My 15 minutes

I am still piecing together how I suddenly went from obscurity to semi-obscurity yesterday.  I had sent Brad Delong my piece on Friedman and Schwartz, and he was kind enough to link to it (without comment.)  I assume that Tyler Cowen saw that link, and his very kind comments suddenly pushed my blog into the public eye.  Then Arnold Kling also had some nice things to say here.

Now that I have readers, I obviously need some new material.  Please be patient as my teaching responsibilities (and my cold) will slow things down for a few days.  However, this weekend I plan two of what I hope will be my best posts.  So please stop back later.  I greatly appreciate all those who commented.  I will reply to recent comments later today.

Ironically, I had already been planning a post to send to some of my favorite pragmatic libertarians (such as Tyler Cowen, Will Wilkinson, Deirdre McCloskey, Robin Hanson) on a non-monetary topic (my recent research on cultural values and neoliberalism.)  I’ll try to have that ready by Sunday.  By Saturday you can expect a longer than average post on rational expectations, policy lags, and monetary transmission mechanisms that will give you an idea of how I developed my somewhat unorthodox take on monetary theory.  I think you will find it interesting.

Update:  Andrew Sullivan linked to me here.

I didn’t get to the comments today, but will tomorrow, and will also add an interesting post (well at least it’s a topic I find interesting.)



23 Responses to “My 15 minutes”

  1. Gravatar of DanC DanC
    26. February 2009 at 05:29

    Well now you must write a book on the everyday effects of monetary policy, with a target audience of casual readers, to really make money off this blog.

  2. Gravatar of ngoldschlag ngoldschlag
    26. February 2009 at 05:45

    I started following your blog yesterday. I very much liked reading some of your other posts and I look forward to reading your newer ones.

  3. Gravatar of Ben Ben
    26. February 2009 at 05:45

    I was linked here from Andrew Sillivan’s blog over at The Atlantic… in case you’re keeping track.

  4. Gravatar of Brendan Brendan
    26. February 2009 at 06:04

    Andrew Sullivan gave you a good mention on The Daily Dish today, too:

    I let him know Bentley is a university now, too.

  5. Gravatar of Aaron Jackson Aaron Jackson
    26. February 2009 at 06:13

    Don’t let the fame go to your head!

  6. Gravatar of Jeff Jeff
    26. February 2009 at 06:32


    Thanks for blogging. I’ve read all your post so far and find them very interesting.

    I understand your point that the fact that both prices and output are falling indicates a big demand shock that you date to July 2008, and your argument is that the Fed should have reacted very aggresively to falling expectations for nominal income. But what if the source of the demand shock was a sudden perception of a permanent adverse supply shock? I.e, it became clear over the summer that not only was the financial system in trouble, but that the political response then taking shape (bailouts) was going to be far worse than anyone imagined. I think it is fair to say that many of us were astounded by how bad the Paulson/Bernanke (“the answer to moral hazard is more moral hazard”) plan was. When it became clear that it was going to pass, many of us realized that the fiscal restraint wheels had just come off, and that we were now rapidly heading down the path to politicized capital allocation, humongous budget deficits leading to monetization of the debt, inflation, and general banana republichood.

    To put it less flamboyantly, it may be that the shock to aggregate demand was in fact a reflection of a sharp drop in expected permanent income. In that case, trying to maintain nominal income by expansive monetary policy only fuels inflation. And depending on what assets the Fed buys, it may even make the supply shock worse by further increasing moral hazard.

    Advocates of more Fed purchases of dodgy assets financed by the printing press like to say that once aggregate demand begins to pick up, the Fed can quickly sell those assets to drain reserves from the banks to avoid inflation. Before all of this started, the Fed’s main assets were roughly $800 billion in Treasury securities. Now Treasuries make up only about a quarter of $1.9 trillion in assets. If there are big declines in the market values of the less-than-stellar assets, it may not be as easy to drain reserves as people think. The Fed would have to recognize losses on the assets it sells, and that could bring a lot of political heat.

  7. Gravatar of NAD NAD
    26. February 2009 at 06:57

    Andrew Sullivan at The Atlantic linked to you as well. He has quite a following at his blog.

  8. Gravatar of Tom Church Tom Church
    26. February 2009 at 07:06


    Don’t worry about writing a lot of material or getting it out when you say you will. Just make it thoughtful. And a lot of people use RSS feeds (myself included). When you send it out, we’ll read it automatically.


  9. Gravatar of Alex Golubev Alex Golubev
    26. February 2009 at 07:11

    Power to the people, my friend. Quality is no longer decided by TV, politicians, or the rating agencies. You’re 2nd from the top:
    Keep up the good work!

  10. Gravatar of Christine Meyer Christine Meyer
    26. February 2009 at 07:45

    Congratulations on your new-found fame. (I saw your name on Andrew Sullivan’s blog — Atlantic Monthly). Based on your thoughtfulness and new insights, I suspect the fame will be more than 15 minutes in duration.
    Say hello to Dave, Bill, Janet, John, Swati, and the rest of the Bentley Econ dept.
    Christine Meyer

  11. Gravatar of Ryan McGarry Ryan McGarry
    26. February 2009 at 09:19

    It was great meeting with you following Tuesday’s forum with my colleague Keith. Reading your posts has been an excellent opportunity to discover significant monetary options not presented elsewhere. As a skeptic of the fiscal stimulus, many of your ideas presenting monetary alternatives are well received. I’m happy to report that TheMoneyIllusion will have a permanent link at

  12. Gravatar of babar babar
    26. February 2009 at 11:08

    i read through the blog yesterday — it is interesting.

    if i could be so bold as to suggest a post, could you suggest specific ways that the fed could have dealt with the october shock in monetary policy terms. neither i nor a lot of your readers are expert in this, and details would be helpful.

  13. Gravatar of Matt C Matt C
    26. February 2009 at 11:39

    Thanks very much Scott. Reading your posts has been very illuminating. I’ve yet to completely get my head around all your points, but as a microeconomist constantly frustrated by the lack of a unifying framework in macro, I find your ideas provoking.

  14. Gravatar of Robin Robin
    26. February 2009 at 11:42

    Re your Saturday post, please answer the oft-repeated question about what caused the acute drop in AD. Thanks

  15. Gravatar of Gareth Gareth
    26. February 2009 at 12:21

    Quality not quantity is far more important! Also, I’d love it if your RSS feed gave full posts rather than a truncated first paragraph. Thanks!

  16. Gravatar of ssumner ssumner
    26. February 2009 at 16:11

    Thanks for all the support. It is very gratifying.

    Jeff, This quick response won’t do justice to your thoughtful comment, but here’s a few quick thoughts. I have argued in previous research that severe AD declines get misdiagnosed as a failure of free market economics (U.S. 1930s, Argentina 2001), and lead to bad statist policies.
    I agree that there is investor worries about bad government decisions that reduce AS, but I see that partly as a response to the fall in demand. In an earlier paper I argued that the October stock crash had three causes.

    1. Primary cause: severe drop in AD–expected to produce bad recession
    2. Expectation that falling AD will greatly worsen the financial crisis.
    3. Expectation that government will react with statist policies (auto bailout, pork spending, maybe a bit of protectionism, higher MTRs, etc.)

    If the Fed had moved aggressively in the late summer and early autumn to boost AD, then there would be much less of 2 and 3.
    There is another point in support of your argument. When the Fed targets interest rates, then bad supply-side policies can reduce AD, by reducing the Wicksellian equilibrium real rate of interest–the rate necessary for full employment. In a sense that automatically makes money a bit tighter, and reduces AD. So there is something to your argument (if the Fed is passive), but I have to stop here as I am just beginning to address a lot of questions. I’ll try to revisit your question in a later post.

    Robin, Your question is equally complex. One way of thinking about why AD falls is to look at money supply and demand, or money supply and velocity. That begs the question of why did real money demand rise in late 2008, or why did velocity fall? The second way of thinking about AD is to look at changes in the expected future path of AD. Lower future expected AD will tend to depress current AD. So where does the causal chain start? If the Fed is passive it probably starts with a increase in money demand (less velocity) due to factors like banks hoarding reserves in response to the financial crisis. So that seems to work against my argument that the falling AD caused the worsening of the financial crisis. Here you must go back to Lars Svensson’s insight that the Fed should not be passive, it should always set policy at a level expected to produce target AD growth over time. From this perspective the real problem isn’t the momentary factor that led to more money demand or less velocity, it is the Fed’s loss of credibility, the point where markets recognized that the Fed would not offset the increased demand for cash aggressively enough to prevent deflation. That loss of credibility occurred in October, and I see it as the best way to visualize why AD fell. It failed its responsibility to insure that outside factors did not cause a big drop in AD.
    I know that this is not the way the term ‘causality’ is usually defined, but I think it’s the right definition for this problem. If doing policy X prevents a depression, then not doing X causes a depression.

  17. Gravatar of DanC DanC
    26. February 2009 at 16:53

    I think you skip over the almost certain recession that the spike in oil prices was causing. The Fed then needed to respond to fears of inflation from oil price spikes plus the risk of a downturn in the economy from the price shock. Which way do you go? No wonder Misken left so quickly.

    I am a bit surprised that you seem to reject the Friedman argument that the Fed should try to navigate a steady path. If the Fed responds to always shifting winds, markets just start to play Fed actions rather then fundamentals. That increasing uncertainty and shifting reactions to Fed actions can start a harmonic distortion in the markets.

    After the oil price shock, we saw multiple ARM resets – the bubble in real estate bursting like a Ponzi game that ran out of new entrants. The gamble that financial institutions had made on real estate hit a wall.

    If the financial institutions could remain viable, they can finance the reallocation of resources to new sectors. Prices adjust, people experience hardship, the sun eventually shines.

    Regretfully this all occurred during a presidential election. Politics came to dominate and one candidate, future President Obama, is a Social Democrat in the European tradition. Once it became clear that Democrats would come to dominate the new Congress, the market was clearly unsure how to plan for the future. It was not, I think, a loss of faith in the Fed but a great deal of risk in the new government.

  18. Gravatar of zanon zanon
    26. February 2009 at 20:03

    Looking forward to your posts!

    I’m working through your explanation of what’s happening here, but I’m curious, is there a post where you detail how monetary policy can work once you are already at ZIRP?

  19. Gravatar of Jerry Jordan Jerry Jordan
    27. February 2009 at 06:48

    I am puzzled about the diagnoses in this and other blogs. How can prescriptions be useful if the problem to be solved has not been correctly diagnosed? There are folks out there who think this was all caused by the Chinese saving too much! Then, there are lots of “loss of consumer confidence,” “excess financial leverage,” et. al. conjectures.

    My take is different. In the early ’90s home refinancings produced mortgage equity withdrawals (MEW) of about $20 B/yr, rising to more by decade end, but still only about 1% of personal cons. exp. Then, thanks to Barney, CRA, American Dream, Fannie and Freddie, zero-down loans, lack of credit reports, etc., refinancings with ARMS and maybe “interest-deferred” loans, MEWs shot up to $600 B to $700 B/yr; some 8% to 10% of PCE! That enabled PCE to climb from around 65% of GDP to 70%. Five percentage pts of $14 Tril is big bucks; it also is a lot of cars, furnishings, appliances, etc.

    People did not wake up to find they had spent too much, had too much debt, and now needed to save and pay off debt. Many had simply walked off the boat, to be told that “owning” was cheaper than renting plus they could refinance and extract “equity”after a bit of time, buy all kinds of stuff their paychecks wouldn’t allow, and enjoy it while it lasted, then turn in the keys, walk away and double up with relatives, and hope for another bubble to come along. Others saw that they could refinance, take the equity from their primary home to get a beach, desert, or mountain place for vacations, or they could place bets in the soaring equity markets.

    All that is gone. This is a major discontinuity from what went on before. It is not an “increased demand to hold money” that produces a decline in velocity. Data may suggest such, but that is a statistical snapshot, not a description of household behavior. The “deleveraging” simply means that a credit-bubble-driven consumer binge has popped and there never was real asset value to support the lending/securities that were based on the assumption that the stock of wealth was much greater than has turned out to be the case.

    Unless economic policies create wealth they will have no aggregate effect. Wealth is created by making things cheaper or making things better (or both, in the case of Honda!). Rarely do governments create wealth. Mainly, actions of government are redistributive/allocative, not wealth enhancing. Institutional arrangements and incentives, which government may either strengthen or diminish, are what determine the pace of wealth creation.

    Regarding the risk of inflation, it has little to do with the recent explosion of the monetary base and whether it subsequently shrinks back. Instead, once any pace of economic expansion resumes, the natural rate will rise, but central bank policy makers will be under great political pressure to wait until the “output gap” is closed, or the NAIRU is in sight, before starting to move intervention rates up toward the natural rate. That is too late to avoid an acceleration of output prices.

  20. Gravatar of David Pearson David Pearson
    27. February 2009 at 10:18


    Your recent fame is well deserved. I look forward to future posts. Thanks for blogging and for taking the time to reply to comments.

  21. Gravatar of Pandora Pandora
    28. February 2009 at 02:34

    Your blog has been informative and nourishing. Glad it’s been pointed out.

    I seek a balance between theory and practice. Theory is essential, it frames what we do and it inspires imagination, new thinking and potentially innovative solutions. At the same time, a dose of grounded practical application gives perspective. With that as context, I hope you’ll indulge my question:

    What if, as a result of the ascension of your blog, you were invited to meet with Obama and Geithner and their current inner circle of economic advisors. What would you suggest? Given the present state of things – not the what could or should have happened last fall – but considering the current trajectory and the decisions which have already been taken, what would you suggest as the best course of action?

    I realize this question could be considered a fantasy or a nightmare, and I respect your decision to think of it in either view, or not to answer it at all. But I couldn’t contain my curiosity.

  22. Gravatar of Bill Woolsey Bill Woolsey
    28. February 2009 at 10:35

    Jerry Jordan,

    OK. Many people consumed more than they could afford by borrowing against real estate.

    However, those who were lending to them were consuming less than they could afford. Someone was accumulating those balances in the money market mutual funds that held the investment banks commercial paper that was fiancing the securitized mortgages.

    If the previous borrowers reduce consumption below income and begin paying off their debts, why shouldn’t we expect that those who are receiving those debt repayments will increase their consumption?

    If these borrowers default, then they reduce their consumption by less out of current income. And, of course, those who had anticpated receiving their repayments won’t be able to consume as much. It looks like a rough balance to me.

    Of course, somebody or other might just accumulate money holdings. Or, it is possible that bank created money could shink.

    Sumner isn’t arguing that money demand rose (or velocity shrank) for no reason. His claim is that a sufficiencly large expansion in the money supply will keep nominal income growing. If there is a shift between different groups of domestic consumers, or from consumption to exports, or from consumption to investment–that all depends on what people want to do with their money.

    My view is that Americans should be earning income by producing goods and services to sell to the Chinese. But I am not a central planner and I don’t see how monetary policy could direct resources in such a way.

    All that is possible is to maintain nominal income and let the market determine what exactly is produced in response to changes in demand. When the Chinese are ready to spend their accumulated savings, then I have no doubt that incomes here wibe earned selling to them.

    I am puzzled why you think that inflation has nothing to do with what happens to base money. Your story regarding “intervention rates” which I assume is a typo, is just another way of describing the same thing.

    Once economic recovery starts and banks being lending all of their currently vast excess reserves, finaincing every growing spending, the Fed will be under great political pressure not to destroy that excess base money until the output gap is fully filled and nairu regained. By then it will be too late.

    Yes, we can instead describe this in terms of the Fed failing to raise its target for the federal funds rate as the naturla interest rate begins to rise.

    It is always a problem. Todays conditions depend on what happened in the past, and polical pressue is generated to do something now, which will only have a impact in the future.

  23. Gravatar of ssumner ssumner
    28. February 2009 at 10:43

    DanC, Good question. The answer is that in an oil shock you go with nominal GDP targeting and take your lumps (lumps being stagflation.) But I don’t think that would have been as bad as people think–not much worse than the first two quarters of 2008. But I agree, given the Fed’s current interest rate targeting procedure to control inflation, they faced a real tricky problem as high inflation quickly changed to deflation.

    Zanon, Here are some options. Do numbers 1 and 2 no matter what:
    1. End interest payments on reserves.
    2. Set a NGDP target growth path, and promise to try to make up any shortfall (or excess) in the future.
    3. Study an interest rate penalty on excess reserves–do it if Fed officials say it’s workable.
    4. Engage in quantitative easing, preferably purchasing assets that are likely to appreciate if the policy succeeds in boosting AD.
    5. Set up and subsidize trading in a nominal GDP futures market on an experimental basis–it may be too risky to try my policy of using that market for open market operations in the midst of such a crisis.
    6. Try exchange rate depreciation. Not recommended for the U.S, might work for Japan.
    7. Similar to 6, but depreciate currency against a basket of commodities. Haven’t thought much about this as I doubt it would ever be tried. It was FDR’s policy in 1933. (Although just with one commodity, gold.)

    Jerry, My next post “Clarification” answers some of your questions. Regarding the last bit, I don’t think it is ever too late to stop inflation as long as inflation expectations haven’t risen. Monitor the indexed bond market closely, and move aggressively if there are signs of that happening.

    Pandora, I wouldn’t be able to tell Obama much in terms of ending this crisis, as the fiscal stimulus is already passed and I’m not an expert on banking. I’d probably ask him to let me pass a message on to Bernanke–and then suggest my response to Zanon above.

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