Please, keep finance out of macro

I saw this in the Journal of Economic Perspectives, under recommended reading:

Claudio Borio asks “The Financial Cycle and Macroeconomics: What Have We Learnt?” “The financial crisis that engulfed mature economies in the late 2000s has Learnt?” “The financial crisis that engulfed mature economies in the late 2000s has prompted much soul searching. Economists are now trying hard to incorporate financial factors into standard macroeconomic models. However, the prevailing, in fact almost exclusive, strategy is a conservative one. It is to graft additional so-called financial “frictions” on otherwise  fully well behaved equilibrium macroeconomic models . . . The main thesis is that macroeconomics without the financial cycle is like Hamlet without the Prince. In the environment that has prevailed for at least three decades now, just as in the one that prevailed in the pre-WW2 years, it is simply not possible to understand business fluctuations and their policy challenges without understanding the financial cycle.” Bank of International Setttlements, Working Paper #395, December 2012. At http://www.bis.org/publ/work395.pdf.

First a bit of history.  In the 1920s the standard view among elite macroeconomists was that the business cycle was a “dance of the dollar,” to use Irving Fisher’s metaphor.  Then came the 1930s, and monetary policy got pushed to the sidelines.  This oversight eventually led to a series of mistakes which culminated in the Great Inflation.  Only then was money rediscovered, and AD brought back under control.

I’m begging the economics profession to avoid another long and fruitless detour into non-monetary theories of the business cycle, although even as I type these words I know I will fail.  The average reader will be far more impressed by Brad DeLong’s long and thoughtful post, than this puny post.

There is nothing in the slightest way mysterious about the current recession.  If in 2007 you told the world’s elite macroeconomists what the path of NGDP would look like over the next 6 years, most of them would have predicted a deep recession and slow recovery in the US, and a deep recession, slow recovery, and then double-dip recession in the eurozone.  And that’s exactly what happened.  Adding finance won’t improve that story one iota.

Let me anticipate some objections:

1.  But why did NGDP fall so sharply?  Because a failure of monetary policy.  No one denies that the banking crisis played a role in that failure, but it wasn’t a necessary role.  There is no evidence that central banks lose control of NGDP during a financial crisis.  Look at 1933.  You can make a slightly stronger argument that they lose control at the zero bound (a completely different argument, BTW) but even that is wrong.  There is no case in recorded history of a fiat money central bank trying to inflate and failing.  When Brad DeLong asked Bernanke why not 3% inflation, Bernanke didn’t say; “can’t do it.”  He said it’s a bad idea.  The Fed also thinks NGDPLT is a bad idea.  The idea that the ECB is out of ammo doesn’t even pass the laugh test, as they’ve repeated raised interest rates during the recession, driving eurozone unemployment ever higher.  Elite macroeconomists continue to publish papers that are meaningless if the BoJ is able to sharply depreciate their currency, and yet they’ve just showed that they are capable of sharply depreciating their currency.  That’s not supposed to happen, if you believe that central banks are incapable of debasing their fiat currencies.

2.  “There are lots of structural problems.”  Of course, there always are structural problems, but then why isn’t unemployment in the US much higher than 7.6%?  We have roughly the unemployment rate you’d expect from the demand shock alone.  So unless demand shocks miraculously don’t cause unemployment when you have structural problems, the unemployment rate should be far higher if structural problem were capable of explaining an extra 2.6% unemployment.  (And this skepticism about the importance of structural problems comes from a conservative economist who has argued the extended UI benefits added about 0.5% to 1.0% to the unemployment rate at the peak, not a 100% demand-sider with his head in the sand about supply-side issues.)

Is there really any harm in adding finance, to make the models a bit more realistic?  Damn right there is.  It will cause us to make the exact same mistake we made in late 2008, trying to fix the banking system while ignoring the huge slide in NGDP expectations, until it is too late.  If you don’t correctly diagnose the crisis, how are you going to get effective solutions?

Economists are too blinded by framing effects—it looked like finance was the root cause of the recession.  But debt doesn’t make workers want to work less, it makes them want to consume less.  There is a difference.  We need economists to look through these framing effects, and see that the standard model that demand shocks cause high unemployment worked fine; it’s our policymakers who failed us.

I never thought I’d say this, but macroeconomists just aren’t autistic enough.

And where has the University of Chicago been?  Who is carrying on the tradition of Milton Friedman?  He taught us to look beyond the financial crises of the 1930s, into the root cause of the Great Depression.  It’s all about M*V.  Do we have to learn that lesson all over again?

In some ways this recent crisis was even more inexcusable, as those poor fools in the 1930s didn’t have a Monetary History of the US telling them what went wrong 8o years earlier.  We did, and still had an excessively tight monetary policy.

Hamlet without the prince?  Sounds kind of interesting, in a post-modern sort of way.  Maybe Gus van Zant could direct.

HT:  Timothy Taylor

PS.  I’ve been asked about the recent Japan debate.  I agree with Nick Rowe:

In other words, I have deliberately set up a case in which Richard Koo would be right (maybe for the wrong reasons, but let that pass). I have deliberately made worst-case assumptions so that the higher interest rates caused by loosening monetary policy creating economic recovery would cause Japan to default on its debt, either literally or via very high inflation.

Does this mean that “Japan cannot afford recovery”?

No. It means that Japan is already dead. It just doesn’t know it yet.

Sure, the Bank of Japan could abandon Abenomics, tighten monetary policy, reduce the inflation target, squash all hopes of recovery, and bring nominal interest rates back down again. But if the past is any guide to the future, this means the debt/NGDP ratio will keep on growing. Because Japan will be scared to tighten fiscal policy in a recession when the Bank of Japan won’t offset that tightening by loosening monetary policy. Which means that recovery, when it does finally come, will cause an even bigger default, because the debt/NGDP ratio will be even bigger.

And recovery will come eventually, one way or another. If not by happenstance, then because there is a limit to the debt/NGDP ratio that the young generation in an OLG economy will be willing to buy from the old.

If Japan is already past the point of no return, then recovery will mean default. But delaying recovery will simply mean an even bigger default.

Now I’m going to cry over spilt milk, and ask: why oh why didn’t they do Abenomics earlier, before the debt/NGDP ratio had grown so big? What was all this talk about “balance sheet recessions”, where monetary policy was impotent to increase Aggregate Demand, so fiscal policy had to be used to prevent AD from falling? And how did we suddenly switch from “monetary policy is impotent” to “monetary policy is very dangerous because it will increase AD which will only cause inflation and higher interest rates which will cause default because loose fiscal policy has made the debt/GDP ratio so big”?

In my view Japan isn’t dead, although I certainly admit it might be.  The real question is why people continue to insist that monetary policy is ineffective at the zero bound, even as Japan shows it is effective.  Nick and I told Japan what to do back in 2009 (and Bernanke even earlier)—why did it take them so long?  And why hasn’t the ECB moved yet?


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52 Responses to “Please, keep finance out of macro”

  1. Gravatar of J Mann J Mann
    11. June 2013 at 05:58

    Ouch. If Rowe’s worst case analysis turns out to be right, then that’s the tipping point on public debt, much more than the Reinhart Rogoff 90%.

    If past a certain level of debt, the central bank is both unable to do monetary stimulus and forced to negate the effect of fiscal stimulus, then at that point, you’re hosed.

  2. Gravatar of marcus nunes marcus nunes
    11. June 2013 at 06:09

    Like in the James Bond movie, with regards to Japan it is “Die another day”.
    And Koo is wrong according to Mark Sadowski who just released Part II of his Koo critique:
    http://thefaintofheart.wordpress.com/2013/06/11/richard-koo-also-misinterprets-japans-lost-decades-part-ii-a-guest-post-by-mark-sadowski/

  3. Gravatar of david david
    11. June 2013 at 07:05

    The escape route for the Japan scenario is for the state fiscal authority to trade all short-term debt for very-long-term debt whilst low nominal rates still hold, and then only let the monetary policy authority play with the rates. Thirty or fifty year bonds should do the trick.

  4. Gravatar of Lars Christensen Lars Christensen
    11. June 2013 at 07:13

    Scott, give the young people at UoC a bit of credit – they are indeed (market) monetarists: http://marketmonetarist.com/2013/04/14/uchicago-monetary-policy-reading-group/

  5. Gravatar of John John
    11. June 2013 at 07:36

    Isn’t the EMH a finance theory that you’ve imported into macro?

  6. Gravatar of Robert Robert
    11. June 2013 at 07:46

    US Federal Government Now the World’s Largest Mortgage Insurer

    Mkt share

    2013 68%
    2007 16%

    #FHA #IMF data

    http://www.lawrencegmcdonald.com/housing-market-fannie-mae/

  7. Gravatar of jknarr jknarr
    11. June 2013 at 07:57

    Great point.

    The profession – academic economists included – are like mideval physicians focussed on bloodletting and humors, but are much more ignorant and destructive.

    Having killed the patient, they now are building witchcraft into their models.

    Why exactly is money causes NGDP causes yield causes finance so unconvincing in these dark ages? Professional burning at the stake?

  8. Gravatar of Robert Robert
    11. June 2013 at 07:59

    Government Spending as a % of GDP: Euro Area vs United States
    https://pbs.twimg.com/media/BMZb7zvCIAAQn-x.jpg:large

  9. Gravatar of 123 123
    11. June 2013 at 08:02

    Finance is a limiting factor. It can make the path NGDP takes along its level target too volatile. But of course, first you have to target NGDPLT, and only then you can take a look at finance.

  10. Gravatar of jknarr jknarr
    11. June 2013 at 08:25

    You don’t like this point of view, Scott, and I will drop it, but let me suggest that:

    The Federal government is now actively and overtly colluding with US industry to keep the citizenry ignorant, indebted, surveiled, and paying high prices:

    Banks, technology, pharma, healthcare, energy, media, autos, journalism, prisons, housing – the list goes on.

    Yet economists – even academic ones – are pure actors thinking only of the public interest? Examine your premises.

  11. Gravatar of JN JN
    11. June 2013 at 08:49

    I’m really not sure to understand this view.

    So, you don’t want NGDP to fall, that’s fine. My guess is that if NGDP does not fall, it will reduce bankruptcies and as a result have less impact on bank’s capital and lending.

    But:
    There will still be losses right? When asset prices (not included in GDP deflator) bubble and then collapse, banks make losses, especially in a fair value accounting system. As a result of those losses, they may well decide to reduce their lending or tighten their underwriting criteria. Less lending may then still brought about a fall in NGDP, even if less sharp than if NGDP had not been supported in the first place.

  12. Gravatar of Don Geddis Don Geddis
    11. June 2013 at 10:13

    @JN: The central bank is capable of targeting any NGDP level they want, regardless of what happens in the banking sector. Even if your scenario is true, and banks reduce lending and thus reduce NGDP, all that means is that the Fed merely needs slightly more monetary infusion in order to stay on target.

  13. Gravatar of Don Geddis Don Geddis
    11. June 2013 at 10:21

    (And before anyone else jumps on my previous comment: “slightly more monetary infusion” assumes a simple model where the Fed’s actions have direct effects. In reality, the indirect expectation channel is more significant, and so merely announcing the target does most of the heavy lifting, regardless of the pressures from the banking sector.)

  14. Gravatar of Doug M Doug M
    11. June 2013 at 10:30

    There is no monetary policy without finance!

  15. Gravatar of Doug M Doug M
    11. June 2013 at 10:34

    “But debt doesn’t make workers want to work less, it makes them want to consume less.”

    No, they WANT to consume at the same level. The unavailability of credit, means that the money that they had been able to borrow to buy the things that they were accustomed to buying ceased to be available.

    This is effectively a tightening of money, but it is a tightening of money that is beyond the influence of the central bank.

  16. Gravatar of ssumner ssumner
    11. June 2013 at 10:59

    J Mann, The tipping point depends on all sorts of things, such as culture, population growth rate, etc.

    Thanks Marcus, I’ll take a look.

    David, Maybe, but wouldn’t that spook the markets?

    Lars, Good point.

    John, I meant finance shocks–I have no problem with abstract finance concepts.

    Robert, Very depressing.

    jknarr, Good analogy.

    Robert, That data is wrong. Perhaps they confused government spending with government output.

    123, Yes, but is it empirically important?

    jknarr, How many economists do you know personally?

    If you were right, and we are that corrupt, wouldn’t the US be poorer than Zimbabwe?

    JN, Check out Don’s reply.

    Doug, I meant given their debt constraints.

  17. Gravatar of Doug M Doug M
    11. June 2013 at 11:22

    “But debt doesn’t make workers want to work less, it makes them want to consume less.”

    “Doug, I meant given their debt constraints.”

    Yes…what is happening to their debt constraint?

    One day millions of families are able to tap their home equity, buy homes with no home equity, and various lines of consumer credit available to them which facility a steam of consumption and investment decisions.

    Then, banks decide that it might not be so wise to continue these lending practices.

    Nothing has changed to the income or debt service burdens to these families, but credit that was available yesterday is not available today. And consumption and investment that might have happened doesn’t happen any more.

    This is a reduction in demand. But, this is a reduction in demand that is coming, not from from the fed, but coming from the financial sector as it reevaluates what is prudent.

    For most of us, it would be painting with too broad a brush to say that this is a symptom of the Fed running too tight a monetary policy.

    When banks fail, it triggers many ripples. Surviving banks tighten their lending practices. Outstanding credit gets called. Revolving credit is shut off. The bank’s existing customers, who may be A rated credits, find themselves shut off from credit as they have do not have relationships with other banks. And depositors find their assets frozen until the the FDIC provides liquidity (for small depositors) and terms of the bankruptcy are determined (for large creditors).

    Systemic financial risk has serious implications for the real economy.

  18. Gravatar of Sumner on Borio | TVHE Sumner on Borio | TVHE
    11. June 2013 at 11:22

    […] A quote via Scott Sumner: […]

  19. Gravatar of OhMy OhMy
    11. June 2013 at 11:22

    ” If in 2007 you told the world’s elite macroeconomists what the path of NGDP would look like over the next 6 years, most of them would have predicted a deep recession and slow recovery in the US, and a deep recession, slow recovery, and then double-dip recession in the eurozone. And that’s exactly what happened. ”

    LOL, really? Apparently nobody asked because there is no record of “elite macroeconomists” making even remotely correct predictions on this at the time. Unless you mean Godley, Baker, MMT-ers? Are they the “elite”?

  20. Gravatar of OhMy OhMy
    11. June 2013 at 11:30

    Btw, people who say banks are crucial are not saying banks caused the crisis in 2008. They say banks created the debt that helped the private sector over leverage and reach the Ponzi stage in the Minsky mechanism.
    Can you explain this graph? : http://www.cainandtable.com/wp-content/uploads/2011/08/t1larg_national_debt_chart.jpg

    Once the Ponzi stage is reached any fall in asset prices (which fluctuate so a fall in inevitable) causes debt deleveraging and a recession with cascading bankruptcies.

    You are just making a huge bet that none of this matters, fingers crossed, because if it does then your brand of macro has nothing to contribute. But it is an article of faith on your part, you have no arguments why the debt deleveraging mechanism didn’t matter, you just *hope* so.

  21. Gravatar of Doug M Doug M
    11. June 2013 at 11:37

    JN,

    “So, you don’t want NGDP to fall, that’s fine. My guess is that if NGDP does not fall, it will reduce bankruptcies and as a result have less impact on bank’s capital and lending.”

    Would it surprise you hear that bankruptcy filings 2007-2009 were consistently lower than 2000-2005?

    This is almost entirely due to legislative changes. However, aside from legislation, consumer bankruptcy has never shown any correlation with the business cycle, unemployment, NDGP or other macro-economic variables.

  22. Gravatar of Doug M Doug M
    11. June 2013 at 11:46

    Oh my,

    “ If in 2007 you told the world’s elite macroeconomists what the path of NGDP would look like over the next 6 years, most of them would have predicted a deep recession and slow recovery in the US, and a deep recession, slow recovery, and then double-dip recession in the eurozone. And that’s exactly what happened. “

    This is a loaded statement that the Professor put out there. If given an chart from the future that showed NGDP contracting 4%, the worlds elite economists would would say “you are joking.”

    And then, if prompted to to take this chart completely seriously, they would have concluded that either there was deflation without a recession, or there was a recession, and a recession was the far more likely scenario.

  23. Gravatar of jknarr jknarr
    11. June 2013 at 11:46

    Scott, yes quite a few. Careerists all, as are the bankers, journalists, doctors, and others. They mostly want rewards, and say the necessary things to gain them.

    It does not take many at the top to set the tone of what is acceptable and what is unacceptable, what with fed and wall street jobs, and krugmans approval, dangled before them.

  24. Gravatar of ssumner ssumner
    11. June 2013 at 12:22

    Doug, Don’t confuse consumption with demand. The decision to consume less and save more doesn’t reduce demand. The Fed controls demand.

    OhMy, I think you better read that again, you completely misunderstood the passage you quoted. I never said elite macroeconomists can predict the business cycle, indeed I’m one of the most radical opponents of that view.

    jknarr, I have met many academic economists, and they are not like the one’s you describe. They tend to be very idealistic.

  25. Gravatar of ssumner ssumner
    11. June 2013 at 12:23

    jknarr, Do you think that Rush Limbaugh and Paul Krugman actually have the same views, and are simply saying the things they say to make money?

  26. Gravatar of Doug M Doug M
    11. June 2013 at 12:34

    “Doug, Don’t confuse consumption with demand. The decision to consume less and save more doesn’t reduce demand. The Fed controls demand.”

    When financial conditions tighten consumers don’t decide do consume less, the decision has been taken from them. They have less ability to consume. They are effectively poorer (despite wages and prices not changing).

    A reduction of credit creates a reduction in both Consumption and Investment.

  27. Gravatar of Don Geddis Don Geddis
    11. June 2013 at 13:38

    @Doug: “credit that was available yesterday is not available today. And consumption and investment that might have happened doesn’t happen any more. […] it would be painting with too broad a brush to say that this is a symptom of the Fed running too tight a monetary policy.

    The Fed is steering a cruise ship across the Atlantic to New York. Yes, of course they can’t predict exactly what the winds will look like on any given day. They have a rough idea that the Gulf Stream will be heading north along the eastern US, but again the day-to-day currents are difficult to predict.

    Still, if they set the tiller at 30 degrees, and then later encountered a surprise storm with unexpected winds and currents, and chose not to change the rudder at all, and wound up missing New York and instead landed in a different port … you’d still say the fault was their steering, wouldn’t you? Even though they weren’t responsible for the storm?

    The Fed could control NGDP if it wanted to. The volatility in NGDP caused the recession and unemployment. Does it really matter that the Fed wasn’t the root cause of the instability? It still had control over the rudder, and could have easily made it to the original port target, simply by changing the tiller setting.

    That’s why the “real” fault was the Fed running too tight a monetary policy (given the conditions it wound up encountering in 2007-2008).

  28. Gravatar of jknarr jknarr
    11. June 2013 at 13:39

    Scott, I think that RL and PK are both very smart guys. I think that they (effectively) have the same employer (hard money establishment). There’s a fiction of debate over trivialities, as long as money remains tight and Federalization proceeds. they both augment the fiction. It’s like world wrestling federation, and just as authentic.

    I think that they began as idealistic, talented, smart true believers and ended up as cynical, talented, wealthy and famous hacks. A long story.

    There is a reason that the Fed is not open to NGDP targeting, and it ain’t ignorance. There’s a reason that there is no accomodation with Krugman, and intellectual acumen or philosophy ain’t the problem. Bad faith is the problem.

  29. Gravatar of Doug M Doug M
    11. June 2013 at 14:45

    Don Geddis,

    To use your cruise ship metaphor….

    “if they set the tiller at 30 degrees, and then later encountered a surprise storm with unexpected winds and currents, and chose not to change the rudder at all, and wound up missing New York and instead landed in a different port … you’d still say the fault was their steering, wouldn’t you?”

    Do you blame the helmsman if the storm system causes the ship to arrive in port, delayed from schedule?

    Do you blame the helmsman if the passengers got sick?

    Do you agree, that storm systems can put the ship off course for some period of time?

    Would you agree that it is is fallacy to suggest that storm systems are irrelevant to boat piloting?

    That pilots shouldn’t study meteorology?

  30. Gravatar of Please, keep finance out of macro | Fifth Estate Please, keep finance out of macro | Fifth Estate
    11. June 2013 at 15:02

    […] See full story on themoneyillusion.com […]

  31. Gravatar of chris mahoney chris mahoney
    11. June 2013 at 16:09

    Scott,
    I don’t see how one can explain the current low velocity and the high liquidity preference without reference to financial behavior.

  32. Gravatar of Nick Rowe Nick Rowe
    11. June 2013 at 18:57

    “Who is carrying on the tradition of Milton Friedman?”

    That guy in the mirror is making a good try at it.

    My response to this good post: http://worthwhile.typepad.com/worthwhile_canadian_initi/2013/06/did-finance-really-matter.html

  33. Gravatar of JN JN
    12. June 2013 at 01:49

    @Don Geddis
    “all that means is that the Fed merely needs slightly more monetary infusion in order to stay on target.”

    And how does the Fed inject more money into the system if banks are unwilling to lend it out (or customers unwilling to borrow)?
    It would directly inject the money into the population’s bank accounts, I would understand. Not when the banking system is an intermediary which decides how much reserves it wishes to maintain.

    @Doug M
    “This is almost entirely due to legislative changes. However, aside from legislation, consumer bankruptcy has never shown any correlation with the business cycle, unemployment, NDGP or other macro-economic variables.”

    Maybe it depends on your definition of “consumer” and your definition of “bankruptcy”? I personally don’t care much about articifical changes introduced by legislative changes. The trend was clearly upward anyway for personal bankruptcies in the US.
    On the corporate side, it clearly isn’t true:
    http://www.standardandpoors.com/spf/fgr_articles/950343/6751545.gif

  34. Gravatar of Browsing Catharsis – 06.12.13 | Increasing Marginal Utility Browsing Catharsis – 06.12.13 | Increasing Marginal Utility
    12. June 2013 at 04:01

    […] -Scott Sumner, “Please, keep finance out of macro.” […]

  35. Gravatar of 123 123
    12. June 2013 at 05:03

    Scott, yes, it is empirically important, if only for the reason that forecast errors increase when credit problems are present.

  36. Gravatar of Doug M Doug M
    12. June 2013 at 07:23

    JN,

    I don’t have the a source with the most current data in chart form…

    but this gives a picture.

    http://www.abiworld.org/bkstats/historical.html

    In 2005 there was a legislative change, wich created the spike in ’05 and trough in ’06.

    Regarding the chart that you linked to, corporate bond defaults are more cyclical. But notice that corporate defaults inreased in 1998 and 1999 while the economy was screaming. And defaults in ’98-’99 was faster than defaults in ’11-’12.

  37. Gravatar of ssumner ssumner
    12. June 2013 at 07:52

    Doug, You said;

    “A reduction of credit creates a reduction in both Consumption and Investment.”

    I don’t agree. It reduces some types of consumption and raises other types. If you keep NGDP rising, then C+I will be fine.

    Jknarr, I’m pretty sure you are wrong, I think Krugman supports easier money.

    Chris, But V doesn’t matter, it’s M*V that matters. In any case, I think you can explain V without recourse to finance. Velocity falls when rates are near zero. As Milton Friedman pointed out, rates fall close to zero because of tight money.

    Nick, Good post.

    123, That doesn’t make it empirically important, you’d need a different argument. That just suggests that there is some effect.

  38. Gravatar of JN JN
    12. June 2013 at 08:01

    @Doug M

    Yes, I had already seen this equivalent chart:
    http://www.zerohedge.com/sites/default/files/images/user5/imageroot/hildebrand/US%20Bankruptcy.jpg

    Legislative changes made to hide a growing reality are irrelevant to me to be honest.

    And true, corporate defaults start increasing before the peak of the cycle. But losses remain subdued at this time. It’s when enough of those losses accumulate that banks suffer and a crisis strike.
    Pretty much like the real estate crisis in the US. Prices started to fall in 2006, but we started to see losses kick in only by end-2007.

  39. Gravatar of Don Geddis Don Geddis
    12. June 2013 at 11:25

    JN: “And how does the Fed inject more money into the system if banks are unwilling to lend it out (or customers unwilling to borrow)?

    Surely the Fed can simply start purchasing assets (e.g. Treasuries via OMOs). What does it matter what kind of lending banks are willing to do? Buying assets puts currency directly in the hands of end consumers. (And Sumner often says: in the limit, just buy up all of planet Earth. Surely inflation will happen, some time before you run out of available things to purchase.)

  40. Gravatar of jknarr jknarr
    12. June 2013 at 12:01

    Scott,

    Krugman believes in a liquidity trap, so he cannot believe in easier money.

    He believes in expansive fiscal policy, which, in his mind, replaces easier monetary policy (as well as supporting his use of fiscal tax-and-spend powers to advance his “Conscience of a Liberal” social views and goals — which is pure coincidence, of course.)

    Because he thinks that monetary policy cannot be effective, he is de facto in favor of existing policy. Current monetary policy is now indisputably tight at a 2% 10 year bond and 3.2% nominal GDP growth.

    Ergo, (wonkish) Krugman is hard-money. I’m sure he would protest and say otherwise, but I look at results, not verbiage.

  41. Gravatar of TallDave TallDave
    12. June 2013 at 12:09

    And how did we suddenly switch from “monetary policy is impotent” to “monetary policy is very dangerous because it will increase AD which will only cause inflation and higher interest rates which will cause default because loose fiscal policy has made the debt/GDP ratio so big”?

    Because some people have strong reasons to argue the former, while others are very worried about the latter, but only we enlightened few are (correctly) concerned about neither.

  42. Gravatar of TallDave TallDave
    12. June 2013 at 12:13

    I must second Scott, excellent post Nick.

  43. Gravatar of 123 123
    12. June 2013 at 21:07

    Scott, the empirical effect is large if you understand monetary policy as interest rates. And that’s why you shouldn’t do it.

  44. Gravatar of Lorenzo from Oz Lorenzo from Oz
    12. June 2013 at 22:39

    DeLong’s post is very thoughtful. But he seems to slide from interest rates “standing for” what influences the opportunity cost of holding money to be the issue for such. Inflation expectations matter, but income expectations not so much, apparently.

  45. Gravatar of JN JN
    13. June 2013 at 01:36

    @Don Geddis

    But by doing OMOs, the Fed injects money mainly through….banks!
    Even if funds sell their treasuries to the Fed, then the money also ends up in banks. Which are unwilling to further lend it out…

  46. Gravatar of dtoh dtoh
    13. June 2013 at 02:11

    Don Geddis, JN,

    OMP is not a helicopter drop. It’s an exchange. An exchange of money for financial assets. Forget the banks. They’re just intermediaries and it will confuse you to think about them. At the other end of the exchange is a willing non-financial counter-party who is handing over financial assets in exchange for money. They’re not doing it because they want to hold more money. (People hold just the amount of money they need for transactions.) They’re doing it because they want to use the money. Why? because they have been induced to exchange financial assets for real goods and services and need the money as an intermediate MOE to purchase those real goods and services. What has induced them to enter into this voluntary exchange? Either a) a higher real price for financial assets and/or b) expectations of higher NGDP.

    It’s very simple!

  47. Gravatar of TheMoneyIllusion » Cardiff Garcia’s taxonomy of demand-siders TheMoneyIllusion » Cardiff Garcia’s taxonomy of demand-siders
    13. June 2013 at 06:44

    […] is fully capable of hitting its targets without the aid of fiscal stimulus, and it can also safely ignore the banking and credit […]

  48. Gravatar of ssumner ssumner
    13. June 2013 at 08:06

    jknarr, You are wrong; Krugman thinks monetary stimulus may not be effective, but supports it anyway.

    123, But monetary policy is not interest rates.

  49. Gravatar of 123 123
    13. June 2013 at 09:04

    Yes, that’s what I wrote too.

  50. Gravatar of jknarr jknarr
    13. June 2013 at 09:13

    Scott, well, you’re the godfather, and I’m just a guy whose learned to work the google on the internet machine. Still, I understand Krugman well and I think I understand you well.

    I find Krugman to be deeply disingenuous in his treatment of monetary policy, almost to the point of bad faith. Of course he has to address it, and have a stance, but his support is ankle-deep.

    Contrast that with the nonsensical webs he weaves about the desirability of fiscal policy. Bottom line, he does great damage to the notion that easier money is feasible and necessary.

    Pointing at Taylor and Feldstein as being worse than himself doesn’t change that fact. He enables status quo tight money policy: http://www.themoneyillusion.com/?p=21668

  51. Gravatar of TheMoneyIllusion » No apology needed TheMoneyIllusion » No apology needed
    22. June 2013 at 09:09

    […] This is a bit puzzling, as I doubt in the entire blogosphere there’s a stronger opponent of mixing monetary policy and credit policy than me.  Just a few days ago I did a post entitled “Please, keep finance out of macro.” […]

  52. Gravatar of The dangers of “financial stability” | TVHE The dangers of “financial stability” | TVHE
    26. June 2013 at 17:06

    […] dangers of focusing on financial stability in such an ill defined way, and one of the reasons why Scott Sumner has pointed out why care must be taken (extra comment […]

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