On walking and chewing gum

During and after WWI the world’s central banks went on an orgy of money printing, leading to a hyperexpansion of NGDP in many economies.  This so discredited expansionary monetary policy that the hard money types were put in charge.  After 8 years of stable NGDP growth we went overboard the other way, as NGDP fell in half between 1929 and 1933.  Now the hard money types were completely discredited.  So we started seeing fast growth in NGDP.  Except for a few sweet spots like 1953-63, the growth was mostly too fast, culminating in the Great Inflation of 1966-81.  This so discredited the doves that the hard money types were again put in charge.  Now we had a long sweet spot lasting from 1985 to 2007.  Then the inevitable happened.  Hard money types always worry more about too much inflation than too little, and so when they screwed up they did so in the only way they know how–falling NGDP.

And that’s where we are today.  Ironically the hard money types are currently worried about inflation, even though it could only come about if they screw up so badly that people turn to the inflation-mongers out of desperation.  During the sweet spot of 1985-2007 there was almost no pressure on the Fed from the left, as NGDP growth was just over 5% and fairly stable.  And there was almost no pressure from the right either, because inflation was fairly low and stable.

It would be nice if we had central bankers that understood the dangers of both too much NGDP growth and too little.  Perhaps that’s simply beyond the ability of the human mind.  It would be an amazing feat, on par with walking and chewing gum at the same time.  So far the Australian central bank seems to be about the only major one that has mastered this subtle art.


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14 Responses to “On walking and chewing gum”

  1. Gravatar of marcus nunes marcus nunes
    23. July 2012 at 18:37

    And even in Australia there are those that think the RBA is “blowing Bubbles”. People like Quggin, Bill Mitchell and Steve Keene. One a post Keynesian, another an MMTer and the other a Krugman style Keynesian!

  2. Gravatar of Blair Blair
    23. July 2012 at 20:15

    It’s funny because the RBA Board is one of the most “populist” central bank committees in the world, being weighted to businesspeople at the expense of academics.

    http://www.theaustralian.com.au/national-affairs/business-has-too-much-say-at-rba-warwick-mckibbin/story-fn59niix-1226117058105

  3. Gravatar of Carola Conces Carola Conces
    23. July 2012 at 20:35

    What is meant by “the inevitable”? I haven’t seen much evidence that hard money caused the crisis. Structured finance, and the resulting increase in household leverage, seem more likely culprits, and I don’t see how looser money could have prevented the crisis. If anything, wouldn’t it have exacerbated the housing bubble?

    From 1929-1933, central banks did not simply go overboard with tight money. Rather, the international gold standard prevented many countries from pursuing reflationary policy. Gold was pooling in the US and France, so other countries had to keep rates high to prevent gold outflow. The international monetary system, not a hard money philosophy, made the Great Depression so deep.

  4. Gravatar of Greg Ransom Greg Ransom
    23. July 2012 at 23:02

    Your unsustainable “sweet spot” created a massive discoordination across the structure of the economy & particularly in the financial, transportation and housing sectors — producing an unstoppable financial crisis & economic crash.

    Fairy tales about “sweet spots” are not science.

  5. Gravatar of Saturos Saturos
    23. July 2012 at 23:52

    Friedman already identified this boom-bust cycle to monetary policy failure, in “The Role of Monetary Policy”. (Unfortunately he then went to talk about policy as though inflation was the only real concern, writing in the 60’s as he was.)

    “So far the Australian central bank seems to be about the only major one that has mastered this subtle art.”

    Don’t worry, they’ll fail too, as soon as we’re hit by a big enough shock. All the flaws in mainstream economic thought apply just as much to the RBA economists as the Americans.

  6. Gravatar of libertaer libertaer
    24. July 2012 at 00:16

    Professor Sumner,

    isn’t there a strong assymetry between the dangers of too high and too low NGDP? Too low created the great depression and in my country it brought Hitler to power, giving us WWII and the holocaust. Too high created what is now refered to as the golden age of capitalism. (Even for the 70s, if I remember correctly, you yourself said, there was no stagnation! Real problems where not caused by too high NGDP, but by oil prices, bad policy like price controls, unions etc)

    Now, to fight hyperinflation caused by a price-wage-spiral inflation or NGDP expectations should be anchored. But if they are anchored, where is the danger in having 15% or 10% instead 5% NGDP targeting? (For a second, forget taxes, let’s assume we only tax consumption.)

    In short, too low or too high NGDP are problems in relation to an anchor, but the anchor itself can only be too low, not too high. Right? Targeting 2% NGDP = bad, targeting 10% = no problem. Right?

  7. Gravatar of maximillian maximillian
    24. July 2012 at 00:50

    yes i hope the huge looming commodity price shock doesn’t derail the RBA but i’m still fearful…

  8. Gravatar of Saturos Saturos
    24. July 2012 at 00:57

    libertaer, there are shoeleather costs as well, which become severe during hyperinflation, but yes you are right. Any stable, predictable rate of NGDP growth poses no other problem so long as prices, wages, and indexes are fully flexible.

  9. Gravatar of Lorenzo from Oz Lorenzo from Oz
    24. July 2012 at 01:18

    producing an unstoppable financial crisis & economic crash. Except at the Australian border, apparently. And we have some really world-class housing bubbles and highly leveraged households to match.

    Is maintaining a theory against the evidence science? (Such as no correlations between sizes of booms and extent of busts?)

  10. Gravatar of Saturos Saturos
    24. July 2012 at 01:42

    I think he would be receptive to Market Monetarism: http://marginalrevolution.com/marginalrevolution/2012/07/gary-gortons-misunderstanding-financial-crises.html

  11. Gravatar of ssumner ssumner
    24. July 2012 at 02:53

    Marcus and Blair, Interesting.

    Carola, You said;

    “I haven’t seen much evidence that hard money caused the crisis.”

    This blog contains a mountain of evidence that tight money caused the crisis. I’d suggest reading some of my older posts, or articles such as the National Affairs piece (online)

    Greg, No, it did not.

    Saturos. Yes, our heroes always disappoint us in the end.

    libertaer, That’s a bit too strong. I do think excessive NGDP growth will reduce capital formation, and slow the economy in the long run. However the effects will tend to show up gradually. The 1970s aren’t the best example, as inflation wasn’t just high, it was rising. But your generally post is correct, deflation is far worse than moderate inflation.

  12. Gravatar of Mike Sax Mike Sax
    24. July 2012 at 05:45

    “It would be nice if we had central bankers that understood the dangers of both too much NGDP growth and too little. Perhaps that’s simply beyond the ability of the human mind.”

    Empirically that sometimes seems like it is beyond it. Take gun control. What I never get is why the NRA pursues such a scorched earth policy against any regluations on gun ownership-no wating periods, no registry, no cooling off period and no bans on assault weapons or even “cop-killer bullets.”

    They seem to believe in the slippery slope argument-you can’t compromise at all today or tomorrow we will be Sweden where there’s very low gun ownership. It’s as if there are just two equilbrium points and it’s all or nothing. There can’t be a point where we have sensible gun control while still having wide gun ownership.

    Similarly in something I read in the WSJ today where they were upset that Obama is talking about allowing bankruptcy for some student loan borrowers. The guy right away said taht this will take us back to the 70s when everyone could walk away from their student loans and the lenders could barely survive.

    What he seemed to not acknowledge is how the current status quo where many young people leave college under a huge burden of student loans while not even been able to find the kind of jobs their college education was supposed to provide for.

    Now even if you can find a decent job you have to spend teh better part of your earning life just paying back student lenders a situation that is hardly optimum either economicallyn or socially.

    So it’s as if these are the only two equilbirum points with student loans-either the student lenders never get payed or borrowers spend their whole life working just to servcie the student lenders.

    We see similar choices between equally unattractive bad equilibriums in the euro crisis as well.

  13. Gravatar of Major_Freedom Major_Freedom
    24. July 2012 at 07:17

    Carola:

    “I haven’t seen much evidence that hard money caused the crisis.”

    This blog contains a mountain of evidence that tight money caused the crisis. I’d suggest reading some of my older posts, or articles such as the National Affairs piece (online)

    By “a mountain of evidence”, Sumner is referring to just one statistic, NGDP. If one statistic, NGDP, is “a mountain of evidence”, then I guess the actual causes for the crisis would consist of evidence the size of the Himalayan mountain range.

  14. Gravatar of Skepticlawyer » Broken by the fix Skepticlawyer » Broken by the fix
    29. July 2012 at 20:01

    […] adjustments necessary to save it. It has been a continuing pattern for central bank policy to respond more to the traumas of the past than the dilemmas of the […]

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