Puritan attitudes toward monetary stimulus

Krugman has criticized people who view depressions as a necessary price to pay for our previous sins of profligate spending and borrowing, or as a way of purging excesses from the system.  I think he is right that this attitude exists, especially (although not exclusively) among those on the right.  I find that this mindset makes it especially hard to argue for monetary stimulus, even compared to fiscal stimulus.

When most people visualize the myriad economic crises that we face, it seems as if we carry an almost unbearable burden on our collective shoulders.  If someone comes along saying that we merely have to debase our currency, and the burden will be magically lifted, the solution seems incommensurate with the problem–it seems to good to be true.  Even fiscal stimulus, often called a politician’s dream, evokes thought of future sacrifice, as we eventually must repay the massive debts we incur.

FDR was probably the only U.S. president to deliberately set out to debase the dollar.  Toward the end of 1933 he joked with his aides that he had used lucky numbers when deciding how much the dollar would be devalued that day.  Even Keynes found this frivolity offensive.  But it worked.  Industrial production rose 57% in just his first 4 months in office, regaining half the ground lost in the previous 44 months.  Prices also rose sharply.  If the recovery had not been aborted in late July by his high wage policy, near complete recovery would have occurred by 1935.

The sober puritan ethic is probably well-suited for all sorts of serious, long term economic problems.  (Social Security reform?)  For an economy facing deflation, however, nothing could be worse.



7 Responses to “Puritan attitudes toward monetary stimulus”

  1. Gravatar of Arare Litus Arare Litus
    27. February 2009 at 15:33

    “and then what?”

    Debasing seems to have good outcomes for short term recovery (conceptually at least, and the empirical evidence appears to clearly support this). But doesn’t debasing the dollar have a negative effect on those who saved and a positive effect on those who over invested in debt? An outcome that punishes prudence – hence the Puritan dislike of the policy. Someone saving for a home is punished, while someone who bought beyond their means is rewarded (or saving for retirement, or X, etc.). In one sense it even feels like fraud – the expectation of monetary value, which informs choice, is changed for “democratic” or utility reasons: as measured in the sort term.

    The question remains open regarding medium term effects – the FDR experiment was aborted and the war provided a shock that washes out any medium term results, but is it not reasonable to expect that after being taught that long term value of money is not meaningful, that savings and debt would reduce and medium term recovery would be slowed when individuals and businesses found it harder to incur debt?

    Repeated use of this policy would reduce the tendency to hit a major recession, due to training people not to save and therefore seriously limiting ability to incur debt, but would not this cure be worse than the illness? Would not overall growth and innovation rates be reduced by limiting debt? I do not know if any empirical evidence exists to estimate the effects, but conceptually it seems that devaluing as a policy would make debt quite difficult to obtain, seriously limiting growth and ability to take prudent risks.

    Once off or limited use punishes those who took hard and prudent choices, and the FDR example doesn’t provide medium term results to accurately judge if things “worked” beyond immediate relief, repeated use does not run into this problem by changing the incentives – but the new incentives do not seem positive (shortened personal and business monetary time horizons).

    There are no free lunches I hear.

  2. Gravatar of Bill Woolsey Bill Woolsey
    28. February 2009 at 05:00

    “Debasing seems to have good outcomes for short term recovery (conceptually at least, and the empirical evidence appears to clearly support this). But doesn’t debasing the dollar have a negative effect on those who saved and a positive effect on those who over invested in debt?”

    The price level depends on both the supply and demand for money. An increase in the demand for money, perhaps due to a loss of confidence, will result in reduced nominal demand for other goods and services. In some sense or other, this “should” result in drops in prices, including nominal incomes like wages, so that the real supply of money rises to meet the demand. Real expenditures then rise to match the productive capacity of the economy. Those who were holding money (because they lack confidence) become so wealthy, that the temptation to consume grows, or pershaps, from this great wealth, they are willing to risk a bit of it on purchases of capital goods. Given a sufficently low level of final goods and resource prices, the real money supply will match any heightened demand and real expenditure will match productive capacity. (Monetary economics 101)

    Now, this is extremely attractive to those who saved by accumulating money balances. And, assuming there is no default, holding debt would be good too. With default, it might help creditors to the degree they grab more wealth from the debtors, less the cost of bankruptcy.

    That is the “benefit” you are seeing.

    Sumner is claiming that if there is an increase in money demand, for whatever reason, then the money supply should rise to meet it. There should be no deflation to clear markets. And so these gains to savers don’t exist.

    Savers should simply be rewarded by nominal (and real) interst.

    I think that your analysis about savers and creditors was based upon assuming that every increase in the money supply raises the price level. But, that is only “cereris paribus,” If the demand for money is rising, then the incease in the money supply prevents deflation–falling prices. The equilibrium price level is higher. The price level is higher than it would have been if the money supply hadn’t increased. But it doesn’t rise relative to past levels.

    I suppose I should note that most of Sumenrs discussions assume maintenace of the current 2% to 3% inflation.

  3. Gravatar of ssumner ssumner
    28. February 2009 at 15:11

    Arare, I have a post today called “clarifications” that may also help answer your question–although I think Bill did a pretty good job already.

  4. Gravatar of Arare Litus Arare Litus
    28. February 2009 at 22:36

    This, and the “clarifications” post, well, clarifies some things: I assumed an inflationary debasement. I will have to do some further thinking on how debasement can occur without inflationary effects. I think my key difficulty is time lag issues – prices can change essentially instantaneously, but various contracts have lags. By targeting one issue, say price deflation, other issues which react on different time scales seem to be problematic.

    Interest rates are set in part by expected inflation – to the extent that the debasement is “advertised” and expected I would assume that prior monetary balances (savings, debts, etc.) could retain value via interest rates (even here, I would think that debasement would have to be phased in, the faster debasement the less increased interest rates can preserve value). If everyone is expecting the change and change occurs somehow such that the “ruler” of money changes without past balances being changed (in terms of value) I see inflation will not destroy debt balances. I would also expect prices and everything else to likewise change (price can change rapidly, and this doesn’t seem a concern). In this scenario, all of past obligations retain former value, and all prices also take the debasement into account. However, wages are somewhat sticky – and I would expect to see inflation effects (i.e. prices go up, wages stay the same, and later increase to match the new reality). To the extent that debt/savings are time locked into contracts at certain rates inflation also will destroy value.

    I have not looked into the effect of debasement rates, and ability of interest to preserve value under debasement at rate X, but I imagine this is a lossy problem – if debasement is timely (i.e. rapid), inflation devaluing former balances occurs even in floating rate contracts. As debasement is spread out over time, reducing inflationary devaluing, the tool becomes increasingly delayed in making changes when wanted.

    Essentially, as I (mis?)understand money I do not see any positive reason to just slowly “change the ruler” by debasing – it doesn’t matter. The only way that it should get any sort of effect is due to lags and asymmetric information, which destroys value of those with delayed information and longer term contracts.

    I will have to think on this more, to see how you can target 2-3% inflation under devaluing the money supply [I’ll read all your posts more carefully to get the big picture and your scheme in sharper focus]. I currently simply do not see how devaluing can be done in a timely manner without causing inflation, to the extent that you can do this it doesn’t seem useful – giving everyone a new ruler to measure the same property (value) with smaller units seems pointless: if we simply took every dollar and magically split it into two dollars how does this change anything?

    Perhaps I am alone in confusion regarding debasement and mechanisms of inflation – could you recommend a good book on this subject?

  5. Gravatar of ssumner ssumner
    1. March 2009 at 18:26

    Arare, You should study the whole “expectations” issue in monetary theory, you might find it helpful. If people had expected 3% inflation, because it had been going on for years, that expectation would be built into loan and wage contracts. if inflation suddenly comes in at 0%, real wages rise causing unemployment, and the real cost of loans rises causing defaults.

    Zero inflation might be best in the long run, but it is hard to suddenly downshift in a recession.

  6. Gravatar of Arare Litus Arare Litus
    1. March 2009 at 23:20

    I will do more reading & thinking on this, in particular the expectations issue.

    I fundamentally believe it is difficult to target one issue/metric as “the” inflation metric, and have other issues change in a simple and correlated manner among different markets without causing undue inflation in the more (relative to the targeted metric) sticky priced markets. In particular, as contracts of all sorts are much sticker than consumable prices, targeting consumable prices seems to be an approach that will inherently lead to difficulties.

    As I see it, the whole reason deflation occurred in the first place is due to a waste of resources due to misallocation, incorrect assumptions/losing bets, shifting productive factors, etc.: i.e. wealth was destroyed. As wealth was destroyed society as a whole has less buying power – and until the system learns how to reallocate resources to efficiently generate wealth again, and it also becomes clear just how much wealth really was destroyed, people will be adverse to spending their money. People literally cannot judge the value of cash to themselves, and the reasonable action of reducing discretionary spending becomes the default (likely slowing down the revealing of risk, losses, finding new wealth generating mechanisms, etc.).

    Given that I believe that a loss underlies the problem, the nature of our economy (a bundle of vastly different markets and contracts, each with different metrics that I would not expect to respond in simple and comparable ways to a given stimulus which targets some subset metrics), and the assumption that people have a well founded and logical reason to be risk adverse, I really do fall into your category of thinking debasing is too good to be true [“If someone comes along saying that we merely have to debase our currency, and the burden will be magically lifted, the solution seems incommensurate with the problem-it seems to good to be true.”].

    Further, and this is a key issue for me, I do not see that debasing can induce a change unless it actually destroys some sort of prior value. To the extent that it causes inflation and wipes out former debts and obligations one can “reboot” the economy, to the extend that it does not change inflation it seems like you are simply redefining what you call a dollar without changing anything real.

    To me the issue is both a moral issue (is it okay to destroy former obligations in order to restart?) as well as an efficiency one (will a stimulus actually help provide information in a manner anywhere near optimal and get the economy working again?).

    I understand your point on expected inflation, and how recession changes it. I seem to disagree that this is the key issue that should be addressed – I see short term deflation as a symptom and treating it (in particular consumable prices) will just mask the underlying disease (slowing a true cure to the lack of knowledge that characterizes recession) and the medicine has bad side effects (impinging on contracts). Underlying things is a lack of information which effects the shortest term prices first – by relieving this pressure I would assume that recovery would actually be slowed, not increased as hoped.

    After reading your “Economics Babel” post** I have to agree, I am not sure what your mental model is [I’m still digesting all your posts] and it seems that my assumptions and beliefs are quite different than yours. I do not understand how you see debasing: you clearly have reasons to think that destruction will not happen and that a positive benefit will occur. I literally do not see the mechanisms that will allow this: I’ll be reading your (and others) work to address this gap I have.

    **This Babel problem seems inherent to philosophical disagreements, many of which seem to come down to difference in sematics and underlying priors. Good evidence that macro is not a science (yet)?

  7. Gravatar of ssumner ssumner
    5. March 2009 at 12:22

    Amare, I’ll try to do a post soon that gives my overall model of macroeconomics.

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