to bond backed financing (since 1980) – to the GSEs and not to the George Baileys of the world (a building and loan banker).

    I.e., it reverses the borrow-short to lend-longer savings-> investment paradigm, reverses George Bailey’s Its a Wonderful Life, where small savings were pooled, expeditiously activated, and put back to work, creating an income velocity.

  27. Gravatar of Carl Carl
    4. January 2022 at 09:26

    I assume you mean that Krugman and you both will assign blame to the Fed if a recent policy adjustment causes NGDP to become unstable whereas only you will assign blame to the Fed if they fail to make an adjustment to prevent NGDP from becoming unstable. If so, is that only true near the zero lower bound or does your disagreement hold above it?

  28. Gravatar of Spencer Bradley Hall Spencer Bradley Hall
    4. January 2022 at 09:29

    How do you expect small savers to squirrel away enough for a down payment when house prices are rising faster than incomes?

  29. Gravatar of Spencer Bradley Hall Spencer Bradley Hall
    4. January 2022 at 09:50

    No such thing as “zero bound”. “Pushing on a string” only applied prior to the nominal legal adherence to the fallacious “Real Bills Doctrine” when terminated in 1932 – due to a paucity of eligible (hopelessly impaired), commercial and agricultural paper for the 12 District Reserve bank’s discounting purposes.

  30. Gravatar of vince vince
    4. January 2022 at 10:10

    ssumner wrote, about Krugman supporting inflation and fiscal stimuls: “Vince, I don’t think so. Check out his new interview with David Beckworth.”

    In the interview, Krugman says this: “I thought that I was all for very aggressive monetary policy and raising inflation targets and eventually I still think that the logic of that was right, but the politics of it turned out to be much harder than I realized and fiscal policy turns out to be much more doable than I realized, although still problematic. … when interest rates are very low, do not worry about the money supply, do not worry about inflationary impacts from monetary expansion. … And the kind of implied point was in a very low interest rate world … don’t worry much about public debt.”

  31. Gravatar of Effem Effem
    4. January 2022 at 11:30

    @scott, yes real interest rates have fallen more significantly so perhaps that’s part of the answer. I still find it very odd that the feedback we get from markets (if we’re focused on wealth) is overwhelmingly “do whatever it takes to engineer a lower discount rate.” Plenty has gone wrong in the past few years yet we’re much wealthier – it just doesn’t add up to me.

  32. Gravatar of Jeff Jeff
    4. January 2022 at 13:10

    >Jeff, The Fed has no ability to target specific sectors. They just need to keep NGDP on a stable path.

    The federal government as a whole exercises a massive amount of control over the housing market through various agencies, and the Fed is in fact currently buying MBS from another instrumentality of the US government, so I’m not sure they can so easily disclaim responsibility.

    Do any of the true believers in wage stickiness as a justification for all of this really think that most Americans are so fixated on the numerical growth of their nominal wage that they would instead rather have wild, capricious swings in the price of a basic human need? Does that really seem like a trade-off that many people would willingly choose?

  33. Gravatar of ssumner ssumner
    4. January 2022 at 14:08

    Carl, I can’t speak for Krugman, but I’d say it’s a matter of degree. I’m more likely to blame the Fed whether at or above the zero bound, but Krugman will also occasionally blame the Fed for policy errors.

    Vince, He’s talk about times you need stimulus. In the interview he said it’s now time to “tap the brakes”.

    Effem, To be clear, the low rates do not come from Fed policy.

    Jeff, You said: “Do any of the true believers in wage stickiness as a justification for all of this really think that most Americans are so fixated on the numerical growth of their nominal wage that they would instead rather have wild, capricious swings in the price of a basic human need? ”

    You are just setting up a straw man, so there’s no point in me even responding. Do you even know my monetary policy views?

  34. Gravatar of Anon Anon
    4. January 2022 at 15:24

    ssumner,
    A question I have about NGDP targeting is how should the level be set and how long should the level remain?
    For instance, if we have a NGDP target of 6%, but RGDP growth accelerates sharply due to reforms or some breakthrough technology, then how should the level be adjusted? I feel like everytime the US has supply side reforms, like tax cuts or regulatory reform, monetary policy then becomes too contractionary relative to the growth potential of the economy, thus causing the supply side reform to be discredited. This also has a history of happening in Latin America countries.

  35. Gravatar of vince vince
    4. January 2022 at 16:28

    ssumner wrote” “In the interview he said it’s now time to “tap the brakes”.”

    Krugman seems to still believe in inflation, but wants to “tap the breaks” to counter inflation psychology. He doesn’t seem concerned about it himself.

  36. Gravatar of Rajat Rajat
    4. January 2022 at 19:45

    I listened to Krugman’s podcast with David and one point I disagreed with early on was that the 1970s inflation started off as “too much money chasing too few goods” but was mainly about wage-price spirals and rising expectations. Krugman seems to believe that the most significant inflation episode in living memory was – apart from its beginning – not a monetary phenomenon!

  37. Gravatar of Spencer Bradley Hall Spencer Bradley Hall
    5. January 2022 at 11:31

    re: “Jeff, The Fed has no ability to target specific sectors. They just need to keep NGDP on a stable path”

    The target is government securities.

  38. Gravatar of ssumner ssumner
    5. January 2022 at 12:04

    Anon, I don’t think it should be adjusted because of changes in productivity growth.

    I’d pick at least 4%, but more importantly a high enough figure that policymakers never want to use fiscal policy.

    Vince, I think he views it as a minor problem (at say 4% inflation), but understands that if it’s too high it might trigger a tight money policy that leads to recession. Hence “tap the breaks”.

    Rajat, I think that’s a bit misleading. He certainly understands that if money had been tighter in the 1970s, inflation would have been lower. It’s just that the 1960s inflation was unneeded in the sense that it was not based on meeting pre-existing public expectations. Whereas by the 1970s, a monetary policy that got inflation down to 2% would have caused high unemployment, as wage contracts reflected high inflation expectations.

  39. Gravatar of c8to c8to
    5. January 2022 at 12:23

    It is my view that monetary policy is hugely ineffective when the interest on reserves is higher than the real interest rate.

    The treasury calculate real rates as:

    DATE 5 YR 7 YR 10 YR 20 YR 30 YR
    01/03/22 -1.58 -1.25 -0.97 -0.55 -0.36
    01/04/22 -1.56 -1.20 -0.91 -0.47 -0.27

    https://www.treasury.gov/resource-center/data-chart-center/interest-rates/Pages/TextView.aspx?data=realyield

    I understand the fed pays the EFFR/FFER on reserves:

    DATE RATE
    (%) 1ST
    PERCENTILE
    (%) 25TH
    PERCENTILE
    (%) 75TH
    PERCENTILE
    (%) 99TH
    PERCENTILE
    (%) VOLUME
    ($Billions) TARGET RATE/RANGE
    (%)
    01/04 0.08 0.06 0.07 0.08 0.10 74 0.00 – 0.25
    01/03 0.08 0.06 0.08 0.08 0.15 74 0.00 – 0.25

    https://www.newyorkfed.org/markets/reference-rates/effr

    How does any monetary stimulus get out of the reserve – why would any bank lend this money out for consumption or production?

    So you’ve got krugman keynesians saying monetary policy is ineffective without once mentioning interest on reserves (in that paper)

    so scott – i agree with you on level targetting – but i cant see the fed having an effective monetary policy without removing IOR.

    scott – thoughts?

  40. Gravatar of c8to c8to
    5. January 2022 at 12:29

    I should clarify on the consumption / production distinction.

    my simple view is the government could mail out checks to people in a downturn (which presumably at the low end would be spent on food and rent) – you could have withdraw only accounts for everyone at the FED (withdraw only so you dont destroy the banking system, regular banks still hold deposits and make loans etc)

    if you had to pay to hold reserves, even at negative real interest rates banks would lend out money for anything that returns more than it costs to pay to hold reserves.

    i see a possible krugman/keynesian point that maybe then everyone just buys t-bonds but if the treasury caps issuance the price just keeps going up until the yield is worse than investing in some negative real return business. or if the treasury keeps issuing bonds and the nominal rate is credible then maybe the government ends up with the money and has to start spending on something real – like digging holes or building rail or repairing something.

    I haven’t thought through in detail what only negative real interest rates mean, is it businesses consuming more than they produce, but otherwise employing people to essentially destroy other resources at the margin…

  41. Gravatar of Spencer Bradley Hall Spencer Bradley Hall
    6. January 2022 at 06:06

    Low rates don’t matter when there is a paucity of credit worthy borrowers or real investment outlets. The paradigm is historical, if not empirical.

    The welfare of the banks is dependent upon the welfare of the nonbanks (putting savings back to work). We got that right in the GD, but not the GFC.

  42. Gravatar of Spencer Bradley Hall Spencer Bradley Hall
    6. January 2022 at 06:29

    O/N RRPs unrecognized subtractions from the broad money stock:

    Apr ,,,,, 0069
    May ,,,,, 0290
    Jun ,,,,, 0673
    Jul ,,,,, 0848
    Aug ,,,,, 1053
    Sep ,,,,, 1211
    Oct ,,,,, 1425
    Nov ,,,,, 1445
    Dec ,,,,, 1600

    Surreptitious tightening.

  43. Gravatar of Spencer Bradley Hall Spencer Bradley Hall
    6. January 2022 at 06:41

    Increase in the money stock over the preceding 4 months:

    09/1/2020 ,,,,,
    10/1/2020 ,,,,,
    11/1/2020 ,,,,,
    12/1/2020 ,,,,, 968.9
    01/1/2021 ,,,,, 940.5
    02/1/2021 ,,,,, 774.5
    03/1/2021 ,,,,, 406.0
    04/1/2021 ,,,,, 478.7
    05/1/2021 ,,,,, 505.2
    06/1/2021 ,,,,, 533.8
    07/1/2021 ,,,,, 581.8
    08/1/2021 ,,,,, 467.2
    09/1/2021 ,,,,, 225.3
    10/1/2021 ,,,,, 223.4
    11/1/2021 ,,,,, 332.2
    12/1/2021 ,,,,, 378.6
    01/1/2022 ,,,,, 348.2

  44. Gravatar of janice janice
    6. January 2022 at 06:45

    Scott’s thug communist Leticia James (gosh, she is fat), is continuing the crazy witch hunt against Trump’s accountant.

    She must be one of these people who never owned a business, and doesn’t understand that the city of New York has the power to “make deals” that are in the best interest of the city. It is true Trump didn’t pay tax on his properties in the 1980’s; it is also true he negotiated a deal with Kock to pay near zero tax for his investment.

    She will waste more tax payer money, and find absolutely nothing.

    The political thuggery from the left continues.

  45. Gravatar of TallDave TallDave
    6. January 2022 at 07:14

    balderdash and mummery, Krgugman knows full well the 2007-8 crisis was triggered primarily by his fellow ideologues’ aggressive regulatory promotion of social justice through risk aggregation that led to mispriced securities… the way banks were forced into this has been exhaustively documented

  46. Gravatar of Sven Sven
    6. January 2022 at 09:53

    Prof. Sumner,

    You say;

    ‘Krugman sees the economy being hit by occasional demand shocks, mostly due to instability in the investment sector of the private economy. Events such as the housing boom and bust of 2006 lead to a sharp fall in the equilibrium interest rate, at which point conventional monetary policy is largely ineffective. Even an average inflation targeting policy, which might call for a couple years of 3% inflation after a deep slump, is not enough. You need aggressive fiscal stimulus.’

    If Krugman claims exactly this way while his judgment is true for temporary business cycles, the period since 2008 is not that kind. The post-2008 period is not the consequence of occasional demand shock. This period is the ultimate outcome of deflationary character of capitalism. So it is here to stay unless strong redistributive measures are taken.

    You say;

    ‘ In my view, the private economy is not inherently unstable. Unlike most economists, I view the 2008 slump as being caused by an inappropriately tight monetary policy that allowed NGDP expectations for 2009, 2010 and 2011 to fall well below the previous trend line, and well below the levels expected in 2007.’

    I think you are the modern equivalent of Milton Friedman. Milton Friedman would blame FED for every slump and inflationary period. For you like for him the market works efficiently. There is no problem in capitalist system. It is only FED that creates problems in the market. And when it comes to 2008 slump, actually interest rate needed to fall before 2008. However, housing boom (artificial excessive demand) delayed this usual pattern.

    You say;

    ‘A level targeting policy (P or NGDP) that committed to do whatever it takes to get back to the previous trend line would have allowed the US to largely avoid the post-Lehman banking crisis, and would have prevented the equilibrium interest rate from falling nearly as far as it fell when NGDP expectations collapsed in 2008. I don’t take the fall in the equilibrium interest rate as a given; I see it as mostly reflecting an excessively tight monetary policy.’

    As far as I know monetary expansion reduces interest rate. I couldn’t get your idea how monetary expansion can keep the equilibrium interest rate high. Yes, aggregate demand might be low due to expectations caused by external shocks in the short term. However, when those external shocks go away equilibrium interest rate should go back to previous trend line. However, if interest rate persistently low for the extended period, this pattern shows that natural rate of interest did actually plunge. And this is the usual pattern of interest rates in the capitalist system. Both post 1929 and post 2008 periods are the usual patterns of the system. Interest rates fall gradually due to increasing savings.

    You say;

    ‘Krugman sees the private economy as a sort of arsonist, with the Fed playing the role of an ill-equipped fireman, and the fiscal authorities being a better-equipped fireman. I see the Fed as being an (unwitting) arsonist, which carelessly causes fires that are then inappropriately blamed on the private sector. (The ECB was even more careless in 2008-11, almost criminally negligent.) Unlike the ECB, the Fed didn’t raise rates in 2008. But it did not cut them fast enough, and more importantly it failed to credibly promise some sort of level targeting make-up policy.’

    Sorry, but another Friedmanian approach. This is what I don’t understand about economists when they have certain perspective. You should look at things with other perspectives as well. 2008 was certainly a failure of the so-called market economy. (For me capitalism is not a genuine market economy) If we compare 2008 with 1929, the FED did a much better job. Yes, it could have been more expansionary. But nobody is perfect to make that fine tuning.

  47. Gravatar of ssumner ssumner
    6. January 2022 at 10:32

    C8to, I favor removing IOR, as it would make monetary policy more effective. But it’s not essential. Even with IOR the Fed can control inflation.

    TallDave, Social justice warriors are bad, as you say, but it’s crazy to think they caused the financial crisis. Was President Bush a SJW? Wasn’t he promoting mortgage lending? Are big bankers SJWs?

    Sven, You said:

    “I think you are the modern equivalent of Milton Friedman.”

    Thank you.

    “As far as I know monetary expansion reduces interest rate.”

    That’s wrong. Look at the 1960s and 1970s, when easy money drove interest rates higher.

    “You should look at things with other perspectives”

    Last year I spent a week reading a 500 page MMT textbook. It was a waste of time, full of basic errors.

    Have you tried other perspectives? I’d encourage you to read my new book.

  48. Gravatar of Kevin Erdmann Kevin Erdmann
    6. January 2022 at 12:05

    “ I’d encourage you to read my new book.”

    Clicks on newly updated Amazon page summary:

    “This is a valuable discussion of the Great Recession by an economist who has been called ‘the modern equivalent of Milton Friedman.’”

  49. Gravatar of ssumner ssumner
    6. January 2022 at 12:26

    Kevin, It’s a sign of how much economics has declined as a profession that I’m being compared to Milton Friedman. 🙂

  50. Gravatar of Sven Sven
    7. January 2022 at 11:53

    Prof. Sumner, You said,

    ‘That’s wrong. Look at the 1960s and 1970s, when easy money drove interest rates higher.’

    That’s true because those times were inflationary periods. However, the post-2008 period is deflationary. An increase in money supply in an inflationary period raises aggregate expenditures then inflation rises. Subsequently, nominal interest rate goes higher. However, a deflationary period is not the same as deflationary one in which interest rates are already at zero lower bound levels. In that case monetary expansion cannot raise interest rate. The reason is that loanable funds are already abundant due to savings glut. Post-1929 period, Japanese case since 1990s and post-2008 world economy are all in that category. I think you should distinguish business cycles when it comes to demand management. When interest rates are already low, monetary expansion increases savings even more. In that case, aggregate demand increases through debt. That’s the difference between 1960-70 period and post-2008.

    “You should look at things with other perspectives”

    Last year I spent a week reading a 500 page MMT textbook. It was a waste of time, full of basic errors.

    500 pages for MMT is definitely waste of time. I think 5 pages are enough. When I say different perspective what I meant was looking at the economy with different sides. However, since you are monetarist you only see the economy from monetary side. Money is definitely critical to understand the economy. It transforms real economy fundamentally. I explained how it happens in my book. However, there are also other factors that might have substantial impact.
    When I also said you are like Milton Friedman that was what I meant. He would always try to explain the economy through money. And blame the FED for every failure in the market.

    You said,
    ‘Have you tried other perspectives? I’d encourage you to read my new book.’
    I’ve tried as many as possible. Ok, I’m starting to read your book.

    ‘Kevin, It’s a sign of how much economics has declined as a profession that I’m being compared to Milton Friedman.’

    You made me laugh. 🙂 I agree with you that economics has declined a lot.

  51. Gravatar of ssumner ssumner
    7. January 2022 at 15:19

    Sven, You said, “However, since you are monetarist you only see the economy from monetary side.”

    Is that a joke?

    “That’s true because those times were inflationary periods.”

    But easy money causes inflation.

  52. Gravatar of Mike Sax Mike Sax
    7. January 2022 at 20:11

    Hey Scott. Just looked up your book on Amazon and am happy to see you have the new one on Audiobook. When I had previously suggested this to you you’d been skeptical that there was much of a market for audio-apparently you since reconsidered.

    I know I at least will be listening to it.

  53. Gravatar of Sven Sven
    8. January 2022 at 08:08

    Prof. Sumner,

    You said;

    Is that a joke?
    No, that’s the impression I got from you so far. Maybe I’m wrong about my judgement. I started reading your book. I hope to have a more comprehensive opinion on your macroeconomic perspective.
    You said;
    “In my view, the private economy is not inherently unstable. Unlike most economists, I view the 2008 slump as being caused by an inappropriately tight monetary policy that allowed NGDP expectations for 2009, 2010 and 2011 to fall well below the previous trend line, and well below the levels expected in 2007.”

    Again, Japanese deflation since 1990s and post-2008 world economy prove strikingly that the private economy is inherently unstable. You can add most episodes of business cycles throughout history all over the world. We haven’t witness yet an equilibrium mechanism that is self-correcting. However, you think that central banks can run the economy with a momentary fine tuning. I think that’s a very bold belief about markets. Since 2008 there have been QEs after QEs by the FED, ECB, BOJ, and Bank of England. We are not seeing interest rates going back to normal levels. It is not about monetary policy. it is about global savings glut.

    You said;
    “That’s true because those times were inflationary periods.
    But easy money causes inflation.”

    Easy money certainly causes inflation. However, when the economy is in a deflationary period. It works through debt mechanism. And when debt levels are already high, fiscal policy has to accompany to monetary policy. It is kind of MMT period. And it is an anomaly. (Not a normal or acceptable situation MMT proponents argue) The best example is Japan. Public debt to GDP ratios around 260% show doubtless that monetary policy is not effective as it would in inflationary periods. This is fundamentally about amount of savings in the economy.

  54. Gravatar of ssumner ssumner
    8. January 2022 at 09:09

    Mike, No, I did not “reconsider”. What makes you think I have any input into how my book comes out?

    Sven, You clearly don’t understand my views. Read my book and then come back here.

    As far as Japan, in 2013 fiscal policy was tightened and monetary policy was loosened. MMT says NGDP growth should have slowed, but it accelerated.

  55. Gravatar of Kester Pembroke Kester Pembroke
    10. January 2022 at 01:22

    The insight from MMT is that the stock of money is not really relevant – some of it will move an awful lot and some of it won’t move at all. Also that money can change hands for money’s sake and doesn’t impact the real economy at all – as in the case of stock markets. The conclusion is that the money circuit and the real circuit are inductively connected, not directly connected, and that monetary flow has a ‘power factor’ just as the flow of electricity does in electrical engineering.
    The one-to-one assumption of money and stuff in mainstream economics is just wrong, and that means the naive quantity theory of money has no basis in fact. To the extent that you cannot really decompose GDP into M and V in any meaningful way.
    which leaves us with Turnover = Quantity * Price and that is just definitional. It doesn’t tell you anything causal.

  56. Gravatar of Kevin Erdmann Kevin Erdmann
    10. January 2022 at 18:05

    Kester, as opposed to short term interest rates?

  57. Gravatar of TallDave TallDave
    11. January 2022 at 07:01

    “TallDave, Social justice warriors are bad, as you say, but it’s crazy to think they caused the financial crisis. Was President Bush a SJW? Wasn’t he promoting mortgage lending? Are big bankers SJWs?”

    Of course Bush was responsible! Don’t you remember him bragging about the highest levels of home ownership in history? That was “compassionate conservatism,” a bipartisan socialist experiment of the sort that Krugman generally applauded.
    ***
    Wait a minute! Paul Krugman told me the CRA was relaxed during the Bush administration. What about that bit of evolution, buster?
    It’s true that the CRA requirements were relaxed during the Bush administration. But at this point the lax lending standards were already in place. In any case, the relaxation took a peculiar form that actually made CRA lending more important rather than less. You see, the government let banks drop things like putting in ATMs in rural areas in favor of letting their compliance be judged entirely on CRA loans. This means the CRA had more of an influence on home lending after the requirements were relaxed, not less.

    What’s more, George W. Bush was a major proponent of the kind of mortgages that banks had started making under the CRA. He urged low-to-no doc mortgages and the elimination of downpayments, just like the CRA regulators had long done. “We certainly don’t want there to be a fine print preventing people from owning their home,” the President said in a 2002 speech. “We can change the print, and we’ve got to.”
    ***
    granted, Fed handled the crisis quite poorly, still worrying about inflation even as recession began

  58. Gravatar of TallDave TallDave
    11. January 2022 at 07:09

    note Xi Jinping is now learning the same lesson writ large

    i.e. you can force people to invest in housing until you’re pouring ten times the OECD average concrete and there are more homes than people, but you can’t do it profitably

  59. Gravatar of ssumner ssumner
    11. January 2022 at 13:16

    Talldave. We agree about Bush’s role, disagree as to whether he’s a SJW.

  60. Gravatar of Jeff Jeff
    12. January 2022 at 05:20

    I wasn’t trying to create a straw man or attribute Krugman’s beliefs to you. I understand your view that NGDP targeting should be able to better head off excess build out of housing, and that your views on the 2006-2008 housing collapse are similar to those of Mr. Erdmann, who makes a lot of good points.

    However, I think those views still sidestep the major issue, which is that land use is undertaxed everywhere, but especially in places like California. Only political will can solve that problem. Building houses in the desert was never a real solution, it was just an illusory dream sold to families accustomed to late 90s gas prices and not yet accustomed to the toll extracted by long commutes. Mr. Erdmann suggests the Fed should have eased sooner to try to keep the party going, but I don’t see how that would have solved anything.

    In fact, inflation has made the problem much worse, as it only reduces the real tax burden on properties whose assessments are nominally chained by Prop 13. Only sustained deflation would have had a fighting chance at solving that problem (the real problem), as it softens entrenched opposition to property tax reform on the part of households who benefit from the Prop 13 regime.

  61. Gravatar of Kevin Erdmann Kevin Erdmann
    15. January 2022 at 14:31

    Jeff, you won’t get any objections here to the idea that building homes in Phoenix is a second best solution to building them in LA. Slowing the economy until we built them in neither is a step in the wrong direction, however.

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