Noah Smith gets market monetarism wrong

Noah Smith is generally an excellent blogger, but when he switches over to Bloomberg.com, he . . . well let’s be charitable and assume the editors forced him to dumb things down.  Waaaaay down:

One crowd-pleaser is Scott Sumner, a professor at Bentley University, who is the champion fighter of a team that calls itself the market monetarists. They believe that it’s the Federal Reserve’s job to fight recessions, doing whatever it takes in the way of monetary easing in order to get nominal gross domestic product (click on the link for a full explanation) back to a healthy trend.

Just for the record, I don’t think the Fed should fight recessions, and indeed I believe they should ignore RGDP entirely.  I believe the Fed should prevent NGDP shortfalls (and overshoots.)  Aren’t they the same thing (some commenters always ask me?) Check out NGDP during Zimbabwe’s 2008 recession.  Or the 1980 recession (which Volcker did “fight,” and was wrong to do so.)

The basic market monetarist case against the Keynesians is that U.S. federal government spending, and deficits, have both been decreasing relative to GDP in recent years, and that this hasn’t brought us to economic ruin.

Readers of this blog know that this is not the “basic market monetarist case.”  They know that monetary offset was the consensus Keynesian view in 2007.  They know that MMs believe there is no reason to abandon that consensus.  They know that the deficit fell by an astounding $500 billion in calendar 2013.   They know that $500 billion is an extraordinary amount of austerity.  They know that Paul Krugman and Mike Konczal called this a “test” of market monetarism.   They know that 350 Keynesians signed a letter warning of recession if just a bit more than $500 billion in austerity were to occur. They know that RGDP growth in calendar 2013 nearly doubled over 2012. But of course readers of Bloomberg learn none of this.

Yes, if it were just a matter of the deficit decreasing in “recent years” then I’d entirely agree with Smith, it would tell us nothing.  Smith makes it seem like we have no good reason to dismiss Keynesianism:

As you can see, government spending flatlined for about four years (and deficits declined) but GDP kept right on growing. In the mind of the market monetarists, that’s case closed — Keynesianism is dead.

That’s not my “mind.”  Smith continues:

Others might claim that what matters is total government spending, including state and local governments, which boosted outlays quite a bit in 2013. Sumner, in his post, waves away these objections, accusing Keynesians of a “shell game” in which they claim to care about whichever method supports their thesis.

This is like those headlines stating, “Is the earth flat?  Opinions differ.”  I mean seriously, is there any Keynesian model that treats state and local spending differently from investment?  If you are going to add S&L spending to Federal spending, then why the hell don’t you add investment too?  They both have a multiplier effect.  Neither are controlled by fiscal policymakers. This is why I use offensive language like “shell games.”  It fits.  And by the way, adding S&L spending to the 2013 experiment doesn’t significantly change anything, even if it should be included—which of course it shouldn’t.

Market monetarists have it even easier. Their credo is that the Fed is basically omnipotent, and so everything that happens is a result either of A) Fed actions, or B) expectations of Fed actions. If government spending goes up and GDP goes up, the market monetarists can say that it wasn’t because of fiscal stimulus, but because the Fed decided to be more dovish, and people realized that.

Obviously this is false.  For instance, I don’t believe the Fed can prevent Noah from writing misleading opinion pieces.  Or cure cancer.  I do believe what almost all respectable economists believed in 2007, that central banks can and should target nominal aggregates like inflation or NGDP.  I still believe that.  Why so many other economists have changed their minds is an interesting question that Smith doesn’t address.

To make things worse, all the gladiators in this combat are looking at noisy time series data with very short samples, and making inferences about policy that might or might not operate with a lag, in an environment in which everything is changing at once. And the gladiators are free to pick out any data point that supports their thesis, and ignore the others.

A time-series econometrician would blanch if you presented her with that kind of analysis. She wouldn’t even give it the time of day. Instead, she’d do a historical study, using data as far back as she could go, instead of picking one or two recent points. She would have to use some theory to guide her along, too. And even then, her conclusions would come with huge uncertainty.

I’ve spent most of my life studying older historical examples. And as far as I can tell it’s the Keynesians who favor making sweeping claims based on one or two data points.  All I did is call them on it.

So who’s right? The answer is that we can’t really know. Chris Sims, winner of the 2011 Economics Nobel Prize, has found lots of evidence that monetary policy has an effect on the economy. Prestigious macroeconomists such as Robert Hall have found that fiscal policy has an effect as well. Maybe the market monetarists and the Keynesians are both a little bit right and a little bit wrong.

Of course Hall found that fiscal policy can affect the economy.  There are lots of ways that can occur, even within the MM model.  Sharply higher government spending can depress consumption, and make people work harder, as in the early 1940s.  Lots of types of tax cuts can shift the AS curve.  If the central bank is targeting inflation then lower VATs or employer-side payroll taxes will cause the central bank to boost AD.  Then there is fiscal policy in scenarios with no monetary offset (fixed exchange rates, members of the euro, etc.)

Unfortunately a reader of this Bloomberg column would learn essentially nothing about market monetarism.  But I’m less pessimistic than Smith.  In the 1960s most economists believed that fiscal policymakers could and should try to do stabilization policy, even when interest rates are positive.  By 2007 Milton Friedman had convinced the profession (including Krugman) that the Fed should steer the nominal economy when rates are positive.  Now we just have to convince the profession that they should also do so at zero rates. And that’s what I’m trying to do.

HT  Saturos, Travis

 


Tags:

 
 
 

54 Responses to “Noah Smith gets market monetarism wrong”

  1. Gravatar of Bryan L Bryan L
    7. February 2015 at 17:01

    Scott, the sort of people reading Noah’s Bloomberg piece to actually become informed about market monetarism will find this blog post as incomprehensible and meaningless as they undoubtedly found Noah’s piece. What they got from Noah’s piece is, “Here’s this new trend in macroeconomic thinking, it has something to do with this thing called Nominal Gross Domestic Product, and they think the mainstream is wrong, but the mainstream isn’t convinced yet.” All this is true. The details are irrelevant to that core message.

    Of course, you still have to point this stuff out on your blog–but there’s no such thing as bad publicity….

  2. Gravatar of ChargerCarl ChargerCarl
    7. February 2015 at 17:13

    Actually using Nick Rowe’s definition of a recession (a state in which its easier to buy output for money than it is to sell it), I’d argue Market Monetarism does aim to fight all recessions.

    And even using the normal definition I think this would be the practical case for almost all industrialized economies. Australia comes to mind.

  3. Gravatar of ChargerCarl ChargerCarl
    7. February 2015 at 17:14

    This is the post I was thinking of:

    http://worthwhile.typepad.com/worthwhile_canadian_initi/2011/08/recessions-are-always-and-everywhere-a-monetary-phenomena.html

  4. Gravatar of ssumner ssumner
    7. February 2015 at 17:22

    Bryan, You said:

    “there’s no such thing as bad publicity….”

    But there such a thing as bad posts.

    Chargercarl, You said:

    “I’d argue Market Monetarism does aim to fight all recessions.”

    Nick Rowe would presumably consider 1980 a recession year in the US, but I don’t think the Fed should have been fighting it, even if the Fed caused it.

  5. Gravatar of Britonomist Britonomist
    7. February 2015 at 17:28

    “I do believe what almost all respectable economists believed in 2007, that central banks can and should target nominal aggregates like inflation or NGDP. I still believe that. Why so many other economists have changed their minds is an interesting question that Smith doesn’t address.”

    Because it’s the wrong question, Keynesians don’t disagree about whether they should, but whether they could (under current conditions).

  6. Gravatar of Negation of Ideology Negation of Ideology
    7. February 2015 at 17:38

    I think there’s a tendency of some people to want to split the difference when there are differences of opinion, as in Noah Smith’s remark –

    “Maybe the market monetarists and the Keynesians are both a little bit right and a little bit wrong.”

    We see that with the many commenters on this blog advising Market Monetarists to compromise and be “reasonable”, and add a dollop of fiscal policy to sweeten our NGDPLT, as if blogging is the same thing as getting a bill through a subcommittee.

    Either monetary offset is true or it’s false. Either monetary policy is necessary and sufficient to hit a nominal target or it is not.

    ChargerCarl – Thanks for posting that Nick Rowe link – great read. It reminds me of Irving Fisher’s statement that the business cycle is a “Dance of the Dollar”.

  7. Gravatar of JLK JLK
    7. February 2015 at 19:59

    In the boundedly rational world of public finance, state and local funding is definitely affected by federal spending. My guess is that fund accounting rules are much easier to apply when large federal -to-state funding is available.
    I haven’t worked through the implications, and I am cognizant that money as delivered by the central bank is different by category than federal transfers delivered to states through programs. But wouldn’t people in a local community react with caution and apprehension (and lower V) when they know state funds will likely be tighter, and the local school/road/bridge improvement project might be delayed until the state Capitol can figure it out?

  8. Gravatar of ssumner ssumner
    7. February 2015 at 20:07

    Britonomist, I don’t think you read the passage you quoted very carefully. Read it again. I said “can.”

    Negation. I’m already the sensible moderate:

    1. I believe both supply and demand-side factors matter quite a bit right now, unlike the Krugmans and Mulligans of the world.

    2. I believe QE does some good, but won’t lead to high inflation, unlike the extreme Keynesians and the extreme Austrians.

    JLK, I certainly agree. If the Federal government spends an extra $100 on aid to the states, then S&L spending may also rise.

  9. Gravatar of Major.Freedom Major.Freedom
    7. February 2015 at 20:47

    NGDP is a poor metric because it includes government spending.

  10. Gravatar of Ray Lopez Ray Lopez
    7. February 2015 at 22:00

    I agree with MF–NGDP indeed includes government spending, which is waste, hence not a good metric.

    Further, Lucas won his Nobel Prize positing money is neutral–rational expectations, ergo, MM does not work–and though you can argue that the evidence during good times does not support Lucas, and money shocks (either foreseen or unforeseen) matter, the fact is during bad times, as now, MM does not seem to work. Hence Sumner advocates a radical new theory to print money during the zero lower bound. Will it work? Perhaps, but people are risk adverse. Do this thought experiment: if I can give every human 100 more years of life in their present bodily condition, but there’s a 10% chance that this will kill you immediately, how many people would take that bet? Not many.

    Sumner wants to play with the money supply to test his theories. I think they will amount to nothing, but, I also think it’s a back-door way of creating hyper-inflation. Sumner’s actual models are non-existent or vague–he should get Duda to fund a short cartoon demo he can place on Youtube, to win popular support. Sumner’s NGDPLT is dangerous experimentation of the kind Edmund Burke would disapprove. Do you feel lucky, punk? Most sane people don’t want to test whether there’s an extra bullet in the .357 Magnum.

  11. Gravatar of Ben J Ben J
    7. February 2015 at 23:19

    Ray,

    Do you have bleeding on the brain or something? I recommend you see a neurologist, you are babbling wildly…

  12. Gravatar of bill woolsey bill woolsey
    8. February 2015 at 04:07

    Using real GDP as a measure of welfare is problematic. Using nominal GDP to measure welfare is worse. It is definitely false that more nominal GDP is always better.

    If expenditure on private output were kept on a stable growth path, then total expenditure would change dollar for dollar with government spending on resources and goods and services. More government spending would lead to inflation certainly. Real private expenditure and output would fall as resources are pulled away from the private sector to the public sector.

    Similarly, if government spending on output and resources were to fall, there would be deflation and recession.

    The simple macroeconomics of public finance where lower government spending does reduce the demand for goods and resources, but the lower taxes increases private disposable income, which raises the demand for goods and resources, would not work. The monetary authority would keep spending on private goods and services from rising. Only has prices and wages fell, would real spending increase and private output expand.

    The point that government goods and services cannot be assumed to be more valuable that the private goods and services sacrificed with the public sector expands is not a point against stabilizing total spending including government.

    If the quantity of money grows at a constant rate, and velocity were constant, then nominal GDP would grow at a constant rate. An increase in taxes and government spending would not lower nominal GDP. It would just continue growing on its past path. If the new government programs were wasteful (or at least worth less than the private goods the taxpayers sacrificed) then welfare would be lower. Nominal GDP would not reflect that at all. Real GDP would not fall due to the loss in welfare either. Trying to make real GDP fall, particularly by having the private sector shrink, would add insult to injury.

    Now, if someone wants to try to measure the value of the government output rather than just use the value of the private goods sacrificed, then maybe that would be a better measure of welfare than real GDP. Fine. It has nothing to do with the benefits of targeting nominal GDP.

  13. Gravatar of Michael Byrnes Michael Byrnes
    8. February 2015 at 05:07

    Why is it that I believe that Scott Sumner is far more familiar with the work of Lucas (and its implications) than Ray Lopez?

  14. Gravatar of Benjamin Cole Benjamin Cole
    8. February 2015 at 05:24

    Michael Byrnes:

    Oh, you feel lucky too, punk? Go ahead on bet on Scott Sumner.

  15. Gravatar of Benjamin Cole Benjamin Cole
    8. February 2015 at 06:20

    BTW, see this from latest job report:

    The participation rate, which indicates the share of working-age people in the labor force, increased to 62.9 percent from 62.7 percent in December.

    So we have three good—not even great, just good—months of employment growth in the USA, and LFPR starts climbing again.

    Yes, it is only one month.

    Yes, we should reduce unemployment comp., VA and SSDA disability.

    But, Heaven’s to Murgatroy, just pour it on, and run the money presses red-hot for a few moons.

    The naysayers insist the LFPR has to go down, demographics etc. I bet robust aggregate demand can make LFPR rates go up. Even so-so demand is making it go back up.

    Anyway, do we believe in supply and demand or not? If wages rise, that will draw more labor into the market.

  16. Gravatar of Market Fiscalist Market Fiscalist
    8. February 2015 at 07:32

    You’re argument seems to be:

    “since NGDP can be made to hit any target purely via the mechanism of CB asset swaps (monetary policy) no matter what the size of the govt deficit (fiscal policy), then it follows that the effects of fiscal policy must all be secondary”

    Is that correct ?

    But couldn’t a fiscalist respond:

    “Even without any monetary policy (the CB never changes the size of monetary base via asset swaps) NGDP can be made to hit any target purely via the mechanism of govt deficits. Monetary policy may or not work but it really doesn’t matter much since it is never needed.”

  17. Gravatar of Nick Rowe Nick Rowe
    8. February 2015 at 08:01

    Market Fiscalist: a fiscalist could respond like that, but there are two problems:

    1. If (say) MB is constant, but you want NGDP growing, this would might require an ever-increasing debt/GDP ratio, and eventual insolvency. (Or eventual communism, with the debt/GDP ratio maxxed out on the negative side.)

    2. You would build more/less schools when the economy needs more/less NGDP, and not when there are more/less kids being born. (Or you would need fluctuations in marginal tax rates which cause bigger distortions than smooth marginal tax rates.)

  18. Gravatar of Market Fiscalist Market Fiscalist
    8. February 2015 at 08:18

    Nick,

    For #2: You choose what level of public spending you want then you vary the deficit (probably via tax adjustments) needed to hit the NGDP target. Even if you want zero public spending you can have a tax/subsidy policy whose sole role is to adjust the money supply.

    For #1: Couldn’t you have a model where the deficits needed to hit the NGDP target would be newly created money(ie not bond funded)? In any case the level of deficits/surpluses needed to hit the target should balance out across the business cycle shouldn’t they, with a bit of wiggle room if you target positive inflation ?

    BTW: Despite my monika I have (mostly) come round to favor monetary policy – but I still can’t see why pure fiscalism wouldn’t work).

  19. Gravatar of Ray Lopez Ray Lopez
    8. February 2015 at 09:27

    @Michael Byrnes – Sumner may have read the works of Lucas, and read the works of monetarists, but I, like Reagan with Marx’s works, have not read them but have understood them. One book I’m reading now: Richard H. Timberlake, “Monetary Policy in the United States”. The chapters dealing with how the USA repriced the dollar from 1865-1870 to bring it back to its pre-Civil War level is remarkable. The same thing happened to a degree after WWI in the USA (see J. Grant’s The Forgotten Depression 1921). And in the 19th C USA, without a central bank (though in the post-Civil War era there was a so-called “Independent Treasury”). Real GDP growth in the US 19th century was about the same as in the post-WWII era, and there was beneficial deflation, not harmful inflation. Bottom line: we don’t need no stinking Fed. It just is a make-work institution for economists, hence Sumner et al talking their book. Rent seeking by economists masquerading as do-gooders bent on saving the world.

  20. Gravatar of Nick Rowe Nick Rowe
    8. February 2015 at 10:20

    Market Fiscalist:

    On #1: if the fixed MB growth rate were less than the target NGDP growth rate, V would need to rise without limit, so the rate of interest would need to rise without limit, so the deficit/GDP or debt/GDP ratio would need to rise without limit.

    On your modified #2: sure, you could do that, but marginal tax rates would still be fluctuating a lot to get the required growth rate in MB.

    (Don’t change your nom de plume, even if it is now misleading!)

  21. Gravatar of Britonomist Britonomist
    8. February 2015 at 10:24

    “Britonomist, I don’t think you read the passage you quoted very carefully. Read it again. I said “can.””

    The point is, you seem to constantly use what economists thought prior to 2007 regarding inflation targeting as strong evidence that the idea the central bank can target any nominal aggregate they like under present conditions is uncontroversial, but it’s not compelling evidence because the conditions then compared to the recent recession are so different.

    You act as if economists suddenly changed their mind, but what really happened is the conditions changed so that their models became less applicable during the recession.

    I agree that a strongly pro-active central bank, that acted far quicker, cut rates far sooner and greater than expectations, and didn’t wait a bit like Bernanke did, could have potentially diverted such a deep recession, as is what happened in Canada to an extent. However, once the central bank has failed to do this, and we’re in the deep end, conditions change; setting interest rates to zero became too little too late, and the only remaining ‘expansionary’ policy becomes QE, of which there is considerable controversy regarding how much it can actually move AD.

  22. Gravatar of ssumner ssumner
    8. February 2015 at 10:58

    Ray, You said:

    “Further, Lucas won his Nobel Prize positing money is neutral”

    Is there any statement so idiotic that you won’t make it? I guess eventually we’ll find out. Lucas says he basically accepts Friedman and Schwartz’s Monetary History, in which money is far from being neutral.

    And yes, you and MF are right that NGDP is a poor measure of welfare. So what does that have to do with NGDPLT?

    Bill, Your final sentence is the key point.

    Michael. Maybe because I took several courses from him? Or perhaps because he was my PhD adviser? Or maybe because I read his academic work on money? But then my credentials certainly cannot compare to Mr. 120.

    Fiscalist, If a Keynesian responded that way they’d be wrong. Fiscal policy cannot hit a 5% NGDP target for very long. It cannot push interest rates high enough to get the needed velocity growth.

    Britonomist, You said:

    “You act as if economists suddenly changed their mind, but what really happened is the conditions changed so that their models became less applicable during the recession.”

    Keynesians have not provide a shred of empirical evidence that monetary policy is ineffective at the zero bound. Even Bernanke says they could have done more. Call me back when a central bank runs out of ammo.

    Even worse, the ECB was not at the zero bound from 2008-12, and the Keynesians were talking like it was!

  23. Gravatar of ssumner ssumner
    8. February 2015 at 11:01

    Britonomist, And one other point. You are wrong in saying central banks needed to cut rates much more and much quicker. Not true. They needed a much more expansionary monetary policy, which might or might not have involved lower rates.

  24. Gravatar of Ray Lopez Ray Lopez
    8. February 2015 at 12:42

    @Sumner – my shhe is sourced, I don’t just pull it out of my ash like some people…

    From John Cassidy’s ‘How Markets Fail’:

    “One of Lucas’s predictions was that anticipated changes in monetary policy wouldn’t have any impact on output or employment. Another way of putting this is to say that money is “neutral”””it doesn’t affect real variables, only financial variables, such as inflation” “If the Fed announces that it is going to expand the money supply, or cut interest rates, to boost growth, workers and businesses will be able to predict the results of this increase, Lucas said, and their responses will exactly offset the policy change. The only way for the Fed to affect job creation and growth is by varying the money supply, or changing interest rates, in ways that people weren’t anticipating. This ‘policy ineffectiveness proposition'””a phrase coined by Thomas Sargent and Neil Wallace, two of Lucas’s followers””turned on its head the Keynesian paradigm, in which the government stabilizes the economy by altering monetary and fiscal policy. Another of Lucas’s followers, Robert Barro, now at Harvard, purported to show that changes in taxes, a favored Keynesian tactic, wouldn’t be any more effective than changes in the money supply. If the government cuts taxes to stimulate spending, consumers will assume that taxes are destined to go back up later, and they will save extra to pay for them, thus negating the impact of the policy change. Even by the standards of Chicago economics, these were controversial arguments, which took Friedman’s skepticism about the usefulness of fine-tuning to its logical (or illogical) extreme. According to the rational expectations theorists, the government was either powerless or a source of trouble. Insofar as it behaved in a predictable manner, its policies wouldn’t make any difference. Insofar as it adapted to this reality by continually surprising the markets, it would destabilize the economy. …
    When I interviewed Lucas in 1996, he was engagingly modest about his achievements, perhaps because he could afford to be. (The preceding year, he had visited Stockholm to pick up his Nobel.) “I write down a bunch of equations, and I say this equation has to do with people’s preferences and this equation is a description of the technology,” he said. “But that doesn’t make it so. Maybe I’m right, maybe I’m wrong. That has to be a matter of evidence.” As it happens, the evidence hasn’t been kind to the rational expectations theory. There is now an overwhelming body of statistical evidence that anticipated changes in monetary policy do affect unemployment and output. Unanticipated policy changes also have an impact, but their role is a lesser one [NOTE THE NEXT SENTENCE GOES TO THE THEME OF ‘LESSER ONE’–RL]. Even Lucas himself has accepted this point. “Monetary shocks just aren’t that important: that’s the view I’ve been driven to,” he told me. “There’s no question, that’s a retreat in my views.”
    Academic studies are one thing, but the rational expectations approach was also subjected to a fascinating real-world test. Between 1979 and 1982, Paul Volcker, the then Fed chairman, made clear his intention to wring inflation out of the system by restricting the growth of the money supply, which is just what Friedman and other Chicago economists had advocated. If workers and firms had formed rational expectations along the lines Lucas suggested, they would have anticipated a big drop in inflation and reduced their wage demands, allowing the economy to jump to a new low-inflation equilibrium, without much of a change in output or unemployment. Instead, the economy plunged into a deep recession, which is precisely what happens in mainstream Keynesian models when the money supply is drastically reduced. Short-term interest rates jumped from 10 percent to 19 percent. The unemployment rate rose to 9.5 percent””which was then its highest level since the Great Depression.”

    from “How Markets Fail: The Logic of Economic Calamities” By John Cassidy (a journalist but he studied economics in business school, and who btw is friendly to monetarists and Keynesians of all stripes. I don’t agree with his book, but I cite it to show I was right and Sumner was wrong for the Lucas passage)

  25. Gravatar of Market Fiscalist Market Fiscalist
    8. February 2015 at 13:20

    ‘Fiscal policy cannot hit a 5% NGDP target for very long. It cannot push interest rates high enough to get the needed velocity growth.’

    Suppose you fund the deficit with newly create money ? What is the difference between creating money that way and creating it via buying assets ? I don’t see why this wouldn’t allow you to consistently hit an NGDP target.

  26. Gravatar of Don Geddis Don Geddis
    8. February 2015 at 13:58

    @Market Fiscalist: “Suppose you fund the deficit with newly create money?” But then you’re no longer keeping the monetary base constant, which was your original hypothetical. Recall what you first wrote: “Even without any monetary policy (the CB never changes the size of monetary base via asset swaps) NGDP can be made to hit any target purely via the mechanism of govt deficits” Using “newly created money” is no longer “pure deficits”. You’re taking an action which combines monetary and fiscal policy. You wind up hitting the NGDP target because of the monetary action that you take, not because of the deficits.

  27. Gravatar of Nick Rowe Nick Rowe
    8. February 2015 at 14:30

    Off-topic: without actually mentioning NGDP, Simon Wren-Lewis has an excellent thought-experiment attacking Divine Coincidence and the failure of IT, and why NGDPLT would be better.
    http://mainlymacro.blogspot.ca/2015/02/the-divine-coincidence-in-parallel.html

  28. Gravatar of William William
    8. February 2015 at 14:34

    “”””
    “Further, Lucas won his Nobel Prize positing money is neutral”

    Is there any statement so idiotic that you won’t make it? I guess eventually we’ll find out. Lucas says he basically accepts Friedman and Schwartz’s Monetary History, in which money is far from being neutral.
    “””

    As someone who respects you very much and was convinced long ago by your NGDPLT proposal, may I recommend that you just refrain from responding to Ray Lopez in the future? Ray’s statement about Lucas is far from idiotic; I think it’s actually pretty accurate, but regardless of whether it’s a good summary of Lucas or not, I think your time and energy would be better spent elsewhere.

  29. Gravatar of Market Fiscalist Market Fiscalist
    8. February 2015 at 14:52

    @Don Geddis

    I was distinguishing , apparently not very clearly 🙂 , between money creation by CB assets swaps and money creation via fiscal deficits.

    I know that fiscal policy is normally done via debt-financed deficits – but there is no economic reason why this has to be the case is there ?

    I was envisaging monetary policy and fiscal policy as two alternative ways of changing the money supply to hit an NGDP target.

  30. Gravatar of Don Geddis Don Geddis
    8. February 2015 at 17:35

    @Market Fiscalist: Yes, of course it’s possible in theory to combine fiscal spending with money creation. You obviously think it matters exactly how the monetary base is changed. I would suggest that the Market Monetarist perspective is that any change in the monetary base (+ expectations of the future path of the MB) has some given macro effects, regardless of the exact way that MB change is implemented.

    But at least in the context of this blog, it is highly misleading for you to talk about an alternative of “pure deficits” or “pure fiscal policy”. That is generally understood here to mean no change in the monetary base.

    Certainly, when the Keynesians were arguing for a massive fiscal stimulus bill in 2008, they weren’t talking about any money creation. Meanwhile, if you want to consider actions that combine fiscal spending with money creation, you may consider that “fiscal policy”, but MMs will probably say that you’re doing joint monetary and fiscal policy, and the fiscal spending part of it is essentially irrelevant. All the NGDP effects come from the changes in the MB, which MMs prefer to label as “monetary policy”.

  31. Gravatar of Market Fiscalist Market Fiscalist
    8. February 2015 at 18:32

    Don,

    ‘But at least in the context of this blog, it is highly misleading for you to talk about an alternative of “pure deficits” or “pure fiscal policy”. That is generally understood here to mean no change in the monetary base.’

    Fair enough – if Scott limits his definition of fiscal policy to just debt-financed deficit spending with no change in the base then I agree with what he is saying in this post.

    But his article talks about Keynesian models – and some Keynesian models include the possibility of money creation via deficit spending – so he needs to be clearer what he is critiquing in that case.

  32. Gravatar of Britonomist Britonomist
    8. February 2015 at 18:36

    @Don

    Actually I think critics (not necessarily all Keynesian) don’t care so much about base money as they do broad money, it’s broad money that matters for AD, and that increasing base money doesn’t necessarily translate to increasing broad money unless consumers can actually access it. In that case, fiscal transfers accompanied by increased base money to finance it might be essential rather than irrelevant to increase the broad money supply and hence AD, while increasing base money alone or even expectations of more base money will induce little economic activity that will lead to an increase in broad money.

  33. Gravatar of Ray Lopez Ray Lopez
    8. February 2015 at 20:54

    @William – clearly you don’t follow this blog, as Sumner has said he enjoys reading and responding to my posts. I’m about the only one here who’s not brainwashed as you are.

    There is a way however to square Sumner’s circle. First, Cassidy is a journalist, not an economist, so when he says: “One of Lucas’s predictions was that anticipated changes in monetary policy wouldn’t have any impact on output or employment. Another way of putting this is to say that money is “neutral”””it doesn’t affect real variables, only financial variables, such as inflation”, you could he misrepresents Lucas on money neutrality.

    Specifically, as a monetarist you can say ‘inflation’ is in fact a ‘real’ variable of sorts, and money is NOT neutral if you change inflation, since, due to ‘money illusion’, you can restart AD/AS (the entire point behind monetarism / Keynesianism). This fallacy of thought is exactly why Sumner and other inflationists (including Phillips, Keynes, pretty much all modern economists) think ‘a little inflation is good’. What they do is confuse a natural recovery from the Great Depression (world wide, with radically different economies and policies) with the idea that more inflation had something to do with it, due to, as I say, the hypothesis (not proven) of money illusion. You’re welcome.

  34. Gravatar of Britonomist Britonomist
    8. February 2015 at 21:03

    Ray, you’re just utterly wrong, read some Eichengreen for a start.

    Each country only recovered from the great depression when they devalued or abandoned the gold standard, much like how the Euro is a straitjacket on recovery in the Eurozone, pegging currencies to gold was also a straitjacket. No natural recovery can occur when, for instance, maintaining the gold standard was causing the UK’s interest rates to be intolerably high, debt unserviceable and forcing fiscal and monetary policy to be so deeply contractionary.

    https://fabiusmaximus.files.wordpress.com/2009/03/gold.png

  35. Gravatar of Don Geddis Don Geddis
    8. February 2015 at 21:24

    @Britonomist: Let me suggest that we’re talking about three different macro theories.

    The Market Monetarists say: give us control over the monetary base, and we can hit any nominal target. It doesn’t matter what we buy with the new money (OMOs, new government spending).

    The Keynesians say: We’re unsure if the central bank “swapping assets” has much macro effect at the Zero Lower Bound, so in that case we recommend massive fiscal stimulus.

    Britonomist and Market Fiscalist say: maybe we could get positive macro effects via fiscal spending paid for with new money.

    I would guess that MMs would respond to you two with: sure, that could work (because of the new money). And Keynesians would respond with: sure, that could work (because of the new spending).

    I suppose you could thus think of it as a political compromise. But it may be somewhat incoherent from a theoretical economics perspective. Whether it works or not, you don’t have a solid understanding of what the real transmission mechanism is.

  36. Gravatar of Ray Lopez Ray Lopez
    8. February 2015 at 23:11

    @Britonomist–seems Don G is getting the better of you in your debate with him, he is schooling you. As for Eichengreen, I’ve read all his works, and have pre-ordered his latest book (no doubt a rehash of his other work). You are completely wrong about gold, since it was manipulated (sterilized) by central banks, especially after 1913 with the Fed, and anyway even countries who did not go off the gold standard until much later, ended up recovering before they went off gold. The only two countries that immediately recovered after going off the gold standard were the UK and the US, and these two countries Eichengreen harps on. Finally, the Panic of 1837 and the Depression after WWI were in some respects as severe as the Great Depression (if not more severe), yet with a gold or quasi-gold standard (respectively) the USA recovered nicely. You’re welcome.

  37. Gravatar of TallDave TallDave
    8. February 2015 at 23:32

    Sharply higher government spending can depress consumption, and make people work harder, as in the early 1940s.

    Keynesians generally elide the fact that living standards fell in the U.S. as a result of WW II despite rising GDP. It’s almost as bad as the Austrian goldbugs who bandy about graphs showing the dollar has lost 99% of its value, as though that were meaningful to living standards.

    MF: Suppose you fund the deficit with newly create money ? What is the difference between creating money that way and creating it via buying assets ? I don’t see why this wouldn’t allow you to consistently hit an NGDP target.

    Well, if you did that, the Fed wouldn’t have assets. That would affect expectations, and the precedent would further unanchor expectations. It seems a bit like loading your mousetrap with a stick of dynamite: it may get results, but you may not like them 🙂

  38. Gravatar of Doug M Doug M
    8. February 2015 at 23:54

    “If you are going to add S&L spending to Federal spending, then why the hell don’t you add investment too? They both have a multiplier effect. Neither are controlled by fiscal policymakers.”

    Fist, state an local is significantly controlled by federal policy makers. Take, for example, federal government transfers money to the states for highway improvements. This is federal fiscal policy and state and local Government spending. Much of the ARRA (2009 stimulus bill) was distributed in this way. This is the most overt bit of Keynesian stimulus in my lifetime, and it was largely “State and Local” spending.

    Regarding Investment, changes in private investment are the single biggest dynamic in the the business cycle. While I may be 1/4 the size of C in terms of the contribution to spending, it is 6x more volatile. The economy doesn’t slip into recession because of a fluctuation in Consumption. Changes in Investment drive AD.

  39. Gravatar of Charlie Jamieson Charlie Jamieson
    9. February 2015 at 07:18

    ‘If you are going to add S&L spending to Federal spending, then why the hell don’t you add investment too? ‘

    Well, we should.
    We didn’t have austerity, because while the government deficit fell, the private sector’s deficit increased.

  40. Gravatar of Britonomist Britonomist
    9. February 2015 at 08:33

    “But it may be somewhat incoherent from a theoretical economics perspective. Whether it works or not, you don’t have a solid understanding of what the real transmission mechanism is.”

    There is a solid basis. The transmission mechanism for QE is far more controversial than it is for ‘helicopter drops’. It is no problem for theory, in fact it’s easy to model a helicopter drop into a modern NK DSGE than it is to model QE, as the representative agent is more better reflected by the general consumer base than it is by a specific part of the financial sector.

    Plenty of prominent economists don’t have a problem finding a solid theoretical basis.

    http://www.voxeu.org/article/helicopter-money-policy-option
    http://www.voxeu.org/article/combatting-eurozone-deflation-qe-people
    http://kansascityfed.org/publicat/sympos/2012/mw.pdf

  41. Gravatar of ssumner ssumner
    9. February 2015 at 08:41

    Ray, You quoted someone as saying:

    “One of Lucas’s predictions was that anticipated changes in monetary policy wouldn’t have any impact on output or employment. Another way of putting this is to say that money is “neutral”””it doesn’t affect real variables, only financial variables, such as inflation””

    This proves my point. Lucas thought anticipated money was neutral and unanticipated money was non-neutral. The quote you provide is self-refuting.

    Fiscalist, You said:

    “Suppose you fund the deficit with newly create money?”

    But that’s not the claim I was responding to. You said monetary policy could do it on its own.

    Why not just use the money, and drop the fiscal policy.

    Thanks Nick, I’ll take a look.

    William, You said:

    “Ray’s statement about Lucas is far from idiotic; I think it’s actually pretty accurate, but regardless of whether it’s a good summary of Lucas or not, I think your time and energy would be better spent elsewhere.”

    Eventually I’ll get tired of it, but right now it’s kind of fun. Contrary to Ray’s claim, Lucas won his Nobel Prize partly for models showing unanticipated money is non-neutral.

    Ray, You’ve said:

    “@William – clearly you don’t follow this blog, as Sumner has said he enjoys reading and responding to my posts. I’m about the only one here who’s not brainwashed as you are.”

    Don’t you think that’s a tad misleading, given that I’ve said repeatedly that what I enjoy is that they are wrong in such a comical way.

    Doug, You said:

    “First, state an local is significantly controlled by federal policy makers. Take, for example, federal government transfers money to the states for highway improvements. This is federal fiscal policy and state and local Government spending.”

    I don’t follow your point. Are you saying we should count the same spending twice? Once as federal spending (aid to S&Ls) and again as state spending?

    And I think you’ve reversed causation on I. It’s not that changes in investment drive AD, it’s that changes in AD drive investment.

  42. Gravatar of Doug M Doug M
    9. February 2015 at 08:59

    “Are you saying we should count the same spending twice? Once as federal spending (aid to S&Ls) and again as state spending?”

    Money is budgeted by the President, allocated by Congress, transferred to the states and municipalities and spend by at the local level.

    Is this not Fiscal policy?

    When we do our GDP accounting, though this is not federal government spending. This is state and local spending.

    You suggest that changes in state and local be excluded when it comes time to calculate Keynesian multipliers because state and local is not controlled by fiscal policy makers… but it is…

  43. Gravatar of William William
    9. February 2015 at 10:10

    “Lucas won his Nobel Prize partly for models showing unanticipated money is non-neutral.”

    Fair enough. Obviously to gloss over the anticipated/unanticipated distinction is a big omission in a summary of Lucas, but I’m thinking that it makes sense to summarize Lucas that way when you’re tracing the trends in macro thinking in the 20th century.

    The very short story would be that prior to Lucas, everybody thought you could control recessions by taking advantage of people’s mechanical and predictable reactions to changes in their nominal income. Then Lucas came along and convinced economists that money is neutral *unless* you can consistently manage to fool all of the people, all of the time. And that’s hard to do.

    It’s worth noting that Lucas’s Nobel Prize lecture is titled, simply, “Money Neutrality.” Okay, “Money is Neutral” would have been just as short, and Lucas didn’t choose that title, but even so, given the academic context at the time Lucas did his work, I think he is much closer to arguing for general monetary neutrality than for the opposite.

    But yes, I accept that Lucas was far from saying money could never, ever have real effects.

  44. Gravatar of ssumner ssumner
    9. February 2015 at 16:42

    Doug, It most certainly is a part of federal government spending. I believe what you are trying to say is that it’s not a part of government output. That’s true, but irrelevant. Government spending is the appropriate variable for looking at fiscal stimulus and austerity, not output.

    William, You said:

    “Then Lucas came along and convinced economists that money is neutral *unless* you can consistently manage to fool all of the people, all of the time.”

    Friedman had already made that point, Lucas provided the microfoundations.

  45. Gravatar of Charlie Jamieson Charlie Jamieson
    9. February 2015 at 17:22

    Most state and local spending is generated from local and state taxes, or bond offerings.
    They’ve been able to spend more in recent years as the tax base increased; some tax hikes, too.

  46. Gravatar of Ray Lopez Ray Lopez
    9. February 2015 at 20:00

    @Sumner, @ William – Sumner is lying–again–and William is right. From the Cassidy passage I quoted above, I repeat it again. Read it slowly. Lucas has repudiated his theory, which underscores the ephemeral nature of economic theory. And we’re to trust the nation’s money supply to such theories? I think not. – RL

    As it happens, the evidence hasn’t been kind to the rational expectations theory. There is now an overwhelming body of statistical evidence that anticipated changes in monetary policy do affect unemployment and output. Unanticipated policy changes also have an impact, but their role is a lesser one [NOTE THE NEXT SENTENCE GOES TO THE THEME OF ‘LESSER ONE’-RL]. Even Lucas himself has accepted this point. “Monetary shocks just aren’t that important: that’s the view I’ve been driven to,” he told me. “There’s no question, that’s a retreat in my views.”

  47. Gravatar of ssumner ssumner
    10. February 2015 at 09:01

    Ray, Even if he now thought money was non-neutral it would have no bearing on your claim that he won a Nobel Prize for that idea. Just the opposite. In any case, saying its effects are smaller than he used to believe is certainly not saying money is neutral.

  48. Gravatar of Britonomist Britonomist
    10. February 2015 at 09:34

    Sumner, I’ve tried to send a comment a couple of times but it’s not getting through, are you able to check if it has been caught in some sort of filter?

  49. Gravatar of ssumner ssumner
    11. February 2015 at 06:35

    Britonomist, Sorry, I can’t find it in the spam list. Since this section is quiet now, try breaking it into 3 or 4 pieces, and see if they go through that way. If one part doesn’t, we could figure out what the problem is.

  50. Gravatar of Britonomist Britonomist
    11. February 2015 at 09:30

    The problem seems to be caused by a link I had to Simon Wren-Lewis’ blog, is that auto-filtered?

  51. Gravatar of ssumner ssumner
    12. February 2015 at 11:17

    Britonomist, It should not be filtered, but I don’t understand these things very well. I’ve linked to Wren-Lewis in the past.

  52. Gravatar of ThomasH ThomasH
    13. February 2015 at 04:07

    Here is a good example of a “Keynesian” explaining why he dismisses the ability/willingness of a central bank (BOE in this case) to off set “austerity” (spending cuts undertaken to reduce the deficit/debt-to-GDP ratio)

    http://stumblingandmumbling.typepad.com/stumbling_and_mumbling/2015/02/austerity-fear-and-bubblethink.html

    It would be helpful if both “sides” were more explicit about the dispute being over differing assumptions about central bank behavior.

  53. Gravatar of ThomasH ThomasH
    13. February 2015 at 05:04

    “what almost all respectable economists believed in 2007, that central banks can and should target nominal aggregates like inflation or NGDP. I still believe that. Why so many other economists have changed their minds is an interesting question that Smith doesn’t address.”

    I agree. This really ought to be addressed, but it isn’t really a mystery. “Keynesians” think that central banks are quite wedded to using sort term interest rates to influence the economy, what ever the target. When that becomes impossible (with more central banks adopting negative short term interest rates, this may be changing) they are quite reluctant — and face severe political push-back it doing QE in the amounts it would take to meet those targets. The fact that the have been undershooting their inflation targets for years now seems to indicate that this self-imposed limit on QE means that the “Keynesian” view of central bank behavior is not all wrong, although their implicit acceptance of this constraint may in fact reinforce it.

    As for why a model might treat S&L governments different from national governments, it’s a matter of degree. Both “ought” to react to declining real interest rates by increasing spending on activities that have present costs and future benefits, but S&L governments do face borrowing constraints that national governments [that have their own currency, sorry Greece, Spain] do not face.

  54. Gravatar of ssumner ssumner
    13. February 2015 at 07:34

    Thomas, You said:

    “It would be helpful if both “sides” were more explicit about the dispute being over differing assumptions about central bank behavior.”

    Exactly! And right now the MMs do that and the Keynesians (mostly) do not.

    You said:

    “I agree. This really ought to be addressed, but it isn’t really a mystery. “Keynesians” think that central banks are quite wedded to using sort term interest rates to influence the economy, what ever the target.”

    Yes, and how did those foolish central bankers become “wedded” to such a ineffective policy instrument? Perhaps because Keynesian economists recommended they target interest rates.

Leave a Reply